4.12 Debt
An acquirer in a business combination is required to recognize any debt of the
acquiree that it assumes at fair value on the acquisition date. The acquiree’s debt
issuance costs do not meet the definition of an asset. Therefore, the acquiree’s
unamortized debt issuance costs are not recognized in a business combination.
Further, an acquirer may incur new debt with a third party to fund the
acquisition. Such debt is neither a liability assumed in the business combination
nor part of the consideration transferred.
4.12.1 Reporting Considerations Related to Debt of the Acquiree Settled on or Shortly After the Acquisition Date
An acquirer may sometimes pay cash to settle all or a portion of
the acquiree’s outstanding debt on, or shortly after, the acquisition date.
Generally, only amounts given to former owners of the acquiree are reported as
consideration transferred. However, if the acquiree’s preacquisition debt
includes a change-in-control provision as described below, cash paid to settle
the acquiree’s outstanding debt is sometimes presented as consideration
transferred rather than as a liability assumed in the acquisition.
4.12.1.1 Settlement of Acquiree Debt That Includes a Preexisting Change-in-Control Provision
An acquiree’s preacquisition debt agreement may include a
provision that requires, or is at the discretion of the lender, that the
debt be repaid upon a change in control of the acquiree so that the acquirer
has no discretion regarding whether the debt can remain outstanding after
the acquisition date. In that case, the acquirer may consider whether the
repayment of the debt could be reported as part of the consideration
transferred rather than as a liability assumed in the accounting for the
acquisition. If it is determined that the acquiree’s debt with the
preexisting change-in-control provision was not assumed by the acquirer, the
debt repayment may be considered part of the consideration transferred in
the accounting for the acquisition (i.e., as if the acquirer repaid the debt
on the acquiree’s behalf). However, if it is determined that the debt was
assumed by the acquirer, the debt is accounted for as a liability assumed in
the accounting for the acquisition.
In some cases, there may be a short administrative delay
(i.e., one or two days) in the acquirer’s repayment of the acquiree’s debt
when such repayment is required. We believe that in such cases, the cash
paid to settle the acquiree’s debt might also be reported as consideration
transferred if the acquirer is deemed to not have assumed the risks inherent
in the debt.
Regardless of whether the repayment of the acquiree’s debt
is presented as consideration transferred or as a liability assumed, the
amount of goodwill reported will not change (see Examples 4-8 and 4-9),
but the acquirer should ensure that its financial statements are presented
consistently throughout. That is, if the acquirer concludes that it did not
assume the acquiree’s debt, the amount paid to settle the debt should be
accounted for and disclosed as part of the consideration transferred. In
addition, in such a case, the acquirer should present the repayment as an
investing cash outflow in a manner consistent with how it would present cash
consideration paid in a business combination.
By contrast, if the acquirer concludes that it assumed the
acquiree’s debt, the debt should be accounted for and disclosed as a
liability assumed in the acquisition accounting. The acquirer would present
the repayment as a financing cash outflow in a manner consistent with how it
would present the repayment of its own debt obligations outside of a
business combination. See Deloitte’s Roadmap Statement of Cash Flows for
more information about cash flow presentation.
Example 4-8
Acquirer Does
Not Assume Acquiree’s Debt
Company A acquires Company B in a
business combination. Before the acquisition, B had
$1 million in outstanding debt owed to a third-party
bank that it was required to settle upon a change in
control of B. Company A pays the seller $5 million
in cash and repays $1 million directly to the bank
at the closing of the business combination. Company
A concludes that it did not assume B’s debt (i.e.,
that it repaid the debt on B’s behalf). As of the
acquisition date, B’s net assets recognized in
accordance with ASC 805 are $4 million. Company A
calculates the goodwill resulting from the
acquisition of B as follows:
Because A did not assume B’s debt,
the total consideration transferred is $6 million in
cash. Therefore, A should present the $6 million as
an investing outflow in its statement of cash
flows.
Example 4-9
Acquirer Assumes
Acquiree’s Debt
Assume the same facts as in the
example above, except that Company A concludes that
it assumed Company B’s debt. As a result, B’s net
assets recognized in accordance with ASC 805 are $3
million (i.e., $4 million less $1 million in debt).
Company A calculates the goodwill resulting from the
acquisition of B as follows:
Because A assumed B’s debt, the
consideration transferred is $5 million in cash paid
to the seller, and the $1 million to repay B’s debt
is a liability assumed in the acquisition
accounting. Therefore, A should present $5 million
as an investing outflow and $1 million as a
financing outflow in its statement of cash
flows.
SEC Considerations
Under ASC 805, an acquirer’s conclusion about
whether it assumed the acquiree’s debt affects the amount of the
consideration transferred in the business combination. In accordance
with SEC Regulation S-X, Rule 3-05, a registrant must perform three
tests to determine (1) the significance of the business acquisition
or probable business acquisition and (2) whether the registrant
should file the acquiree’s separate annual and interim financial
statements and, if so, for how many periods. The three tests are the
investment test, the asset test, and the income test.
When an entity performs the investment test, the
registrant’s “investment in” the acquiree is the consideration
transferred under ASC 805. Debt that the acquirer assumes from the
acquiree is not included as part of the consideration transferred.
However, debt that is not assumed by the acquirer and is included as
part of the consideration transferred would be included in the
investment test.
4.12.1.2 Settlement of Acquiree’s Debt That Does Not Include a Preexisting Change-in-Control Provision
In some cases, an acquiree’s preacquisition debt
agreements do not include a provision requiring settlement of the
acquiree’s debt upon a change in control of the acquiree, but the
acquirer decides to repay the outstanding debt on, or shortly after, the
acquisition date. This may be the case, for example, if the acquirer can
obtain more favorable financing than the acquiree’s outstanding
arrangements because of the acquirer’s credit rating or if the acquirer
determines that it does not need the debt financing. Given that the
decision to repay the debt or leave it outstanding is at the acquirer’s
discretion, we believe that the acquirer should report the debt as a
liability assumed. The repayment of the debt would therefore be
accounted for as a transaction separate from the business combination,
even if it is settled on, or shortly after, the acquisition date (in a
manner consistent with Example 4-9). Accordingly, the acquirer would present
the repayment of the debt as a financing cash outflow in its
postacquisition financial statements.
4.12.2 Additional Measurement Considerations Related to Acquiree’s Debt
When an acquiree’s debt has a preexisting provision requiring
that it be settled upon a change in control of the acquiree, the repayment of
the debt may be presented as part of the consideration transferred or as a
liability assumed, depending on the acquirer’s determination of whether it has
assumed the debt as described in Section 4.12.1. Because of the preexisting
change-in-control provision, the acquirer has no discretion regarding whether to
settle the debt or regarding the settlement amount. For example, the terms of
the debt agreement may require the payment of a prepayment penalty. Accordingly,
we generally believe that the fair value of the debt includes these terms, and
thus the fair value is typically the debt’s settlement amount.
However, in some circumstances, an acquiree’s preacquisition
debt agreement does not include a provision requiring settlement of the debt
upon a change in control of the acquiree but the acquirer decides to repay the
outstanding debt on the acquisition date and possibly incurs a prepayment
penalty. In such cases, the settlement of the debt is a transaction that is
accounted for separately from the business combination, as described in
Section
4.12.1.2. Entities must therefore consider whether any portion of
the settlement should be presented as an expense in the acquirer’s
postacquisition financial statements to the extent that the settlement amount
exceeds the debt’s fair value on the acquisition date.
4.12.3 Changes in an Acquirer’s Debt as a Result of a Business Combination
The acquirer in a business combination may have outstanding debt with provisions that result in an
increase in the interest rate in the event of an acquisition. If the interest rate on the acquirer’s debt
is increased as a result of the business combination, the additional interest costs are not part of the
business combination transaction and therefore are not included in the consideration transferred. The
additional interest costs are recognized by the acquirer as incurred or accreted. In addition, if an acquirer incurs any prepayment penalties for settling its own debt in contemplation of a business combination, such penalties should be recognized as an expense in the acquirer’s financial statements.
4.12.4 Accounting for Debt Between the Acquirer and the Acquiree in a Business Combination
A business combination may result in the effective extinguishment of debt between the acquirer
and acquiree. See Section 6.2 for guidance on accounting for the settlement of such a preexisting
relationship in a business combination.