Chapter 1 — Overview of Accounting for Business Combinations

In December 2007, the FASB completed the second phase of the project, addressing the accounting rules for business combinations that were not reconsidered in the first phase. The second phase ultimately resulted in the issuance of two standards: Statement 141(R) (codified in ASC 805) and Statement 160 (codified in ASC 810-10).

ASC 805 introduces the term “acquisition method of accounting” (or “acquisition method”), which refers to the approach used to account for a business combination. This term was intended to be broader than the former term, “purchase method,” and to align with the revised definition of a business combination, which includes any transaction or event in which an acquirer obtains control of a business, not just a transaction in which a business is purchased.

The underlying premise of ASC 805 is that when an entity obtains control of a business, it becomes accountable for all of its assets and liabilities and therefore should recognize the assets acquired and liabilities assumed at their fair values on the acquisition date. Accordingly, the recognition and measurement of the assets acquired and liabilities assumed should be the same regardless of whether the acquirer obtains a 100 percent or lesser controlling interest in a business.

In a manner consistent with that premise, ASC 805 has two key principles, known as the “recognition principle” and the “measurement principle.” According to the recognition principle, an acquirer must “recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.” Under the measurement principle, the acquirer must then measure “the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values.” The objective of the principles is to provide guidance that an acquirer can apply when ASC 805 does not provide specific recognition or measurement guidance for a particular asset or liability. Although ASC 805 includes a number of exceptions to the recognition principle, the measurement principle, or both (e.g., exceptions for preacquisition contingencies, employee benefits, and income taxes), in the absence of a specific exception, an acquirer is expected to apply the principles in accounting for the items exchanged in a business combination.

The FASB worked with the International Accounting Standards Board (IASB®) on the second phase of the business combinations project. The boards concurrently deliberated and reached the same conclusions on most issues. As a result, the FASB’s and IASB’s standards on business combinations are substantially converged. Appendix E of this publication summarizes significant differences between the two sets of standards.

Since issuing Statement 141(R) (codified in ASC 805) in December 2007, the FASB has issued updates to the accounting requirements in ASC 805 for business combinations. Those updates are discussed throughout this publication.