Chapter 6 — Other Acquisition Method Guidance

6.5 Business Combinations Achieved in Stages

ASC 805-10

A Business Combination Achieved in Stages

25-9 An acquirer sometimes obtains control of an acquiree in which it held an equity interest immediately before the acquisition date. For example, on December 31, 20X1, Entity A holds a 35 percent noncontrolling equity interest in Entity B. On that date, Entity A purchases an additional 40 percent interest in Entity B, which gives it control of Entity B. This Topic refers to such a transaction as a business combination achieved in stages, sometimes also referred to as a step acquisition.

25-10 In a business combination achieved in stages, the acquirer shall remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognize the resulting gain or loss, if any, in earnings. In prior reporting periods, with respect to its previously held equity method investment, the acquirer may have recognized amounts in other comprehensive income in accordance with paragraph 323-10-35-18. If so, the amount that was recognized in other comprehensive income shall be reclassified and included in the calculation of gain or loss as of the acquisition date. If the business combination achieved in stages relates to a previously held equity method investment that is a foreign entity, the amount of accumulated other comprehensive income that is reclassified and included in the calculation of gain or loss shall include any foreign currency translation adjustment related to that previously held investment. For guidance on derecognizing foreign currency translation adjustments recorded in accumulated other comprehensive income, see Section 830-30-40.

As described in ASC 805-10-25-9, in a business combination achieved in stages, an acquirer “obtains control of an acquiree in which it held an equity interest immediately before the acquisition date.” Such transactions are also commonly called “step acquisitions.” Because, as stated previously, an acquirer is accountable and responsible for all of the acquiree’s assets and liabilities regardless of the ownership percentage acquired on the acquisition date, the acquirer in a step acquisition recognizes in its consolidated financial statements the assets acquired, liabilities assumed, and noncontrolling interest at 100 percent of their values, measured in accordance with ASC 805 (generally at fair value).

However, on the acquisition date of a business combination achieved in stages, the acquirer only transfers consideration for the portion of the equity interests acquired in that transaction. Therefore, to determine the amounts to recognize for the assets acquired (including goodwill), liabilities assumed, and any noncontrolling interests, the acquirer must determine the fair value of the acquiree as a whole. To do so, the acquirer must remeasure its previously held equity interest in the acquiree as of its acquisition-date fair value and recognize the resulting gain or loss, if any, in earnings. The acquirer then measures the goodwill in accordance with the guidance in ASC 805-30-30-1 and accounts for the acquisition as if it had sold the previously held interest, recognized any gain or loss in current-period earnings, and then acquired a controlling interest in the acquiree. Paragraph B384 of the Basis for Conclusions of Statement 141(R) explains the FASB’s rationale for the accounting treatment:

The Boards concluded that a change from holding a noncontrolling investment in an entity to obtaining control of that entity is a significant change in the nature of and economic circumstances surrounding that investment. That change warrants a change in the classification and measurement of that investment. Once it obtains control, the acquirer no longer is the owner of a noncontrolling investment asset in the acquiree. As in present practice, the acquirer ceases its accounting for an investment asset and begins reporting in its financial statements the underlying assets, liabilities, and results of operations of the acquiree. In effect, the acquirer exchanges its status as an owner of an investment asset in an entity for a controlling financial interest in all of the underlying assets and liabilities of that entity (acquiree) and the right to direct how the acquiree and its management use those assets in its operations.

In prior periods, the previously held interest may have been remeasured to fair value, with changes recognized in other comprehensive income. Alternatively, the investment may have been in a foreign entity for which the acquirer had recognized cumulative translation adjustments. In such cases, any amounts in accumulated comprehensive income related to the previously held interest should be reclassified and included in the calculation of the gain or loss.

Once the acquirer obtains control of the acquiree, subsequent increases or decreases in its ownership interest are accounted for as equity transactions in accordance with ASC 810-10 as long the acquirer retains control. For more information about acquisitions of noncontrolling interests, see Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest.

Example 6-19

Business Combination Achieved in Stages (Step Acquisition)

Company A purchases a 35 percent interest in Company B, a publicly traded entity, for $2,000 on January 1, 20X8. (The deferred tax accounting implications are ignored in this example.) Company A accounts for its 35 percent interest in B by using the equity method of accounting.

On December 31, 20X9, A purchases the remaining 65 percent interest for $6,500 and obtains control of B. Company A accounts for the transaction as a business combination. Company B’s identifiable net assets are recognized at $8,000 under ASC 805, and the fair value of A’s 35 percent interest in B is $3,500. The book value of that interest is $2,500.

Company A should account for the acquisition of B as follows:

6.5.1 Measuring the Fair Value of a Previously Held Interest

ASC 805 does not specify how to measure a previously held equity interest. For publicly traded interests, entities should measure fair value by using the market price on the acquisition date. However, some have questioned whether a previously held interest that is not publicly traded should be remeasured with or without a control premium.

Some have looked to ASC 805-30-30-1, which describes how to measure goodwill, as support for remeasuring a previously held interest without a control premium. That paragraph states:

The acquirer shall recognize goodwill as of the acquisition date, measured as the excess of (a) over (b):

The aggregate of the following:
1. The consideration transferred measured in accordance with this Section, which generally requires acquisition-date fair value (see paragraph 805-30-30-7)
2. The fair value of any noncontrolling interest in the acquiree
3. In a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree.
The net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this Topic.

Proponents of this view believe that this guidance indicates that a previously held interest is its own unit of account. That is, in measuring the fair value of the acquiree, entities should separately measure (1) the consideration transferred for the interest that gave the acquirer control, (2) the fair value of any noncontrolling interest, and (3) the fair value of any previously held interest. Because there are three separate units of account, each is measured individually, and possibly differently, from the others. Entities should then look to ASC 805-20-30-8, which clarifies how a noncontrolling interest in a partial acquisition should be measured:

The fair values of the acquirer’s interest in the acquiree and the noncontrolling interest on a per-share basis might differ. The main difference is likely to be the inclusion of a control premium in the per-share fair value of the acquirer’s interest in the acquiree or, conversely, the inclusion of a discount for lack of control (also referred to as a noncontrolling interest discount) in the per-share fair value of the noncontrolling interest if market participants would take into account such a premium or discount when pricing the noncontrolling interest.

ASC 805-20-30-8 clarifies that a noncontrolling interest is a separate unit of account that should be measured differently from the acquirer’s controlling interest. Thus, if the previously held interest is also a separate unit of account, it must also be measured independently, which suggests that no control premium should be included in the value of the previously held interest.

Alternatively, others believe that the acquirer’s entire ownership interest (both the newly acquired and the previously held interest) in the acquiree should be measured as a single unit of account. This view could result in the inclusion of a control premium in the remeasurement of the previously held interest.

Supporters of this view also look to the guidance in ASC 805-20-30-8, but they interpret the words “the fair values of the acquirer’s interest in the acquiree and the noncontrolling interest” to indicate that there are two units of account in the measurement of the acquiree’s fair value: the acquirer’s total interest (both the newly acquired and the previously held interest) and the noncontrolling interest, if any. They then read the words “inclusion of a control premium in the per-share fair value of the acquirer’s interest in the acquiree” to indicate that the valuation of the acquirer’s interest (both the newly acquired and the previously held interest) should include a control premium.

We understand that members of both the FASB’s and IASB’s staffs discussed this issue at the September 23, 2008, FASB Valuation Resource Group meeting. At that meeting, two staff members, one from each staff, expressed their belief that measuring a previously held interest without a control premium is consistent with both boards’ intent in jointly developing Statement 141(R) (now ASC 805) and IFRS 3. However, we note that there has been no additional standard setting in response to the staff discussions. We also note that sometimes, such as in the case of a publicly traded acquiree, it would be appropriate to measure at the same per-share amount both the interest that gives the acquirer control and the previously held interest, which may include a control premium. We therefore believe that measuring a previously held interest requires the use of judgment and that different approaches may be reasonable under different circumstances.

6.5.2 Call Options to Acquire a Controlling Interest in a Business

An entity may hold a freestanding call option that, when exercised, will result in the acquisition of a controlling financial interest in a business. In some cases, the entity may have no previous equity ownership in the business, while in others, the entity may have held a noncontrolling interest in the business before exercising the call option. The call option may not be measured at fair value on a recurring basis under applicable U.S. GAAP; for example, it may not meet the definition of a derivative in ASC 815 as a result of the net settlement criterion. Accordingly, we believe that if the entity exercises the call option and obtains a controlling financial interest in the business, the acquirer should account for the call option as a previously held equity interest and remeasure the call option to its acquisition-date fair value, with any resulting gain or loss recognized in earnings in accordance with ASC 805-10-25-10. See Section 6.5 for more information about previously held equity interests and business combinations achieved in stages.

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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.