Chapter 5 — Measurement of Goodwill or Gain From a Bargain Purchase, and Consideration Transferred in a Business Combination

5.3 Measuring the Consideration Transferred

ASC 805-30

30-7 The consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the equity interests issued by the acquirer. (However, any portion of the acquirer’s share-based payment awards exchanged for awards held by the acquiree’s grantees that is included in consideration transferred in the business combination shall be measured in accordance with paragraph 805-20-30-21 rather than at fair value.) Examples of potential forms of consideration include the following:

Cash
Other assets
A business or a subsidiary of the acquirer
Contingent consideration (see paragraphs 805-30-25-5 through 25-7)
Common or preferred equity instruments
Options
Warrants
Member interests of mutual entities.

The consideration transferred by the acquirer to the seller is commonly in the form of cash, equity instruments of the acquirer, or a combination of both. However, it can take many other forms, including liabilities incurred to the seller (e.g., contingent consideration or a seller note). The consideration transferred in a business combination is measured at fair value as of the acquisition date, which is consistent with the fair value measurement and recognition principles of ASC 805, with one exception: replacement share-based payment awards are calculated by using a fair-value-based measure in accordance with ASC 718 (see Section 5.6).

If an acquirer transfers noncash assets to the seller as consideration in a business combination and loses control of those assets, the acquirer should remeasure them at their fair values as of the acquisition date and recognize the resulting gains or losses, if any, in earnings (see Section 5.8). However, if an acquirer transfers noncash assets to the acquiree as consideration in a business combination and does not lose control of those assets (i.e., they stay within the combined entity after the acquisition), the acquirer would not recognize a gain or loss on the acquisition date. An acquirer should not recognize a gain or loss in earnings on assets it controls both before and after an acquisition (see Section 5.8.1).

Sometimes an acquisition agreement includes payments to the seller that are not in exchange for the business, such as payments to (1) compensate for services, (2) use property, or (3) settle preexisting relationships, contracts, or disputes. Such payments should be accounted for separately from the business combination in accordance with their nature. See Section 6.2 for more information about accounting for transactions that are separate from a business combination.

Other times, a buyer and a seller may enter into a business combination and one or more other arrangements at or near the same time, such as an acquisition agreement and a supply agreement. The acquirer must assess whether such arrangements should be accounted for separately or as one single arrangement. See Section 6.3 for more information about determining whether multiple arrangements should be accounted for as one.

5.3.1 Consideration Held in Escrow Pending Resolution of Representation and Warranty Provisions

Acquisition agreements may require that a specified portion of the consideration be held in escrow pending resolution of the agreement’s general representation and warranty provisions. If such consideration is in the form of shares or other securities, the arrangement typically stipulates that the risks and rewards of ownership are transferred to the seller. Voting rights and any dividends related to the shares or other securities held in escrow are also generally conveyed to the seller during the escrow period.

The escrowed shares or other securities are a means for an acquirer to gain further assurance that the acquisition agreement’s representations and warranties are accurate and, if they are not, to readily obtain restitution. Representation and warranty provisions generally lapse within a short period after the acquisition date.

In the absence of evidence to the contrary, since the representations and warranties in an acquisition agreement are assumed to be accurate, release of the consideration from escrow is likely to occur. Accordingly, it is generally considered appropriate to include amounts held in escrow in the total consideration transferred as of the acquisition date. However, if the amount held in escrow is related to the outcome of an uncertain future event rather than to circumstances that existed as of the acquisition date, the acquirer should consider whether the amount is contingent consideration (see Section 5.7). The terms of each escrow arrangement must be evaluated individually.

An acquirer also should carefully evaluate the legal terms of the business combination agreement and escrow agreement to determine whether cash held in escrow should continue to be presented as an asset on the acquirer’s balance sheet (e.g., the cash is held in an account legally owned by the acquirer). If the escrowed cash still qualifies for presentation as an asset on its balance sheet, the acquirer should consider whether to recognize a corresponding liability to the seller, which would be a liability incurred to the seller and included as a component of the consideration transferred.

5.3.2 Working Capital Adjustments

Acquisition agreements may include provisions that adjust the consideration transferred for excesses or shortfalls in the stipulated amount of working capital as of the acquisition date as defined by the parties to the combination. Such provisions establish the amount of working capital that should exist as of the acquisition date.

Excesses or shortfalls in working capital that result in the acquirer’s payment or receipt of amounts after the acquisition date should adjust the consideration transferred if the adjustment is made before the end of the measurement period. Working capital adjustments paid or received after the end of the measurement period should be recognized in earnings.

Occasionally, disputes may arise over a working capital provision (e.g., after the acquisition date, entities might question how working capital is defined or how to measure the inputs used in its calculation). In these cases, it is necessary to evaluate whether the nature of the settlement of any such disputes represents the operation of the working capital adjustment or the settlement, in whole or in part, of a dispute arising from the business combination (see Section 6.2.6).

5.3.3 Ticking Fees

Some acquisition agreements include a provision stipulating that the amount paid by the acquirer is increased if the transaction closes after a specified date. Such a provision, which may be included in the initial agreement or added at a later date, is sometimes referred to as a “ticking fee” because it increases the amount the acquirer pays as more time elapses or “as the clock ticks.” Since the ticking fee begins accruing from an agreed-on date until the acquisition closes, it provides incentive to the acquirer to not unnecessarily delay the closing of the transaction. The provision may specify that the amount paid must be increased on specific dates or when a particular event occurs, or it may set out a constant rate of increase per day from the time the provision becomes effective until the closing of the transaction.

Whether included in the acquisition agreement initially or added at a later date, ticking fees are generally accounted for as part of the consideration transferred, provided that the business combination closes. In other words, the consideration transferred increases if the provision is triggered. However, entities should consider whether any overpayment resulting from the triggered provision may indicate that the goodwill is not recoverable in subsequent goodwill impairment testing under ASC 350-20 or represents payment for something other than the business acquired. See Section 6.2 for more information about accounting for transactions separately from the business combination.

5.3.4 Hedging the Commitment to Enter Into a Business Combination

ASC 815-20-25-43(c)(5) states that a “firm commitment . . . to enter into a business combination” is not eligible for designation as a fair value hedge. In addition, ASC 815-20-25-15(g) states that if a forecasted transaction involves a “business combination subject to the provisions of Topic 805,” the transaction is not eligible for “designation as a hedged transaction in a cash flow hedge.” While firm commitments may be used as economic hedges of various risks related to a business combination, they generally are not eligible for hedge accounting under ASC 815-20-25-12, ASC 815-20-25-43, and ASC 815-20-25-15(g)). Rather, these instruments are treated as freestanding financial instruments on the acquirer’s books.

Accordingly, the costs of and proceeds from using these instruments (including subsequent gains and losses) are not part of the consideration transferred in a business combination and instead are accounted for in accordance with other applicable GAAP (e.g., ASC 815). For example, if a derivative is executed in connection with a business combination to economically hedge the foreign currency risk associated with the consideration to be transferred, the acquirer initially recognizes the derivative at fair value and records subsequent changes in the derivative’s fair value in earnings. See Section 2.2.1.3 of Deloitte’s Roadmap Hedge Accounting for more information.

Example 5-1

Foreign Currency Hedge of a Forecasted Business Combination

On January 1, 20X0, Company A, a U.S. company whose functional currency is the U.S. dollar, announced a tender offer to acquire all of the common stock of Company B, a British company. Company A offered £6.90 for each share of B, £3.5 billion in total. The transaction is expected to close sometime in the third quarter of 20X0. Company A is exposed to foreign currency risk during the tender period because of the higher cost it would incur as a result of a strengthening of the pound. Company Z, an investment banker, has provided A with a hedging proposal under which the currency exposure would be mitigated by use of at-the-money call options on pounds. Under ASC 815-20-25-15(g), the forecasted business combination does not meet the criteria to qualify as the hedged item in a foreign currency cash flow hedge because it involves a business combination. In addition, ASC 815-20-25-43(c) states that a firm commitment to enter into a business combination cannot be the hedged item in a fair value hedge.

Connecting the Dots

In a June 19, 2018, agenda request, the ISDA’s Accounting Committee asked the FASB to consider an agenda topic that “extends the ability to designate a fair value or cash flow hedge of foreign currency exposure” related to either a firmly committed or forecasted acquisition of a business. As of the date of the publication of this Roadmap, the FASB has not added this topic to its agenda.

While an entity cannot hedge an expected business combination or a firm commitment to enter into such a combination, it is not prohibited from designating a transaction that is contingent on a business combination (e.g., interest payments related to the acquirer’s forecasted issuance of debt to fund the business combination) as the hedged item in a qualifying cash flow hedging relationship. However, the hedging relationship would need to meet the criteria to qualify for cash flow hedge accounting, and it may be difficult to assert that the consummation of a business combination is probable. An entity should consider the many uncertainties involved in entering into a business combination, including the need to obtain shareholder and regulatory approvals. See Section 4.1.1.1 of Deloitte’s Roadmap Hedge Accounting for more information.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.