Chapter 1 — Overview of Accounting for Business Combinations
Chapter 1 — Overview of Accounting for Business Combinations
In the first phase of its business combinations project, which was completed in 2001, the FASB issued Statements 141 and 142. Statement 141 required that a single method — the purchase method — be used to account for all acquisitions of businesses and eliminated the pooling-of-interest method of accounting for business combinations. Statement 142 (codified in ASC 350) introduced new
criteria for recognizing intangible assets separately from goodwill,
provided criteria for testing goodwill for impairment, and
eliminated the amortization of goodwill.
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.
1.1 Summary of Accounting for Business Combinations
1.1.1 Identifying a Business Combination
Before an entity can apply the acquisition method, it must determine whether a transaction meets
the definition of a business combination. The ASC master glossary defines a business combination as
“[a] transaction or other event in which an acquirer obtains control of one or more businesses.” Typically,
a business combination occurs when an entity purchases the equity interests or the net assets of one or
more businesses in exchange for cash, equity interests of the acquirer, or other consideration. However,
the definition of a business combination applies to more than just purchase transactions: it incorporates
all transactions or events in which an entity or individual obtains control of a business.
Control has the same meaning as “controlling financial interest,” and an entity
applies the guidance in ASC 810-10 to determine whether it has obtained a
controlling financial interest in a business. Under ASC 810-10, an entity
determines whether it has obtained a controlling financial interest by applying
the variable interest entity (VIE) model or the voting interest entity model.
Chapter 2 of
this publication addresses the determination of whether a transaction should be
accounted for as a business combination.
1.1.2 Determining Whether the Acquiree Meets the Definition of a Business
For a transaction to meet the definition of a business combination, the entity or net assets acquired
must meet the definition of a business in ASC 805. In January 2017, the FASB issued ASU 2017-01
to clarify the definition of a business because the previous definition in ASC 805 was often applied
so broadly that transactions that were more akin to asset acquisitions were being accounted for as
business combinations. The ASU introduces a screen for determining when a set of activities and assets
is not a business. An entity uses the screen to assess whether substantially all of the fair value of the
gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar
identifiable assets. If so, the set is not a business. The screen is intended to reduce the number of
transactions that an entity must further evaluate to determine whether they are business combinations
or asset acquisitions.
If the screen is not met, a set cannot be considered a business unless it
includes an input and a substantive process that together significantly
contribute to the ability to create outputs. Under the previous definition of a
business, it was not always clear whether an element was an input or a process
or whether a process had to be substantive to affect the determination.
Therefore, the ASU provides a framework to help entities evaluate whether both
an input and a substantive process are present.
Chapter 2 of this publication addresses whether the entity or the net assets acquired meet the
definition of a business.
1.1.3 Steps to Applying the Acquisition Method
As described in ASC 805-10-05-4, applying the acquisition method requires all the following steps:
- “Identifying the acquirer” — see Section 1.1.4.
- “Determining the acquisition date” — see Section 1.1.5.
- “Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree” — see Section 1.1.6.
- “Recognizing and measuring goodwill or a gain from a bargain purchase” — see Section 1.1.7.
1.1.4 Identifying the Acquirer
The acquisition method includes four steps, the first of which is identifying the acquirer. The ASC
master glossary defines an acquirer as “[t]he entity that obtains control of the acquiree.” The process of
identifying the acquirer begins with consideration of the guidance in ASC 810-10, which will often clearly
indicate which of the parties is the acquirer. However, if it is not clear which of the combining entities
has obtained control of the other after the guidance in ASC 810-10 has been considered, entities should
identify the acquirer by applying the factors in ASC 805. Chapter 3 of this publication addresses the
determination of the acquirer.
1.1.5 Determining the Acquisition Date
The second step in the acquisition method is determining the acquisition date, which is the date on
which the acquirer obtains control of the acquiree and usually is the date on which the acquirer legally
transfers the consideration to the seller, receives the assets, and incurs or assumes the liabilities (i.e.,
the closing date). However, in unusual circumstances, the acquisition date can be before or after the
closing date. Chapter 3 of this publication addresses the determination of the acquisition date.
1.1.6 Recognizing and Measuring the Identifiable Assets, Liabilities, and Noncontrolling Interests in the Acquiree
The third step in the acquisition method is recognizing and measuring the identifiable assets, liabilities,
and any noncontrolling interest in the acquiree. According to the recognition principle in ASC 805-20-25-1, 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
in ASC 805-20-30-1, 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.” However,
certain assets or liabilities are exceptions to the recognition principle, the measurement principle, or
both, and are measured in accordance with other GAAP. For example:
- Income taxes are recognized and measured in accordance with ASC 740.
- Acquired contingencies whose fair value is not determinable during the measurement period are recognized only if they are probable and reasonably estimable.
- Assumed pension and postretirement benefit obligations are measured and recognized in accordance with ASC 715. The effects of expected terminations, curtailments, or amendments of an assumed acquiree benefit plan are not included in acquisition accounting.
- Indemnification assets associated with assets or liabilities recognized in a business combination are recognized and measured by using assumptions that are consistent with those used to measure the item they are related to, subject to any contractual limitations on the indemnification amount and management’s assessment of collectibility.
Changing Lanes
On October 28, 2021, the FASB issued ASU 2021-08, which amends ASC 805
to “require acquiring entities to apply Topic 606 to recognize and
measure contract assets and contract liabilities in a business
combination.” Specifically, ASU 2021-08 amends ASC 805 to add contract
assets and contract liabilities to the list of exceptions to the
recognition and measurement principles that apply to business
combinations and to “require that an entity (acquirer) recognize and
measure contract assets and contract liabilities acquired in a business
combination in accordance with Topic 606.” Before the amendments made by
ASU 2021-08, an acquirer generally recognizes contract assets and
contract liabilities at fair value on the acquisition date.
See Section 4.3.13 for further
discussion of the amendments made by ASU 2021-08 and the effective date
and transition requirements of the amendments.
Chapter 4 of this publication addresses the measurement and recognition of identifiable assets,
liabilities, and noncontrolling interests.
1.1.7 Recognizing and Measuring the Consideration Transferred and Goodwill or a Bargain Purchase Gain
The fourth and final step in the acquisition method is recognizing and measuring goodwill or a gain
from a bargain purchase. Because goodwill is not separately identifiable, it cannot be measured directly.
Goodwill is measured as a residual and is calculated as the excess of the sum of (1) the consideration transferred, (2) the
fair value of any noncontrolling interest in the acquiree, and (3), in a business combination achieved in
stages, the acquisition-date fair value of the acquiree’s previously held equity interest in the acquiree
over the net of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed.
If the sum of items (1) through (3) above is less than the net assets acquired, the acquirer recognizes a
gain, referred to as a bargain purchase gain, in earnings, but only after reassessing whether the items
exchanged in the business combination were appropriately recognized and measured.
The consideration transferred by the acquirer to the seller can take many forms,
including cash, other tangible or intangible assets, contingent consideration,
and the acquirer’s equity interests such as common or preferred shares, options,
warrants, and share-based payment awards. It can also include noncash assets,
which may or may not stay within the combined entity after the acquisition.
Items of consideration transferred in a business combination are measured at
fair value on the acquisition date, with the exception of acquirer share-based
payment awards, which are measured by using a fair-value-based measure in
accordance with ASC 718.
Chapter 5 of this publication addresses the measurement of goodwill or a bargain purchase gain as well
as the items of consideration transferred in a business combination.
In some business combinations, no consideration is transferred and goodwill must
be measured by using the fair value of the acquiree. In other business
combinations, the acquirer obtains a controlling, but less than a 100 percent,
interest in the acquiree or has an equity interest in the acquiree before the
date on which it obtains control. Chapter 6 of this publication addresses
the measurement of goodwill or a bargain purchase gain in these scenarios.
1.1.8 Measurement Period
Because it may take time for an entity to obtain the information necessary to recognize and measure all
the items exchanged in a business combination, the acquirer is allowed a period in which to complete
its accounting for the acquisition. That period — referred to as the measurement period — ends as
soon as the acquirer (1) receives the information it had been seeking about facts and circumstances that
existed as of the acquisition date or (2) learns that it cannot obtain further information. However, the
measurement period cannot be more than one year after the acquisition date. During the measurement
period, the acquirer recognizes provisional amounts for the items for which the accounting is
incomplete. Adjustments to any of these items will affect the amount of goodwill recognized or bargain
purchase gain.
ASC 805 originally required that if a measurement-period adjustment was identified, the acquirer
retrospectively revised comparative information for prior periods, including making any change in
depreciation, amortization, or other income effects as if the accounting for the business combination
had been completed as of the acquisition date. However, revising prior periods to reflect measurement-period
adjustments added cost and complexity to financial reporting and many believed it did not
significantly improve the usefulness of the information provided to users. To address those concerns,
the FASB issued ASU 2015-16 in September 2015. Under the ASU, an acquirer must recognize
adjustments to provisional amounts that are identified during the measurement period in the reporting
period in which the adjustment amounts are determined rather than retrospectively. The acquirer would include the effect
on earnings of changes in depreciation or amortization, or other income effects (if any) as a result of
the change to the provisional amounts, calculated as if the accounting had been completed as of the
acquisition date. Chapter 6 of this publication addresses issues related to the measurement period.
1.1.9 Determining What Is Part of the Business Combination
An acquirer must assess whether any assets acquired, liabilities assumed, or portion of the
consideration transferred is not part of the exchange for the acquiree. Examples of items that are not
part of the exchange for the acquiree include payments that effectively settle preexisting relationships
between the acquirer and acquiree, payments to compensate employees or former shareholders of the
acquiree for future services, and reimbursement of the acquirer’s transaction costs. Such items must be
accounted for separately from the business combination. Chapter 6 of this publication addresses items
that should be accounted for separately from a business combination.
1.1.10 Presentation and Disclosure
The FASB developed an overall disclosure objective for information related to a business combination.
In accordance with this objective, an acquirer must disclose enough information for users to evaluate
the nature and financial effect of a business combination. ASC 805 also contains detailed requirements
related to the disclosures an entity must provide at a minimum to meet that disclosure objective.
However, if the disclosures an entity provides under these requirements (along with those provided
under other GAAP) do not meet the overall disclosure objective, an acquirer must disclose any
additional information necessary. Chapter 7 of this publication addresses presentation and disclosure
requirements for business combinations.
1.1.11 Private-Company and Not-for-Profit Entity Accounting Alternatives
In 2012, the Financial Accounting Foundation, which oversees the FASB,
established the Private Company Council (PCC), which is tasked with improving
accounting standard setting for private companies. The PCC has two principal
responsibilities:
-
To determine whether exceptions or modifications to existing nongovernmental U.S. GAAP are necessary to address the needs of users of private-company financial statements. The PCC identifies, deliberates, and votes on any proposed changes, which are subject to endorsement by the FASB and submitted for public comment before being incorporated into GAAP.
-
To advise the FASB regarding how private companies should treat items under active consideration on the FASB’s technical agenda.
In December 2014, the FASB issued ASU 2014-18, which gives private
companies the option of not recognizing separately from goodwill the following
intangible assets: (1) customer-related intangible assets, unless they can be
sold or licensed independently from other assets of a business, and (2)
noncompetition agreements.
The FASB’s issuance of ASU 2014-02 in January 2014 gives private companies a simplified alternative
for the subsequent accounting for goodwill. It allows private companies the option of (1) amortizing
goodwill on a straight-line basis over a useful life of 10 years or less than 10 years if the entity is able to
demonstrate that a shorter useful life is more appropriate, (2) testing goodwill for impairment only when
a triggering event occurs instead of having to perform the test at least annually, and (3) testing goodwill
for impairment at either the entity level or the reporting-unit level. The ASU also eliminates step 2 of the
goodwill impairment test.
In May 2019, the FASB issued ASU 2019-06, which extends the private-company accounting alternatives for certain identifiable intangible assets and goodwill to not-for-profit entities.
Chapter 8 of this publication addresses the private-company and not-for-profit entity accounting alternatives related to business
combinations.
1.2 Pushdown Accounting
When an entity obtains control of a business, a new basis of accounting is established in the acquirer’s
financial statements for the assets acquired and liabilities assumed. Sometimes the acquiree prepares
separate financial statements after its acquisition. Use of the acquirer’s basis of accounting in the
preparation of an acquiree’s separate financial statements is called “pushdown accounting.”
In November 2014, the FASB issued ASU 2014-17, which gives an acquiree the
option of applying pushdown accounting in its separate financial statements when it
undergoes a change in control. Before the issuance of ASU 2014-17, the guidance on
pushdown accounting only applied to SEC registrants and was based on bright lines
that provided opportunities for structuring and the potential for misapplication.
ASU 2014-17, which was codified into the “Pushdown Accounting” subsections of ASC
805-50, now provides both public and nonpublic entities with authoritative guidance
on applying pushdown accounting. Appendix A of this publication addresses the application of pushdown
accounting.
1.3 Common-Control Transactions
A common-control transaction does not meet the definition of a business combination because there
is no change in control over the net assets. The accounting for these transactions is addressed in the
“Transactions Between Entities Under Common Control” subsections of ASC 805-50.
In a common-control transaction, the net assets are derecognized by the
transferring entity and recognized by the
receiving entity at the historical cost of the
ultimate parent of the entities under common
control. Any difference between the proceeds
transferred or received and the carrying amounts
of the net assets is recognized in equity in the
transferring and receiving entities’ separate
financial statements and eliminated in
consolidation. ASC 805-50 also provides guidance
addressing whether the receiving entity should
report the net assets received prospectively from
the date of the transfer or retrospectively for
all periods presented. ASC 805-50 does not
specifically address the reporting by the
transferring entity; however, the transferring
entity usually presents the transfer as a disposal
on the date of the transfer in its separate
financial statements. Appendix B of
this publication addresses common-control
transactions.
1.4 Asset Acquisitions
An asset acquisition is an acquisition of an asset, or a group of assets, that does not meet the definition
of a business; such an acquisition therefore does not meet the definition of a business combination.
The accounting for these transactions is addressed in the “Acquisition of Assets Rather Than a Business”
subsections of ASC 805-50. Asset acquisitions are accounted for by using a cost accumulation model
(i.e., the cost of the acquisition, including certain transaction costs, is allocated to the assets acquired on
the basis of relative fair values, with some exceptions). In contrast, a business combination is accounted
for by using a fair value model (i.e., the assets and liabilities are generally recognized at their fair values,
and the difference between the consideration paid, excluding transaction costs, and the fair values
of the assets and liabilities is recognized as goodwill or, in unusual circumstances, a bargain purchase gain). As a result, there are differences between the
accounting for an asset acquisition and the accounting for a business combination. Appendix C of this
publication addresses asset acquisitions as well as the differences between the accounting for asset
acquisitions and the accounting for business combinations.
1.5 SEC Reporting Considerations for Business Acquisitions
When an acquirer is an SEC registrant and consummates — or it is probable that
it will consummate — a significant business acquisition, the SEC may require the
filing of certain financial statements for the acquired or to be acquired business
(the acquiree) under SEC Regulation S-X, Rule 3-05. For example, if the acquirer
files a registration statement or a proxy statement, separate financial statements
for the acquiree may be required in addition to the financial statements of the
registrant. Including the separate preacquisition financial statements of the
acquiree in a filing allows current and prospective investors to evaluate the future
impact of the acquiree on the registrant’s consolidated results. Pro forma
information may also be required under SEC Regulation S-X, Article 11, for the
acquisition or probable acquisition of a business.
For additional information and interpretive guidance on SEC rules regarding
business acquisitions and other SEC requirements
related to business acquisitions, see Deloitte’s
Roadmap SEC
Reporting Considerations for Business
Acquisitions.
1.6 Comparison of U.S. GAAP and IFRS Accounting Standards
ASC 805 is the primary source of guidance in U.S. GAAP on the accounting for
business combinations and related matters. IFRS 3 is the primary source of such
guidance under IFRS® Accounting Standards. Although the standards are
largely converged, some differences remain. See Appendix E for a discussion of those
differences.