Deloitte's Roadmap: Business Combinations
Preface
Preface
We are pleased to present the 2023 edition of
Business Combinations. This Roadmap provides Deloitte’s insights into and
interpretations of the guidance in ASC 8051 on business combinations, pushdown accounting, common-control transactions,
and asset acquisitions as well as an overview of related SEC reporting requirements.
The Roadmap reflects guidance issued through November 30, 2023. Appendix H highlights all new
content in the Roadmap as well as any substantive revisions to previous content.
Be sure to check out On the
Radar (also available as a stand-alone
publication), which briefly summarizes
emerging issues and trends related to the accounting and
financial reporting topics addressed in the Roadmap.
The accounting frameworks for business
combinations, pushdown accounting, common-control transactions, and asset
acquisitions have been in place for many years. However, views on the application of
the frameworks continue to evolve, and entities may need to use significant judgment
in applying them to current transactions.
While this Roadmap is intended to be a helpful
resource, it is not a substitute for consultation with professional advisers. We
hope that we will have the opportunity to serve you as you complete your business
combination transactions.
Footnotes
1
For a list of the titles of standards and other literature
referred to in this publication, see Appendix F. For a list of
abbreviations used in this publication, see Appendix G.
On the Radar
On the Radar
Entities engage in acquisitions for various reasons. For example,
they may be looking to grow in size, diversify their product offerings, or expand
into new markets or geographies. The accounting for acquisitions can be complex and
begins with a determination of whether an acquisition should be accounted for as a
business combination. ASC 805-10, ASC 805-20, and ASC 805-30 address the accounting
for a business combination, which is defined in the ASC master glossary 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.
If the acquisition does not meet the definition of a business combination, the entity
must determine whether it should be accounted for as an asset acquisition under ASC
805-50. Distinguishing between the acquisition of a business and the acquisition of
an asset or a group of assets is important because there are many differences
between the accounting for each. Alternatively, if the assets acquired consist of
primarily cash or investments, the substance of the transaction may be a capital
transaction (a recapitalization) rather than a business combination or an asset
acquisition.
Determining Whether an Acquisition Is a Business Combination or an Asset Acquisition
To determine whether an acquisition should be accounted for as a business
combination, an entity must evaluate whether the acquired set of assets and
activities together meet the definition of a business in ASC 805.
An entity first uses a “screen” to assess whether substantially all of the fair
value of the gross assets acquired is concentrated in a single identifiable
asset or group of similar identifiable assets. If the screen is not met, the
entity must apply a “framework” for determining whether the acquired set
includes, at a minimum, an input and a substantive process that together
significantly contribute to the ability to create outputs. If so, the acquired
set is a business.
The decision tree below
illustrates how to determine whether an acquisition represents a business
combination or an asset acquisition.
SEC registrants are required to use the definition of
a business in SEC Regulation S-X, Rule 11-01(d),
when evaluating the requirements of SEC Regulation
S-X, Rule 3-05, and SEC Regulation S-X, Article 11.
The definition of a business in Rule 11-01(d) is
different from the definition of a business in ASC
805-10.
Business Combinations
ASC 805 requires an entity to account for a
business combination by using the acquisition method of accounting. Application
of the acquisition method requires the following steps:
The first step of applying the acquisition method is identifying the acquirer.
ASC 805-10-25-4 requires entities to identify an acquirer in every business
combination. The ASC master glossary defines an acquirer as follows:
The
entity that obtains control of the acquiree. However, in a business
combination in which a variable interest entity (VIE) is acquired, the
primary beneficiary of that entity always is the acquirer.
The entity identified as the acquirer for accounting purposes usually is the
entity that transfers the consideration (e.g., cash, other assets, or its equity
interests) to effect the acquisition. However, in some business combinations,
the entity that issues its equity interests (the “legal acquirer”) is determined
for accounting purposes to be the acquiree (also called the “accounting
acquiree”), while the entity whose equity interests are acquired (the “legal
acquiree”) is for accounting purposes the acquirer (also called the “accounting
acquirer”). Such transactions are commonly called reverse acquisitions.
In many acquisitions, the identification of the acquirer is
straightforward, but in others, it can require significant judgment. If the
entity identified as the accounting acquiree meets the definition of a business,
the accounting acquirer accounts for the acquisition as a business combination
in accordance with ASC 805. If the accounting acquiree does not meet the
definition of a business, an entity must assess the nature of the assets and
operations acquired. If the accounting acquiree has substantive assets (other
than cash and investments), the acquisition generally is accounted for as a
reverse asset acquisition. However, if the entity identified as the accounting
acquiree has no substantive assets other than cash and investments, the nature
of the transaction may be a reverse recapitalization rather than an acquisition.
Transactions
involving special-purpose acquisition companies
(SPACs) have been common in the marketplace. In such
transactions, private operating companies
(“targets”) have been raising capital by merging
with SPACs rather than using traditional IPOs or
other financing activities. A SPAC is a newly formed
company that raises cash in an IPO and uses that
cash or the equity of the SPAC, or both, to fund the
acquisition of a target. A transaction in which a
SPAC acquires an operating company target must be
analyzed to determine whether the SPAC or the target
is the accounting acquirer. An entity should
consider all pertinent facts and circumstances in
its evaluation.
In situations in which the target is determined to be
the accounting acquirer, typically, the SPAC’s only
precombination assets are cash and investments and
the SPAC does not meet the definition of a business
in ASC 805. Therefore, the substance of the
transaction is a recapitalization of the target
(i.e., a reverse recapitalization) rather than a
business combination or an asset acquisition. In
such cases, the transaction would be accounted for
as though the target issued its equity for the net
assets of the SPAC and, since a business combination
has not occurred, no goodwill or intangible assets
would be recorded.
The second step of applying the acquisition method is determining the acquisition
date. The acquisition date is the date on which control of the business
transfers to the acquirer and generally coincides with 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.
Determining the acquisition date is important because on this date:
- The consideration transferred is measured at fair value as the sum of (1) the assets transferred by the acquirer, (2) the liabilities incurred by the acquirer to former owners of the acquiree (e.g., contingent consideration), and (3) the equity interests issued by the acquirer.
- The assets acquired, liabilities assumed, and any noncontrolling interests are identified and measured.
- The acquirer begins consolidating the acquiree, if required.
The third step of applying the acquisition method is recognizing and measuring
the identifiable assets acquired, liabilities assumed, and any noncontrolling
interests in the acquiree. Step three is based on two key principles, which ASC
805 calls the recognition principle and the measurement principle. Under 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.” As a result of
applying the recognition principle, an acquirer may recognize certain assets and
liabilities that were not previously recognized in the acquiree’s financial
statements, such as certain intangible assets.
Under the measurement principle in ASC 805-20-30-1, an acquirer is required to
measure “the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at their acquisition-date fair values.”
Thus, most assets and liabilities and items of consideration are measured at
fair value in accordance with the principles of ASC 820.
ASC 805 does include exceptions to its recognition and fair
value measurement principles, such as for deferred taxes, employee benefits,
share-based payments, and assets held for sale. Such exceptions are recognized
and measured in accordance with other applicable GAAP rather than the general
principles discussed in ASC 805.
Recently Issued Guidance
On October 28, 2021, the FASB issued ASU
2021-08, which 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.” While primarily related to contract assets and contract liabilities
that were accounted for by the acquiree in accordance with ASC 606, “the
amendments also apply to contract assets and contract liabilities from other
contracts to which the provisions of Topic 606 apply, such as contract
liabilities from the sale of nonfinancial assets within the scope of
Subtopic 610-20.” Before adopting the amendments, an acquirer generally
recognizes contract assets and contract liabilities at fair value on the
acquisition date.
As a result of the amendments made by ASU 2021-08, it is expected that an
acquirer will generally recognize and measure acquired contract assets and
contract liabilities in a manner consistent with how the acquiree recognized
and measured them in its preacquisition financial statements. However, the
Board acknowledges that:
[T]here may be circumstances in which the
acquirer is unable to assess or rely on how the acquiree applied Topic
606, such as if the acquiree does not follow GAAP, if there were errors
identified in the acquiree’s accounting, or if there were changes
identified to conform with the acquirer’s accounting policies. In those
circumstances, the acquirer should consider the terms of the acquired
contracts, such as timing of payment, identify each performance
obligation in the contracts, and allocate the total transaction price to
each identified performance obligation on a relative standalone selling
price basis as of contract inception (that is, the date the acquiree
entered into the contracts) or contract modification to determine what
should be recorded at the acquisition date.
Therefore, the Board notes that “the amendments may not always be as simple
as recording the same contract assets and contract liabilities that were
recorded by the acquiree before the acquisition and that there may be
additional effort required to evaluate how the acquiree applied Topic
606.”
In addition, ASU 2021-08 indicates that the amendments “do not affect the
accounting for other assets or liabilities that may arise from revenue
contracts with customers in accordance with Topic 606, such as refund
liabilities, or in a business combination, such as customer-related
intangible assets and contract-based intangible assets. For example, if
acquired revenue contracts are considered to have terms that are unfavorable
or favorable relative to market terms, the acquirer should recognize a
liability or asset for the off-market contract terms at the acquisition
date.”
The ASU’s amendments are effective as follows:
- For public business entities — Fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.
- For all other entities — Fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.
The amendments should be applied prospectively to business combinations
occurring on or after the effective date of the amendments.
The ASU clarifies that “[e]arly adoption of the amendments is permitted,
including adoption in an interim period. An entity that early adopts in an
interim period should apply the amendments (1) retrospectively to all
business combinations for which the acquisition date occurs on or after the
beginning of the fiscal year that includes the interim period of early
application and (2) prospectively to all business combinations that occur on
or after the date of initial application.” For example, assume that an
entity with a calendar year-end had one business combination in the second
quarter of 2020 and another business combination in the third quarter of
2021. If the entity adopts the amendments in the fourth quarter of 2021, it
would apply the amendments retrospectively to the acquisition that occurred
in the third quarter of 2021 but would not apply the amendments
retrospectively to the acquisition that occurred in the second quarter of
2020 even if it had not yet issued financial statements for the year ended
December 31, 2020.
The fourth and final step in applying the acquisition method
is recognizing and measuring goodwill or a gain from a bargain purchase. The
ASC master glossary defines goodwill as “[a]n asset representing the future
economic benefits arising from other assets acquired in a business
combination or an acquisition by a not-for-profit entity that are not
individually identified and separately recognized.” Because goodwill is not
a separately identifiable asset, it cannot be measured directly. It is
therefore measured as a residual and calculated as the excess of the sum of
the following items over the net of the acquisition-date values of the
identifiable assets acquired and the liabilities assumed: (1) the
consideration transferred, (2) the fair value of any noncontrolling interest
in the acquiree if a less than 100 percent interest in the acquiree is
acquired, and (3) the fair value of the acquirer’s previously held equity
interest in the acquiree if the acquirer had a noncontrolling equity
interest in the acquiree before the acquisition. Occasionally, the sum of
(1) through (3) above is less than the net of the acquisition-date fair
values of the identifiable assets acquired and the liabilities assumed. In
such a case, the acquirer recognizes a gain, referred to as a bargain
purchase gain, in earnings on the acquisition date.
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.
Under ASC 805-10-55-16, the acquirer is required to recognize any adjustments
to the provisional amounts that were recognized during the measurement
period “in the reporting period the adjustments are determined.” The
adjustments are calculated as if the accounting had been completed on the
acquisition date. When an acquirer adjusts a provisional amount, the
offsetting entry generally increases or decreases goodwill but may also
result in adjustments to other assets and liabilities. Measurement-period
adjustments may also affect the income statement. In accordance with ASC
805-10-25-17, an acquirer must recognize, in the reporting period in which
the adjustment amounts are determined (rather than retrospectively), the
“effect [on earnings] of changes in depreciation, 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 at the
acquisition date.”
Other Related Issues
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. ASC 805-10, ASC 805-20, and ASC 805-30
provide guidance on accounting for an acquisition of a business in the
acquirer’s consolidated financial statements. Sometimes the acquiree in
a business combination will prepare separate financial statements after
the acquisition. In such cases, the acquiree has the option of whether
to use the parent’s basis of accounting or the acquiree’s historical
carrying amounts for the assets acquired and liabilities assumed in its
separate financial statements. Use of the acquirer’s basis of accounting
in the preparation of an acquiree’s separate financial statements is
called “pushdown accounting.”
An acquiree can elect to apply pushdown accounting in its separate
financial statements each time another entity or individual obtains
control of it. If it does not elect to apply pushdown accounting before
the financial statements are issued (SEC filer) or are available to be
issued (other entities), it may subsequently elect to apply pushdown
accounting to its most recent change-in-control event in a later
reporting period. However, such a later election would be a change in
accounting principle and the acquiree would be required to apply the
guidance on a change in accounting principle in ASC 250 in such
circumstances, including all relevant disclosure requirements.
ASC 250-10-45-5 requires that an entity
“report a change in accounting principle through
retrospective application . . . to all prior
periods” unless doing so would be impracticable.
We would expect entities that elect pushdown
accounting on a later date to apply it
retroactively to the acquisition date since the
parent generally would be expected to have
maintained the records for all prior periods.
Further, an SEC registrant that elects a voluntary
change in accounting principle must file a
preferability letter with the SEC.
While an entity can elect to apply pushdown accounting in a subsequent
reporting period, it cannot reverse the application of pushdown
accounting in financial statements that have been issued (SEC filer) or
are available to be issued (other entities).
Common-Control Transactions
A common-control transaction is typically a transfer of net assets or an
exchange of equity interests between entities under the control of the
same parent. While a common-control transaction is similar to a business
combination for the entity that receives the net assets or equity
interests, such a transaction does not meet the definition of a business
combination because there is no change in control over the net assets.
Therefore, the accounting and reporting for a transaction between
entities under common control is outside the scope of the business
combinations guidance in ASC 805-10, ASC 805-20, and ASC 805-30 and is
addressed in the “Transactions Between Entities Under Common Control“
subsections of ASC 805-50.
Since there is no change in control over the net assets
from the parent’s perspective in a common-control transaction, there is
no change in basis in the net assets. ASC 805-50 requires the receiving
entity to recognize the net assets received at their historical carrying
amounts, as reflected in the ultimate parent’s financial statements.
Entities
should also be aware that internal reorganizations
could trigger a requirement to apply pushdown
accounting. While common-control transactions are
generally accounted for at historical cost,
sometimes the carrying amounts of the transferred
assets and liabilities in the ultimate parent’s
consolidated financial statements differ from the
carrying amounts in the transferring entity’s
separate financial statements (e.g., if the
transferring entity had not applied pushdown
accounting). ASC 805-50-30-5 states that, in such
cases, the receiving entity’s financial statements
must “reflect the transferred assets and
liabilities at the historical cost of the parent
of the entities under common control.” We believe
that the historical cost of the parent refers to
the historical cost of the ultimate parent or
controlling shareholder. Therefore, while the
application of pushdown accounting is optional in
the acquiree’s separate financial statements, it
may be required in certain cases after an internal
reorganization.
Asset Acquisitions
The term “asset acquisition” is used to describe an acquisition of an
asset, or a group of assets, that does not meet the definition of a
business in ASC 805. An asset acquisition is accounted for in accordance
with the “Acquisition of Assets Rather Than a Business” subsections of
ASC 805-50 by using a cost accumulation model. In such a model, the cost
of the acquisition, including certain transaction costs, is allocated to
the assets acquired on a relative fair value basis and no goodwill is
recognized. By contrast, in a business combination, the assets acquired
are recognized generally at fair value and goodwill is recognized. As a
result, there are significant differences between the accounting for an
asset acquisition and the accounting for a business combination.
Joint Venture Formations
On August 23, 2023, the FASB issued ASU 2023-05, under which an entity that
qualifies as either a joint venture or a corporate joint venture as defined
in the ASC master glossary is required to apply a new basis of accounting
upon the formation of the joint venture. Under ASU 2023-05 (codified in ASC
805-60), the formation of a joint venture or a corporate joint venture
(collectively, “joint ventures”) results in the “creation of a new reporting
entity,” and no accounting acquirer is identified under ASC 805.
Accordingly, a new basis of accounting would be established upon the
formation date. A joint venture must initially measure its assets and
liabilities at fair value on the formation date, which the ASU defines as
“the date on which an entity initially meets the definition of a joint
venture.” Further, the excess of the fair value of a joint venture as a
whole over the net assets of the joint venture is recognized as
goodwill.
The amendments in ASU 2023-05 are effective for all joint
ventures within the ASU’s scope that are formed on or after January 1, 2025,
and early adoption is permitted. Joint ventures formed on or after the
effective date of ASU 2023-05 will be required to apply the new guidance
prospectively.Joint ventures formed before the ASU’s effective date are
permitted to apply the new guidance (1) retrospectively, if they have
“sufficient information” to do so, or (2) prospectively, if financial
statements have not yet been issued (or made available for issuance). If
retrospective application is elected, transition disclosures must be
provided in accordance with ASC 250.
Purchased Financial Assets
In June 2023, the FASB issued a proposed ASU
that would amend the guidance in ASU 2016-13 regarding the accounting
upon the acquisition of financial assets acquired in (1) a business
combination, (2) an asset acquisition, or (3) the consolidation of a VIE
that is not a business. The proposed ASU would broaden the population of
financial assets that are within the scope of the gross-up approach
under ASC 326 by requiring an acquirer to apply the gross-up approach in
accordance with ASC 805 to all financial assets acquired in a business
combination rather than only to purchased financial assets with credit
deterioration (PCD assets). For financial assets acquired as a result of
an asset acquisition or through consolidation of a VIE that is not a
business, the asset acquirer would apply the gross-up approach to
seasoned assets, which are acquired assets unless the asset is deemed
akin to an in-substance origination. A seasoned asset is an asset (1)
that is acquired more than 90 days after origination and (2) for which
the acquirer was not involved with the origination. Practitioners should
monitor the proposed ASU for any developments that might change the
current accounting.
SEC Reporting Requirements
To ensure that investors receive relevant financial information about a
company’s significant activities, the SEC requires registrants to report
financial information about significant acquired or to be acquired
businesses or the acquisition of real estate operations (the acquiree) in
certain filings under Regulation S-X, Rules 3-05 and 3-14, respectively.
See Deloitte’s Roadmap SEC Reporting Considerations for Business
Acquisitions for more information.
This Roadmap provides Deloitte’s insights into and
interpretations of the guidance in ASC 805 on
business combinations, pushdown accounting,
common-control transactions, and asset acquisitions
as well as an overview of related SEC reporting
requirements.
Contacts
Contacts
|
Matt Himmelman
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 714 436 7277
|
|
James Webb
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 415 783 4586
|
|
Derek Bradfield
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 303 305 3878
|
|
Chris Chiriatti
Audit &
Assurance
Managing Director
Deloitte & Touche
LLP
+1 203 761 3039
|
|
Dennis Howell
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 203 761 3478
|
|
Sandie Kim
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 415 783 4848
|
|
Christine Mazor
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 212 436 6462
|
|
Ignacio Perez
Audit &
Assurance
Managing Director
Deloitte & Touche
LLP
+1 203 761 3379
|
|
Doug Rand
Audit &
Assurance
Managing Director
Deloitte & Touche
LLP
+1 202 220 2754
|
|
Aaron Shaw
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 202 220 2122
|
|
Mark Strassler
Audit &
Assurance
Managing Director
Deloitte & Touche
LLP
+1 415 783 6120
|
|
Stefanie Tamulis
Audit &
Assurance
Managing Director
Deloitte & Touche
LLP
+1 203 563 2648
|
|
Andrew Winters
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 203 761 3355
|
For information about Deloitte’s service offerings related to
business combinations, please contact:
|
Jamie Davis
Audit &
Assurance
Partner
Deloitte & Touche
LLP
+1 312 486 0303
|
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.
Chapter 2 — Identifying a Business Combination
Chapter 2 — Identifying a Business Combination
ASC 805 requires an entity to account for a business combination by
using the acquisition method. For an entity to apply the acquisition method, the
transaction must meet the definition of a business combination and the net assets
acquired must meet the definition of a business in ASC 805. This chapter discusses
those definitions and addresses the scope of the business combinations guidance in
ASC 805-10, ASC 805-20, and ASC 805-30.
2.1 Definition of a Business Combination
ASC 805-10
25-1 An entity shall determine whether a transaction or other event
is a business combination by applying the definition in this Subtopic, which requires that
the assets acquired and liabilities assumed constitute a business. If the assets acquired
are not a business, the reporting entity shall account for the transaction or other event
as an asset acquisition. An entity shall account for each business combination by applying
the acquisition method.
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. Transactions
sometimes referred to as true mergers or mergers of equals also are business combinations.
A business combination typically occurs when an acquirer purchases the equity
interests or 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 is broader
and applies to all transactions or events in which an acquirer obtains control of a business.
ASC 805-10 includes examples of ways in which an acquirer may obtain control of a business:
ASC 805-10
55-2 Paragraph 805-10-25-1 requires an entity to determine whether a transaction or event is a business
combination. In a business combination, an acquirer might obtain control of an acquiree in a variety of ways,
including any of the following:
- By transferring cash, cash equivalents, or other assets (including net assets that constitute a business)
- By incurring liabilities
- By issuing equity interests
- By providing more than one type of consideration
- Without transferring consideration, including by contract alone (see paragraph 805-10-25-11).
55-3 A business combination may be structured in a variety of ways for legal, taxation, or other reasons, which
include but are not limited to, the following:
- One or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer.
- One combining entity transfers its net assets or its owners transfer their equity interests to another combining entity or its owners.
- All of the combining entities transfer their net assets or the owners of those entities transfer their equity interests to a newly formed entity (sometimes referred to as a roll-up or put-together transaction).
- A group of former owners of one of the combining entities obtains control of the combined entity.
The ASC master glossary indicates that the term “control” has the same meaning as the term “controlling
financial interest” in ASC 810-10-15-8. Therefore, an entity applies the guidance in ASC 810-10 to
determine whether it has obtained a controlling financial interest in a business. ASC 810-10-15-8 states:
For legal entities other than limited partnerships, the usual condition for a controlling financial interest is
ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity,
directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition
pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for
example, by contract, lease, agreement with other stockholders, or by court decree.
In assessing whether it has obtained control of a business under ASC 810-10, an
entity begins with an assessment of whether the acquiree is a VIE under the VIE model, which was
established for situations in which control may be demonstrated other than by the possession of
a majority of the voting rights in a legal entity. Accordingly, the evaluation of whether an
entity has a controlling financial interest in a VIE focuses on “the power to direct the
activities of a VIE that most significantly impact the VIE’s economic performance” and “the
obligation to absorb losses of the VIE that could potentially be significant to the VIE or the
right to receive benefits from the VIE that could potentially be significant to the VIE.” Under
ASC 810-10-30-2, if the acquired business is determined to be a VIE on the basis of the guidance
in ASC 810-10, “[t]he initial consolidation of a VIE that is a business is a business
combination and shall be accounted for in accordance with the provisions in Topic 805.”
If a VIE does not meet the definition of a business, the primary beneficiary
applies the initial-measurement guidance in ASC 805 to the VIE’s assets and liabilities, except
for goodwill. The primary beneficiary is prohibited from recognizing goodwill that otherwise
might be measured and instead recognizes a loss. ASC 810-10-30-3 and 30-4 state:
ASC 810-10
30-3 When a reporting entity becomes the primary beneficiary of a VIE that is not a business, no goodwill shall
be recognized. The primary beneficiary initially shall measure and recognize the assets (except for goodwill) and
liabilities of the VIE in accordance with Sections 805-20-25 and 805-20-30. However, the primary beneficiary
initially shall measure assets and liabilities that it has transferred to that VIE at, after, or shortly before the date
that the reporting entity became the primary beneficiary at the same amounts at which the assets and liabilities
would have been measured if they had not been transferred. No gain or loss shall be recognized because of
such transfers.
30-4 The primary beneficiary of a VIE that is not a business shall recognize a gain or loss for the difference
between (a) and (b):
- The sum of:
- The fair value of any consideration paid
- The fair value of any noncontrolling interests
- The reported amount of any previously held interests
- The net amount of the VIE’s identifiable assets and liabilities recognized and measured in accordance with Topic 805.
If the acquiree is not a VIE, an entity proceeds to the voting interest model. Under that model, an entity
with ownership of a majority of the voting interests of a legal entity is generally considered to have a
controlling financial interest in the entity. However, ASC 810-10-15-8 notes that “control may also exist
with a lesser percentage of ownership” in certain situations. In limited situations, an entity may obtain
control over another entity that is not a VIE through a contractual arrangement rather than through
voting interests (see Section 6.6.3 for more information).
For more information, see Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial
Interest.
2.2 Transactions Within the Scope of ASC 805-10, ASC 805-20, and ASC 805-30
ASC 805-10
15-2 The guidance in the Business Combinations Topic applies to all entities, with specific qualifications and
exceptions in paragraph 805-10-15-4.
15-3 The guidance in the Business Combinations Topic applies to all transactions or other events that meet the
definition of a business combination or an acquisition by a not-for-profit entity.
The guidance in ASC 805-10, ASC 805-20, and ASC 805-30 applies to all transactions or events in which
an entity obtains control over one or more businesses. ASC 805-10 specifies that the acquisition method
should be used to account for the following types of transactions:
- Roll-up or put-together transactions — see Section 2.2.1.
- Combinations between two or more mutual entities — see Section 2.2.2.
- True mergers or mergers of equals — see Section 2.2.3.
- Acquisitions in which control, but less than 100 percent of the equity interests, is obtained (partial acquisitions) — see Section 6.4.
- Business combinations achieved in stages (step acquisitions) — see Section 6.5.
- Business combinations achieved without the transfer of consideration — see Section 6.6.
2.2.1 Roll-Up or Put-Together Transactions
In some transactions, all the combining entities transfer their net assets or the owners of those entities
transfer their equity interests to a newly formed entity. Often, the entities are in the same or similar lines
of business. Such transactions are sometimes referred to as “roll-up” or “put-together” transactions. In
some cases, one of the owners receives a majority of the voting interests of the combined entity, but
in other cases no one individual owner does. Regardless, ASC 805-10-55-3(c) indicates that roll-up or
put-together transactions should be accounted for by using the acquisition method.
The FASB discussed its view on roll-up or put-together transactions in paragraph
B27 of Statement 141(R), which states:
The Boards concluded
that most business combinations, both two-party transactions and those
involving three or more entities (multiparty combinations) are acquisitions.
The Boards acknowledged that some multiparty combinations (in particular,
those that are commonly referred to as roll-up or put-together transactions)
might not be acquisitions; however, they noted that the acquisition method
has generally been used to account for them. The Boards decided not to
change that practice at this time. Consequently, [ASC 805-10, ASC 805-20,
and ASC 805-30 require] the acquisition method to be used to account for all
business combinations, including those that some might not consider
acquisitions.
As a result, in a roll-up or put-together transaction, one entity is identified
as the acquirer (see Section
3.1) and the net assets of the other entities are recognized by
using the acquisition method.
2.2.2 Combinations Between Two or More Mutual Entities
Business combinations between two or more mutual entities are within the scope of ASC 805. The ASC
master glossary defines a mutual entity as:
An entity other than an investor-owned entity that provides dividends, lower costs, or other economic benefits
directly and proportionately to its owners, members, or participants. Mutual insurance entities, credit unions,
and farm and rural electric cooperatives are examples of mutual entities.
Because a combination of mutual entities involves an exchange, albeit typically
of membership interests, ASC 805 makes no concession regarding application of
the acquisition method of accounting. Consequently, in a combination between
mutual entities, one of the entities must be identified as the acquirer (see
Section 3.1)
and the acquirer must apply the acquisition method to the acquired assets and
assumed liabilities. ASC 805 provides guidance on measuring the consideration
transferred in a combination between mutual entities, as addressed in Section 5.10.1.
2.2.3 True Mergers or Mergers of Equals
The term “merger of equals” is sometimes used to describe a transaction in which two entities of
approximately equal size combine to form a new company. The definition of a business combination in
the ASC master glossary specifies that “[t]ransactions sometimes referred to as true mergers or mergers
of equals also are business combinations.” The FASB’s rationale for including mergers of equals within
the scope of ASC 805-10, ASC 805-20, and ASC 805-30 was that mergers of equals between for-profit
businesses or mutual entities may not be frequent enough in practice to warrant developing a separate
accounting model for them. As a result, in a merger between two businesses, one of the entities must
be identified as the acquirer, and the acquirer must apply the acquisition method to the acquired assets
and assumed liabilities even when, for example, the parties characterize the transaction as a merger of
equals, the entities are of approximately equal size, or the initial composition of the governing body and
of management are equal or close to equal. However, determining whether a transaction is a merger
of equals or a joint venture can be challenging. As discussed below, joint control is not the only defining
characteristic of a joint venture. A joint venture is also expected to meet the definition of a “corporate
joint venture” in the ASC master glossary. See Section 2.3.1 for information about identifying a joint
venture arrangement.
2.2.4 Multiple Arrangements With a Seller That Result in a Business Combination
An acquirer and a seller may agree to transfer a business in more than one
transaction for regulatory or other purposes. Sometimes, the parties execute the
acquisition as part of a single agreement; other times, the parties enter into
multiple separate agreements. In certain cases, each individual acquisition may
not meet the definition of a business but would meet it if all the acquisitions
were evaluated together. For example, the acquirer and seller may agree to
transfer what would constitute a business in the first transaction and agree to
transfer only inputs (e.g., customer contracts) in a second transaction. In
other cases, the parties may enter into a contract to transfer multiple
individual businesses under which each of the individual acquisitions close at
different times and in various reporting periods. In such cases, the acquisition
agreement may include a single acquisition price for all the acquisitions.
Alternatively, each business may be priced separately and, while each individual
amount may not represent the fair value of the related business, the total
acquisition price will represent the fair value of all the businesses together.
In some instances, it may be appropriate to evaluate the separate transactions as
a single acquisition. We believe that when performing this evaluation, an entity
should consider the following factors listed in ASC 810-10-40-6 related to
identifying when multiple deconsolidation arrangements should be accounted for
as a single transaction:
- “They are entered into at the same time or in contemplation of one another.”
- “They form a single transaction designed to achieve an overall commercial effect.”
- “The occurrence of one arrangement is dependent on the occurrence of at least one other arrangement.”
- “One arrangement considered on its own is not economically justified, but they are economically justified when considered together. An example is when one disposal is priced below market, compensated for by a subsequent disposal priced above market.”
All facts and circumstances associated with such arrangements should be
considered in the evaluation. When the facts and circumstances indicate that
multiple arrangements should be accounted for as a single transaction
representing a business combination, an entity may need to use judgment in
applying acquisition accounting to each arrangement if closing dates are in
different reporting periods. For example, when goodwill is expected to be
recognized if all the transactions are accounted for together, a bargain
purchase gain should not be recognized, even provisionally, when no bargain
purchase gain is expected to result in total.
See Section 6.5 for information about
business combinations that are achieved in stages when an acquirer obtains
control of an acquiree in which it held a noncontrolling equity interest
immediately before the acquisition date.
2.3 Transactions Outside the Scope of ASC 805-10, ASC 805-20, and ASC 805-30
The guidance in ASC 805-10, ASC 805-20, and ASC 805-30 applies to all transactions or events in which
an entity obtains control over one or more businesses. However, ASC 805-10-15-4 includes a list of
scope exceptions, which are described in further detail below.
ASC 805-10
15-4 The guidance in the Business Combinations Topic does not apply to any of the following:
- The formation of a joint venture
- The acquisition of an asset or a group of assets that does not constitute a business or a nonprofit activity
- A combination between entities, businesses, or nonprofit activities under common control (see paragraph 805-50-15-6 for examples)
- An acquisition by a not-for-profit entity for which the acquisition date is before December 15, 2009 or a merger of not-for-profit entities (NFPs)
- A transaction or other event in which an NFP obtains control of a not-for-profit entity but does not consolidate that entity, as described in paragraph 958-810-25-4. The Business Combinations Topic also does not apply if an NFP that obtained control in a transaction or other event in which consolidation was permitted but not required decides in a subsequent annual reporting period to begin consolidating a controlled entity that it initially chose not to consolidate.
- Financial assets and financial liabilities of a consolidated variable interest entity that is a collateralized financing entity within the scope of the guidance on collateralized financing entities in Subtopic 810-10.
2.3.1 Joint Venture Formations
The formation of a joint venture is outside the scope of ASC 805-10, ASC 805-20, and ASC 805-30. Paragraph B61 of FASB Statement 141(R) states:
In developing Statement 141, the FASB noted that
constituents consider the guidance in paragraph 3(d) of APB Opinion No. 18,
The Equity Method of Accounting for Investments in Common Stock,
in assessing whether an entity is a joint venture, and it decided not to
change that practice in its project on business combinations.
The ASC master glossary defines a corporate joint venture as:
A corporation owned and operated by a small group of
entities (the joint venturers) as a separate and specific business or
project for the mutual benefit of the members of the group. A government may
also be a member of the group. The purpose of a corporate joint venture
frequently is to share risks and rewards in developing a new market, product
or technology; to combine complementary technological knowledge; or to pool
resources in developing production or other facilities. A corporate joint
venture also usually provides an arrangement under which each joint venturer
may participate, directly or indirectly, in the overall management of the
joint venture. Joint venturers thus have an interest or relationship other
than as passive investors. An entity that is a subsidiary of one of the
joint venturers is not a corporate joint venture. The ownership of a
corporate joint venture seldom changes, and its stock is usually not traded
publicly. A noncontrolling interest held by public ownership, however, does
not preclude a corporation from being a corporate joint venture.
To be considered a joint venture, an entity should also be jointly controlled by
its investors.
In identifying whether a transaction meets the definition of a corporate joint
venture, an entity must use judgment and consider its particular facts and
circumstances. In his remarks at the 2014 AICPA Conference on Current SEC and
PCAOB Developments, Christopher Rogers, then a professional accounting fellow in
the SEC’s Office of the Chief Accountant (OCA), reiterated the following
long-standing SEC staff view:
In evaluating joint venture
formation transactions, the staff continues to believe that joint control is
not the only defining characteristic of a joint venture. Rather, each of the
characteristics in the definition of a joint venture in Topic 323 should be
met for an entity to be a joint venture, including that the “purpose” of the
entity is consistent with that of a joint venture. [Footnotes omitted]
In addition, ASC 805-10-S99-8 notes a comment made by an SEC observer at an EITF
meeting, stating that:
The SEC staff will object to a
conclusion that did not result in the application of Topic 805 to
transactions in which businesses are contributed to a newly formed, jointly
controlled entity if that entity is not a joint venture. The SEC staff also
would object to a conclusion that joint control is the only defining
characteristic of a joint venture.
Changing Lanes
In August 2023, the FASB issued ASU 2023-05, under which an entity
that qualifies as either a joint venture or a corporate joint venture,
as defined in the ASC master glossary, is required to apply a new basis
of accounting upon the formation of the joint venture. Specifically, the
ASU provides that a joint venture or a corporate joint venture
(collectively, “joint ventures”) must initially measure its assets and
liabilities at fair value on the formation date. The amendments in ASU
2023-05 apply to the formation of all joint ventures regardless of
whether the venture meets the definition of a business in ASC 805-10.
Further, under the ASU:
- The formation of a joint venture results in the “creation of a new reporting entity,” and no accounting acquirer is identified under ASC 805. Accordingly, a new basis of accounting is established on the formation date. Paragraph BC23 of the ASU notes that this treatment is “generally consistent with other new basis of accounting models in GAAP, such as fresh-start reporting” under ASC 852.
- A joint venture measures the net assets and liabilities on the formation date, which the ASU defines as “the date on which an entity initially meets the definition of a joint venture.” Thus, the formation date is not necessarily the date on which the legal entity was formed (e.g., the assets of the joint venture may be contributed by one or both of the parties to the joint venture at a later point in time).
- A joint venture may establish a measurement period in a manner consistent with the measurement-period guidance in ASC 805-10 for business combinations when it identifies and measures the net assets received.
- The excess of the fair value of a joint venture as a whole over the net assets of the joint venture is recognized as goodwill. On the formation date, the joint venture’s measurement of its net assets should be “equal to the fair value of 100 percent of [its] equity.” Although the ASU does not preclude a joint venture from recognizing goodwill if it does not meet the definition of a business, paragraph BC48 of the ASU notes, in a manner consistent with the guidance in ASC 805-10-55-9, that “the Board does not expect that an entity that meets the definition of a joint venture will have more than an insignificant amount of goodwill if it does not already meet the definition of a business.”
- In situations in which the net assets of a joint venture exceed the venture’s fair value as a whole, the joint venture is required to recognize any “negative goodwill” as an adjustment to equity.
- The treatment of in-process research and development (IPR&D) contributed to a joint venture at formation is aligned with the treatment of IPR&D acquired in a business combination. Therefore, the joint venture should account for IPR&D as capitalized indefinite-lived intangible assets regardless of whether the R&D asset has an alternative future use.
A joint venture is required to provide specific
disclosures aimed at giving financial statement users a better
understanding of the nature and financial effect of the joint venture’s
formation in the period in which the formation occurred. Those
disclosures should include (1) a description of the joint venture’s
purpose, (2) the fair value of the joint venture on the formation date,
(3) the “amounts recognized by the joint venture for each major class of
assets and liabilities,” and (4) a “qualitative description of the
factors that make up any goodwill recognized.”
See Deloitte’s September 8, 2023, Heads Up,
as well as Deloitte’s Roadmap Equity Method Investments and Joint
Ventures for more information about identifying
joint ventures, joint venture formation transactions, and the newly
issued ASU.
2.3.2 Common-Control Transactions
A common-control transaction is similar to a business combination for the entity that receives the
net assets or equity interests; however, such a transaction does not meet the definition of a business
combination because there is no change in control over the net assets. Therefore, the accounting
and reporting for a transaction between entities under common control is outside the scope of the
business combinations guidance in ASC 805-10, ASC 805-20, and ASC 805-30 and is addressed in the
“Transactions Between Entities Under Common Control” subsections of ASC 805-50. Since there is no
change in control over the net assets from the parent’s perspective, there is no change in the parent’s
basis in the net assets. See Appendix B for more information about common-control transactions.
2.3.3 Common-Ownership Transactions
Common ownership exists when two or more entities have the same shareholders but no one
shareholder controls all of the entities. Transfers of net assets or equity interests among entities that
have common ownership are not common-control transactions. However, they may be accounted for
similarly to common-control transactions if the transfer lacks economic substance. See Appendix B for
more information about common-ownership transactions.
2.3.4 Asset Acquisitions
For an acquisition to meet the definition of a business combination, the net assets acquired must meet
the definition of a business in ASC 805-10 (see Section 2.4). The acquisition of an asset, or a group of
assets, that does not meet the definition of a business is called an asset acquisition and is accounted for
in accordance with the “Acquisition of Assets Rather Than a Business” subsections of ASC 805-50. See
Appendix C for more information about accounting for asset acquisitions.
2.3.5 Combinations of Not-for-Profit Entities
Combinations between not-for-profit entities and acquisitions of for-profit businesses by not-for-profit
entities are not within the scope of ASC 805-10, ASC 805-20, and ASC 805-30, although these subtopics
apply when a for-profit entity acquires a not-for-profit business.
The ASC master glossary defines a not-for-profit entity as follows:
An entity that possesses the following characteristics, in
varying degrees, that distinguish it from a business entity:
-
Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
-
Operating purposes other than to provide goods or services at a profit
-
Absence of ownership interests like those of business entities.
-
All investor-owned entities
-
Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
Combinations between not-for-profit entities or acquisitions of a for-profit business by a not-for-profit
entity are accounted for in accordance with ASC 958-805. In contrast to the FASB’s decision regarding
mergers of equals between for-profit entities (see Section 2.2.3), ASC 958-805 requires that entities
determine whether a combination between not-for-profit entities is a merger or an acquisition. Not-for-profit
entities apply the carryover method to account for a merger and the acquisition method to
account for an acquisition. However, ASC 805-10, ASC 805-20, and ASC 805-30 apply when a for-profit
entity acquires a not-for-profit business.
In May 2019, the FASB issued ASU 2019-06, which extends the private-company accounting alternatives on certain identifiable intangible assets and goodwill to not-for-profit entities. See Chapter 8 of this publication for more information about the accounting alternatives available to not-for-profit entities.
2.3.6 Collateralized Financing Entities
ASU 2014-13 amended ASC 805-10 to exclude from the scope of the business combinations guidance
financial assets and financial liabilities of a consolidated VIE that is a collateralized financing entity within
the scope of the guidance on collateralized financing entities in ASC 810-10. The ASC master glossary
defines a collateralized financing entity as:
A variable interest entity that holds financial assets, issues beneficial interests in those financial assets, and has
no more than nominal equity. The beneficial interests have contractual recourse only to the related assets of
the collateralized financing entity and are classified as financial liabilities. A collateralized financing entity may
hold nonfinancial assets temporarily as a result of default by the debtor on the underlying debt instruments
held as assets by the collateralized financing entity or in an effort to restructure the debt instruments held
as assets by the collateralized financing entity. A collateralized financing entity also may hold other financial
assets and financial liabilities that are incidental to the operations of the collateralized financing entity and have
carrying values that approximate fair value (for example, cash, broker receivables, or broker payables).
2.4 Definition of a Business
In January 2017, the FASB issued ASU 2017-01 to clarify the guidance in ASC 805-10 on evaluating
whether a transaction should be accounted for as an acquisition (or disposition) of assets or a business.
The FASB issued the ASU in response to stakeholder feedback indicating that the previous definition
of a business in ASC 805-10 was being applied too broadly and was difficult and costly to apply. The
amendments to ASC 805-10 were intended to make the application of the guidance more consistent
and cost-efficient. As expected at the time of ASU 2017-01’s issuance, some transactions that would have been accounted for as business combinations under previous guidance are being accounted for as asset acquisitions under ASU 2017-01. See Appendix C of this Roadmap for more information about accounting for asset acquisitions, including the differences between such accounting and the accounting for business combinations.
Under the clarified definition of a business, entities use the screen as
described in ASC 805-10-55-5A through 55-5C, to determine whether an acquired set of assets
and activities is not a business. In accordance with ASU 2017-01, if “substantially all of
the fair value of the gross assets acquired (or disposed of) is concentrated in a single
identifiable asset or a group of similar identifiable assets, the set is not a business.” If
such a concentration is not found, the screen is not met and entities must then apply the
framework discussed in Section
2.4.3 to determine whether the set is a business.
Distinguishing between the acquisition of a business and the acquisition of an asset or a group
of assets is important because there are many differences between the accounting for each. For
example, in a business combination, the assets acquired are recognized at fair value and goodwill
is recognized, whereas in an asset acquisition, the cost of the acquisition is allocated to the assets
acquired on a relative fair value basis and no goodwill is recognized. See Section C.1.1 for a summary
of the differences between the accounting for a business combination and the accounting for an asset
acquisition.
SEC Considerations
SEC registrants are required to use the definition of a business in
SEC Regulation S-X, Rule 11-01(d), when evaluating the requirements of SEC Regulation
S-X, Rule 3-05, and SEC Regulation S-X, Article 11. The definition of a business in Rule
11-01(d) is different from that in ASC 805-10. See Section
2.1 of Deloitte’s Roadmap SEC Reporting Considerations for Business
Acquisitions for more information about the definition of a business
in Rule 11-01(d) and related reporting requirements for SEC registrants.
The flowchart below outlines the application of
the FASB’s guidance on the definition of a business.
2.4.1 Identifying the Activities and Assets of the Acquired Set
To evaluate whether an acquired set of activities and assets meets the definition of a business, an entity
must first identify the set (i.e., what is being exchanged). While the identification of the acquired set is
relatively straightforward in most acquisitions, judgment may be required in some, as discussed below.
2.4.1.1 Employees of the Seller
In some acquisitions, the acquirer obtains control of a legal entity from the seller, and any employees
of that legal entity become employees of the acquirer. In these acquisitions, the acquirer obtains an
organized workforce that is expected to be included in the acquired set.
In other acquisitions, the acquirer obtains control of an asset or a group of
assets, rather than a legal entity, and it must separately hire the employees of the
seller after the acquisition if it seeks to obtain their services. We believe that in
such a case, the determination of whether the acquired set includes those employees
should be based on an evaluation of all relevant facts and circumstances and that such
employees should not be presumptively excluded from the set on the basis of the legal
form of the transaction. Employees of the seller are more likely to be included in the
acquired set when hired in close proximity to the transaction date and when the seller
is involved in facilitating the acquirer’s hiring of the employees, as might be the case
if such hiring is a condition of the closing.
2.4.1.2 Contractual Arrangements Between the Acquirer and a Party Other Than the Seller
Contractual arrangements that are separately negotiated between the acquirer and
a party other than the seller typically are not considered part of the acquired set even
if they are entered into at or around the time of the acquisition or are contingent on
the acquisition. In addition, certain contractual arrangements, even if assumed in the
acquisition, might be excluded from the acquired set when there is substantial
involvement of the acquirer in initiating or modifying the contract that is contingent
on the acquisition such that the contract is effectively between the acquirer and a
party other than the seller.
2.4.1.3 Revenue Arrangements With the Seller
In some acquisitions, the buyer and seller may enter into revenue arrangements at the time of, or in
close proximity to, the acquisition date that will take effect on or after the acquisition date. Paragraph
BC54 of ASU 2017-01 clarifies that “[t]he Board decided to specifically exclude those revenue
arrangements from the analysis of whether a substantive process has been acquired. That is, the Board
decided that a set is not a business just because there is a contract that provides a continuing revenue
stream.”
2.4.1.4 Transactions That Are Separate From the Business Combination
As part of its accounting for an acquisition, an acquirer must assess whether the items
exchanged include amounts that should be accounted for separately from the business
combination. Transactions that are determined to be separate from the business
combination should be excluded from the acquired set. See Section 6.2 for more information.
2.4.2 Single or Similar Assets
ASC 805-10
55-5A If substantially all of the
fair value of the gross assets acquired is concentrated in a single
identifiable asset or group of similar identifiable assets, the set is not
considered a business. Gross assets acquired should exclude cash and cash
equivalents, deferred tax assets, and goodwill resulting from the effects of
deferred tax liabilities. However, the gross assets acquired should include
any consideration transferred (plus the fair value of any noncontrolling
interest and previously held interest, if any) in excess of the fair value of
net identifiable assets acquired.
Once an entity has identified the acquired set, it then evaluates whether that set is not a business on the
basis of the screen in ASC 805-10-55-5A through 55-5C. As noted above, under the screen, “[i]f
substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable
asset or group of similar identifiable assets, the set is not considered a business.” An entity can evaluate
whether the screen is met by applying the following steps:
- Step 1 — Combine the identifiable assets into a single identifiable asset.
- Step 2 — Combine the assets into similar assets.
- Step 3 — Measure the fair value of the gross assets acquired.
- Step 4 — Determine whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets.
An entity must apply the recognition and measurement guidance for business
combinations in ASC 805-10, ASC 805-20, and ASC 805-30 (including any recognition or
measurement exceptions) to perform the screen; however, if the entity determines that the
acquired set is not a business, it should recognize and measure the assets (and
liabilities) in its financial statements by using the principles in ASC 805-50 (or the
guidance in ASC 810-10-30-3 and 30-4 if the entity is a VIE). See Appendix C for more information about
accounting for asset acquisitions, including potential differences in the recognition and
measurement of acquired assets.
2.4.2.1 Step 1 — Combine the Identifiable Assets Into a Single Identifiable Asset
ASC 805-10
55-5B A single identifiable asset
includes any individual asset or group of assets that could be recognized
and measured as a single identifiable asset in a business combination.
However, for purposes of this evaluation, the following should be considered
a single asset:
-
A tangible asset that is attached to and cannot be physically removed and used separately from another tangible asset (or an intangible asset representing the right to use a tangible asset) without incurring significant cost or significant diminution in utility or fair value to either asset (for example, land and building)
-
In-place lease intangibles, including favorable and unfavorable intangible assets or liabilities, and the related leased assets.
The FASB notes in paragraph BC24 of ASU 2017-01 that “[f]or ease of application, the Board decided
that an entity should use the same unit of account when assessing the [screen] that it would use for
identifying assets recognized in a business combination even if it results in some tangible assets and
intangible assets being combined into a single asset.” The FASB reasoned that the assessment related
to the screen should not result in significant incremental costs for acquisitions because entities must
determine the fair value of each asset in both asset acquisitions and business combinations.
ASC 805 provides no specific guidance on determining the unit of account for
identifiable assets, but it offers the following three examples of acquired assets that
may be recognized as a single asset in financial reporting:
-
“[A] group of complementary assets such as a trademark (or service mark) and its related trade name, formulas, recipes, and technological expertise.” (See ASC 805-20-55-18.)
-
A license to operate a nuclear power plant and the power plant. (See ASC 805-20-55-2(b).)
-
An artistic-related copyright “and any related assignments or license agreements.” (See ASC 805-20-55-30.)
In each example, the assets that are combined for financial reporting have
similar useful lives. In addition, we believe that to be combined into a single unit of
account, the assets should have similar methods of amortization, since this would ensure
that they have a similar effect on financial reporting. Determining whether it is
appropriate to combine assets into a single unit of account may require considerable
judgment, particularly when it comes to combining tangible and intangible assets. See
Section 4.10.3 for more
information about determining the unit of account.
While entities should generally apply the same unit of account when both performing the evaluation
required by the screen and recognizing assets in a business combination, ASC 805-10-55-5B provides
two exceptions. The first exception requires entities to combine “[a] tangible asset that is attached to
and cannot be physically removed and used separately from another tangible asset (or an intangible
asset representing the right to use a tangible asset) without incurring significant cost or significant
diminution in utility or fair value to either asset.” In paragraph BC23 of ASU 2017-01, the FASB notes
that it permitted this exception because without it, “the [screen] could not be applied practically in
certain circumstances, such as in the real estate industry where land and buildings are often transferred
together.”
As indicated in ASC 805-10-55-5B(b), the second exception requires entities to combine “[i]n-place
lease intangibles, including favorable and unfavorable intangible assets or liabilities, and the related
leased assets.” This exception was primarily intended to increase consistency in the accounting for real
estate transactions by reducing the likelihood that an acquisition would be accounted for as a business
combination simply because a lease was in a sought-after location and had significant in-place value or
because a lease had above- or below-market rents.
We do not believe that entities should combine other assets by analogy to these
exceptions in ASC 805-10-55-5B. For example, it would not be appropriate to combine a
hotel and its related brand name or to combine a wind or solar farm and a related power
purchase agreement if the power purchase arrangement does not meet the definition of a
lease.
Entities should combine identifiable assets that meet the exceptions (e.g., land
and building or in-place lease intangible asset and the related leased assets) only when
evaluating the screen; for other purposes, such assets typically should be recognized
separately regardless of whether the acquired set is a business or a group of assets.
For example, while a building and an in-place lease would be combined in the evaluation
required by the screen, they would be recognized separately for financial reporting
purposes.
The table below summarizes the examples in ASC
805-10-55-52 through 55-87 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes
whether to combine assets into a single identifiable asset.
Case | Facts | Can Some or All of the Identifiable Assets
Be Combined Into a Single Identifiable
Asset? |
---|---|---|
Case A: Acquisition of Real
Estate (Scenario 1 in ASC 805-10-55-52 through 55-54) | Acquisition of a portfolio of single-family
homes that each have an
in-place lease. Each single-family
home includes the land, building, and
property improvements. |
Yes. The building and property improvements are attached
to the land, and the entity cannot remove them without incurring significant
cost. The in-place lease is an intangible asset that should be combined with
the related real estate asset and considered a single asset.
|
Case B: Acquisition of a Drug
Candidate (Scenario 1 in ASC 805-10-55-65 and 55-66) | Acquisition of a biotech entity that contains the rights to a phase 3 compound.
Included in the IPR&D project is the historical know-how, formula
protocols, designs, and procedures expected to be needed to complete the
related phase of testing. | Yes. The IPR&D is an identifiable asset that
would be accounted for as a single asset. |
Case D: Acquisition
of a Television
Station (ASC 805-10-
55-73 through 55-76) | Acquisition of an FCC license,
broadcasting equipment, and an
office building. | No. The acquired assets cannot be combined into a single asset in accordance
with the guidance in ASC 805-10-55-5B(a). |
Case E: Acquisition
of a Manufacturing
Facility (ASC 805-10-
55-77 through 55-81) | Acquisition of idled equipment and
facility (land and buildings). | No. The equipment and facility cannot be combined into a single asset in
accordance with the guidance in ASC 805-10-55-5B(a). |
Case G: Acquisition
of Brands
(ASC 805-10-55-85
through 55-87) | Acquisition of intellectual property
(the trademark, related trade name,
and recipes), customer contracts
and relationships, finished goods
inventory, supply contracts, and
equipment. | Yes. The intellectual property associated with
the brand (i.e., the trademark, the related
trade name, and recipes) is determined to be
a single intangible asset in accordance with the
guidance in ASC 805-20-55-18. |
2.4.2.2 Step 2 — Combine the Assets Into Similar Assets
ASC 805-10
55-5C A group of similar assets
includes multiple assets identified in accordance with paragraph
805-10-55-5B. When evaluating whether assets are similar, an entity should
consider the nature of each single identifiable asset and the risks
associated with managing and creating outputs from the assets (that is, the
risk characteristics). However, the following should not be considered
similar assets:
-
A tangible asset and an intangible asset
-
Identifiable intangible assets in different major intangible asset classes (for example, customer-related intangibles, trademarks, and in-process research and development)
-
A financial asset and a nonfinancial asset
-
Different major classes of financial assets (for example, accounts receivable and marketable securities)
-
Different major classes of tangible assets (for example, inventory, manufacturing equipment, and automobiles)
-
Identifiable assets within the same major asset class that have significantly different risk characteristics.
In accordance with ASC 805-10-55-5C, if the acquired set includes multiple assets, entities should
combine the assets that qualify for combination as similar assets. Paragraph BC28 of ASU 2017-01
states, in part:
If an entity acquires, for example, multiple versions of substantially the same asset type instead of precisely one
asset, the Board noted that should not disqualify the acquired items from being considered assets. The Board
added that this could help alleviate pressure around what is a single asset because some stakeholders may
conclude that they will be required to separate what is typically a single unit of account into multiple units of
account (for example, separating a customer list into 1,000 different assets because there are 1,000 different
customers).
Although the FASB does not define the term “similar” in ASC 805-10-55-5C, the
guidance provides examples of assets that cannot be considered similar. For
example, entities cannot combine financial assets with nonfinancial assets or tangible
assets with intangible assets. However, assets that are combined under ASC 805-10-55-5B
into a single identifiable asset can continue to be combined. For example, if entities
combine a building and an in-place lease intangible asset into a single identifiable
asset in step 1, they can continue to combine those assets in applying this step even
though tangible and intangible assets cannot be combined into similar assets.
In addition, different major classes of the following asset types cannot be
combined into similar assets:
-
Identifiable intangible assets (e.g., customer-related intangibles, trademarks, and IPR&D).
-
Financial assets (e.g., accounts receivable and marketable securities).
-
Tangible assets (e.g., inventory, manufacturing equipment, and automobiles).
Entities may need to use judgment when determining whether financial assets,
tangible assets, or intangible assets are in the same major class of asset. The ASC
master glossary defines an intangible asset class as “[a] group of intangible assets
that are similar, either by their nature or by their use in the operations of an
entity,” and ASC 350-30-50-1 requires entities to provide disclosures about the amounts
assigned to each major intangible asset class. Accordingly, while the FASB does not
specifically define major classes of tangible assets and financial assets, we believe
that an entity performing the screen should consider the definition of intangible asset
class as well as its ASC 350-30 disclosures when assessing its major classes of
assets.
Further, ASC 805-10-55-5C states that entities cannot combine identifiable
assets within the same major asset class if the assets have “significantly different
risk characteristics.” Paragraph BC31 of ASU 2017-01 states, in part:
The Board clarified that the risks to be evaluated should be linked
to the risks associated with the management of the assets and creation of outputs
because this assessment may be instructive on whether an integrated set of assets and
activities has been acquired. That is, when the risks associated with managing and
creating outputs from the assets are significantly different, the set would need more
sophisticated processes to manage and create outputs.
Entities in different industries are typically affected by different types of risks. For example, in the
real estate industry, entities may consider risk characteristics associated with the type of property
(e.g., commercial vs. residential), size (e.g., single tenant vs. multitenant), geographic location (e.g., high-growth
areas vs. low-growth areas), and class of customer (e.g., high default-risk tenants vs. low
default-risk tenants). By contrast, in the life sciences industry, entities may evaluate risk characteristics
associated with the stage of drug development (e.g., compounds in early development stages vs.
later stages), class of customer (e.g., compounds that treat one medical condition vs. another medical
condition), and market risk (e.g., products for use in the United States vs. outside the United States).
Entities should consider all relevant facts and circumstances in making their determination.
The table below summarizes the examples in ASC
805-10-55-52 through 55-92 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes
whether assets are similar.
Case | Facts | Can Some or All of the Identifiable Assets
Be Combined as Similar Assets? |
---|---|---|
Case A: Acquisition of Real
Estate (Scenario 1 in ASC 805-10-55-52 through 55-54) (Scenario 2 in ASC 805-10-55-55 through 55-61) | Acquisition of a portfolio of single-family
homes that all have in-place
leases. Each home has a different
floor plan, square footage, lot, and
interior design. | Yes. The risks associated with operating
the properties and managing and acquiring
tenants are not significantly different. |
Acquisition of a portfolio of single-family
homes and an office park with
multiple office buildings. |
No. The risks associated with operating the assets and
obtaining and managing tenants are significantly different for the
single-family homes and the office park.
| |
Case B: Acquisition of a Drug
Candidate (Scenario 2 in ASC 805-10-55-67 through 55-69) | Acquisition of a biotech entity with
two IPR&D projects that are in
different phases of development and
that would treat significantly different
medical conditions. | No. The two IPR&D projects are not similar
assets because each has significantly different
risks associated with creating outputs and with
developing and marketing the compound to
customers (i.e., the projects are intended to
treat significantly different medical conditions,
and each project has a significantly different
potential customer base and different
expected market and regulatory risks). |
Case C: Acquisition
of Biotech
(ASC 805-10-55-70
through 55-72) | Acquisition of a biotech entity with
several IPR&D projects that are in
different phases of the FDA approval
process and that would treat
significantly different diseases. | No. The IPR&D projects are not similar assets
because each has significantly different risks
associated with managing the assets and
creating the outputs (i.e., there are significantly
different development risks, because of the
different phases of development, and market
risks, because of the different customer bases
and potential markets for the compounds). |
Case D: Acquisition
of a Television
Station (ASC 805-10-
55-73 through 55-76) | Acquisition of an FCC license,
broadcasting equipment, and an
office building. | No. The acquired assets are not similar assets because the FCC license cannot be considered similar to the tangible assets and the tangible assets are in different major asset classes. |
Case E: Acquisition
of a Manufacturing
Facility (ASC 805-10-
55-77 through 55-81) | Acquisition of idled equipment and
facility (land and buildings). | No. The acquired assets are not similar assets
because the manufacturing equipment and
facility are in different major classes of tangible
assets. |
Case F: License of
Distribution Rights
(ASC 805-10-55-82
through 55-84) | Acquisition of distribution rights,
customer contracts, and an at-market
supply agreement. | No. The acquired assets that have fair value
assigned to them (e.g., the distribution license
and customer contracts) are not considered
similar assets because they are in different
major classes of identifiable intangible assets. |
Case H: Acquisition of Loan
Portfolio (Scenario 1 in ASC 805-10-55-88 and 55-89) (Scenario 2 in ASC 805-10-55-90 through 55-92) | Acquisition of a portfolio of residential
mortgage loans. | Yes. The loans represent similar assets
because their terms, sizes, and risk ratings are
not significantly different and thus the risks
associated with managing and creating outputs
are not significantly different. |
Acquisition of a portfolio of
commercial loans. | No. The loans do not represent similar assets
because their terms, sizes, and risk ratings are
significantly different, and therefore the risks
associated with managing them and creating
outputs are significantly different. |
2.4.2.3 Step 3 — Measure the Fair Value of the Gross Assets Acquired
The measurement of the fair value of gross assets acquired, which is used in determining whether
substantially all of the fair value is concentrated in a single identifiable asset or group of similar
identifiable assets, includes any noncontrolling interests in a partial acquisition and any previously
held interests in a step acquisition. Specifically, the measurement will include (1) any consideration
transferred in excess of the fair value of the net identifiable assets acquired (i.e., goodwill in a business
combination) and (2) any value attributable to an assembled workforce (since it is subsumed into
goodwill).
The measurement of gross assets acquired excludes cash and cash equivalents (including restricted
cash), deferred tax assets, and goodwill resulting from the effects of deferred tax liabilities. As stated in
paragraph BC27 of ASU 2017-01:
The Board concluded that deferred taxes should be excluded from the evaluation of the [screen]. That is,
any value associated with deferred tax assets and the effects of deferred tax liabilities on gross assets would
be excluded from gross assets acquired. The Board reasoned that the tax form of the transaction that often
dictates the amount of deferred taxes in the transaction should not affect the determination of whether the
transaction is a business.
In addition, as described in Section 2.4.1.4, entities should exclude any amounts related to
transactions that are separate from the acquisition (e.g., arrangements that represent
compensation for future services).
With the exception of unfavorable lease liabilities that are combined with the
related leased asset under ASC 805-10-55-5B(b), the calculation of gross assets acquired
excludes debt and other liabilities. Paragraph BC20 of ASU 2017-01 states that “[t]he
Board reached this conclusion to avoid the existence of debt (for example, a building
with a mortgage) or other liabilities affecting the analysis of whether the [screen] has
been met. That could potentially result in a group of assets that would otherwise be
subject to further evaluation under the model bypassing such evaluation solely because a
transaction includes liabilities in addition to assets.”
The requirement to exclude liabilities also applies to asset retirement obligations
(AROs) related to assets included in the acquired set. For example, assume that Company
A acquires Company B, a utility, in a transaction that is accounted for as a business
combination. Company A determines that an ARO exists related to B’s facility and
estimates the ARO’s fair value to be $25 million. Company A estimates the fair value of
the facility to be $100 million, meaning that the value of the facility would be $25
million higher if the costs associated with the ARO were ignored. Accordingly, in
determining the single identifiable asset or similar assets and the gross assets
acquired, A would use $125 million. See Section
4.8.1 for more information about assets subject to AROs.
ASC 805-10-55-5A states that gross assets “should include any consideration
transferred . . . in excess of the fair value of net identifiable assets acquired,” but
it does not address whether the screen should include any deficit (i.e., bargain
purchase gains). We believe that bargain purchase gains should be excluded from the
screen because their inclusion would distort the calculation in a manner similar to the
inclusion of liabilities.
2.4.2.4 Step 4 — Determine Whether Substantially All of the Fair Value of the Gross Assets Acquired Is Concentrated in a Single Identifiable Asset or Group of Similar Identifiable Assets
The term “substantially all” is used throughout GAAP (e.g., in ASC 810, ASC 606,
and ASC 842) and is generally interpreted to mean 90 percent or more. However, the FASB
did not intend that entities treat the term as a bright line; thus, judgment must be
applied in circumstances in which the quantitative result of the screen is close to 90
percent. In such cases, entities might consider other evidence to support their
evaluation. For example, the following may be indicators that a set is a business:
-
The set includes many different types of assets (whereas a set with only a few assets may be more indicative of a group of assets).
-
The set includes an organized workforce or other substantive processes.
-
The set has outputs.
-
The set includes a significant amount of goodwill.
-
The set can operate independently on a stand-alone basis.
If the quantitative result is close to 90 percent, the presence of one or more
of these indicators might warrant a determination that the screen is not met. In that
case, entities should apply the framework to determine whether the set is a
business.
Entities may be able to perform the screen qualitatively or bypass it in certain
circumstances. See Section
2.4.2.6 for more information.
2.4.2.5 Illustration of the Screen
The example below illustrates how the steps described above are used in the screen.
Example 2-1
Company A acquires Company B for $5 million in a nontaxable acquisition. Company B is in the real estate
industry and owns an apartment complex. As part of the transaction, A assumes a property management
contract that was in place between B and a third-party property manager for three years before the acquisition.
The pricing of the property management contract is favorable to A in terms of current market rates. Company A
measures and recognizes the assets acquired and liabilities assumed at fair value as follows:
Step 1
Company A applies step 1 (see Section 2.4.2.1) and determines that the building, land, and in-place lease
intangible asset are identifiable assets that qualify for combination into a single identifiable asset as follows:
Step 2
Company A applies step 2 (see Section 2.4.2.2) and concludes that none of the remaining assets (i.e., cash,
furniture or fixtures, or the intangible asset for the favorable property management contract) qualify for
combination as similar assets under ASC 805-10-55-5B.
Step 3
Company A applies step 3 (see Section 2.4.2.3) and concludes that the gross assets acquired include any
consideration transferred in excess of the fair value of the net identifiable assets acquired (i.e., goodwill in a
business combination), but it does not include goodwill that results from the effects of deferred tax liabilities,
cash and cash equivalents, deferred taxes, or liabilities. Company A calculates the fair value of gross assets
acquired as follows:
Step 4
Company A applies step 4 (see Section 2.4.2.4) and compares the fair value of the single
identifiable asset (or group of similar assets), measured in step 2, to the
fair value of the gross assets acquired, measured in step 3.
While “substantially all” is generally interpreted to mean 90 percent or more in the definition of a business, it is
not a bright line. Since 90.4 percent is only slightly above 90 percent, A might consider the qualitative factors in
assessing whether the screen has been met.
For example, A might consider the nature of the acquired assets and liabilities, all of which are directly related
to the apartment complex. Although A did not acquire any employees, it might consider whether the property
management contract it obtained gives it access to an organized workforce, which could be an indicator that
A has acquired a substantive process. In this case, A concludes that the contract is not unique or scarce and
could be replaced without significantly delaying its ability to continue earning revenues. However, it decides
not to replace the property manager because the pricing in the contract is favorable to A compared with the
pricing it would be able to obtain on the acquisition date. In addition, A notes that if it had assumed that the
acquisition were a business, the amount of goodwill measured would not be a significant amount. Company A
believes that the qualitative factors support a determination that the screen is met and that the transaction is
an asset acquisition.
2.4.2.6 Assessing the Screen Qualitatively
In some instances, an entity may be able to determine that the screen has been
met solely on the basis of qualitative factors. For example, if the acquisition includes
a license for a drug candidate and an at-market contract that would have no fair value
assigned to it, it may be clear that the screen has been met. By contrast, an entity may
often be able to qualitatively determine that the screen has not been met if
there is clearly significant value in assets that are not similar. Paragraph BC19 of ASU
2017-01 states, in part:
In addition, an entity also could conclude
that the set is not a business by assessing the guidance in
paragraphs 805-10-55-5D through 55-6 and 805-10-55-8 through 55-9. The Board noted
that if the set is not a business, an entity could choose to
document its conclusion in the most cost-effective manner depending on its situation.
[Emphasis added]
Therefore, entities may bypass the screen and proceed directly to the framework (see Section 2.4.3)
as long as the set is determined not to be a business under the framework. However, entities may not
bypass the screen and apply the framework to conclude that a set is a business since that determination
may contradict the conclusion that would have been made by applying the screen.
2.4.3 Framework for Assessing Whether an Input and a Substantive Process Are Present
ASC 805-10
55-5 To be capable of being conducted
and managed for the purposes described in paragraph 805-10-55-3A, an
integrated set of activities and assets requires two essential elements —
inputs and processes applied to those inputs. A business need not include all
the inputs or processes that the seller used in operating that business.
However, to be considered a business, the set must include, at a minimum, an
input and a substantive process that together significantly contribute to the
ability to create output. Paragraphs 805-10-55-5A through 55-5C provide a
practical screen to determine when a set would not be considered a business.
If the screen is not met, further assessment is necessary to determine whether
the set is a business. Paragraphs 805-10-55-5D through 55-6 and 805-10-55-8
through 55-9 provide a framework to assist an entity in evaluating whether the
set includes both an input and a substantive process.
55-8 Determining whether a particular
set of assets and activities is a business should be based on whether the
integrated set is capable of being conducted and managed as a business by a
market participant. Thus, in evaluating whether a particular set is a
business, it is not relevant whether a seller operated the set as a business
or whether the acquirer intends to operate the set as a business.
If the screen is not met, entities must determine whether the acquired set includes, at a minimum, an
input and a substantive process that together significantly contribute to the ability to create outputs.
ASC 805-10-55 provides a framework for making that judgment.
The assessment of whether a set meets the definition of a business under the
framework should be based on whether a market participant would be capable of conducting
and managing the set as a business. Neither how the seller operated the set nor how the
acquirer intends to operate it is relevant in making the determination. For example, if an
acquirer obtains a set with operations that are similar to its own, its plans to integrate
the set into its operations and use its own processes to continue the production of
outputs are not relevant in the determination of whether a substantive process was
acquired.
ASU 2017-01 eliminated the need to assess whether a market participant is
capable of replacing any missing elements to continue the production of outputs.
Therefore, entities must now focus their analysis on what was acquired and no longer on
whether a market participant could potentially replace missing elements.
2.4.3.1 Identify the Elements of a Business
ASC 805-10
55-3A A business is an integrated
set of activities and assets that is capable of being conducted and managed
for the purpose of providing a return in the form of dividends, lower costs,
or other economic benefits directly to investors or other owners, members,
or participants. To be considered a business, an integrated set must meet
the requirements in paragraphs 805-10-55-4 through 55-6 and 805-10-55-8
through 55-9.
55-4 A business consists of inputs
and processes applied to those inputs that have the ability to contribute to
the creation of outputs. Although businesses usually have outputs, outputs
are not required for an integrated set to qualify as a business. The three
elements of a business are defined as follows:
-
Input. Any economic resource that creates, or has the ability to contribute to the creation of, outputs when one or more processes are applied to it. Examples include long-lived assets (including intangible assets or rights to use long-lived assets), intellectual property, the ability to obtain access to necessary materials or rights, and employees.
-
Process. Any system, standard, protocol, convention, or rule that when applied to an input or inputs, creates or has the ability to contribute to the creation of outputs. Examples include strategic management processes, operational processes, and resource management processes. These processes typically are documented, but the intellectual capacity of an organized workforce having the necessary skills and experience following rules and conventions may provide the necessary processes that are capable of being applied to inputs to create outputs. Accounting, billing, payroll, and other administrative systems typically are not processes used to create outputs.
-
Output. The result of inputs and processes applied to those inputs that provide goods or services to customers, investment income (such as dividends or interest), or other revenues.
55-6 The nature of the elements of
a business varies by industry and by the structure of an entity’s operations
(activities), including the entity’s stage of development. Established
businesses often have many different types of inputs, processes, and
outputs, whereas new businesses often have few inputs and processes and
sometimes only a single output (product). Nearly all businesses also have
liabilities, but a business need not have liabilities. In addition, some
transferred sets of assets and activities that are not a business may have
liabilities.
Both a business and an asset or a group of assets possess one or more inputs. As indicated in ASC
805-10-55-4, what distinguishes a business from an asset or a group of assets is that “[a] business
consists of inputs and processes applied to those inputs that have the ability to contribute to the
creation of outputs.”
According to ASC 805-10-55-4(b), a process is “[a]ny system, standard, protocol, convention, or rule that
when applied to an input or inputs, creates or has the ability to contribute to the creation of outputs.”
Examples of processes include:
- Strategic management processes — for setting the overall strategy and direction of operations.
- Operational processes — for obtaining contracts or customers, or developing, fulfilling, or producing outputs.
- Resource management processes — for obtaining inventory and managing operational employees.
While processes are usually documented, they do not need to be. For example, employees are an input,
but they may form an organized workforce whose knowledge and ability may be considered a process,
even if that process is not documented.
Determining whether a substantive process is present in a set can be challenging. ASC 805-10-55
provides guidance for making that judgment in response to the practice issues that existed under the
previous definition of a business. According to the revised guidance, only processes that are used in the
creation of outputs should be considered substantive under the definition of a business. For example,
accounting, billing, payroll, and other administrative systems typically are not used to create outputs.
While acquiring a contract that gives access to an organized workforce may
represent the acquisition of a substantive process, ASC 805-10-55-5F states that assumed
contracts that provide for a continuation of revenues — such as customer contracts,
customer lists, and leases (from the lessor’s perspective) — should not be considered
acquired processes and should be excluded from the analysis.
To help reduce the likelihood that a transaction is inappropriately accounted
for as a business acquisition, the Board emphasized in paragraph BC35 of ASU 2017-01
that a process must be important to the ability to create outputs. While ASC 805-10-55-5
notes that a “business need not include all the inputs or processes that the seller used
in operating that business . . . to be considered a business, the set must include, at a
minimum, an input and a substantive process that together significantly contribute to
the ability to create output.”
As indicated in ASC 805-10-55-4(c), outputs are “[t]he result of inputs and processes applied to those
inputs that provide goods or services to customers, investment income (such as dividends or interest),
or other revenues.” ASU 2017-01 narrowed the definition of outputs to align it with the ability to
generate goods or services for customers and make it consistent with the description of outputs in ASC
606. However, as discussed in paragraph BC59 of the ASU, “the Board noted that not all entities have
revenues within the scope of Topic 606 and therefore, decided to incorporate other types of revenues
in the definition. For example, the Board decided to include the reference to investment income in the
definition of outputs in the amendments . . . to ensure that the purchase of an investment company can
still qualify as a business combination.”
Although outputs are not required for a set to be a business, ASC 805-10-55 provides different criteria
for determining whether a set has one or more substantive processes, depending on whether the set
has outputs (i.e., a continuation of revenues before and after the acquisition). Because outputs are
usually a fundamental element of a business, the Board reasoned that if there are no outputs, the
other elements should be more significant. Therefore, the guidance includes more stringent criteria on
what is required for a set to have a substantive process when outputs are not present.
ASC 805-10-55 does not specify the amount of outputs an entity should consider when assessing whether to apply the criteria for a set without outputs rather than a set with outputs. We believe that when determining which criteria to apply, an entity may need to use judgment. For example, if an acquired a set has only an insignificant amount of outputs (i.e., revenues), it may be appropriate for an entity to evaluate the criteria for a set without outputs to determine whether a substantive process exists.
2.4.3.2 Sets Without Outputs
ASC 805-10
55-5D When a set does not have
outputs (for example, an early stage company that has not generated
revenues), the set will have both an input and a substantive process that
together significantly contribute to the ability to create outputs only if
it includes employees that form an organized workforce and an input that the
workforce could develop or convert into output. The organized workforce must
have the necessary skills, knowledge, or experience to perform an acquired
process (or group of processes) that when applied to another acquired input
or inputs is critical to the ability to develop or convert that acquired
input or inputs into outputs. An entity should consider the following in
evaluating whether the acquired workforce is performing a substantive
process:
-
A process (or group of processes) is not critical if, for example, it is considered ancillary or minor in the context of all the processes required to create outputs.
-
Inputs that employees who form an organized workforce could develop (or are developing) or convert into outputs could include the following:
-
Intellectual property that could be used to develop a good or service
-
Resources that could be developed to create outputs
-
Access to necessary materials or rights that enable the creation of future outputs.
Examples of inputs that could be developed include technology, mineral interests, real estate, and in-process research and development. -
ASC 805-10-55-5D states that if a set does not have outputs, a substantive process can only be provided
by employees that form an organized workforce with “the necessary skills, knowledge, or experience
to perform an acquired process (or group of processes) that when applied to another acquired input
or inputs is critical to the ability to develop or convert that acquired input or inputs into outputs.” ASC
805-10-55 does not provide guidance on determining whether employees are providing a “critical”
process, except to say that “[a] process (or group of processes) is not critical if, for example, it is
considered ancillary or minor in the context of all the processes required to create outputs.” Accordingly,
entities will need to use judgment in determining whether a process is critical.
While an organized workforce is an input, it is the workforce’s ability to make
the set active that must be evaluated as a substantive process. In paragraph BC41 of ASU
2017-01, the Board explained:
If there is no organized workforce to
perform an acquired process, the set on its own likely would not be able to actively
contribute to the creation of outputs because the acquirer has to provide all of the
activities to perform the process. For example, . . . without an organized workforce,
an entity could conclude that the acquisition of a blueprint for an airplane includes
a substantive process. When the set does not have outputs, . . . the process embedded
in that blueprint is not substantive unless there is an organized workforce that could
make the set active and contribute to the production of the airplane.
The determination of whether an organized workforce is performing a critical
process requires judgment and varies from transaction to transaction and from industry
to industry. Entities should evaluate whether the process (or group of processes) is
critical in the context of all the processes required to create outputs. If the process
(or group of processes) is considered ancillary or minor in that context, it is not
critical. The following factors may be indicators that the acquired organized workforce
has the necessary skills, knowledge, or experience to perform a critical process (none
of the factors below are individually determinative):
- Composition and size of the workforce — Generally, the greater the number of employees in an organized workforce, the more likely the process (or group of processes) they perform is critical. However, the composition of the workforce also needs to be considered. That is, a large number of employees that perform ancillary or minor tasks may not have the requisite skills, knowledge, or experience to perform a critical process. By contrast, a small number of employees that have significant skills, knowledge, or experience may perform a process critical to the development of outputs.
- Ability for the set to operate independently — A set that includes an organized workforce that was operating independently before the acquisition may be an indicator that the organized workforce is performing a critical process (or group of processes).
- Significant amount of goodwill — A set that includes a significant amount of goodwill may be an indicator that the organized workforce has the necessary skills, knowledge, or experience to perform a critical process (or group of processes).
- Advanced stage of activities — A set that includes an organized workforce that is in advanced stages of converting acquired inputs into outputs (i.e., generating revenues) may be an indicator that the processes being performed by the employees are critical. For example, if an acquired set is close to generating revenues on a stand-alone basis and the acquirer does not anticipate the need to add a significant number of employees with requisite skills, knowledge, or experience, this may indicate that the organized workforce is performing a critical process (or group of processes).
When an entity obtains access to an organized workforce as a result of an
acquired contractual arrangement, the entity cannot consider such workforce to be an
acquired substantive process if outputs are not present. The Board indicated in
paragraph BC47 of ASU 2017-01 that:
[W]ithout an employee to manage
the performance of the vendor, there are inherent limitations on the processes that
can be performed in a development capacity without further decision making or actions
from an employee. In contrast, when a vendor is actively contributing to and
continuously creating outputs (for example, an asset manager that continuously manages
an investment portfolio and generates investment revenues), the Board concluded that
the process performed by the service provider is more likely to be substantive and
should still be a factor to consider when the set has outputs.
However, the management of service providers could be considered a critical process performed by
employees. In paragraph BC48 of ASU 2017-01, the Board noted that “as an example, an entity should
come to consistent conclusions when evaluating a set that has 100 employees and a set that has
20 employees with the equivalent of 80 employees replaced by outsourced service providers because
the 20 employees would be responsible for the management and performance of the outsourced
employees.” If a set without outputs includes both employees and an outsourced workforce, entities
must use judgment to determine whether the employees represent an organized workforce that
provides a substantive process.
Under ASC 805-10-55-5D(b), for a set without outputs to be a business,
it must contain both an organized workforce performing a substantive process and
“[i]nputs that employees who form an organized workforce could develop (or are
developing) or convert into outputs.” The acquisition of an organized workforce alone is
not sufficient to conclude that a set is a business.
The table below summarizes the examples in ASC
805-10-55-65 through 55-81 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes
whether a set without outputs is a business.
Case | Facts | Does the Set Without Outputs Have an
Input and a Substantive Process? |
---|---|---|
Case B: Acquisition
of a Drug Candidate
(Scenario 2 in
ASC 805-10-55-65
through 55-69) | Acquisition of a legal entity that
contains the rights to two phase 3
compounds; each is being developed
to treat a different medical condition.
The set is not yet producing outputs.
No employees, other assets, or other
activities are transferred. | No. The set includes inputs but not a
substantive process, since no employees
are acquired as part of the transaction. An
organized workforce must be present for a set
without outputs to have a substantive process. |
Case C: Acquisition
of Biotech
(ASC 805-10-55-70
through 55-72) | Acquisition of a biotech with several IPR&D projects that are in different
phases of the FDA approval process and that would treat significantly
different diseases. The set includes senior management and scientists who
have the necessary skills, knowledge, or experience to perform R&D
activities. It is not yet generating revenues. | Yes. The set includes inputs and a substantive
process, since senior management and the
scientists form an organized workforce that is
critical to the ability to develop the inputs into a
product that will be provided to customers. |
Case D: Acquisition of a
Television Station (ASC 805-10-55-73 through 55-76) | Acquisition of an FCC license,
broadcasting equipment, and an
office building. No employees will
be transferred and the set is not
producing outputs. | No. The set includes inputs but not a
substantive process, since the set does not
include an organized workforce. An organized
workforce must be present for a set without
outputs to have a substantive process. |
Case E: Acquisition of a
Manufacturing Facility (ASC 805-10-55-77 through 55-81) | Acquisition of an idled manufacturing
facility and related equipment but
no intellectual property, inventory,
customer relationships, or other
inputs. To comply with local labor
laws, the set must include the
furloughed employees. | No. The set includes an organized workforce
with the skills to use the equipment but not the
necessary intellectual property or other inputs
that could be converted into outputs by using
the equipment. |
2.4.3.3 Sets With Outputs
ASC 805-10
55-5E When the set has outputs (that is, there is a
continuation of revenue before and after the transaction), the set will have
both an input and a substantive process that together significantly
contribute to the ability to create outputs when any of the following are
present:
- Employees that form an organized workforce that has the necessary skills, knowledge, or experience to perform an acquired process (or group of processes) that when applied to an acquired input or inputs is critical to the ability to continue producing outputs. A process (or group of processes) is not critical if, for example, it is considered ancillary or minor in the context of all of the processes required to continue producing outputs.
- An acquired contract that provides access to an organized workforce that has the necessary skills, knowledge, or experience to perform an acquired process (or group of processes) that when applied to an acquired input or inputs is critical to the ability to continue producing outputs. An entity should assess the substance of an acquired contract and whether it has effectively acquired an organized workforce that performs a substantive process (for example, considering the duration and the renewal terms of the contract).
- The acquired process (or group of processes) when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and cannot be replaced without significant cost, effort, or delay in the ability to continue producing outputs.
- The acquired process (or group of processes) when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and is considered unique or scarce.
55-5F If a set has
outputs, continuation of revenues does not on its own indicate that both an
input and a substantive process have been acquired. Accordingly, assumed
contractual arrangements that provide for the continuation of revenues (for
example, customer contracts, customer lists, and leases [when the set is the
lessor]) should be excluded from the analysis in paragraph 805-10-55-5E of
whether a process has been acquired.
Like a set without outputs, a set with outputs is a business if it includes, at a minimum, both an input
and a substantive process that together significantly contribute to the ability to create outputs. A set has
outputs if there is a continuation of revenue before and after the transaction. While the continuation
of revenues alone does not mean that a set is a business, the Board concluded in paragraph BC51 of
ASU 2017-01 that a set with outputs is more likely to include an input and substantive process than a
set without outputs. Therefore, the criteria for determining whether a substantive process is present are
less stringent than those for a set that is not producing outputs. According to ASC 805-10-55-5E, when a
set has outputs, a substantive process may be provided by any of the following:
- “[E]mployees that form an organized workforce.”
- “[A]n acquired contract that provides access to an organized workforce.”
- A process (or group of processes) that, “when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and cannot be replaced without significant cost, effort, or delay in the ability to continue producing outputs.”
- A process (or group of processes) that, “when applied to an acquired input or inputs significantly contributes to the ability to continue producing outputs and is considered unique or scarce.”
As indicated by that guidance, an organized workforce “must have the necessary
skills, knowledge, or experience to perform an acquired process (or group of processes)
that when applied to another acquired input or inputs is critical to the ability to
develop or convert that acquired input or inputs into outputs.”
The determination of whether an organized workforce is performing a critical
process requires judgment and varies from transaction to transaction and from industry
to industry. Entities should evaluate whether the process (or group of processes) is
critical in the context of all the processes required to create outputs. If that process
(or group of processes) is considered ancillary or minor in that context, it is not
critical. We generally believe that entities should consider the same factors described
in Section 2.4.3.2 to
determine whether an organized workforce in a set with outputs has the necessary skills,
knowledge, or experience to perform a critical process (or group of processes).
Many industries outsource operating activities that may not be significantly
different from those that would be performed by employees (e.g., contract manufacturers
or property managers). When a set has outputs, an entity must evaluate acquired
contracts to determine whether they represent an acquired substantive process or,
possibly, an input. Paragraph BC46 of ASU 2017-01 states:
The Board
concluded that the assessment of a contractual arrangement, such as a supply
agreement, should be relatively straightforward, meaning those contracts would likely
be inputs because the supplier is not applying a process to another input in the set.
However, the Board rejected the view that a service provided through a contractual
arrangement should never indicate that a substantive process was acquired. The Board
observed that there are many industries in which operating activities are outsourced,
and the activities performed by a service provider may not be significantly different
than the activities that would be performed by employees. The Board acknowledges that
in some circumstances, whether an organized workforce accessed through a contractual
arrangement performs or provides a process could be subjective and the critical factor
to determining whether a set is a business.
Therefore, when a set has outputs, entities must use judgment in determining whether an
acquired contract that provides access to an organized workforce also represents a
substantive process. Entities should consider the substance of the contract, including:
-
The nature of the activities performed by the outsourced workforce.
-
The duration and the renewal terms of the contract.
-
Whether the outsourced workforce is critical to the ability to continue producing outputs.
-
Whether the outsourced workforce could be replaced without significant cost, effort, or delay in the ability to continue producing outputs.
As part of an acquisition, the buyer and seller may agree that the seller will provide
services to the buyer after the acquisition. Such an arrangement, commonly referred to
as a transition services agreement or a TSA, specifies the period of services and the
fee to be paid by the buyer. We believe that a TSA typically does not give the acquirer
access to an organized workforce that represents a substantive process because the
services provided under a TSA are often limited both in duration and scope.
A substantive process may also be present without an organized workforce when a set has outputs.
For example, a set may have one or more automated processes through acquired technology or
infrastructure (e.g., automated technology, or a manufacturing or production line). In accordance with
ASC 805-10-55-5E, for an automated process to be considered substantive, (1) it must significantly
contribute “to the ability to continue producing outputs” when applied to an input or inputs and (2) the
acquirer cannot have the ability to replace it “without significant cost, effort, or delay in the ability to
continue producing outputs,” or it must be “unique or scarce.”
The table below summarizes the examples in ASC
805-10-55-52 through 55-96 (see Section 2.4.4), which illustrate scenarios in which an entity analyzes
whether a set with outputs is a business.
Case | Facts | Does the Set With Outputs Have an Input
and a Substantive Process? |
---|---|---|
Case A: Acquisition of Real
Estate (Scenario 2 in ASC 805-10-55-52 through 55-64)
(Scenario 3 in
ASC 805-10-55-52
through 55-64) | Acquisition of a portfolio of single-family
homes, an office park with
multiple office buildings, and vendor
contracts for outsourced cleaning
security and maintenance. The set
has continuing revenues through
in-place leases. | No. The set has inputs but does not have a
substantive process because (1) no employees
are acquired, (2) the processes provided by the
outsourced contracts are ancillary or minor in
the context of all of the processes required in
the creation of outputs, and (3) the contracts
can be replaced with little cost, effort, or delay
and are not unique or scarce. |
Acquisition of a portfolio of single-family
homes; an office park with
multiple office buildings; employees
responsible for leasing, tenant
management, and managing
operational processes; and vendor
contracts for outsourced cleaning
security and maintenance. The set
has continuing revenues through
in-place leases. | Yes. The set has inputs and a substantive
process in the form of an organized workforce
that performs processes that are critical to the
ability to continue producing outputs. | |
Case F: License of
Distribution Rights
(ASC 805-10-55-82
through 55-84) | Acquisition of distribution rights,
customer contracts, and an at-market
supply agreement. The set has
outputs through a continuation of
revenues. | No. The set has inputs (distribution contracts,
customer contracts, and supply agreement)
but does not include an organized workforce
or other process. |
Case G: Acquisition
of Brands
(ASC 805-10-55-85
through 55-87) | Acquisition of a right to a brand,
including all related intellectual
property, customer contracts and
relationships, inventory, marketing
materials, customer incentive
programs, supply contracts,
specialized equipment, and
documented processes. It does
not include employees, any of
the manufacturing equipment or
processes needed to create the
product, or distribution facilities
or processes. The set has outputs
through a continuation of revenues. | Yes. Even though no employees are acquired,
the set includes inputs and a substantive
process in the form of unique manufacturing
processes. |
Case H: Acquisition
of Loan Portfolio
(Scenario 2 in
ASC 805-10-55-88
through 55-96) (Scenario 3 in
ASC 805-10-55-88
through 55-96) | Acquisition of a portfolio of
commercial loans. No employees
are acquired, and the set has a
continuation of revenues (interest
income). | No. The set has inputs but does not have
a substantive process because it does not
include an organized workforce or other
processes. |
Acquisition of a portfolio of
commercial loans and the employees
that managed the credit risk of the
portfolio and the relationship with the
borrowers. The set has a continuation
of revenues (interest income). | Yes. The set includes an input and a
substantive process in the form of an
organized workforce that performs processes
that are critical to the ability to continue to
produce outputs. |
2.4.3.4 Groups of Processes
Individual processes that are used to create outputs may sometimes be considered insignificant on their
own but could be substantive as a group because all the processes together could be difficult to replace
without significant cost or effort or a delay in operations. In determining whether a substantive process
is present, entities should consider whether a group of processes are together significant.
2.4.3.5 Presence of Goodwill
ASC 805-10
55-9
When evaluating whether a set meets the criteria in paragraphs 805-10-55-5D
through 55-5E, the presence of more than an insignificant amount of goodwill
may be an indicator that the acquired process is substantive and, therefore,
the acquired set is a business. However, a business need not have
goodwill.
To help entities evaluate whether a set includes a substantive process, the FASB notes in ASC 805-10-55-9 that “the presence of more than an insignificant amount of goodwill may be an indicator that the
acquired process is substantive.” That is, the presence of more than an insignificant amount of goodwill
could be an indicator that an organized workforce is performing a critical process or that an acquired
process in a set is substantive.
Paragraph B313 of the Basis for Conclusions of FASB Statement 141(R) describes
components that are conceptually part of goodwill — the fair values of “the
going-concern element of the acquiree’s existing business” and “the expected
synergies and other benefits from combining the acquirer’s and acquiree’s net assets and
businesses.” The guidance also lists elements that are captured in the measurement of
goodwill in a business combination but are not conceptually part of goodwill — namely,
“[o]vervaluation of the consideration paid by the acquirer stemming from [valuation]
errors” and “[o]verpayment or underpayment by the acquirer.” We believe that while the
nonrecognition of certain assets and liabilities and the measurement of certain assets
or liabilities at amounts other than fair value are not conceptually part of goodwill,
those components are captured in the measurement of goodwill. In evaluating goodwill as
an indicator of a substantive process, entities should consider the reasons why they
have calculated an excess and whether the excess is related to the elements that are
conceptually part of goodwill.
Often, part of an excess is the result of an assembled workforce intangible asset that is subsumed into
goodwill in a business combination. In such cases, entities should consider whether the employees
represent an organized workforce as described in Section 2.4.3.2. That is, in accordance with ASC
805-10-55-5D, entities should assess whether the employees “have the necessary skills, knowledge,
or experience to perform an acquired process (or group of processes) that when applied to another
acquired input or inputs is critical to the ability to develop or convert that acquired input or inputs into
outputs.” The presence of an assembled workforce that has significant fair value may be an indicator
that the employees are performing a substantive process. Similarly, an excess may indicate that there is
value in an acquired process that would not be captured in an identifiable asset.
2.4.4 Examples Illustrating the Application of the Guidance
The examples in ASC 805-10-55-52 through 55-96 below illustrate the application of the guidance on the
definition of a business discussed throughout this chapter.
ASC 805-10
Case A: Acquisition of Real Estate
Scenario 1
55-52 ABC acquires, renovates,
leases, sells, and manages real estate properties. ABC acquires a portfolio of
10 single-family homes that each have in-place leases. The only elements
included in the acquired set are the 10 single-family homes and the 10
in-place leases. Each single-family home includes the land, building, and
property improvements. Each home has a different floor plan, square footage,
lot, and interior design. No employees or other assets are acquired.
55-53 ABC first considers the
threshold guidance in paragraphs 805-10-55-5A through 55-5C. ABC concludes
that the land, building, property improvements, and in-place leases at each
property can be considered a single asset in accordance with paragraph
805-10-55-5B. That is, the building and property improvements are attached to
the land and cannot be removed without incurring significant cost.
Additionally, the in-place lease is an intangible asset that should be
combined with the related real estate and considered a single asset.
55-54 ABC also concludes that the 10
single assets (the combined land, building, in-place lease intangible, and
property improvements) are similar. Each home has a different floor plan;
however, the nature of the assets (all single-family homes) are similar. ABC
also concludes that the risks associated with managing and creating outputs
are not significantly different. That is, the risks associated with operating
the properties and tenant acquisition and management are not significantly
different because the types of homes and class of customers are not
significantly different. Similarly, the risks associated with operating in the
real estate market of the homes acquired are not significantly different.
Consequently, ABC concludes that substantially all of the fair value of the
gross assets acquired is concentrated in the group of similar identifiable
assets; thus, the set is not a business.
Scenario 2
55-55 Assume the same facts as in
Scenario 1 except that ABC also acquires an office park with six 10-story
office buildings leased to maximum occupancy of which all have significant
fair value. ABC also acquires the vendor contracts for outsourced cleaning,
security, and maintenance. Seller’s employees that perform leasing (sales,
underwriting, and so forth), tenant management, financing, and other strategic
management processes are not included in the set. ABC plans to replace the
property management and employees with its own internal resources.
55-56 ABC concludes that the
single-family homes and office park are not similar assets. ABC considers the
risks associated with operating the assets, obtaining tenants, and tenant
management between the single-family homes and office park to be significantly
different because the scale of operations and risks associated with the class
of customers are significantly different. Therefore, substantially all of the
fair value of the gross assets acquired is not concentrated in a single
identifiable asset or group of similar identifiable assets. Thus, ABC must
further evaluate whether the set has the minimum requirements to be considered
a business.
55-57 The set has continuing revenues
through the in-place leases and, therefore, has outputs. ABC must consider the
criteria in paragraph 805-10-55-5E to determine whether the set includes both
an input and a substantive process that together significantly contribute to
the ability to create outputs.
55-58 ABC concludes that the criteria
in paragraph 805-10-55-5E(a) through (b) are not met because the set does not
include employees and the processes performed through the cleaning and
security contracts (the only processes acquired) will be considered ancillary
or minor in the context of all the processes required to create outputs in the
real estate industry. That is, while those outsourcing agreements may be
considered to provide an organized workforce that performs cleaning and
security processes when applied to the building, the processes performed by
the cleaning, security, and maintenance personnel are not considered critical
in the context of all the processes required to create outputs.
55-59 ABC also concludes that the
criterion in paragraph 805-10-55-5E(c) is not met because the cleaning and
security processes could be easily replaced with little cost, effort, or delay
in the ability to continue producing outputs. While the cleaning and security
processes are necessary for continued operations of the buildings, these
contracts can be replaced quickly with little effect on the ability to
continue producing outputs.
55-60 ABC concludes that the
criterion in paragraph 805-10-55-5E(d) is not met because the cleaning and
security contracts are not considered unique or scarce. That is, these types
of arrangements are readily accessible in the marketplace.
55-61 Because none of the criteria
were met, ABC concludes that the set does not include both an input and
substantive processes that together significantly contribute to the ability to
create outputs and, therefore, is not considered a business.
Scenario 3
55-62 Assume the same facts as in
Scenario 2, except that the set includes the employees responsible for
leasing, tenant management, and managing and supervising all operational
processes.
55-63 The set has continuing revenues
through the in-place leases and, therefore, has outputs. ABC must consider the
criteria in paragraph 805-10-55-5E to determine whether the set includes both
an input and a substantive process that together significantly contribute to
the ability to create outputs.
55-64 ABC determines that the
criterion in paragraph 805-10-55-5E(a) is met because the set includes an
organized workforce that performs processes that when applied to the acquired
inputs in the set (the land, building, and in-place leases) are critical to
the ability to continue producing outputs. That is, ABC concludes that the
leasing, tenant management, and supervision of the operational processes are
critical to the creation of outputs. Because it includes both an input and a
substantive process, the set is considered a business.
Case B: Acquisition of a Drug Candidate
Scenario 1
55-65 Pharma Co. purchases from
Biotech a legal entity that contains the rights to a Phase 3 (in the clinical
research phase) compound being developed to treat diabetes (the in-process
research and development project). Included in the in-process research and
development project is the historical know-how, formula protocols, designs,
and procedures expected to be needed to complete the related phase of testing.
The legal entity also holds an at-market clinical research organization
contract and an at-market clinical manufacturing organization contract. No
employees, other assets, or other activities are transferred.
55-66 Pharma Co. first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. Pharma Co. concludes that
the in-process research and development project is an identifiable intangible
asset that would be accounted for as a single asset in a business combination.
Pharma Co. also qualitatively concludes that there is no fair value associated
with the clinical research organization contract and the clinical
manufacturing organization contract because the services are being provided at
market rates and could be provided by multiple vendors in the marketplace.
Therefore, all of the consideration in the transaction will be allocated to
the in-process research and development project. As such, Pharma Co. concludes
that substantially all of the fair value of the gross assets acquired is
concentrated in the single in-process research and development asset and the
set is not a business.
Scenario 2
55-67 Pharma Co. purchases from
Biotech a legal entity that contains the rights to a Phase 3 compound being
developed to treat diabetes (Project 1) and a Phase 3 compound being developed
to treat Alzheimer’s disease (Project 2). Included with each project are the
historical know-how, formula protocols, designs, and procedures expected to be
needed to complete the related phase of testing. The legal entity also holds
at-market clinical research organization contracts and at-market clinical
manufacturing organization contracts associated with each project. Assume that
Project 1 and Project 2 have equal fair value. No employees, other assets, or
other activities are transferred.
55-68 Pharma Co. concludes that
Project 1 and Project 2 are each separately identifiable intangible assets,
both of which would be accounted for as a single asset in a business
combination. Pharma Co. then considers whether Project 1 and Project 2 are
similar assets. Pharma Co. notes that the nature of the assets is similar in
that both Project 1 and Project 2 are in-process research and development
assets in the same major asset class. However, Pharma Co. concludes that
Project 1 and Project 2 have significantly different risks associated with
creating outputs from each asset because each project has different risks
associated with developing and marketing the compound to customers. The
projects are intended to treat significantly different medical conditions, and
each project has a significantly different potential customer base and
expected market and regulatory risks associated with the assets. Thus, Pharma
Co. concludes that substantially all of the fair value of the gross assets
acquired is not concentrated in a single identifiable asset or group of
similar identifiable assets and that it must further evaluate whether the set
has the minimum requirements to be considered a business.
55-69 Because the set does not have
outputs, Pharma Co. evaluates the criteria in paragraph 805-10-55-5D to
determine whether the set has both an input and a substantive process that
together significantly contribute to the ability to create outputs. Pharma Co.
concludes that the criteria are not met because the set does not have
employees. As such, Pharma Co. concludes that the set is not a business.
Case C: Acquisition of Biotech
55-70 Pharma Co. buys all of the
outstanding shares of Biotech. Biotech’s operations include research and
development activities on several drug compounds that it is developing
(in-process research and development projects). The in-process research and
development projects are in different phases of the U.S. Food and Drug
Administration approval process and would treat significantly different
diseases. The set includes senior management and scientists that have the
necessary skills, knowledge, or experience to perform research and development
activities. In addition, Biotech has long-lived tangible assets such as a
corporate headquarters, a research lab, and lab equipment. Biotech does not
yet have a marketable product and, therefore, has not generated revenues.
Assume that each research and development project has a significant amount of
fair value.
55-71 Pharma Co. first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. The identifiable assets in
the set include multiple in-process research and development projects and
tangible assets (the corporate headquarters, the research lab, and the lab
equipment). Pharma Co. concludes that the in-process research and development
projects are not similar assets because the projects have significantly
different risks associated with managing the assets and creating the outputs
(that is, because there are significantly different development risks in the
different phases of development, market risks related to the different
customer base, and potential markets for the compounds). In addition, Pharma
Co. concludes that there is fair value associated with the acquired workforce
because of the proprietary knowledge of and experience with Biotech’s ongoing
development projects and the potential for creation of new development
projects that the workforce embodies. As such, Pharma Co. concludes that
substantially all of the fair value of the gross assets acquired is not
concentrated in a single identifiable asset or group of similar identifiable
assets and that it must further evaluate whether the set has the minimum
requirements to be considered a business.
55-72 Because the set does not have
outputs, Pharma Co. evaluates the criteria in paragraph 805-10-55-5D to
determine whether the set has both an input and a substantive process that
together significantly contribute to the ability to create outputs. Pharma Co.
concludes that the criteria are met because the scientists make up an
organized workforce that has the necessary skills, knowledge, or experience to
perform processes that when applied to the in-process research and development
inputs is critical to the ability to develop those inputs into a product that
can be provided to a customer. Pharma Co. also determines that there is a
more-than-insignificant amount of goodwill (including the fair value
associated with the workforce), which is another indicator that the workforce
is performing a critical process. Thus, the set includes both inputs and
substantive processes and is a business.
Case D: Acquisition of a Television Station
55-73 Company A is a television
broadcaster whose principal business is the ownership and operation of a
television station group in the United States through which it broadcasts its
proprietary health-care-related programming. Company B owns and operates
several television stations in the western United States. Because of a recent
merger, Company B must divest itself of a station in Portland, Oregon (KPOR),
and agrees to sell the station to Company A.
55-74 Company A plans to change
KPOR’s programming format to its proprietary health-care-related programming.
Therefore, Company A will receive only the U.S. Federal Communications
Commission license, the broadcasting equipment, and the office building. KPOR
will be integrated into Company A’s operations, with most of the station
processes centralized at Company A’s corporate headquarters. Company A will
not extend offers of employment to any of KPOR’s employees or assume any of
KPOR’s contractual relationships.
55-75 Company A first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. The U.S. Federal
Communications Commission license is an intangible asset that is recognized
and measured separately in a business combination, while the broadcast
equipment and building are tangible nonfinancial assets in different major
classes. Company A concludes that the broadcast equipment and building are not
considered a single asset because the equipment is not attached to the
building and can be removed without significant cost or diminution in fair
value. Furthermore, none of the assets will be considered similar in
accordance with paragraph 805-10-55-5C because the U.S. Federal Communications
Commission license cannot be considered similar to tangible assets and the
tangible assets are in different major asset classes. Each of the separate
identifiable assets has significant fair value. Thus, Company A concludes that
substantially all of the fair value of the gross assets acquired is not
concentrated in a single identifiable asset or group of similar identifiable
assets and that it must further evaluate whether the set has the minimum
requirements to be considered a business.
55-76 The set does not have outputs;
therefore, Company A considers the criteria in paragraph 805-10-55-5D to
determine whether the set includes both an input and a substantive process
that together significantly contribute to the ability to create outputs. The
set does not include an organized workforce, so it does not meet the criteria
in paragraph 805-10-55-5D. Therefore, the set does not include both an input
and a substantive process and is not considered a business.
Case E: Acquisition of a Manufacturing Facility
55-77 Widget Co. manufactures
complex equipment and has manufacturing facilities throughout the world.
Widget Co. decided to idle a facility in a foreign jurisdiction in a
reorganization of its manufacturing footprint and furloughed the assembly line
employees.
55-78 Acquirer enters into an
agreement to purchase a manufacturing facility and related equipment from
Widget Co. To comply with the local labor laws, Acquirer also must assume the
furloughed employees.
55-79 The assets acquired include the
equipment and facility (land and building) but no intellectual property,
inventory, customer relationships, or any other inputs.
55-80 Acquirer first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. Acquirer concludes that the
equipment in the facility can be removed without significant cost or
diminution in utility or fair value because the equipment is not attached to
the building and can be used in many types of manufacturing facilities.
Therefore, the equipment and building are not a single asset. Furthermore, the
equipment and facility are not considered similar assets because they are
different major classes of tangible assets. Acquirer determines that there is
significant fair value in both the equipment and the facility and, thus,
concludes that it must further evaluate whether the set has the minimum
requirements to be considered a business.
55-81 The set is not currently
producing outputs because there is no continuation of revenue before and after
the transaction; therefore, Acquirer considers the criteria in paragraph
805-10-55-5D and whether the set includes both employees that form an
organized workforce and an input that the workforce could develop or convert
into output. The set includes employees that have the necessary skills,
knowledge, or experience to use the equipment; however, without intellectual
property or other inputs that could be converted into outputs using the
equipment, the set does not include both an organized workforce and an input
that will meet the criteria in paragraph 805-10-55-5D. That is, the equipment
itself cannot be developed or converted into an output by those employees.
Therefore, the set is not a business.
Case F: License of Distribution Rights
55-82 Company A is a distributor of
food and beverages. Company A enters into an agreement to sublicense the Latin
American distribution rights of Yogurt Brand F to Company B, whereby Company B
will distribute Yogurt Brand F in Latin America. As part of the agreement,
Company A transfers the existing customer contracts in Latin America to
Company B and an at-market supply contract with the producer of Yogurt Brand
F. Company A retains all of its employees and distribution capabilities.
55-83 Company B first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. The identifiable assets
that could be recognized in a business combination include the license to
distribute Yogurt Brand F, customer contracts, and the supply agreement.
Company B concludes that the license and customer contracts will have fair
value assigned to them. Company B concludes that neither asset represents
substantially all of the fair value of the gross assets. Company B then
considers whether the license and customer contracts are a group of similar
intangible assets. Because the license and customer contracts are in different
major classes of identifiable intangible assets, they are not considered
similar assets. Therefore, substantially all of the fair value of the gross
assets acquired is not concentrated in a single identifiable asset or group of
similar identifiable assets, and Company B must evaluate whether the set has
both an input and a substantive process.
55-84 The set has outputs through the
continuation of revenues with customers in Latin America. As such, Company B
must evaluate the criteria in paragraph 805-10-55-5E to determine whether the
set includes an input and a substantive process that together significantly
contribute to the ability to create outputs. Company B considers whether the
acquired contracts are providing access to an organized workforce that
performs a substantive process. However, because the contracts are not
providing a service that applies a process to another acquired input, Company
B concludes that the substance of the contracts are only that of acquiring
inputs. The set is not a business because:
-
It does not include an organized workforce that could meet the criteria in paragraph 805-10-55- 5E(a) through (b).
-
There are no acquired processes that could meet the criteria in paragraph 805-10-55-5E(c) through (d).
-
It does not include both an input and a substantive process.
Case G: Acquisition of Brands
55-85 Company A is a global producer
of food and beverages. Company A sells the worldwide rights of Yogurt Brand F,
including all related intellectual property, to Company B. Company B also
acquires all customer contracts and relationships, finished goods inventory,
marketing materials, customer incentive programs, raw material supply
contracts, specialized equipment specific to manufacturing Yogurt Brand F, and
documented processes and protocols to produce Yogurt Brand F. Company B does
not receive employees, manufacturing facilities, all of the manufacturing
equipment and processes required to produce the product, and distribution
facilities and processes.
55-86 Company B first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. The gross assets include
intellectual property (the trademark, the related trade name, and recipes)
associated with Yogurt Brand F (the intellectual property associated with the
brand is determined to be a single intangible asset in accordance with the
guidance in paragraph 805-20-55-18), customer contracts and related
relationships, equipment, finished goods inventory, and the excess of the
consideration transferred over the fair value of the net assets acquired.
Company B concludes that substantially all of the fair value of the gross
assets acquired is not concentrated in a single identifiable asset or group of
similar identifiable assets even though, for purposes of the analysis, the
intellectual property is considered to be a single identifiable asset. In
addition, because there is significant fair value in both tangible assets and
intangible assets, Company B concludes that there is not a group of similar
assets that meets this threshold.
55-87 The set has outputs through the
continuation of revenues, and Company B must consider the criteria in
paragraph 805-10-55-5E to determine whether the set includes both inputs and a
substantive process that together significantly contribute to the ability to
create outputs. The set does not include an organized workforce and,
therefore, does not meet the criteria in paragraph 805-10-55-5E(a) through
(b). However, the acquired manufacturing processes are unique to Yogurt Brand
F, and when those processes are applied to acquired inputs such as the
intellectual property, raw material supply contracts, and the equipment, they
significantly contribute to the ability to continue producing outputs. As
such, the criterion in paragraph 805-10-55-5E(c) is met, and the set includes
both inputs and substantive processes. Because the set includes inputs and
substantive processes that together significantly contribute to the ability to
create outputs, it is considered a business.
Case H: Acquisition of Loan Portfolio
Scenario 1
55-88 Bank A purchases a loan
portfolio from Bank Z. The portfolio of loans consists of residential
mortgages with terms, size, and risk ratings that are not significantly
different. Bank A does not take over the employees of Bank Z that managed the
credit risk of the portfolio and the relationship with the borrowers (such as
brokers, vendors, and risk managers).
55-89 Bank A first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. Bank A concludes that the
nature of the assets (residential mortgage loans) is similar. Bank A also
concludes that the risks associated with managing and creating outputs are not
significantly different because the terms, size, and risk ratings of the loans
are not significantly different. Because all of the fair value of the gross
assets acquired is in a group of similar identifiable assets, the set is not a
business.
Scenario 2
55-90 Assume the same facts as in Scenario 1 except
that the portfolio of loans consists of commercial loans with term, size, and
risk ratings that are significantly different.
55-91 Bank A first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. Bank A must consider
whether the loans are similar. Bank A concludes that the nature of the assets
(commercial loans) is similar; however, because the term, size, and risk
ratings of the loans are significantly different, Bank A concludes that the
risks associated with managing and creating outputs are significantly
different. Thus, Bank A concludes that substantially all of the fair value of
the gross assets acquired is not concentrated in a single identifiable asset
or group of similar identifiable assets and that it must further evaluate
whether the set has the minimum requirements to be considered a business.
55-92 The set has outputs through the
continuation of revenues (interest income). Consequently, Bank A considers the
criteria in paragraph 805-10-55-5E to determine whether the set includes both
inputs and a substantive process that together significantly contribute to the
ability to create outputs. Because the set does not include an organized
workforce or acquired processes, the criteria in paragraph 805-10-55-5E are
not met and the set is not a business.
Scenario 3
55-93 Assume the same facts as in
Scenario 2 except that Bank A takes over the employees of Bank Z that managed
the credit risk of the portfolio and the relationship with the borrowers (such
as brokers and risk managers). Additionally, consideration transferred is
significantly higher than Bank A’s estimate of the fair value of the loan
portfolio.
55-94 Bank A first considers the
guidance in paragraphs 805-10-55-5A through 55-5C. Bank A concludes that the
loan portfolio does not consist of similar identifiable assets. Bank A also
concludes that there is significant fair value associated with different
groups of financial assets and the acquired workforce. As such, Bank A
concludes that substantially all of the fair value of the gross assets
acquired is not concentrated in a single identifiable asset or group of
similar identifiable assets and that it must further evaluate whether the set
has met the minimum requirements to be considered a business.
55-95 The set has outputs through the
continuation of revenues (interest income). Consequently, Bank A considers the
criteria in paragraph 805-10-55-5E to determine whether the set includes both
an input and a substantive process that together significantly contribute to
the ability to create outputs.
55-96 Bank A evaluates the criteria
in paragraph 805-10-55-5E and concludes that the criterion in paragraph
805-10-55-5E(a) is met because the set includes an organized workforce that
performs processes (customer relationship management and credit risk
management) critical to the ability to continue producing outputs; therefore,
the set is a business.
Chapter 3 — Identifying the Acquirer and Determining the Acquisition Date
Chapter 3 — Identifying the Acquirer and Determining the Acquisition Date
If a transaction is determined to be a business combination, it is
accounted for by applying the acquisition method. ASC 805-10-05-4 states that the
“acquisition method requires all of the following steps”:
-
“Identifying the acquirer” — see Section 3.1.
-
“Determining the acquisition date” — see Section 3.2.
-
“Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree” — see Chapter 4.
-
“Recognizing and measuring goodwill or a gain from a bargain purchase” — see Chapter 5.
3.1 Identifying the Acquirer
ASC 805-10
25-4 For each business combination, one of the combining entities shall be identified as the acquirer.
25-5 The guidance in the General Subsections of Subtopic 810-10 related to determining the existence of
a controlling financial interest shall be used to identify the acquirer — the entity that obtains control of the
acquiree. If a business combination has occurred but applying that guidance does not clearly indicate which
of the combining entities is the acquirer, the factors in paragraphs 805-10-55-11 through 55-15 shall be
considered in making that determination. However, in a business combination in which a variable interest entity
(VIE) is acquired, the primary beneficiary of that entity always is the acquirer. The determination of which party,
if any, is the primary beneficiary of a VIE shall be made in accordance with the guidance in the Variable Interest
Entities Subsections of Subtopic 810-10, not by applying either the guidance in the General Subsections of that
Subtopic, relating to a controlling financial interest, or in paragraphs 805-10-55-11 through 55-15.
55-10 Paragraph 805-10-25-5 provides that the guidance in the General Subsections of Subtopic 810-10
related to determining the existence of a controlling financial interest should be used to identify the acquirer in
a business combination, except when a variable interest entity (VIE) is acquired. If a business combination has
occurred but applying that guidance does not clearly indicate which of the combining entities is the acquirer,
paragraph 805-10-25-5 requires the factors in paragraphs 805-10-55-11 through 55-15 to be considered in
making that determination.
ASC 805-10-25-4 requires entities to identify an acquirer in every business combination. The ASC master
glossary defines an acquirer as follows:
The entity that obtains control of the acquiree. However, in a business combination in which a variable interest
entity (VIE) is acquired, the primary beneficiary of that entity always is the acquirer.
The entity identified as the acquirer for
accounting purposes usually is the entity that transfers the consideration (e.g., cash,
other assets, or its equity interests) to effect the transaction. However, in some business
combinations, the entity that issues its equity interests (the “legal acquirer”) is
determined for accounting purposes to be the acquiree (also called the “accounting
acquiree”), while the entity whose equity interests are acquired (the “legal acquiree”) is
for accounting purposes the acquirer (also called the “accounting acquirer”). Such
transactions are commonly called reverse acquisitions. See Section 6.8 for more information.
In all cases, the entity identified as the
accounting acquiree must meet the definition of a
business (see Section 2.4) for
the accounting acquirer to apply the acquisition
method.
3.1.1 Identifying the Acquirer if the Acquiree Is a VIE
If the legal acquiree in a business combination is a VIE, the primary
beneficiary of the VIE is considered the accounting acquirer in accordance with the
guidance in ASC 805-10-25-5. Consequently, entities must consider whether the legal
acquiree is a VIE on the basis of the guidance in ASC 810-10-15-14. To qualify as a VIE, a
legal entity needs to have only one of the following characteristics:
- The legal entity does not have sufficient equity investment at risk (see Section 5.2 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
- The equity investors at risk, as a group, lack the characteristics of a controlling financial interest (see Section 5.3 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest). In this assessment, there are specific requirements for entities that are limited partnerships or similar legal entities such as limited liability companies with managing members. Some of these entities may be VIEs, depending on what voting rights are provided to limited partners in a limited partnership or to nonmanaging members for certain limited liability corporations (see Section 5.3.1.2 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
- The legal entity is structured with disproportionate voting rights, and substantially all of the activities are conducted on behalf of an investor with disproportionately few voting rights (see Section 5.4 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
3.1.2 Identifying the Acquirer if the Acquiree Is a Voting Interest Entity
If the acquiree in a business combination is a voting interest entity rather
than a VIE, entities should first consider the guidance in the general subsections of ASC
810-10 related to determining the existence of a controlling financial interest to
identify the accounting acquirer. In many cases, entities can clearly identify the
accounting acquirer by applying that guidance. If they cannot, the identification of the
accounting acquirer should be based on an evaluation of “pertinent facts and
circumstances.” ASC 805-10-55-11 through 55-15 provide guidance to assist in this
evaluation.
3.1.2.1 Business Combinations Effected Primarily by Transferring Cash or Other Assets or by Incurring Liabilities
ASC 805-10
55-11 In a business combination effected primarily by transferring cash or other assets or by incurring
liabilities, the acquirer usually is the entity that transfers the cash or other assets or incurs the liabilities.
3.1.2.2 Business Combinations Effected Primarily by Exchanging Equity Interests
ASC 805-10
55-12 In a business combination effected primarily by exchanging equity interests, the acquirer usually is
the entity that issues its equity interests. However, in some business combinations, commonly called reverse
acquisitions, the issuing entity is the acquiree. Subtopic 805-40 provides guidance on accounting for reverse
acquisitions. Other pertinent facts and circumstances also shall be considered in identifying the acquirer in a
business combination effected by exchanging equity interests, including the following:
- The relative voting rights in the combined entity after the business combination. The acquirer usually is the combining entity whose owners as a group retain or receive the largest portion of the voting rights in the combined entity. In determining which group of owners retains or receives the largest portion of the voting rights, an entity shall consider the existence of any unusual or special voting arrangements and options, warrants, or convertible securities.
- The existence of a large minority voting interest in the combined entity if no other owner or organized group of owners has a significant voting interest. The acquirer usually is the combining entity whose single owner or organized group of owners holds the largest minority voting interest in the combined entity.
- The composition of the governing body of the combined entity. The acquirer usually is the combining entity whose owners have the ability to elect or appoint or to remove a majority of the members of the governing body of the combined entity.
- The composition of the senior management of the combined entity. The acquirer usually is the combining entity whose former management dominates the management of the combined entity.
- The terms of the exchange of equity interests. The acquirer usually is the combining entity that pays a premium over the precombination fair value of the equity interests of the other combining entity or entities.
In a business combination effected primarily by exchanging equity interests, the
identification of the accounting acquirer is based on an evaluation of pertinent facts
and circumstances, including the following:
-
“The relative voting rights in the combined entity after the business combination” (ASC 805-10-55-12(a)) — see Section 3.1.2.2.1.
-
“The existence of a large minority voting interest in the combined entity” (ASC 805-10-55-12(b)) — see Section 3.1.2.2.2.
-
“The composition of the governing body of the combined entity” (ASC 805-10-55-12(c)) — see Section 3.1.2.2.3.
-
“The composition of the senior management of the combined entity” (ASC 805-10-55-12(d)) — see Section 3.1.2.2.4.
-
“The terms of the exchange of equity interests” (ASC 805-10-55-12(e)) — see Section 3.1.2.2.5.
-
The relative size of the combining entities (ASC 805-10-55-13) — see Section 3.1.2.3.
-
Other considerations — see Section 3.1.2.4.
3.1.2.2.1 Relative Voting Rights in the Combined Entity After the Business Combination
ASC 805-10
55-12(a) The relative voting rights in the combined entity after the business combination. The acquirer usually
is the combining entity whose owners as a group retain or receive the largest portion of the voting rights
in the combined entity. In determining which group of owners retains or receives the largest portion of the
voting rights, an entity shall consider the existence of any unusual or special voting arrangements and options,
warrants, or convertible securities.
When evaluating relative voting rights in the combined entity after a business combination, entities
should consider the following:
- All securities with voting rights — not just voting common shares.
- Any unusual or special voting arrangements.
- Options, warrants, and convertible securities.
Generally, the evaluation of relative voting interests should take into account any in-the-money options,
warrants, or convertible securities that are vested and exercisable or convertible into voting interests
as of the acquisition date. If any instruments are out-of-the-money but exercisable or convertible into
voting shares as of the acquisition date, entities must use judgment in determining how the instruments
affect the evaluation of relative voting interests. In making this determination, entities would most likely
consider the following:
- The extent to which the instruments are out-of-the-money.
- The volatility of the underlying shares.
- Expectations that the instruments will become in-the-money before their exercisability or conversion features expire.
- The attributes of the instrument holders (e.g., board members, executive management, or a large minority voting interest holder in one of the combining companies).
Instruments that are not vested, exercisable, or convertible until after the
acquisition date generally should not be considered in the evaluation of relative
voting interests unless they will become exercisable or convertible shortly after the
acquisition date. In addition, while some of an acquiree’s options, warrants, or
convertible securities may be exchanged for voting securities as of the acquisition
date, other similar securities of the acquiree or acquirer may remain outstanding,
which could result in the subsequent issuance of voting securities in the combined
entity. In such situations, entities should consider the specific facts and
circumstances associated with these instruments.
In practice, as the ratio of relative voting rights in the combined entity
deviates from 50:50, entities place increasing weight on this factor as an indicator
of which combining entity is the accounting acquirer.
3.1.2.2.2 Existence of a Large Minority Voting Interest in the Combined Entity
ASC 805-10
55-12(b) The existence of a large minority voting interest in the combined entity if no other owner or organized
group of owners has a significant voting interest. The acquirer usually is the combining entity whose single
owner or organized group of owners holds the largest minority voting interest in the combined entity.
When evaluating the effect of minority voting interests in the combined entity
on the identification of the accounting acquirer, entities should consider voting
interests held both individually and as a part of an organized shareholder group. In
practice, as the percentage of voting interests held by a single owner or organized
group of owners increases, entities place additional weight on this factor as an
indicator of which combining entity is the accounting acquirer, particularly if the
voting interest includes additional rights beyond voting (e.g., entitlement to one or
more positions on the combined entity’s governing body).
3.1.2.2.3 Composition of the Governing Body of the Combined Entity
ASC 805-10
55-12(c) The composition of the governing body of the combined entity. The acquirer usually is the combining
entity whose owners have the ability to elect or appoint or to remove a majority of the members of the
governing body of the combined entity.
While the accounting acquirer usually is the combining entity whose owners have
the ability to elect, appoint, or remove a majority of the members of the combined
entity’s governing body (i.e., its initial composition), the entity’s ability to
affect subsequent corporate governance decisions might be limited by requirements for
specified matters to be approved beyond a simple majority.
In addition, if the initial composition of the governing body is subject to
change shortly after the business combination, entities should also consider how that
composition might change. Changes might occur shortly after an acquisition because of
the expected retirement of a member or a recurring or special election in which one or
more current members may not be reelected.
In evaluating the composition of the governing body of the combined entity, entities
might also consider the initial composition of its committees, the individuals who
will serve as committee chairs, and whether each chair will hold any specific powers.
In the absence of a nominating committee, entities might also evaluate the process for
identifying future candidates for the governing body, especially if there may be a
change in its composition shortly after the business combination.
Special consideration is warranted in circumstances in which the
board of directors is required to include certain independent directors. For example,
because such independent directors are often elected or appointed solely by one of the
entities involved in the business combination, questions can arise regarding how to
factor such directors into the ASC 805-10-55-12(c) assessment. In these situations, we
generally consider an entity’s ability to elect or appoint or to remove independent
directors as providing that entity with the power over those positions.
Example 3-1
Company A enters into an agreement to buy Company B and the parties agree
that the combined entity’s board of directors will be composed of seven
members — three elected or appointed by A (two of which must be
independent) and four elected or appointed by B (two of which must be
independent).
While four of the seven board members are deemed independent, perhaps
suggesting that neither party controls the combined entity, we believe
that when completing the ASC 805-10-55-12(c) assessment, B would be deemed
to control the board by virtue of its ability to elect or appoint or to
remove four of the seven members.
If there is an equal number of members and voting rights in the initial
composition of the governing body, and matters are subject to majority approval,
entities should consider the procedures established for resolving tie votes to
determine whether the performance of such procedures would be among the pertinent
facts and circumstances evaluated in the identification of the acquirer.
3.1.2.2.4 Composition of the Senior Management of the Combined Entity
ASC 805-10
55-12(d) The composition of the senior management of the combined entity. The acquirer usually is the
combining entity whose former management dominates the management of the combined entity.
When evaluating the composition of the senior management of the combined entity, entities should
consider the executive chairman of the board, the chief executive officer, the chief operating officer,
the chief financial officer, and members of the executive committee, if one exists. Entities may also
consider other positions such as division heads, if they represent senior management, on the basis of
the organizational structure and the nature of the combined entity’s business. Typically, the roles and
responsibilities of each position are more important in the evaluation than the relative number of senior
management positions taken by the combining entity’s former management.
If the initial composition of senior management is subject to change shortly
after the acquisition date, entities should also consider how that composition might
change. Changes could be the result of scheduled retirements or planned
reorganizations of management roles.
3.1.2.2.5 Terms of the Exchange of Equity Interests
ASC 805-10
55-12(e) The terms of the exchange of equity interests. The acquirer usually is the combining entity that pays a
premium over the precombination fair value of the equity interests of the other combining entity or entities.
While the accounting acquirer usually is the combining entity that pays a
premium over the precombination fair value of the equity interests of the other
combining entity or entities, in certain cases it may be difficult to identify whether
a premium is paid, because the combining entities’ precombination fair values are not
readily determinable.
3.1.2.3 Consideration of the Relative Size of the Combining Entities
ASC 805-10
55-13 The acquirer usually is the combining entity whose relative size (measured in, for example, assets,
revenues, or earnings) is significantly larger than that of the other combining entity or entities.
When evaluating the relative size of the combining entities, entities should consider the specific asset,
revenue, and earning measures determined to be pertinent, which may vary on the basis of the
combining entities’ industry. Entities may also identify one or more additional pertinent measures, such
as operating cash flows. Further, entities must use judgment to determine which period(s) to evaluate
and whether to consider future budgeted amounts (when available).
When comparing the combining entities’ relative size, entities should evaluate
the effects of any differences between their accounting policies, capitalization, or
histories (i.e., organic growth versus acquisitions) and the existence of any items
deemed to be nonrecurring.
3.1.2.4 Other Considerations
If, after consideration of the factors in ASC 805-10-55-12 and 55-13, it is not
clear which combining entity is the accounting acquirer, entities sometimes evaluate
other evidence such as the following:
-
Which combining entity initiated the combination.
-
The name to be used for the combined entity.
-
The location of the combined entity’s headquarters.
Entities are expected to demonstrate the relevance of any other factors
considered in the identification of the acquirer.
3.1.3 Evaluating Pertinent Facts and Circumstances in Identifying the Acquirer
While an evaluation of the pertinent facts and circumstances often results in
the clear identification of one of the combining entities as the accounting acquirer, in
some transactions the determination of the acquirer may be less straight-forward (i.e.,
some indicators point to one entity and others point to the other). Since ASC 805 does not
specify a hierarchy or the weight to place on each fact and circumstance associated with
the assessment, an entity may sometimes need to use judgment. In such cases, the SEC staff
typically expects the entity’s disclosures to give financial statement users insight into
how the accounting acquirer was determined (e.g., a description of the facts and
circumstances deemed by the entity to be the most instructive in its identification of the
accounting acquirer).
3.1.4 Business Combinations Involving More Than Two Entities
ASC 805-10
55-14 In a business combination involving more than two entities, determining the acquirer shall include a
consideration of, among other things, which of the combining entities initiated the combination, as well as the
relative size of the combining entities, as discussed in the preceding paragraph.
Even though a business combination is defined as a transaction or other event in which an entity
obtains control of one or more businesses, some combinations are specifically within the scope of the
business combinations guidance even if no one party obtains control. For example, in some roll-up or
put-together transactions, more than two entities combine their businesses but none of the owners of
the combining entities individually or as a group retains or receives a majority of the combined entity’s
voting rights. ASC 805-10 requires that these transactions be accounted for as business combinations,
as discussed in Section 2.2. Therefore, in such transactions, the factors in ASC 805-10-55-11 through
55-15 must be used to identify an acquirer.
3.1.5 Use of a New Entity Formed to Effect a Business Combination
ASC 805-10
55-15 A new entity formed to effect a business combination is not necessarily the acquirer. If a new entity is
formed to issue equity interests to effect a business combination, one of the combining entities that existed
before the business combination shall be identified as the acquirer by applying the guidance in paragraphs
805-10-55-10 through 55-14. In contrast, a new entity that transfers cash or other assets or incurs liabilities as
consideration may be the acquirer.
A business combination may be effected by forming a new legal entity (commonly
called a “newco”) to issue shares to the combining entities’ shareholders. ASC
805-10-55-15 precludes a newco that only issues equity instruments from being identified
as the acquirer because it is deemed to have no economic substance. The newco is disregarded for accounting purposes, and one of the combining entities should be identified as the acquirer. The guidance in ASC 805-10-55-15 was carried forward from FASB Statement 141. In paragraph B100 of the Basis for Conclusions of Statement 141(R), the
FASB explains why the IASB agreed with its rationale for such treatment:
The IASB also considered whether treating a new entity formed to issue
equity instruments to effect a business combination as the acquirer would place the form
of the transaction over its substance, because the new entity may have no economic
substance. The formation of such entities is often related to legal, tax, or other
business considerations that do not affect the identification of the acquirer. For
example, a combination between two entities that is structured so that one entity
directs the formation of a new entity to issue equity instruments to the owners of both
of the combining entities is, in substance, no different from a transaction in which one
of the combining entities directly acquires the other. Therefore, the transaction should
be accounted for in the same way as a transaction in which one of the combining entities
directly acquires the other. To do otherwise would impair both the comparability and the
reliability of the information.
Example 3-2
Newco Only Issues Equity Interests and Is Not the Acquirer
Company A and Company B enter into an agreement to merge. Both A and B meet the definition of a
business in ASC 805-10. Either A or B forms a new legal entity (Newco) to effect the combination. The former
shareholders of A and B exchange their equity interests in A and B for equity interests in Newco, and A and B
become subsidiaries of Newco. Newco is not a corporate joint venture.
Newco is newly formed to issue equity interests to effect the merger of A and B.
Since the transaction was not the formation of a joint venture, under ASC
805-10-55-15, “one of the combining entities that existed before the business
combination [A or B] shall be identified as the acquirer by applying the
guidance in paragraphs 805-10-55-10 through 55-14.” The transaction described
above is economically the same as a transaction in which either A or B
directly acquires the other company in exchange for shares in the acquiring
company.
In some cases, a newco may be identified as the acquirer if the newco is
determined to have economic substance. An entity must often use judgment on the basis of
an evaluation of the specific facts and circumstances to determine whether a newco is
substantive. Note that in the evaluation of whether a newco has substance, it should not
matter which entity (i.e., the buyer or the seller) created the newco. As discussed above,
a newco that only issues equity interests to effect an acquisition would generally not be
considered substantive (see the example above). However, a newco may be deemed to be
substantive in the following circumstances:
-
It has substantive precombination operations or assets.
-
It engages in substantial precombination activities such as raising capital to fund an acquisition from third-party debt financing or from third parties in the public market (e.g., a SPAC).
-
It is actively involved in identifying acquisition targets, negotiating, or promoting acquisitions.
-
It had any ownership in the acquiree before the acquisition.
Some also believe that a newco has significant precombination activities if its
parent or investors loan or contribute cash to the newco and that cash is used to fund the
acquisition. However, others believe that having cash contributed by or loaned from the
newco’s parent or investors to fund the acquisition does not constitute a substantive
precombination activity and does not make the newco substantive (see Example 3-3).
In addition, some regard a newco that survives the transaction (i.e., a
surviving newco) as substantive regardless of the significance of its precombination
activities. However, a newco that does not survive the transaction (sometimes called a
“transitory newco” or a “mergersub”) may be determined to be the acquirer if it is
substantive (see Example
3-4).
If a newco is identified as the acquirer, the entity or entities that merge into
the newco are the acquiree in a business combination, and the acquiree’s assets and
liabilities are measured in accordance with the guidance in ASC 805, generally at their
acquisition-date fair values.
Example 3-3
Surviving Newco Is Identified as the Acquirer
Company A forms a new legal entity, Newco, to effect the acquisition of Company B from an unrelated seller.
Company B meets the definition of a business in ASC 805-10. Company A contributes cash to Newco in
exchange for 90 percent of Newco’s issued shares. Newco transfers the cash and 10 percent of its issued
shares to the seller in exchange for all of B’s outstanding shares. Newco is a surviving legal entity and is a
reporting entity after the transaction. Company B becomes a subsidiary of Newco.
Immediately Before the Acquisition
Immediately After the Acquisition
ASC 805-10-55-15 states that “a new entity that transfers cash or other assets
or incurs liabilities as consideration may be the acquirer.” We believe that
it would be appropriate to identify Newco as the acquirer in this transaction
since it survived the transaction and transferred cash to acquire the equity
interests in B. In that case, Newco would apply acquisition accounting and
recognize in its separate financial statements a new basis of accounting for
B’s assets and liabilities. However, we acknowledge that ASC 805-10-55-15 is
not clear and that some may believe that using the cash contributed by a
parent or investor as consideration does not constitute a significant
precombination activity. In addition, this transaction is economically the
same as the transaction described in Example 3-4, in which no new basis is
recognized because B does not elect to apply pushdown accounting.
Assume the same facts except that instead of A contributing cash to Newco, Newco
obtains debt financing to fund the acquisition of B. Obtaining debt financing
is often viewed as a significant precombination activity. In such a case,
Newco would be identified as the acquirer.
Example 3-4
Transitory Newco Is Not Identified as the Acquirer
Company A forms a new legal entity, Newco, to effect the acquisition of Company
B from an unrelated seller. Company B meets the definition of a business in
ASC 805-10. Newco issues shares to the seller in exchange for 90 percent of
B’s outstanding shares. Newco merges with and into Company B. Company B is the
surviving legal entity and a reporting entity after the transaction.
Immediately Before the Acquisition
Immediately After the Acquisition
Because Newco only issued its equity to effect the acquisition, it is not deemed
to be substantive and is not identified as the acquirer. In other words, Newco
is disregarded and A is identified as the acquirer. Company A has obtained
control of B and accounts for the transaction as a business combination. This
transaction is effectively the same as one in which A acquires 90 percent of
B’s shares directly from the seller. Because B elects not to apply pushdown
accounting, it does not recognize a new basis of accounting for its assets and
liabilities in its separate financial statements.
Assume the same facts except that Newco obtains debt financing to fund the
acquisition of B. Obtaining debt financing is often viewed as a significant
precombination activity. In such a case, Newco would be identified as the
acquirer.
3.2 Determining the Acquisition Date
ASC 805-10
25-6 The acquirer shall identify the acquisition date, which is the date on which it obtains control of the
acquiree.
25-7 The date on which the acquirer obtains control of the acquiree generally is the date on which the acquirer
legally transfers the consideration, acquires the assets, and assumes the liabilities of the acquiree — the closing
date. However, the acquirer might obtain control on a date that is either earlier or later than the closing date.
For example, the acquisition date precedes the closing date if a written agreement provides that the acquirer
obtains control of the acquiree on a date before the closing date. An acquirer shall consider all pertinent facts
and circumstances in identifying the acquisition date.
The acquisition date is the date on which control of the business transfers to the acquirer and generally
coincides with 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).
Determining the acquisition date is important because on this date:
- All forms of consideration are measured, including contingent consideration, and the acquirer’s equity securities that are issued to the seller.
- The assets acquired, liabilities assumed, and any noncontrolling interests are identified and measured.
- The acquirer begins consolidating the acquiree, if required.
In unusual circumstances, the acquisition date can be before or after the
closing date. We believe that the acquisition date can precede the closing date only
if a written agreement is in place between the acquirer and the seller and that
agreement gives the acquirer control over the acquiree. Such a written agreement
must give the acquirer the ability to make all operating and financing decisions
related to the acquiree without the seller’s approval. That is, the seller should
not have any participation in the acquiree’s operations, other than having possible
protective rights. If the acquisition date occurs before the date on which the
consideration is transferred, the acquirer should recognize a liability for the
consideration to be transferred to the seller.
If the acquisition requires regulatory or shareholder approval, or shareholder
approval is sought by either the acquirer or acquiree, it is generally presumed that
control cannot pass to the acquirer until such approval is obtained. In rare
circumstances, shareholder approval may be considered perfunctory if management and
the board of directors control enough votes to approve the acquisition and a written
agreement exists evidencing their intent to approve the transaction. In such cases,
the acquisition date may occur before shareholder approval is obtained, provided
that control is transferred.
ASC 805 does not contain the “convenience” exception that was present in FASB
Statement 141. That exception allowed an acquirer, in certain circumstances, to
designate an effective date other than the acquisition date of the business
combination (e.g., the end of an accounting period between the dates on which a
business combination is initiated and consummated). In the Basis for Conclusions of
Statement 141(R), the FASB acknowledges that although there is no longer a
convenience-date exception, entities may still designate such a date if its effect
on the acquirer’s financial statements would be immaterial. Paragraph B110 of
Statement 141(R) states the following:
The Boards concluded that
the financial statement effects of eliminating that exception were rarely likely
to be material. For example, for convenience an entity might wish to designate
an acquisition date of the end (or the beginning) of a month, the date on which
it closes its books, rather than the actual acquisition date during the month.
Unless events between the “convenience” date and the actual acquisition date
result in material changes in the amounts recognized, that entity’s practice
would comply with the requirements of this Statement.
Chapter 4 — Recognizing and Measuring the Identifiable Assets Acquired and Liabilities Assumed
Chapter 4 — Recognizing and Measuring the Identifiable Assets Acquired and Liabilities Assumed
This chapter addresses the recognition and measurement of the
identifiable assets acquired and liabilities assumed in a business combination,
which is part of step 3 of the acquisition method (see Section 1.1.3). The recognition and
measurement of noncontrolling interests, also part of step 3, is addressed in
connection with the accounting for partial acquisitions in Section 6.4.
4.1 Recognition and Measurement Principles
ASC 805-20
25-1 As of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. Recognition of identifiable
assets acquired and liabilities assumed is subject to the conditions specified in paragraphs 805-20-25-2
through 25-3. However, an entity (the acquirer) within the scope of paragraph 805-20-15-2 may elect to
apply the accounting alternative for the recognition of identifiable intangible assets acquired in a business
combination as described in paragraphs 805-20-25-29 through 25-33.
Recognition Conditions
25-2 To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired
and liabilities assumed must meet the definitions of assets and liabilities in FASB Concepts Statement No. 6,
Elements of Financial Statements, at the acquisition date. For example, costs the acquirer expects but is
not obligated to incur in the future to effect its plan to exit an activity of an acquiree or to terminate the
employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. Therefore, the
acquirer does not recognize those costs as part of applying the acquisition method. Instead, the acquirer
recognizes those costs in its postcombination financial statements in accordance with other applicable
generally accepted accounting principles (GAAP).
25-3 In
addition, to qualify for recognition as part of applying the
acquisition method, the identifiable assets acquired and
liabilities assumed must be part of what the acquirer and
the acquiree (or its former owners) exchanged in the
business combination transaction rather than the result of
separate transactions. The acquirer shall apply the guidance
in paragraphs 805-10-25-20 through 25-23 to determine which
assets acquired or liabilities assumed are part of the
exchange for the acquiree and which, if any, are the result
of separate transactions to be accounted for in accordance
with their nature and the applicable GAAP.
25-4 The acquirer’s application of the recognition principle and conditions may result in recognizing some
assets and liabilities that the acquiree had not previously recognized as assets and liabilities in its financial
statements. For example, the acquirer recognizes the acquired identifiable intangible assets, such as a brand
name, a patent, or a customer relationship, that the acquiree did not recognize as assets in its financial
statements because it developed them internally and charged the related costs to expense.
30-1 The acquirer shall measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree at their acquisition-date fair values.
The accounting for a business combination is based on two key principles, which ASC 805 calls
the recognition principle and the measurement principle. The objective of the principles is to
provide guidance that an acquirer can apply when ASC 805 does not contain specific recognition or
measurement guidance for a particular asset or liability.
Under 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.” To qualify for recognition as part of a business combination, an item must:
- Meet the definition of an asset or a liability on the acquisition date (see ASC 805-20-25-2).
- Be part of the business combination transaction and not the result of separate transactions (see Section 6.2).
As a result of applying the recognition principle, an acquirer may recognize
certain of the acquiree’s assets and liabilities that were not previously recognized
in the acquiree’s financial statements, such as customer-related intangible
assets.
Under the measurement principle in ASC 805-20-30-1, an acquirer is required to
measure “the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at their acquisition-date fair values.”
Thus, most assets and liabilities and items of consideration are measured at fair
value in accordance with the principles of ASC 820. However, there are exceptions to
ASC 805’s fair value measurement principle. For example, an acquirer must measure an
acquiree’s deferred taxes, employee benefits, share-based payments, and assets held
for sale in accordance with other applicable GAAP rather than the general principles
discussed in ASC 805. The exceptions to the measurement principle are discussed in
Section 4.3. Also
see Section 2.3.6 of
Deloitte’s Roadmap Fair Value
Measurements and Disclosures (Including the Fair Value
Option) for additional details on the exception to the
measurement principle.
Changing Lanes
In December 2021, the FASB issued FASB Concepts Statement 8,
Chapter 4, which supersedes FASB Concepts Statement 6 and includes new
definitions of elements of financial statements, including definitions of
assets and liabilities. In addition, the Board currently has an ongoing
project on codification improvements that considers removing from the
Codification any references to the Concepts Statements. While we do not
believe that the new definitions in FASB Concepts Statement 8, Chapter 4, or
the project to remove references from the Codification will result in any
significant changes to the recognition of assets and liabilities in a
business combination, practitioners should monitor that project for
developments.
4.1.1 Use of a Third-Party Specialist to Measure Fair Value
Some entities elect to engage a third-party specialist to assist management in
the valuation of some or all of the assets acquired and liabilities assumed in a
business combination, especially if the fair value measurements are unusually
complex or management wishes to otherwise supplement its internal valuation
expertise. The SEC staff has indicated that under certain conditions, a
registrant’s filings do not need to refer to the third-party valuation firm that
provided assistance. On November 26, 2008, the SEC’s Division of Corporation
Finance issued revised Compliance and Disclosure Interpretations (C&DIs) of
Securities Act Sections related to the use of third-party specialists.
C&DI Question
141.02 of the Securities Act Sections states:
Question: A registrant has engaged
a third party expert to assist in determining the fair values of certain
assets or liabilities disclosed in the registrant’s Securities Act
registration statement. Must the registrant disclose in the registration
statement that it used a third party expert for this purpose? In what
circumstances must the registrant disclose the name of the third party
expert in its registration statement and obtain the third party’s consent to
be named?
Answer: The
registrant has no requirement to make reference to a third party expert
simply because the registrant used or relied on the third party expert’s
report or valuation or opinion in connection with the preparation of a
Securities Act registration statement. The consent requirement in Securities
Act Section 7(a) applies only when a report, valuation or opinion of an
expert is included or summarized in the registration statement and
attributed to the third party and thus becomes “expertised” disclosure for
purposes of Securities Act Section 11(a), with resultant Section 11
liability for the expert and a reduction in the due diligence defense burden
of proof for other Section 11 defendants with respect to such disclosure, as
provided in Securities Act Section 11(b).
If the
registrant determines to make reference to a third party expert, the
disclosure should make clear whether any related statement included or
incorporated in a registration statement is a statement of the third party
expert or a statement of the registrant. If the disclosure attributes a
statement to a third party expert, the registrant must comply with the
requirements of Securities Act Rule 436 with respect to such statement. For
example, if a registrant discloses purchase price allocation figures in the
notes to its financial statements and discloses that these figures were
taken from or prepared based on the report of a third party expert, or
provides similar disclosure that attributes the purchase price allocation
figures to the third party expert and not the registrant, then the
registrant should comply with Rule 436 with respect to the purchase price
allocation figures. On the other hand, if the disclosure states that
management or the board prepared the purchase price allocations and in doing
so considered or relied in part upon a report of a third party expert, or
provides similar disclosure that attributes the purchase price allocation
figures to the registrant and not the third party expert, then there would
be no requirement to comply with Rule 436 with respect to the purchase price
allocation figures as the purchase price allocation figures are attributed
to the registrant.
Independent of Section 7(a)
considerations, a registrant that uses or relies on a third party expert
report, valuation or opinion should consider whether the inclusion or
summary of that report, valuation or opinion is required in the registration
statement to comply with specific disclosure requirements, such as Item 1015
of Regulation M-A, Item 601(b) of Regulation S-K or the general disclosure
requirement of Securities Act Rule 408.
According to the SEC, a registrant that does not refer to a valuation firm in its filing must provide
disclosures explaining the method and assumptions that were used in the valuation. A registrant that
does refer to a valuation firm must provide:
- The valuation firm’s name.
- A consent from the valuation firm as required by of SEC Regulation S-K, Item 601(b)(23).
- The registrant’s analysis of the qualifications of those assisting management in preparing the valuation.
The staff also cautioned that registrants seeking to incorporate their financial
statements into their registration statement must amend the financial statements
to include the valuation firm’s name and consent, if the statements do not
already do so.
Regardless of whether a fair value measurement is prepared entirely by the
entity or with the assistance of a third-party specialist, a similar level of
evidence is needed to support the measurement; and management is ultimately
responsible for the appropriateness of the accounting and reporting of all the
fair value measurements — including the valuation techniques, the underlying
assumptions, and the completeness and accuracy of the data provided to, and
received from, specialists.
4.2 Classifying or Designating the Assets Acquired and Liabilities Assumed
ASC 805-20
25-6 At the acquisition date, the acquirer shall classify or designate the identifiable assets acquired
and liabilities assumed as necessary to subsequently apply other GAAP. The acquirer shall make those
classifications or designations on the basis of the contractual terms, economic conditions, its operating or
accounting policies, and other pertinent conditions as they exist at the acquisition date.
25-7 In some situations, GAAP provides for different accounting depending on how an entity classifies or designates a particular asset or liability. Examples of classifications or designations that the acquirer shall make
on the basis of the pertinent conditions as they exist at the acquisition date include but are not limited to the
following:
- Classification of particular investments in securities as trading, available for sale, or held to maturity in accordance with Section 320-10-25
- Designation of a derivative instrument as a hedging instrument in accordance with paragraph 815-10- 05-4
- Assessment of whether an embedded derivative should be separated from the host contract in accordance with Section 815-15-25 (which is a matter of classification as this Subtopic uses that term).
Because a business combination results in the initial recognition of the assets acquired and liabilities
assumed in the acquirer’s financial statements, the acquiree’s assets and liabilities are recognized even if
they did not qualify for recognition before the business combination, and they are generally remeasured
at fair value. Similarly, any prior classifications or designations by the acquiree are reconsidered as of the
acquisition date. The subsequent accounting for some assets and liabilities differs depending on how
they are classified or designated. ASC 805-20-25-7 provides three examples:
- Classification of particular investments in securities as trading, available for sale, or held to maturity in accordance with Section 320-10-25
- Designation of a derivative instrument as a hedging instrument in accordance with paragraph 815-10-05-4
- Assessment of whether an embedded derivative should be separated from the host contract in accordance with Section 815-15-25 (which is a matter of classification as this Subtopic uses that term).
Other examples include classifying newly acquired assets as held for sale or
electing the fair value option for eligible items acquired in a business
combination. Under ASC 805-20-25-6, an acquirer must classify or designate the
acquiree’s assets and liabilities on the basis of all relevant facts as of the
acquisition date in the context of the contractual terms, its accounting policies,
and other pertinent factors as of that date, with two exceptions that are discussed
below.
4.3 Exceptions to Recognition, Measurement, and Designation or Classification of Assets or Liabilities
4.3.1 Exceptions to Recognition and Measurement
ASC 805-20
25-16 This Topic provides
limited exceptions to the recognition and
measurement principles applicable to business
combinations. Paragraphs 805-20-25-17 through
25-28B specify the types of identifiable assets
and liabilities that include items for which this
Subtopic provides limited exceptions to the
recognition principle in paragraph 805-20-25-1.
The acquirer shall apply the specified GAAP or the
specified requirements rather than that
recognition principle to determine when to
recognize the assets or liabilities identified in
paragraphs 805-20-25-17 through 25-28B. That will
result in some items being recognized either by
applying recognition conditions in addition to
those in paragraphs 805-20-25-2 through 25-3 or by
applying the requirements of other GAAP, with
results that differ from applying the recognition
principle and conditions in paragraphs 805-20-25-1
through 25-3.
Pending Content (Transition Guidance: ASC
805-20-65-3)
25-16 This Topic provides limited
exceptions to the recognition and measurement
principles applicable to business combinations.
Paragraphs 805-20-25-17 through 25-28C specify the
types of identifiable assets and liabilities that
include items for which this Subtopic provides
limited exceptions to the recognition principle in
paragraph 805-20-25-1. The acquirer shall apply
the specified GAAP or the specified requirements
rather than that recognition principle to
determine when to recognize the assets or
liabilities identified in paragraphs 805-20-25-17
through 25-28C. That will result in some items
being recognized either by applying recognition
conditions in addition to those in paragraphs
805-20-25-2 through 25-3 or by applying the
requirements of other GAAP, with results that
differ from applying the recognition principle and
conditions in paragraphs 805-20-25-1 through
25-3.
25-17 Guidance is presented
on all of the following exceptions to the
recognition principle:
-
Assets and liabilities arising from contingencies
-
Income taxes
-
Employee benefits
-
Indemnification assets
-
Leases.
Pending Content (Transition Guidance: ASC
805-20-65-3)
25-17 Guidance is presented on all of
the following exceptions to the recognition
principle:
- Assets and liabilities arising from contingencies
- Income taxes
- Employee benefits
- Indemnification assets
- Leases
- Contract assets and contract liabilities.
30-12 Guidance is presented
on all of the following exceptions to the
measurement principle:
-
Income taxes
-
Employee benefits
-
Indemnification assets
-
Reacquired rights
-
Share-based payment awards
-
Assets held for sale
-
Certain assets and liabilities arising from contingencies
-
Leases
-
Purchased financial assets with credit deterioration.
Pending Content (Transition
Guidance: ASC 805-20-65-3)
30-12
Guidance is presented on all of the following
exceptions to the measurement principle:
- Income taxes
- Employee benefits
- Indemnification assets
- Reacquired rights
- Share-based payment awards
- Assets held for sale
- Certain assets and liabilities arising from contingencies
- Leases
- Purchased financial assets with credit deterioration
- Contract assets and contract liabilities.
As discussed above, ASC 805 includes several exceptions to fair value
measurement and recognition. Because most assets acquired and
liabilities assumed in an acquisition are subsequently accounted for
under the relevant GAAP, the guidance provides exceptions to ensure
that those subsequent applications of GAAP do not result in the
recognition of a gain or loss when no such economic change occurred.
For example, income taxes are an exception to the recognition and
measurement principles and are accounted for under ASC 740. If that
exception did not exist, an acquirer would be required to recognize
and measure income taxes at fair value and the subsequent application
of ASC 740 would result in the acquirer’s recognition of deferred
taxes at amounts other than fair value or not at all. As a result, the
acquirer would recognize a gain or loss even though no economic change
had occurred.
4.3.2 Exceptions to Designation or Classification of Assets or Liabilities
ASC 805-20
25-8 This Section provides
the following two exceptions to the principle in
paragraph 805-20-25-6:
-
Classification of a lease of an acquiree shall be in accordance with the guidance in paragraph 842-10-55-11
-
Classification of a contract written by an entity that is in the scope of Subtopic 944-10 as an insurance or reinsurance contract or a deposit contract. The acquirer shall classify that contract on the basis of the contractual terms and other factors at the inception of the contract (or, if the terms of the contract have been modified in a manner that would change its classification, at the date of that modification, which might be the acquisition date).
ASC 805 requires most contracts, assets, and liabilities to be classified or designated on the acquisition
date. However, there are two exceptions: lease agreements and insurance or reinsurance contracts.
ASC 805-20-25-8 notes that if a contract has been modified in a manner that would change its
classification, the acquirer should classify it on the basis of the contractual terms and other factors “at
the date of that modification, which might be the acquisition date.” That is, if contracts are modified
as a result of a business combination, an acquirer should take the modifications into account when
classifying or designating the contracts, assets, or liabilities. However, some common changes to
contracts do not affect the contracts’ terms. For example, as a result of a business combination, a
lease agreement may be modified to change one of the parties to the contract. Such a change is not a
substantive modification to the terms of the lease and would not affect its classification.
4.3.3 List of Exceptions to the Recognition, Measurement, Designation, or Classification of Assets or Liabilities
The table below lists the exceptions and
highlights the sections in which they are discussed in this
publication.
Recognition and measurement
exceptions |
|
Classification or designation
exceptions |
|
4.3.4 Indemnification Assets
The seller in a business combination may contractually indemnify the acquirer for uncertainties related
to specific assets or liabilities, such as those associated with lawsuits and uncertain tax positions. This
type of indemnification represents an asset obtained in the business combination. Indemnification
assets are an exception to the recognition and measurement principles.
Connecting the Dots
Amounts held in escrow pending resolution of general representation and warranty provisions
contained in the acquisition agreement are not indemnification assets. See Section 5.3.1 for
information about amounts held in escrow as part of an acquisition agreement.
4.3.4.1 Initial Accounting for Indemnification Assets
ASC 805-20
Indemnification Assets
25-27 The seller in a business combination may contractually indemnify the acquirer for the outcome of
a contingency or uncertainty related to all or part of a specific asset or liability. For example, the seller
may indemnify the acquirer against losses above a specified amount on a liability arising from a particular
contingency; in other words, the seller will guarantee that the acquirer’s liability will not exceed a specified
amount. As a result, the acquirer obtains an indemnification asset. The acquirer shall recognize an
indemnification asset at the same time that it recognizes the indemnified item, measured on the same basis
as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts. Therefore,
if the indemnification relates to an asset or a liability that is recognized at the acquisition date and measured
at its acquisition-date fair value, the acquirer shall recognize the indemnification asset at the acquisition date
measured at its acquisition-date fair value.
25-28 In some circumstances, the indemnification may relate to an asset or a liability that is an exception to the
recognition or measurement principles. For example, an indemnification may relate to a contingency that is not
recognized at the acquisition date because it does not satisfy the criteria for recognition in paragraphs 805-20-25-18A through 25-19 at that date. In those circumstances, the indemnification asset shall be recognized
and measured using assumptions consistent with those used to measure the indemnified item, subject to
management’s assessment of the collectibility of the indemnification asset and any contractual limitations on
the indemnified amount.
30-18 Paragraph 805-20-25-27 requires that the acquirer recognize an indemnification asset at the same
time that it recognizes the indemnified item, measured on the same basis as the indemnified item, subject
to the need for a valuation allowance for uncollectible amounts. That paragraph also requires that, if the
indemnification relates to an asset or a liability that is recognized at the acquisition date and measured at its
acquisition-date fair value, the acquirer recognize the indemnification asset at the acquisition date measured
at its acquisition-date fair value. For an indemnification asset measured at fair value, the effects of uncertainty
about future cash flows because of collectibility considerations are included in the fair value measure and a
separate valuation allowance is not necessary, as noted in paragraph 805-20-30-4.
30-19 Paragraph 805-20-25-28 states that in some circumstances, the indemnification may relate to an asset
or a liability that is an exception to the recognition or measurement principles, and provides an example of an
indemnification that may relate to a contingency that is not recognized at the acquisition date because it does
not satisfy the criteria for recognition in paragraphs 805-20-25-18A through 25-19 at that date. Alternatively,
an indemnification may relate to an asset or a liability, for example, one that results from an uncertain tax
position that is measured on a basis other than acquisition-date fair value. (Paragraph 805-20-30-13 identifies
the business-combination-related measurement requirements for income taxes.) Paragraph 805-20-25-28
establishes that in those circumstances, the indemnification asset shall be recognized and measured
using assumptions consistent with those used to measure the indemnified item, subject to management’s
assessment of the collectibility of the indemnification asset and any contractual limitations on the indemnified
amount.
The recognition and measurement of an
indemnification asset depends on whether the acquirer recognizes
the indemnified item as part of the accounting for the business
combination and how the acquirer measures the indemnified item.
The following are examples of the recognition and measurement of
certain types of indemnified items and the resulting
indemnification assets:
Recognition and Measurement of the
Indemnified Item | Recognition and Measurement of the
Indemnification Asset |
---|---|
Recognized and measured at its acquisition-date
fair value (e.g., a liability arising from a contingency
recognized at its fair value as of the acquisition date). | Recognized and measured at its fair value as of the acquisition date, adjusted
for any contractual limitations and the credit
risk of the indemnifying party. Before adoption of
ASU
2016-13, no separate valuation
allowance is recognized related to collectibility
for indemnification assets measured at fair value.
We believe that after adoption of ASU 2016-13, if
the indemnified item is a financial asset measured
at amortized cost, the associated indemnification
asset is within the scope of ASC 326-20 because
ASC 805-20-25-27 requires the indemnification
assets to be “measured on the same basis as the
indemnified item, subject to the need for a
valuation allowance for uncollectible amounts.”
See Deloitte’s Roadmap Current Expected Credit
Losses for more information. |
Recognized as of the acquisition date but measured at
an amount other than fair value (e.g., an uncertain tax
position). | Recognized and measured by using assumptions
that are consistent with those used to measure
the indemnified item, adjusted for any contractual
limitations and the credit risk of the indemnifying
party. A separate valuation allowance is permitted for
indemnification assets measured at other than fair
value. |
Unrecognized as of the acquisition date (e.g., a liability
arising from a contingency that does not meet the
criteria for recognition as of the acquisition date)
and does not qualify for recognition during the
measurement period. | Unrecognized as part of the business combination
accounting. Subsequent accounting is based on
applicable GAAP (see Section 4.3.4.2). |
Recognized as of the acquisition date, but the
indemnification only gives the acquirer the ability to
recover a portion of the amount (e.g., the amount of
recovery is limited to a specific amount or percentage). | Recognized and measured by using assumptions
that are consistent with those used to measure
the indemnified item, adjusted for the contractual
limitations on recovery and the credit risk of the
indemnifying party. |
For indemnification assets recognized at fair value, no separate valuation
allowance is recognized for concerns about collectibility before
the adoption of ASU 2016-13. Entities should take into account
collectibility concerns when measuring fair value since such
concerns could result in a measurement of the indemnification
asset that differs from that of the indemnified item. For
indemnification assets measured at other than fair value,
entities can establish a separate valuation allowance for
collectibility concerns. Such an allowance would only affect
presentation. We believe that after adoption of ASU 2016-13, if
the indemnified item is a financial asset measured at amortized
cost, the associated indemnification asset is within the scope
of ASC 326-20 because ASC 805-20-25-27 requires indemnification
assets to be “measured on the same basis as the indemnified
item, subject to the need for a valuation allowance for
uncollectible amounts.” See Deloitte’s Roadmap Current
Expected Credit Losses for more
information.
Example 4-1
Initial Recognition and Measurement of Indemnification Assets
On June 15, 20X9, Company A acquires Company B in a transaction accounted for as a business combination.
In applying the acquisition method of accounting, A recognizes a $100 liability related to B’s uncertain tax
position in accordance with ASC 740. As part of the acquisition, B’s former owners agree to indemnify A for any
losses related to the tax position.
Under ASC 805, A should recognize an indemnification asset at the same amount as
the liability, $100 (assuming collectibility is
not in doubt). This amount most likely does not
represent the asset’s fair value because ASC 740
does not require fair value measurement.
Acquisition agreements often include indemnification arrangements, but the parties to the business
combination may instead establish such arrangements separately. In such cases, we believe that entities
should consider analogizing to the factors in ASC 810-10-40-6 in determining whether to account
for the acquisition agreement and the separate indemnification agreement as a single arrangement.
Typically, we would expect that the application of those factors would lead an entity to conclude that
the indemnification arrangement is part of the business combination agreement, in which case the
acquirer would recognize, measure, and subsequently account for the indemnification assets by using
the guidance in ASC 805.
4.3.4.2 Subsequent Accounting for Indemnification Assets
ASC 805-20
Indemnification Assets
35-4 At each subsequent reporting date, the acquirer shall measure an indemnification asset that was
recognized in accordance with paragraphs 805-20-25-27 through 25-28 at the acquisition date on the same
basis as the indemnified liability or asset, subject to any contractual limitations on its amount, except as noted
in paragraph 805-20-35-4B, and, for an indemnification asset that is not subsequently measured at its fair
value, management’s assessment of the collectibility of the indemnification asset.
40-3 The acquirer shall derecognize an indemnification asset recognized in accordance with paragraphs
805-20-25-27 through 25-28 only when it collects the asset, sells it, or otherwise loses the right to it.
When measuring an indemnification asset that was initially recognized as part of the accounting for a
business combination, an entity should use assumptions that are consistent with those used to measure
the indemnified item after the acquisition date, subject to any contractual limitations and considerations
about the indemnifying party’s credit risk. If a change in the amount recognized for the indemnification
asset is not the result of a qualifying measurement-period adjustment, the entity should recognize
the change in earnings. An entity should use judgment in determining whether the changes to the
indemnified item and the indemnification asset should be recognized in the same income statement line
item so that they effectively offset one another.
Example 4-2
Subsequent Accounting for Indemnification Assets Recognized as of the Acquisition Date
Company A acquires Company B in a transaction accounted for as a business combination. As of the
acquisition date, B has an open claim related to a contract dispute with a former supplier who is asserting
damages of $100 million. In connection with the business combination, B’s selling shareholders agree to
indemnify A for any losses related to this ongoing litigation up to $75 million. In applying the acquisition
method of accounting, A recognizes and measures a $50 million liability for this ongoing litigation and an
indemnification asset of $50 million because collectibility is not in doubt. After the measurement period for this
item closes, a settlement is reached in the amount of $60 million.
Company A should increase its measurement of the liability to $60 million with a corresponding $10 million
debit to the income statement. Also, if the additional amount due under the indemnification agreement is
determined to be collectible, A should increase the indemnification asset to $60 million with a corresponding
$10 million credit to the income statement.
If an indemnification asset only becomes recognizable after the measurement
period for the indemnified item is closed, the recognition of
the asset is subject to other GAAP rather than the guidance in
ASC 805. In some cases, it may be appropriate to apply a loss
recovery model to the recognition of the indemnification asset.
The accounting framework underlying such a model is based on an
analogy to the guidance on recognition of potential loss
recoveries in ASC 410. Specifically, ASC 410-30-35-8, which
provides subsequent measurement guidance related to
environmental obligations, states, in part:
Potential recoveries may be claimed from a number of
different parties or sources, including insurers,
potentially responsible parties other than participating
potentially responsible parties (see paragraph 410-30-
30-2), and governmental or third-party funds. The amount
of an environmental remediation liability should be
determined independently from any potential claim for
recovery, and an asset relating to the recovery shall be
recognized only when realization of the claim for recovery
is deemed probable. The term probable is used in
this Subtopic with the specific technical meaning in
paragraph 450-20-25-1 [the future event or events are
likely to occur].
The recognition criteria for a loss recovery is different from that for a gain contingency. Provided that its collection is probable, a loss recovery is recognized in the period in which the loss is incurred (or the period in which collection becomes probable). However, a gain contingency is recognized on the earlier of when the gain is realized or is realizable. While not codified, paragraph 16 of EITF Issue 01-10 provides the EITF’s
understanding of the distinction between a loss recovery and a
gain contingency: a loss recovery represents the recovery of a
loss already recognized in the financial statements, whereas a
gain contingency represents the recovery of a loss not yet
recognized in the financial statements or recovery of an amount
that is greater than the loss recognized in the financial
statements.
Example 4-3
Subsequent Accounting for Indemnification Asset Not Recognized as of the Acquisition Date
On June 15, 20X9, Company A acquires Company B. Before the acquisition, B had ongoing litigation with a
former supplier. In connection with the business combination, B’s selling shareholders agree to indemnify A
for any losses related to that ongoing litigation. In applying the acquisition method, A concludes that a liability
related to the ongoing litigation does not meet the criteria for recognition during the measurement period.
Therefore, A does not recognize a liability or an indemnification asset related to the litigation. Eighteen months
after the acquisition, A recognizes a liability for $100 million on the basis of a judgment reached in a similar
case.
Company A should recognize an indemnification asset for $100 million under a
loss recovery model (provided that collectibility
of this amount from B’s selling shareholders is
not in doubt) since recognition of the
indemnification asset represents the recovery of a
loss that is already recognized in the financial
statements.
ASC 805-20-40-3 states that an acquirer only derecognizes an indemnification asset “when it collects the
asset, sells it, or otherwise loses the right to it.” If there were no changes in the values of the recorded
liability and associated indemnification asset after the acquisition date, both the asset and liability would
be reversed upon derecognition, with no net effect on the income statement.
4.3.4.3 Subsequent Accounting for an Indemnification Asset Recognized as of the Acquisition Date After a Government-Assisted Acquisition of a Financial Institution
ASC 805-20
35-4B An indemnification
asset recognized at the acquisition date in
accordance with paragraphs 805-20-25-27 through
25-28 as a result of a government-assisted
acquisition of a financial institution involving
an indemnification agreement shall be subsequently
measured on the same basis as the indemnified
item. For example, if the expected cash flows on
indemnified assets increase such that a previously
recorded valuation allowance is reversed, an
entity shall account for the associated decrease
in the indemnification assets immediately in
earnings.
4.3.5 Assets Held for Sale
ASC 805-20
Assets Held for Sale
30-22 The acquirer shall measure an acquired long-lived asset (or disposal group) that is classified as held for
sale at the acquisition date in accordance with Subtopic 360-10, at fair value less cost to sell in accordance with
paragraphs 360-10-35-38 and 360-10-35-43.
An entity may acquire a business with the intention of selling some of its
long-lived assets shortly after the acquisition date. ASC 805-20-30-22
requires an acquirer to “measure an acquired long-lived asset (or
disposal group) that is classified as held for sale at the acquisition
date in accordance with Subtopic 360-10, at fair value less cost to
sell in accordance with paragraphs 360-10-35-38 and 360-10-35-43.”
Accordingly, a long-lived asset (or disposal group) that meets the
criteria in ASC 360-10-45-12 for held-for-sale classification on the
acquisition date is an exception to the measurement principle in ASC
805.
ASC 360-10-45-12 requires entities to classify a newly acquired long-lived asset
or a disposal group as held for sale as of the acquisition date if it
meets both of the following conditions:
-
“[I]f the one-year requirement in paragraph 360-10-45-9(d) is met (except as permitted by [paragraph 360-10-45-11]).”
-
“[A]ny other criteria in paragraph 360-10-45-9 that are not met [as of the acquisition] date are probable of being met within a short period following the acquisition (usually within three months).”
Accordingly, as specified in ASC 360-10-45-12, the acquirer must satisfy the
one-year criterion in ASC 360-10-45-9(d) as of the acquisition date,
but it can satisfy the other criteria in ASC 360-10-45-9 if they “are
probable of being met within a short period following the acquisition
(usually within three months).” If the long-lived asset or disposal
group cannot be classified as held for sale, the assets and
liabilities would be measured in accordance with the requirements in
ASC 805, which would generally be fair value.
See Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and
Discontinued Operations for more
information about the held-for-sale and discontinued-operations
reporting criteria for a business or nonprofit activity that meets the
held-for-sale classification criteria upon acquisition.
4.3.6 Assets and Liabilities Arising From Contingencies
ASC 805-20
25-18A The following recognition guidance in paragraphs 805-20-25-19 through 25-20B applies to assets and
liabilities meeting both of the following conditions:
- Assets acquired and liabilities assumed that would be within the scope of Topic 450 if not acquired or assumed in a business combination
- Assets or liabilities arising from contingencies that are not otherwise subject to specific guidance in this Subtopic.
The ASC master glossary defines a contingency as “[a]n existing condition, situation, or set of
circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an
entity that will ultimately be resolved when one or more future events occur or fail to occur.” Examples
of contingencies include litigation, environmental liabilities, or warranty claims.
The guidance in ASC 805-20 on assets and liabilities arising from contingencies
applies to assets and liabilities “that would be within the scope of
Topic 450 if not acquired or assumed in a business combination” and
are “not otherwise subject to specific guidance in this Subtopic
[805-20].” For example, indemnification assets may meet the definition
of a contingency; however, ASC 805-20 provides specific guidance on
accounting for indemnification assets in a business combination.
Similarly, income tax uncertainties or temporary differences,
including loss carryforwards, are not contingencies because they are
accounted for under ASC 740 rather than ASC 450 when they are outside
of a business combination.
Contingencies that exist as of the acquisition date result from prior events or
circumstances, which is why assets and liabilities arising from
contingencies are often referred to as “preacquisition contingencies.”
Outside of a business combination, contingencies are accounted for in
accordance with the applicable GAAP (e.g., environmental liabilities);
however, if no specific GAAP applies to them, they are accounted for
as loss contingencies or gain contingencies under ASC 450. Loss
contingencies are recognized if they are probable and reasonably
estimable, whereas gain contingencies are recognized on the earlier of
when they are realized or are realizable.
While contingencies acquired or assumed in a business combination result from past events, they may
not have been recognized by the acquiree before the business combination because the recognition
criteria are different for contingencies that arise outside of a business combination.
4.3.6.1 Initial Recognition and Measurement of Assets and Liabilities Arising From Contingencies
ASC 805-20
Acquisition Date Fair Value Determinable During Measurement Period
25-19 If the acquisition-date fair value of the asset or liability arising from a contingency can be determined
during the measurement period, that asset or liability shall be recognized at the acquisition date. For example,
the acquisition-date fair value of a warranty obligation often can be determined.
Acquisition Date Fair Value Not Determinable During Measurement Period
25-20 If the acquisition-date fair value of the asset or liability arising from a contingency cannot be determined
during the measurement period, an asset or a liability shall be recognized at the acquisition date if both of the
following criteria are met:
- Information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date. It is implicit in this condition that it must be probable at the acquisition date that one or more future events confirming the existence of the asset or liability will occur.
- The amount of the asset or liability can be reasonably estimated.
25-20A The criteria in the preceding paragraph shall be applied using the guidance in Topic 450 for application
of similar criteria in paragraph 450-20-25-2.
Recognition Criteria Not Met During Measurement Period
25-20B If the recognition criteria in paragraphs 805-20-25-19 through 25-20A are not met at the acquisition
date using information that is available during the measurement period about facts and circumstances that
existed as of the acquisition date, the acquirer shall not recognize an asset or liability as of the acquisition
date. In periods after the acquisition date, the acquirer shall account for an asset or a liability arising from
a contingency that does not meet the recognition criteria at the acquisition date in accordance with other
applicable GAAP, including Topic 450, as appropriate.
Measurement of Assets and Liabilities Arising From Contingencies
30-9 Paragraphs 805-20-25-18A through 25-20B establish the requirements related to recognition of certain
assets and liabilities arising from contingencies. Initial measurement of assets and liabilities meeting the
recognition criteria in paragraph 805-20-25-19 shall be at acquisition-date fair value. Guidance on the initial
measurement of other assets and liabilities from contingencies not meeting the recognition criteria of that
paragraph, but meeting the criteria in paragraph 805-20-25-20 is at paragraph 805-20-30-23.
30-23 Initial measurement of assets and liabilities meeting the recognition criteria in paragraph 805-20-25-20
shall be at the amount that can be reasonably estimated by applying the guidance in Topic 450 for application
of similar criteria in paragraph 450-20-25-2.
ASC 805 requires entities to perform two steps in determining whether an asset or liability arising from a
contingency qualifies for recognition in a business combination. The first step is to evaluate whether the
“fair value of the asset or liability arising from a contingency can be determined [at the acquisition date
or] during the measurement period.” If so, the asset or liability is recognized as of its acquisition-date fair
value as part of the accounting for the business combination.
Although ASC 805 does not provide specific guidance on whether the fair value of a contingency is
determinable, it does state that “the acquisition-date fair value of a warranty obligation often can
be determined.” However, in practice, the acquisition-date fair value of many contingencies, such as
contingencies related to litigation, may not be determinable.
If an acquirer cannot determine the acquisition-date fair value of a contingency
during the measurement period, it proceeds to the second step
and recognizes the contingency at its estimated amount if (1)
“it is probable that an asset existed or that a liability had
been incurred at the acquisition date” and (2) “[t]he amount of
the asset or liability can be reasonably estimated.” These
requirements are similar to those in ASC 450 related to loss
contingencies. However, in a business combination, both assets
and liabilities arising from contingencies have the same
recognition criteria, whereas under ASC 450 a gain contingency
is not recognized until the earlier of when it is realized or it
is realizable.
In some cases, an acquirer may not have identified the contingency either before
or on the acquisition date. Although the contingency must have
existed as of the acquisition date (i.e., it resulted from prior
events), the acquirer is not limited to only recognizing items
that were known at the time of acquisition. Contingencies
identified during the measurement period that existed as of the
acquisition date still qualify for recognition as part of the
business combination accounting.
The fair value measurement of a contingent liability takes into account the time
value of money. However, for contingent liabilities recognized
at their estimated amounts, discounting is permitted, but not
required, only if both the timing and amounts of future cash
flows are fixed or reliably determinable on the basis of
objective and verifiable information. Although ASC 410-30
specifically addresses environmental remediation liabilities, an
entity may also find the guidance useful for evaluating whether
discounting is appropriate for other contingencies arising from
liabilities. ASC 410-30-35-12 states, in part, that the
“measurement of the liability, or of a component of the
liability, may be discounted to reflect the time value of money
if the aggregate amount of the liability or component and the
amount and timing of cash payments for the liability or
component are fixed or reliably determinable.” However, because
the timing and amounts of future cash flows of many
contingencies are inherently subjective, it is often difficult
for an entity to meet the criteria for discounting (e.g., in the
early phases of litigation and environmental remediation
efforts). In addition, if the timing and amounts of future cash
flows are fixed or reliably determinable, the acquirer would
likely be able to measure the contingency at fair value.
SEC Considerations
The Interpretative Response to Question 1 in SAB Topic 5.Y states that if a contingent liability is
recognized on a discounted basis, the “notes to the financial statements should, at a minimum,
include disclosures of the discount rate used, the expected aggregate undiscounted amount,
expected payments for each of the five succeeding years and the aggregate amount thereafter,
and a reconciliation of the expected aggregate undiscounted amount to amounts recognized in
the statements of financial position.”
4.3.6.2 Subsequent Accounting for Contingencies Recognized as Part of the Business Combination
ASC 805-20
35-3 An acquirer shall develop a systematic and rational basis for subsequently measuring and accounting for
assets and liabilities arising from contingencies depending on their nature.
ASC 805 does not provide specific subsequent measurement guidance for contingencies recognized in a business combination, except to say that “[a]n acquirer shall develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies depending on their nature.” The subsequent accounting depends on whether the contingency was measured at fair value or at its estimated amount.
For contingencies initially recognized at fair value, the acquirer must develop a “systematic and rational” subsequent measurement approach that is consistent with the nature of the asset or liability. In paragraph B20 of the Basis for Conclusions of FSP FAS 141(R)-1, the FASB suggested that the methods used to subsequently account for guarantees initially recognized at fair value under ASC 460-10 (formerly FASB Interpretation 45) could be applied to
warranty obligations initially recognized at fair value. We
believe that the guidance in ASC 460-10 for the subsequent
accounting of guarantees would also be an acceptable approach to
accounting for other contingencies recognized at fair value, not
just warranty obligations. Another systematic and rational
approach would be for entities to subsequently account for
contingencies by applying the methods used for AROs under ASC
410. Entities should use judgment in assessing whether the
subsequent accounting method they select is consistent with the
nature of the asset or liability. Entities should also apply the
same method to similar assets and liabilities.
However, we do not believe that the application of ASC 450 to contingencies
recognized at fair value would be a systematic or rational
approach. This is because it would not be appropriate for an
entity to recognize a contingency at fair value on the
acquisition date and then immediately recognize a gain or loss
upon measuring the contingency at its estimated amount under ASC
450. In addition, subsequently measuring a contingency at fair
value is not a systematic or rational approach unless fair value
measurement is required by other GAAP.
For contingencies initially recognized in accordance with ASC 805-20-30-23 at
the amount that can be reasonably estimated, acquirers should
apply other GAAP, including ASC 450, in periods after the
acquisition date. However, assets arising from contingencies
should not be derecognized after the acquisition date because
they do not meet the gain contingency recognition threshold in
ASC 450.
Adjustments to the amounts recognized for a contingency should be accounted for
as measurement-period adjustments (see Section
6.1) if they are (1) made within the
measurement period and (2) based on the facts and circumstances
that existed as of the acquisition date. If the adjustments
resulted from facts or circumstances that did not exist as of
the acquisition date, they should be recognized in the income
statement. It can be particularly challenging for entities to
determine whether adjustments to contingencies result from
changes in fact or are related to facts that existed as of the
acquisition date, especially in the case of litigation-related
contingencies.
If a contingency does not qualify for recognition as part of the accounting for
a business combination, the acquirer should recognize the asset
or liability when it meets the recognition criteria in the
applicable GAAP, such as ASC 450 for contingencies or ASC 410
for loss recoveries (see discussion in Section
4.3.4.2 for more information). Under ASC 450,
gain contingencies are not recognized until the earlier of when
they are realized or are realizable. Because an acquirer cannot
adjust the acquisition accounting for the recognition of a
contingency after the end of the measurement period,
contingencies that qualify for recognition outside of the
business combination accounting are recognized in the income
statement. Also, contingencies for which the obligating event
did not exist on the acquisition date, even those that arose
before the end of the measurement period, do not qualify as
measurement-period adjustments since they are not related to
facts and circumstances that existed as of the acquisition
date.
Connecting the Dots
After a business combination, disputes may occur between an acquirer and the acquiree’s
sellers, sometimes resulting in payments between the parties after the acquisition date.
Alternatively, an acquirer’s shareholders may bring litigation against the acquirer for various
reasons, such as a claim that the acquirer overpaid for the acquiree. Litigation arising from a
business combination is not an asset or a liability arising from a contingency because it did not
exist on or before the acquisition date. See Section 6.2.6 for information about disputes arising
from the business combination.
For more information, see Deloitte’s Roadmap Contingencies, Loss Recoveries,
and Guarantees.
4.3.7 Reacquired Rights
ASC 805-20-25-14 states that “[a]s part of a business combination, an acquirer may reacquire a right
that it had previously granted to the acquiree to use one or more of the acquirer’s recognized
or unrecognized assets. Examples of such rights include a right to use the acquirer’s trade name
under a franchise agreement or a right to use the acquirer’s technology under a technology licensing
agreement.” Such assets are called reacquired rights.
4.3.7.1 Initial Measurement of Reacquired Rights
ASC 805-20
Reacquired Rights
25-14 As part of a business combination, an acquirer may reacquire a right that it had previously granted to
the acquiree to use one or more of the acquirer’s recognized or unrecognized assets. Examples of such rights
include a right to use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s
technology under a technology licensing agreement. A reacquired right is an identifiable intangible asset that
the acquirer recognizes separately from goodwill. Paragraph 805-20-30-20 provides guidance on measuring
a reacquired right, and paragraph 805-20-35-2 provides guidance on the subsequent accounting for a
reacquired right.
25-15 If the terms of the contract giving rise to a reacquired right are favorable or unfavorable relative to the
terms of current market transactions for the same or similar items, the acquirer shall recognize a settlement
gain or loss. Paragraph 805-10-55-21 provides guidance for measuring that settlement gain or loss.
30-20 The acquirer shall measure the value of a reacquired right recognized as an intangible asset in
accordance with paragraph 805-20-25-14 on the basis of the remaining contractual term of the related
contract regardless of whether market participants would consider potential contractual renewals in
determining its fair value.
A reacquired right is an identifiable intangible asset that an acquirer recognizes separately from goodwill
because it arises from contractual rights. However, reacquired rights are an exception to ASC 805’s
measurement principle because ASC 805 requires entities to measure them on the basis of the related
contract’s remaining term, regardless of whether market participants would consider potential contract
renewals in determining the rights’ fair value. While market participants would generally reflect expected
renewals of the term of a contractual right in their fair value estimate of a right traded in the market, the
FASB has observed that an acquirer that controls a reacquired right could assume indefinite renewals
of its contractual term, effectively making the reacquired right an indefinite-lived intangible asset. The
Board has therefore concluded that a right reacquired from an acquiree is no longer a contract with a
third party and, in substance, has a finite life. Accordingly, reacquired rights are measured only on the
basis of the remaining contractual term.
However, complexities can arise when a contract has no stated term or is perpetual. In making
reacquired rights an exception to the measurement principle, the FASB intended to limit the value
attributed to a reacquired right by restricting the measurement to only the remaining contractual term.
In this way, an acquirer could not assume that there would be unlimited renewals (since the reacquired
right becomes a contract between the acquirer and itself as a result of the acquisition), classify the
reacquired right as indefinite-lived, and measure it consistently with its classification. Accordingly, we
would expect it to be unusual for a reacquired right to be classified as indefinite-lived. Before classifying
a reacquired right as indefinite-lived and measuring it consistently with its classification, entities should
consider consulting with experts, and SEC registrants should consider consulting with the SEC staff on a
prefiling basis.
At the 2005 AICPA Conference on Current SEC and PCAOB Developments, then SEC OCA
Professional Accounting Fellow Brian Roberson stated the following regarding the
valuation of reacquired rights:
[R]egarding
valuation, you need to value the right as if you were
buying a right that you did not previously own. A problem
is that the rights are oftentimes not transacted on a
standalone basis after the initial sale. For example, a
restaurant franchise is granted and the franchisee
develops a business using the trade name granted by the
franchise agreement. Upon reacquisition, the franchisor
typically purchases the entire business, which is now an
operating restaurant. On the surface, it seems intuitive
that a mature franchise right such as in this example
would be worth more than a new franchise right, but you
have to think about what is driving that value. The
restaurant’s value may be driven by other assets, such as
customer relationship intangibles from catering contracts,
appreciated real estate, and a strong workforce, which is
a component of goodwill.
While a reacquired right is the result of a preexisting contractual relationship
with the acquiree, not all preexisting relationships with an
acquiree will result in the recognition of a reacquired right
because not all preexisting relationships (e.g., a lawsuit) lead
to the reacquisition of a right previously granted to the
acquiree. If the terms of the preexisting contractual
relationship giving rise to a reacquired right are favorable or
unfavorable relative to the terms of current market transactions
for the same or similar items, the acquirer must recognize a
settlement gain or loss related to the preexisting contractual
relationship separately from the accounting for the business
combination. ASC 805-10-55-21 provides guidance on measuring
that settlement gain or loss (see Section 6.2.2 for more
information).
4.3.7.2 Subsequent Accounting for Reacquired Rights
ASC 805-20
35-2 A reacquired right recognized as an intangible asset in accordance with paragraph 805-20-25-14 shall be
amortized over the remaining contractual period of the contract in which the right was granted. An acquirer
that subsequently sells a reacquired right to a third party shall include the carrying amount of the intangible
asset in determining the gain or loss on the sale.
ASC 805-20-35-2 states that an entity amortizes a reacquired right “over the
remaining contractual period of the contract in which the right
was granted.” If an acquirer subsequently sells a reacquired
right to a third party, the carrying amount of the intangible
asset is included in the determination of the gain or loss on
the sale. If the acquirer subsequently sells only a portion of
the reacquired right to the third party, the acquirer will need
to develop a reasonable allocation method for measuring the
portion of the intangible asset’s carrying amount that it will
include in determining the gain or loss on the sale. Such an
allocation method would be necessary if, for example, an
acquirer reacquires a franchise right to a specific geographic
area and then subsequently subdivides that geographic area and
sells only a portion of it to a third party.
4.3.8 Income Taxes
Income taxes are an exception to the recognition and measurement principles in
ASC 805. For information about accounting for income taxes in a
business combination, see Deloitte’s Roadmap Income
Taxes.
4.3.9 Employee Benefits
ASC 805-20
25-22 The acquirer shall recognize a liability (or asset, if any) related to the acquiree’s employee benefit
arrangements in accordance with other GAAP. For example, employee benefits in the scope of the guidance
identified in paragraphs 805-20-25-23 through 25-26 would be recognized in accordance with that guidance
and as specified in those paragraphs.
Pension and Postretirement Benefits Other Than Pensions
25-23 Guidance on defined
benefit pension plans is presented in Subtopic
715-30. If an acquiree sponsors a single-employer
defined benefit pension plan, the acquirer shall
recognize as part of the business combination an
asset or a liability representing the funded
status of the plan (see paragraph 715-30-25-1).
Paragraph 805-20-30-15 provides guidance on
determining that funded status. If an acquiree
participates in a multiemployer plan, and it is
probable as of the acquisition date that the
acquirer will withdraw from that plan, the
acquirer shall recognize as part of the business
combination a withdrawal liability in accordance
with Subtopic 450-20.
25-24 The Settlements, Curtailments, and Certain Termination Benefits Subsections of Sections 715-30-25 and
715-30-35 establish the recognition guidance related to accounting for settlements and curtailments of defined
benefit pension plans and certain termination benefits.
25-25 Guidance on defined benefit other postretirement plans is presented in Subtopic 715-60. If an acquiree
sponsors a single-employer defined benefit postretirement plan, the acquirer shall recognize as part of
the business combination an asset or a liability representing the funded status of the plan (see paragraph
715-60-25-1). Paragraph 805-20-30-15 provides guidance on determining that funded status. If an acquiree
participates in a multiemployer plan and it is probable as of the acquisition date that the acquirer will withdraw
from that plan, the acquirer shall recognize as part of the business combination a withdrawal liability in
accordance with Subtopic 450-20.
Other Employee Benefit Arrangements
25-26 See also the
recognition-related guidance for the following
other employee benefit arrangements:
-
One-time termination benefits in connection with exit or disposal activities. See Section 420-10-25.
-
Compensated absences. See Section 710-10-25.
-
Deferred compensation contracts. See Section 710-10-25.
-
Nonretirement postemployment benefits. See Section 712-10-25.
30-14 The acquirer shall measure a liability (or asset, if any) related to the acquiree’s employee benefit
arrangements in accordance with other GAAP. For example, employee benefits in the scope of the guidance
identified in paragraphs 805-20-30-15 through 30-17 would be measured in accordance with that guidance
and as specified in those paragraphs.
Pension and Postretirement Benefits Other Than Pensions
30-15 Guidance on defined benefit pension plans is presented in Subtopic 715-30. Guidance on defined
benefit other postretirement plans is presented in Subtopic 715-60. Paragraphs 805-20-25-23 and 805-20-25-25 require an acquirer to recognize as part of a business combination an asset or a liability representing the
funded status of a single-employer defined benefit pension or postretirement plan. In determining that funded
status, the acquirer shall exclude the effects of expected plan amendments, terminations, or curtailments that
at the acquisition date it has no obligation to make. The projected benefit obligation assumed shall reflect any
other necessary changes in assumptions based on the acquirer’s assessment of relevant future events.
30-16 The Settlements, Curtailments, and Certain Termination Benefits Subsection of Section 715-30-35
establishes the measurement guidance related to accounting for settlements and curtailments of defined
benefit pension plans and certain termination benefits.
Other Employee Benefit Arrangements
30-17 See also
measurement-related guidance for the following
other employee benefit arrangements:
-
One-time termination benefits in connection with exit or disposal activities. See Section 420-10-30.
-
Compensated absences. See Section 710-10-25.
-
Deferred compensation contracts. See Section 710-10-30.
-
Nonretirement postemployment benefits. See Section 712-10-25.
Contractual Termination Benefits and Curtailment Losses
55-50 An entity that has agreed to a business combination may develop a plan to terminate certain employees.
The plan will be implemented only if the combination is consummated, but the entity assesses the likelihood
of the combination to be probable. In this circumstance, when terminated, the employees will be entitled to
termination benefits under a preexisting plan or contractual relationship. The termination of the employees
also may affect the entity’s assumptions in estimating its obligations for pension benefits, other postretirement
benefits, and postemployment benefits; that is, the termination of the employees may trigger curtailment
losses or the recording of a contractual termination benefit.
55-51 The liability for the contractual termination benefits and the curtailment losses under employee benefit
plans that will be triggered by the consummation of the business combination shall not be recognized when
it is probable that the business combination will be consummated; rather it shall be recognized when the
business combination is consummated.
Employee benefit arrangements that are within the scope of ASC 710, ASC 712, and
ASC 715 are exceptions to ASC 805’s recognition and measurement
principles. The FASB established this broad exception to avoid having
to reconsider the requirements under multiple standards, which would
have been outside the scope of the business combinations project. ASC
805-20-25-22 requires an acquirer to “recognize [and measure] a
liability (or asset, if any) related to the acquiree’s employee
benefit arrangements in accordance with other GAAP.” ASC 805-20-25-23
through 25-26 also note that the following standards provide
recognition and measurement guidance on employee benefits:
-
Deferred compensation contracts — see ASC 710-10-25.
-
Compensated absences — see ASC 710-10-25.
-
Defined benefit pension plans — see ASC 715-30.
-
Settlements, curtailments, and certain termination benefits — see ASC 715-30-25 and ASC 715-30-35.
-
Other postretirement plans — see ASC 715-60.
-
Multiemployer plans for which “it is probable as of the acquisition date that the acquirer will withdraw from that plan” — see ASC 450-20.
-
Nonretirement postemployment benefits — see ASC 712-10-25.
-
One-time termination benefits related to exit or disposal activities — see ASC 420-10-25.
4.3.9.1 Pension and Other Postretirement Benefit Plans
If an acquirer will assume as part of a business combination a single-employer defined benefit plan
(including a defined benefit pension plan or postretirement benefit plan) sponsored by the acquiree, the
acquirer should recognize an asset or a liability on the acquisition date for the funded status of the plan.
If, as of the acquisition date, the fair value of the plan assets exceeds the projected benefit obligation, an
asset is recognized; however, if the projected benefit obligation exceeds the fair value of the plan assets,
a liability is recognized. Previously unrecognized prior service costs, gains or losses, and transition
amounts of the acquiree related to the assumed plan, including amounts previously recognized in other
comprehensive income, are not carried forward.
Under ASC 805-20-30-15, when measuring the funded status of pension and other
postretirement plans, an acquirer must exclude the effects of an
entity’s planned but not executed amendments, terminations, and
curtailments. Planned or expected amendments, terminations, and
curtailments are not considered part of the liability assumed on
the acquisition date. Such actions are recognized in the
postcombination financial statements in accordance with ASC
715.
Upon an acquisition or a change in control, an acquirer may be obligated to
modify an existing plan. The acquirer should assess the
modification to determine whether it is part of the business
combination or whether it should be accounted for outside of the
business combination in accordance with ASC 805-10-55-18. If the
modification is determined to be part of the business
combination, the acquirer should include the effect of the
modification on the existing plan in measuring the plan’s funded
status.
The measurement of the projected benefit obligation for pensions or accumulated
postretirement benefit obligation for other postretirement
benefits and the fair value of the plan assets on the
acquisition date should reflect any other necessary changes in
discount rates or other assumptions that are based on the
acquirer’s assessment of relevant future events.
In addition, ASC 805-20-55-51 addresses the accounting for contractual
termination benefits and curtailment losses in an acquiree’s
preacquisition financial statements. It states that “[t]he
liability for the contractual termination benefits and the
curtailment losses under employee benefit plans that will be
triggered by the consummation of the business combination shall
not be recognized when it is probable that the business
combination will be consummated; rather it shall be recognized
when the business combination is consummated.”
Example 4-4
Anticipated Plan Amendments in Connection With a Business Combination
Company A intends to acquire Company B in a business combination. Company B currently offers pension
benefits to its employees, and as part of the acquisition agreement, A agrees to offer competitive pension
benefits to B’s employees for one year after the transaction. Company A is evaluating the possibility of reducing
these benefits after one year; but as of the acquisition date, it has not decided how or to what extent the
benefits will change. Any change most likely would result in a reduction in the liability representing the plan’s
funded status.
ASC 805-20-30-15 states that in “determining that funded status, the acquirer
shall exclude the effects of expected plan
amendments . . . that at the acquisition date it
has no obligation to make.” Because A has no
obligation as of the acquisition date to recognize
the effects of an expected, but voluntary,
amendment, it should not recognize the effect of
its expected modification as part of the business
combination accounting. If A decides to change B’s
employees’ pension benefits after the acquisition
date, these changes should be treated as plan
amendments in accordance with ASC 715-30-35-10
through 35-17.
Example 4-5
Anticipated Changes to OPEB Plan in Connection With a Business Combination
Company A is acquiring Company B, which currently sponsors an other
postemployment benefits (OPEB) plan. The
assumptions that B uses to measure the funded
status of its plan (e.g., the method to determine
the discount rate) differ from those used by A. In
addition, certain provisions of B’s plan are
different from those of A. After the business
combination, A intends to amend B’s plan to make
it consistent with its own plans; however, A has
no obligation to make amendments on the
acquisition date.
ASC 805-20-30-15 states that “the acquirer shall exclude the effects of expected
plan amendments, terminations, or curtailments
that at the acquisition date it has no obligation
to make.” However, in accordance with ASC
805-20-30-15, the plan liabilities that A assumes
should “reflect any other necessary changes in
assumptions based on the acquirer’s assessment of
relevant future events.” That is, to measure B’s
plan liabilities, A may use assumptions that are
consistent with those used in the measurement of
its existing plans, including, for example, the
discount rates, health care cost inflation,
Medicare reimbursement rates, and expected return
on plan assets.
4.3.9.2 Postemployment Benefits
ASC 712 applies to all types of postemployment benefits other than pensions, postretirement benefits, deferred compensation arrangements, and termination benefits, which are addressed in other standards. ASC 712-10-25-5 requires an entity to account for a liability for postemployment benefits in accordance with ASC 450 if those benefits within the scope of ASC 712 do not meet the conditions in ASC 710-10-25-1. In addition, the Background Information and Basis for Conclusions of FASB Statement 112 states that an entity may refer to the guidance in FASB Statement 87 (ASC 715-30) and FASB Statement 106 (ASC 715-60) on measuring a liability for postemployment benefit obligations. While not codified, the guidance in Statement 112’s Background Information and Basis for Conclusions continues to be relevant.
Thus, in a manner consistent with the treatment of pensions and OPEBs (see Section 4.3.9.1), an acquirer must exclude
the effects of any planned amendments, terminations, or curtailments from the measurement of
the assumed obligation in a business combination unless such information is required as part
of the acquisition agreement or as a result of the change in control. Measurement of the
assumed obligation should reflect any other necessary changes in discount rates or other
assumptions based on the acquirer’s assessment of the relevant future event.
4.3.9.3 Multiemployer Plans
Multiemployer plans are accounted for differently than single employer plans, as discussed in
ASC 715-80. Liabilities for multiemployer plans generally are recognized only for unpaid contributions as
of the acquisition date. ASC 805-20-25-23 states that an acquirer recognizes a withdrawal liability as of
the acquisition date in accordance with ASC 450-20 if it is probable that, as of that date, the acquirer will
withdraw from a multiemployer plan.
4.3.10 Purchased Financial Assets — After Adoption of ASU 2016-13
ASC 805-20
30-4A For
acquired financial assets that are not purchased
financial assets with credit deterioration, the
acquirer shall record the purchased financial
assets at the acquisition-date fair value.
Additionally, for these financial assets within
the scope of Topic 326, an allowance shall be
recorded with a corresponding charge to credit
loss expense as of the reporting date.
30-4B For
assets accounted for as purchased financial assets
with credit deterioration (which includes
beneficial interests that meet the criteria in
paragraph 325-40-30-1A), an acquirer shall
recognize an allowance in accordance with Topic
326 with a corresponding increase to the amortized
cost basis of the financial asset(s) as of the
acquisition date.
30-26 An
acquirer shall recognize purchased financial
assets with credit deterioration (including
beneficial interests meeting the conditions in
paragraph 325-40-30-1A) in accordance with Section
326-20-30 for financial instruments measured at
amortized cost or Section 326-30-30 for
available-for-sale debt securities. Paragraphs
326-20-55-57 through 55-78 illustrate how the
guidance is applied for purchased financial assets
with credit deterioration measured at amortized
cost. Paragraphs 326-30-55-5 through 55-7
illustrate how the guidance is applied to
available-for-sale debt securities. An acquirer
shall not accrete into interest income the credit
losses embedded in the purchase price for
purchased financial assets with credit
deterioration.
In June 2016, the FASB issued ASU
2016-13, which not only provides a model for
recognizing credit losses on financial assets held at amortized cost
and available-for-sale (AFS) debt securities but also amends ASC 805
to provide guidance on accounting for purchased financial assets in a
business combination. After an entity adopts ASU 2016-13, the
accounting for acquired financial assets within the scope of ASC 326
will depend on whether the assets have experienced
more-than-insignificant deterioration in credit quality since
origination. Before adoption of ASU 2016-13, an acquirer is not
permitted to recognize a valuation allowance as of the acquisition
date for assets acquired in a business combination that are initially
recognized at fair value (see Section 4.5 for more
information).
As noted in ASC 805-20-30-4A, “[f]or acquired financial
assets that are not purchased financial assets with credit
deterioration, the acquirer shall record the purchased financial
assets at the acquisition-date fair value. Additionally, for these
financial assets within the scope of Topic 326, an allowance shall be
recorded with a corresponding charge to credit loss expense as of the
reporting date.”
However, ASC 805-20-30-4B states that “[f]or assets
accounted for as purchased financial assets with credit deterioration
(which includes beneficial interests that meet the criteria in
paragraph 325-40-30-1A), an acquirer shall recognize an allowance in
accordance with Topic 326 with a corresponding increase to the
amortized cost basis of the financial asset(s) as of the acquisition
date.” The ASC master glossary, as amended by ASU 2016-13, defines
purchased financial assets with credit deterioration as:
Acquired individual financial assets (or
acquired groups of financial assets with similar risk
characteristics) that as of the date of acquisition have
experienced a more-than-insignificant deterioration in credit
quality since origination, as determined by an acquirer’s
assessment.
As a result, upon acquiring a PCD asset, an entity that has adopted ASU
2016-13 would recognize an allowance for expected credit losses as an
adjustment that increases the asset’s cost basis (the “gross-up”
approach). That is, an acquirer initially measures the amortized cost
of a PCD asset by (1) determining the acquisition-date estimate of
expected credit losses under the applicable impairment model (e.g.,
ASC 326-20-30 for financial instruments measured at amortized cost or
ASC 326-30-30 for AFS debt securities) and (2) adding that amount to
the asset’s fair value. No credit loss expense is recognized upon
acquisition since an allowance for expected credit losses is
recognized separately from the PCD asset to establish its amortized
cost on the acquisition date. In addition, ASC 326-20-30-13 clarifies
that “[a]ny noncredit discount or premium resulting from acquiring a
pool of purchased financial assets with credit deterioration shall be
allocated to each individual asset. At the acquisition date, the
initial allowance for credit losses determined on a collective basis
shall be allocated to individual assets to appropriately allocate any
noncredit discount or premium.”
Example 12 in ASC 326-20 illustrates how an entity
applies the PCD model, specifically the gross-up approach to
recognizing expected credit losses as an adjustment to the amortized
cost basis of the acquired assets.
After initial recognition of the PCD asset and its
related allowance, the entity continues to apply the current expected
credit losses model to the asset — that is, any changes in the
estimate of cash flows that the entity expects to collect (favorable
or unfavorable) are recognized immediately as credit loss expense in
the income statement. Interest income recognition is based on the
purchase price plus the initial allowance accreting to the contractual
cash flows.
Changing Lanes
In June 2023, the FASB issued a
proposed
ASU that would amend the guidance in
ASU 2016-13 regarding the accounting upon the acquisition
of financial assets acquired in (1) a business
combination, (2) an asset acquisition, or (3) the
consolidation of a VIE that is not a business. The
proposed ASU would broaden the population of financial
assets that are within the scope of the gross-up approach
under ASC 326 by requiring an acquirer to apply the
gross-up approach in accordance with ASC 805 to all
financial assets acquired in a business combination rather
than only to PCD assets. Practitioners should monitor the
proposed ASU for any developments that might change the
current accounting. See additional discussion regarding
the impact of the proposed ASU on the accounting for asset
acquisitions in Section C.3.7.
See Deloitte’s Roadmap Current Expected Credit
Losses for more information.
4.3.11 Leases
In February 2016, the FASB issued ASU
2016-02, which amends the Board’s guidance on
the accounting for leases. The ASU added to U.S. GAAP ASC 842, which,
when effective for all entities, will supersede the existing leasing
guidance in ASC 840. The sections below address the accounting for
leases acquired in a business combination both after and before
adoption of ASC 842.
4.3.11.1 Leases — After Adoption of ASC 842
Leases (including contracts that contain a lease) acquired in a business
combination may result in the recognition of various assets or
liabilities, depending on the classification of the lease and
whether the acquiree is the lessee or the lessor under the lease
contract. The subsections that follow describe the accounting
for leases acquired in a business combination after the adoption
of ASC 842.
For additional information on the issues discussed in this section, see
Deloitte’s Roadmap Leases.
4.3.11.1.1 Classification
ASC 805-20
Classifying or Designating Identifiable Assets Acquired and Liabilities Assumed in a Business Combination
25-6 At the acquisition date, the acquirer shall classify or designate the identifiable assets acquired
and liabilities assumed as necessary to subsequently apply other GAAP. The acquirer shall make those
classifications or designations on the basis of the contractual terms, economic conditions, its operating or
accounting policies, and other pertinent conditions as they exist at the acquisition date.
25-8 This
Section provides the following two exceptions to
the principle in paragraph 805-20-25-6:
-
Classification of a lease of an acquiree shall be in accordance with the guidance in paragraph 842-10-55-11 . . . .
ASC 842-10
55-11 In a
business combination or an acquisition by a
not-for-profit entity, the acquiring entity should
retain the previous lease classification in
accordance with this Subtopic unless there is a
lease modification and that modification is not
accounted for as a separate contract in accordance
with paragraph 842-10-25-8.
As indicated in ASC 842-10-55-11, an acquirer in a business combination should
retain the acquiree’s classification of its leases unless
“there is a lease modification and that modification is
not accounted for as a separate contract.”
The ASC master glossary defines a lease modification as:
A
change to the terms and conditions of a contract that results in a change in the
scope of or the consideration for a lease (for
example, a change to the terms and conditions of the
contract that adds or terminates the right to use
one or more underlying assets or extends or shortens
the contractual lease term). [Emphasis
added]
As part of a business combination, a lease might also be changed in ways that do
not qualify as a lease modification. For
example, a lease may be changed to reflect the new owner
of the acquiree. Such a change in the name of one of the
parties identified in the contract would not qualify as a
lease modification without a change in the scope of or
consideration for the lease.
If the terms of a lease are modified as part of a business combination such that
there is a lease modification, the acquirer should use the
guidance in ASC 842 to determine whether to account for
that modification as a separate contract. ASC 842-10-25-8
states that a lease modification should be considered a
separate contract (i.e., “separate from the original
contract”) if both of the following conditions exist:
-
The modification grants the lessee an additional right of use not included in the original lease (for example, the right to use an additional asset).
-
The lease payments increase commensurate with the standalone price for the additional right of use, adjusted for the circumstances of the particular contract. For example, the standalone price for the lease of one floor of an office building in which the lessee already leases other floors in that building may be different from the standalone price of a similar floor in a different office building, because it was not necessary for a lessor to incur costs that it would have incurred for a new lessee.
Therefore, a lease modification that meets the conditions in ASC 842-10-25-8
effectively results in two separate contracts: (1) the
original unmodified contract and (2) a separate contract
for the additional right of use. Accordingly, if the lease
modification is considered a separate contract, the
classification of the original lease is not reconsidered
as part of the business combination and the additional
right of use added in the lease modification is accounted
for, and classified as, a separate “new” lease in
accordance with ASC 842 when that lease commences.
However, if the modification does not meet the conditions to be accounted for as
a separate contract, the acquirer reconsiders the
classification of the lease on the basis of modified terms
and conditions that exist as of the acquisition date
(i.e., the effective date of the modification) in
accordance with ASC 842-10-25-9 and ASC 842-10-25-11
through 25-18.
The flowchart below summarizes the process for
classifying an acquiree’s lease contracts.
4.3.11.1.2 Potential Assets or Liabilities Arising From an Acquiree’s Lease
ASC 805-20
Leases
25-28A The
acquirer shall recognize assets and liabilities
arising from leases of an acquiree in accordance
with Topic 842 on leases (taking into account the
requirements in paragraph 805-20-25-8(a)).
Right-of-use (ROU) assets and lease liabilities arising from an acquiree’s operating or finance leases
are exceptions to ASC 805’s recognition and fair value measurement principles. Instead, ROU assets
and lease liabilities are recognized and measured in accordance with ASC 842. However, an acquirer
should recognize and measure at fair value certain lease-related intangible assets or liabilities previously
recognized by the acquiree (e.g., in-place lease intangible assets).
The table below lists the potential assets or
liabilities that may be recognized in connection with an
acquiree’s leases. Each item is discussed in more detail
in the sections noted.
Lease Type | Asset or Liability That May Be Recognized |
---|---|
Acquiree is the lessee in an
operating or finance lease |
|
Acquiree is the lessee, and
the remaining lease term is
12 months or less |
|
Acquiree is the lessor in an
operating lease |
|
Acquiree is the lessor
in a sales-type or direct
financing lease |
|
4.3.11.1.3 Acquiree Is the Lessee in an Operating or Finance Lease
ASC 805-20
25-10A An
identifiable intangible asset may be associated
with a lease, which may be evidenced by market
participants’ willingness to pay a price for the
lease even if it is at market terms. For example,
a lease of gates at an airport or of retail space
in a prime shopping area might provide entry into
a market or other future economic benefits that
qualify as identifiable intangible assets, such as
a customer relationship. In that situation, the
acquirer shall recognize the associated
identifiable intangible asset(s) in accordance
with paragraph 805-20-25-10.
25-11 The
acquirer shall recognize assets or liabilities
related to an operating lease in which the
acquiree is the lessee as required by paragraphs
805-20-25-10A and 805-20-25-28A.
25-28A The
acquirer shall recognize assets and liabilities
arising from leases of an acquiree in accordance
with Topic 842 on leases (taking into account the
requirements in paragraph 805-20-25-8(a)).
Measurement of Lease Assets and Lease
Liabilities Arising From Leases in Which the
Acquiree Is the Lessee
30-24 For leases in which the
acquiree is a lessee, the acquirer shall measure
the lease liability at the present value of the
remaining lease payments, as if the acquired lease
were a new lease of the acquirer at the
acquisition date. The acquirer shall measure the
right-of-use asset at the same amount as the lease
liability as adjusted to reflect favorable or
unfavorable terms of the lease when compared with
market terms.
For acquired operating or finance leases in which the acquiree is the lessee,
the acquirer measures the lease liability and ROU asset in
accordance with the principles in ASC 842, and thus their
measurement is an exception to ASC 805’s fair value
measurement principle. (The acquirer may elect, as an
accounting policy, not to recognize assets or liabilities
as of the acquisition date for leases that, on the
acquisition date, have a remaining lease term of 12 months
or less; see Section
4.3.11.1.4.) The FASB considered whether to
require an acquirer to apply the general measurement
principle in ASC 805 and measure the acquiree’s ROU assets
and lease liabilities at fair value as of the acquisition
date but decided against it, as described in paragraph
BC416 of ASU 2016-02:
[T]he Board
decided that the benefits associated with measuring
lease assets and lease liabilities at fair value
will not justify the costs because obtaining fair
value information — particularly for the
right-of-use asset — might be difficult and, thus,
costly. The Board also noted that when the acquiree
is a lessee, the guidance on the measurement of
lease assets and lease liabilities will result in
recognizing a net carrying amount for the lease at
the date of acquisition that approximates the fair
value of the lease at that date.
Accordingly, ASC 805-20-30-24 requires an acquirer to measure “the lease
liability at the present value of the remaining lease
payments, as if the acquired lease were a new lease of the
acquirer at the acquisition date.” The remaining lease
payments are those expected to be received over the
balance of the lease term and should be determined in
accordance with the guidance in ASC 842-10-30-5, except
that the commencement date for an acquired lease is the
acquisition date. Paragraph BC415 of ASU 2016-02 clarifies
that “[m]easuring the acquired lease as if it were a new
lease at the date of acquisition includes undertaking a
reassessment of all of the following:
-
The lease term
-
Any lessee options to purchase the underlying asset
-
Lease payments (for example, amounts probable of being owed by the lessee under a residual value guarantee)
-
The discount rate for the lease.”
We believe that the lease term should be assessed from the acquirer’s
perspective. The acquirer should take into account any
renewal or purchase options it expects to exercise (see
Section 4.3.11.1.8) and use the discount
rate that is implicit in the lease, if readily
determinable; otherwise, the acquirer should use its
incremental borrowing rate. In a manner consistent with
how an entity would determine the incremental borrowing
rate for a new lease, the acquirer should evaluate whether
the incremental borrowing rate at the parent level (i.e.,
acquirer level) or the subsidiary level (i.e., acquiree
level) would be appropriate on the basis of the terms and
conditions of the lease arrangement. Regardless of this
determination, the incremental borrowing rate used should
be the rate determined as of the acquisition date.
However, the acquirer would not reassess the acquiree’s
lease classification solely on the basis of differences
between the acquirer’s and acquiree’s assessment of the
lease term or likelihood of purchase option exercise by
the lessee. In other words, the acquirer will retain the
lease classification of the acquiree’s leases, regardless
of whether the acquirer’s and acquiree’s conclusions
differ regarding lease term or purchase options, as long
as the acquisition does not result in a lease modification
that is not accounted for as a separate contract. (See
Chapter 7 of Deloitte’s Roadmap
Leases for additional
information about the determination of the discount rate
and measurement of a new lease under ASC 842 and Section
8.3.5.1.2 of Deloitte’s Roadmap Leases for subsequent
accounting considerations for an acquirer that is
reasonably certain to exercise a purchase option in an
acquired operating lease.
ASC 805-20-30-24 also requires the acquirer to measure the “right-of-use asset
at the same amount as the lease liability as adjusted to
reflect favorable or unfavorable terms of the lease when
compared with market terms.” Accordingly, an acquirer
would not recognize a separate intangible asset or
liability if an acquired lease in which the acquiree is a
lessee is favorable or unfavorable relative to market
terms as of the acquisition date. Thus, the acquirer will
first measure the ROU asset in accordance with ASC 842 and
then adjust the ROU asset for any off-market terms in
accordance with ASC 805.
Connecting the Dots
ASC 842-10-55-12 states, in
part, that “[l]eases between related parties
should be classified in accordance with the lease
classification criteria applicable to all other
leases on the basis of the legally enforceable
terms and conditions of the lease.” In addition,
ASC 842-10-15-3A, which was added by
ASU
2023-01, states, in part, that
"as a practical expedient, an entity that is
not a public business entity . . . may use the
written terms and conditions of a related party
arrangement between entities under common control
to determine whether that arrangement is or
contains a lease.” Therefore, under ASC 842, there
are no circumstances in which entities would
adjust the accounting for related-party leases for
off-market terms or conditions. However, an ROU
asset acquired in a business combination is
adjusted for any off-market terms. We believe that
even though it is not explicitly required to do
so, an acquirer should, in a manner consistent
with the measurement guidance in ASC 805 for all
acquired ROU assets, adjust the carrying amount of
an ROU asset acquired in a business combination
for any off-market terms in a related-party lease.
Otherwise, the off-market portion would be
captured in goodwill (or possibly a bargain
purchase gain) rather than through the
amortization of the ROU asset.
In addition to the ROU asset and lease liability, when the acquiree is the
lessee, an acquirer should recognize separately:
-
Leasehold improvements owned by the acquiree (see Section 4.3.11.1.9).
-
An intangible asset for the value associated with an in-place lease even if the lease is at market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.1.10).
4.3.11.1.4 Leases With a Remaining Lease Term of 12 Months or Less in Which the Acquiree Is the Lessee
ASC 805-20
25-28B For
leases for which the acquiree is a lessee, the
acquirer may elect, as an accounting policy
election by class of underlying asset and
applicable to all of the entity’s acquisitions,
not to recognize assets or liabilities at the
acquisition date for leases that, at the
acquisition date, have a remaining lease term of
12 months or less. This includes not recognizing
an intangible asset if the terms of an operating
lease are favorable relative to market terms or a
liability if the terms are unfavorable relative to
market terms.
The ASC master glossary defines a short-term lease as “[a] lease that, at the
commencement date, has a lease term of 12 months or less
and does not include an option to purchase the underlying
asset that the lessee is reasonably certain to exercise.”
Lessees may elect an accounting policy (by class of
underlying asset to which the right of use relates) to not
recognize on the balance sheet lease liabilities or ROU
assets of short-term leases (i.e., the “short-term lease
exemption”). Rather, a lessee that makes this accounting
policy election recognizes (1) fixed lease payments as an
expense on a straight-line basis over the lease term and
(2) variable lease payments that do not depend on an index
or rate as an expense in the period in which achieving the
specified target that triggers the variable lease payments
becomes probable. See Deloitte’s Roadmap Leases for further
discussion.
ASC 842 amended ASC 805 to allow a similar exemption for leases acquired in a
business combination on the basis of a remaining lease
term of 12 months or less on the acquisition date. ASC
805-20-25-28B states, in part:
For
leases for which the acquiree is a lessee, the
acquirer may elect, as an accounting policy election
by class of underlying asset and applicable to all
of the entity’s acquisitions, not to recognize
assets or liabilities at the acquisition date for
leases that, at the acquisition date, have a
remaining lease term of 12 months or less.
ASC 805-20-25-28B clarifies that the recognition exemption, when elected, also
applies to intangible assets or liabilities for favorable
or unfavorable terms of acquired operating leases. We also
believe that this exception may be applied to in-place
lease intangible assets.
4.3.11.1.5 Acquiree Is the Lessor in an Operating Lease
ASC 805-20
Assets Subject to Operating Leases in Which the Acquiree Is the Lessor
30-5 The acquirer shall measure the acquisition-date fair value of an asset, such as a building or a patent or
other intangible asset, that is subject to an operating lease in which the acquiree is the lessor separately from
the lease contract. In other words, the fair value of the asset shall be the same regardless of whether it is
subject to an operating lease. In accordance with paragraph 805-20-25-12, the acquirer separately recognizes
an asset or a liability if the terms of the lease are favorable or unfavorable relative to market terms.
The lessor in an operating lease continues to report the assets subject to the lease on its balance
sheet. In a business combination in which the acquiree is a lessor, the assets subject to the lease
are recognized by the acquirer and measured at their acquisition-date fair values. The fair value
measurement of the assets does not take into consideration the terms of the lease arrangement. That is, ASC 805-20-30-5 clarifies that “the fair value of the asset shall be the same regardless of whether it is
subject to an operating lease.”
In addition to the asset subject to the lease, an acquirer may recognize the
following separately when the acquiree is the lessor in an
operating lease:
-
An intangible asset or a liability if the terms of the lease are favorable or unfavorable compared with the market terms of leases of the same or similar items as of the acquisition date (see Section 4.3.11.1.7), including favorable or unfavorable renewal or termination options (see Section 4.3.11.1.8).
-
Leasehold improvements owned by the acquiree (see Section 4.3.11.1.9).
-
An intangible asset for the value associated with an in-place lease, including a lease that is at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.1.10).
-
An intangible asset for the value of the existing customer relationship between the acquiree and its lessee (see Section 4.3.11.1.11).
4.3.11.1.6 Acquiree Is the Lessor in a Sales-Type or Direct Financing Lease
ASC 805-20
Measurement of Assets and Liabilities Arising
From Leases in Which the Acquiree Is the
Lessor
30-25 For leases in which the
acquiree is a lessor of a sales-type lease or a
direct financing lease, the acquirer shall measure
its net investment in the lease as the sum of both
of the following (which will equal the fair value
of the underlying asset at the acquisition date):
-
The lease receivable at the present value, discounted using the rate implicit in the lease, of the following, as if the acquired lease were a new lease at the acquisition date:
-
The remaining lease payments
-
The amount the lessor expects to derive from the underlying asset following the end of the lease term that is guaranteed by the lessee or any other third party unrelated to the lessor.
-
-
The unguaranteed residual asset as the difference between the fair value of the underlying asset at the acquisition date and the carrying amount of the lease receivable, as determined in accordance with (a), at that date.
The acquirer shall take into
account the terms and conditions of the lease in
calculating the acquisition-date fair value of an
underlying asset that is subject to a sales-type
lease or a direct financing lease by the
acquiree-lessor.
ASC 805-20-30-25 requires that when the acquiree is a lessor in a sales-type or
direct financing lease, the acquirer must recognize the
net investment in the lease — measured as the sum of the
present value of the lease receivable and the unguaranteed
residual asset — which should approximate fair value. The
ASC master glossary defines a lease receivable as “[a]
lessor’s right to receive lease payments arising from a
sales-type lease or a direct financing lease plus any
amount that a lessor expects to derive from the underlying
asset following the end of the lease term to the extent
that it is guaranteed by the lessee or any other third
party unrelated to the lessor, measured on a discounted
basis.” In the measurement of a lease receivable, it is
assumed that the acquirer entered into the lease on the
acquisition date under the terms in effect on that date.
The measurement should include assessment of the lease
term, any lessee options to purchase the underlying asset,
lease payments, and the discount rate for the lease as
described in paragraph BC415 of ASU 2016-02. See
Deloitte’s Roadmap Leases for
discussion about the measurement of a new lease under ASC
842.
The ASC master glossary defines an unguaranteed residual asset as “[t]he amount
that a lessor expects to derive from the underlying asset
following the end of the lease term that is not guaranteed
by the lessee or any other third party unrelated to the
lessor, measured on a discounted basis.” Such an asset is
measured as “the difference between the fair value of the
underlying asset at the acquisition date and the carrying
amount of the lease receivable, as determined in
accordance with [ASC 805-20-30-25(a)], at that date.”
Because the measurement of the acquisition-date fair value
of the underlying asset takes into account the terms and
conditions of the existing lease arrangement, including
any favorable or unfavorable terms, the acquirer does not
recognize a separate intangible asset or liability for
such off-market terms.
As described in paragraph BC417 of ASU 2016-02, the Board considered requiring
an acquirer to apply the general principle in ASC 805 and
measure the acquiree’s lease receivable and unguaranteed
residual asset at fair value as of the acquisition date
but ultimately decided against such an approach:
The Board considered requiring the
measurement of the net investment in the lease and
its components — both the lease receivable and the
unguaranteed residual asset — at fair value at the
date of acquisition. However, the Board noted that
there will be costs associated with measuring each
of those assets at fair value and that it had
decided not to require such a measurement basis for
the lease receivable and the unguaranteed residual
asset more generally because of those costs.
Although the proposed initial measurement of the
lease receivable and the unguaranteed residual asset
may not represent the fair value of those assets,
the sum of the initial measurement of those assets
(that is, the net investment in the lease) will
equal the fair value of the underlying asset, which
is consistent with the principles in Topic 805.
Consequently, the Board concluded that the benefits
of requiring an acquirer to measure the lease
receivable and the unguaranteed residual asset at
fair value will not justify the costs.
The net investment in the lease is subsequently accounted for in accordance with
ASC 842. See Deloitte’s Roadmap Leases for
more information on the subsequent accounting for the net
investment in a sales-type or direct financing lease.
In addition to the net investment in the lease, an acquirer may recognize the
following separately when the acquiree is the lessor in a
sales-type or direct financing lease:
-
An intangible asset for the value associated with an in-place lease, including a lease that is at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.1.10).
-
An intangible asset for the value of the existing customer relationship between the acquiree and its lessees (see Section 4.3.11.1.11).
4.3.11.1.7 Favorable or Unfavorable Terms in Leases
ASC 805-20
25-12
Regardless of whether the acquiree is the lessee
or the lessor, the acquirer shall determine
whether the terms of each of an acquiree’s
operating leases are favorable or unfavorable
compared with the market terms of leases of the
same or similar items at the acquisition date. If
the acquiree is a lessor, the acquirer shall
recognize an intangible asset if the terms of an
operating lease are favorable relative to market
terms and a liability if the terms are unfavorable
relative to market terms. If the acquiree is a
lessee, the acquirer shall adjust the measurement
of the acquired right-of-use asset for any
favorable or unfavorable terms in accordance with
paragraph 805-20-30-24.
One or more of an acquiree’s leases may be
favorable or unfavorable (i.e., off-market) as of the
acquisition date compared with the market terms of leases
of the same or similar items. From the perspective of the
acquirer, a favorable lease represents an asset, while an
unfavorable lease represents a liability (balance sheet
credit). The acquirer accounts for each favorable or
unfavorable lease as of the acquisition date as
follows:
Lease Type | Asset or Liability That May Be Recognized |
---|---|
Acquiree is the lessee in an
operating or finance lease | The acquirer adjusts the measurement of the ROU asset for any off-market terms
(see Section 4.3.11.1.3). |
Acquiree is the lessee and the remaining lease term is 12 months or less | The acquirer may make an accounting policy election not to recognize assets
or liabilities for short-term leases, including intangible assets or liabilities for
off-market terms or in-place leases (see Section 4.3.11.1.4). |
Acquiree is the lessor in an
operating lease | The acquirer recognizes a separate intangible asset or liability for off-market
terms (see Section 4.3.11.1.5). Assets and liabilities should be recognized
separately and not offset. |
Acquiree is the lessor
in a sales-type or direct
financing lease | The acquirer adjusts the measurement of the underlying asset for any
off-market terms (see Section 4.3.11.1.6), which affects the measurement of the
unguaranteed residual asset (in accordance with ASC 805-20-30-25) and thus the
measurement of the net investment in the lease. |
Connecting the Dots
The above guidance on the
recognition of favorable or unfavorable terms in a
lease arrangement also applies to sublease
transaction scenarios in which the lessee (i.e.,
intermediate lessor) is not relieved of its
primary obligation under the head lease
arrangement. For example, if the acquiree is the
lessee in a sublease transaction, it would adjust
the measurement of its ROU asset for any
off-market terms as if it were the lessee in a
normal lease arrangement. Likewise, if the
acquirer is the intermediate lessor in a sublease
transaction, it would account for the off-market
terms as if it were the lessor in a normal lease
arrangement. Thus, it would either recognize a
separate intangible asset or liability or
recognize an adjustment to the measurement of the
underlying asset, depending on the classification
of the sublease as either an operating lease or a
sales-type or direct financing lease. See
Deloitte’s Roadmap Leases
for more information about sublease
arrangements.
4.3.11.1.8 Renewal or Termination Options in a Lease
An acquired lease may include a renewal or termination option that the acquirer may factor into the
lease term and include in the measurement and recognition of the lease. The
ASC master glossary defines lease term as follows:
The noncancellable period for which a lessee has the right to use an underlying asset, together with all of the
following:
- Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option
- Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option
- Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor.
Accordingly, whether a renewal period is
factored into a lease term depends on whether it is
reasonably certain that the renewal option will be
exercised. Similarly, whether the period after a
termination option is factored into the lease term depends
on whether it is reasonably certain that the termination
option will not be exercised. As discussed in
Section 4.3.11.1.1, if the acquiree (at
lease commencement) and the acquirer (on the acquisition
date) reach different conclusions about the likelihood of
exercising an option to extend or terminate a lease, the
classification of the acquired lease does not change
unless the lease is modified and the modification is not
accounted for as a separate contract. The following table
summarizes the acquirer’s accounting for renewal or
termination options:
Acquiree is the lessee in an
operating or financing lease | If the lease term includes a period covered by a renewal option (or an option not
to terminate), the favorability or unfavorability of the option is considered in the
measurement of the ROU asset. |
Acquiree is the lessor in an
operating lease | If the lease term includes a period covered by a renewal option (or an option not
to terminate), the acquirer separately recognizes (1) an intangible asset if the
terms of an operating lease are favorable relative to market terms or (2) a liability
if the terms are unfavorable relative to market terms. That is, the measurement
of any favorable lease asset or unfavorable lease liability includes any favorable or
unfavorable renewal or termination options. |
Acquiree is the lessor
in a sales-type or direct
financing lease | If the lease term includes a period covered by a renewal option (or an option not
to terminate), the acquirer does not separately recognize (1) an intangible asset
if the terms of the lease are favorable relative to market terms or (2) a liability
if the terms are unfavorable relative to market terms. Rather, the favorable or
unfavorable terms of the renewal option are considered in the measurement of
the lease receivable and unguaranteed residual asset (i.e., the net investment in
the lease). |
4.3.11.1.9 Leasehold Improvements
ASC 805-20
35-6
Leasehold improvements acquired in a business
combination shall be amortized over the shorter of
the useful life of the assets and the remaining
lease term at the date of acquisition. However, if
the lease transfers ownership of the underlying
asset to the lessee, or the lessee is reasonably
certain to exercise an option to purchase the
underlying asset, the lessee shall amortize the
leasehold improvements to the end of their useful
life.
ASC 842-20
35-13
Leasehold improvements acquired in a business
combination or an acquisition by a not-for-profit
entity shall be amortized over the shorter of the
useful life of the assets and the remaining lease
term at the date of acquisition.
Acquired leasehold improvements that are owned by the acquiree are measured at
their acquisition-date fair values. ASC 805-20-35-6
requires such improvements, once recognized, to be
amortized over the shorter of the remaining lease term or
the useful life of those assets, as determined by the
acquirer, unless (1) “the lease transfers ownership of the
underlying asset to the lessee” or (2) “the lessee is
reasonably certain to exercise an option to purchase the
underlying asset,” in which case the acquirer is required
to amortize the leasehold improvements to the end of their
useful life.
The existence of leasehold improvements owned by the acquiree can affect the acquirer’s determination
of the lease term (and thus of the acquirer’s measurement of lease assets and lease liabilities). As
discussed in Sections 4.3.11.1.3 and 4.3.11.1.6, the acquirer measures the acquired lease as if it were
a new lease on the acquisition date, which includes undertaking a reassessment of the lease term (and
other inputs). For example, if, as of the acquisition date, the acquiree/lessee has significant leasehold
improvements, the acquirer may be likely to exercise a renewal option if failing to do so would result in
the loss of those improvements with a remaining useful life.
For additional information about the accounting for leasehold improvements
(including the importance of determining which party owns
the improvements and the issuance of ASU 2023-01 related
to the accounting for leasehold improvements in
common-control arrangements), see Deloitte’s Roadmap
Leases.
4.3.11.1.10 Intangible Assets for In-Place Lease Value
ASC 805-20
25-10A An
identifiable intangible asset may be associated
with a lease, which may be evidenced by market
participants’ willingness to pay a price for the
lease even if it is at market terms. For example,
a lease of gates at an airport or of retail space
in a prime shopping area might provide entry into
a market or other future economic benefits that
qualify as identifiable intangible assets, such as
a customer relationship. In that situation, the
acquirer shall recognize the associated
identifiable intangible asset(s) in accordance
with paragraph 805-20-25-10.
An in-place lease intangible asset represents the price that a market
participant would be willing to pay for an at-market
lease. The value associated with an in-place lease
reflects, for example, the value associated with avoiding
(1) the costs of originating an acquired lease (such as
the costs to execute the lease, including marketing costs,
sales or leasing commissions, and legal and other related
costs) and (2) costs that would be incurred if an asset
that was intended to be leased was acquired without a
lessee.
An intangible asset for an in-place lease should be recognized separately in the
financial statements and not combined with other
lease-related assets or liabilities (e.g., not combined
with lessee ROU assets, lessor net investments in leases,
intangible assets for favorable lease terms, or
liabilities for unfavorable lease terms).
4.3.11.1.11 Customer-Relationship Intangible Assets — Acquiree Is the Lessor
Regardless of the classification of a lease as operating, sales-type, or direct financing, if the acquiree is
the lessor, the lease contract may provide value to the acquirer as a result of the existing relationship
between the acquiree and its lessee (i.e., customer). Accordingly, the acquirer in a business combination
may recognize a separate intangible asset for that customer relationship if it is identifiable (i.e., arises
from contractual rights or is separable). Because, as noted in ASC 805-20-55-24, the assets’ useful lives and the pattern in which their economic benefits are consumed may differ, the acquirer may need to
recognize separately the assets and liabilities that are related to a single lessee. See Section 4.10.4.2 for
more information about customer-related intangible assets.
The interrelationship of various types of intangible assets associated with the
same lessee can pose challenges in the recognition and
measurement of a customer-related intangible asset. The
values assigned to other assets and liabilities — such as
lease receivables, off-market contracts, and in-place
lease intangible assets — may also affect the valuation of
customer-related intangible assets.
4.3.11.1.12 Prepaid or Accrued Rent
Assets or liabilities for prepaid or accrued rent are not recognized under ASC 805 regardless of whether
the acquiree is the lessee or the lessor in a lease. Paragraph BC415 of ASU 2016-02 clarifies that:
The acquiree’s right-of-use asset should be measured at the amount of the lease liability, adjusted for any
off-market terms (that is, favorable or unfavorable terms) present in the lease. Prepaid or accrued rent should
not be recognized [in a business combination] because such amounts do not meet the definition of an asset or
a liability in Concepts Statement 6 under the acquisition method of Topic 805, Business Combinations. Instead,
the remaining lease payments required under the terms of the lease are considered in evaluating whether the
terms of the lease are favorable or unfavorable at the acquisition date.
When an entity enters into a lease, the terms of the lease are presumed to be at
market even if the arrangement includes up-front or
deferred payments (i.e., the total amount of the payments
is presumed to reflect the market rate). However, if a
lease with prepaid or deferred payments is acquired in a
business combination, the remaining lease payments may be
more or less than they would be for a new lease of the
property with the same remaining term. As a result, the
lease may be above or below market as of the acquisition
date. See Section 4.3.11.1.7
for the accounting for off-market terms, which depend on
whether the acquiree is the lessee or the lessor and the
classification of the lease.
4.3.11.1.13 Variable Lease Payments
The terms of a lease are presumed to be at market even if the lease includes variable payments that
are based on the use or performance of the underlying asset (i.e., the total amount of the expected
payments is presumed to reflect the market rate). If such a lease is acquired in a business combination,
the remaining lease payments may be more or less than the lease payments would be for a new lease of
the property with the same remaining term. Consequently, an acquirer may determine that an acquired
lease with variable payments is above or below market as of the acquisition date. See Section 4.3.11.1.7
for more information on the accounting for leases with off-market terms, which depends on whether the
acquiree is the lessee or the lessor and the classification of the lease.
4.3.11.1.14 Leveraged Leases
ASC 842-50
Leveraged
Lease Acquired in a Business Combination or an
Acquisition by a Not-for-Profit Entity
25-2 In a
business combination or an acquisition by a
not-for-profit entity, the acquiring entity shall
retain the classification of the acquired entity’s
investment as a lessor in a leveraged lease at the
date of the combination. The net investment of the
acquired leveraged lease shall be disaggregated
into its component parts, namely net rentals
receivable, estimated residual value, and unearned
income including discount to adjust other
components to present value.
30-2 In a
business combination or an acquisition by a
not-for-profit entity, the acquiring entity shall
assign an amount to the acquired net investment in
the leveraged lease in accordance with the general
guidance in Topic 805 on business combinations,
based on the remaining future cash flows and
giving appropriate recognition to the estimated
future tax effects of those cash flows.
35-1 In a
business combination or an acquisition by a
not-for-profit entity, the acquiring entity shall
subsequently account for its acquired investment
as a lessor in a leveraged lease in accordance
with the guidance in this Subtopic as it would for
any other leveraged lease.
On the adoption date of ASC 842, leases that were previously classified as leveraged leases under
ASC 840 are subject to the guidance in ASC 842-50, which is generally consistent with the accounting
requirements for leveraged leases in ASC 840 and effectively carries forward that guidance. However,
if a leveraged lease is modified after the entity adopts ASC 842, it is accounted for as a new lease in
accordance with ASC 842 (i.e., classification is reassessed and leveraged lease accounting would no
longer be available). Entities are not permitted to account for any new lease arrangements as leveraged
leases after the adoption of ASC 842.
If a leveraged lease is acquired in a business combination after the adoption of
ASC 842, the acquirer does not reassess the lease’s
classification (unless it is modified on or after the date
of acquisition) and must apply the recognition,
measurement, presentation, and disclosure guidance for
leveraged leases in ASC 842-50. If the acquired leveraged
lease is modified as part of the business combination, it
should be reclassified in accordance with the lease
classification guidance in ASC 842. As discussed in
Section 4.3.11.1.1, a modification is a
change in the scope of or consideration for a lease.
Changing the parties identified in a lease contract would
not change the classification of a leveraged lease because
such a change does not alter the scope of or consideration
for the lease.
If the acquiree is a lessor in a leveraged lease that is not modified as part of
the business combination, the acquirer measures the net
investment on the basis of the remaining net future cash
flows and gives appropriate recognition to the estimated
future tax effects of such cash flows. The net investment
is then broken down into its component parts (i.e., net
rentals receivable, estimated residual value, and unearned
income, including the discount to adjust the other
components to present value), which are recognized as of
the acquisition date. After the acquisition, the acquirer
accounts for the investment in the leveraged lease in
accordance with ASC 842-50.
Example 4 in ASC 842-50-55-27 through 55-33 illustrates the accounting for a
leveraged lease acquired in a business combination. Also,
see Deloitte’s Roadmap Leases for
more information about the accounting for leveraged
leases.
4.3.11.1.15 Sale-and-Leaseback Transactions
A sale-and-leaseback transaction is a common financing method that involves the
transfer of an asset from the owner to a buyer and a leaseback of that asset to the seller.
The buyer/lessor in a sale-and-leaseback transaction receives a steady return on its
investment in the form of annual rental payments and may receive certain tax advantages.
Furthermore, the buyer/lessor obtains the benefits of owning the asset, including any future
asset appreciation.
If the initial transfer of the asset is determined to be a sale in accordance
with ASC 842-40 and ASC 606, the transaction is accounted
for as a sale and leaseback under ASC 842-40. The
seller/lessee derecognizes the underlying asset,
recognizes any gain or loss on the sale, and accounts for
the leaseback as it would any other operating lease. The
buyer/lessor recognizes the underlying asset and accounts
for the lease as it would any other operating or direct
financing lease. If the seller/lessee or buyer/lessor in a
sale-and-leaseback transaction is subsequently acquired in
a business combination, the acquirer should account for
the leaseback as described in Sections 4.3.11.1.1 through
4.3.11.1.14.
If the initial transfer does not meet the criteria to be a sale in accordance
with ASC 842-40 and ASC 606 (i.e., it is a “failed” sale
and leaseback), the seller/lessee and the buyer/lessor
account for the transaction as a financing transaction.
The seller/lessee continues to report the property on its
balance sheet as if it were its owner and recognizes a
financial liability (i.e., debt). The buyer/lessor does
not recognize the property on its balance sheet and
instead recognizes a financial asset (i.e., a loan
receivable). If the seller/lessee or buyer/lessor in a
failed sale-and-leaseback transaction is subsequently
acquired in a business combination, the acquirer should
not reassess the transaction. For example, the acquirer
may continue to use the acquiree’s accounting for the
failed sale-and-leaseback transaction until the
transaction meets the requirements in ASC 842-40 and ASC
606 for the transfer to be accounted for as a sale. The
assets and liabilities related to the arrangement should
be measured at their acquisition-date fair values.
In addition, there may be situations in
which a third party acquires an asset directly from the
acquiree before or concurrently with the business
combination and subsequently leases the asset back to the
acquirer after the acquisition. In substance, such
arrangements may represent sale-and-leaseback transactions
if it is determined that the acquirer or future lessee
controls the asset before or concurrently with the
acquisition. See Chapter 10 of
Deloitte’s Roadmap Leases for
more information.
4.3.11.1.16 Preexisting Leases Between the Acquirer and Acquiree
An acquirer and an acquiree may have a preexisting lease arrangement that was entered into
before negotiations for the business combination began. As described in Section 6.2.2, a preexisting
relationship between an acquirer and acquiree is considered effectively settled as part of the business
combination even if it is not legally cancelled, because it becomes an intercompany relationship upon
the acquisition and is eliminated in consolidation in the postcombination financial statements. Thus,
the acquirer does not recognize any lease assets or lease liabilities related to the preexisting lease. In
accordance with ASC 805-10-55-21(b), it recognizes a gain or loss on the settlement of the lease in an
amount equal to the lesser of (1) “[t]he amount by which the [lease] is favorable or unfavorable from
the perspective of the acquirer” relative to market terms or (2) “[t]he amount of any stated settlement
provisions in the [lease] available to the counterparty to whom the contract is unfavorable.”
In addition, the acquirer should consider whether it has recognized any assets
or liabilities related to the lease that should be
derecognized as part of the effective settlement of the
arrangement. The carrying amounts of the recognized assets
or liabilities, if any, would adjust the amount of the
gain or loss recognized for the settlement of the
preexisting relationship, as illustrated in Example 3 in
ASC 805-10- 55-33 (reproduced in Section
6.2.2.3).
4.3.11.2 Leases — Before Adoption of ASC 842
Leases (including contracts that contain a lease) acquired in a business
combination may result in the recognition of various assets or
liabilities, depending on the classification of the lease and
whether the acquiree is the lessee or lessor. The subsections
that follow describe the accounting for leases acquired in a
business combination before the adoption of ASC 842.
4.3.11.2.1 Classification
ASC 805-20
Classifying or Designating Identifiable Assets Acquired and Liabilities Assumed in a Business Combination
25-6 At the acquisition date,
the acquirer shall classify or designate the
identifiable assets acquired and liabilities
assumed as necessary to subsequently apply other
GAAP. The acquirer shall make those
classifications or designations on the basis of
the contractual terms, economic conditions, its
operating or accounting policies, and other
pertinent conditions as they exist at the
acquisition date.
25-8 This Section provides the following two exceptions to the principle in paragraph 805-20-25-6:
- Classification of a lease contract as either an operating lease or a capital lease in accordance with the guidance in paragraph 840-10-25-27 . . . .
ASC 840-10
35-5 The classification of a lease in accordance with the criteria in this Subtopic shall not be changed as a
result of a business combination or an acquisition by a not-for-profit entity unless the provisions of the lease
are modified. At the acquisition date, an acquirer may contemplate renegotiating and modifying leases of the
business or nonprofit activity acquired. Modifications made after the acquisition date, including those that were
planned at the time of the combination, are postcombination events that shall be accounted for separately by
the acquirer in accordance with the provisions of this Topic. If in connection with a business combination or
an acquisition by a not-for-profit entity the provisions of a lease are modified in a way that would require the
revised agreement to be considered a new agreement under the preceding paragraph, the new lease shall
be classified by the combined entity according to the criteria set forth in this Subtopic, based on conditions as
of the date of the modification of the lease. After the recording of the amounts called for by Subtopic 805-20,
the leases shall be accounted for in accordance with this Subtopic. Subtopic 840-30 explains the application
of this paragraph to a leveraged lease by an entity that acquires a lessor. This Subtopic does not address the
subsequent accounting for amounts recorded for favorable or unfavorable operating leases.
As indicated in ASC 805-20-25-6, if a lease is modified as part of a business combination, the acquirer
reconsiders the acquiree’s classification of the lease. Otherwise, the acquiree’s classification generally
carries over to the acquirer. See Section 4.2 for more information.
If the terms of a lease are modified as part of the business combination and the
lease qualifies as a new lease in accordance with ASC
840-10-35-4, the acquirer classifies the lease as of the
acquisition date on the basis of the modified lease
terms.
Alternatively, a lease might be changed as part of a business combination in
ways that do not qualify as a lease modification.
For example, a lease may be changed to reflect the new
owner of the acquiree. Such a change in the name of one of
the parties identified in the contract would not qualify
as a lease modification without a change in the scope of
or consideration for the lease.
4.3.11.2.2 Potential Assets or Liabilities Related to an Acquiree’s Leases
Under ASC 805, most assets acquired and
liabilities assumed are measured and recognized at fair
value, including lease-related assets and liabilities that
are recognized before the adoption of ASC 842. The table
below lists the potential assets or liabilities that may
be recognized in connection with an acquiree’s leases.
Each item is discussed in more detail in the sections
noted.
Lease Type | Asset or Liability That May Be Recognized |
---|---|
Acquiree is the lessee in an
operating lease |
|
Acquiree is the lessee in a
capital lease |
|
Acquiree is the lessor in an
operating lease |
|
Acquiree is the lessor
in a sales-type or direct
financing lease |
|
4.3.11.2.3 Acquiree Is the Lessee in an Operating Lease
ASC 805-20
Operating Leases
25-11 The acquirer shall
recognize no assets or liabilities related to an
operating lease in which the acquiree is the
lessee except as required by paragraphs
805-20-25-12 through 25-13.
For acquired operating leases in which the acquiree is the lessee, ASC 840 and ASC 805 prohibit
recognition of a separate asset for the right to use the underlying asset or a separate liability for the
remaining minimum lease payments.
However, an acquirer may recognize other assets or liabilities, such as:
-
Any leasehold improvements owned by the acquiree (see Section 4.3.11.2.7).
-
An intangible asset or a liability if the terms of the lease (including renewal or purchase options) are favorable or unfavorable relative to current market terms for similar leases (see Section 4.3.11.2.8).
-
An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).
4.3.11.2.4 Acquiree Is the Lessee in a Capital Lease
An entity may acquire a capital lease in which the acquiree is the lessee. Capital lease assets and lease
obligations must be separately recognized and measured at fair value as of the acquisition date.
Before measuring a capital lease asset, the acquirer must determine whether it
expects to obtain ownership of the leased property at the
end of the lease term. It must consider all facts and
circumstances, including the terms of the contract,
whether it contains a bargain purchase option, and
entity-specific factors. If the acquirer expects to obtain
ownership of the property subject to the capital lease, it
measures the lease asset at the fair value of the
underlying property. If the acquirer does not expect to
obtain ownership of the property subject to the capital
lease, it measures the lease asset at the fair value of
the leasehold interest, which is the fair value of the
right to use the property until the end of the lease
term.
The acquirer also recognizes a liability at fair value for the remaining minimum
lease payments. The assumptions used in measuring the
liability should be consistent with those used in
measuring the asset (e.g., the same lease term should be
used in measuring both the asset and the liability).
In addition, when the acquiree is the lessee in a capital lease, the acquirer
may recognize other assets or liabilities, such as:
-
Any leasehold improvements owned by the acquiree (see Section 4.3.11.2.7).
-
An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).
4.3.11.2.5 Acquiree Is the Lessor in an Operating Lease
ASC 805-20
Assets Subject to Operating Leases in Which the Acquiree Is the Lessor
30-5 The acquirer shall measure the acquisition-date fair value of an asset, such as a building or a patent or
other intangible asset, that is subject to an operating lease in which the acquiree is the lessor separately from
the lease contract. In other words, the fair value of the asset shall be the same regardless of whether it is
subject to an operating lease. In accordance with paragraph 805-20-25-12, the acquirer separately recognizes
an asset or a liability if the terms of the lease are favorable or unfavorable relative to market terms.
The lessor in an operating lease continues to report the assets subject to the lease on its balance
sheet. In a business combination in which the acquiree is a lessor, the assets subject to the lease
are recognized by the acquirer and measured at their acquisition-date fair values. The fair value
measurement of the assets does not take into consideration the terms or conditions of the lease
arrangement. That is, ASC 805-20-30-5 clarifies that “the fair value of the asset shall be the same
regardless of whether it is subject to an operating lease.”
In addition to the property subject to the lease, an acquirer may recognize the
following separately when the acquiree is the lessor in an
operating lease:
-
Any leasehold improvements owned by the acquiree (see Section 4.3.11.2.7).
-
An intangible asset or a liability if the terms of the lease (including renewal or purchase options) are favorable or unfavorable relative to current market terms for similar leases (see Section 4.3.11.2.8).
-
An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).
-
An intangible asset for the value of the existing customer relationship between the acquiree and its lessees (see Section 4.3.11.2.10).
4.3.11.2.6 Acquiree Is the Lessor in a Sales-Type or Direct Financing Lease
When the acquiree is a lessor in a sales-type or direct financing lease, the acquirer recognizes and
measures at fair value its net investment in the lease. The lessor’s remaining net investment in the lease
includes the residual value, if any, of the leased asset and any renewal or purchase options.
In addition to the net investment in the lease, the acquirer may recognize the
following separately when the acquiree is the lessor in a
sales-type or direct financing lease:
-
An intangible asset for the value associated with an in-place lease, including a lease at current market terms if market participants would place value on an at-the-money contract (see Section 4.3.11.2.9).
-
An intangible asset for the value of the existing customer relationship between the acquiree and its lessees (see Section 4.3.11.2.10).
4.3.11.2.7 Leasehold Improvements
ASC 805-20
35-6 Leasehold improvements acquired in a business combination shall be amortized over the shorter of the
useful life of the assets or a term that includes required lease periods and renewals that are deemed to be
reasonably assured (as used in the definition of lease term) at the date of acquisition.
Acquired leasehold improvements that are owned by the acquiree are measured at their acquisition-date
fair values. ASC 805-20-35-6 requires that acquirers amortize leasehold improvements “over the
shorter of the useful life of the assets or a term that includes required lease periods and renewals that
are deemed to be reasonably assured.” Therefore, to determine the amortization period of leasehold
improvements acquired in a business combination, acquirers must evaluate as of the acquisition date
both the useful life of those improvements and the required lease periods and renewals that are
deemed to be reasonably assured.
When determining the required lease periods and renewals that are deemed to be
reasonably assured, entities should consider the
definition of lease term in the ASC master glossary, which
states that the term should include “[a]ll periods, if
any, for which failure to renew the lease imposes a
penalty on the lessee in such amount that a renewal
appears, at lease inception, to be reasonably assured.”
Acquirers should assess whether the renewal options are
bargain renewal options or whether failure to renew would
impose a significant penalty, and, on the basis of that
assessment, use judgment to determine whether the renewal
options are reasonably assured. If, as of the acquisition
date, the acquiree has significant leasehold improvements,
the acquirer may assume that it is reasonably assured that
the acquiree will exercise its renewal options because the
loss of the improvements that would result from the
failure to renew the lease would impose a significant
penalty.
4.3.11.2.8 Intangible Asset or Liability Related to Favorable or Unfavorable Operating Leases
ASC 805-20
25-12 Regardless of whether the acquiree is the lessee or the lessor, the acquirer shall determine whether
the terms of each of an acquiree’s operating leases are favorable or unfavorable compared with the market
terms of leases of the same or similar items at the acquisition date. The acquirer shall recognize an intangible
asset if the terms of an operating lease are favorable relative to market terms and a liability if the terms are
unfavorable relative to market terms.
One or more of an acquiree’s lease contracts may be favorable or unfavorable (i.e., off-market) as of
the acquisition date relative to current market terms. ASC 805-20-25-12 applies to all operating leases
regardless of whether the acquiree was the lessee or the lessor.
From the perspective of the acquirer, a favorable lease represents an asset,
while an unfavorable lease represents a liability (balance
sheet credit). Some lease contracts may result in the
recognition of an intangible asset and others may result
in the recognition of a liability. Entities should present
intangible assets and liabilities separately on the
balance sheet.
The acquirer must consider any renewal options or purchase options in the
valuation of an intangible asset or liability as follows:
-
If the acquiree is the lessee in an operating lease and the exercise of options is within the acquiree/lessee’s control:
-
Renewal or purchase options that are favorable to the acquiree/lessee are generally considered in the valuation of the intangible asset or liability.
-
Renewal or purchase options that are unfavorable to the acquiree/lessee are generally not considered in the valuation of the intangible asset or liability since the acquirer would not be expected to exercise an unfavorable option.
-
-
If the acquiree is the lessor in an operating lease and the exercise of options is within the lessee’s control:
-
Renewal or purchase options that are unfavorable to the acquiree/lessor are generally considered in the valuation of the intangible asset or liability.
-
Renewal or purchase options that are favorable to the acquiree/lessor are generally not considered in the valuation of the intangible asset or liability since the lessee would not be expected to exercise an unfavorable option.
-
4.3.11.2.9 Intangible Assets for In-Place Lease Value
ASC 805-20
25-13 An identifiable intangible asset may be associated with an operating lease, which may be evidenced by
market participants’ willingness to pay a price for the lease even if it is at market terms. For example, a lease
of gates at an airport or of retail space in a prime shopping area might provide entry into a market or other
future economic benefits that qualify as identifiable intangible assets, such as a customer relationship. In
that situation, the acquirer shall recognize the associated identifiable intangible asset(s) in accordance with
paragraph 805-20-25-10.
The value of an in-place lease represents the price that a market participant would be willing to pay
for an at-market lease. An intangible asset for the value associated with an in-place lease may exist
regardless of (1) the lease classification and (2) whether the acquiree is the lessor or the lessee.
A lease that is in place on the acquisition date may provide value to the lessee
because it gives the lessee access to property that is
unique or scarce and may permit future contract renewals
or extensions.
An in-place lease may also provide value to the lessor by allowing it to avoid
certain cash outflows to originate the lease (such as
marketing, sales commissions, legal costs, and lease
incentives) and lost cash flows during an otherwise
required lease-up period. Accordingly, measurement of
in-place lease intangible assets should reflect both of
these benefits to the acquirer (net of service costs to
tenants, such as security and maintenance).
4.3.11.2.10 Customer-Related Intangible Assets — Acquiree Is the Lessor
Regardless of the classification of a lease as operating, sales-type, or direct financing, if the acquiree
is the lessor, a lease contract may provide value to the acquirer as a result of the existing relationship
between the acquiree and its lessee (i.e., customer). Accordingly, the acquirer in a business combination
recognizes a separate intangible asset for that customer relationship if it is identifiable (i.e., arises from
contractual rights or is separable). Because, as noted in ASC 805-20-55-24, the assets’ useful lives
and the pattern in which their economic benefits are consumed may differ, the acquirer may need to
recognize separately the assets and liabilities that are related to a single lessee. See Section 4.10.4.2 for
more information about customer-related intangible assets.
The interrelationship of various types of intangible assets associated with the
same lessee can pose challenges in the recognition and
measurement of a customer-related intangible asset. The
values assigned to other assets and liabilities — such as
lease receivables, off-market contracts, and in-place
lease intangible assets — may also affect the valuation of
customer-related intangible assets.
4.3.11.2.11 Deferred Rent
Before the acquisition date, an acquiree may have recognized an asset or a liability for deferred rent
related to an operating lease. The recognition of deferred rent results from the guidance in ASC 840-20-25-2 that generally requires lessees and lessors to recognize scheduled rent increases on a straight-line
basis over the lease term.
In a business combination, the acquirer does not recognize the acquiree’s
deferred rent balance because it does not meet the
definition of an asset or liability. The impact of any
previously recognized asset or liability of the acquiree
for deferred rent would be captured in the fair value
measurement of an intangible asset or liability for
favorable or unfavorable terms (see Section
4.3.11.2.8). After a business
combination, the acquirer accounts for any acquired leases
in accordance with ASC 840. Accordingly, the acquirer
recognizes any deferred rent starting from the acquisition
date in the postcombination period on the basis of the
terms of the assumed lease.
Example 4-6
Accounting for Deferred Rent in a Business Combination
On January 1, 20X6, Company B enters into a four-year operating lease. The
payments required under the lease escalate each
year. The following table illustrates the
calculation of the deferred rent (1) liability, if
B is the lessee, or (2) asset, if B is the lessor,
at the end of each of years 1 through 4:
On January 1, 20X8 (i.e., the end of year 2), Company A acquires B and accounts for the acquisition as a
business combination. As of the acquisition date, A does not record an asset or a liability for B’s deferred rent,
regardless of whether B is the lessee or the lessor. However, starting on the acquisition date, A will account for
the acquired lease in accordance with ASC 840 and will begin recognizing deferred rent in the postcombination
period. The following table illustrates the calculation of the deferred rent (1) liability, if B is the lessee, or
(2) asset, if B is the lessor at the end of years 3 and 4:
4.3.11.2.12 Sale-Leaseback Transactions
A sale-leaseback transaction is a common financing method that involves the transfer of an asset from
the owner to a buyer and a leaseback of that asset to the seller. The buyer/lessor in a sale-leaseback
transaction receives a steady return on its investment in the form of annual rental payments and may
receive certain tax advantages. Furthermore, the buyer/lessor obtains the benefits of owning the asset,
including any future asset appreciation.
If the initial transfer of the asset is determined to be a sale, the transaction
is accounted for as a sale-leaseback under ASC 840-40. If
the sale-leaseback does not meet the criteria for a sale
(i.e., it is a “failed” sale-leaseback), the
seller’s/lessee’s accounting for the transaction depends
on the type of underlying asset. If the underlying asset
is equipment, the seller/lessee accounts for the
transaction as a financing transaction — that is, it
continues to recognize the asset on its balance sheet as
if it were its owner and recognizes a liability. If the
underlying asset is real estate, the seller/lessee
accounts for the transaction either as a financing
transaction or by using the deposit method, depending on
the facts and circumstances.
If the seller/lessee is subsequently acquired in a business combination, the
acquirer should not reassess the transaction. For example,
the acquirer should continue with the acquiree’s
accounting for a failed sale-leaseback transaction until
the transaction meets the requirements in ASC 840-40 to be
accounted for as a sale. The assets and liabilities
related to the arrangement should be measured at their
acquisition-date fair values.
4.3.11.2.13 Preexisting Leases Between the Acquirer and Acquiree
An acquirer and acquiree may have a preexisting lease arrangement that was entered into before
negotiations for the business combination began. As described in Section 6.2.2, a preexisting
relationship between an acquirer and acquiree is considered effectively settled as part of the business
combination even if it is not legally cancelled because it becomes an intercompany relationship upon
the acquisition and is eliminated in consolidation in the postcombination financial statements. Thus,
the acquirer does not recognize any lease assets or lease liabilities related to the preexisting lease. In
accordance with ASC 805-10-55-21(b), it recognizes a gain or loss on the settlement of the lease in an
amount equal to the lesser of (1) “[t]he amount by which the [lease] is favorable or unfavorable from
the perspective of the acquirer” relative to market terms or (2) “[t]he amount of any stated settlement
provisions in the [lease] available to the counterparty to whom the contract is unfavorable.”
In addition, the acquirer should consider whether it has recognized any assets
or liabilities related to the lease that should be
derecognized as part of the effective settlement of the
arrangement. The carrying amounts of the recognized assets
or liabilities, if any, would adjust the amount of the
gain or loss recognized for the settlement of the
preexisting relationship, as illustrated in Example 3 in
ASC 805-10-55-33 (reproduced in Section
6.2.2.3).
4.3.12 Insurance or Reinsurance Contracts
As part of deliberating Statement 141(R) (codified in ASC 805), the FASB established specific guidance on accounting for insurance and reinsurance contracts acquired in a business combination.
4.3.12.1 Classification of Contracts
In a manner consistent with the concept that a business combination results in the initial recognition
of an acquiree’s assets and liabilities in the acquirer’s financial statements, most contracts, assets, and
liabilities are classified or designated as of the acquisition date as if they were entered into or acquired
on that date. ASC 805 provides for two exceptions to that concept, one of which is the classification of
contracts as insurance or reinsurance contracts.
ASC 805-20-25-8(b) requires an acquirer to carry forward the classification of an acquired contract as
an insurance or a reinsurance contract (rather than a deposit) that the acquiree made at the inception
of the contract on the basis of its terms and any related contracts or agreements. If the terms of those
contracts or agreements were modified in a way that would change their classification, the acquirer
determines the classification of the contract on the basis of its terms and other pertinent factors on the
modification date, which may be the acquisition date. When assessing whether a contract qualifies as
insurance or reinsurance, an entity must consider related contracts and arrangements because they can
significantly affect the amount of risk transferred.
4.3.12.2 Recognition and Measurement of Insurance Contracts
ASC 944-805
30-1 The acquirer shall measure at fair value the assets and liabilities recognized under paragraph 944-805-25-3. However, the acquirer shall recognize that fair value in components as follows:
- Assets and liabilities measured in accordance with the acquirer’s accounting policies for insurance and reinsurance contracts that it issues or holds. For example, the contractual assets acquired could include a reinsurance recoverable and the liabilities assumed could include a liability to pay future contract claims and claims expenses on the unexpired portion of the acquired contracts and a liability to pay incurred contract claims and claims expenses. However, those assets acquired and liabilities assumed would not include the acquiree’s deferred acquisition costs and unearned premiums that do not represent future cash flows.
- An intangible asset (or occasionally another liability), representing the difference between the following:
- The fair value of the contractual insurance and reinsurance assets acquired and liabilities assumed
- The amount described in (a).
30-2 Other related contracts that are not insurance or reinsurance contracts shall be measured at the date of
acquisition in accordance with Topic 805.
The assets and liabilities arising from the rights and obligations of insurance and reinsurance contracts
acquired in a business combination are recognized on the acquisition date and measured at their
acquisition-date fair values. That recognition and measurement might include a reinsurance recoverable,
a liability to pay future contractual claims and claim expenses on the unexpired portions of the acquired
contracts, and a liability to pay incurred contractual claims and claim expenses. However, those assets
acquired and liabilities assumed would not include the acquiree’s insurance and reinsurance contract
accounts, such as deferred acquisition costs and unearned premiums that do not represent future cash
flows.
Although insurance and reinsurance contracts are measured at fair value, the FASB noted in paragraph B192 of Statement 141(R) that an
acquirer should be able to subsequently report the acquired
business on the same basis as its written business. However,
rights and obligations related to insurance and reinsurance
contracts are not measured at fair value under existing GAAP.
Thus, in ASC 944-805, the Board provided specific measurement
and recognition guidance that requires an acquirer to separate
the fair value of the insurance and reinsurance contracts it
acquires into (1) insurance and reinsurance GAAP accounting
balances, in keeping with the acquirer’s accounting policies,
and (2) an intangible asset (or, infrequently, another
liability) for the difference between the fair value of the
insurance and reinsurance contracts and the amount recognized in
accordance with the acquirer’s existing accounting policies. As
a result, the acquirer is permitted to subsequently report the
acquired business on the same basis as its written business
since the intangible asset is amortized separately. However,
while the total value of an insurance contract represents its
fair value, the elements of a contract do not (i.e., the rights
and obligations related to insurance and reinsurance contracts
are measured under existing GAAP, and the intangible asset (or
liability) is calculated as a residual).
Other contracts that provide third-party contingent commissions are accounted
for in the same manner as other contingencies, and contracts
that provide guarantees of the adequacy of claims liabilities
are accounted for as indemnifications.
4.3.12.3 Deferred Acquisition Costs and Unearned Premiums
An acquiree’s capitalized deferred acquisition costs and unearned premiums do
not meet the definition of assets and are not carried forward or
recognized by the acquirer in a business combination.
4.3.12.4 Subsequent Accounting for Insurance or Reinsurance Contracts
ASC 805-20
35-7 Topic 944 on insurance provides guidance on the subsequent
accounting for an insurance or reinsurance contract acquired in a business
combination.
ASC 805 refers to the subsequent measurement guidance for insurance contracts in ASC 944. Under
that guidance, the insurance contract intangible asset (or liability) is measured on a basis consistent with
the related insurance or reinsurance liability. Specifically, ASC 944-805-35-1 through 35-3 provide the
following guidance:
ASC 944-805
35-1 After the business combination, the acquirer shall measure the intangible asset (or other liability) on a
basis consistent with the related insurance or reinsurance liability.
35-2 For example, for most short-duration contracts such as many property and liability insurance contracts,
claim liabilities are not discounted under generally accepted accounting principles (GAAP), so amortizing the
intangible asset like a discount using an interest method could be an appropriate method.
35-3 For certain long-duration contracts such as most traditional life insurance contracts, using a basis
consistent with the measurement of the liability would be similar to the guidance provided in paragraph
944-30-35-3, which requires that deferred acquisition costs be amortized using methods that include the same
assumptions used in estimating the liability for future policy benefits.
Pending Content (Transition Guidance: ASC 944-40-65-2)
35-3 For certain long-duration contracts such as
traditional life insurance contracts, using a
basis consistent with the measurement of the
liability would be similar to the guidance
provided in paragraph 944-30-35-3, which requires
that deferred acquisition costs be amortized using
methods that include assumptions consistent with
those used in estimating the liability for future
policy benefits including subsequent revisions to
those assumptions. Also, paragraph 944-30-35-63
specifies that the present value of future profits
is subject to premium deficiency testing in
accordance with the provisions of Subtopic
944-60.
4.3.13 Contract Assets and Contract Liabilities — After Adoption of ASU 2021-08
Sections 4.3.13.1 through
4.3.13.4 address the accounting for contract assets
and contract liabilities assumed in a business combination after the
adoption of ASU
2021-08. See Section 4.11 for information
about recognizing and measuring assets and liabilities associated with
revenue contracts before an entity adopts ASU 2021-08.
Changing Lanes
On October 28, 2021, the FASB issued ASU 2021-08, which
requires “acquiring entities to apply Topic 606 to
recognize and measure contract assets and contract
liabilities in a business combination.” 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, an acquirer generally recognizes such
items at fair value on the acquisition date.
ASU 2021-08’s amendments are effective as follows:
-
For public business entities — Fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.
-
For all other entities — Fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.
The amendments should be applied prospectively to business
combinations occurring on or after the effective date of
the amendments.
The ASU clarifies that “[e]arly adoption of the amendments is
permitted, including adoption in an interim period. An
entity that early adopts in an interim period should apply
the amendments (1) retrospectively to all business
combinations for which the acquisition date occurs on or
after the beginning of the fiscal year that includes the
interim period of early application and (2) prospectively
to all business combinations that occur on or after the
date of initial application.” For example, assume that an
entity with a calendar year-end had one business
combination in the second quarter of 2020 and another
business combination in the third quarter of 2021. If the
entity adopts the amendments in the fourth quarter of
2021, it would apply the amendments retrospectively to the
acquisition that occurred in the third quarter of 2021 but
would not apply them retrospectively to the acquisition
that occurred in the second quarter of 2020 even if it had
not yet issued financial statements for the year ended
December 31, 2020.
ASC 805-20
Pending Content (Transition Guidance: ASC
805-20-65-3)
30-27 An acquirer shall
measure a contract asset or contract liability in
accordance with Topic 606 on revenue from
contracts with customers. This includes a contract
asset or contract liability from the following:
- Contracts with customers
- Other contracts to which the provisions of Topic 606 apply.
30-28 An acquirer shall
measure the contract assets and contract
liabilities of the acquired contract as if the
acquirer had originated the acquired contract.
Topic 606 specifies when certain assessments and
estimates should be made, for example, as of
contract inception or on a recurring basis. At the
acquisition date, the acquirer shall make those
assessments as of the dates required by Topic
606.
30-29 An acquirer may use one
or more of the following practical expedients when
applying paragraphs 805-20-30-27 through 30-28 at
the acquisition date:
- For contracts that were
modified before the acquisition date, an acquirer
may reflect the aggregate effect of all
modifications that occur before the acquisition
date when:
- Identifying the satisfied and unsatisfied performance obligations
- Determining the transaction price
- Allocating the transaction price to the satisfied and unsatisfied performance obligations.
- For all contracts, for purposes of allocating the transaction price, an acquirer may determine the standalone selling price at the acquisition date (instead of the contract inception date) of each performance obligation in the contract.
30-30 For any of the
practical expedients in paragraph 805-20-30-29
that an acquirer uses, the acquirer shall apply
that expedient on an acquisition-by-acquisition
basis. Each practical expedient that is elected
shall be applied consistently to all contracts
acquired in the same business combination. In
addition, the acquirer shall provide the
disclosures in paragraph 805-20-50-5.
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. As a
result of the amendments, an acquirer will recognize and measure
“contract assets and contract liabilities acquired in a business
combination in accordance with Topic 606.” The amendments also clarify
that entities should use the definition of a “performance obligation”
in the ASC master glossary to determine whether a contract liability
should be recognized in a business combination. While primarily
related to contract assets and contract liabilities that were
accounted for by the acquiree in accordance with ASC 606, “the
amendments also apply to contract assets and contract liabilities from
other contracts to which the provisions of Topic 606 apply, such as
contract liabilities from the sale of nonfinancial assets within the
scope of Subtopic 610-20.”
After the amendments are adopted, it is expected that an acquirer will
generally recognize and measure acquired contract assets and contract
liabilities in a manner consistent with how the acquiree recognized
and measured them in its preacquisition financial statements. However,
the Board acknowledges that:
[T]here may be circumstances in which
the acquirer is unable to assess or rely on how the acquiree
applied Topic 606, such as if the acquiree does not follow GAAP,
if there were errors identified in the acquiree’s accounting, or
if there were changes identified to conform with the acquirer’s
accounting policies. In those circumstances, the acquirer should
consider the terms of the acquired contracts, such as timing of
payment, identify each performance obligation in the contracts,
and allocate the total transaction price to each identified
performance obligation on a relative standalone selling price
basis as of contract inception (that is, the date the acquiree
entered into the contracts) or contract modification to
determine what should be recorded at the acquisition date.
We believe that another circumstance in which the
acquirer would not be able to carry over the acquiree’s contract asset
or contract liability amounts would be if there are differences
between the acquirer’s and the acquiree’s estimates in the application
of ASC 606 (e.g., the estimates of variable consideration and
application of the constraint or the estimates of stand-alone selling
prices or the measure of progress when revenue is recognized over
time).
Therefore, the Board notes that “the amendments may not
always be as simple as recording the same contract assets and contract
liabilities that were recorded by the acquiree before the acquisition
and that there may be additional effort required to evaluate how the
acquiree applied Topic 606.” According to the FASB, ASU 2021-08 is
intended “to improve the accounting for acquired revenue contracts
with customers in a business combination by addressing diversity in
practice and inconsistency related to the following:
- Recognition of an acquired contract liability
- Payment terms and their effect on subsequent revenue recognized by the acquirer.”
Since the issuance of ASC 606, questions have arisen
related to both the recognition and measurement of contract assets and
contract liabilities in a business combination. Specifically,
stakeholders have questioned whether entities should apply the concept
of a performance obligation in determining whether a contract
liability should be recognized as part of an acquisition. Before the
concept of a performance obligation was introduced in ASC 606, an
acquirer generally only recognized an acquiree’s deferred revenue
(i.e., contract liability) when the acquirer determined that the
acquiree had a “legal obligation.” However, under ASC 606, a
performance obligation also includes implied promises and customary
business practices within contracts with customers regardless of
whether such promises are legally enforceable. Therefore, a
performance obligation may be broader than a legal obligation.
Before the issuance of ASU 2021-08, stakeholders had
also asked the Board to provide guidance on measuring revenue
contracts in a business combination. Before adoption of the
amendments, assets and liabilities from revenue contracts with
customers are measured at fair value under ASC 805 rather than on the
basis of the principles in ASC 606. In addition, paragraph BC13 of the
ASU notes that before adoption of its amendments, the timing of a
customer’s payment under a revenue contract could affect the amount of
revenue recognized by the acquirer in the postacquisition period:
When a revenue contract is paid upfront, an
acquirer recognizes an assumed contract liability at fair value
when the acquiree has received consideration from the customer
and there is still a remaining unsatisfied, or partially
unsatisfied, obligation as of the acquisition date. The
resulting fair value measurement will often be lower than the
contract liability balance that is recorded by the acquiree.
Under fair value measurement techniques, the costs or activities
to enter into the contract are considered to have already been
performed by the acquiree before the acquisition and, therefore,
are not included in the measurement of the remaining obligation
for the related contract liability. However, under Topic 606,
the costs to enter into the contract are not considered for
purposes of revenue recognition, and contract liabilities are
derecognized as the corresponding performance obligation is
satisfied by transferring either a good or service to the
customer. Alternatively, when a contract is paid over time as
performance occurs, an acquirer likely would not analyze the
specific revenue contract at the acquisition date because there
would be no identifiable assets or liabilities assumed to
measure at fair value for that contract (absent assumed
intangible assets). Therefore, there is no contract-specific
fair value adjustment, and an acquirer likely would subsequently
recognize the same amount of revenue that the acquiree would
have recognized if no business combination took place.
As a result of these considerations, the Board decided to amend ASC 805
to improve comparability for both the recognition and measurement of
acquired revenue contracts by providing (1) guidance on “how to
determine whether a contract liability is recognized by the acquirer
in a business combination” and (2) “specific guidance on how to
recognize and measure acquired contract assets and contract
liabilities from revenue contracts in a business combination.”
The Board acknowledged that measuring contract
liabilities under ASC 606 rather than at fair value under ASC 805
could result in an increase in the amounts of both the contract
liability recognized and, correspondingly, the revenue the acquirer
recognizes in the postacquisition period. Paragraph BC42 states, in
part:
The Board acknowledged that the
expected increase in contract liabilities in a business
combination will result in an increase in the subsequent revenue
recognized by an acquirer, which a few stakeholders equated to
creating an opportunity to “buy revenue.” That is, the acquirer
may be able to recognize revenue for activities performed by an
acquiree before the acquisition (for example, selling and
marketing efforts to enter into the contracts). This concern was
included in the basis for conclusions of Statement 141(R) as
support for why previous business combination accounting under
the pooling-of-interests method was inappropriate. However, the
comprehensive guidance in Topic 606, which was issued after
Statement 141(R), limited the number of arrangements that
present this opportunity. Additionally, the model in Topic 606,
which requires that an entity recognize revenue as the entity
satisfies performance obligations, represents a faithful
representation of performance and the revenue recognized for
that performance. Accordingly, satisfying a performance
obligation postacquisition will result in a consistent approach
to recognizing revenue that is generally not affected by the
timing of payment or by whether it was originated by the
acquiree or the acquirer. The Board also indicated that
stakeholders understand the Topic 606 guidance and its resulting
outcomes and that the amendments in this Update provide
subsequent revenue information that users seek when an entity
completes a business combination.
However, the Board believes that the amendments to ASU
2021-08 will:
-
“[I]mprove comparability for both the recognition and measurement of acquired revenue contracts with customers at the date of and after a business combination.”
-
“[I]mprove comparability by specifying for all acquired revenue contracts regardless of their timing of payment (1) the circumstances in which the acquirer should recognize contract assets and contract liabilities that are acquired in a business combination and (2) how to measure those contract assets and contract liabilities.”
-
“[I]mprove comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination.”
See Deloitte’s Roadmap Revenue
Recognition for more information.
4.3.13.1 Practical Expedients
As discussed in paragraphs BC34 and BC35 of ASU
2021-08, to address stakeholder “concerns about the complexity
of the guidance related to circumstances in which (a) the
acquirer has to assess long-term, complex contracts that may
have been previously modified or (b) the acquirer is unable to
assess or rely on the acquiree’s accounting under Topic 606,”
the Board decided to provide certain expedients. ASC
805-20-30-29 allows an acquirer to “use one or more of the
following practical expedients when applying paragraphs
805-20-30-27 through 30-28 at the acquisition date:
- For contracts that were modified
before the acquisition date, an acquirer may reflect
the aggregate effect of all modifications that occur
before the acquisition date when:
- Identifying the satisfied and unsatisfied performance obligations
- Determining the transaction price
- Allocating the transaction price to the satisfied and unsatisfied performance obligations.
- For all contracts, for purposes of allocating the transaction price, an acquirer may determine the standalone selling price at the acquisition date (instead of the contract inception date) of each performance obligation in the contract.”
As explained in paragraph BC35 of the ASU, the
first expedient “provides relief for contracts that have been
previously modified before the acquisition date” by allowing an
acquirer to reflect the aggregate effect of all modifications as
of the acquisition date. The second expedient provides “relief
for situations in which the acquirer does not have the
appropriate data or expertise to analyze the historical periods
in which the contract was entered into” by allowing an acquirer
to determine the stand-alone selling price as of the acquisition
date. Under ASC 805-20-30-30, any practical expedients used by
the acquirer should be applied (1) “on an
acquisition-by-acquisition basis” and (2) “consistently to all
contracts acquired in the same business combination.” Entities
are also required to provide certain disclosures if they elect
to use any of the practical expedients. See Section
7.3.6 for more information.
4.3.13.2 Subsequent Accounting
Assets acquired and liabilities assumed in a
business combination are accounted for after the acquisition
date in accordance with applicable GAAP on the basis of the
nature of the assets and liabilities unless ASC 805 provides
specific subsequent measurement guidance. Accordingly, an
acquirer should apply the appropriate GAAP (e.g., ASC 606 or ASC
610-20) to contract assets and contract liabilities acquired in
a business combination after the acquisition date.
4.3.13.3 Other Assets That Arise From Revenue Contracts
ASU 2021-08 notes that the amendments “do not affect the accounting
for other assets or liabilities that may arise from revenue
contracts with customers in accordance with Topic 606, such as
refund liabilities, or in a business combination, such as
customer-related intangible assets and contract-based intangible
assets. For example, if acquired revenue contracts are
considered to have terms that are unfavorable or favorable
relative to market terms, the acquirer should recognize a
liability or asset for the off-market contract terms at the
acquisition date.”
4.3.13.4 Costs of Obtaining a Contract
Before a business combination, an acquiree may have recognized an
asset for the incremental costs of obtaining a contract with a
customer (e.g., sales commissions) in accordance with ASC
340-40-25-1. While we do not believe that the acquirer of such
an entity should recognize an asset for those costs in its
postcombination financial statements, we do believe that the
costs incurred to obtain a customer may be reflected in the
value of another asset, such as a customer relationship
intangible asset.
4.3.13.5 Up-Front Payments to Customers
ASC 606 specifies that if consideration paid to a
customer is not in exchange for a distinct good or service, the
consideration paid should be reflected as a reduction of the
transaction price that is allocated to the performance
obligations in the contract. If an up-front payment is made as
part of an enforceable contract with a customer, treating that
payment as a reduction of the transaction price would result in
the recording of an asset for the up-front payment made, which
would then be recognized as a reduction of revenue as the
promised goods or services are transferred to the customer. (See
Section
6.6.3 of Deloitte’s Roadmap Revenue
Recognition for more
information).
While we do not believe that the acquirer should
recognize a separate asset for those up-front payments in its
postcombination financial statements, we do believe that the
up-front payments to customers could affect the value of another
asset, such as a customer relationship intangible asset or an
off-market component of a customer contract.
4.4 Working Capital
ASC 805 requires the components of working capital (e.g., accounts receivable, accounts payable, and
accrued liabilities) to be recorded at their acquisition-date fair values. An acquirer cannot recognize a
separate valuation allowance as of the acquisition date for assets initially recognized at fair value (see
Section 4.5). Before the FASB incorporated this guidance into ASC 805, an entity generally recorded
working capital as the present value of amounts to be received or paid, determined at current interest
rates. Because of the short duration in expected cash flows, acquired working capital was often
recorded at the acquiree’s carrying value as of the acquisition date.
According to the FASB’s Valuation Resource Group (VRG),1 because ASC 805 requires working capital items to be measured at fair value,
simply carrying over the amounts recorded in the acquiree’s precombination financial
statements may not be appropriate. In addition, VRG members have indicated that they
do not believe that the exit price notion requires entities to value receivables at
the amount they would receive if they sold the receivables to a market participant
who engaged in the business of acquiring receivables. The VRG has indicated that the
in-exchange price would generally not be the highest and best use of the accounts
receivable.
Footnotes
1
The FASB established the VRG to provide the FASB staff with
information on implementation issues about fair value measurements used for
financial statement reporting and the alternative viewpoints associated with
those implementation issues. The VRG’s conclusions are not
authoritative.
4.5 Assets With Uncertain Cash Flows (Valuation Allowances)
ASC 805-20
Assets With Uncertain Cash Flows (Valuation Allowances)
30-4 The acquirer shall not
recognize a separate valuation allowance as of the
acquisition date for assets acquired in a business
combination that are measured at their acquisition-date fair
values because the effects of uncertainty about future cash
flows are included in the fair value measure, unless the
assets acquired are financial assets for which the acquirer
shall refer to the guidance in paragraphs 805-20-30-4A
through 30-4B.
Entities that have not yet adopted ASU 2016-13 are not permitted to recognize
separate valuation allowances as of the
acquisition date for assets that are initially
recognized at fair value; uncertainty about
collectibility and future cash flows is
incorporated into the fair value measurement. For
example, no separate valuation allowance is
recognized as of the acquisition date for acquired
loans and receivables measured at fair value. To
comply with disclosure or regulatory requirements,
entities may need to track their estimates of
uncollectible acquired receivables and loans
separately from preexisting receivables and loans.
Valuation allowances are permitted for assets not
measured at fair value, such as deferred tax
assets.
In June 2016, the FASB issued ASU
2016-13, which, in addition to providing a model for recognizing
credit losses on financial assets held at amortized cost and AFS debt securities,
also amends ASC 805 to provide guidance on accounting for purchased financial assets
in a business combination. After an entity adopts ASU 2016-13, the way it measures
financial assets in the scope of ASC 326 acquired in a business combination will
depend on whether the assets have experienced more-than-insignificant deterioration
in credit quality since origination. See Section 4.3.10 for more information.
4.6 Financial Instruments
4.6.1 Acquiree’s Equity Investments
An acquiree’s equity investments are measured and recognized at fair value on
the acquisition date in accordance with ASC 820.
If the equity securities do not have a readily
determinable fair value (i.e., are not exchange
traded), an acquirer must use other valuation
techniques to measure the fair value as of the
acquisition date. According to ASC 805-20-25-6, an
acquirer must classify the assets acquired and
liabilities assumed in a business combination “on
the basis of the contractual terms, economic
conditions, its operating or accounting policies,
and other pertinent conditions as they exist at
the acquisition date” (see Section
4.2). ASC 805 does not provide an
exception for financial instruments within the
scope of ASC 815 (see Section
4.6.2).
An acquiree may have an investment in an entity that it accounted for by using
the equity method of accounting before the
business combination. If the investment continues
to qualify as an equity method investment after
the acquisition, it is recognized at its fair
value as if it were newly acquired on the
acquisition date. Fair value is measured in
accordance with the guidance in ASC 820. The
underlying basis differences are also remeasured
as of the acquisition date.
4.6.2 Derivatives
An acquiree will often have outstanding financial instruments that meet the
definition of a derivative or are designated in a
hedging relationship under ASC 815. The acquirer
should reevaluate these instruments as of the
acquisition date to determine their designation.
ASC 805-20-25-7 states that an acquirer should
consider the “[d]esignation of a derivative
instrument as a hedging instrument” and assess
“whether an embedded derivative should be
separated from the host contract” in accordance
with ASC 815 on the basis of “pertinent conditions
as they exist at the acquisition date.” This could
include redesignating preexisting hedging
relationships and reevaluating certain contracts
of the acquiree. See Section 2.5.2.1.4 of Deloitte’s
Roadmap Hedge
Accounting for more information.
4.7 Inventory
Inventory acquired in a business combination must be measured at its acquisition-date fair value — that
is, the price at which market participants would be willing to sell or buy the inventory. Neither ASC 805
nor ASC 820 provides detailed guidance on measuring the fair value of inventory, but carryover of the
book basis of the acquiree’s inventories is not permitted. Because there are many acceptable methods
for accounting for inventory, an acquirer and acquiree often have different policies for doing so. The
method used to account for inventory (e.g., FIFO, LIFO, or average cost) does not affect its fair value
measurement. See Section 4.16 for more information about conforming accounting policies.
The objective of measuring the fair value of inventory is to determine the value
created by the acquiree before the acquisition date. Conceptually, the acquiree
incurs each expense with the expectation of earning a profit. Therefore, the fair
value of inventory consists of the raw materials and the direct and indirect
expenses that were required to bring the inventory to its current state of
completion, plus a reasonable profit margin. Finished goods inventories and
work-in-process inventories are usually valued by using a top-down approach, whereas
raw materials are generally valued by using a bottom-up approach. The fair value of
inventory should be the same regardless of which approach is used.
4.7.1 Finished Goods
The fair value of finished goods inventory is often measured by using a top-down approach, which starts
with a market participant‘s estimated selling price, adjusted for both (1) the costs of the selling effort and
(2) an approximately normal profit for the selling effort. The acquirer’s results of operations after the
business combination should reflect the costs and profits of the selling effort after the acquisition.
Because neither ASC 805 nor ASC 820 provides detailed guidance on measuring the
fair value of inventory, stakeholders have questioned whether an acquirer is
permitted to recognize any profit on finished goods inventory acquired in a
business combination under ASC 820’s exit price notion and highest-and-best-use
concept. When asked to discuss the issue, the FASB’s VRG indicated that the fair
value of inventory is probably close to its net realizable value, which allows
an acquirer to realize a profit on the selling effort. The VRG noted that this
view is supported by ASC 820-10-55-21(f), which provides the following guidance
on valuing finished goods inventory at a retail outlet:
For
finished goods inventory that is acquired in a business combination, a Level
2 input would be either a price to customers in a retail market or a price
to retailers in a wholesale market, adjusted for differences between the
condition and location of the inventory item and the comparable (that is,
similar) inventory items so that the fair value measurement reflects the
price that would be received in a transaction to sell the inventory to
another retailer that would complete the requisite selling efforts.
Conceptually, the fair value measurement will be the same, whether
adjustments are made to a retail price (downward) or to a wholesale price
(upward). Generally, the price that requires the least amount of subjective
adjustments should be used for the fair value measurement.
The costs of the selling effort must be incremental and directly related to the inventory and must
be based on assumptions that other market participants would make. Direct costs are those that
would not have been incurred if the finished goods inventory had not been produced — for example,
transportation, packaging, and direct marketing costs, as well as sales commissions based on the sale
of the inventory. The costs of the selling effort should not include indirect and general expenses not
attributable to the production of the inventory.
An approximately normal profit for the selling effort should be based on the
assumptions of a market participant. The acquirer should not receive credit for
any portion of the selling effort completed by the acquiree before the
acquisition; that effort should be part of the fair value of the acquired
inventory.
4.7.2 Work in Process
An acquirer generally measures the fair value of acquired work-in-process inventory similarly to the
way it measures the fair value of finished goods inventory, except that the measure also includes
estimates for completing the production process. To determine the fair value of work in process, an
entity generally uses a market participant‘s estimated selling price for the finished product, adjusted for
(1) the costs of both the selling effort and the effort to complete the manufacturing process and (2) an
approximately normal profit for both the selling and manufacturing efforts.
An approximately normal profit for the work-in-process inventory will be greater
than the profit for the acquired finished goods inventory since the profit will
include the portion related to the manufacturing effort to complete the
product.
The costs to complete the manufacturing process should include all inventoriable
costs. ASC 330-10- 30-2 through 30-8 provide general guidance on determining
which costs should and should not be included in inventory.
4.7.3 Raw Materials
Raw materials must be measured at fair value as of the acquisition date from the perspective of a
market participant; an acquiree’s cost cannot be presumed to be an item’s fair value. Entities typically
apply a bottom-up approach, which uses a market method for valuation if observable market prices are
available or a cost approach if they are not. The fair value of raw materials inventory will often be similar
to its replacement cost. In accordance with ASC 820-10-35-5, it is assumed in the measurement of a raw
material’s fair value that the transaction to sell the raw material occurs in the principal market or, in the
absence of a principal market, the most advantageous market.
4.7.4 Supply Inventory
Supplies used in the manufacturing process are measured at fair value as of the acquisition date, in a
similar manner to raw materials inventory.
4.7.5 LIFO Inventories
Inventory should be measured at fair value as of the acquisition date. Neither the acquirer’s future
method of accounting nor the acquiree’s past method is relevant in the fair value determination. An
acquirer is not permitted to carry over the book basis of the acquiree’s inventories, including inventories
that will be carried under the LIFO method of accounting even if the acquirer is able to carry over the
acquiree’s prior LIFO basis for income tax purposes.
SAB Topic 5.L (SAB 58) states that registrants should refer to the AICPA Issues Paper Identification
and Discussion of Certain Financial Accounting and Reporting Issues Concerning LIFO Inventories for guidance on determining what constitutes acceptable LIFO accounting practices. The Issues Paper
states that if acquired inventory is treated as a separate business unit or a new LIFO pool, the acquired
inventory should be considered the LIFO base inventory. If, however, the acquired inventory is combined
into an existing pool, it should be considered part of the current year’s purchases. Paragraph 2-15 of
the Issues Paper notes that the order of acquisition approach (first purchase price) to pricing current
purchases is the most compatible with the LIFO objective; however, any of the three approaches noted
in paragraph 2-10 may be used: “(a) the order of acquisition price (first purchase price), (b) the most
recent acquisition price (latest purchase price), [or] (c) the average purchase price.”
4.8 Property, Plant, and Equipment
Property, plant, and equipment (PP&E) that is acquired in a business
combination and classified as held and used by the
acquirer should be measured at fair value. The
acquiree’s accumulated depreciation is not carried
over into the acquirer’s financial statements;
rather, the acquirer’s financial statements should
reflect only the accumulated depreciation since
the acquisition date.
Connecting the Dots
If PP&E is acquired in a business combination and the acquirer intends to
sell it shortly after the acquisition, the PP&E may qualify for
held-for-sale classification as of the acquisition date. Such PP&E is
measured at fair value less costs to sell in accordance with ASC 360 and is
therefore an exception to ASC 805’s measurement principle. PP&E that the
acquirer intends to abandon, however, must be recognized and measured at
fair value by using market participant assumptions. See Section 4.3.5 for
more information about classifying assets as held for sale as of the
acquisition date and Section 4.9 for information about assets that the acquirer
intends to use in a manner other than their highest and best use.
4.8.1 PP&E Subject to Asset Retirement Obligations
ASC 410-20 provides guidance on accounting for AROs and, as indicated
in ASC 410-20-15-2(a), its scope includes “[l]egal obligations associated with the retirement of a tangible
long-lived asset that result from the acquisition, construction, or development and (or) the normal
operation of a long-lived asset, including any legal obligations that require disposal of a replaced part
that is a component of a tangible long-lived asset.” For a long-lived asset acquired and a related ARO
assumed in a business combination, an entity should measure and record both of the following:
- The ARO on the basis of the fair value of the liability by using the credit-adjusted risk-free rate as of the acquisition date.
- The associated long-lived asset at fair value without considering any future cash outflows associated with the asset retirement activities and without making an adjustment to add the amount of the ARO.
While quoted market prices, if available, provide the most reliable and best
evidence of an ARO’s fair value, often they do not
exist and fair value is determined by using an
income approach. ASC 410-20- 30-1 states, in part,
that “[a]n expected present value technique will
usually be the only appropriate technique with
which to estimate the fair value of a liability
for an asset retirement obligation.”
In a manner consistent with the above framework, if an income approach is used
to measure the fair value of the PP&E to which
the ARO is related, the cash outflows associated
with the obligation may not be incorporated into
the measure. However, if the measure does
incorporate such cash outflows, the fair value of
the ARO should be added back to the value of the
PP&E to remove that effect from the
measurement of the PP&E. Either approach
should result in a consistent PP&E measure
exclusive of any future cash outflows associated
with the asset retirement activities.
Further, if a quoted market price is used to obtain the fair value of the PP&E to which the ARO is related,
and the market price incorporates costs that will be incurred to retire the asset, an entity should add
back the fair value of the ARO to appropriately measure the fair value of the asset.
Example 4-7
Initial Recognition of an ARO in a Business Combination
Company A acquires Company B in a transaction accounted for as a business
combination. Company B is a utility, and A
determines that an ARO related to the facility
exists and estimates its fair value to be $25
million. Company A estimates the fair value of the
facility to be $100 million (by using either (1)
an income approach that includes the expected cash
outflows for the ARO in the cash flow model or (2)
an approach based on a quoted market price that
incorporates the ARO into the measure of fair
value). Thus, the value of the facility would be
$25 million higher if the costs associated with
the ARO were ignored.
Company A should recognize an asset of $125 million for the facility and a
liability of $25 million for the ARO.
After the acquisition date, the ARO should be subsequently measured in accordance with ASC
410-20-35.
4.8.2 Mineral Rights and Mining Assets
The ASC master glossary defines mineral rights as “[t]he legal right to explore, extract, and retain at least
a portion of the benefits from mineral deposits.” While some mineral rights may have characteristics of
both tangible and intangible assets, ASC 805-20-55-37 states that “mineral rights are tangible assets.”
Mining assets include mineral rights. ASC 805 requires entities to recognize
mining assets at fair value as of the acquisition
date. Entities should use the guidance in ASC
930-805-30-1 and 30-2 when measuring the fair
value of mining assets. The guidance states that
in estimating the fair value of mining assets, an
acquirer should take into account both of the
following:
-
The “value beyond proven and probable reserves” (VBPP) “to the extent that a market participant would include [VBPP] in determining the fair value of the asset.”
-
The “effects of anticipated fluctuations in the future market price of minerals . . . in a manner that is consistent with the expectations of marketplace participants.”
Estimates of anticipated fluctuations in market prices should be based on all
available information, including current prices,
historical averages, and forward pricing
curves.
4.9 Assets That the Acquirer Does Not Intend to Use, or Intends to Use in a Manner Other Than Their Highest and Best Use
ASC 805-20
Assets That the Acquirer Intends Not to Use or to Use in a Way Other Than Their Highest and Best Use
30-6 To protect its competitive position, or for other reasons, the acquirer may intend not to use an acquired
nonfinancial asset actively, or it may not intend to use the asset according to its highest and best use. For
example, that might be the case for an acquired research and development intangible asset that the acquirer
plans to use defensively by preventing others from using it. Nevertheless, the acquirer shall measure the
fair value of the nonfinancial asset in accordance with Subtopic 820-10 assuming its highest and best use by
market participants in accordance with the appropriate valuation premise, both initially and for purposes of
subsequent impairment testing.
Unless a specific recognition or measurement exception applies, all tangible and
intangible assets must be recognized and measured at fair value by using the
guidance in ASC 820, even if the acquirer does not intend to use the asset or
intends to use it in a manner other than its highest and best use. Such assets are
often intangible rather than tangible assets, but the requirement to measure them at
fair value is the same. See Section 4.10.4.8 for information about defensive intangible
assets.
4.10 Intangible Assets
ASC 805-20
25-10 The acquirer shall recognize separately from goodwill the identifiable intangible assets acquired in
a business combination. An intangible asset is identifiable if it meets either the separability criterion or the
contractual-legal criterion described in the definition of identifiable. Additional guidance on applying that
definition is provided in paragraphs 805-20-25-14 through 25-15, 805-20-55-2 through 55-45, and Example 1
(see paragraph 805-20-55-52). For guidance on the recognition and subsequent measurement of a defensive
intangible asset, see Subtopic 350-30.
The ASC master glossary defines intangible assets as “[a]ssets (not including financial assets) that lack
physical substance. (The term intangible assets is used to refer to intangible assets other than goodwill).”
An acquirer must recognize, separately from goodwill, the identifiable intangible assets acquired in a
business combination. An intangible asset is identifiable if it meets either the separability criterion or the
contractual-legal criterion.
Changing Lanes
The FASB had a project to improve the accounting for asset acquisitions and
business combinations by narrowing the differences
between the two accounting models. However, at its
June 15, 2022, meeting, the FASB decided to remove
this project from its agenda.
4.10.1 Initial Recognition of Intangible Assets
An intangible asset is identifiable and therefore recognized separately from goodwill if it meets either of
the following criteria:
- The intangible asset arises from contractual or other legal rights (i.e., the “contractual-legal criterion”), regardless of whether those rights are transferable or separable from the acquiree or from other rights and obligations.
- The intangible asset is separable (i.e., the “separability criterion”). According to ASC 805-20-55-3, an asset that meets this criterion “is capable of being separated or divided from the acquiree and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability.” An intangible asset is separable regardless of whether the acquirer intends to transfer it.
Both of these criteria are explained in more detail in the following
sections.
4.10.1.1 The Contractual-Legal Criterion
ASC 805-20
55-2 Paragraph 805-20-25-10 establishes that an intangible asset is identifiable if it meets either the
separability criterion or the contractual-legal criterion described in the definition of identifiable. An intangible
asset that meets the contractual-legal criterion is identifiable even if the asset is not transferable or separable
from the acquiree or from other rights and obligations. . . .
Many intangible assets arise from rights conveyed by contract, statute, or similar means. As stated in paragraph B156 of the Background Information and Basis for Conclusions of FASB Statement 141, “franchises are granted to
automobile dealers, fast-food outlets, and
professional sports teams. Trademarks and service
marks may be registered with the government.
Contracts are often negotiated with customers or
suppliers. Technological innovations are often
protected by patent.” Therefore, the fact that an
intangible asset arises from contractual or other
legal rights distinguishes it from goodwill. Such
an intangible asset must be recognized separately
from goodwill even if the acquirer is legally or
contractually restricted from selling,
transferring, or otherwise exchanging it.
Restrictions on selling or otherwise transferring
an intangible asset arising from contractual
rights do not affect its recognition; however,
such restrictions may affect its fair value
measurement.
ASC 805-20-55-2 provides the following examples of intangible assets arising
from contractual or other legal rights:
ASC 805-20
55-2 . . .
-
An acquiree leases a manufacturing facility to a lessee under an operating lease that has terms that are favorable relative to market terms. The lease terms explicitly prohibit transfer of the lease (through either sale or sublease). The amount by which the lease terms are favorable compared with the pricing of current market transactions for the same or similar items is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even though the acquirer cannot sell or otherwise transfer the lease contract. See also paragraph 805-20-25-12.
-
An acquiree owns and operates a nuclear power plant. The license to operate that power plant is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even if the acquirer cannot sell or transfer it separately from the acquired power plant. An acquirer may recognize the fair value of the operating license and the fair value of the power plant as a single asset for financial reporting purposes if the useful lives of those assets are similar.
-
An acquiree owns a technology patent. It has licensed that patent to others for their exclusive use outside the domestic market, receiving a specified percentage of future foreign revenue in exchange. Both the technology patent and the related license agreement meet the contractual-legal criterion for recognition separately from goodwill even if selling or exchanging the patent and the related license agreement separately from one another would not be practical.
Some intangible assets that meet the contractual-legal criterion may also meet the separability criterion,
but only one criterion must be met for an intangible asset to be identifiable. Similarly, an intangible
asset that meets the separability criterion is identifiable even if it does not arise from a contractual or
legal right.
4.10.1.2 The Separability Criterion
ASC 805-20
55-3 The separability criterion means that an acquired intangible asset is capable of being separated or divided
from the acquiree and sold, transferred, licensed, rented, or exchanged, either individually or together with a
related contract, identifiable asset, or liability. An intangible asset that the acquirer would be able to sell, license,
or otherwise exchange for something else of value meets the separability criterion even if the acquirer does not
intend to sell, license, or otherwise exchange it.
55-4 An acquired intangible asset meets the separability criterion if there is evidence of exchange transactions
for that type of asset or an asset of a similar type, even if those transactions are infrequent and regardless of
whether the acquirer is involved in them. For example, customer and subscriber lists are frequently licensed
and thus meet the separability criterion. Even if an acquiree believes its customer lists have characteristics
different from other customer lists, the fact that customer lists are frequently licensed generally means that
the acquired customer list meets the separability criterion. However, a customer list acquired in a business
combination would not meet the separability criterion if the terms of confidentiality or other agreements
prohibit an entity from selling, leasing, or otherwise exchanging information about its customers.
In contrast to goodwill, which cannot be separated from an entity, some intangible assets do not
arise from contractual or other legal rights but are capable of being separated from the acquiree and
exchanged for something else of value. Therefore, identifiable assets can also be distinguished from
goodwill on the basis of separability.
An acquired intangible asset meets the separability criterion if there is
evidence of exchange transactions for the asset or
similar assets, even if such exchanges occur
infrequently and the acquirer has not participated
and does not intend to participate in such
exchanges. It is the acquirer’s ability to
separate the asset from the combined entity that
makes an intangible asset separable. ASC
805-20-55-4 provides the following example of
customer-related intangible assets that meet the
separability criterion:
[C]ustomer and subscriber lists are frequently
licensed and thus meet the separability criterion.
Even if an acquiree believes its customer lists
have characteristics different from other customer
lists, the fact that customer lists are frequently
licensed generally means that the acquired
customer list meets the separability criterion.
However, a customer list acquired in a business
combination would not meet the separability
criterion if the terms of confidentiality or other
agreements prohibit an entity from selling,
leasing, or otherwise exchanging information about
its customers.
Therefore, even if an intangible asset that is related to a contract,
identifiable asset, or liability cannot be
separated individually from that contract,
identifiable asset, or liability, it will still
meet the separability criterion if it can be
transferred together with that related contract,
identifiable asset, or liability. ASC 805-20-55-5
provides examples of intangible assets that, while
not individually separable, are separable when
combined with other assets or liabilities.
ASC 805-20
55-5 An intangible asset that is not individually separable from the acquiree or combined entity meets the
separability criterion if it is separable in combination with a related contract, identifiable asset, or liability. For
example:
- Market participants exchange deposit liabilities and related depositor relationship intangible assets in observable exchange transactions. Therefore, the acquirer should recognize the depositor relationship intangible asset separately from goodwill.
- An acquiree owns a registered trademark and documented but unpatented technical expertise used to manufacture the trademarked product. To transfer ownership of a trademark, the owner is also required to transfer everything else necessary for the new owner to produce a product or service indistinguishable from that produced by the former owner. Because the unpatented technical expertise must be separated from the acquiree or combined entity and sold if the related trademark is sold, it meets the separability criterion.
Unlike the contractual-legal criterion, restrictions on the sale, transfer, or exchange of an intangible
asset may preclude the asset from meeting the separability criterion. If agreements, laws, or statutes
prohibit the sale, transfer, license, rent, or exchange of an intangible asset, that asset does not meet the
separability criterion, although it could still meet the contractual-legal criterion.
4.10.1.3 Intangible Assets That Are Not Identifiable as of the Acquisition Date
ASC 805-20
55-7 The acquirer also subsumes into goodwill any value attributed to items that do not qualify as assets at
the acquisition date. For example, the acquirer might attribute value to potential contracts the acquiree is
negotiating with prospective new customers at the acquisition date. Because those potential contracts are
not themselves assets at the acquisition date, the acquirer does not recognize them separately from goodwill.
The acquirer should not subsequently reclassify the value of those contracts from goodwill for events that
occur after the acquisition date. However, the acquirer should assess the facts and circumstances surrounding
events occurring shortly after the acquisition to determine whether a separately recognizable intangible asset
existed at the acquisition date.
An acquirer might identify certain intangible assets acquired in a business combination that may
have value but do not meet either the separability or contractual-legal criterion. Thus, such assets are
subsumed into goodwill.
FASB Statement 141 includes the following examples of intangible assets that are
not identifiable (while ASC 805 did not carry
forward all of these examples, they continue to be
relevant):
-
Potential contracts that an acquiree is negotiating with prospective new customers as of the acquisition date, which is specifically addressed in ASC 805-20-55-7.
-
Customer base or unidentifiable customers — a group of customers that are not known or identifiable to the entity (e.g., customers of a fast-food franchise).
-
Assembled workforce, which is specifically addressed in ASC 805-20-55-6.
-
Customer service capacity.
-
A presence in geographic markets or in certain locations.
-
Status as a nonunion, or strong labor relations.
-
Training that is ongoing.
-
Recruitment programs.
-
Outstanding credit ratings.
-
Access to capital markets.
-
Favorable governmental relationships.
ASC 805-20-55-7 acknowledges that while potential contracts do not meet the criteria for separate
recognition as of the acquisition date and cannot be subsequently reclassified from goodwill for
events that occur after the acquisition date, the acquirer should “assess the facts and circumstances
surrounding events occurring shortly after the acquisition to determine whether a separately
recognizable intangible asset existed at the acquisition date.”
In a business combination, an intangible asset must be identifiable according to the specific criteria in ASC 805 to be recognized, but in an asset acquisition, it must only meet the asset recognition criteria in FASB Concepts Statement 5 to be recognized in accordance with
ASC 350-30-25-4. (See Section C.3.4
for more information.)
4.10.1.3.1 Assembled Workforce
ASC 805-20
Assembled Workforce and Other Items That Are Not Identifiable
55-6 The acquirer subsumes into goodwill the value of an acquired intangible asset that is not identifiable as of
the acquisition date. For example, an acquirer may attribute value to the existence of an assembled workforce,
which is an existing collection of employees that permits the acquirer to continue to operate an acquired
business from the acquisition date. An assembled workforce does not represent the intellectual capital of the
skilled workforce ― the (often specialized) knowledge and experience that employees of an acquiree bring
to their jobs. Because the assembled workforce is not an identifiable asset to be recognized separately from
goodwill, any value attributed to it is subsumed into goodwill.
An assembled workforce is an example of an intangible asset that is not identifiable and therefore not separately recognizable in a business combination. In paragraph B178 of the Basis for Conclusions of Statement 141(R), the FASB explains why an assembled workforce is not an identifiable intangible asset to be recognized separately from goodwill in a business combination:
Because an assembled workforce is a collection of employees rather than an individual employee, it does not
arise from contractual or legal rights. Although individual employees might have employment contracts with the
employer, the collection of employees, as a whole, does not have such a contract. In addition, an assembled
workforce is not separable, either as individual employees or together with a related contract, identifiable asset,
or liability. An assembled workforce cannot be sold, transferred, licensed, rented, or otherwise exchanged
without causing disruption to the acquirer’s business. In contrast, an entity could continue to operate after
transferring an identifiable asset.
By contrast, an assembled workforce meets the recognition criteria if it is
acquired in an asset acquisition, as discussed in
Section C.3.4.1.
4.10.2 Initial Measurement of Intangible Assets
ASC 805-20
55-9 The identifiability criteria determine whether an intangible asset is recognized separately from goodwill.
However, the criteria neither provide guidance for measuring the fair value of an intangible asset nor restrict
the assumptions used in measuring the fair value of an intangible asset. For example, the acquirer would
take into account the assumptions that market participants would use when pricing the intangible asset,
such as expectations of future contract renewals, in measuring fair value. It is not necessary for the renewals
themselves to meet the identifiability criteria. (However, see paragraph 805-20-30-20, which establishes an
exception to the fair value measurement principle for reacquired rights recognized in a business combination.)
Intangible assets acquired in a business combination are measured at their acquisition-date fair values
in accordance with the guidance in ASC 820 unless the intangible asset qualifies for an exception to
ASC 805’s fair value measurement principle (e.g., a reacquired right).
SEC Considerations
The SEC staff frequently asks registrants how they have assigned amounts to assets acquired
and liabilities assumed in business combinations. In particular, the staff asks registrants that
have recorded a significant amount of goodwill why they have not attributed value to identifiable
intangible assets. The staff also compares the disclosures provided in press releases, the
business section, and MD&A to the disclosures in the financial statements. For example, the
SEC staff may ask why a registrant did not recognize a customer-related intangible asset if its
MD&A discloses that it acquired customers in a business combination. In addition, the SEC staff
may ask detailed questions about (1) how a registrant determined that intangible assets would
have finite or indefinite useful lives, (2) the useful lives of identified intangible assets determined
to have finite useful lives, and (3) material revisions to the initial accounting for a business
combination, including what significant assumptions have changed to support a revision to the
value of intangible assets.
4.10.2.1 Use of the Residual Method to Value Intangible Assets
In the past, some entities used what was called the “residual method” for assigning fair value to certain intangible assets that, it was believed, could not be separately and directly valued. However, in EITF Topic D-108, the SEC staff indicated that this method is not acceptable. Topic D-108 states, in part:
The SEC staff is aware of instances in which registrants have asserted that certain intangible assets that arise
from legal or contractual rights cannot be separately and directly valued (hereinafter referred to as a “direct
value method”) because the nature of the particular asset makes it fundamentally indistinguishable from
goodwill in a business combination (for example, cellular/spectrum licenses, cable franchise agreements, and
so forth). . . .
The SEC staff notes that a fundamental distinction between other recognized intangible assets and goodwill is
that goodwill is both defined and measured as an excess or residual asset, while other recognized intangible
assets are required to be measured at fair value. The SEC staff does not believe that the application of the
residual method to the valuation of intangible assets can be assumed to produce amounts representing the
fair values of those assets. . . . Furthermore, the SEC staff notes that the same types of assets being valued
using the residual method by some entities are being valued using a direct value method by other entities.
Accordingly, the SEC staff believes the residual method should no longer be used to value intangible assets
other than goodwill.
4.10.3 Combining Intangible Assets Into a Single Unit of Account
ASC 805 does not provide any specific guidance on identifying the unit of account for tangible or
intangible assets, but it offers the following three examples of acquired assets that may be combined for
financial reporting:
- “[A] group of complementary assets such as a trademark (or service mark) and its related trade name, formulas, recipes, and technological expertise.” (See ASC 805-20-55-18.)
- A license to operate a nuclear power plant and a power plant. (See ASC 805-20-55-2(b).)
- An artistic-related copyright “and any related assignments or license agreements.” (See ASC 805-20-55-30.)
In each example, the individual assets cited have similar useful lives — a factor that supports combining
them for financial reporting. In addition, we believe that to ensure that their effect on financial reporting
is similar, only assets that have similar methods of amortization should be combined. Likewise, ASC
805-20-55-24 states that “[a] customer contract and the related customer relationship may represent
two distinct intangible assets” because “[b]oth the useful lives and the pattern in which the economic
benefits of the two assets are consumed may differ.” Determining whether it is appropriate to combine
intangible assets into a single unit of account requires considerable judgment. See Section 4.10.4.2.8 for
more information about the unit of account for customer-related intangible assets.
4.10.4 Examples of Identifiable Intangible Assets
The implementation guidance in ASC 805-20-55 lists intangible assets that are frequently recognized
in business combinations. In correspondence to the FASB staff dated August 16, 2001, then SEC Chief
Accountant Lynn Turner notes the following:
Appendix A of SFAS No. 141 indicates that the list of identifiable intangible assets is illustrative. The SEC staff
believes there is a rebuttable presumption that any intangible asset identified in the listing will be valued in
a purchase business combination. In its review of filings, the staff may look to such documentation as the
sales agreement, memorandums, presentations by the target to the buyer, minutes of the Board of Directors
Meetings, etc. for discussions and evidence of assets, including intangibles, being purchased.
While the SEC staff’s comments referred to FASB Statement 141, the list of
intangible assets it describes was carried forward
to ASC 805, and therefore the views expressed
remain applicable.
The list of examples in ASC 805-20 is not all-inclusive. Entities should also
consider the following when searching for the
presence of acquired intangible assets:
-
Other acquisitions by the acquirer in the same line of business.
-
Other acquisitions by companies in the same industry.
-
Historical financial statements of the acquired entity for disclosure, discussion, or both, of any previously recognized or unrecognized intangibles.
ASC 805-20-55-12 indicates that the identifiable intangible assets discussed in
ASC 805-20 are divided into two groups that are
designated as follows (emphasis added):
-
“Intangible assets designated with the symbol # are those that arise from contractual or other legal rights.”
-
“Those designated with the symbol * do not arise from contractual or other legal rights but are separable.”
The guidance also notes that “[i]ntangible assets designated with the symbol # might also be separable,
but separability is not a necessary condition for an asset to meet the contractual-legal criterion.”
The sections below discuss both types of identifiable intangible assets.
4.10.4.1 Marketing-Related Intangible Assets
Marketing-related intangible assets are “primarily used in the marketing or promotion of products or
services.” They are typically registered or protected through legal rights and, therefore, generally meet
the contractual-legal criterion for recognition separately as intangible assets. ASC 805-20-55-14 provides
the following examples of marketing-related intangible assets:
- Trademarks, trade names, service marks, collective marks, certification marks #
- Trade dress (unique color, shape, package design) #
- Newspaper mastheads #
- Internet domain names #
- Noncompetition agreements. #
4.10.4.1.1 Trademarks, Trade Names, Service Marks, Collective Marks, and Certification Marks
ASC 805-20
Trademarks, Trade Names, Service Marks, Collective Marks, Certification Marks
#
55-16 Trademarks are words, names, symbols, or other devices used in trade to indicate the source of a
product and to distinguish it from the products of others. A service mark identifies and distinguishes the source
of a service rather than a product. Collective marks identify the goods or services of members of a group.
Certification marks certify the geographical origin or other characteristics of a good or service.
55-17 Trademarks, trade names, service marks, collective marks, and certification marks may be protected
legally through registration with governmental agencies, continuous use in commerce, or by other means. If
it is protected legally through registration or other means, a trademark or other mark acquired in a business
combination is an intangible asset that meets the contractual-legal criterion. Otherwise, a trademark or other
mark acquired in a business combination can be recognized separately from goodwill if the separability
criterion is met, which normally it would be.
55-18 The terms brand and brand name, often used as synonyms for trademarks and other marks, are general
marketing terms that typically refer to a group of complementary assets such as a trademark (or service mark)
and its related trade name, formulas, recipes, and technological expertise. This Subtopic does not preclude an
entity from recognizing, as a single asset separately from goodwill, a group of complementary intangible assets
commonly referred to as a brand if the assets that make up that group have similar useful lives.
4.10.4.1.2 Internet Domain Names
ASC 805-20
Internet Domain Names #
55-19 An Internet domain name is a unique alphanumeric name that is used to identify a particular numeric
Internet address. Registration of a domain name creates an association between that name and a designated
computer on the Internet for the period of the registration. Those registrations are renewable. A registered
domain name acquired in a business combination meets the contractual-legal criterion.
4.10.4.1.3 Noncompetition Agreements
Noncompetition or “noncompete” agreements are legal agreements that prohibit or restrict one party
from competing against another party, typically in a defined market for a specified period. Noncompete
agreements of the acquiree that were in place before the business combination would meet the
contractual-legal criterion because such agreements arise from legal or contractual rights. The terms,
conditions, and enforceability of noncompete agreements affect the fair value of such agreements (e.g.,
in certain jurisdictions, noncompete agreements may be unenforceable as a matter of law and therefore
have little value) but not their recognition. Amounts assigned to noncompete agreements are generally
subject to amortization; however, determining the period of amortization is a matter of judgment, and all
terms of the agreement, including restrictions on its enforceability, should be considered.
The acquirer and the acquiree may also enter into noncompete agreements at the
time of the business combination. There are
differing views regarding whether such agreements
should be accounted for as part of the business
combination or whether they represent transactions
that are separate from the acquisition (see
Section 6.2). These differing views
are discussed in paragraph BC19 of ASU 2014-18,
which is based on a consensus of the PCC. It
states, in part:
[W]hile many
reporting entities and public accountants consider
noncompetition agreements to be part of most
business combinations, to other reporting entities
and public accountants, most noncompetition
agreements represent transactions separate from a
business combination. Noncompetition agreements
are not specifically discussed in the guidance on
determining what is part of a business combination
transaction. To date, however, the diversity in
practice has not resulted in significantly
different financial reporting outcomes. As a
result, the PCC and the Board decided not to
provide additional guidance to clarify whether
noncompetition agreements are part of a business
combination.
Connecting the Dots
If the acquirer is a private company or not-for-profit entity, it may elect to apply the accounting alternative for the
recognition of noncompetition agreements acquired in a business combination, which is
discussed in Chapter 8.
4.10.4.2 Customer-Related Intangible Assets
Customer-related intangible assets include, but are not limited to, customer contracts and related
customer relationships, noncontractual customer relationships, customer lists, order and production
backlogs, and customer loyalty programs. Entities may find it challenging to recognize and measure
these assets because in many cases, an acquiree’s relationship with a customer can encompass various
types of intangible assets (e.g., a customer contract and related relationship, a customer list, and a
backlog), which may be interrelated. The values assigned to other intangible assets, such as brand
names and trademarks, may also affect the valuation of customer-related intangible assets. Further, as
noted in ASC 805-25-55-24, because the useful lives and pattern in which the assets’ economic benefits
are consumed may differ, entities may need to recognize separately the intangible assets related to a single customer relationship. ASC 805-20-55-20 provides the following examples of customer-related
intangible assets:
- Customer lists *
- Order or production backlog #
- Customer contracts and related customer relationships #
- Noncontractual customer relationships. *
4.10.4.2.1 Valuation Techniques and Assumptions Used in Measuring Customer- Related Intangible Assets
Because of the absence of market transactions involving identical or comparable assets, it is often
difficult to use the market approach to measure the fair value of a customer-relationship intangible
asset. Likewise, the cost approach may not be appropriate. Therefore, in most cases, customer-related
intangible assets are measured by using an income approach.
At the 2003 AICPA Conference on Current SEC Developments, then SEC OCA
Professional Accounting Fellow Chad Kokenge stated
the following in prepared
remarks:
[T]he [cost] approach only focuses on the
entity’s specific costs that are necessary to
“establish” the relationship. Such an approach
would not be sensitive to the volume of business
that might be generated by the customer, other
relationship aspects, such as referral capability,
or other factors that may be important to how a
marketplace participant might assess the asset. If
these factors are significant, we believe the use
of such an approach would generally be
inconsistent with the . . . definition of fair
value.
In addition, in a statement at the 2006 AICPA Conference on Current SEC and
PCAOB Developments, then SEC OCA Professional
Accounting Fellow Joseph Ucuzoglu also
addressed
the valuation of customer-relationship intangible
assets in a business combination:
Some have suggested that the SEC
staff always requires the use of an income
approach to value customer relationship intangible
assets. The staff has even heard some suggest
that, as long as a registrant characterizes its
valuation method as an income approach, the
specific assumptions used or results obtained will
not be challenged by the staff, because one has
complied with a perceived bright line requirement
to use an income approach. Let me assure you,
these statements are simply false. While an income
approach often provides the most appropriate
valuation of acquired customer relationship
intangible assets, circumstances may certainly
indicate that a different method provides a better
estimate of fair value. On the flipside, even when
a registrant concludes that an income approach is
the most appropriate valuation methodology, the
staff may nevertheless question the result
obtained when the underlying assumptions, such as
contributory asset charges, do not appear
reasonable in light of the circumstances.
When determining the appropriate
valuation of a customer relationship intangible
asset, I believe that the first step in the
process should be to obtain a thorough
understanding of the value drivers in the acquired
entity. That is, why is it that customers
continually return to purchase products or
services from the acquired entity? In some cases,
the nature of the relationship may be such that
customers are naturally “sticky,” and tend to stay
with the same vendor over time without frequently
reconsidering their purchasing decisions. In that
circumstance, it would appear that a significant
portion of the ongoing cash flows that the
acquired entity will generate can be attributed to
the strength of its customer relationships.
At the other end of the
spectrum, relationships may be a less significant
value driver in an environment where customers
frequently reassess their purchasing decisions and
can easily switch to another vendor with a lower
price or a superior product. In that environment,
if customers continually return to buy products
from the acquired entity, perhaps they do so in
large part due to factors other than the
relationship, such as a well-know[n] tradename,
strong brands, and proprietary technologies. As a
result, the value of the customer relationship
intangible asset may be less than would be the
case in a circumstance where the relationship is
stronger. However, the staff would generally
expect that the amount attributed to other
intangible assets would be commensurately higher,
reflecting the increasingly important role of
those assets in generating cash flows.
4.10.4.2.2 Customer Lists
ASC 805-20
Customer Lists *
55-21 A customer list consists of information about customers, such as their names and contact information. A
customer list also may be in the form of a database that includes other information about the customers, such
as their order histories and demographic information. A customer list generally does not arise from contractual
or other legal rights. However, customer lists are frequently leased or exchanged. Therefore, a customer list
acquired in a business combination normally meets the separability criterion.
There is often an active market for customer information, referred to as customer lists, which an entity
may receive regarding the acquiree’s customers. Such information is generally deemed to be separable
if there are no terms of confidentiality or restrictions on selling, leasing, or otherwise exchanging it, even
if the entity has no intention of doing so.
However, if the terms of confidentiality or restrictions on the sale or transfer
of customer lists prohibit a company from selling,
leasing, or otherwise exchanging a noncontractual
customer list, the separability criterion would
not be met and an intangible asset would not be
recognized apart from goodwill. While most
entities will possess some information about their
customers, thereby establishing the presence of a
customer-list intangible asset, the specific
information possessed and the resulting value of
this asset will vary.
The decision tree below is intended to help an
entity evaluate the criteria related to the
recognition apart from goodwill of a customer-list
intangible asset.
4.10.4.2.3 Order or Production Backlog
ASC 805-20
Order or Production Backlog #
55-22 An order or production backlog arises from contracts such as purchase or sales orders. An order or
production backlog acquired in a business combination meets the contractual-legal criterion even if the
purchase or sales orders are cancelable.
An order or production backlog acquired in a business combination meets the contractual-legal criterion
even if the purchase or sales orders are cancelable. However, the fact that a contract is cancelable may
affect the fair value measurement of the associated intangible asset.
4.10.4.2.4 Customer Contracts and Customer Relationships
ASC 805-20
Customer Contracts and the Related Customer Relationships #
55-23 If an entity establishes relationships with its customers through contracts, those customer relationships
arise from contractual rights. Therefore, customer contracts and the related customer relationships acquired
in a business combination meet the contractual-legal criterion, even if confidentiality or other contractual terms
prohibit the sale or transfer of a contract separately from the acquiree.
55-24 A customer contract and the related customer relationship may represent two distinct intangible assets.
Both the useful lives and the pattern in which the economic benefits of the two assets are consumed may
differ.
55-25 A customer relationship exists between an entity and its customer if the entity has information about
the customer and has regular contact with the customer, and the customer has the ability to make direct
contact with the entity. Customer relationships meet the contractual-legal criterion if an entity has a practice
of establishing contracts with its customers, regardless of whether a contract exists at the acquisition date.
Customer relationships also may arise through means other than contracts, such as through regular contact by
sales or service representatives. As noted in paragraph 805-20-55-22, an order or a production backlog arises
from contracts such as purchase or sales orders and therefore is considered a contractual right. Consequently,
if an entity has relationships with its customers through these types of contracts, the customer relationships
also arise from contractual rights and therefore meet the contractual-legal criterion.
Noncontractual Customer Relationships *
55-27 A customer relationship acquired in a business combination that does not arise from a contract may
nevertheless be identifiable because the relationship is separable. Exchange transactions for the same asset
or a similar asset that indicate that other entities have sold or otherwise transferred a particular type of
noncontractual customer relationship would provide evidence that the noncontractual customer relationship is
separable. For example, relationships with depositors are frequently exchanged with the related deposits and
therefore meet the criteria for recognition as an intangible asset separately from goodwill.
Customer relationships (both contractual and noncontractual) are recognized separately from goodwill
only if they exist as of the acquisition date. If the acquiree routinely signs contracts with its customers
(e.g., sales and purchase orders), the acquirer would recognize separate intangible assets for the
following:
- Customer contracts that exist as of the acquisition date.
- Customer relationships that exist as of the acquisition date, regardless of whether a contract exists on that date.
Although ASC 805 does not define the term “contractual,” it indicates that both of the above items would
satisfy the contractual-legal criterion. Therefore, the absence of enforceable rights by the parties to a
particular arrangement does not preclude recognition. The SEC staff has historically agreed with this
view.
In addition, while a noncontractual customer relationship may not be separable
by itself, it may be separable along with another
identifiable asset, liability, or contract — such
as a sales representative’s contract or a brand,
trademark, or product line — even if management
has no intention of separating it. In that case,
the customer relationship would meet the
separability criterion. ASC 805-20-55-25 provides
the following three criteria that may indicate
that a relationship exists between an entity and
its customer:
-
The acquired entity maintains current customer information.
-
The acquired entity contacts its customers regularly.
-
Customers can directly contact the acquired entity.
ASC 805 nullified EITF Issue 02-17 but carried forward the EITF’s prior decisions about customer contracts and related customer relationships. Issue 02-17 offered the
following illustration, which is still considered
relevant under the guidance in ASC 805:
Company X acquires Company Y in a
business combination on December 31, 20X2. Company
Y does business with its customers solely through
purchase and sales orders. At December 31, 20X2,
Company Y has a backlog of customer purchase
orders in-house from 60 percent of its customers,
all of whom are recurring customers. The other 40
percent of Company Y’s customers are also
recurring customers; however, as of December 31,
20X2, Company Y does not have any open purchase
orders, or other contracts, with those
customers.
Evaluation: The purchase orders from 60
percent of Company Y’s customers (whether
cancelable or not) meet the contractual-legal
criterion and, therefore, must be recorded at fair
value apart from goodwill. Additionally, since
Company Y has established its relationship with 60
percent of its customers through a contract, those
customer relationships meet the contractual-legal
criterion and must also be recorded at fair value
apart from goodwill.
Because Company Y has a practice of establishing
contracts with the remaining 40 percent of its
customers, those customer relationships also arise
through contractual rights and, therefore, meet
the contractual-legal criterion. Company X must
record the customer relationship for the remaining
40 percent of Company Y’s customers at fair value
apart from goodwill, even though Company Y does
not have contracts with those customers at
December 31, 20X2.
Connecting the Dots
If the acquirer is a private company or not-for-profit entity, it may elect to apply the accounting alternative for the
recognition of certain customer-related intangible assets acquired in a business combination,
which are discussed in Chapter 8.
The following cases from ASC 805-20-55-53 through 55-57 illustrate the
recognition of customer-contract and customer-relationship intangible
assets acquired in a business combination:
ASC 805-20
55-53 In each of the Cases, the Acquirer acquires Target in a business combination on December 31, 20X5.
Case A: Five-Year Supply Agreement
55-54 Target has a five-year agreement to supply goods to Customer. Both Target and Acquirer believe that
Customer will renew the agreement at the end of the current contract. The agreement is not separable. The
agreement, whether cancelable or not, meets the contractual-legal criterion. Additionally, because Target
establishes its relationship with Customer through a contract, not only the agreement itself but also Target’s
customer relationship with Customer meet the contractual-legal criterion.
Case B: One Customer, Contract in One of Two Lines of Business
55-55 Target manufactures goods in two distinct lines of business: sporting goods and electronics. Customer
purchases both sporting goods and electronics from Target. Target has a contract with Customer to be its
exclusive provider of sporting goods but has no contract for the supply of electronics to Customer. Both
Target and Acquirer believe that only one overall customer relationship exists between Target and Customer.
The contract to be Customer’s exclusive supplier of sporting goods, whether cancelable or not, meets the
contractual-legal criterion. Additionally, because Target establishes its relationship with Customer through a
contract, the customer relationship with Customer meets the contractual-legal criterion. Because Target has
only one customer relationship with Customer, the fair value of that relationship incorporates assumptions
about Target’s relationship with Customer related to both sporting goods and electronics. However, if
Acquirer determines that the customer relationships with Customer for sporting goods and for electronics are
separate from each other, Acquirer would assess whether the customer relationship for electronics meets the
separability criterion for identification as an intangible asset.
Case C: Purchase and Sales Orders
55-56 Target does business with its customers solely through purchase and sales orders. At December 31,
20X5, Target has a backlog of customer purchase orders from 60 percent of its customers, all of whom are
recurring customers. The other 40 percent of Target’s customers also are recurring customers. However, as of
December 31, 20X5, Target has no open purchase orders or other contracts with those customers. Regardless
of whether they are cancelable or not, the purchase orders from 60 percent of Target’s customers meet the
contractual-legal criterion. Additionally, because Target has established its relationship with 60 percent of its
customers through contracts, not only the purchase orders but also Target’s customer relationships meet
the contractual-legal criterion. Because Target has a practice of establishing contracts with the remaining
40 percent of its customers, its relationship with those customers also arises through contractual rights
and therefore meets the contractual-legal criterion even though Target does not have contracts with those
customers at December 31, 20X5.
Case D: Cancelable Contracts
55-57 Target has a portfolio of one-year motor insurance contracts that are cancelable by policyholders.
Because Target establishes its relationships with policyholders through insurance contracts, the customer
relationship with policyholders meets the contractual-legal criterion. The guidance in Subtopic 350-30 applies
to the customer relationship intangible asset.
4.10.4.2.5 Customer Loyalty Programs
Customer loyalty programs generally allow customers to earn current or future discounts, free products
or services, or other benefits on the basis of cumulative purchases from the operator of the program.
Many airlines, casinos, hotels, and retailers offer such programs. Typically, a program’s enrollment
process is designed to be easy for customers to complete, with the participants agreeing to the terms
and conditions of the program at the time of enrollment. Participants in such programs usually have no obligation to complete future purchases of products or services, and operators of such programs
generally reserve the right to modify or cancel the program at any time.
Despite the absence of enforceable rights between the parties regarding future
purchases or the fulfillment of accrued benefits,
such loyalty program arrangements are deemed to
meet the contractual-legal criterion because the
parties have agreed to certain terms and
conditions or had a previous contractual
relationship, or both. Any liability accruals, or
revenue deferrals, by the operator would also
indicate that the arrangement is “contractual.” In
addition to evaluating the recognition and
measurement of an acquired customer-related
intangible asset, an acquirer must separately
evaluate the recognition and measurement of
assumed liabilities related to the acquiree’s
customer loyalty program as of the acquisition
date.
4.10.4.2.6 Overlapping Customers
An acquirer and acquiree may have relationships with the same customers, sometimes referred to
as overlapping customers. If the acquired customer relationship is identifiable, the acquirer should
recognize an intangible asset. When estimating the fair value of the acquired relationship, the acquirer
must use assumptions that market participants would make about their ability to generate incremental
cash flows from these relationships.
In prepared remarks at the 2005 AICPA
Conference on SEC and PCAOB Developments, then SEC
OCA Professional Accounting Fellow Pamela
Schlosser offered the following example, which
discussed a scenario in which overlapping
customers would provide value to the acquirer:
Company A, which sells apparel
products to retail customers, acquires Company B,
which sells toy products to those same retail
customers. The question is: at what amount the
customer relationships of Company B should be
recognized, considering the fact that Company A
already had relationships with those very same
customers, albeit for different product sales?
Some have argued that in
this situation, no value should be attributed to
these intangible assets since Company A already
sold its products to Company B’s customer base,
and thus already had pre-established relationships
with them. However, we have found this argument
difficult to accept. Because of the acquisition,
Company A now has the ability to sell new products
(that is, toy products) to its retail customers
that it was unable to sell prior to the
acquisition of Company B. And even if the two
companies sold competing products to the same
retail customers, for instance both sold toy
products, the fact that Company A has increased
its “shelf space” at each of its customers’ retail
locations would be indicative of value to those
relationships.
In the SEC staff’s view, an acquired customer relationship that overlaps an
existing customer relationship has value because
it gives the acquirer the ability to generate
incremental cash flows; for example, an acquirer
can sell new products to the customer or increase
its “shelf space” with the customer. That value
may also be reflected in the recognition of other
intangible assets, such as trade names, that drive
customer loyalty. The SEC staff also indicated
that the most appropriate approach to valuing the
intangible asset would generally be an income
approach based on the benefits of incremental
sales to those customers.
4.10.4.2.7 Customer Base
A customer base is a group of customers, also referred to as walk-up customers,
that are not known or identifiable to the company.
For example, customers who make purchases from
newsstands or fast food restaurants may be loyal,
repeat customers, but often specific demographic
data on those customers is not maintained in such
a way that the separability criterion would be
met. However, if information about the customers
is obtained, a customer base may give rise to a
customer list or customer loyalty program. For
example, even just basic contact information about
a customer, such as name and address or telephone
number, may constitute a customer list.
4.10.4.2.8 Unit of Account for Customer-Related Intangible Assets
Customer-related intangible assets can pose challenging unit of account issues that require the use of
judgment. One issue is that if an acquiree’s relationship with a single customer gives rise to multiple
customer-related intangible assets (e.g., customer relationships, customer contracts, customer lists, or
backlog), questions may arise about whether different customer-related intangible assets pertaining
to the same customer should be recognized separately or as a single unit of account. As noted in
Section 4.10.3, we believe that to be combined for financial reporting, assets should have similar useful
lives and methods of amortization.
Another unit of account issue can occur if numerous customer-related intangible
assets with different customers are acquired. In
practice, customer-related intangible assets with
different customers but with similar
characteristics are frequently aggregated into
pools for recognition and measurement. Entities
must apply judgment in determining which
characteristics make the customers similar.
Subsequent useful life determinations and methods of amortization might differ
among pools. ASC 350-30 provides additional
guidance on subsequently measuring and accounting
for assets acquired in a business combination (see
Section 4.10.5).
4.10.4.3 Artistic-Related Intangible Assets
ASC 805-20
55-30 Artistic-related assets acquired in a business combination are identifiable if they arise from contractual
or legal rights such as those provided by copyright. The holder can transfer a copyright, either in whole through
an assignment or in part through a licensing agreement. An acquirer is not precluded from recognizing a
copyright intangible asset and any related assignments or license agreements as a single asset, provided they
have similar useful lives.
ASC 805-20-55-29 provides the following examples of artistic-related intangible assets:
- Plays, operas, ballets #
- Books, magazines, newspapers, other literary works #
- Musical works such as compositions, song lyrics, advertising jingles #
- Pictures, photographs #
- Video and audiovisual material, including motion pictures or films, music videos, television programs. #
4.10.4.4 Contract-Based Intangible Assets
ASC 805-20
55-31 Contract-based
intangible assets represent the value of rights
that arise from contractual arrangements. Customer
contracts are one type of contract-based
intangible asset. If the terms of a contract give
rise to a liability (for example, if the terms of
an operating lease or customer contract are
unfavorable relative to market terms), the
acquirer recognizes it as a liability assumed in
the business combination. . . .
As stated in ASC 805-20-55-31, “[c]ontract-based intangible assets represent the value of rights that
arise from contractual arrangements.” Contracts with terms that are favorable relative to market terms
give rise to contract-based intangible assets, and contracts with terms that are unfavorable relative to
market terms give rise to a liability assumed in the business combination (see additional discussion in
Section 4.10.4.4.5).
ASC 805-20-55-31 also provides the following examples of contract-based
intangible assets:
-
Licensing, royalty, standstill agreements #
-
Advertising, construction, management, service or supply contracts #
-
Operating lease agreements of a lessor #
-
Construction permits #
-
Franchise agreements #
-
Operating and broadcast rights #
-
Servicing contracts such as mortgage servicing contracts #
-
Employment contracts #
-
Use rights such as drilling, water, air, timber cutting, and route authorities. #
4.10.4.4.1 Franchise Agreements
A franchise agreement is a contractual arrangement through which a franchisor grants a franchisee the
right to operate a franchised outlet for a specified period. The purpose of the agreement is to distribute
a product or service, or an entire business concept, within a particular market area. A franchise
agreement of the acquiree that has terms that are favorable relative to market terms gives rise to
contract-based intangible assets, whereas an agreement that has terms that are unfavorable relative
to market terms gives rise to a liability assumed in the business combination. In addition, there may be
other intangible assets that an acquirer should recognize (e.g., customer lists or customer contracts and
related customer-relationship intangible assets).
4.10.4.4.2 Servicing Contracts Such as Mortgage Servicing Contracts
ASC 805-20
Servicing Contracts Such as Mortgage Servicing Contracts #
55-33 Contracts to service financial assets are one type of contract-based intangible asset. Although servicing is
inherent in all financial assets, it becomes a distinct asset or liability by either of the following:
- If the transfer of the servicer’s financial assets met the requirements for sale accounting
- Through the separate acquisition or assumption of a servicing obligation that does not relate to financial assets of the combined entity.
55-34 Topic 860 provides guidance on accounting for servicing contracts.
55-35 If mortgage loans, credit card receivables, or other financial assets are acquired in a business
combination with the servicing obligation, the inherent servicing rights are not a separate intangible asset
because the fair value of those servicing rights is included in the measurement of the fair value of the acquired
financial asset.
The ASC master glossary defines a servicing asset as “[a] contract to service financial assets under which
the benefits of servicing are expected to more than adequately compensate the servicer for performing
the servicing. A servicing contract is either: [(a)] [u]ndertaken in conjunction with selling or securitizing the
financial assets being serviced [or (b)] [p]urchased or assumed separately.” Further, ASC 860-50-05-3
states that contracts to service financial assets may include the following:
- Collecting principal, interest, and escrow payments from borrowers
- Paying taxes and insurance from escrowed funds
- Monitoring delinquencies
- Executing foreclosure if necessary
- Temporarily investing funds pending distribution
- Remitting fees to guarantors, trustees, and others providing services
- Accounting for and remitting principal and interest payments to the holders of beneficial interests or participating interests in the financial assets.
Although servicing is inherent in all financial assets, it is not recognized as
a separate intangible asset unless (1) the
underlying financial assets (e.g., receivables)
are sold or securitized and the servicing contract
is retained by the seller or (2) the servicing
contract is separately purchased or assumed.
4.10.4.4.3 Employment Contracts
ASC 805-20
Employment Contracts #
55-36 Employment contracts that are beneficial contracts from the perspective of the employer because the
pricing of those contracts is favorable relative to market terms are one type of contract-based intangible asset.
Employment contracts, including collective bargaining agreements, meet the contractual-legal criterion
for recognition apart from goodwill as intangible assets (or, in some circumstances, liabilities). When
valuing an employment contract, an entity should consider whether there are any favorable or
unfavorable contract elements and any inherent fair value related to the price that a market participant
would pay for an at-market employment contract. In practice, little value is often attributed to at-market
employment contracts because employees often give relatively short notice of their intention to leave
their job and the employment contracts are often not enforced. In addition, while an employment
contract may be perceived to be above or below market from the employer’s perspective (i.e., the pricing
of the contract is favorable or unfavorable relative to market terms), an entity may find it challenging
to measure such an asset or liability because of the difficulty of substantiating market compensation
for specific employees. Therefore, it is unusual for an acquirer to recognize an asset or liability for an
off-market employment contract. The value of an employment contract should be recognized separately
from the value of a noncompete agreement (see Section 4.10.4.1.3).
4.10.4.4.4 Use Rights
ASC 805-20
Use Rights #
55-37 Use rights such as drilling, water, air, timber cutting, and route authorities are contract-based intangible
assets to be accounted for separately from goodwill. Particular use rights may have characteristics of tangible,
rather than intangible, assets. For example, mineral rights are tangible assets. An acquirer should account for
use rights based on their nature.
Use rights are contract-based intangible assets. Certain use rights are
tangible, rather than intangible, assets. An acquirer should account for use rights on the basis of their
nature. For example, mineral rights, which are legal rights to explore, extract, and retain all or a portion
of mineral deposits, are tangible assets (see Section 4.8.2).
4.10.4.4.5 Executory Contracts
An executory contract is a contract that remains wholly unperformed or for which there remains
something to be done by either or both parties to the contract. Examples of executory contracts include
purchase and supply contracts, franchise agreements, service contracts, and licensing arrangements.
Because executory contracts arise from contractual rights, they are identifiable intangible assets. While
an executory contract acquired or assumed in a business combination is required to be recognized at its
fair value unless it is subject to an exception (e.g., a reacquired right), most executory contracts do not
have significant fair value unless they are favorable (or unfavorable) compared with the market terms for
the same or similar items as of the acquisition date or they have inherent fair value related to the price
that a market participant would to pay for an in-place, at-market contract.
4.10.4.5 Technology-Based Intangible Assets
Technology-based intangible assets generally represent innovations on products or services but can
also include collections of information held electronically. Many innovations and technological advances
are protected by contractual or other legal rights, such as patents and copyrights, and therefore meet
the contractual-legal criterion. ASC 805-20-55-38 provides the following examples of technology-based
intangible assets:
- Patented technology #
- Computer software and mask works #
- Unpatented technology *
- Databases, including title plants *
- Trade secrets, such as secret formulas, processes, recipes. #
4.10.4.5.1 Patented Technology, Unpatented Technology, and Trade Secrets
Patented technology is protected legally and, therefore, meets the contractual-legal criterion for
separate recognition as an intangible asset. Unpatented technology is typically not protected by legal or
contractual means and therefore does not meet the contractual-legal criterion. Unpatented technology,
however, is often sold in conjunction with other intangible assets, such as trade names or secret
formulas. If it can be sold with a related asset, the unpatented technology would meet the separability
criterion. However, the fact that the technology is unpatented may affect its fair value measurement.
4.10.4.5.2 Computer Software and Mask Works
ASC 805-20
Computer Software and Mask Works #
55-40 Computer software and program formats acquired in a business combination that are protected legally,
such as by patent or copyright, meet the contractual-legal criterion for identification as intangible assets.
55-41 Mask works are software permanently stored on a read-only memory chip as a series of stencils or
integrated circuitry. Mask works may have legal protection. Mask works with legal protection that are acquired
in a business combination meet the contractual-legal criterion for identification as intangible assets.
ASC 805-20-55-40 states that “[c]omputer software and program formats acquired in a business
combination that are protected legally, such as by patent or copyright, meet the contractual-legal
criterion for identification as intangible assets.” However, even software and program formats not
protected by patent or copyright may meet the separability criterion if they can be separated or divided from the acquiree (individually or combined with a related identifiable asset, liability, or contract) and
sold, transferred, licensed, rented, or exchanged.
4.10.4.5.3 Databases, Including Title Plants
ASC 805-20
Databases, Including Title Plants
55-42 Databases are collections of information, often stored in electronic form, such as on computer disks or
files. A database that includes original works of authorship may be entitled to copyright protection. A database
acquired in a business combination that is protected by copyright meets the contractual-legal criterion.
However, a database typically includes information created as a consequence of an entity’s normal operations,
such as customer lists, or specialized information, such as scientific data or credit information. Databases that
are not protected by copyright can be, and often are, exchanged, licensed, or leased to others in their entirety
or in part. Therefore, even if the future economic benefits from a database do not arise from legal rights, a
database acquired in a business combination meets the separability criterion.
55-43 Title plants constitute a historical record of all matters affecting title to parcels of land in a particular
geographical area. Title plant assets are bought and sold, either in whole or in part, in exchange transactions or
are licensed. Therefore, title plant assets acquired in a business combination meet the separability criterion.
While a database acquired in a business combination that is protected by copyright would meet
the contractual-legal criterion, databases that are not protected by copyright can be, and often are,
exchanged, licensed, or leased to others in their entirety or in part. Such databases acquired in a
business combination meet the separability criterion even if they do not arise from contractual rights
unless there is a restriction on their transfer or exchange.
ASC 805-20-55-43 defines title plant as “[a] historical record of all matters
affecting title to parcels of land in a particular
geographical area.” The number of years covered by
a title plant varies depending on regulatory
requirements and the minimum information period
considered necessary to issue title insurance
policies efficiently. Because title plant assets
are bought and sold (either in whole or in part)
in exchange transactions or are licensed, they
meet the separability criterion unless there is a
restriction on their transfer or exchange.
4.10.4.5.4 Trade Secrets Such as Secret Formulas, Processes, and Recipes
ASC 805-20
Trade Secrets Such as Secret Formulas, Processes, Recipes #
55-44 A trade secret is
“information, including a formula, pattern,
recipe, compilation, program, device, method,
technique, or process that (1) derives independent
economic value, actual or potential, from not
being generally known and (2) is the subject of
efforts that are reasonable under the
circumstances to maintain its secrecy,” according
to The New Role of Intellectual Property in
Commercial Transactions (Simensky and Breyer
1998).
55-45 If the future economic benefits from a trade secret acquired in a business combination are legally
protected, that asset meets the contractual-legal criterion. Otherwise, trade secrets acquired in a business
combination are identifiable only if the separability criterion is met, which is likely to be the case.
Antipiracy laws or regulations frequently exist to protect trade secrets and other intellectual property.
Even a trade secret that is not protected by laws or regulations would generally be recognized as an
intangible asset apart from goodwill if the separability criterion was met, which is likely to be the case.
However, the value of such a trade secret might be adversely affected by the lack of legal or regulatory
protection.
4.10.4.6 Examples of Intangible Assets by Industry
While some intangible assets, such as customer
relationships and trade names, are common in
various industries, others are specific to
particular industries. The table below provides
examples of intangible assets that may exist in
certain industries. Intangible assets should be
identified on the basis of the facts and
circumstances of each transaction.
Intangible Assets Associated With Certain Industries | |
---|---|
Asset
Management
|
Banking
|
|
|
Credit
Card Issuers
|
Consumer
Products
|
|
|
Energy
|
Entertainment and Media
|
|
|
Insurance
|
Pharmaceuticals
|
|
|
Real
Estate
|
Technology
|
|
|
Telecommunications
|
|
|
4.10.4.7 R&D Assets
Under ASC 805 and ASC 350, an acquirer recognizes all tangible and intangible
R&D assets acquired in a business combination
(e.g., IPR&D) at fair value as of the
acquisition date and subsequently accounts for
them as indefinite-lived intangible assets until
completion or abandonment of the associated
R&D efforts. An acquirer recognizes and
measures such assets independently of (1) whether
the acquiree had previously capitalized any
amounts related to its R&D activities or (2)
the amounts previously expended by the acquiree in
connection with those activities.
An acquirer recognizes tangible and intangible assets that result from, or are
to be used in, R&D activities as assets
regardless of whether the acquired assets have an
alternative future use. Acquired IPR&D assets
must be measured at their acquisition-date fair
values. Uncertainty about the outcome of an
individual project does not affect the recognition
of IPR&D but does affect its fair value
measurement. Even though the guidance describes
R&D as a single asset, ASC 730 defines the
terms “research” and “development” separately, as
follows:
Research is planned
search or critical investigation aimed at
discovery of new knowledge with the hope that such
knowledge will be useful in developing a new
product or service (referred to as product) or a
new process or technique (referred to as process)
or in bringing about a significant improvement to
an existing product or process.
Development is the
translation of research findings or other
knowledge into a plan or design for a new product
or process or for a significant improvement to an
existing product or process whether intended for
sale or use. It includes the conceptual
formulation, design, and testing of product
alternatives, construction of prototypes, and
operation of pilot plants.
ASC 730-10-55-1 lists examples of activities that are within the scope of ASC
730, and ASC 730-10-55-2 notes those that are
not.
ASC 730-10
Examples of Activities Typically Included in Research and Development
55-1 The following activities typically would be considered research and development within the scope of this
Topic (unless conducted for others under a contractual arrangement — see paragraph 730-10-15-4[a]):
- Laboratory research aimed at discovery of new knowledge
- Searching for applications of new research findings or other knowledge
- Conceptual formulation and design of possible product or process alternatives
- Testing in search for or evaluation of product or process alternatives
- Modification of the formulation or design of a product or process
- Design, construction, and testing of preproduction prototypes and models
- Design of tools, jigs, molds, and dies involving new technology
- Design, construction, and operation of a pilot plant that is not of a scale economically feasible to the entity for commercial production
- Engineering activity required to advance the design of a product to the point that it meets specific functional and economic requirements and is ready for manufacture
- Design and development of tools used to facilitate research and development or components of a product or process that are undergoing research and development activities.
Examples of Activities Typically Excluded From Research and Development
55-2 The following activities typically would not be considered research and development within the scope of
this Topic:
- Engineering follow-through in an early phase of commercial production
- Quality control during commercial production including routine testing of products
- Trouble-shooting in connection with break-downs during commercial production
- Routine, ongoing efforts to refine, enrich, or otherwise improve upon the qualities of an existing product
- Adaptation of an existing capability to a particular requirement or customer’s need as part of a continuing commercial activity
- Seasonal or other periodic design changes to existing products
- Routine design of tools, jigs, molds, and dies
- Activity, including design and construction engineering, related to the construction, relocation, rearrangement, or start-up of facilities or equipment other than the following:
- Pilot plants (see [h] in the preceding paragraph)
- Facilities or equipment whose sole use is for a particular research and development project (see paragraph 730-10-25-2[a]).
- Legal work in connection with patent applications or litigation, and the sale or licensing of patents.
R&D activities are only considered to be within the scope of ASC 730 if they are not “conducted for
others under a contractual arrangement.” If R&D activities are conducted for others under a contractual
arrangement, the costs should not be recognized as part of the acquired IPR&D.
If an entity acquires IPR&D in a business combination that it intends to use
in a manner other than its highest and best use
(e.g., it has plans to discontinue the R&D
project after the acquisition even though a
marketplace participant would continue the R&D
efforts), it would still be required to recognize
an intangible asset at fair value for the
IPR&D (see Section
4.9).
The guidance in ASC 805 does not affect the accounting for R&D expenditures
incurred outside of a business combination.
Therefore, if R&D costs related to an acquired
IPR&D project are incurred after the
acquisition date, an acquirer would expense them
in accordance with ASC 730, unless they have an
alternative future use.
Also, see Section
C.3.4.2 for information about
accounting for IPR&D acquired in an asset
acquisition.
Once complete, R&D projects may become other identifiable assets such as
patents, formulas, trade secrets, or
blueprints.
The AICPA Accounting & Valuation Guide Assets Acquired to Be Used in
Research and Development Activities outlines
best practices for the recognition and measurement
of IPR&D assets acquired in a business
combination or an asset acquisition. While the
guide focuses primarily on the software,
electronic devices, and pharmaceutical industries,
it is a useful reference for recognizing and
measuring acquired IPR&D assets in all
industries. The guide indicates that both of the
following conditions must be met for an IPR&D
asset to be recognized in a business combination:
-
The acquired asset (whether tangible or intangible) meets the definition of an asset on the acquisition date and is part of what the acquirer and acquiree exchanged in the business combination.
-
There is persuasive evidence that the specific IPR&D project has substance and is incomplete.
If the acquired IPR&D asset does not meet both of those criteria, it does not qualify for recognition.
However, even if the acquired asset does not qualify as IPR&D, it may still be recognized in the business
combination. For example, if a project has substance but is complete, the IPR&D may represent another
identifiable intangible asset such as a patent, formula, trade secret, or blueprint.
4.10.4.8 Defensive Intangible Assets
ASC 350-30
Defensive Intangible Assets
55-1 This implementation guidance addresses the determination of whether or not an intangible asset meets
the definition of a defensive intangible asset. A defensive intangible asset could include any of the following:
- An asset that the entity will never actively use
- An asset that will be used by the entity during a transition period when the intention of the entity is to discontinue the use of that asset.
55-1B The determination of whether an intangible asset is a defensive intangible asset is based on the
intentions of the reporting entity and that determination may change as the reporting entity’s intentions
change. For example, an intangible asset that was accounted for as a defensive intangible asset on the date
of acquisition will cease to be a defensive asset if the entity subsequently decides to actively use the asset).
Examples 9C and 9D (see paragraphs 350-30-55-28G through 55-28L) illustrate the determination of whether
an acquired intangible asset is a defensive intangible asset.
Sometimes, an entity may acquire an asset that it either does not intend to use or intends to use in a
manner other than its highest and best use. Such an asset is commonly called a defensive intangible
asset, which the ASC master glossary defines as “[a]n acquired intangible asset in a situation in which an
entity does not intend to actively use the asset but intends to hold (lock up) the asset to prevent others
from obtaining access to the asset.” For example, an entity may decide not to use the acquired trade
name of a competitor but intend to keep the name (rather than sell it) solely to prevent others from
using it. In this case, the asset is determined to have value to the acquirer albeit in a defensive manner
(i.e., by denying others access to its use). When measuring the fair value of a defensive intangible asset
in accordance with ASC 820, an acquirer should assume its highest and best use by market participants.
The implementation guidance in ASC 350-30-55 provides examples of defensive
intangible assets:
ASC 350-30
Example 9C: Trade Name
55-28H Entity A, a consumer products manufacturer, acquires an entity that sells a product that competes
with one of Entity A’s existing products. Entity A plans to discontinue the sale of the competing product within
the next six months, but will maintain the rights to the trade name, at minimal expected cost, to prevent a
competitor from using the trade name. As a result, Entity A’s existing product is expected to experience an
increase in market share. Entity A does not have any current plans to reintroduce the acquired trade name in
the future.
55-28I Because Entity A does not intend to actively use the acquired trade name, but intends to hold the rights
to the trade name to prevent others from using it, the trade name meets the definition of a defensive intangible
asset.
Example 9D: Internally Developed Software
55-28K Entity A acquires a group of assets, one of which is billing software developed by the selling entity for its
own use. After a six month transition period, Entity A plans to discontinue use of the internally developed billing
software. In valuing the billing software in connection with the acquisition, Entity A determines that a market
participant would use the billing software, along with other assets in the asset group, for its full remaining
economic life — that is, Entity A does not intend to use the asset in a way that is at its highest and best use.
Due to the specialized nature of the software, Entity A does not believe the software could be sold to a third
party without the other assets acquired.
55-28L Although Entity A does not intend to actively use the internally developed billing software after a six
month transition period, Entity A is not holding the internally developed software to prevent others from using
it. Therefore, the internally developed software asset does not meet the definition of a defensive intangible
asset.
4.10.4.8.1 Subsequent Accounting for Defensive Intangible Assets
ASC 350-30
Defensive Intangible Assets
25-5 A defensive intangible asset, other than an intangible asset that is used in research and development
activities, shall be accounted for as a separate unit of accounting. Such a defensive intangible asset shall
not be included as part of the cost of an entity’s existing intangible asset(s). For implementation guidance
on determining whether an intangible asset is a defensive intangible asset, see paragraph 350-30-55-1. For
guidance on intangible assets acquired in a business combination or in an acquisition by a not-for-profit
entity that are used in research and development activities (regardless of whether they have an alternative
future use), see paragraph 350-30-35-17A. For guidance on intangibles that are purchased from others for a
particular research and development project and that have no alternative future uses (in other research and
development projects or otherwise), see Subtopic 730-10.
35-5A This guidance addresses
the application of paragraphs 350-30-35-1 through
35-4 to a defensive intangible asset other than an
intangible asset that is used in research and
development activities. A defensive intangible
asset shall be assigned a useful life that
reflects the entity’s consumption of the expected
benefits related to that asset. The benefit a
reporting entity receives from holding a defensive
intangible asset is the direct and indirect cash
flows resulting from the entity preventing others
from realizing any value from the intangible asset
(defensively or otherwise). An entity shall
determine a defensive intangible asset’s useful
life, that is, the period over which an entity
consumes the expected benefits of the asset, by
estimating the period over which the defensive
intangible asset will diminish in fair value. The
period over which a defensive intangible asset
diminishes in fair value is a proxy for the period
over which the reporting entity expects a
defensive intangible asset to contribute directly
or indirectly to the future cash flows of the
entity.
35-5B
It would be rare for a defensive intangible asset to have an indefinite life because the fair value of the defensive intangible asset will generally diminish over time as a result of a lack of market exposure or as a result of competitive or other factors. Additionally, if an acquired intangible asset meets the definition of a defensive intangible asset, it shall not be considered immediately abandoned.
The guidance on the subsequent accounting for defensive intangible assets was developed in EITF Issue 08-7, which was codified in ASC 350-30. In Issue 08-7, the EITF concluded that intangible assets that an acquirer intends to use as defensive assets are a unit of account that is separate from any of the acquirer’s existing assets. The EITF also indicated that an acquirer should assign a useful life to a defensive intangible asset that reflects the period over which the entity consumes the asset’s expected benefits — that is, the direct and indirect cash flows resulting from the entity’s preventing others from realizing any value from the asset (defensively or otherwise). An acquirer should determine a defensive intangible asset’s useful life by estimating the period over which the asset will diminish in value, which is a proxy for the period over which the acquirer expects a defensive intangible asset to contribute directly or indirectly to its future cash flows.
While that Issue did not preclude an acquirer from assigning an indefinite life
to a defensive intangible asset, the EITF
concluded that it would be rare for an acquirer to
do so. The fair value of a defensive intangible
asset is generally expected to diminish over time
as a result of a lack of market exposure,
investment, competitive, and other factors. In
addition, the EITF indicated that if an acquired
intangible asset meets the definition of a
defensive intangible asset, it cannot be
considered immediately abandoned and written
off.
4.10.4.9 Digital Assets
Some digital assets may meet
the definition of an intangible asset and,
therefore, be accounted for in accordance with ASC
350. In a business combination, acquired digital
assets classified as identifiable intangible
assets, as well as digital assets that meet the
definition of a financial asset, are typically
recognized and measured at fair value as of the
acquisition date.
Changing Lanes
In September 2023, the FASB
discussed feedback on its proposed
ASU on the accounting for and
disclosure of certain crypto assets. On the basis
of comments received on the proposal, the Board
directed its staff to draft a final standard.
Currently, an entity must
account for crypto assets as indefinite-lived
intangible assets in accordance with ASC 350
(i.e., the assets must be measured at historical
cost less impairment) unless the entity is within
the scope of the investment-company guidance in
ASC 946 or is a certain type of broker-dealer.
Stakeholders have raised concerns that, among
other factors, this traditional intangible asset
model (1) does not faithfully represent the
economics of crypto assets and (2) makes the
recognition of impairments needlessly complex by
requiring entities to use a crypto asset’s lowest
observable fair value within a reporting period.
Accordingly, the proposed guidance would require
an entity, after initial recognition, to
subsequently measure certain crypto assets at fair
value, with changes in fair value included in net
income in each reporting period. The proposed
amendments are intended to better reflect the
economics of crypto assets held by entities as
well as to reduce the complexity and cost of
complying with a historical-cost-less-impairment
model under the existing requirements in ASC 350.
Practitioners should monitor the status of the
project for any developments that might change the
current accounting.
4.10.5 Subsequent Accounting for Intangible Assets
ASC 805-20
35-5 Additional guidance on subsequently measuring and accounting for assets acquired in a business
combination is addressed in Subtopic 350-30, which prescribes the accounting for identifiable intangible
assets acquired in a business combination, including recognition of intangible assets used in research
and development activities, regardless of whether those assets have an alternative future use, and their
classification as indefinite-lived until the completion or abandonment of the associated research and
development efforts.
ASC 805 clarifies that except for reacquired rights, an acquirer should apply the guidance in ASC 350-30
on the subsequent accounting for intangible assets acquired in a business combination.
4.11 Assets and Liabilities Associated With Revenue Contracts — Before Adoption of ASU 2021-08
Sections 4.11.1 through
4.11.3 address the accounting for
assets and liabilities associated with revenue
contracts before an entity adopts ASU 2021-08. ASU
2021-08 was issued in October 2021 to reduce
diversity and inconsistency in the measurement and
recognition of contract assets and contract
liabilities acquired in a business combination.
After the adoption of ASU 2021-08, contract
assets and contract liabilities are measured in
accordance with ASC 606 rather than ASC 805 and
are therefore an exception to the recognition and
measurement principle in ASC 805. Thus, the
discussion of contract assets and liabilities
after adoption of ASU 2021-08 is included in
Section
4.3.13 under the topic of exceptions to
ASC 805’s recognition, measurement, and
designation or classification principles.
4.11.1 Contract Assets and Contract Liabilities — Before Adoption of ASU 2021-08
Before a business combination, an acquiree may have entered into revenue
contracts for which it has recognized contract
assets, contract liabilities, or both under ASC
606 in its preacquisition financial statements.
Contract assets and liabilities that arise outside
of a business combination are measured in
accordance with the measurement principles in ASC
606; however, contract assets and liabilities that
arise in a business combination before an entity
adopts ASU 2021-08 are measured on the basis of
the guidance in ASC 805 at their acquisition-date
fair values, and those values may be different
from the amounts that the acquiree recognized
under ASC 606. The acquisition-date fair value of
a contract asset or liability measured in
accordance with ASC 805 is not affected by the
timing of revenue recognition after the
acquisition (over time or point in time) or by the
acquirer’s revenue recognition policies.
4.11.1.1 Contract Assets — Before Adoption of ASU 2021-08
The ASC master glossary defines a contract asset as:
An
entity’s right to consideration in exchange for
goods or services that the entity has transferred
to a customer when that right is conditioned on
something other than the passage of time (for
example, the entity’s future
performance).
As described in ASC 606-10-45-1, the existence of a contract asset depends “on
the relationship between the entity’s performance
and the customer’s payment.” For example, a
contract asset exists when an entity has a
contract with a customer for which revenue has
been recognized (i.e., goods or services have been
transferred to the customer) but the customer’s
payment is contingent on a future event (e.g.,
billed on an agreed-upon future schedule or only
along with completion of additional performance
obligations). Such an asset might be referred to
as an unbilled receivable or as a progress payment
to be billed. If the entity’s right to
consideration is contingent only on the passage of
time, the right represents a receivable.
An acquiree’s contract assets and receivables are both recognized at fair value
in a business combination and are similar in that
they both represent an entity’s right to
consideration for the transfer of goods or
services, but there are different risks associated
with each. The fair value of a receivable takes
into account the time value of money and the
customer’s credit risk (see Section
4.5), whereas the fair value of a
contract asset incorporates the same risks as
receivables as well as other risks (e.g., risks
associated with additional performance obligations
or price variability). Contract assets should be
presented separately from receivables in the
financial statements.
4.11.1.2 Contract Liabilities — Before Adoption of ASU 2021-08
The ASC master glossary defines a contract liability as:
An
entity’s obligation to transfer goods or services
to a customer for which the entity has received
consideration (or the amount is due) from the
customer.
As described in ASC 606-10-45-1, the existence of a contract liability depends
“on the relationship between the entity’s
performance and the customer’s payment.” A
contract liability exists when an entity has
received consideration but has not yet transferred
the promised goods or services to the customer.
Such a liability might be referred to as deferred
revenue or unearned revenue.
An acquirer recognizes an assumed contract liability when the acquiree has
received consideration under a revenue contract
but still retained a performance obligation (even
if partially satisfied) as of the acquisition
date. The ASC master glossary (pending content)
defines a performance obligation as:
A promise in a contract with a
customer to transfer to the customer either:
-
A good or service (or a bundle of goods or services) that is distinct
-
A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
ASC 606-10-25-14 through 25-22 provide guidance on identifying performance
obligations. In accordance with ASC 606-10-25-19,
a promised good or service is distinct (and
therefore a performance obligation) if it is both
of the following:
-
Capable of being distinct — “The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.”
-
Distinct within the context of the contract — “The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.”
Under ASC 606, a performance obligation may be created not only on the basis of
the terms of a contract but also on a customer’s
reasonable expectations and may include promises
that are implied by an entity’s customary business
practices or industry norms.
If the acquirer determines that it has assumed an unsatisfied (or partially
satisfied) performance obligation, it recognizes a
contract liability at its acquisition-date fair
value, which is the amount the acquirer would have
to pay a third party to assume the liability.
Under ASC 606, the contract liability recognized
on the acquiree’s preacquisition balance sheet
typically represents the consideration the
acquiree received in advance from the customer,
less the amount recognized for services performed
to date. Therefore, the amount recognized by the
acquiree before the business combination is
unlikely to equal its fair value. After the
acquisition, the acquirer recognizes revenue and
derecognizes the contract liability as it
satisfies its obligation by transferring the
promised goods or services to the customer under
the contract.
In practice, there are two methods for measuring a contract liability at fair
value in accordance with ASC 820. Under one
method, sometimes called the cost build-up method,
the liability is measured as the direct
incremental cost of fulfilling the remaining
performance obligation, plus a reasonable profit
margin. Such a margin should take into account the
level of effort required or risk assumed by the
acquirer after the acquisition date but should not
include any profit related to the selling,
marketing, or other efforts completed by the
acquiree before the acquisition.
Under the other method, the liability is measured by using market data about the
amount of revenue that an entity would earn in a
transaction to provide the remaining performance
obligation in the contract, less the cost of the
selling effort that was already performed by the
acquiree before the acquisition date, plus a
reasonable profit margin on that effort. This
method is less common since relevant market data
are often unavailable.
Regardless of the method used, entities should perform the fair value
measurement from the perspective of a market
participant.
4.11.1.3 Costs of Obtaining a Contract
Before a business combination, an acquiree may have recognized an asset for the
incremental costs of obtaining a contract with a customer (e.g., sales
commissions) in accordance with ASC 340-40-25-1. While we do not believe
that the acquirer of such an entity should recognize an asset for those
costs in its postcombination financial statements, we do believe that the
costs incurred to obtain a customer may be reflected in the value of another
asset, such as a customer relationship intangible asset.
4.11.2 Long-Term Revenue Contracts — Before Adoption of ASU 2021-08
Long-term revenue contracts are common in the service, construction, and aerospace and defense
industries, and they arise in other industries as well. If an acquiree has long-term revenue contracts
that are partially complete at the time of a business combination, the acquirer must measure the assets
and liabilities related to such contracts at fair value as of the acquisition date by using the principles
in ASC 820, even though the assets and liabilities were probably not recognized at fair value in the
acquiree’s preacquisition financial statements.
Once these assets and liabilities are recognized and measured as of the
acquisition date, the acquirer will need to
determine whether the revenue from these contracts
should be recognized over time or at a point in
time under the guidance in ASC 606. For more
information about determining whether revenue
should be recognized at a point in time or over
time, see Deloitte’s Roadmap Revenue
Recognition.
The fair value of any assumed contract assets or liabilities is not affected by
the method that the acquirer will use to recognize
revenue under the assumed contract after the
acquisition. That is, regardless of the manner in
which revenue is recognized, the acquirer is
entitled to the same amount of cash flows from the
contract and will incur the same costs.
Often, an individual revenue contract (whether long term or not) may have
multiple assets or liabilities associated with it
and may therefore have several units of account.
For example, an acquired long-term revenue
contract may include a customer relationship
intangible asset, a backlog intangible asset, an
asset or a liability if the pricing in the
contract is not at market terms, or a contract
asset or liability if costs exceeded billings or
billings exceeded costs. Determining the
appropriate unit of account may be difficult
because of the interrelationships between the
various assets and liabilities. Generally, the
assets (and liabilities) would be recognized
separately if the assets’ useful lives and the
patterns in which their economic benefits are
consumed differ. In addition, some contracts may
result in the recognition of assets, and others
may result in the recognition of liabilities. It
is generally not appropriate to net the assets and
liabilities of different contracts.
For revenue contracts that qualify for revenue recognition over time, the measure of progress
should be based on the acquirer’s remaining effort after the acquisition date and should exclude the
acquiree’s efforts before the acquisition. For revenue contracts that qualify for point-in-time revenue recognition, the postacquisition revenue and project costs that are eligible for capitalization
should be recognized once control of the asset has been transferred to the customer.
4.11.3 Business Combinations Before the Adoption of ASC 606
An acquirer may have recognized assets or liabilities from acquired revenue contracts as part of a
business combination that occurred before it adopted ASC 606. An acquired revenue contract has
the same fair value regardless of whether it is subsequently accounted for under ASC 605 or ASC 606
(i.e., the cash flows related to a contract are the same regardless of the subsequent accounting).
Accordingly, we believe that entities should not remeasure those assets and liabilities upon adoption of
ASC 606.
Because the definitions of contract assets and contract liabilities did not
exist under ASC 605, we believe that entities
could recognize different assets or liabilities
for acquired revenue contracts after adopting ASC
606 than they recognized under ASC 605 (e.g., a
shift between a contract asset and a receivable or
a customer relationship intangible asset).
However, we do not believe that entities are
required to reclassify the assets or liabilities
recognized in association with revenue contracts
upon adopting ASC 606.
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 above). 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.
4.13 Guarantees
Liabilities for guarantees made by the acquiree that are assumed by the acquirer
must be measured at fair value as of the acquisition date. After assets and
liabilities are initially recognized in a business combination, other GAAP generally
provide guidance on the subsequent accounting for them. However, ASC 460 does not
provide detailed guidance on how to measure the guarantor’s liability for its
obligations under the guarantee after its initial recognition. Typically, the
liability that an acquirer initially recognizes as of the acquisition date would be
reduced (by a credit to earnings) as it is released from risk under the guarantee.
In some instances, the release from risk does not occur until the expiration of the
guarantee’s settlement. ASC 460-10-35-2 states, in part:
A
guarantor shall not use fair value in subsequently accounting for the liability
for its obligations under a previously issued guarantee unless the use of that
method can be justified under generally accepted accounting principles (GAAP).
For example, fair value is used to subsequently measure guarantees accounted for
as derivative instruments under Topic 815.
At the 2003 AICPA Conference on Current SEC Developments, then SEC OCA
Professional Accounting Fellow Gregory Faucette stated the following:
So what do we believe the appropriate “day two” accounting for
the obligation to stand ready would be? . . . It would seem a systematic and
rational amortization method would most likely be the appropriate accounting. .
. .
We understand that some believe that a fair value
model for these guarantee liabilities and recourse obligations is the right
accounting. However, we find it difficult to support such an approach in the
current literature.
ASC 460 does not apply to guarantees between parents and their subsidiaries. If
an acquirer and acquiree previously entered into a guarantee arrangement, the
guarantee is not recognized as part of the business combination; however, the
acquirer must determine whether the transaction represents the settlement of a
preexisting relationship (see Section 6.2.2). The acquirer would also be subject to the disclosure
requirements in ASC 460.
4.14 Liabilities for Exit or Restructuring Activities
ASC 805-20
25-2 To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired
and liabilities assumed must meet the definitions of assets and liabilities in FASB Concepts Statement No.
6, Elements of Financial Statements, at the acquisition date. For example, costs the acquirer expects but
is not obligated to incur in the future to effect its plan to exit an activity of an acquiree or to terminate the
employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. Therefore, the
acquirer does not recognize those costs as part of applying the acquisition method. Instead, the acquirer
recognizes those costs in its postcombination financial statements in accordance with other applicable
generally accepted accounting principles (GAAP).
The costs that the acquirer expects to incur in the future related to its plans to (1) exit an activity,
(2) involuntarily terminate employees, or (3) relocate the acquiree’s employees (commonly called
restructuring costs) generally would not qualify as liabilities assumed in the business combination. To
qualify as such, the restructuring costs would need to meet the recognition criteria in ASC 420-10 as of
the acquisition date. ASC 420-10-25-2 states:
A liability for a cost associated with an exit or disposal activity is incurred when the definition of a liability
included in FASB Concepts Statement No. 6, Elements of Financial Statements, is met. Only present obligations
to others are liabilities under the definition. An obligation becomes a present obligation when a transaction or
event occurs that leaves an entity little or no discretion to avoid the future transfer or use of assets to settle
the liability. An exit or disposal plan, by itself, does not create a present obligation to others for costs expected
to be incurred under the plan; thus, an entity’s commitment to an exit or disposal plan, by itself, is not the
requisite past transaction or event for recognition of a liability.
An acquirer is not likely to meet the recognition criteria in ASC 420-10 as of
the acquisition date unless the acquiree previously recognized a restructuring
liability in accordance with ASC 420-10 in its preacquisition financial statements
and the acquirer assumes that obligation. An entity should carefully examine an
arrangement that the acquiree entered into after negotiations for the business
combination had started to determine whether it meets the criteria to be recognized
as part of the business combination (see Section 6.2).
4.15 Instruments Indexed to or Settled in Shares and Classified as Liabilities
An acquiree may have issued securities that are equity in legal form but classified and accounted for
as a liability under ASC 480 or ASC 715. Regardless of their legal form or accounting classification, if the
instruments remain outstanding after the business combination, an acquirer must recognize them on
the acquisition date as part of the business combination and measure them at their fair value. Equity
instruments classified as liabilities are not considered noncontrolling interests.
4.16 Conforming Accounting Policies
Financial statements are more transparent and relevant if the policies used to account for similar assets,
liabilities, operations, and transactions are the same. Therefore, the acquirer and acquiree should
conform their accounting policies in the consolidated financial statements if there is no justification for
differences between them.
In some cases, an acquirer may choose to conform the accounting principles of
the acquiree to its own. Because acquisition accounting results in a new basis of
accounting for the acquiree, the acquirer’s accounting principles may be applied
without regard to the acquiree’s previous accounting principles and there is no need
to assess the preferability of the acquirer’s principles. If an acquirer chooses to
change one or more of its accounting policies to conform to the acquiree’s policies,
such a change would represent a voluntary change in accounting principle under ASC
250-10 and would be permitted only if the acquirer could justify the preferability
of the acquiree’s accounting principle.
Only in limited circumstances is it acceptable for a parent and one or more of
its subsidiaries to apply different accounting policies in the parent’s consolidated
financial statements. For example, entities may have different accounting policies
for inventory or they may use one method (e.g., LIFO) to measure certain categories
of inventories and another method (e.g., FIFO or average cost) to measure others. In
addition, policies that are transaction-specific could result in the use of
different accounting policies for similar items in the consolidated financial
statements. For example, the fair value option under ASC 825-10 can generally be
elected on an instrument-by-instrument basis.
Entities may sometimes be required to apply different accounting policies to
comply with industry-specific guidance. ASC 810-10-25-15 states that “[f]or the
purposes of consolidating a subsidiary subject to guidance in an industry-specific
Topic, an entity shall retain the industry-specific guidance applied by that
subsidiary.” This guidance is not intended to result in the use of multiple
accounting policies but rather to retain the industry-specific guidance applied by
the subsidiary in the consolidated financial statements even if the parent itself or
any of its other subsidiaries are not subject to that guidance.
Moreover, the facts and circumstances may support a conclusion that a
subsidiary’s accounting policies should be different from that of its parent in the
subsidiary’s stand-alone financial statements. For example, a subsidiary may be
acquired in a business combination in which pushdown accounting is not applied. The
subsidiary would continue to apply the policies it used before the acquisition in
its stand-alone financial statements, which might be different from the parent’s
accounting policies. If the subsidiary wanted to adopt the parent’s policies in its
stand-alone financial statements, such a change would represent a voluntary change
in accounting principle under ASC 250-10 and would be permitted only if the
subsidiary could justify the preferability of the parent’s accounting principle.
In addition, in its separate financial statements, a subsidiary may adopt a new
standard in a period other than the period in which the parent adopts it or may use
a different transition method for its adoption. In such cases, even though the
subsidiary may use different accounting policies in its stand-alone financial
statements, the subsidiary’s policies must be conformed to those of the parent in
the parent’s consolidated financial statements.
4.17 Subsequent Measurement of Assets Acquired and Liabilities Assumed
Generally, assets acquired and liabilities assumed in a business combination are accounted for after
the acquisition date in accordance with applicable GAAP on the basis of the nature of the assets and
liabilities. Accordingly, ASC 805 does not provide subsequent accounting guidance for assets acquired
and liabilities assumed in a business combination, except for the following:
- Indemnification assets, including those arising from government-assisted acquisitions of financial institutions — see Section 4.3.4.
- Assets and liabilities arising from contingencies — see Section 4.3.6.
- Reacquired rights — see Section 4.3.7.
- Leasehold improvements — see Section 4.3.11.1.9 after adoption of ASC 842 and Section 4.3.11.2.7 before adoption of ASC 842.
- Insurance and reinsurance contracts — see Section 4.3.12.
- Intangible assets, including R&D assets — see Section 4.10.
- Contingent consideration arrangements of an acquiree assumed by the acquirer — see Section 5.7.5.
Chapter 5 — Measurement of Goodwill or Gain From a Bargain Purchase, and Consideration Transferred in a Business Combination
Chapter 5 — Measurement of Goodwill or Gain From a Bargain Purchase, and Consideration Transferred in a Business Combination
This chapter discusses the fourth and final step in the acquisition
method, which is recognizing and measuring goodwill or a gain from a bargain
purchase. It also addresses the consideration transferred in a business combination,
which is used to measure goodwill or a gain from a bargain purchase.
5.1 Measuring Goodwill
The ASC master glossary defines goodwill as “[a]n asset representing the future economic benefits
arising from other assets acquired in a business combination or an acquisition by a not-for-profit entity
that are not individually identified and separately recognized.” Because goodwill is not a separately
identifiable asset, it cannot be measured directly. It is therefore measured as a residual and 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) the fair value of the acquirer’s previously held equity interest in the
acquiree over the net of the acquisition-date values of the identifiable assets acquired and the liabilities
assumed.
Occasionally, the sum of (1) through (3) above is less than the net of the
acquisition-date values of the identifiable assets acquired and the liabilities
assumed. In such a case, the acquirer recognizes a gain, referred to as a bargain
purchase gain, in earnings on the acquisition date. Conceptually, goodwill
represents both the fair values of the going-concern element of the acquired
business and the expected synergies of combining the acquirer’s and acquiree’s
businesses. However, because goodwill is measured as a residual, it includes other
components as well.
One such component is the difference between the fair values and the amounts at
which items that are exceptions to the recognition and measurement principles are
recognized. ASC 805 requires entities to measure most assets, liabilities, equity
interests, and items of consideration exchanged in a business combination at their
fair values as of the acquisition date. However, some items exchanged in a business
combination are exceptions to the recognition or measurement principle (or both) and
are therefore either recognized or measured in accordance with other guidance or not
recognized or measured at all.
For example, income taxes are measured in accordance with ASC 740 rather than at
fair value, and preacquisition contingencies are often unrecognized in a business
combination. Nonrecognition of items or recognition of items at amounts other than
fair value either increases or decreases goodwill. Accordingly, while the FASB
strived to reduce the number of exceptions to the fair value and recognition
principles in ASC 805, exceptions still exist.
Another component of goodwill is overpayments. In paragraph B382 of the Basis for Conclusions of Statement 141(R), the FASB “acknowledged that overpayments are possible and, in concept, an overpayment should lead to the acquirer’s recognition of an expense (or loss) in the period of the acquisition.” However, the Board noted that “in practice any overpayment is unlikely to be detectable or known at the acquisition date [and] is best addressed through subsequent impairment testing when evidence of a potential overpayment first arises.” Underpayments, however, are not a component of goodwill because ASC 805-30 requires entities to recognize a bargain purchase as a gain in earnings on the acquisition date (see Section 5.2).
ASC 805-30 provides the following guidance on measuring goodwill:
ASC 805-30
30-1 The acquirer shall recognize goodwill as of the acquisition date, measured as the excess of (a) over (b):
- The aggregate of the following:
- The consideration transferred measured in accordance with this Section, which generally requires acquisition-date fair value (see paragraph 805-30-30-7)
- The fair value of any noncontrolling interest in the acquiree
- 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.
In some business combinations, the acquirer obtains a controlling financial interest but less than
100 percent of the equity interests in the acquiree. Such acquisitions, referred to as partial acquisitions,
require the acquirer to include the fair value of the noncontrolling interest in the measurement of
goodwill. See Section 6.4 for more information about the accounting for partial acquisitions.
In other business combinations, an acquirer obtains a controlling financial
interest in an acquiree in which it held a noncontrolling equity interest
immediately before the acquisition date. For example, an acquirer may hold a 25
percent noncontrolling equity interest in a business and then acquire an additional
equity interest, giving it control of the business. ASC 805 refers to such an
acquisition as a business combination achieved in stages, which is also commonly
referred to as a step acquisition. In a step acquisition, the acquirer must also
include the fair value of its previously held interest in the goodwill calculation.
See Section 6.5 for
more information about the accounting for step acquisitions.
Once recognized, goodwill is tested for impairment in accordance with ASC
350-20, which also provides an accounting alternative for the subsequent accounting
for goodwill for entities that do not meet the definition of a public business
entity (PBE) or are not-for-profit entities. Such entities may elect to amortize
goodwill acquired in a business combination and to use a simplified, one-step
impairment test. See Chapter
8 for more information about accounting alternatives available to
private companies and not-for-profit entities.
5.2 Measuring a Bargain Purchase Gain
ASC 805-30
25-2 Occasionally, an acquirer will make a bargain purchase, which is a business combination in which the
amount in paragraph 805-30-30-1(b) exceeds the aggregate of the amounts specified in (a) in that paragraph. If
that excess remains after applying the requirements in paragraph 805-30-25-4, the acquirer shall recognize the
resulting gain in earnings on the acquisition date. The gain shall be attributed to the acquirer. Example 1 (see
paragraph 805-30-55-14) provides an illustration of this guidance.
25-3 A bargain purchase might happen, for example, in a business combination that is a forced sale in which
the seller is acting under compulsion. However, the recognition or measurement exceptions for particular
items identified in paragraphs 805-20-25-16, and 805-20-30-10 also may result in recognizing a gain (or change
the amount of a recognized gain) on a bargain purchase.
Bargain purchases are expected to be infrequent and should not result from recognition or
measurement errors since ASC 805-30 requires the acquirer to reassess both recognition and
measurement before recognizing a bargain purchase gain. ASC 805-30-25-4 and ASC 805-30-30-5 and
30-6 state the following:
ASC 805-30
25-4 Before recognizing a gain on a bargain purchase, the acquirer shall reassess whether it has correctly
identified all of the assets acquired and all of the liabilities assumed and shall recognize any additional assets
or liabilities that are identified in that review. See paragraphs 805-30-30-4 through 30-6 for guidance on the
review of measurement procedures in connection with a reassessment required by this paragraph.
30-5 Paragraph 805-30-25-4 requires the acquirer to reassess whether it has correctly identified all of the
assets acquired and all of the liabilities assumed before recognizing a gain on a bargain purchase. As part of
that required reassessment, the acquirer shall then review the procedures used to measure the amounts this
Topic requires to be recognized at the acquisition date for all of the following:
- The identifiable assets acquired and liabilities assumed
- The noncontrolling interest in the acquiree, if any
- For a business combination achieved in stages, the acquirer’s previously held equity interest in the acquiree
- The consideration transferred.
30-6 The objective of the review is to ensure that the measurements appropriately reflect consideration of all
available information as of the acquisition date.
Bargain purchases could result from what might be viewed as market imperfections, including situations
in which the seller may not have had adequate time to market the business and thus did not subject the
sale to a competitive bidding process, or in which the seller was compelled to sell, such as in a forced
liquidation or distressed sale. However, because it is expected that a seller would not accept less than
fair value for its business and that additional potential buyers also would emerge to take advantage of a
potential bargain and thus increase the price, bargain purchases resulting from underpayments relative
to fair value do not occur frequently.
More commonly, bargain purchase gains occur because not all assets acquired or liabilities assumed
are recognized or measured at their fair values. For example, an acquirer would be expected to pay less
for a business that has a contingent liability associated with it, but that liability may go unrecognized
when the business combination is accounted for if the liability does not meet the recognition criteria in
ASC 805. The risk related to that liability would be reflected in what the acquirer paid for the acquiree,
resulting in a mismatch between the consideration transferred and the net assets recognized. That
mismatch could lead to the recognition of a bargain purchase gain.
If, even after reassessing both recognition and measurement, the acquirer
continues to calculate a bargain purchase, the
acquirer recognizes the gain in earnings. If a
gain is recognized from a bargain purchase, the
acquirer cannot also recognize goodwill from that
acquisition because there can be only one residual
amount calculated. In addition, ASC 805-30-25-2
states that if the acquirer obtains a controlling
but less than a 100 percent interest in the
acquiree in a partial acquisition, the gain must
be attributed to the acquirer.
Under ASC 805-30-50-1(f), the acquirer must disclose the amount of the gain, the
line item in which the gain is recognized, and a
description of why the acquisition resulted in a
gain (e.g., why the acquirer was able to acquire a
business for less than its fair value or whether
the gain was a result of the recognition or
measurement of items at amounts other than their
fair values). See Section 7.5 for
more information.
ASC 805-30-55-14 through 55-16 provide an example of how to account for a
bargain purchase:
ASC 805-30
Example 1: Bargain Purchases
55-14 Paragraphs 805-30-25-2 through 25-4 establish the required accounting for a bargain purchase. This
Example provides additional guidance on bargain purchases and illustrates its application.
55-15 On January 1, 20X5, the acquiring entity, or Acquirer, acquires 80 percent of the equity interests of
the acquiree, or Target, a private entity, in exchange for cash of $150. Because the former owners of Target
needed to dispose of their investments in Target by a specified date, they did not have sufficient time to
market Target to multiple potential buyers. The management of Acquirer initially measures the separately
recognizable identifiable assets acquired and the liabilities assumed as of the acquisition date in accordance
with the requirements of the Business Combinations Topic. The identifiable assets are measured at $250, and
the liabilities assumed are measured at $50. Acquirer engages an independent consultant who determines
that the fair value of the 20 percent noncontrolling interest in Target is $42. The amount of Target’s identifiable
net assets ($200, calculated as $250 – $50) exceeds the fair value of the consideration transferred plus the fair
value of the noncontrolling interest in Target. Therefore, Acquirer reviews the procedures it used to identify and
measure the assets acquired and liabilities assumed and to measure the fair value of both the noncontrolling
interest in Target and the consideration transferred. After that review, Acquirer decides that the procedures
and resulting measures were appropriate. Acquirer measures the gain on its purchase of the 80 percent
interest as follows.
55-16 Acquirer would record its acquisition of Target in its consolidated financial statements as follows.
5.2.1 Recognition of a Provisional Bargain Purchase Gain During the Measurement Period
As part of the initial accounting for a business combination, an acquirer may
initially calculate a bargain purchase gain but may still be waiting for
additional information to finalize the accounting for the business combination.
In situations in which that information does not become available before the end
of the reporting period, some have questioned whether the acquirer should
recognize a “provisional bargain purchase gain” or whether it should defer
recognition of any gain (i.e., recognize a provisional deferred credit) until
the accounting for the business combination is complete.
Some have looked to the guidance in ASC 805-10-25-13 as support for recognizing
a provisional bargain purchase gain in earnings of
the reporting period. That guidance states that
“[i]f the initial accounting for a business
combination is incomplete by the end of the
reporting period in which the combination occurs,
the acquirer shall report in its financial
statements provisional amounts for the items for
which the accounting is incomplete.” Others have
looked to the guidance in ASC 805-30-25-4 and ASC
805-30-30-5 as support for recognizing a deferred
credit (i.e., a liability) rather than a
provisional bargain purchase gain until the
accounting for the acquisition is complete (i.e.,
the end of the measurement period). That guidance
requires an acquirer to reassess whether it has
correctly identified and measured all of the
assets acquired and liabilities assumed before
recognizing a gain.
We believe that either approach is acceptable. Entities should disclose (1) that
the initial accounting is still provisional and the gain or deferred credit
recognized may therefore be subject to future adjustments and (2) the amount of
the gain or deferred credit, the line item in which it is recognized, and a
description of why the acquisition may result in a gain in accordance with ASC
805-30-50-1(f). The acquirer should also provide the other disclosures required
by ASC 805-20-50-4A when the initial accounting for a business combination is
incomplete (see Section 7.11).
Some have suggested that a provisional gain should be recognized as a
contra-asset if the acquirer believes that the
gain may be related to the overstatement of a
specific asset or assets, such as identifiable
intangible assets, which would be confirmed once
the valuations are complete. However, we believe
that such an approach suggests that the acquirer’s
estimates of fair value may not be appropriate,
even provisionally.
5.2.2 Accounting for Income Taxes in a Business Combination That Resulted in a Bargain Purchase
The acquirer calculates the gain on the bargain purchase after the deferred
taxes on the inside basis differences are recorded
on the acquiree’s assets and liabilities. This
recognized gain increases the acquirer’s
investment in the acquiree and causes a
corresponding increase in the acquiree’s equity
for financial reporting purposes. However, for tax
purposes, the bargain purchase gain is generally
not included in the tax basis of the investment in
the acquiree. Therefore, a difference arises
between the investment in the acquiree for
financial reporting purposes and the investment in
the acquiree for tax purposes. If deferred taxes
are recorded on the outside basis difference
caused by the bargain purchase gain, the tax
effects would be recorded outside the business
combination as a component of income tax expense.
See Deloitte’s Roadmap Income
Taxes for more information.
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.
5.4 Acquisition-Related Costs
ASC 805-10
25-23 Acquisition-related costs are costs the acquirer incurs to effect a business combination. Those costs
include finder’s fees; advisory, legal, accounting, valuation, and other professional or consulting fees; general
administrative costs, including the costs of maintaining an internal acquisitions department; and costs of
registering and issuing debt and equity securities. The acquirer shall account for acquisition-related costs as
expenses in the periods in which the costs are incurred and the services are received, with one exception. The
costs to issue debt or equity securities shall be recognized in accordance with other applicable GAAP.
Both the acquirer and the acquiree may incur costs related to effecting the business combination.
Because acquisition-related costs incurred by the acquirer are not part of the fair value exchanged
between the acquirer and the seller for the acquired business, those costs are accounted for separately
from the business combination in accordance with their nature.
5.4.1 Acquirer’s Acquisition-Related Costs
The acquirer’s acquisition-related costs are the costs that the acquirer incurs to effect a business
combination and include:
- Direct costs of the acquisition, such as third-party costs for finders’ fees as well as advisory, legal, accounting, valuation, and other professional or consulting fees.
- Indirect costs of the acquisition, such as general and administrative costs, including the costs of maintaining an internal acquisitions department.
- Financing costs, such as the costs of registering and issuing debt or equity securities to fund the acquisition.
The acquirer’s acquisition-related costs are not part of the consideration
transferred. ASC 805-10-25-23 states that “[t]he acquirer shall account for
acquisition-related costs as expenses in the periods in which the costs are
incurred and the services are received, with one exception. The costs to issue
debt or equity securities shall be recognized in accordance with other
applicable GAAP.” Therefore, the acquirer should account for the direct and
indirect costs of the acquisition as expenses in the periods in which the costs
are incurred and the services are received.
In SAB Topic 5.A, the SEC staff states that “[s]pecific incremental costs directly attributable to a proposed
or actual offering of securities may properly be deferred and charged against the gross proceeds of
the offering.” Therefore, the costs to issue equity securities are generally reflected as a reduction of the
amount that would have otherwise been recognized in additional paid-in capital (APIC).
SAB Topic 5.A goes on to say:
[M]anagement salaries or
other general and administrative expenses may not be allocated as costs of
the offering and deferred costs of an aborted offering may not be deferred
and charged against proceeds of a subsequent offering. A short postponement
(up to 90 days) does not represent an aborted offering.
If the acquirer incurs debt to fund the acquisition, it should present the debt
issuance costs in the balance sheet as a direct deduction from the face amount
of the debt and amortize the costs as interest expense in accordance with ASC
835-30-45.
Connecting the Dots
In April 2015, the FASB issued ASU 2015-03, which amends ASC 835-30 by (1) requiring “debt
issuance costs related to a note [to] be reported in the balance sheet as a direct deduction from
the face amount of that note” and (2) eliminating the guidance that allowed entities to report
“issue costs . . . as deferred charges.”
In our discussions with the FASB staff, the staff confirmed that the ASU does
not address the presentation of issuance costs associated with
line-of-credit or revolving-debt arrangements. Accordingly, an entity
should elect an accounting policy for the presentation of such
costs.
At the EITF’s June 18, 2015, meeting, the SEC staff made an announcement
clarifying that the ASU does not address issuance costs associated with
revolving-debt arrangements and announced that it would “not object to
an entity deferring and presenting [such] costs as an asset and
subsequently amortizing the . . . costs ratably over the term of the
line-of-credit arrangement.”
If an entity adopts the method outlined by the SEC staff on June 18, 2015, as
its accounting policy, it would present remaining unamortized debt
issuance costs associated with a line-of-credit or revolving-debt
arrangement as an asset even if the entity currently has a recognized
debt liability for amounts outstanding under the arrangement. Further,
such costs are amortized over the life of the arrangement even if the
entity repays previously drawn amounts.
The SEC staff’s announcement does not address whether other accounting policies
might be acceptable. Therefore, when previously drawn amounts are repaid
or the remaining unamortized costs exceed the amount of the obligation,
an entity is encouraged to consult with its accounting adviser before
electing a policy that could result in (1) a write-off of remaining
unamortized costs before the end of the term of the arrangement or (2)
the presentation of a negative liability balance for the
arrangement.
This guidance is limited to line-of-credit or revolving-debt arrangements that
are not reported at fair value and should not be applied by analogy to
other types of debt liabilities.
SAB Topic 2.A.6 discusses a scenario in which an investment banker provides both advisory services and
underwriting services associated with issuing debt or equity securities in connection with a business
combination and the costs are billed to the acquirer as a single amount. The interpretative response to
Question 1 of SAB Topic 2.A.6 states:
Fees paid to an investment banker in connection with a business combination or asset acquisition, when the
investment banker is also providing interim financing or underwriting services, must be allocated between
acquisition related services and debt issue costs.
When an investment banker provides services in connection with a business combination or asset acquisition
and also provides underwriting services associated with the issuance of debt or equity securities, the total
fees incurred by an entity should be allocated between the services received on a relative fair value basis. The
objective of the allocation is to ascribe the total fees incurred to the actual services provided by the investment
banker.
While SAB Topic 2.A.6 states that “the total fees incurred by an entity should
be allocated between the services received on a relative fair value basis,” we
believe that the amounts allocated to debt issuance costs should result in an
effective interest rate on the debt that is consistent with an effective market
interest rate. Likewise, we believe that the amounts allocated to equity
issuance costs should be consistent with fees an underwriter would charge.
The interpretive response to Question 2 of SAB Topic 2.A.6 also addresses the
amortization of debt issue costs related to interim “bridge financing.” It
states:
Debt issue costs should be amortized by the
interest method over the life of the debt to which they relate. Debt issue
costs related to the bridge financing should be recognized as interest cost
during the estimated interim period preceding the placement of the permanent
financing with any unamortized amounts charged to expense if the bridge loan
is repaid prior to the expiration of the estimated period. Where the bridged
financing consists of increasing rate debt, the guidance issued in FASB ASC
Topic 470, Debt, should be followed. [Footnote omitted]
Any debt issuance costs allocated to bridge financing should be amortized over
the estimated term of the bridge financing. If the bridge financing is repaid
before the end of the originally estimated term, the unamortized amount of the
debt issuance costs of such financing is written off as interest cost in
accordance with ASC 340-10-S99. When bridge financing consists of
increasing-rate debt and term-extending debt (i.e., debt that can be extended
upon maturity at the option of the issuer with specified interest rate increases
each time the maturity is extended), acquirers should consider the guidance in
ASC 470-10-35-1 and 35-2 and ASC 835-30 on the application of the effective
interest method. They should also consider the guidance in ASC 815-15 and ASC
815-10-55-19 through 55-21 on determining whether to bifurcate embedded
derivatives related to the option to extend.
5.4.1.1 Reimbursing the Acquiree for Paying the Acquirer’s Acquisition-Related Costs
ASC 805-10-25-21 provides examples of separate transactions that are not to be included in the
application of the acquisition method, including “[a] transaction that reimburses the acquiree or its
former owners for paying the acquirer’s acquisition-related costs.” Accordingly, any such payments
to the acquiree or its former owners do not represent a cost of the acquisition but instead should be
reflected in the acquirer’s financial statements in accordance with the payment’s nature (i.e., direct,
indirect, financing), as described above.
5.4.2 Acquiree’s Acquisition-Related Costs
An acquiree’s acquisition-related costs associated with the business
combination, such as legal fees or sell-side due diligence costs, should be
recognized in the acquiree’s separate financial statements in the periods in
which the services are received. On the acquisition date, the acquiree may have
a liability recognized related to its acquisition-related expenses incurred but
not yet paid. The acquirer may agree to pay the liability for the acquiree’s
acquisition-related expenses on, or shortly after, the acquisition date.
Generally, only amounts given to former owners of the acquiree are reported as
consideration transferred. Therefore, the amounts paid should be presented as a
liability assumed in the accounting for the acquisition.
We believe that the acquirer’s direct expenses for acquisition-related costs
should not be recognized in the acquiree’s separate financial statements unless
the acquirer incurred such costs on behalf of, or for the benefit of, the
acquiree. The interpretive response to Question 1 of SAB Topic 1.B.1
states, in part, that “[i]n general, the staff believes that the historical
income statements of a registrant should reflect all of its costs of doing
business. Therefore, in specific situations, the staff has required the
subsidiary to revise its financial statements to include certain expenses
incurred by the parent on its behalf.” See Section A.12 for more information.
SAB Topic
5.T also discusses the concept of reflecting costs incurred
by a shareholder on behalf of a company in the company’s financial statements.
It states that a transaction in which “a principal stockholder pays an expense
for the company, unless the stockholder’s action is caused by a relationship or
obligation completely unrelated to his position as a stockholder or such action
clearly does not benefit the company,” should be reflected as an expense in the
company’s financial statements, with a corresponding credit to APIC. While the
guidance in SAB Topics 1.B and 5.T pertains to public companies, we believe that
private companies should also apply it when evaluating the recognition of
acquisition-related costs.
5.4.3 Success Fees
In some situations, an acquirer or an acquiree may agree to make a payment to a third party
(e.g., adviser, investment banker) that is contingent on the closing of the transaction. Such a payment
may be called a success fee. Because there is no obligation to pay the fee until the business combination
closes, we generally believe that by analogy to the guidance in ASC 805-20-55-51, it would not be
appropriate for either the acquirer or the acquiree to recognize the success fee as a liability until the
acquisition date. ASC 805-20-55-51, which addresses a liability that will be triggered by a business
combination for contractual termination benefits and curtailment losses under employee benefit plans,
states that the liability “shall not be recognized when it is probable that the business combination will be
consummated; rather it shall be recognized when the business combination is consummated.”
If the success fee is the legal obligation of the acquirer, an entity recognizes
it as an expense in the acquirer’s financial statements at the time of the
business combination. See Section A.16.1 for guidance on accounting for expenses of the
acquiree triggered by a business combination in the separate financial
statements of an acquiree that applies pushdown accounting.
5.5 Acquirer’s Equity Securities Issued as Consideration
If the acquirer issues its equity securities (e.g., common or preferred shares, options, or warrants)
as consideration in the business combination, it measures the equity securities at fair value as of
the acquisition date by applying ASC 820. If its equity instruments are publicly traded, the acquirer
determines the fair value on the basis of quoted market prices. If the shares are not publicly traded, the
acquirer must use other valuation techniques to measure the fair value the equity instruments.
5.5.1 Issuance of Subsidiary Shares as Consideration
The consideration transferred in a business combination could include shares of a subsidiary of the
acquirer. If so, such shares issued would be measured as of the acquisition date at fair value under
ASC 820. If the acquirer retains its controlling interest in the subsidiary, the acquirer would account for
the issuance of its subsidiary’s shares as an equity transaction under ASC 810-10-45-23. That guidance
states that “[t]he carrying amount of the noncontrolling interest shall be adjusted to reflect the change
in its ownership interest in the subsidiary” and that “[a]ny difference between the fair value of the
consideration received or paid and the amount by which the noncontrolling interest is adjusted shall be
recognized in equity attributable to the parent.”
5.6 Replacement of Share-Based Payment Awards
In a business combination, share-based payment awards held by grantees of the acquiree are often
exchanged for share-based payment awards of the acquirer. ASC 805 refers to the new awards as
“replacement awards.” The acquirer must analyze the terms of both the preexisting and the replacement
awards to determine what portion of the replacement awards is related to precombination vesting (i.e., past goods or services) and therefore
part of the consideration transferred in the business combination. The portion of replacement awards
that is related to postcombination vesting (i.e., future goods or services) should be recognized as compensation cost in the postcombination
period.
For more information about accounting for replacement awards in a business
combination, see Chapter 10 of Deloitte’s
Roadmap Share-Based Payment
Awards.
5.7 Contingent Consideration
The ASC master glossary defines contingent consideration as:
Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners of
an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions
are met. However, contingent consideration also may give the acquirer the right to the return of previously
transferred consideration if specified conditions are met.
Contingent consideration arrangements in which the acquirer may be required to
make a future payment are commonly referred to as “earn-out” provisions. The
acquirer and acquiree may specify future events or conditions such as (1) the
acquiree’s postcombination performance measured on the basis of certain financial
targets (e.g., revenue, EBITDA, or operating profit) over a specified period after
the acquisition, (2) the market price of the acquirer’s shares after the
acquisition, or (3) the occurrence of a discrete event, such as the FDA’s approval
of a drug candidate of the acquiree that is under development as of the acquisition
date.
5.7.1 Initial Measurement of Contingent Consideration
ASC 805-30
25-5 The consideration the acquirer transfers in exchange for the acquiree includes any asset or liability
resulting from a contingent consideration arrangement. The acquirer shall recognize the acquisition-date fair
value of contingent consideration as part of the consideration transferred in exchange for the acquiree.
Contingent consideration is part of the consideration transferred for the acquiree and therefore must
be measured and recognized at fair value as of the acquisition date, which can be challenging. Acquirers
need to identify the key inputs of the arrangement and use market participant assumptions when
determining the fair value of contingent consideration. Key inputs may include estimated timing and
the probability that the conditions or milestones in the arrangement will be met. Acquirers also need to
apply judgment when assessing the probability that each potential outcome will be achieved.
Not all payments to be made to the seller in the future should be classified as
contingent consideration. For example:
-
Consideration held in escrow, or payments related to working capital adjustments, are not contingent consideration because they are not contingent on a future event; such amounts are payable on the basis of facts and circumstances that existed as of the acquisition date (see Sections 5.3.1 and 5.3.2).
-
A conditional future payment linked to continuing employment should be accounted for as compensation in the acquirer’s postcombination financial statements (see Section 6.2.3.3.1).
-
Obligations to deliver consideration in the future that are not contingent on the occurrence of a future event (e.g., a seller note or a payment for the use of property) should be accounted for by using other applicable GAAP, depending on the nature of the obligation. Like contingent consideration, noncontingent obligations would generally be initially measured at fair value; however, the subsequent accounting may differ.
Example 5-2
Noncontingent Arrangement to Transfer Consideration in the Future
Company A acquires Company B for $2 million in cash in a transaction accounted
for as a business combination. The acquisition agreement
also obligates A to pay additional cash consideration of
$1 million to the seller on the fifth anniversary of its
acquisition of B. Because the obligation to transfer
additional cash of $1 million is not contingent on a
future event and the payment is based solely on the
passage of time, the obligation is not contingent
consideration but rather seller financing. Company A
measures the obligation at fair value as of the
acquisition date, taking into account the financing
component, and includes the fair value as an element of
the consideration transferred. After the acquisition, A
accounts for the obligation under ASC 835-30.
5.7.2 Initial Classification of Contingent Consideration
ASC 805-30
25-6 The acquirer shall classify an obligation to pay contingent consideration as a liability or as equity in
accordance with Subtopics 480-10 and 815-40 or other applicable generally accepted accounting principles
(GAAP). For example, Subtopic 480-10 provides guidance on whether to classify as a liability a contingent
consideration arrangement that is, in substance, a put option written by the acquirer on the market price of the
acquirer’s shares issued in the business combination.
25-7 The acquirer shall classify as an asset a right to the return of previously transferred consideration if
specified conditions are met.
While ASC 805 specifies that contingent consideration must be recognized at its acquisition-date
fair value, it refers to other GAAP for determining the classification of such consideration as of the
acquisition date as a liability, as equity, or (less frequently) as an asset. How an acquirer classifies a
contingent consideration arrangement determines the subsequent accounting for the arrangement.
The classification of many contingent consideration arrangements will be evident. For example,
arrangements are classified as liabilities if they obligate the acquirer to deliver to the seller cash, other
assets, or equity securities of a third party. Similarly, contingent consideration arrangements are
classified as assets (or as equity if appropriate under ASC 815-40) if they require the seller to return
previously transferred consideration to the acquirer if the contingency is met in the future.
Example 5-3
Arrangement to Transfer Cash Consideration in the Future on the Basis of Security Prices
Company A acquires Company B for 1 million shares of A’s common stock and an
agreement to pay cash if the quoted market price of A’s
common stock is below $25 on the one-year anniversary of
the acquisition date. The total cash, if any, paid by A
on the one-year anniversary date will be the amount
necessary to guarantee the $25 per share price. Because
the value of the arrangement is contingent on a future
event (i.e., the market price of A’s common stock), the
arrangement is contingent consideration and is measured
at fair value on the acquisition date. Company A
concludes that this arrangement is a liability because A
is obligated to deliver cash to B if the price of its
common stock is below $25 on the one-year anniversary of
the acquisition date.
Often, contingent consideration arrangements obligate the acquirer to deliver its own equity
instruments (or the equity instruments of one of the acquirer’s substantive subsidiaries) to the seller.
Determining the classification of a contingent consideration arrangement that is settleable in the
acquirer’s own equity can be challenging. ASC 805 does not provide guidance on classifying such
contingent consideration arrangements, but it refers to other accounting standards for guidance
(generally ASC 480-10 and ASC 815). To determine the classification of a contingent consideration
arrangement that is settleable in the acquirer’s own equity, an acquirer should consider the following
guidance:
- ASC 480-10 on distinguishing liabilities from equity.
- ASC 815-10-15 on determining whether an arrangement meets the definition of a derivative instrument and is within the scope of ASC 815-10.
- ASC 815-40-15-5 through 15-8 on determining whether an arrangement is indexed to the acquirer’s own shares.
- ASC 815-40-25 on determining whether an arrangement is classified in equity in the acquirer’s statement of financial position.
Most contingent consideration arrangements will be classified as liabilities
under the above guidance. However, entities should base their determination on
their specific facts and circumstances. Depending on the complexity of the
arrangement, they may decide to consult with a financial instruments specialist.
The discussion below highlights some common contingent consideration scenarios
but does not provide comprehensive guidance.
Changing Lanes
In August 2020, the FASB issued ASU 2020-06, which simplifies
the accounting for certain financial instruments with characteristics of
liabilities and equity, including convertible instruments and contracts
on an entity’s own equity. ASU 2020-06 amends ASC 815-20-45 to remove
some of the conditions for equity classification related to an entity’s
ability to settle a contract on its own equity by delivering shares. For
more information about ASU 2020-06, see Deloitte’s August 5, 2020,
Heads
Up.
5.7.2.1 Unit of Account for Contingent Consideration Arrangements
Before classifying a contingent consideration arrangement, an acquirer must determine the
arrangement’s unit of account. Contingent consideration arrangements often specify that the issuance
of shares under the arrangement depends on whether successive or cumulative performance targets
(e.g., earnings or revenues) for the acquired entity are met. For example, an arrangement may require
the entity to deliver (1) 100,000 of its equity shares if the subsidiary’s revenue exceeds $100 million in
the first year after the acquisition and (2) an additional 50,000 of its equity shares if the subsidiary’s
revenue exceeds $125 million in the second year after the acquisition. If so, the entity should evaluate
whether the contingent consideration arrangement contains one or multiple units of account.
The entity’s determination of whether the contingent arrangement contains one or multiple units
of account may affect whether the arrangement qualifies as equity in whole or in part. If an entity
determines that an arrangement includes multiple payment conditions, triggers, or targets that are
independent of one another and that would, if met, result in the issuance of specified consideration
regardless of whether any other targets were met, each target-based payment is treated as a separate
unit of account (contract) that must be assessed for classification. If the payment conditions or targets
are cumulative or not independent of one another, the arrangement is considered one contract that
requires delivery of a variable number of shares.
The following are examples that illustrate this
approach to identifying the appropriate units of account for contingent
consideration arrangements:
Contingent Consideration Arrangement — Acquirer Must Deliver 10,000 of Its
Equity Shares to the Seller if the Acquiree: | Analysis |
---|---|
Has earnings of at least $100 million in the year after the acquisition
(otherwise, no shares will be delivered). | One unit of account. There is only
one payment condition and target. |
Has earnings of at least $100 million in the first year after the acquisition
(otherwise, no shares will be delivered at the end of the first year). In
addition, the acquirer must deliver 10,000 of its equity shares if the
acquiree has earnings of at least $100 million in the second year after
the acquisition (otherwise, no shares will be delivered at the end of the
second year). | Two units of account. There are two
independent payment conditions
and targets. |
Has earnings of at least $100 million in the year after the acquisition. The
acquirer will deliver an additional 5,000 shares if earnings in that year
exceed $125 million. Otherwise, no shares will be delivered. | One unit of account. There are two
targets, but they cover the same
period, and that period has multiple
outcomes. |
Has earnings of at least $100 million in the first year after the acquisition
(otherwise, no shares will be delivered at the end of the first year). In
addition, the acquirer is required to deliver 10,000 of its equity shares if
the acquiree has cumulative earnings of at least $200 million in the first
two years after the acquisition (otherwise, no shares will be delivered at
the end of the second year). | Two units of account. There are two
targets that cover different periods. |
For more information about determining the unit of account for contingent
consideration arrangements, see Deloitte’s Roadmap Contracts on an Entity’s Own
Equity.
5.7.2.2 Distinguishing Liabilities From Equity Under ASC 480-10
ASC 480-10 establishes standards for an issuer’s classification of certain financial instruments with
characteristics of both liabilities and equity. Contingent consideration arrangements that obligate an
acquirer to deliver its own equity instruments meet the definition of a financial instrument. We believe
that a contingent consideration arrangement must be analyzed as if it is a separate freestanding
instrument. ASC 480-10 requires a freestanding financial instrument to be classified as a liability (or, in
some circumstances, an asset) if the instrument has any of the following characteristics:
- It is a share in legal form and is mandatorily redeemable (e.g., the instrument unconditionally requires the issuer to redeem it by transferring its assets on a specified or determinable date (or dates) or upon an event that is certain to occur other than liquidation or termination of the reporting entity).
- It is not an outstanding share and, at inception, embodies an obligation to repurchase the issuer’s equity shares (e.g., forward purchase contracts or written put options that are to be physically settled) or is indexed to such an obligation (e.g., a warrant on puttable shares or a written put option that is cash settled) and requires or may require the issuer to settle the obligation by transferring assets.
- It will or may be settled by the issuance of a variable number of the issuer’s shares, and at inception the monetary value of the instrument is solely or predominantly based on any one of the following:
- A fixed amount (e.g., a payable for a fixed amount that is settleable with a variable number of the issuer’s equity shares).
- Being derived from something other than the fair value of the issuer’s equity shares (e.g., an obligation to deliver shares indexed to the S&P 500 and settleable with a variable number of the issuer’s equity shares).
- Movement in a direction opposite to the value of the issuer’s equity shares (e.g., a written put option that can be net share settled).
Contingent consideration arrangements are often evaluated under the third item
above because they involve instruments that require delivery of the
acquirer’s shares, and the value of the obligation is solely or
predominantly based on whether certain contingencies or target thresholds
are met. If an arrangement varies on the basis of the extent to which
contingencies or metrics are met (e.g., the number of shares delivered
depends on how much EBITDA exceeds a target), we believe that a
determination of whether it is within the scope of ASC 480 depends on
whether its monetary value, at inception, is based solely or predominantly
on the exercise contingency (e.g., EBITDA or revenue target) or share price.
If the monetary value is based solely or predominately on the exercise
contingency, the arrangement is likely to be classified as a liability under
ASC 480. If, however, the monetary value is based solely or predominately on
the share price, the arrangement is likely to be outside the scope of ASC
480, but entities would need to consider the guidance in ASC 815. Further,
we believe that the determination of whether an arrangement’s monetary
value, at inception, is based solely or predominately on the exercise
contingency or share price depends on the entity’s particular facts and
circumstances.
ASC 480 discusses the underlying in a contingent consideration arrangement and
notes that instruments that “solely or predominantly” vary on the basis of
something other than the entity’s shares do not qualify for equity
treatment.
Since ASC 805 specifically addresses the subsequent measurement of contingent consideration, the
subsequent measurement guidance in ASC 480 does not apply. See Section 5.7.3 for more information
about subsequent measurement of the contingent consideration.
Example 5-4
Determining the Classification of Contingent Consideration
Under ASC 480-10 — Issuance of a Fixed Number of
the Acquirer’s Shares if an Earnings Target Is
Met
Company A acquires Company B for 1 million shares of A’s common stock and an
agreement to issue an additional 250,000 shares if
B’s earnings exceed a specified target for the
12-month period after the acquisition.
The terms of the contingent consideration arrangement obligate A to issue a
fixed number of its shares if the earnings target is
met. The arrangement is not within the scope of ASC
480-10 because it (1) is not mandatorily redeemable,
(2) does not embody an obligation to repurchase the
issuer’s equity shares, and (3) does not obligate A
to deliver a variable number of its shares. While
the obligation does require A to deliver its own
shares, the number of shares delivered is fixed at
250,000. However, A still must consider whether it
has to classify the arrangement as a liability in
accordance with ASC 815-40 (see Example
5-8).
Example 5-5
Determining the Classification of Contingent Consideration Under ASC 480-10 — Issuance of a Fixed
Number of the Acquirer’s Shares for Each Year That Earnings Exceed a Specified Amount
Company A acquires Company B for 1 million shares of A’s common stock and an agreement to issue, for five
years, an additional 25,000 shares for each 12-month postacquisition period in which B’s earnings exceed
$2 million. The shares must be issued within a reasonable period after the end of each year in which the
earnings target is achieved.
Because each yearly delivery of the 25,000 shares is independent of the others, the arrangement is considered
five separate units of account. The arrangements are not within the scope of ASC 480-10 because each
arrangement (1) is not mandatorily redeemable, (2) does not embody an obligation to repurchase the
issuer’s equity shares, and (3) does not obligate A to deliver a variable number of its shares. However, A still
must consider whether it has to classify the arrangements as liabilities in accordance with ASC 815-40 (see Example 5-9).
Example 5-6
Determining the Classification of Contingent Consideration Under ASC 480-10 — Issuance of a
Variable Number of the Acquirer’s Shares as a Security Price Guarantee
Company A acquires Company B for 1 million shares of A’s common stock and an agreement to issue additional
shares if the quoted market price of A’s common stock is below $25 on the one-year anniversary of the
acquisition date. The number of shares, if any, that A will issue will be the amount necessary to guarantee the
price of $25 per share.
In accordance with ASC 480-10-25-14(c), A concludes that this arrangement should
be classified as a liability because it requires A
to settle the obligation by issuing a variable
number of its own equity shares, the monetary value
of which move in the direction opposite to the value
of its shares.
Example 5-7
Determining the Classification of Contingent Consideration Under ASC 480-10 — Issuance of a Fixed
Number of the Acquirer’s Shares for Each Increment of Earnings That Exceeds a Specified Amount
Company A acquires Company B for 1 million shares of A’s common stock and an agreement to issue an
additional 25,000 shares for each $500,000 increment of B’s earnings that exceeds $2 million, not to exceed
$5 million for the 12-month period after the acquisition.
Because each delivery of 25,000 increment of shares is not independent of the
others, the arrangement is one unit of account. In
accordance with ASC 480-10-25-14(b), A concludes
that the arrangement should be classified as a
liability because it requires A to issue a variable
number of its shares, the value of which is
predominantly derived from something other than the
fair value of A’s equity shares (derived from B’s
earnings over a 12-month period).
5.7.2.3 Definition of a Derivative in ASC 815-10-15
To determine whether a contingent consideration arrangement that is settleable in an acquirer’s own
equity is a derivative instrument, the acquirer must consider the guidance in ASC 815-10-15-83, which
states that a derivative is a financial instrument or other contract with all of the following characteristics:
- It has one or more underlyings and notional amounts or payment provisions or both.
- It has “no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors.”
- It can be net settled.
A contingent consideration arrangement that is a derivative is classified as a
liability unless the arrangement meets a scope exception that allows equity
classification. ASC 815-10-15-74(a) provides a scope exception for an
entity’s contracts that are both (1) indexed to the entity’s own shares and
(2) classified in equity in the entity’s statement of financial
position.
5.7.2.4 Indexed to the Acquirer’s Own Shares Under ASC 815-40-15
ASC 815-40-15-5 through 15-8 discuss how to determine whether a contingent consideration
arrangement that is settleable in an acquirer’s own equity is indexed to the acquirer’s own shares. Under
that guidance, an acquirer performs the two-step evaluation discussed below.
5.7.2.4.1 Step 1 — Evaluate Contingent Exercise Provisions
Contingent consideration, by its nature, has an exercise contingency, which the ASC master glossary
defines as “a provision that entitles the entity (or the counterparty) to exercise an equity-linked financial
instrument (or embedded feature) based on changes in an underlying, including the occurrence (or
nonoccurrence) of a specified event.” For example, exercise contingencies include provisions that:
- Affect whether an instrument becomes exercisable or settleable.
- Accelerate the timing of (1) an entity’s ability to exercise an instrument or (2) the settlement of an instrument.
- Extend or defer the timing of (1) an entity’s ability to exercise an instrument or (2) the settlement of an instrument.
- Result in the cancellation of an instrument.
An arrangement with an exercise contingency is not necessarily classified as a liability. According to
ASC 815-40-15-7A, the only contingent exercise provisions that would preclude an arrangement from
being considered indexed to the entity’s own shares are those that are based on either of the following
(emphasis added):
- “An observable market, other than the market for the issuer’s stock (if applicable).”
- “An observable index, other than an index calculated or measured solely by reference to the issuer’s own operations (for example, sales revenue of the issuer; earnings before interest, taxes, depreciation, and amortization of the issuer; net income of the issuer; or total equity of the issuer).”
If the exercise contingency does not preclude an arrangement from being
considered indexed to the acquirer’s own shares, the next step is to
evaluate the settlement provisions.
ASC 815-40-15-5C indicates that an instrument is not precluded from being
considered indexed to the entity’s own shares under ASC 815-40-15-5
through 15-8 if the payoff is based, in whole or in part, on the shares
of a consolidated subsidiary as long as the subsidiary is a substantive
entity. If the subsidiary is not a substantive entity, the instrument is
not considered to be indexed to the entity’s own shares. If an acquiree
meets the definition of a business in ASC 805 and is therefore
substantive, we believe that the guidance in ASC 815-40-15-5C applies
and that a contingent consideration arrangement based on the performance
of the acquired business can be considered indexed to the entity’s
shares. ASC 815-40-15-5C clarifies that the guidance applies regardless
of whether the parent or consolidated subsidiary entered into the
arrangement.
For additional discussion of the effect of exercise contingencies on the
classification of a contract, see Deloitte’s Roadmap Contracts on an Entity’s
Own Equity.
5.7.2.4.2 Step 2 — Evaluate Settlement Provisions
ASC 815-40-15-7C states, in part, that an arrangement is considered indexed to
an entity’s own shares if its settlement amount will equal the
difference between:
-
“The fair value of a fixed number of the entity’s equity shares.”
-
“A fixed monetary amount or a fixed amount of a debt instrument issued by the entity.”
In addition, ASC 815-40-15-7D states:
An instrument’s
strike price or the number of shares used to calculate the
settlement amount are not fixed if its terms provide for any
potential adjustment [to the strike price or number of shares used
to calculate the settlement amount], regardless of the probability
of such adjustment(s) or whether such adjustments are in the
entity’s control. If the instrument’s strike price or the number of
shares used to calculate the settlement amount are not fixed, the
instrument (or embedded feature) shall still be considered indexed
to an entity’s own stock if the only variables that could affect the
settlement amount would be inputs to the fair value of a
fixed-for-fixed forward or option on equity shares.
The fair value inputs of a fixed-for-fixed forward or option on equity shares
may include (1) the entity’s share price, (2) the strike price of the
instrument, (3) the term of the instrument, (4) expected dividends or
other dilutive activities, (5) share borrow cost, (6) interest rates,
(7) share price volatility, (8) the entity’s credit spread, and (9) the
ability to maintain a standard hedge position in the underlying
shares.
An instrument cannot be considered indexed to the entity’s own shares if (1) the instrument’s settlement
calculation incorporates variables other than those used to determine the fair value of a fixed-for-fixed
forward or an option on equity shares or (2) the instrument contains a feature (such as a leverage factor)
that increases exposure to the additional variables listed in the preceding paragraph in a manner that is
inconsistent with a fixed-for-fixed forward or an option on equity shares.
For additional discussion of the effect of settlement provisions on the
classification of a contract, see Deloitte’s Roadmap Contracts on an Entity’s
Own Equity.
Example 5-8
Determining the Classification of Contingent Consideration Under ASC 815-40-15 — Issuance of a
Fixed Number of the Acquirer’s Shares on the Basis of an Earnings Target
Company A acquires Company B for 1 million shares of A’s common stock and an
agreement to issue an additional 250,000 shares if
the earnings of B exceed a specified target for
the 12-month period after the acquisition. Company
A determined that this arrangement is not within
the scope of ASC 480-10 (see Example
5-4) and concluded as follows as a
result of performing the two-step assessment in
ASC 815-40-15-5 through 15-8:
-
Step 1 — The exercise contingency (i.e., exceeding the earnings target) is based on an observable index, but it can only be measured by reference to B’s operations. Therefore, step 1 does not preclude A from considering the contingent consideration arrangement to be indexed to its own shares.
-
Step 2 — The settlement amount is considered fixed-for-fixed because it equals the difference between the fair value of a fixed number of A’s shares (i.e., the fair value of 250,000 of A’s own shares) and a fixed exercise price (i.e., zero).
The contingent consideration arrangement is therefore considered indexed to A’s
own shares. However, A still must determine
whether the arrangement qualifies for equity
classification or must be classified as a
liability in accordance with ASC 815-40-25.
Example 5-9
Determining the Classification of Contingent Consideration Under ASC 815-40-15 — Issuance of a
Fixed Number of the Acquirer’s Shares for Each Year That Earnings Exceed a Specified Amount
Company A acquires Company B for 1 million shares of A’s common stock and an
agreement to issue an additional 25,000 shares for
each 12-month postacquisition period in which B’s
earnings exceed $2 million for five years. In each
year in which the earnings target is achieved, the
shares must be issued within a reasonable period
after the end of the year.
Because each yearly delivery of the 25,000 shares is independent of the others, the arrangement is considered
to contain five units of account. Company A determined that this arrangement is not within the scope of
ASC 480-10 and concluded the following as a result of performing the two-step assessment in ASC 815-40-15-5
through 15-8 (see Example 5-5):
- Step 1 — The exercise contingency (i.e., exceeding the earnings target) is based on an observable index, but it can be measured only by reference to B’s operations. Therefore, step 1 does not preclude each arrangement from being considered indexed to A’s own shares.
- Step 2 — The settlement amount is considered fixed-for-fixed because it equals the difference between the fair value of a fixed number of A’s shares (i.e., the fair value of 25,000 of A’s own shares) and a fixed exercise price (i.e., zero).
The five separate contingent consideration arrangements are therefore considered
indexed to A’s own shares. However, A still must
consider whether the arrangement qualifies for
equity classification or must be classified as a
liability in accordance with ASC 815-40-25.
Example 5-10
Determining the Classification of Contingent Consideration Under ASC 815-40-15 — Issuance of a
Fixed Number of the Acquirer’s Shares as a Security Price Guarantee
Company A acquires Company B for 1 million shares of A’s common stock and an agreement to issue an
additional 25,000 shares if the quoted market price of A’s common stock is below $25 on the one-year
anniversary of the acquisition date. Company A determined that this arrangement is not within the scope of
ASC 480-10 and concluded the following as a result of performing the two-step assessment in ASC 815-40-15-5
through 15-8:
- Step 1 — The exercise contingency (i.e., the quoted market price of A’s common stock is below $25 on the one-year anniversary) is based on an observable market, but it is the market for A’s shares. Therefore, step 1 does not preclude the arrangement from being considered indexed to A’s own shares.
- Step 2 — The settlement amount is considered fixed-for-fixed because it equals the difference between the fair value of a fixed number of A’s shares (i.e., the fair value of 25,000 of A’s own shares) and a fixed exercise price (i.e., zero).
The contingent consideration arrangement is therefore considered indexed to A’s
own shares. However, A still must consider whether
the arrangement qualifies for equity
classification or must be classified as a
liability in accordance with ASC 815-40-25.
Example 5-11
Determining the Classification of Contingent Consideration Under ASC 815-40-15 — Issuance of a
Fixed Number of the Acquirer’s Shares on the Basis of an Observable Market Increase
Company A acquires Company B for 1 million shares of A’s common stock and an agreement to issue an
additional 25,000 shares in three years if the S&P 500 Index increases 1,000 points within any given calendar
year during that three-year period. The arrangement meets the definition of a derivative instrument in
ASC 815-10-15. Company A determined that this arrangement is not within the scope of ASC 480-10 and
concluded the following as a result of performing the two-step assessment in ASC 815-40-15-5 through 15-8:
- Step 1 — The exercise contingency (i.e., a 1,000-point increase in the S&P 500 Index) is based on an observable index that is not measured solely by reference to A’s (or B’s) own operations. Therefore, the arrangement is not considered indexed to A’s own shares.
- Step 2 — Not necessary.
The contingent consideration arrangement is not indexed to A’s shares. Since the
arrangement does not qualify for equity
classification in accordance with ASC 815-40-25,
it must be classified as a liability.
Example 5-12
Determining the Classification of Contingent Consideration Under ASC 815-40-15 — Issuance of a
Fixed Number of the Acquirer’s Shares on the Basis of Regulatory Approval
Company A acquires Company B for 1 million shares of A’s common stock and an agreement to issue an
additional 250,000 shares if B obtains regulatory approval for a drug within three years of the acquisition
date. Company A determined that this arrangement is not within the scope of ASC 480-10 and concluded the
following as a result of performing the two-step assessment in ASC 815-40-15-5 through 15-8:
- Step 1 — The exercise contingency (i.e., obtaining regulatory approval) is not based on an observable market or index. Therefore, step 1 does not preclude the arrangement from being considered indexed to A’s own shares.
- Step 2 — The settlement amount is considered fixed-for-fixed because it equals the difference between the fair value of a fixed number of A’s shares (i.e., the fair value of 250,000 of A’s own shares) and a fixed exercise price (i.e., zero).
The contingent consideration arrangement is therefore considered indexed to A’s
own shares. However, A still must consider whether
the arrangement qualifies for equity
classification or must be classified as a
liability in accordance with ASC 815-40-25.
5.7.2.5 Determining Whether Contingent Consideration Is Classified as Equity Under ASC 815-40-25
If the acquirer determines that a contingent consideration arrangement (1) is not required to be
classified as a liability under ASC 480-10 and (2) is indexed to the entity’s own shares under ASC 815-40-15-5 through 15-8, the acquirer must consider whether the arrangement meets the criteria in
ASC 815-40-25 to be classified in equity. If an entity determines that a contingent consideration
arrangement is indexed to the entity’s own shares, it applies the guidance in ASC 815-40-25, which
generally permits equity classification for instruments that require settlement in their own shares
(physical settlement or net share settlement) or gives the issuer a choice of net cash settlement or
physical settlement as long as certain conditions are met.
A contingent consideration arrangement that is not precluded from equity
classification under ASC 480-10 and ASC 815-40-15 may be classified in
equity only if it meets all of the following
conditions in ASC 815-40-25:
-
It is required to be physically settled in shares or net share settled or the acquirer has a choice of net cash settlement or settlement in shares (either net share settlement or physical settlement).
-
If an event could trigger net cash settlement that is outside the issuer’s control, the arrangement requires net cash settlement only in specific circumstances in which holders of shares underlying the contract also would receive cash in exchange for their shares.
-
It permits the acquirer to settle in unregistered shares (however, see Changing Lanes discussion below).
-
The acquirer has sufficient authorized and unissued shares to settle the contract. In making that determination, the acquirer must consider all other commitments or potentially dilutive instruments (e.g., options, warrants, convertible arrangements) that may require the issuance of shares during the maximum period the arrangement could remain outstanding.
-
The arrangement contains an explicit limit on the number of shares to be delivered in a share settlement.
-
There are no required cash payments to the seller in the event the acquirer fails to make timely filings with the SEC.
-
There are no cash-settled top-off or make-whole provisions.
-
There are no provisions in the arrangement that indicate that the seller has rights that rank higher than those of a holder of the shares underlying the contract (however, see Changing Lanes discussion below).
-
There is no requirement in the contract to post collateral at any point or for any reason (however, see Changing Lanes discussion below).
These conditions are discussed in detail in ASC 815-40-25, and entities should
consider them carefully in determining whether an arrangement would be
classified in equity. In addition, entities must reassess a contingent
consideration arrangement as of each reporting date. If equity
classification is no longer appropriate, the arrangement must be
reclassified as a liability. Similarly, if equity classification becomes
appropriate, the arrangement must be reclassified as equity as of the date
of the event that caused the reclassification. For additional discussion,
see Deloitte’s Roadmap Contracts on an Entity’s Own Equity.
Changing Lanes
In August 2020, the FASB issued ASU 2020-06, which
simplifies the accounting for certain financial instruments with
characteristics of liabilities and equity, including convertible
instruments and contracts on an entity’s own equity. ASU 2020-06
amends ASC 815-40-25 to remove the following three conditions for
equity classification related to an entity’s ability to settle a
contract on its own equity by delivering shares:
- Settlement permitted in unregistered shares; however, the ASU clarifies that if a contract explicitly states that cash settlement is required if registered shares are unavailable, the contract will not qualify as equity.
- There are no provisions in the arrangement that indicate that the seller has rights that rank higher than those of a holder of the shares underlying the contract.
- There is no requirement in the contract to post collateral at any point or for any reason.
For more information about ASU 2020-06, see
Deloitte’s August 5, 2020, Heads Up.
Example 5-13
Determining the Classification of Contingent Consideration Under ASC 815-40-25 — Issuance of a
Fixed Number of the Acquirer’s Shares on the Basis of an Earnings Target
Company A acquires Company B for 1 million shares of A’s common stock and an
agreement to issue an additional 250,000 shares if
the earnings of B exceed a specified target for the
12-month period after the acquisition. Company A has
not adopted ASU 2020-06. The arrangement was
previously determined (1) not to be within the scope
of ASC 480-10 (see Example 5-4) and
(2) to be indexed to A’s shares in accordance with
ASC 815-40-15 (see Example
5-8).
The arrangement requires A to physically deliver shares to the former owners if
the contingency is met. In addition, A must consider
the other conditions in ASC 815-40-25 for equity
classification, including:
-
Whether the arrangement limits the number of shares A would have to deliver (250,000).
-
Whether A has sufficient authorized and unissued shares. In making that determination, A must consider all of its other commitments and any potentially dilutive instruments that may require the issuance of its shares during the 12-month period in which the arrangement will be outstanding.
After reviewing all of its other arrangements (e.g., options, warrants, convertible arrangements), A determines
that it has sufficient shares available. Further, the arrangement does not include any:
- Provisions that require A to settle in registered shares.
- Required cash payments to the former owners if the acquirer fails to make timely filings with the SEC.
- Cash-settled top-off or make-whole provisions.
- Provisions that indicate that the former owners have rights that rank higher than those of a shareholder of the shares underlying the contract.
- Requirements related to posting collateral.
If the above criteria are met, and after considering the guidance in ASC 480-10,
ASC 815-40-15, and ASC 815-40-25, A could conclude
that the contingent consideration arrangement
qualifies for equity classification.
5.7.3 Subsequent Accounting for Contingent Consideration
ASC 805-30
35-1 Some changes in the fair value of contingent consideration that the acquirer recognizes after the
acquisition date may be the result of additional information about facts and circumstances that existed at the
acquisition date that the acquirer obtained after that date. Such changes are measurement period adjustments
in accordance with paragraphs 805-10-25-13 through 25-18 and Section 805-10-30. However, changes
resulting from events after the acquisition date, such as meeting an earnings target, reaching a specified
share price, or reaching a milestone on a research and development project, are not measurement period
adjustments. The acquirer shall account for changes in the fair value of contingent consideration that are not
measurement period adjustments as follows:
- Contingent consideration classified as equity shall not be remeasured and its subsequent settlement shall be accounted for within equity.
- Contingent consideration classified as an asset or a liability shall be remeasured to fair value at each reporting date until the contingency is resolved. The changes in fair value shall be recognized in earnings unless the arrangement is a hedging instrument for which Topic 815 requires the changes to be initially recognized in other comprehensive income.
A contingent consideration arrangement that is classified as an asset or a liability is remeasured at fair
value each reporting period until the contingency is resolved. The acquirer recognizes changes in fair
value in earnings each period unless it designates the arrangement as a cash flow hedging instrument
that is subject to ASC 815-10.
If the contingent consideration is classified as an equity instrument, it is not
remeasured. The initial amount recognized for contingent consideration
classified as equity is not adjusted even if the fair value of the arrangement
changes. The subsequent settlement of the arrangement on the date the
contingency is resolved is accounted for in equity.
Adjustments made during the measurement period that pertain to facts and
circumstances that existed as of the acquisition date are recognized as
adjustments to goodwill. The acquirer must consider all pertinent factors in
determining whether information obtained after the acquisition date should
result in an adjustment to the provisional amounts recognized or whether that
information results from events that occurred after the acquisition date.
Changes in fair value resulting from events that occur after the acquisition
date are recognized in earnings and not as adjustments to goodwill.
ASC 350-20-35-30 requires entities to test a reporting unit’s goodwill for
impairment between annual dates if an event occurs or circumstances change that
would more likely than not reduce the reporting unit’s fair value below its
carrying amount. The acquirer should consider whether a reduced likelihood that
a contingent consideration payment will be made is an indicator of impairment
for any reporting units to which the arrangement is related (e.g., the earnings
targets specified in an arrangement are no longer expected to be achieved or the
likelihood of achievement is significantly reduced).
Example 5-14
Subsequent Accounting for a Contingent Consideration Arrangement Classified as a Liability
Company A acquires Company B for $15 million and an agreement to pay an additional $6 million to the
former owners if the cumulative net income of B reaches $10 million within three years of the acquisition date.
The contingent consideration arrangement is classified as a liability and has an acquisition-date fair value of
$4 million.
At the end of each reporting period after the acquisition date, the arrangement is remeasured at its fair value,
with changes in fair value recorded in earnings. For example, if the likelihood of meeting the target increases,
the fair value of the contingent consideration would most likely increase. If the target is met and the $6 million
contingent consideration is payable, $2 million will have been recorded cumulatively in the income statement
(the difference between the $6 million payment and the $4 million originally recorded on the acquisition date)
by the time the $6 million is paid. Conversely, if the contingency is not met or its fair value declines, any accrued
liability would be reversed in the income statement.
5.7.4 Effect of Contingently Issuable Equity on EPS Calculations
Contingent consideration agreements under which the acquirer is obligated to issue additional common
shares upon resolution of a contingency may affect the acquirer’s computation of EPS, if presented,
during the contingency period. ASC 260-10-45-13 and ASC 260-10-45-48 through 45-57 address the
accounting for contingently issuable shares. Such shares, which include shares placed in escrow and
shares that are issued but contingently returnable, are those whose issuance is contingent on the
satisfaction of certain conditions. An agreement that requires an entity to issue common shares or
potential common shares after the mere passage of time is not considered a contingently issuable share
arrangement because the passage of time is not a contingency.
For additional discussion of the effect of contingently issuable shares on EPS
calculations, see Deloitte’s Roadmap Earnings per Share.
5.7.5 Acquiree Contingent Consideration Arrangements Assumed by the Acquirer
If an acquired entity was a party to a contingent consideration arrangement from a previous business
combination, the accounting would depend on whether the acquiree was the acquirer or the acquiree in
that previous transaction.
5.7.5.1 Acquiree Was the Acquirer in a Previous Business Combination
ASC 805-20
25-15A Contingent consideration arrangements of an acquiree assumed by the acquirer in a business
combination shall be recognized initially at fair value in accordance with the guidance for contingent
consideration arrangements in paragraph 805-30-25-5.
30-9A Contingent consideration arrangements of an acquiree assumed by the acquirer in a business
combination shall be measured initially at fair value in accordance with the guidance for contingent
consideration arrangements in paragraph 805-30-25-5.
35-4C Contingent consideration arrangements of an acquiree assumed by the acquirer in a business
combination shall be measured subsequently in accordance with the guidance for contingent consideration
arrangements in paragraph 805-30-35-1.
ASC 805-30
35-1A Contingent consideration arrangements of an acquiree assumed by the acquirer in a business
combination shall be measured subsequently in accordance with the guidance for contingent consideration
arrangements in the preceding paragraph.
Before the acquisition date, an acquiree may have completed a prior business combination in which it
was the acquirer and had issued contingent consideration to the seller. Consequently, at the time of the
new acquisition, the acquiree may have a liability (or asset) recognized for the contingent consideration.
The nature of contingent consideration does not change because of the subsequent acquisition of the
acquirer. Therefore, if an acquirer assumes a preexisting contingent consideration liability (or asset)
in a business combination, the acquirer measures and recognizes that arrangement at fair value and
classifies it in the same manner as if it had entered into that arrangement at the same time as the
current business combination.
After initial recognition, such contingent consideration arrangements are
accounted for in accordance with the requirements for acquirer contingent
consideration in ASC 805-30-35-1. However, acquiree contingent consideration
arrangements are assumed liabilities (or acquired assets) rather than part
of the consideration transferred in the business combination because they
are payable to (or receivable from) parties other than the sellers in the
current business combination.
5.7.5.2 Acquiree Was the Seller in a Previous Business Combination
An acquirer may obtain the right to receive contingent consideration from an acquiree that previously
was the seller of a business. The acquirer should account for that acquired right to receive (or obligation
to pay) contingent consideration as an asset (or liability) arising from a contingency (see Section 4.3.6).
Therefore, if the acquirer can determine the acquisition-date fair value during the measurement period,
the acquiree’s contingent consideration should be recognized and measured at fair value. In accordance
with ASC 805-20-25-20, if an acquirer cannot determine the acquisition-date fair value of a contingency
during the measurement period, it recognizes the contingency at its estimated amount if (1) “it is
probable that an asset existed or that a liability had been incurred at the acquisition date” and (2) “[t]he
amount of the asset or liability can be reasonably estimated.” If an asset or liability arising from a
contingency does not qualify for recognition during the measurement period, it would be accounted for
in accordance with other GAAP (e.g., ASC 450) separately from the business combination.
5.8 Noncash Assets Transferred as Consideration
ASC 805-30
30-8 The consideration transferred may include assets or liabilities of the acquirer that have carrying amounts
that differ from their fair values at the acquisition date (for example, nonmonetary assets or a business of
the acquirer). If so, the acquirer shall remeasure the transferred assets or liabilities to their fair values as of
the acquisition date and recognize the resulting gains or losses, if any, in earnings. However, sometimes the
transferred assets or liabilities remain within the combined entity after the business combination (for example,
because the assets or liabilities were transferred to the acquiree rather than to its former owners), and the
acquirer therefore retains control of them. In that situation, the acquirer shall measure those assets and
liabilities at their carrying amounts immediately before the acquisition date and shall not recognize a gain or
loss in earnings on assets or liabilities it controls both before and after the business combination.
An acquirer may transfer as consideration tangible or intangible assets whose fair value differs from
their carrying amounts in the acquirer’s financial statements as of the acquisition date. Examples include
financial assets, inventory, property, or intangible assets. An acquirer may also transfer a business
or subsidiary that includes liabilities. If the carrying amount of an asset (or liability) transferred to the
seller differs from the acquisition-date fair value of the asset, the acquirer recognizes a gain or a loss in
earnings (separately from the business combination transaction) for any difference between the asset’s
or liability’s acquisition-date fair value and its carrying amount.
Example 5-15
Acquisition of a Business by Transferring Noncash Consideration to the Seller
Company A enters into an agreement to acquire Company B for consideration of $1
million in cash and a building, both of which are
transferred to the seller. Company A accounts for the
transaction as a business combination. On the acquisition
date, the building’s carrying amount in A’s financial
statements is $100,000 and its fair value is $250,000. Under
ASC 805, the amount recognized as of the acquisition date
for B’s net identifiable assets is $700,000. The gain on the
building transferred and the goodwill recognized as part of
the acquisition are calculated as follows:
This measurement of goodwill would be the same if A had sold the building to a third party at its fair value and
included the cash received in the consideration transferred.
5.8.1 Noncash Assets That Are Used as Consideration and That Remain Within the Combined Entity
The consideration transferred may include noncash assets or liabilities that the acquirer transfers to
the acquiree rather than to the seller. Any assets (or liabilities) used as consideration that remain within
the combined entity must be measured at their carrying amounts in the acquirer’s financial statements
immediately before the acquisition date. As described in ASC 805-30-30-8, the acquirer is precluded
from recognizing a gain or loss in earnings on assets (and liabilities) that it controls both before and after
the business combination. This is true even if the acquirer obtains a controlling financial interest in, but
less than 100 percent of, an acquiree. If the acquisition is a partial acquisition and includes assets used
as consideration that stay within the combined entity, ASC 805 does not address how to measure the
noncontrolling interest. The example below illustrates one way to measure the noncontrolling interest,
although other alternatives may exist.
Example 5-16
Acquisition of a Business by Transferring Noncash Consideration to the Acquiree
Company A enters into an agreement to acquire an 80 percent interest in Company
B in exchange for A’s transfer of its wholly owned
subsidiary, Sub X, to B. The transaction is determined
to be a business combination, and A is identified as the
acquirer. On the acquisition date, Sub X’s fair value is
$4,000 and its carrying amount is $2,000. (This example
includes simplified assumptions and ignores the effects
of a discount for lack of control or income taxes.) The
fair value of B is $1,000. The following diagram
illustrates the ownership structure immediately before
and after the acquisition:
Before the acquisition:
After the acquisition:
Because A controls Sub X both before and after the acquisition, A must recognize Sub X’s assets and liabilities at their
carrying amounts (i.e., the transfer of Sub X to B is similar to a common-control transaction). Therefore, A cannot
recognize a gain or loss in earnings for the difference between the fair value and the carrying amount of Sub X’s assets
and liabilities. Company A accounts for the reduction in its ownership interest in Sub X from 100 percent to 80 percent
as an equity transaction under ASC 810-10-45-23 (i.e., as an adjustment to APIC).
Company A recognizes the following:
Because A was identified as the acquirer of B, the transaction would be accounted for as the acquisition of B by
Sub X in B’s stand-alone financial statements (i.e., as a reverse acquisition). Therefore, Sub X is the accounting
acquirer/legal acquiree and B is the accounting acquiree/legal acquirer. The consideration transferred in
the transaction is equal to 20 percent of Sub X, which was exchanged for 80 percent of B. In B’s stand-alone
financial statements, B’s net assets are recognized at their acquisition-date fair value of $1,000, and Sub X’s net
assets are recognized at their carrying amount of $2,000. The financial statements before the acquisition would
present the assets, liabilities, and operations of Sub X, and B would not be included in the financial statements
until the acquisition date. See Section 6.8 for more information about the accounting for reverse acquisitions.
5.9 Liabilities Incurred as Consideration
ASC 805-30-30-7 states that the consideration transferred includes “liabilities incurred by the acquirer
to former owners of the acquiree.” For example, liabilities incurred include contingent consideration and
seller notes or loans to the acquirer. They do not include the acquiree’s preexisting liabilities payable to
third parties that may be assumed by the acquirer in a business combination or settled on behalf of the
acquiree or its seller at the closing of the acquisition.
See Section 4.12
for more information about accounting for an acquiree’s debt in a business
combination. In addition, the acquirer may incur new debt with a third party to fund
the acquisition, which also is not part of the consideration transferred.
5.10 When Consideration Transferred Is Not Reliably Measurable or a Business Is Acquired Without the Transfer of Consideration
ASC 805-30
30-2 In a business combination in which the acquirer and the acquiree (or its former owners) exchange
only equity interests, the acquisition-date fair value of the acquiree’s equity interests may be more reliably
measurable than the acquisition-date fair value of the acquirer’s equity interests. If so, the acquirer shall
determine the amount of goodwill by using the acquisition-date fair value of the acquiree’s equity interests
instead of the acquisition-date fair value of the equity interests transferred.
30-3 To determine the amount of goodwill in a business combination in which no consideration is transferred,
the acquirer shall use the acquisition-date fair value of the acquirer’s interest in the acquiree determined
using a valuation technique in place of the acquisition-date fair value of the consideration transferred (see
paragraph 805-30-30-1(a)(1)). Paragraphs 805-30-55-3 through 55-5 provide additional guidance on applying
the acquisition method to combinations of mutual entities, including measuring the acquisition-date fair value
of the acquiree’s equity interests using a valuation technique.
55-2 In a business combination achieved without the transfer of consideration, the acquirer must substitute the
acquisition-date fair value of its interest in the acquiree for the acquisition-date fair value of the consideration
transferred to measure goodwill or a gain on a bargain purchase (see paragraphs 805-30-30-1 through 30-4).
Subtopic 820-10 provides guidance on using valuation techniques to measure fair value.
Most business combinations include the transfer of consideration, and that
consideration is used to measure the fair value of the business acquired. In some
acquisitions, however, either no consideration is transferred or the consideration
transferred is less reliably measurable than a direct measurement of the business
acquired (e.g., when the acquiree’s shares were publicly traded before the business
combinations and the acquirer’s shares were not). ASC 805-30-30-2 states that when
only equity interests are exchanged, goodwill should be calculated by using the fair
value of the acquiree’s equity interests if they are more reliably measurable than
the fair value of the acquirer’s equity interests. When no consideration is
transferred (e.g., if control is obtained through a lapse in minority veto rights)
or the consideration transferred is not reliably measurable, the acquirer
substitutes the acquisition-date fair value of its interest in the acquiree for the
acquisition-date fair value of the consideration transferred to measure goodwill or
a gain on a bargain purchase. The acquisition-date fair value of the acquirer’s
interest in the acquiree is determined by using appropriate valuation techniques
instead of the fair value of the consideration transferred.
5.10.1 Business Combinations Between Mutual Entities
ASC 805-30
Special Consideration in Applying the Acquisition Method to Combinations of Mutual Entities
55-3 When two mutual entities
combine, the fair value of the equity or member
interests in the acquiree (or the fair value of
the acquiree) may be more reliably measurable than
the fair value of the member interests transferred
by the acquirer. In that situation, paragraph
805-30-30-2 through 30-3 requires the acquirer to
determine the amount of goodwill by using the
acquisition-date fair value of the acquiree’s
equity interests instead of the acquisition-date
fair value of the acquirer’s equity interests
transferred as consideration. In addition, the
acquirer in a combination of mutual entities shall
recognize the acquiree’s net assets as a direct
addition to capital or equity in its statement of
financial position, not as an addition to retained
earnings, which is consistent with the way in
which other types of entities apply the
acquisition method.
55-4 Although they are similar in many ways to other businesses, mutual entities have distinct characteristics
that arise primarily because their members are both customers and owners. Members of mutual entities
generally expect to receive benefits for their membership, often in the form of reduced fees charged for goods
and services or patronage dividends. The portion of patronage dividends allocated to each member is often
based on the amount of business the member did with the mutual entity during the year.
55-5 A fair value measurement of a mutual entity should include the assumptions that market participants
would make about future member benefits as well as any other relevant assumptions market participants
would make about the mutual entity. For example, an estimated cash flow model may be used to determine
the fair value of a mutual entity. The cash flows used as inputs to the model should be based on the expected
cash flows of the mutual entity, which are likely to reflect reductions for member benefits, such as reduced fees
charged for goods and services.
A mutual entity is a private company whose owners are also its customers. As owner-customers, they
are entitled to receive the profits or income generated by the mutual entity. Such profits may be in the
form of dividends or lower costs that are distributed pro rata on the basis of the amount of business
each customer conducts with the mutual entity. Examples of mutual entities include mutual insurance
companies, cooperatives, credit unions, and savings and loans.
As discussed in Section 2.2.2, acquisitions between mutual entities are within the scope of ASC 805.
Accordingly, one of the combining entities must be identified as the acquirer on the basis of the factors
in ASC 805-10-55-11 through 55-15 (see Section 3.1). Typically, no consideration is transferred in a
combination between mutual entities. The combination is effected through the exchange of member
interests. To apply the acquisition method, the entity must determine which is more reliably measurable,
the fair value of the member interests transferred by the entity identified as the acquirer or the fair
value of the member interests of the entity identified as the acquiree (i.e., the fair value of the acquiree
as a whole). In some cases, because member interests of mutual entities are not publicly traded, the
fair value of the entity identified as the acquiree is more reliably measurable. Therefore, the fair value of
the acquiree as a whole would be used as a substitute for the consideration transferred. In a business
combination between mutual entities, goodwill is measured on the basis of the amount by which the
acquiree’s fair value as a whole exceeds the fair value of its net assets. The acquiree’s assets acquired,
including identifiable intangible assets, and liabilities assumed must be measured in accordance with
ASC 805, generally at their fair values. The fair value of the acquiree is added directly to the acquirer’s
equity (e.g., generally APIC) and not to its retained earnings.
Chapter 6 — Other Acquisition Method Guidance
Chapter 6 — Other Acquisition Method Guidance
This chapter discusses other aspects of the acquisition method,
including the measurement period, assessing whether a transaction is separate from
the business combination (e.g., a compensation arrangement), business combinations
achieved in stages (i.e., step acquisitions), partial acquisitions, and reverse
acquisitions.
6.1 Measurement Period
ASC 805-10
25-15 The measurement period is the period after the acquisition date during which the acquirer may
adjust the provisional amounts recognized for a business combination. The measurement period provides
the acquirer with a reasonable time to obtain the information necessary to identify and measure any of the
following as of the acquisition date in accordance with the requirements of this Topic:
- The identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree (see Subtopic 805-20)
- The consideration transferred for the acquiree (or the other amount used in measuring goodwill in accordance with paragraphs 805-30-30-1 through 30-3)
- In a business combination achieved in stages, the equity interest in the acquiree previously held by the acquirer (see paragraph 805-30-30-1(a)(3))
- The resulting goodwill recognized in accordance with paragraph 805-30-30-1 or the gain on a bargain purchase recognized in accordance with paragraph 805-30-25-2.
30-1 Paragraph 805-10-25-15 establishes that the measurement period provides the acquirer with a
reasonable time to obtain the information necessary to identify and measure various items in a business
combination.
An acquirer may not have the information necessary to complete the accounting for a business
combination by the end of the reporting period after the acquisition, especially when the business
combination closes shortly before the end of the acquirer’s reporting period or when the acquiree’s
operations are significant or complex. Thus, ASC 805-10-25-15 provides a measurement period during
which an acquirer can obtain the information it needs to identify and measure the consideration
transferred, assets acquired, and liabilities assumed, as well as any previously held or noncontrolling
interests. The objective of the measurement period is to give the acquirer a reasonable period in which
to obtain the information necessary to complete the accounting for the business combination while
maintaining normal reporting schedules.
The measurement period for a particular asset, liability, or equity instrument
ends once the acquirer determines that either (1) the necessary information has been
obtained or (2) the information is not available. However, the measurement period
for all items is limited to one year from the acquisition date. See Section 7.11 for a discussion
of the specific disclosure requirements for situations in which the accounting for a
business combination has not been completed by the end of the acquirer’s reporting
period.
6.1.1 Recognition of Provisional Amounts
ASC 805-10
25-13 If the initial accounting for a business combination is incomplete by the end of the reporting period in
which the combination occurs, the acquirer shall report in its financial statements provisional amounts for the
items for which the accounting is incomplete. During the measurement period, in accordance with paragraph
805-10-25-17, the acquirer shall adjust the provisional amounts recognized at the acquisition date to reflect
new information obtained about facts and circumstances that existed as of the acquisition date that, if known,
would have affected the measurement of the amounts recognized as of that date.
25-14 During the measurement period, the acquirer also shall recognize additional assets or liabilities if new
information is obtained about facts and circumstances that existed as of the acquisition date that, if known,
would have resulted in the recognition of those assets and liabilities as of that date. The measurement period
ends as soon as the acquirer receives the information it was seeking about facts and circumstances that
existed as of the acquisition date or learns that more information is not obtainable. However, the measurement
period shall not exceed one year from the acquisition date.
55-16 Paragraphs 805-10-25-14 through 25-19 and 805-10-30-2 through 30-3 discuss requirements related
to the measurement period in a business combination. If the initial accounting for a business combination is
incomplete at the end of the financial reporting period in which the combination occurs, paragraph 805-10-25-13 requires that the acquirer recognize in its financial statements provisional amounts for the items for
which the accounting is incomplete. During the measurement period, the acquirer recognizes adjustments
to the provisional amounts needed to reflect new information obtained about facts and circumstances that
existed as of the acquisition date that, if known, would have affected the measurement of the amounts
recognized as of that date. Paragraph 805-10-25-17 requires the acquirer to recognize such adjustments with
a corresponding adjustment to goodwill in the reporting period the adjustments are determined. The effects
of adjustments to provisional amounts to periods after the acquisition date are included in the earnings of the
adjustment period.
If the acquirer does not have the information necessary to complete the accounting for the business
combination by the next reporting date, it must recognize provisional amounts for those items for which
the accounting is incomplete by using its best estimates of their fair value (or other measurement as
required by ASC 805) on the basis of the information available. See Section 7.11 for a discussion of the
specific disclosure requirements for provisional measurements.
When the accounting for a business combination is incomplete at the end of the reporting period,
the acquirer must not knowingly understate or overstate an asset or liability, as might be the case if
no amount, a nominal amount, or the acquiree’s carrying amount were to be used as the provisional
amount until the measurement has been completed. Instead, the acquirer must determine provisional
amounts by using the best information available. If the acquirer becomes aware of new information
during the measurement period related to conditions that existed as of the acquisition date, it must
make subsequent adjustments to the provisional amounts, and additional assets acquired or liabilities
assumed might be identified for recognition and measurement.
6.1.2 Adjustments Identified During the Measurement Period
ASC 805-10
25-16 The acquirer recognizes an increase (decrease) in the provisional amount recognized for an identifiable
asset (liability) by means of a decrease (increase) in goodwill. However, new information obtained during
the measurement period sometimes may result in an adjustment to the provisional amount of more than
one asset or liability. For example, the acquirer might have assumed a liability to pay damages related to an
accident in one of the acquiree’s facilities, part or all of which are covered by the acquiree’s liability insurance
policy. If the acquirer obtains new information during the measurement period about the acquisition-date fair
value of that liability, the adjustment to goodwill resulting from a change to the provisional amount recognized
for the liability would be offset (in whole or in part) by a corresponding adjustment to goodwill resulting from a
change to the provisional amount recognized for the claim receivable from the insurer.
25-17 During the measurement period, the acquirer shall recognize adjustments to the provisional amounts
with a corresponding adjustment to goodwill in the reporting period in which the adjustments to the
provisional amounts are determined. Thus, the acquirer shall adjust its financial statements as needed,
including recognizing in its current-period earnings the full effect of changes in depreciation, amortization, or
other income effects, by line item, if any, as a result of the change to the provisional amounts calculated as
if the accounting had been completed at the acquisition date. Paragraph 805-10-55-16 and Example 1 (see
paragraph 805-10-55-27) provide additional guidance.
25-18 Paragraphs 805-10-30-2 through 30-3 require consideration of all pertinent factors in determining
whether information obtained after the acquisition date should result in an adjustment to the provisional
amounts recognized or whether that information results from events that occurred after the acquisition date.
30-2 The acquirer shall consider all pertinent factors in determining whether information obtained after
the acquisition date should result in an adjustment to the provisional amounts recognized or whether that
information results from events that occurred after the acquisition date. Pertinent factors include the time
at which additional information is obtained and whether the acquirer can identify a reason for a change to
provisional amounts.
30-3 Information that is obtained shortly after the acquisition date is more likely to reflect circumstances that
existed at the acquisition date than is information obtained several months later. For example, unless an
intervening event that changed its fair value can be identified, the sale of an asset to a third party shortly after
the acquisition date for an amount that differs significantly from its provisional fair value determined at that
date is likely to indicate an error in the provisional amount.
In September 2015, the FASB issued ASU 2015-16, which amended the guidance in ASC 805 on
the accounting for measurement-period adjustments. As described in paragraph BC3 of 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 amount is determined.” The
adjustments are calculated as if the accounting had been completed on the acquisition date. When an
acquirer adjusts a provisional amount, the offsetting entry generally increases or decreases goodwill but
may also result in adjustments to other assets and liabilities. For example, if an acquirer recognizes a
liability for a contingency and has an offsetting indemnification asset, an adjustment to the liability may
result in an offsetting increase or decrease in the indemnification asset.
Measurement-period adjustments may also affect the income statement. In
accordance with the guidance in ASU 2015-16, an acquirer must recognize, in the
reporting period in which the adjustment amounts are determined (rather than
retrospectively), the “effect on earnings of changes in depreciation,
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 at the
acquisition date.” For example, if a measurement-period adjustment increases the
value of fixed assets or finite-lived intangible assets, the acquirer should
recognize any catch-up depreciation or amortization in the reporting period in
which the adjustment is determined.
According to ASU 2015-16, acquirers must also “present separately on the face of
the income statement or disclose in the notes the portion of the amount recorded
in current-period earnings by line item that would have been recorded in
previous reporting periods if the adjustment to the provisional amounts had been
recognized as of the acquisition date.” See Section 7.11 for more information about
the disclosure requirements for measurement-period adjustments.
ASC 805-10 provides the following example illustrating the accounting for
measurement-period adjustments:
ASC 805-10
Example 1: Appraisal That Is Incomplete at the Reporting Date
55-27 This Example
illustrates the measurement period guidance in paragraph
805-10-55-16. Acquirer acquires Target on September 30,
20X7. Acquirer seeks an independent appraisal for an
item of property, plant, and equipment acquired in the
combination, and the appraisal was not complete by the
time Acquirer issued its financial statements for the
year ended December 31, 20X7. In its 20X7 annual
financial statements, Acquirer recognized a provisional
fair value for the asset of $30,000. At the acquisition
date, the item of property, plant, and equipment had a
remaining useful life of five years. Six months after
the acquisition date, Acquirer received the independent
appraisal, which estimated the asset’s acquisition-date
fair value as $40,000.
55-28 In its interim financial statements for the quarter ended March 31, 20X8, Acquirer adjusts the provisional
amounts recorded and the related effects on that period’s earnings as follows:
- The carrying amount of property, plant, and equipment as of March 31, 20X8, is increased by $9,000. That adjustment is measured as the fair value adjustment at the acquisition date of $10,000 less the additional depreciation that would have been recognized had the asset’s fair value at the acquisition date been recognized from that date ($1,000 for 6 months’ depreciation).
- The carrying amount of goodwill as of March 31, 20X8, is decreased by $10,000.
- Depreciation expense for the period ended March 31, 20X8, is increased by $1,000 to reflect the effect on earnings as a result of the change to the provisional amount recognized.
55-29 In accordance with paragraph 805-20-50-4A, Acquirer discloses both of the following:
- In its 20X7 financial statements, that the initial accounting for the business combination has not been completed because the appraisal of property, plant, and equipment has not yet been received
- In its March 31, 20X8 financial statements, the amounts and explanations of the adjustments to the provisional values recognized during the current reporting period. Therefore, Acquirer discloses that the increase to the fair value of the item of property, plant, and equipment was $10,000, with a corresponding decrease to goodwill. Additionally, the change to the provisional amount resulted in an increase in depreciation expense and accumulated depreciation of $1,000, of which $500 relates to the previous quarter.
The measurement period is not intended to allow for subsequent adjustments of the amounts
recognized as part of the business combination that result from the uncertainties and related risks
the acquirer assumed in the combination. Adjustments that are due to decisions made by the
combined company or changes in facts and circumstances or economic conditions that occurred
after the acquisition date are not measurement-period adjustments; rather, they are included in the
determination of net income in the period in which they are made. For example, if acquired equipment
is damaged after the acquisition date, the decrease in the equipment’s value is the result of changes in
facts and circumstances after the acquisition date and should not be recognized as a measurement-period
adjustment.
Determining whether an adjustment to an item’s value is a measurement-period adjustment or is
due to a change in fact or circumstance after the acquisition date may require significant judgment.
New information received soon after a business combination is more likely to reflect facts and
circumstances that existed as of the acquisition date than information received later during an open
measurement period; however, before reaching a conclusion, an acquirer must consider all pertinent
factors to determine whether information it obtained after the acquisition date is related to facts and
circumstances that existed as of the acquisition date or occurred after the acquisition date. For example,
deferred taxes recognized in a business combination should reflect the structure of the combined entity
as it existed on the acquisition date. Generally, the tax effects of subsequent transaction steps that may
be considered acquisition-related integration steps are not measurement-period adjustments and are
accounted for separately from the business combination.
Example 6-1
Potential Litigation Known as of the Acquisition Date
On January 1, 20X9, Company A acquires Company B in a transaction accounted for as a business combination.
As a result of due diligence activities associated with the acquisition, A was aware of a potential liability related
to a claim that B had breached a contract with a customer before the business combination. On the basis of
its understanding of the claim as of the acquisition date, A recognizes a provisional liability of $500,000 as part
of its initial accounting for the acquisition and asks its legal counsel to fully evaluate the claim. On April 1, 20X9,
A’s legal counsel confirms to A’s management that the claim does have merit since it appears that B breached
the contract. On the basis of this legal analysis, A determines that it should increase the provisional liability it
recognized to $750,000.
Because the new information became available during the measurement period and
is related to a circumstance that existed on the
acquisition date, A should recognize an increase of
$250,000 to the liability, with a corresponding
adjustment to goodwill.
Example 6-2
Potential Litigation Not Known as of the Acquisition Date
Assume the same facts as in the example above, except that Company A did not
know about Company B’s breach of contract as of the
acquisition date. Therefore, in the initial accounting
for the acquisition of B, A did not recognize a
liability. On March 1, 20X9, A becomes aware of B’s
potential breach of contract and asks its legal counsel
to evaluate the claim. On May 1, 20X9, A’s legal counsel
notifies A’s management that the claim does have merit
and that B may have breached the contract. Company A
determines that it should have recognized a liability of
$750,000 as part of the initial accounting for the
acquisition.
The breach of contract was a circumstance that existed as of the acquisition date, even though A was not aware
of it on that date. Because the new information became available during the measurement period and was
related to a circumstance that existed as of the acquisition date, A should recognize a liability for $750,000 as
part of the business combination accounting with a corresponding adjustment to goodwill.
6.1.2.1 Settlement of Litigation Shortly After the Acquisition Date
An acquiree may have ongoing litigation at the time of the business combination.
We believe that, by analogy to the subsequent-events guidance in ASC 855, if
the litigation is settled shortly after the acquisition date during an open
measurement period, the acquirer should consider whether that settlement
provides evidence about facts and circumstances that existed as of the
acquisition date. ASC 855-10-25-1 states, in part, that “[a]n entity shall
recognize in the financial statements the effects of all subsequent events
that provide additional evidence about conditions that existed at the date
of the balance sheet” (i.e., recognized subsequent events). ASC 855-10-55-1
provides the following example of a recognized subsequent event:
If the events that gave rise to litigation had taken
place before the balance sheet date and that litigation is settled after
the balance sheet date but before the financial statements are issued or
are available to be issued, for an amount different from the liability
recorded in the accounts, then the settlement amount should be
considered in estimating the amount of liability recognized in the
financial statements at the balance sheet date.
If an adjustment results from a settlement that occurs after the measurement
period — either because it occurs after the one-year anniversary of the
acquisition or because the acquirer concludes that it is no longer waiting
for information about that item — the change should be recognized in the
income statement. In addition, if the event that gives rise to the claim
takes place after the acquisition date, settlement of litigation does not
result in a measurement-period adjustment and should be recognized in the
income statement.
6.1.3 Adjustments Identified After the Measurement Period Has Ended
ASC 805-10
25-19 After the measurement period ends, the acquirer shall revise the accounting for a business combination
only to correct an error in accordance with Topic 250.
ASC 805-10-25-19 states that “[a]fter the measurement period ends, the acquirer shall revise the
accounting for a business combination only to correct an error in accordance with Topic 250”
(emphasis added). ASC 250-10-45-23 requires that an “error in the financial statements of a prior period
discovered after the financial statements are issued or are available to be issued . . . shall be reported as
an error correction, by restating the prior-period financial statements.” If an adjustment identified after
the measurement period is not the result of an error, it must be recognized in current-period earnings.
Entities must use judgment in determining whether an identified adjustment should be considered an
error correction or the result of events occurring after the acquisition date that require prospective
treatment in a manner consistent with a change in estimate.
ASC 250-10-20 defines an error in previously issued financial statements (an
“error”) as follows:
An error in recognition,
measurement, presentation, or disclosure in financial statements
resulting from mathematical mistakes, mistakes in the application of
generally accepted accounting principles (GAAP), or oversight or misuse
of facts that existed at the time the financial statements were
prepared. A change from an accounting principle that is not generally
accepted to one that is generally accepted is a correction of an
error.
When considering whether a change is a correction of an error, an entity should
use judgment to determine (1) whether the correct information was or should
have been “reasonably knowable” or was “readily accessible” from the
acquiree’s books and records in a prior reporting period and (2) whether use
of that information at that time would have resulted in different
reporting.
Connecting the Dots
In his remarks at the 2016 AICPA Conference on Current SEC and PCAOB Developments,
then SEC OCA Associate Chief Accountant Jonathan Wiggins noted that although ASU 2015-16
eliminated the requirement to retrospectively account for measurement-period adjustments,
it “does not change the measurement period or apply when an adjustment represents the
correction of an accounting error.” He also reminded registrants that they “should ensure they
have sufficient internal control over financial reporting to identify and account for measurement
period adjustments appropriately and separately identify accounting errors.”
Example 6-3
Accounting for an Adjustment Outside the Measurement Period
Company A acquires Company B on November 30, 20X1, in a nontaxable business combination accounted for
under ASC 805. Company A sought an independent valuation for several of the intangible assets it acquired in
the combination, but the valuation has not been completed as of the time A issues its financial statements for
the year ended December 31, 20X1. Thus, A includes a provisional measurement of the intangible assets and
the related deferred tax liabilities in its annual financial statements.
In June 20X2, A receives the final independent valuation of the intangible assets, which increases the fair
value it recorded as a provisional amount. Because this information pertained to the facts and circumstances
that existed as of the acquisition date, A adjusts its intangible-asset balances and recognizes any catch-up
amortization to account for this updated information in its interim financial statements for the quarter ended
June 30, 20X2. Company A then concludes that the measurement period has closed because it is not waiting
for any additional information regarding the provisional amounts.
In January 20X3 (i.e., after the measurement period has ended), A discovers that
although the financial statements were adjusted for
the change in fair value of its acquired intangible
assets, the related deferred tax liability was not
adjusted accordingly. Company A concludes that in
accordance with ASC 250, this was an error in the
accounting for the business combination.
6.2 Assessing Whether a Transaction Is Separate From the Business Combination
ASC 805-10
Determining What Is Part of the Business Combination Transaction
25-20 The acquirer and the
acquiree may have a preexisting relationship or other
arrangement before negotiations for the business combination
began, or they may enter into an arrangement during the
negotiations that is separate from the business combination.
In either situation, the acquirer shall identify any amounts
that are not part of what the acquirer and the acquiree (or
its former owners) exchanged in the business combination,
that is, amounts that are not part of the exchange for the
acquiree. The acquirer shall recognize as part of applying
the acquisition method only the consideration transferred
for the acquiree and the assets acquired and liabilities
assumed in the exchange for the acquiree. Separate
transactions shall be accounted for in accordance with the
relevant generally accepted accounting principles
(GAAP).
25-21 A transaction entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer
or the combined entity, rather than primarily for the benefit of the acquiree (or its former owners) before the
combination, is likely to be a separate transaction. The following are examples of separate transactions that are
not to be included in applying the acquisition method:
- A transaction that in effect settles preexisting relationships between the acquirer and acquiree (see paragraphs 805-10-55-20 through 55-23)
- A transaction that compensates employees or former owners of the acquiree for future services (see paragraphs 805-10-55-24 through 55-26)
- A transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs (see paragraph 805-10-25-23).
As part of its accounting for an acquisition, an acquirer must assess whether the items exchanged
include amounts that are separate from the business combination. In some cases, an acquirer
and seller (or acquiree) may have an arrangement or relationship — such as a supply, distribution,
franchise, or licensing agreement; lease contracts; or potential or ongoing litigation — that arose
before the negotiations for the acquisition began. ASC 805 refers to such arrangements as preexisting
relationships. In other cases, an acquirer and seller (or acquiree) may enter into agreements or
arrangements in close proximity to the business combination. ASC 805 provides guidance for assessing whether particular transactions or arrangements are part of the business combination or should be
accounted for separately from the business combination accounting.
6.2.1 Determining What Should Be Accounted for Separately From a Business Combination
To determine what is or is not part of a business combination, an entity must
consider the relevant facts and circumstances of the arrangement. ASC
805-10-25-20 states, in part, that “[t]he acquirer shall recognize as part of
applying the acquisition method only the consideration transferred for the
acquiree and the assets acquired and liabilities assumed in the exchange for the
acquiree. Separate transactions shall be accounted for in accordance with the
relevant generally accepted accounting principles (GAAP).” Specifically, ASC
805-10-55-18 provides three factors, which “are neither mutually exclusive nor
individually conclusive,” for an entity to consider when making this
determination:
-
The reasons for the transaction. Understanding the reasons why the parties to the combination (the acquirer, the acquiree, and their owners, directors, managers, and their agents) entered into a particular transaction or arrangement may provide insight into whether it is part of the consideration transferred and the assets acquired or liabilities assumed. For example, if a transaction is arranged primarily for the benefit of the acquirer or the combined entity rather than primarily for the benefit of the acquiree or its former owners before the combination, that portion of the transaction price paid (and any related assets or liabilities) is less likely to be part of the exchange for the acquiree. Accordingly, the acquirer would account for that portion separately from the business combination.
-
Who initiated the transaction. Understanding who initiated the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction or other event that is initiated by the acquirer may be entered into for the purpose of providing future economic benefits to the acquirer or combined entity with little or no benefit received by the acquiree or its former owners before the combination. On the other hand, a transaction or arrangement initiated by the acquiree or its former owners is less likely to be for the benefit of the acquirer or the combined entity and more likely to be part of the business combination transaction.
-
The timing of the transaction. The timing of the transaction may also provide insight into whether it is part of the exchange for the acquiree. For example, a transaction between the acquirer and the acquiree that takes place during the negotiations of the terms of a business combination may have been entered into in contemplation of the business combination to provide future economic benefits to the acquirer or the combined entity. If so, the acquiree or its former owners before the business combination are likely to receive little or no benefit from the transaction except for benefits they receive as part of the combined entity.
Determining what is or is not part of a business combination requires judgment, particularly when both
the acquirer and acquiree may benefit from a particular transaction.
ASC 805-10-25-21 specifies that “[a] transaction entered into by or on behalf of
the acquirer or primarily for the benefit of the acquirer or the combined
entity, rather than primarily for the benefit of the acquiree (or its former
owners) before the combination, is likely to be a separate transaction.”
However, it also states that the following are transactions that must be
accounted for separately from the business combination:
-
“A transaction that in effect settles preexisting relationships between the acquirer and acquiree” — see ASC 805-10-55-20 through 55-23 and Section 6.2.2.
-
“A transaction that compensates employees or former owners of the acquiree for future services” — see ASC 805-10-55-24 through 55-26 and Section 6.2.3.
-
“A transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisition-related costs” — see ASC 805-10-25-23 and Section 5.4.1.1.
These are examples only. Acquirers must assess whether other transactions with
the acquiree should be accounted for separately from the business
combination.
6.2.2 Effective Settlement of Preexisting Relationships Between the Acquirer and Acquiree
ASC 805-10
Effective Settlement of a Preexisting Relationship Between the Acquirer and Acquiree in a Business
Combination
55-20 The acquirer and
acquiree may have a relationship that existed before
they contemplated the business combination, referred to
here as a preexisting relationship. A preexisting
relationship between the acquirer and acquiree may be
contractual (for example, vendor and customer or
licensor and licensee) or noncontractual (for example,
plaintiff and defendant).
55-21 If the business combination in effect settles a preexisting relationship, the acquirer recognizes a gain or
loss, measured as follows:
- For a preexisting noncontractual relationship, such as a lawsuit, fair value
- For a preexisting contractual relationship, the lesser of the following:
- The amount by which the contract is favorable or unfavorable from the perspective of the acquirer when compared with pricing for current market transactions for the same or similar items. An unfavorable contract is a contract that is unfavorable in terms of current market terms. It is not necessarily a loss contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.
- The amount of any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavorable. If this amount is less than the amount in (b)(1), the difference is included as part of the business combination accounting.
55-22 Examples 2 and 3 (see paragraphs 805-10-55-30 through 55-33) illustrate the accounting for the
effective settlement of a preexisting relationship as a result of a business combination. As indicated in
Example 3 (see paragraph 805-10-55-33), the amount of gain or loss recognized may depend in part on
whether the acquirer had previously recognized a related asset or liability, and the reported gain or loss
therefore may differ from the amount calculated by applying paragraph 805-10-55-21.
55-23 A preexisting relationship may be a contract that the acquirer recognizes as a reacquired right in
accordance with paragraph 805-20-25-14. If the contract includes terms that are favorable or unfavorable
when compared with pricing for current market transactions for the same or similar items, the acquirer
recognizes, separately from the business combination, a gain or loss for the effective settlement of the
contract, measured in accordance with paragraph 805-10-55-21.
A preexisting relationship between an acquirer and acquiree may be contractual
(e.g., a lease contract or a supply, distribution, franchise, licensing, or debt
agreement) or noncontractual (e.g., a dispute or litigation between the acquirer
and the seller or acquiree). Such a relationship is considered effectively
settled as part of the business combination even if it is not legally cancelled
since, upon the acquisition date, it becomes an “intercompany” relationship that
is eliminated in consolidation in the postcombination financial statements. A
reacquired right is also a preexisting relationship (see Section 4.3.7). When
there is more than one contract or agreement between the parties to the business
combination, the effective settlement of each preexisting relationship should be
assessed separately. ASC 805 provides guidance on measuring any gain or loss
from the effective settlement of a preexisting relationship. The measurement
depends on whether the relationship is contractual or noncontractual, as
discussed below.
6.2.2.1 Effective Settlement of a Noncontractual Preexisting Relationship
If a business combination results in the effective settlement of a noncontractual preexisting relationship
such as a lawsuit, threatened litigation, or dispute, the gain or loss should be recognized and measured
at fair value in accordance with the guidance in ASC 805-10-55-21. However, measuring the fair value of
the effective settlement of such a noncontractual preexisting relationship may be challenging, and the
gain or loss may differ from the amount the acquirer previously recognized, if any. For example, the fair
value of the settlement of a lawsuit would most likely differ from the amount the acquiree would have
recognized under ASC 450.
In his remarks at the 2007 AICPA Conference on Current SEC and
PCAOB Developments, then SEC OCA Associate Chief Accountant Eric West
discussed the accounting for litigation settlements that occur in
combination with other arrangements. He stated, in part:
[W]e believe that it would be acceptable to value each element of the
arrangement and allocate the consideration paid to each element using
relative fair values. To the extent that one of the elements of the
arrangement just can’t be valued, we believe that a residual approach
may be a reasonable solution. In fact, we have found that many companies
are not able to reliably estimate the fair value of the litigation
component of any settlement and have not objected to judgments made when
registrants have measured this component as a residual. In a few
circumstances companies have directly measured the value of the
litigation settlement component.
These remarks indicate that if an entity cannot measure the fair value of an
element of a transaction, such as litigation, it can measure the element as
a residual. However, we believe that the measurement of the fair value of
the acquiree should exclude any preexisting relationships. That is, while a
market participant would include the preexisting relationship in its
measurement of the acquiree, the guidance requires the acquirer to account
for that preexisting relationship separately from the business combination.
Therefore, the acquirer’s measurement of the acquiree should be exclusive of
any relationships that are effectively settled as part of the
combination.
While Mr. West’s speech was delivered before FASB Statement 141(R) was issued,
we believe that the guidance continues to be relevant under ASC 805.
Example 6-4
Effective Settlement of a Lawsuit in a Business Combination
Company A files a lawsuit against Company B for unauthorized use of A’s
intellectual property. Company A concludes that any
potential settlement with B would be a contingent
gain and therefore does not recognize an asset in
its financial statements. Likewise, B does not
recognize a liability in its financial statements
for the contingent loss related to the lawsuit
because it believes that no amount of loss is
probable. Company A acquires B and accounts for the
acquisition as a business combination.
As part of the accounting for the acquisition, A determines that a gain exists
related to the effective settlement of the lawsuit.
Company A should measure that gain at fair value and
recognize it separately from the accounting for the
acquisition. If A cannot directly determine the
lawsuit’s fair value, A can measure it as the
difference between the amount paid for the
acquisition and the fair value of B without the
lawsuit. While a market participant would include
the lawsuit in its measurement of B, we believe that
A’s exclusion of it is consistent with the
requirement to account for preexisting relationships
separately from the business combination.
6.2.2.2 Effective Settlement of a Contractual Preexisting Relationship
When a business combination results in the effective settlement of a preexisting contractual
relationship, entities should recognize and measure the resulting gain or loss in accordance with
the guidance in ASC 805-10-55-21(b). That guidance requires that the settlement gain or loss for a
contractual preexisting relationship be measured as the lesser of the following:
- “The amount by which the contract is favorable or unfavorable from the perspective of the acquirer when compared with pricing for current market transactions for the same or similar items. An unfavorable contract is a contract that is unfavorable in terms of current market terms. It is not necessarily a loss contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.”
- “The amount of any stated settlement provisions in the contract available to the counterparty to whom the contract is unfavorable. If this amount is less than the amount in (b)(1), the difference is included as part of the business combination accounting.”
If a contractual preexisting relationship is cancelable by either party without
penalty, the stated settlement provision is zero and no settlement gain or
loss should be recognized regardless of whether the contract is favorable or
unfavorable to the acquirer. However, if there are no stated settlement
provisions and the contract is not cancelable, entities should recognize a
settlement gain or loss on the basis of the amount by which the contract is
favorable or unfavorable to the acquirer (i.e., on the basis of the settled
contract’s acquisition-date fair value). ASC 805 provides the following
example to illustrate the accounting for the effective settlement of a
preexisting relationship when an acquirer does not have an amount previously
recognized related to the contract:
ASC 805-10
Example 2: Effective Settlement of a Supply Contract as a Result of a Business Combination
55-30 This Example
illustrates the guidance in paragraphs 805-10-55-20
through 55-21. Acquirer purchases electronic
components from Target under a five-year supply
contract at fixed rates. Currently, the fixed rates
are higher than rates at which Acquirer could
purchase similar electronic components from another
supplier. The supply contract allows Acquirer to
terminate the contract before the end of the initial
5-year term only by paying a $6 million penalty.
With 3 years remaining under the supply contract,
Acquirer pays $50 million to acquire Target, which
is the fair value of Target based on what other
market participants would be willing to pay.
55-31 Included in the total fair value of Target is $8 million related to the fair value of the supply contract with
Acquirer. The $8 million represents a $3 million component that is at-market because the pricing is comparable
to pricing for current market transactions for the same or similar items (selling effort, customer relationships,
and so forth) and a $5 million component for pricing that is unfavorable to Acquirer because it exceeds the
price of current market transactions for similar items. Target has no other identifiable assets or liabilities
related to the supply contract, and Acquirer has not recognized any assets or liabilities related to the supply
contract before the business combination.
55-32 In this Example, Acquirer recognizes a loss of $5 million (the lesser of the $6 million stated settlement
amount and the amount by which the contract is unfavorable to the acquirer) separately from the business
combination. The $3 million at-market component of the contract is part of goodwill.
6.2.2.3 Settlement of a Preexisting Relationship if the Acquirer Had Previously Recognized an Asset or Liability
If an acquirer has recognized an asset or liability related to the preexisting
relationship before the acquisition, it should include that amount in
calculating the settlement gain or loss. The scenario in Example 2 in ASC
805-10-55-30 through 55-32 is continued below in Example 3, which illustrates
the accounting for the effective settlement of a preexisting relationship when
an acquirer has an amount previously recognized related to the contract.
ASC 805-10
Example 3: Effective Settlement of a Contract
Between the Acquirer and Acquiree in Which the
Acquirer Had Recognized a Liability Before the
Business Combination
55-33 This
Example illustrates the guidance in paragraphs
805-10-55-20 through 55-21. Whether Acquirer had
previously recognized an amount in its financial
statements related to a preexisting relationship will
affect the amount recognized as a gain or loss for the
effective settlement of the relationship. In Example 2
(see paragraph 805-10-55-30), generally accepted
accounting principles (GAAP) might have required
Acquirer to recognize a $6 million liability for the
supply contract before the business combination. In that
situation, Acquirer recognizes a $1 million settlement
gain on the contract in earnings at the acquisition date
(the $5 million measured loss on the contract less the
$6 million loss previously recognized). In other words,
Acquirer has in effect settled a recognized liability of
$6 million for $5 million, resulting in a gain of $1
million.
Example 6-4A
Company A acquires all of the outstanding shares of
Company B in a business combination by paying $1 million
in cash to the former owners of B. On the acquisition
date, A has a $50,000 account receivable from B, and B
has an equal account payable to A.
As a result of the acquisition of B, the account
receivable and payable is effectively settled between
the parties. Accordingly, the consideration transferred
for B is $1,050,000 (i.e., $1 million in cash plus the
forgiveness of the accounts receivable). Because there
is no off-market amount or stated settlement provisions,
A does not recognize a gain or loss upon the
settlement.
6.2.2.3.1 Effective Settlement of Debt Between the Parties to a Business Combination
A business combination may result in the effective settlement of debt between
an acquirer and an acquiree. If the acquirer was the issuer of the debt and
it is settled as a result of the business combination, the acquirer would
apply the guidance in ASC 470-50 to account for the debt extinguishment. An
extinguishment gain or loss would be recognized if the reacquisition price
(fair value or stated settlement amount) differs from the net carrying
amount of the debt. Any settlement gain or loss would be recognized
separately from the business combination.
Example 6-4B
On January 1, 20X2, Company A issued $50,000 in debt
securities to Company B. On June 30, 20X3, A
acquires all of the outstanding shares of B in a
business combination by paying $1 million in cash to
the former owners of B. On the acquisition date, the
carrying amount of the debt is $40,000 and its fair
value is $41,000.
As a result of the acquisition of B, A would
recognize a $1,000 loss related to the settlement of
the debt securities with B, calculated as the amount
by which the fair value of the debt exceeds its
carrying amount. The consideration transferred for B
is $959,000, calculated as the cash paid to the
former owners of B less the fair value of the
debt.
If the acquiree was the issuer of the debt and it is settled
as a result of the business combination, the acquirer would be effectively
settling a receivable and would apply the guidance in ASC 805-10-55-21
related to the settlement of preexisting relationships in a business
combination. See the next section for more information.
6.2.2.4 Settlement of a Preexisting Relationship if the Acquirer Is a Customer of the Acquiree
If an entity acquires one of its vendors (i.e., the acquirer was a customer of
the acquiree) in a business combination, the acquirer should recognize a
settlement gain or loss in accordance with ASC 805-10- 55-21 for the effective
settlement of any contractual arrangements. However, even though the parties
have a preexisting relationship, the acquirer would not recognize a
customer-relationship intangible asset for its relationship with its former
vendor because the customer relationship no longer exists after the acquisition
(i.e., the acquirer would not record a customer relationship with itself as a
result of the business combination). The guidance in ASC 805-10-55-32 (see
above) demonstrates that the acquirer should not recognize a separate intangible
asset for the customer relationship; instead, that amount should be part of
goodwill.
6.2.2.5 Settlement of a Preexisting Relationship When Less Than 100 Percent of the Acquiree Is Acquired
The SEC staff has discussed the accounting for a preexisting
relationship in a less than 100 percent acquisition. In prepared remarks at the 2005 AICPA Conference on Current SEC and
PCAOB Developments, then SEC OCA Professional Accounting Fellow Brian Roberson
discussed preexisting relationships between parties to a business combination in
a partial acquisition:
One issue that has arisen is whether this issue applies
to other than 100 percent acquisitions and, if so, how it is applied.
The answer is that it applies anytime you have something that qualifies
as a business combination. The harder part of the question is how to
value the preexisting relationship and that is where facts and
circumstances come into play.
For instance, assume you own 40 percent of an entity and
another party owns 60 percent and that you have an unfavorable supply
contract with the entity. If you buy an additional 15 percent interest
in the entity and you, as the new controlling shareholder, have the
ability to cancel the supply contract, you would likely have to pay the
other shareholder its entire portion of the value of the supply contract
since it will be giving up its favorable position in the contract. If,
on the other hand, you buy the same 15 percent interest but cannot
cancel the contract, you would likely only pay the other shareholder the
value of the 15 percent interest in the contract as the other
shareholder will still realize value for the 45 percent interest it
retained. I do not mean to imply that all valuations will be this
straightforward, but the important point is that determining the
settlement gain or loss in a partial acquisition is not a simple
mathematical exercise - you need to step back and consider all of the
facts and circumstances and the impact they would have on the value lost
or gained by the other interest holders.
While the SEC staff made these remarks before the FASB issued Statement 141(R),
we believe that they continue to be relevant.
6.2.2.6 Reacquired Rights
ASC 805-10
55-23 A preexisting relationship may be a contract that the acquirer recognizes as a reacquired right in
accordance with paragraph 805-20-25-14. If the contract includes terms that are favorable or unfavorable
when compared with pricing for current market transactions for the same or similar items, the acquirer
recognizes, separately from the business combination, a gain or loss for the effective settlement of the
contract, measured in accordance with paragraph 805-10-55-21.
A preexisting relationship may represent a reacquired right of the acquirer — for example, a “right to
use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s technology
under a technology licensing agreement.” All reacquired rights are preexisting relationships, even
though all preexisting relationships are not reacquired rights. If a preexisting relationship represents a
reacquired right, the acquirer recognizes a settlement gain or loss, if any, separately from the business
combination measured in accordance with ASC 805-10-55-21.
The acquirer also recognizes a reacquired right as an identifiable intangible
asset separately from goodwill because it arises from contractual rights.
However, reacquired rights are an exception to the measurement principle in
ASC 805 because such rights must be measured on the basis of the remaining
contractual term of the related contract, regardless of whether market
participants would consider potential contractual renewals in determining
the fair value of those rights. See Section 4.3.7 for more information
about the measurement of reacquired rights.
6.2.2.7 Reimbursement of the Acquirer’s Acquisition-Related Costs
ASC 805-10-25-21(c) specifies that “[a] transaction that reimburses the acquiree or its former owners
for paying the acquirer’s acquisition-related costs” is a separate transaction that should not be
included in the application of the acquisition method. That is, if the acquirer and acquiree enter into an
arrangement in which the acquiree pays the acquirer’s acquisition-related costs and the acquirer agrees
to reimburse the acquiree either as part of the consideration transferred or otherwise, such costs must be accounted for separately from the business combination in accordance with their nature and
not as part of the consideration transferred. See Section 5.4.1 for guidance on the accounting for the
acquirer’s acquisition-related costs.
6.2.3 Compensation Arrangements
An acquiree in a business combination may have agreements in place to provide specified employees
with additional compensation that is predicated on a change in control of the acquiree. Such
arrangements could have been established either before or after the negotiations began for the
business combination. When determining whether the acquirer should account for these arrangements
as part of the business combination or separately as compensation, entities must use judgment and
consider the specific facts and circumstances as discussed below. However, if a business combination
results in additional compensation arrangements that include payments to the acquirer’s employees,
such payments are always compensation.
6.2.3.1 Arrangements to Pay an Acquiree’s Employee Upon a Change in Control
Arrangements may be established with the objective of retaining one or more of
the acquiree’s employees until the acquisition date and possibly for a
defined period thereafter. Such arrangements — often referred to in practice
as “stay bonuses,” “change in control payments,” or “golden parachutes” —
may also provide additional compensation for performance related to the
business combination or compensate employees who are terminated after the
combination. An entity should account for these arrangements on the basis of
their substance. In assessing the substance of an arrangement, an entity
should consider the factors listed in ASC 805-10-55-18 (i.e., “[t]he reasons
for the transaction,” “[w]ho initiated the transaction,” and “[t]he timing
of the transaction”). See Section 10.7.1 of Deloitte’s Roadmap Share Based Payment
Awards for more information.
ASC 805-10-55-34 through 55-36 provide the following example of a contingent
payment to an acquiree’s employee:
ASC 805-10
Example 4: Arrangement for Contingent Payment to an Employee
55-34 This Example
illustrates the guidance in paragraphs 805-10-55-24
through 55-25 relating to contingent payments to
employees in a business combination. Target hired a
candidate as its new chief executive officer under a
10-year contract. The contract required Target to
pay the candidate $5 million if Target is acquired
before the contract expires. Acquirer acquires
Target eight years later. The chief executive
officer was still employed at the acquisition date
and will receive the additional payment under the
existing contract.
55-35 In this Example, Target entered into the employment agreement before the negotiations of the
combination began, and the purpose of the agreement was to obtain the services of the chief executive
officer. Thus, there is no evidence that the agreement was arranged primarily to provide benefits to Acquirer
or the combined entity. Therefore, the liability to pay $5 million is included in the application of the acquisition
method.
55-36 In other circumstances, Target might enter into a similar agreement with the chief executive officer at the
suggestion of Acquirer during the negotiations for the business combination. If so, the primary purpose of the
agreement might be to provide severance pay to the chief executive officer, and the agreement may primarily
benefit Acquirer or the combined entity rather than Target or its former owners. In that situation, Acquirer
accounts for the liability to pay the chief executive officer in its postcombination financial statements separately
from application of the acquisition method.
In accounting for the acquisition, the acquirer will need to assess whether to
recognize amounts that have been determined to be part of the business
combination as part of the consideration transferred or as a liability
assumed.
If the acquirer issues cash, other assets, or its equity instruments to settle
the acquiree’s awards that were equity-classified in the acquiree’s
precombination financial statements, the portion determined to be part of
the business combination represents consideration transferred since the
acquiree’s employees were owners of (or increased their ownership in) the
acquiree as a result of the arrangement.
By contrast, if the acquirer issues cash, other assets, or its equity
instruments to settle a bonus arrangement (e.g., stay bonus) with the
acquiree’s employees or to settle the acquiree’s awards that were
liability-classified in the acquiree’s precombination financial statements,
the portion determined to be part of the business combination would be
treated in the acquisition accounting as a liability assumed.
If arrangements to pay an acquiree’s employees upon a change in control are
settled in cash or in other assets after the acquisition date rather than at
the closing of the business combination, the acquirer would recognize a
liability in its acquisition accounting for the portion determined to be
part of the business combination. In the acquisition accounting, the nature
of that liability as either consideration transferred or a liability assumed
should be determined on the basis of the analysis described above.
6.2.3.2 Dual- or Double-Trigger Arrangements
An employment agreement entered into before negotiations began for the business
combination may include terms that require a payment or accelerate vesting
upon (1) a change of control and (2) a second defined event or
“trigger,” which is why such provisions are commonly called “dual trigger”
or “double trigger” arrangements. The second defined event is generally the
separation of the employee from the acquirer and might be limited to
involuntary terminations or might also include resignation of the employee
in specified conditions (sometimes referred to as “good reasons”) such as:
-
A demotion or significant reduction in the employee’s duties or responsibilities after the acquisition date.
-
A significant reduction in the employee’s salary after the acquisition date.
-
The relocation of the employee’s job site beyond a specified radius after the acquisition date.
The objective of such employment agreements, which are typically entered into
before negotiations have begun for a business combination, is generally to
obtain the employee’s services. While the three factors in ASC 805-10-55-18
(i.e., “[t]he reasons for the transaction,” “[w]ho initiated the
transaction,” and “[t]he timing of the transaction”) might indicate that the
payments should be accounted for as part of the business combination, such
arrangements are generally accounted for separately from the business
combination. This is because the decision to effect the second trigger
(i.e., the employee’s involuntary termination or voluntary termination for
“good reason”) is under the control of the acquirer and is therefore
presumed to be made primarily for the acquirer’s benefit (e.g., to reduce
cost by eliminating the unneeded employee).
Example 6-5
Dual- or Double-Trigger Arrangement Involving the Termination of Employment
Company A acquires Company B in a transaction accounted for as a business combination. Company B has
an existing employment agreement with its CEO that was put in place before negotiations began for the
combination. Under the agreement, all of the CEO’s unvested awards will fully vest upon (1) a change in the
control of B and (2) the involuntary termination of the CEO’s employment within one year after the acquisition
date.
Before the closing, A determines that it will not offer employment to the CEO after the combination has been
completed. Thus, both conditions are triggered, and the vesting of the CEO’s awards is accelerated upon the
closing of the acquisition.
The decision not to employ B’s former CEO was under A’s control and was made for
A’s benefit (i.e., to reduce costs). Therefore, A
should recognize the compensation cost related to
the acceleration of the unvested portion of the
awards in its postcombination financial statements
and not as part of the business combination.
Example 6-6
Dual- or Double-Trigger Arrangement in Which Employee Resigns for “Good Reason”
As in the example above, Company A acquires Company B in a transaction accounted
for as a business combination, and B has an existing
employment agreement with its CEO. However, in this
example, the agreement provides that all of the
CEO’s unvested awards will fully vest upon (1) a
change in the control of B and (2) either the
involuntary termination of the CEO or the voluntary
departure of the CEO for “good reason” within one
year after the acquisition date. The agreement
specifies that a significant reduction in job
responsibilities would be a good reason. After the
acquisition date, B’s CEO will not assume the role
of CEO of the combined entity but instead will be
assigned a position with significantly reduced
responsibilities. In response, B’s CEO will resign
upon the change in control.
The decision to significantly reduce the responsibilities of B’s former CEO
after the acquisition date is within A’s control.
Therefore, A should recognize the compensation cost
related to the acceleration of the unvested portion
of the awards in its postcombination financial
statements and not as part of the business
combination.
6.2.3.3 Arrangements for Contingent Payments to Employees or Selling Shareholders
ASC 805-10
55-24 Whether arrangements for contingent payments to employees or selling shareholders are contingent
consideration in the business combination or are separate transactions depends on the nature of the
arrangements. Understanding the reasons why the acquisition agreement includes a provision for contingent
payments, who initiated the arrangement, and when the parties entered into the arrangement may be helpful
in assessing the nature of the arrangement.
During negotiations of the business combination, an acquirer may agree to a provision for contingent
payments to employees or selling shareholders after the acquisition date. Such payments may be
in cash, other assets, the acquirer’s equity instruments, or a combination thereof. The acquirer
must evaluate any contingent payments (i.e., payments that include conditions other than the
passage of time) to the acquiree’s former shareholders to determine whether they represent
(1) consideration transferred (i.e., contingent consideration), which is part of the business combination,
or (2) compensation, which is a transaction separate from the business combination. Payments to
individuals who were not shareholders or owners of the acquiree before an acquisition should be
accounted for as transactions that are separate from the business combination in accordance with the
nature of the payment. Accordingly, contingent payments to individuals who were not the acquiree’s owners but become employees of the combined entity should be accounted for as compensation in the
acquirer’s postcombination financial statements.
When deciding whether a contingent payment to a shareholder of the acquiree who
becomes an employee of the combined entity is part of the consideration
transferred or a transaction that is separate from the business combination,
the acquirer should first consider the factors in ASC 805-10-55-18.
Specifically, by applying the factors in ASC 805-10-55-18(a) and (b) to
determine the reason for the payment and who initiated it, the acquirer may
gain insight into the nature and intent of an arrangement. In addition, we
note that in practice, the only time an acquirer would negotiate a payment
to a shareholder of the acquiree that is contingent on the shareholder’s
becoming an employee of the combined entity would be during the period
leading up to the acquisition; thus, the guidance in ASC 805-10-55-18(c) on
the timing of a transaction suggests that such a payment would be a separate
transaction. However, the factors in ASC 805-10-55-18 are not intended to be
a checklist, and no one factor is determinative.
Further, an acquirer should consider the following indicators in ASC
805-10-55-25 “[i]f it is not clear whether an arrangement for payments to
employees or selling shareholders is part of the exchange for the acquiree
or is a transaction separate from the business combination”:
-
Continuing employment — see Section 6.2.3.3.1.
-
Duration of continuing employment — see Section 6.2.3.3.2.
-
Level of compensation — see Section 6.2.3.3.3.
-
Incremental payments to employees — see Section 6.2.3.3.4.
-
Number of shares owned — see Section 6.2.3.3.5.
-
Linkage to valuation — see Section 6.2.3.3.6.
-
Formula for determining compensation — see Section 6.2.3.3.7.
-
Other arrangements and issues — see Section 6.2.4.
According to ASC 805-10-55-24, “whether arrangements for contingent payments to
employees or selling shareholders are contingent consideration in the
business combination or are separate transactions depends on the nature of
the arrangements.” While ASC 805-10-55-25(a) (i.e., the continuing
employment factor — see Section 6.2.3.3.1) states that “a contingent consideration
arrangement in which the payments are automatically forfeited if employment
terminates is compensation for postcombination
services” (emphasis added), the other indicators in ASC 805-10-55-25 are not
as conclusive. Thus, in the absence of the automatic forfeiture condition
described in ASC 805-10-55-25(a), an acquirer must use judgment to determine
the nature of an arrangement, especially if not all indicators point to the
same conclusion.
6.2.3.3.1 Continuing Employment
ASC 805-10
55-25(a) Continuing employment. The terms of continuing employment by the selling shareholders who
become key employees may be an indicator of the substance of a contingent consideration arrangement.
The relevant terms of continuing employment may be included in an employment agreement, acquisition
agreement, or some other document. A contingent consideration arrangement in which the payments are
automatically forfeited if employment terminates is compensation for postcombination services. Arrangements
in which the contingent payments are not affected by employment termination may indicate that the
contingent payments are additional consideration rather than compensation.
If an arrangement requires a contingent payment to a selling shareholder who
becomes an employee of the combined entity to be forfeited upon the
termination of the shareholder’s employment, the acquirer must account
for the arrangement as compensation in its postcombination financial
statements. Such a determination cannot be overcome by consideration of
the other indicators in ASC 805-10-55-25.
Example 6-7
Payment Contingent on Continuing Employment
Company A acquires Company B in a transaction accounted for as a business
combination. Company B’s three shareholders are
executive officers of B and agree to become
employees of A after the acquisition. Under the
terms of the acquisition agreement, each
shareholder of B is entitled to an additional
payment at the end of three years after the
acquisition date if a specified revenue target is
met and the individual is
still employed by A.
Because the future payment for each shareholder of B is contingent on continued
employment with A after the acquisition, A should
recognize each arrangement as compensation in the
postcombination period and not as contingent
consideration in the business combination.
Assume the same facts as those above, except that under the terms of the acquisition agreement, each of the three shareholders would be entitled to the additional payment if they are no longer employed by A at the end of three years because of death, disability, or involuntary termination. If the shareholders are no longer employed by A at the end of three years because of voluntary resignation or because they were terminated for cause, they would not be entitled to the additional payment. Even though there are situations in which the shareholders could receive the additional payment without being employed by A at the end of three years, we believe that the future payment for each shareholder of B is contingent on continued employment with A after the acquisition. Therefore, A should recognize each arrangement as compensation in the postcombination period and not as contingent consideration in the business combination.
Example 6-8
Contingent Payment Reverts to Nonemployee Shareholder if
Employment Terminates
Company A acquires Company B from a single selling shareholder in a transaction
accounted for as a business combination. Company A
hires B’s top salesperson and agrees to pay the
individual a percentage of sales above a specified
amount at the end of each year for three years
provided the individual is employed by A at the
end of each year. If the individual is not
employed at a year-end, any amount due under the
arrangement will instead be paid to B’s selling
shareholder.
Even though A is required to make the payments regardless of whether the salesperson remains employed by
A, we believe that the substance of the arrangement is to induce the individual to remain employed. Therefore,
A should account for the payments as compensation in its postcombination financial statements and not as
part of the consideration transferred for the acquiree.
Arrangements with a shareholder of the acquiree who becomes an employee of the combined entity
may contain some elements that are linked to continuing employment and some that are not. Because
ASC 805-10-55-25(a) specifies that “a contingent consideration arrangement in which the payments
are automatically forfeited if employment terminates is compensation for postcombination services,” a
question arises regarding whether linking any portion of the arrangement to continuing employment
causes the entire arrangement to be compensation for postcombination services. We believe that if
arrangements involve a single shareholder of the acquiree who becomes an employee of the combined
entity, an acquirer should separately account for each element.
Example 6-9
Contingent Payment Affected in Part by Continuing Employment
Company A acquires Company B in a transaction accounted for as a business combination. One of B’s
shareholders (Shareholder Y) is an executive officer of B and agrees to become an employee of A after the
acquisition. Under the terms of the acquisition agreement, all selling shareholders of B are entitled to an
additional payment at the end of the first year after the acquisition date if certain performance targets have
been met for that year; however, any amount due to Y will be paid at the end of the first year only if Y is then
employed by A. If Y is not employed by A at that time, any contingent amount due under the acquisition
agreement will be distributed at the end of the fifth year after the acquisition date.
Since it is possible for the executive officer to receive a payment even if he or she is no longer employed by A,
we believe that it is appropriate for A to isolate the element that is contingent on continuing employment and
account for that element as compensation in its postcombination financial statements. In this example, A is
likely to measure the compensatory element of the arrangement as the value of receiving the amount that is
due in one year rather than in five years.
Arrangements such as this might be viewed as containing a “floor” amount that is
not affected by continued employment, and thus
that amount is appropriately accounted for as
contingent consideration in the business
combination as long as it satisfies the other
criteria for contingent consideration in ASC
805-10-55-25.
In general, if more than one shareholder of the acquiree becomes an employee of the combined
entity and one or more of those individuals are required to continue employment, the arrangement
is compensatory and not part of the exchange for the acquiree. However, there may be diversity in
practice related to these arrangements.
Example 6-10
Payment Contingent on the Continued Employment of a Specific Employee
Company A acquires Company B in a transaction accounted for as a business combination. One of B’s three
shareholders, its CEO, agrees to become A’s employee after the acquisition. The terms of the acquisition
agreement require A to make an additional payment if B’s CEO is employed by A at the end of three years.
The payment, if due, would be divided among the three shareholders on the basis of their relative ownership
percentages in B. However, if B’s CEO is not employed by A for the full three-year period, none of the
shareholders will receive their portion of the payment.
We believe that Company A should account for the entire payment as compensation in the postcombination
period because all of the payment is contingent on continued employment, albeit on only one person’s
employment.
We are also aware of an alternative view in which only the payments to the CEO
would be considered contingent on continued
employment and therefore be compensation. Under
that view, the payments to the other two
shareholders should be evaluated in accordance
with the other factors in ASC 805-10-55-25.
The guidance in ASC 805-10-55-25(a) requires contingent consideration arrangements to be accounted
for as compensation if the payments would be automatically forfeited upon the termination of
employment. We believe that when evaluating a provision for forfeiture in the event of employment
termination, an entity should assess the substance of any defined stay period. Accordingly, we believe
that on the basis of an evaluation of the other indicators in ASC 805-10-55-25, an entity could conclude
in unusual circumstances that payments that are contingent on a nonsubstantive stay period are eligible
to be accounted for as consideration transferred. We expect such circumstances to be rare.
Example 6-11
Postcombination Service Requirement Might Be Viewed as Nonsubstantive
Company A acquires Company B in a transaction accounted for as a business combination. Company B’s
three shareholders are executive officers of B and agree to become employees of A after the acquisition. The
terms of the acquisition agreement require that A pay B’s shareholders (1) 50 percent of the consideration at
the closing of the acquisition and (2) 50 percent of the consideration if the employees are employed by A one
month after the closing of the acquisition. The payment will be divided among the shareholders on the basis of
their relative ownership percentages in B. The amount of the contingent payment far exceeds the salary and
benefits that the employees would earn in a one-month period.
We believe that before determining that the 50 percent payable one month after
the closing is consideration transferred, entities
should evaluate the reason for the agreed-upon
employment period, the nature of the employees’
activities, and other evidence to assess whether
the required stay period is substantive. If it is
determined to be nonsubstantive, further analysis
of the specific facts and circumstances and the
other factors in ASC 805-10-55-25 is
necessary.
Example 6-12
Conditional Payment Disproportional to Payment at Closing
Company A acquires Company B, a manufacturing company, in a transaction accounted for as a business
combination. Company B is a substantive operating company with revenues, expenses, inventory, PP&E,
customers and customer contracts, and liabilities. Company A determines that B’s fair value on the acquisition
date is $20 million. Company B’s three shareholders are executive officers of B and agree to become
employees of A after the acquisition.
The terms of the acquisition agreement require A to pay B’s shareholders (1) $1
million in cash consideration at the closing of
the acquisition and (2) $25 million in three years
from the acquisition date if the
shareholders/employees remain employed by A. The
conditional payment would be divided among those
shareholders on the basis of their relative
ownership percentages in B.
While the future payment is contingent on the executive officers’ continuing
employment with A after the acquisition, we
believe that it is not clear whether the guidance
in ASC 805-10-55-25(a) is applicable because of
the insignificant amount of the consideration paid
at closing compared with B’s fair value.
For example, if A accounts for the contingent payment as compensation on the
basis of applying ASC 805-10-55-25(a), it will be
expected to recognize a bargain purchase gain (the
difference between the $1 million in consideration
transferred and the fair value of the net assets
acquired as of the acquisition date) and
compensation over the next five years. We believe
that such facts might indicate that a portion of
the future payments (i.e., the portion
representing B’s fair value) should be accounted
for as consideration transferred and the remainder
should be accounted for as compensation in the
postcombination period. Further analysis of the
specific facts and circumstances is warranted.
6.2.3.3.1.1 Arrangements to Reallocate Forfeited Awards or Amounts
An acquirer may issue share-based payment awards to a group of shareholders of the acquiree, all
of whom become employees of the combined entity with such awards subject to vesting based on
continued employment. The awards may be placed in a trust by the acquirer on the acquisition date.
Such arrangements are sometimes referred to as “last man standing” arrangements if any forfeited
awards must be reallocated to the remaining participants in the group. Some arrangements may not
specify what happens if none of the participants are still employed by the acquirer at the end of the
term; however, since these arrangements typically encompass many employees, it would be unlikely
that none remain. Other arrangements may specify that the amounts revert to the acquiree’s former
shareholders if none of the participants are still employed at the end of the term.
In his remarks at the 2000 AICPA Conference on Current SEC Developments, then SEC OCA Professional
Accounting Fellow R. Scott Blackley provided the following example of such an arrangement:
For illustration, consider an example business combination where a company acquires another enterprise,
XYZ Company, for cash and stock. All of the shareholders of XYZ Company are also employees. The acquiring
company expects and desires to have the employee shareholders of XYZ Company continue as employees of
the combined companies. Accordingly, of the shares issued to the shareholders of XYZ Company, a portion is
held in an irrevocable trust, subject to a three year vesting requirement (“forfeiture shares”).
The forfeiture provision requires that if, prior to vesting, a shareholder resigns from employment or is
terminated for cause, the shares held in the trust allocable to the employee shareholder be forfeited.
Additionally, any shares actually forfeited are reallocated to the remaining employee shareholders based on
their remaining ownership interests such that all of the forfeiture shares in the trust will ultimately be issued.
Mr. Blackley said that in this scenario, the SEC staff concluded that “the
forfeiture shares must be accounted for as a compensation
arrangement.” He noted that the staff placed “significant weight” on
the shares’ vesting on the basis of continued employment even though the amount of consideration was fixed because it would not be returned to the acquirer under any circumstances. Although Mr. Blackley made these remarks before Statement 141(R) was issued, we
believe that they remain relevant.
Therefore, in an arrangement in which share-based payment awards are issued to a
group of shareholders of the acquiree, all of whom become employees
of the combined entity on the basis of a requirement to continue
employment, the forfeiture and subsequent redistribution of the
awards are accounted for as (1) the forfeiture of the original award
and (2) the grant of a new award. That is, the acquirer would
reverse any compensation previously recognized for the forfeited
award (on the basis of the original grant-date fair-value-based
measure) and then recognize compensation for the new award (on the
basis of the fair-value-based measure on the date the award is
redistributed) over the remaining requisite service period.
Example 6-13
Arrangement to Reallocate Forfeited Awards to Remaining Shareholders/Employees
On January 1, 20X1, Company A acquires Company B and, as part of the acquisition agreement, grants each
of B’s 10 shareholders/employees 100 new share-based payment awards that vest at the end of five years of
service (cliff vesting). The grant-date fair-value-based measure of each award as of the acquisition date is $10.
The terms of the award state that if employment is terminated before the end of five years (i.e., the vesting
date), the employee’s awards are forfeited and redistributed among the remaining employees within the group.
The total grant-date fair-value-based measure of the awards as of the acquisition date is $10,000
(10 employees × 100 awards × $10 grant-date fair-value-based measure), which A recognizes in the
postcombination financial statements as compensation cost over the five-year service period ($2,000 per year).
On December 31, 20X3, two employees in the group terminate their employment and forfeit their awards,
which are then redistributed to the eight remaining group members. The fair-value-based measure of each
redistributed (i.e., new) award is $12 on the date the awards are redistributed.
On December 31, 20X3, A should reverse $1,200 of previously recognized
compensation cost (2 employees × 100 awards × $10
grant-date fair value × 60% for 3 out of 5 years
of services rendered) corresponding to the
forfeited awards. Company A should continue to
recognize $1,600 in annual compensation cost (8
employees × 100 awards × $10 grant-date fair value
÷ 5 years) over each of the remaining two years of
service for the original awards provided to the
remaining employees. In addition, A should
recognize $1,200 in additional annual compensation
cost (200 awards × $12 grant-date fair value ÷ 2
years of remaining service) over each of the
remaining two years of service for the
redistributed awards.
In some cases, payments to the shareholders/employees may be made in cash rather than forfeitable
shares. We do not believe that the form of the payment affects the conclusion that such arrangements
are based on continued employment and therefore should be accounted for as compensation and not
as part of the exchange for the acquiree.
6.2.3.3.1.2 Refundable Payments or Forgiveness of Loans to Selling Shareholders Who Become Employees of the Combined Entity
An acquirer may structure a contingent consideration arrangement such that payments to selling
shareholders who become employees of the combined entity are distributed in advance but must be
returned if specified conditions are not met. Such amounts might be characterized as refundable payments or loans subject to
forgiveness and should be evaluated in accordance with the guidance in ASC
805-10-55-25(a). Accordingly, if the selling shareholders must remain employed by the combined entity
for the amount to not become refundable or for the loan to be forgiven, the acquirer should account for the arrangement as compensation rather
than contingent consideration.
6.2.3.3.2 Duration of Continuing Employment
ASC 805-10
55-25(b) Duration of
continuing employment. If the period of required
employment coincides with or is longer than the
contingent payment period, that fact may indicate
that the contingent payments are, in substance,
compensation.
ASC 805-10-55-25(b) states, in part, that “[i]f the period of required employment coincides with or is longer
than the contingent payment period, that fact may indicate that the
contingent payments are, in substance, compensation” (emphasis added).
In evaluating this indicator, the acquirer should consider any
employment and noncompetition agreements with a selling shareholder who
becomes an employee of the combined entity and whether such agreements
create a “requirement” to remain employed with the acquirer.
6.2.3.3.3 Level of Compensation
ASC 805-10
55-25(c) Level of
compensation. Situations in which employee
compensation other than the contingent payments is
at a reasonable level in comparison to that of
other key employees in the combined entity may
indicate that the contingent payments are
additional consideration rather than
compensation.
As indicated in ASC 805-10-55-25(c), if the compensation, excluding the contingent payment to the
selling shareholder who becomes an employee of the combined entity, “is at a reasonable level in
comparison to that of other key employees in the combined entity,” the contingent payment may
represent contingent consideration. However, assessing the compensation may be difficult because the
responsibilities of such an employee may not be readily comparable to those of the acquirer’s other key
employees, and levels of compensation may vary significantly within the combined entity on the basis of
other factors.
6.2.3.3.4 Incremental Payments to Employees
ASC 805-10
55-25(d) Incremental payments
to employees. If selling shareholders who do not
become employees receive lower contingent payments
on a per-share basis than the selling shareholders
who become employees of the combined entity, that
fact may indicate that the incremental amount of
contingent payments to the selling shareholders
who become employees is compensation.
There may be differences between the per-share contingent payments made to selling shareholders
who become employees of the combined entity and the payments made to those who do not. Such
differences may be indicators that a portion or all of the payments are compensation. For example:
- The selling shareholders who become employees of the combined entity may be entitled to receive higher contingent payments on a per-share basis than selling shareholders who do not become the entity’s employees. Such a scenario may be an indicator that the incremental portion paid to the selling shareholders/employees is compensation.
- Only selling shareholders who become employees of the combined entity may be entitled to receive the contingent payments. Such a scenario may be an indicator that the contingent payments are compensation.
Example 6-14
Incremental Contingent Payment to Shareholder Who Becomes an Employee
Company A acquires Company B in a transaction accounted for as a business combination. Company B is
owned equally by three shareholders. One of those shareholders, B’s CEO, agrees to become A’s employee
after the acquisition. The terms of the acquisition agreement require A to pay B’s shareholders a fixed amount
upon the closing of the acquisition. In addition, A must pay (1) the two shareholders who do not become
employees 5 percent of B’s EBITDA above $1 million for each of the next five years and (2) B’s CEO/shareholder
12 percent of B’s EBITDA above $1.5 million for each of the next five years.
The fact that B’s CEO received a higher contingent payment and is employed by A after the business
combination indicates that the incremental amount paid (12 percent of B’s EBITDA above $1.5 million less
5 percent of B’s EBITDA above $1 million) is compensation in A’s postcombination financial statements, whereas
the remainder of the payments should be accounted for as contingent consideration provided that they qualify
as such on the basis of the other factors in ASC 805-10-55-25.
6.2.3.3.5 Number of Shares Owned
ASC 805-10
55-25(e) Number of shares
owned. The relative number of shares owned by the
selling shareholders who remain as key employees
may be an indicator of the substance of the
contingent consideration arrangement. For example,
if the selling shareholders who owned
substantially all of the shares in the acquiree
continue as key employees, that fact may indicate
that the arrangement is, in substance, a
profit-sharing arrangement intended to provide
compensation for postcombination services.
Alternatively, if selling shareholders who
continue as key employees owned only a small
number of shares of the acquiree and all selling
shareholders receive the same amount of contingent
consideration on a per-share basis, that fact may
indicate that the contingent payments are
additional consideration. The preacquisition
ownership interests held by parties related to
selling shareholders who continue as key
employees, such as family members, also should be
considered.
The proportion of shares owned by selling shareholders who become employees of the combined entity
may be an indicator of whether a contingent payment is a profit-sharing arrangement. For example, if
the owners of substantially all of the acquiree’s shares become key employees of the combined entity,
the contingent payments may be profit-sharing arrangements (i.e., compensation). However, if such
shareholders owned only a small number of the acquiree’s shares, and all selling shareholders received
the same amount of contingent consideration on a per-share basis, the conditional payments may be
contingent consideration.
When evaluating whether selling shareholders who become employees of the combined entity owned
substantially all of the shares in the acquiree, entities also should consider preacquisition ownership
interests held by parties related to the selling shareholders, such as family members. Entities may need
to use judgment in determining which parties are considered “related to selling shareholders.”
6.2.3.3.6 Linkage to the Valuation
ASC 805-10
55-25(f) Linkage to the
valuation. If the initial consideration
transferred at the acquisition date is based on
the low end of a range established in the
valuation of the acquiree and the contingent
formula relates to that valuation approach, that
fact may suggest that the contingent payments are
additional consideration. Alternatively, if the
contingent payment formula is consistent with
prior profit-sharing arrangements, that fact may
suggest that the substance of the arrangement is
to provide compensation.
Entities should consider whether the sum of the consideration transferred on the acquisition date and
any anticipated contingent payments is consistent with the acquirer’s estimate of the acquiree’s fair
value or whether that total exceeds the estimate. For example, an acquirer and acquiree may disagree
on the specific fair value of the acquiree but agree on a related range of value. In such a scenario, the
acquirer may agree to pay the seller (1) a fixed amount at the closing that would represent the low
end of the range and (2) a contingent amount if earnings exceed a certain target that would represent
the higher end of the range, in which case the contingent payments might be viewed as additional
consideration. By contrast, if the sum of the fixed amount at the closing and any anticipated contingent
payments exceeds the higher end of the range of the acquiree’s estimated fair value, the substance of
the arrangement might be to provide compensation.
6.2.3.3.7 Formula for Determining Contingent Consideration
ASC 805-10
55-25(g) Formula for
determining consideration. The formula used to
determine the contingent payment may be helpful in
assessing the substance of the arrangement. For
example, if a contingent payment is determined on
the basis of a multiple of earnings, that might
suggest that the obligation is contingent
consideration in the business combination and that
the formula is intended to establish or verify the
fair value of the acquiree. In contrast, a
contingent payment that is a specified percentage
of earnings might suggest that the obligation to
employees is a profit-sharing arrangement to
compensate employees for services rendered.
Payments based on multiples of earnings (e.g., EBITDA, EBIT, net income, or revenues) may be more
likely to be contingent consideration than payments based on percentages of earnings, which are more
likely to be profit-sharing arrangements that should be accounted for as compensation.
6.2.4 Other Arrangements
ASC 805-10
55-25(h) Other agreements and issues. The terms of other arrangements with selling shareholders (such as
noncompete agreements, executory contracts, consulting contracts, and property lease agreements) and
the income tax treatment of contingent payments may indicate that contingent payments are attributable
to something other than consideration for the acquiree. For example, in connection with the acquisition, the
acquirer might enter into a property lease arrangement with a significant selling shareholder. If the lease
payments specified in the lease contract are significantly below market, some or all of the contingent payments
to the lessor (the selling shareholder) required by a separate arrangement for contingent payments might be,
in substance, payments for the use of the leased property that the acquirer should recognize separately in
its postcombination financial statements. In contrast, if the lease contract specifies lease payments that are
consistent with market terms for the leased property, the arrangement for contingent payments to the selling
shareholder may be contingent consideration in the business combination.
The acquirer and the selling shareholders may enter into other arrangements simultaneously with, or
in close proximity to, the acquisition. If so, the acquirer should determine whether to attribute some or
all of the contingent payments under the acquisition agreement to such other arrangements (e.g., in
circumstances in which the other arrangement provides for no payment or a below-market payment).
Amounts attributable to other arrangements should be accounted for separately from the business
combination in accordance with their nature.
In addition, ASC 805-10-55-25(h) states that “the income tax treatment of
contingent payments may indicate that contingent payments are attributable to
something other than consideration for the acquiree.” When assessing the
substance of an arrangement, entities should evaluate any lack of symmetry
between the accounting treatment and the tax treatment of contingent
payments.
6.2.5 Selling Shareholders Share Proceeds With Specified Employees of the Acquiree
In some acquisitions, one or more of the selling shareholders may decide to share some of the proceeds
that they are entitled to receive with one or more of the acquiree’s nonshareholder employees. Such
arrangements may be structured in various ways. For example, the selling shareholders may decide
to share a portion of the consideration that they are entitled to receive on the acquisition date or to
share a portion of any future contingent payments that they are entitled to receive, or both. The selling
shareholders may direct the acquirer to deliver the amounts directly to the specified employees or may
pay the specified employees directly from their proceeds.
On the basis of the guidance in ASC 718-10-15-4, unless the amount “is clearly
for a purpose other than compensation,” the framework described in Section 6.2.3 should be
used to determine whether the compensation is for precombination or
postcombination services.
6.2.6 Disputes Arising From the Business Combination
After the completion of a business combination, a dispute may occur between an acquirer and the
acquiree’s sellers that sometimes results in payments between the parties after the acquisition date.
Alternatively, an acquirer’s shareholders may bring a claim against the acquirer for various reasons
(e.g., overpayment for the acquiree — see discussion in Section 6.2.6.2).
6.2.6.1 Settlement of Disputes With the Sellers Over a Business Combination
When a dispute between the acquirer and the seller results in a transfer of
amounts between the parties after the acquisition date, questions may arise
about whether the acquirer, when accounting for such subsequent payments,
should reflect the amount paid or received either (1) as an adjustment to
the consideration transferred for the acquiree or (2) in its postacquisition
income statement. At the 2003 AICPA Conference on Current SEC Developments,
then SEC OCA Professional Accounting Fellow Randolph Green indicated in
prepared remarks that the SEC has “generally concluded that
legal claims between an acquirer and the former owners of an acquired
business should be reflected in the income statement when settled.” This
view is based on the general belief that contingencies related to litigation
about the business combination itself are not preacquisition contingencies.
However, Mr. Green noted that an acquirer may be able to treat such payments
as an adjustment to the consideration transferred for the acquisition if
there is a “clear and direct link to the purchase price.” He gave the
following example:
[A]ssume a purchase agreement
explicitly sets forth the understanding that each “acquired customer” is
worth $1,000, that not less than one thousand customers will be
transferred as of the consummation date, and subsequent litigation
determines that the actual number of acquired customers was only nine
hundred. The effects of the litigation should properly be reflected as
part of the purchase price. In contrast, if the purchase agreement
obligates the seller to affect its best efforts to retain customers
through the consummation date and litigation subsequently determines
that the seller failed to do so, the effects are not clearly and
directly linked to the purchase price and, accordingly, should be
reflected in the income statement.
Even when an acquirer is able to establish “a clear and direct link” to the
consideration transferred, we believe that it is only appropriate to adjust
the consideration transferred if the measurement period is still open. If it
is closed, entities should recognize such amounts in the income statement.
In an alternative example, Mr. Green noted that “claims that assert one
party [misled] the other or that a provision of the agreement is unclear are
not unique to business combination agreements.” Therefore, such claims do
not generally establish a clear and direct link to the consideration
transferred and should be reflected in the income statement.
Mr. Green also noted that “[f]requently, claims seeking enforcement of an escrow
or escrow-like arrangement also include claims of misrepresentation or
otherwise constitute a mixed claim.” He went on to say that “[i]n order to
reflect some or all of the settlement of such a [mixed] claim as an
adjustment of the purchase price of the acquired business, the acquirer
should be able to persuasively demonstrate that all or a specifically
identified portion of the mixed claim is clearly and directly linked to the
purchase price.”
Although not stated by Mr. Green, neither the acquirer’s legal costs to settle the dispute nor any
settlement amounts used to reimburse the sellers for legal costs or other damages are clearly and
directly linked to the consideration transferred. Thus, they should be reflected in the income statement.
While this SEC staff speech was given before FASB Statement 141(R) was issued,
we believe that the views expressed in it continue to apply.
6.2.6.2 Settlement of Disputes With the Acquirer’s Shareholders Over a Business Combination
An acquirer’s shareholders may bring a claim against the acquirer after the acquisition date for
various reasons, such as the shareholders’ assertion that the acquirer overpaid for the acquiree. The
acquirer should recognize costs incurred for such disputes, including any settlement amounts if paid,
in the income statement and not as part of the consideration transferred to the acquiree. This view
is consistent with an additional statement by Mr. Green that, in reference to settlements of litigation
over the consideration transferred, “the cost of litigation brought by the acquirer’s shareholders should
always be reflected in the income statement.”
6.3 Accounting for Arrangements Entered Into Concurrently With the Business Combination
An acquirer and seller may enter into one or more other agreements in close proximity to, or
simultaneously with, the business combination. For example, an acquirer and seller may enter into a
business combination transaction as well as execute an ongoing supply, distribution, collaboration,
or licensing agreement. Such agreements may be transitional (e.g., for a few months) or more long
term. The acquirer should account for individual agreements in accordance with their nature and
should specifically consider whether each agreement’s stated price reflects an amount that would be
expected in the absence of a concurrent business combination. For example, the consideration for the
business could be overstated while the pricing for the supply agreement could be understated or vice
versa. Therefore, an entity may need to adjust the stated contractual amounts when recognizing each
arrangement.
Example 6-15
Supply Agreement Entered Into Simultaneously With the Acquisition
Company B enters into an agreement with Company C to acquire C’s subsidiary,
Subsidiary S. Subsidiary S has been supplying a specific raw
material to C, and C wants to continue to receive it after
the acquisition. Company B agrees to pay a fixed amount on
the acquisition date and to provide a predetermined amount
of raw materials to C at no cost for one year after the
closing date.
In determining the consideration transferred in the business combination, B
should include the value related to the amount of raw
materials to be provided to C for no cost, because an
arrangement to provide no-cost materials would be unexpected
in the absence of the business combination.
6.4 Partial Acquisitions
A “partial acquisition” is a business combination in which an entity acquires a controlling interest,
but less than 100 percent of the voting interests, in an entity. The ASC master glossary defines a
noncontrolling interest (also known as a minority interest) as “[t]he portion of equity (net assets) in a
subsidiary not attributable, directly or indirectly, to a parent.” Therefore, the portion of equity in the
acquiree held by other parties is presented as a noncontrolling interest in the acquirer’s consolidated
financial statements.
An underlying premise of ASC 805 is that obtaining control of a business makes
the acquirer accountable and responsible for all of the acquiree’s assets and liabilities,
regardless of the acquirer’s ownership percentage. Therefore, in a partial acquisition, the
acquirer 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). That is, even if the acquirer obtains a
less than 100 percent interest in the acquiree, all of the assets and liabilities, including
goodwill, are measured at 100 percent of their values, as calculated in accordance with ASC
805.
On the acquisition date of a partial acquisition, 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 include
in the calculation “the fair value of any noncontrolling interest,” in accordance with ASC
805-30-30-1. That guidance requires entities to measure goodwill in business combinations,
including partial acquisitions, as follows:
The acquirer shall
recognize goodwill as of the acquisition date, measured as the excess of (a) over (b):
-
The aggregate of the following:
-
The consideration transferred measured in accordance with this Section, which generally requires acquisition-date fair value (see paragraph 805-30-30-7)
-
The fair value of any noncontrolling interest in the acquiree
-
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. [Emphasis added]
Once an entity has control of a subsidiary, any subsequent acquisitions of some
or all of the noncontrolling interests in that subsidiary are accounted for as equity
transactions under ASC 810-10, as long as the acquirer maintains control. For more
information about acquisitions of noncontrolling interests, see Deloitte’s Roadmap Consolidation — Identifying a Controlling
Financial Interest.
Example 6-16
Measuring Goodwill in a Partial Acquisition
Company A acquires 80 percent of the equity interests in, and control of,
Company B for $1,600. Company A had no prior ownership in B. The transaction
meets the definition of a business combination. The fair value of the
noncontrolling interest is $380. The fair value of B’s identifiable net assets
as of the acquisition date is $1,500.
Company A should measure goodwill as follows:
6.4.1 Measuring the Fair Value of a Noncontrolling Interest
ASC 805-20
Measuring the Fair Value of a Noncontrolling Interest in an Acquiree
30-7 Paragraph 805-20-30-1 requires the acquirer to measure a noncontrolling interest in the acquiree at its
fair value at the acquisition date. An acquirer sometimes will be able to measure the acquisition-date fair value
of a noncontrolling interest on the basis of a quoted price in an active market for the equity shares (that is,
those not held by the acquirer). In other situations, however, a quoted price in an active market for the equity
shares will not be available. In those situations, the acquirer would measure the fair value of the noncontrolling
interest using another valuation technique.
30-8 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 requires an acquirer to determine the acquisition-date fair value of any noncontrolling interest
in the acquiree. If there is an active market for the noncontrolling interest, it must be measured “on the
basis of a quoted price in an active market for the equity shares (that is, those not held by the acquirer).”
However, ASC 805 does not provide detailed guidance on valuing the noncontrolling interest when
an active market does not exist, except to say that “the acquirer would measure the fair value of the
noncontrolling interest using another valuation technique” and that the “main difference [in valuing the
noncontrolling interests] is likely to be . . . the inclusion of a discount for lack of control.” The valuation
techniques used by entities to measure the noncontrolling interest should be consistent with the fair
value measurement principles in ASC 820.
Example 6-17
Impact of a Control Premium on the Fair Value of the Noncontrolling Interest
Company A acquires 60 percent (600,000 shares) of Company B for $6 million (or
$10 per share). However, on the acquisition date, B’s shares are trading at
$9.00 per share. The acquirer acknowledges that it is paying a premium over
the market because it believes that it will derive synergies from integrating
B with its own business.
Because A paid a premium over B’s market value per share, it may not be
reasonable to conclude that the fair value of each share held by
noncontrolling shareholders is $10.00.
Example 6-18
Determining the Fair Value of the Noncontrolling Interest
Company C acquired 75 percent (750,000 shares) of Company D, a privately held
entity, for $15 million in cash (or $20 per share). An independent third-party
valuation firm calculates the fair value of D as a whole (i.e., 100 percent)
as $19 million by using valuation techniques in accordance with the guidance
in ASC 820.
It may be appropriate for C to derive the fair value of the noncontrolling
interest as $4 million (or $16 per share), calculated as the fair value of the
entire business ($19 million) less the fair value of the consideration
transferred by C ($15 million), which includes a control premium.
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:
-
The consideration transferred measured in accordance with this Section, which generally requires acquisition-date fair value (see paragraph 805-30-30-7)
-
The fair value of any noncontrolling interest in the acquiree
-
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.
6.6 Business Combinations Achieved Without the Transfer of Consideration
ASC 805-10
25-11 An acquirer sometimes obtains control of an acquiree without transferring consideration. The acquisition
method of accounting for a business combination applies to those combinations. Such circumstances include
any of the following:
- The acquiree repurchases a sufficient number of its own shares for an existing investor (the acquirer) to obtain control.
- Minority veto rights lapse that previously kept the acquirer from controlling an acquiree in which the acquirer held the majority voting interest.
- The acquirer and acquiree agree to combine their businesses by contract alone. The acquirer transfers no consideration in exchange for control of an acquiree and holds no equity interests in the acquiree, either on the acquisition date or previously. Examples of business combinations achieved by contract alone include bringing two businesses together in a stapling arrangement or forming a dual-listed corporation.
25-12 In a business combination achieved by contract alone, the acquirer shall attribute to the equity holders
of the acquiree the amount of the acquiree’s net assets recognized in accordance with the requirements of
this Topic. In other words, the equity interests in the acquiree held by parties other than the acquirer are a
noncontrolling interest in the acquirer’s postcombination financial statements even if the result is that all of the
equity interests in the acquiree are attributed to the noncontrolling interest.
ASC 805-30
55-2 In a business combination achieved without the transfer of consideration, the acquirer must substitute the
acquisition-date fair value of its interest in the acquiree for the acquisition-date fair value of the consideration
transferred to measure goodwill or a gain on a bargain purchase (see paragraphs 805-30-30-1 through 30-4).
Subtopic 820-10 provides guidance on using valuation techniques to measure fair value.
An acquirer may obtain control of an acquiree without transferring any consideration on the acquisition
date. Even though no consideration is transferred, the acquirer must still account for the transaction
by using the acquisition method. ASC 805-30-55-2 states that “[t]he acquirer must substitute the
acquisition-date fair value of its interest in the acquiree for the acquisition-date fair value of the
consideration transferred to measure goodwill or a gain on a bargain purchase.”
ASC 805-10-25-11 provides three examples of business combinations achieved
without the transfer of consideration:
-
The acquiree repurchases a sufficient number of its own shares for an existing investor (the acquirer) to obtain control [see Section 6.6.1].
-
Minority veto rights lapse that previously kept the acquirer from controlling an acquiree in which the acquirer held the majority voting interest [see Section 6.6.2].
-
The acquirer and acquiree agree to combine their businesses by contract alone [see Section 6.6.3].
These are examples only, and there may be other transactions or events that
qualify as business combinations achieved without the transfer of
consideration.
6.6.1 Share Repurchases
A business combination can occur when an entity repurchases a sufficient number of its own shares
from existing investors and another existing investor obtains control of the entity. In such cases, the
acquiree transfers consideration to buy back its own shares, but the acquirer does not transfer any
consideration to obtain control of its investee.
Example 6-20
Share Repurchase
Company A holds a 48 percent interest in Company B and accounts for it by using
the equity method of accounting. The remaining 52
percent interest in B is widely held. Company B
announces a share buyback program. Company A does
not sell any of its interest. As a result of B’s
share buybacks, A’s percent interest in B
increases to greater than 50 percent of the
outstanding shares, and A obtains control of
B.
Company A should account for this event as a business combination (i.e., an
acquisition achieved in stages, since A had a
previously held interest). While A did not
transfer consideration to obtain control of B, it
did obtain control as a result of B’s repurchase
of its own shares.
6.6.2 Lapse of Minority Veto Rights or Substantive Participating Rights
A business combination can occur when minority veto rights or substantive
participating rights held by one or more shareholders lapse, giving a majority
shareholder control over an entity. While it is presumed under the guidance in
ASC 810-10 that a voting interest entity is controlled by the holder of more
than 50 percent of an entity’s voting interest, noncontrolling interest holders
sometimes have the right to either participate in or block certain significant
financial and operating decisions that an entity makes in the ordinary course of
business. In such situations, the majority investor cannot control the entity.
However, if those minority veto rights or substantive participating rights
lapse, the holder of the majority interest may obtain control of the entity and
would account for that event as a business combination. For more information
about minority veto rights and substantive participating rights, see Deloitte’s
Roadmap Consolidation —
Identifying a Controlling Financial Interest.
Example 6-21
Lapse of Minority Veto Rights
Company A holds a majority interest in Company X, and Company D holds both a noncontrolling interest and
minority veto rights in X. The minority veto rights preclude A from exercising control over X, so A accounts for its
interest in X by using the equity method of accounting. On the date that D’s veto rights expire, A gains control
over X.
Once A obtains control of X, it should account for this event as a business
combination.
6.6.3 Control by Contract
A business combination can occur when an acquirer and acquiree agree to combine their businesses
by contract alone (e.g., a stapling arrangement or dual-listed corporations). In such cases, one of the
entities must be identified as the acquirer for accounting purposes, and the assets and liabilities of the
entity determined to be the acquiree for accounting purposes are recognized by using the acquisition
method, generally at the acquisition-date fair values. ASC 805-10-25-12 states, in part, that for business
combinations achieved by contract alone, “the acquirer shall attribute to the equity holders of the
acquiree the amount of the acquiree’s net assets recognized.” In other words, the acquirer should
consolidate the acquiree even if the acquirer owns little or none of the acquiree’s outstanding equity.
The acquirer should recognize in its postcombination financial statements a noncontrolling interest for the equity in the acquiree owned by other parties even if the result is that the noncontrolling interest
represents 100 percent of the acquiree’s net assets.
With the introduction of the VIE model, the relevance of the control by contract
model has diminished. This is because a legal entity
controlled by contract would most likely be a VIE since one
of the conditions for exemption from the VIE model is that
the equity investors at risk must control the legal entity’s
most significant activities. However, in the rare instances
in which such a legal entity is not a VIE, the guidance in
ASC 810-10-15-20 through 15-22 applies. See Deloitte’s
Roadmap Consolidation — Identifying a Controlling
Financial Interest for more
information about the control-by-contract model.
6.7 Recapitalization Transactions
A recapitalization is a type of reorganization designed to change an entity’s capital structure (e.g., the
mix of debt and equity). Usually, these transactions involve new debt financing, issuing new shares, or
repurchasing outstanding shares. In a leveraged recapitalization, new debt is issued, and the proceeds
are used to redeem shares from existing shareholders as part of a series of steps that may also result
in the establishment of a new majority shareholder. If the transaction results in a change in control of
the entity undergoing the recapitalization, the new controlling entity would account for the entity that
underwent the recapitalization (if it meets the definition of a business) as an acquiree in a business
combination. In such a situation, an entity should evaluate all facts and circumstances in determining
whether it has obtained control of a business as a result of an investee undergoing a recapitalization
transaction.
Example 6-22
Recapitalization Transaction Without a Change in Control
Entities A, B, C, D, and E each own 20 percent of the issued and outstanding
shares of Company X. Company X meets the definition of a
business. None of the entities has control of X. Company X
buys back all of E’s shares, and the ownership of A, B, C,
and D increases to 25 percent each. However, no entity
obtains control of X and thus a business combination has not
occurred as a result of the recapitalization.
Recapitalization Transaction With a Change in Control
Entities A, B, and C own all of the issued and outstanding shares of Company X.
Company X meets the definition of a business. Entity A owns
45 percent, B owns 40 percent, and C owns 15 percent. None
of the entities has control of X. Company X buys back all of
C’s shares, and A’s ownership increases to 53 percent. In
the absence of evidence that A does not control X, a
business combination between A and X has occurred as a
result of the recapitalization.
6.7.1 Transaction Costs in a Recapitalization
Entities may incur costs related to structuring a recapitalization. An entity undergoing a recapitalization
should account for its costs on the basis of their nature. For example:
- Costs related to issuing debt are capitalized as debt issuance costs and amortized over the life of the debt by using the effective interest method.
- Costs related to issuing equity and raising capital are recognized as a reduction to the total amount of equity raised. (See Section 5.7 of Deloitte’s Roadmap Initial Public Offerings for more information about offering costs and SAB Topic 5.A.)
- Direct and incremental costs (e.g., costs related to advisory or legal services) should be expensed as incurred.
If the costs are billed to the entity as a single amount, we believe that the
entity should apply the guidance in the Interpretive Response to Question 1 of SAB Topic 2.A.6,
which states, in part:
When an investment banker provides
services in connection with a business combination or asset acquisition and
also provides underwriting services associated with the issuance of debt or
equity securities, the total fees incurred by an entity should be allocated
between the services received on a relative fair value basis. The objective
of the allocation is to ascribe the total fees incurred to the actual
services provided by the investment banker.
We believe that the amounts allocated to debt issuance costs should result in an
effective interest rate on the debt that is consistent with the effective market
interest rate and that the amounts allocated to equity issuance costs should be
consistent with the fees an underwriter would charge.
Further, we believe that if the fees are incurred by a new investor, those costs
should not be recognized in the financial statements of the entity undergoing
the recapitalization unless they were incurred by the investor on the entity’s
behalf. We believe that entities should consider the guidance in SAB Topic 1.B and SAB Topic 5.T in
determining whether such costs were incurred on behalf of, and for the benefit
of, the entity.
6.8 Reverse Acquisitions
As discussed in Chapter
3, a reverse acquisition occurs when the entity that issues its
shares or gives other consideration to effect the transaction is determined for
accounting purposes to be the acquiree (also called the accounting acquiree or legal
acquirer), while the entity whose shares are acquired is for accounting purposes the
acquirer (also called the accounting acquirer or legal acquiree). The accounting
acquiree/legal acquirer generally continues in existence as the legal entity whose
shares represent the outstanding common shares of the combined company. While the
accounting acquiree/legal acquirer continues to issue its own financial statements,
those statements are often in the name of the accounting acquirer/legal acquiree
because the legal acquirer often adopts the name of the legal acquiree. The
financial reporting reflects the accounting acquirer’s/legal acquiree’s financial
information, except for its equity, which is retroactively adjusted to reflect the
equity of the accounting acquiree/legal acquirer.
Example 6-23
Reverse Acquisition
Company A, a public company with substantive operations and a December 31
year-end, has one million common shares outstanding as of
June 30, 20X9. On July 1, 20X9, in a transaction accounted
for as a business combination, A issues four million of its
newly registered common shares to Company B, a private
entity, in exchange for all of B’s two million outstanding
common shares (an exchange rate of 2:1). After the
transaction, B controls A’s voting rights through its 80
percent ownership interest (four million common shares held
÷ five million total common shares outstanding) and its
ability to elect the majority of the combined entity’s board
members.
Although A issued common shares to effect the business combination, B would be
considered the accounting acquirer under ASC 805, provided
that there are no other existing pertinent facts and
circumstances to the contrary after consideration of the
factors in ASC 805-10-55-12 through 55-14.
6.8.1 Accounting Acquiree Must Meet the Definition of a Business
ASC 805-40
25-1 For a business combination transaction to be accounted for as a reverse acquisition, the accounting
acquiree must meet the definition of a business. All of the recognition principles in Subtopics 805-10, 805-20,
and 805-30, including the requirement to recognize goodwill, apply to a reverse acquisition.
ASC 805-40-25-1 states that the guidance in ASC 805-40 on reverse acquisitions only applies if the
accounting acquiree/legal acquirer meets the definition of a business in ASC 805 (see Section 2.4).
Otherwise, the transaction is accounted for as either a reverse asset acquisition or a capital transaction, depending on the substance of the transaction.
See Appendix C for more information about accounting for asset acquisitions.
6.8.2 Measuring Consideration Transferred
ASC 805-40
30-2 In a reverse acquisition, the accounting acquirer usually issues no consideration for the acquiree. Instead,
the accounting acquiree usually issues its equity shares to the owners of the accounting acquirer. Accordingly,
the acquisition-date fair value of the consideration transferred by the accounting acquirer for its interest in the
accounting acquiree is based on the number of equity interests the legal subsidiary would have had to issue
to give the owners of the legal parent the same percentage equity interest in the combined entity that results
from the reverse acquisition. Example 1, Case A (see paragraph 805-40-55-8) illustrates that calculation. The
fair value of the number of equity interests calculated in that way can be used as the fair value of consideration
transferred in exchange for the acquiree.
In a reverse acquisition, the accounting acquiree/legal acquirer typically
issues its shares to the owners of the accounting acquirer/legal acquiree as
consideration in the transaction. However, to apply the acquisition method of
accounting, the accounting acquirer/legal acquiree must calculate the
hypothetical amount of consideration that it would have transferred to acquire
the accounting acquiree/legal acquirer and obtain the same percentage of
ownership interest in the combined entity that results from the transaction.
Accordingly, the fair value of the consideration transferred is determined on
the basis of the number of equity interests that the accounting acquirer/legal
acquiree would have had to issue to the accounting acquiree’s/legal acquirer’s
owners to provide the same ratio of ownership of equity interests in the
combined entity as a result of the reverse acquisition. Generally, the fair
value of the consideration transferred equals the fair value of the accounting
acquiree/legal acquirer.
In some reverse acquisitions, the accounting acquiree/legal acquirer may issue
cash or other consideration, as well as shares, to acquire the shares of the
accounting acquirer/legal acquiree. The payment of cash to the shareholders of
the accounting acquirer/legal acquiree should be considered a distribution of
capital and, accordingly, a reduction of shareholders’ equity of the accounting
acquirer/ legal acquiree.
For reverse acquisitions between a public company and a private company in which
the public company is the legal acquirer but is determined to be the accounting
acquiree, the fair value of the public company’s shares generally is more
reliably determinable than the fair value of the private company’s shares. Thus,
the determination of the consideration transferred might be based on the fair
value of the legal acquirer’s shares rather than the fair value of the legal
acquiree’s shares.
6.8.3 Measuring the Accounting Acquiree’s Assets and Liabilities, Including Goodwill
ASC 805-40
30-1 All of the measurement principles applicable to business combinations in Subtopics 805-10, 805-20, and
805-30 apply to a reverse acquisition.
In a reverse acquisition accounted for as a business combination, the accounting acquiree’s/legal
acquirer’s assets and liabilities are measured in accordance with the guidance in ASC 805 on business
combinations. ASC 805-40-55-12 clarifies that an entity should measure goodwill in a reverse acquisition
“as the excess of the fair value of the consideration effectively transferred” (emphasis added) by the
accounting acquirer/legal acquiree divided by the fair value of the accounting acquiree’s/legal acquirer’s
identifiable assets and liabilities. The consideration effectively transferred is calculated as described in
Section 6.8.2.
In some reverse acquisitions, the accounting acquirer/legal acquiree owns shares
of the accounting acquiree/legal acquirer before the transaction. To calculate
the amount of goodwill to recognize, the accounting acquirer/legal acquiree must
remeasure its previously held interest in the accounting acquiree/legal acquirer
at its acquisition-date fair value and add it to the consideration transferred.
See Section 6.5 for
more information about the accounting for previously held interests.
If the accounting acquiree/legal acquirer does not meet the definition of a business and the acquisition
is accounted for as a reverse asset acquisition, the accounting acquiree’s assets and liabilities are
measured in accordance with the subsections in ASC 805-50 on the acquisition of assets rather than a
business. See Appendix C for more information about accounting for asset acquisitions.
6.8.4 Noncontrolling Interests
ASC 805-40
25-2 In a reverse acquisition, some of the owners of the legal acquiree (the accounting acquirer) might not
exchange their equity interests for equity interests of the legal parent (the accounting acquiree). Those owners
are treated as a noncontrolling interest in the consolidated financial statements after the reverse acquisition.
That is because the owners of the legal acquiree that do not exchange their equity interests for equity interests
of the legal acquirer have an interest in only the results and net assets of the legal acquiree ― not in the
results and net assets of the combined entity. Conversely, even though the legal acquirer is the acquiree for
accounting purposes, the owners of the legal acquirer have an interest in the results and net assets of the
combined entity.
30-3 The assets and liabilities of the legal acquiree are measured and recognized in the consolidated financial
statements at their precombination carrying amounts (see paragraph 805-40-45-2(a)). Therefore, in a reverse
acquisition the noncontrolling interest reflects the noncontrolling shareholders’ proportionate interest in the
precombination carrying amounts of the legal acquiree’s net assets even though the noncontrolling interests in
other acquisitions are measured at their fair values at the acquisition date.
In some reverse acquisitions, some shareholders of the accounting acquirer/legal acquiree may
not exchange their interests for interests in the accounting acquiree/legal acquirer, which results
in noncontrolling interests in the combined entity. Because the noncontrolling interest holders
own ownership interests in the entity determined to be the acquirer for accounting purposes,
“the noncontrolling interest reflects the noncontrolling shareholders’ proportionate interest in the precombination carrying amounts of the legal acquiree’s net assets even though the noncontrolling
interests in other acquisitions are measured at their fair values at the acquisition date.”
6.8.5 Presentation of the Combined Entity’s Financial Statements
In a reverse acquisition, the financial statements of the newly combined entity represent a continuation
of the financial statements of the accounting acquirer/legal acquiree. As a result, the assets and
liabilities of the accounting acquirer/legal acquiree are presented at their historical carrying values in
the consolidated financial statements of the newly combined entity and the assets and liabilities of the
accounting acquiree/legal acquirer are recognized on the acquisition date and measured by using the
acquisition method. The results of the accounting acquiree’s/legal acquirer’s results of operations are
included in the combined company’s financial statements beginning on the acquisition date.
ASC 805-40
30-4 Paragraph 805-40-45-1 provides guidance on required adjustments to the accounting acquirer’s legal
capital to reflect the legal capital of the legal parent (accounting acquiree) in the consolidated financial
statements following a reverse acquisition.
45-1 Consolidated financial statements prepared following a reverse acquisition are issued under the
name of the legal parent (accounting acquiree) but described in the notes as a continuation of the financial
statements of the legal subsidiary (accounting acquirer), with one adjustment, which is to retroactively adjust
the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree. That adjustment is
required to reflect the capital of the legal parent (the accounting acquiree). Comparative information presented
in those consolidated financial statements also is retroactively adjusted to reflect the legal capital of the legal
parent (accounting acquiree).
45-2 Because the consolidated financial statements represent the continuation of the financial statements
of the legal subsidiary except for its capital structure, the consolidated financial statements reflect all of the
following:
- The assets and liabilities of the legal subsidiary (the accounting acquirer) recognized and measured at their precombination carrying amounts.
- The assets and liabilities of the legal parent (the accounting acquiree) recognized and measured in accordance with the guidance in this Topic applicable to business combinations.
- The retained earnings and other equity balances of the legal subsidiary (accounting acquirer) before the business combination.
- The amount recognized as issued equity interests in the consolidated financial statements determined by adding the issued equity interest of the legal subsidiary (the accounting acquirer) outstanding immediately before the business combination to the fair value of the legal parent (accounting acquiree) determined in accordance with the guidance in this Topic applicable to business combinations. However, the equity structure (that is, the number and type of equity interests issued) reflects the equity structure of the legal parent (the accounting acquiree), including the equity interests the legal parent issued to effect the combination. Accordingly, the equity structure of the legal subsidiary (the accounting acquirer) is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares of the legal parent (the accounting acquiree) issued in the reverse acquisition.
- The noncontrolling interest’s proportionate share of the legal subsidiary’s (accounting acquirer’s) precombination carrying amounts of retained earnings and other equity interests as discussed in paragraphs 805-40-25-2 and 805-40-30-3 and illustrated in Example 1, Case B (see paragraph 805-40-55-18).
The table below summarizes the presentation of
the combined entity’s financial statements at the time of a reverse
acquisition.
Statement of Financial
Position Balance(s) | Presentation |
---|---|
Assets and liabilities | Sum of (1) the accounting acquiree’s/legal acquirer’s assets and liabilities,
measured by using the acquisition method under ASC 805, and (2) the
accounting acquirer’s/legal acquiree’s assets and liabilities, measured at their
carrying values. |
Retained earnings and other
equity balances | The accounting acquirer’s/legal acquiree’s precombination carrying amount,
proportionately reduced by any noncontrolling interests. |
Issued equity | Sum of (1) the accounting acquirer’s/legal acquiree’s issued equity immediately
before the reverse acquisition, proportionately reduced
by any noncontrolling interests, and (2) the fair value
of the accounting acquiree/legal acquirer (i.e., the
hypothetical consideration transferred). The equity
structure (i.e., the number and type of equity interests
issued) reflects the accounting acquiree’s/legal
acquirer’s equity structure. However, the balance is
adjusted to reflect the par value of the outstanding
shares of the accounting acquiree/legal acquirer,
including the number of shares issued in the reverse
acquisition. Any difference is recognized as an
adjustment to the APIC account. |
APIC | The historical APIC account of the accounting acquirer/legal acquiree
immediately before the reverse acquisition is carried forward and increased to
reflect the additional fair value of the accounting acquiree/legal acquirer less
the par value of the shares held by its preacquisition shareholders. |
Noncontrolling interest | The noncontrolling interest’s proportionate share of the accounting acquirer’s/legal acquiree’s precombination retained earnings, issued equity, and other
equity balances. |
Prior-period presentation | For periods before the reverse acquisition, the shareholders’ equity of
the combined entity presented on the basis of the historical equity of the
accounting acquirer/legal acquiree before the acquisition, retroactively recast to
reflect the number of shares received in the acquisition. |
6.8.6 EPS Calculation
In a reverse acquisition, the financial statements of the combined entity reflect the equity of the
accounting acquiree/legal acquirer, including the equity interests issued as part of the reverse
acquisition. As a result, EPS is calculated on the basis of the capital structure of the accounting acquiree/legal acquirer.
ASC 805-40
45-3 As noted in (d) in the preceding paragraph [ASC 805-40-45-2(d)], the equity structure in the consolidated financial statements
following a reverse acquisition reflects the equity structure of the legal acquirer (the accounting acquiree),
including the equity interests issued by the legal acquirer to effect the business combination.
45-4 In calculating the weighted-average number of common shares outstanding (the denominator of the
earnings-per-share [EPS] calculation) during the period in which the reverse acquisition occurs:
- The number of common shares outstanding from the beginning of that period to the acquisition date shall be computed on the basis of the weighted-average number of common shares of the legal acquiree (accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the merger agreement.
- The number of common shares outstanding from the acquisition date to the end of that period shall be the actual number of common shares of the legal acquirer (the accounting acquiree) outstanding during that period.
45-5 The basic EPS for each comparative period before the acquisition date presented in the consolidated
financial statements following a reverse acquisition shall be calculated by dividing (a) by (b):
- The income of the legal acquiree attributable to common shareholders in each of those periods
- The legal acquiree’s historical weighted-average number of common shares outstanding multiplied by the exchange ratio established in the acquisition agreement.
6.8.7 Illustrative Example
ASC 805-40-55-2 through 55-23 illustrate the guidance on accounting for reverse acquisitions:
ASC 805-40
55-2 The following Cases illustrate the guidance in this Subtopic on accounting for a reverse acquisition:
- A reverse acquisition if all the shares of the legal subsidiary are exchanged (Case A)
- A reverse acquisition if not all of the shares of the legal subsidiary are exchanged and a noncontrolling interest results (Case B).
55-3 In these Cases, Entity B, the legal subsidiary, acquires Entity A, the entity issuing equity instruments and
therefore the legal parent, on September 30, 20X6. These Cases ignore the accounting for any income tax
effects. Cases A and B share all of the following information and assumptions.
55-4 The statements of financial position of Entity A and Entity B immediately before the business combination
are as follows.
55-5 On September 30, 20X6, Entity A issues 2.5 shares in exchange for each common share of Entity B. All
of Entity B’s shareholders exchange their shares in Entity B. Therefore, Entity A issues 150 common shares in
exchange for all 60 common shares of Entity B.
55-6 The fair value of each common share of Entity B at September 30, 20X6, is $40. The quoted market price
of Entity A’s common shares at that date is $16.
55-7 The fair values of Entity A’s identifiable assets and liabilities at September 30, 20X6, are the same as their
carrying amounts, except that the fair value of Entity A’s noncurrent assets at September 30, 20X6, is $1,500.
Case A: All the Shares of the Legal Subsidiary Are Exchanged
55-8 This Case illustrates the accounting for a reverse acquisition if all of the shares of the legal subsidiary,
the accounting acquirer, are exchanged in a business combination. The accounting illustrated in this Case
includes the calculation of the fair value of the consideration transferred, the measurement of goodwill and the
calculation of earnings per share (EPS).
55-9 The calculation of the fair value of the consideration transferred follows
55-10 As a result of the issuance of 150 common shares by Entity A (legal parent, accounting acquiree), Entity
B’s shareholders own 60 percent of the issued shares of the combined entity, that is, 150 of 250 issued
shares. The remaining 40 percent are owned by Entity A’s shareholders. If the business combination had
taken the form of Entity B issuing additional common shares to Entity A’s shareholders in exchange for their
common shares in Entity A, Entity B would have had to issue 40 shares for the ratio of ownership interest
in the combined entity to be the same. Entity B’s shareholders would then own 60 of the 100 issued shares
of Entity B — 60 percent of the combined entity. As a result, the fair value of the consideration effectively
transferred by Entity B and the group’s interest in Entity A is $1,600 (40 shares with a per-share fair value of
$40). The fair value of the consideration effectively transferred should be based on the most reliable measure.
In this Case, the quoted market price of Entity A’s shares provides a more reliable basis for measuring
the consideration effectively transferred than the estimated fair value of the shares in Entity B, and the
consideration is measured using the market price of Entity A’s shares ― 100 shares with a per-share fair value
of $16.
55-11 Goodwill is measured as
follows.
55-12 Goodwill is measured as the excess of the fair value of the consideration effectively transferred (the
group’s interest in Entity A) over the net amount of Entity A’s recognized identifiable assets and liabilities, as
follows.
55-13 The consolidated statement of financial position immediately after the business combination is as
follows.
55-14 In accordance with paragraph 805-40-45-2(c) through (d), the amount recognized as issued equity
interests in the consolidated financial statements ($2,200) is determined by adding the issued equity of the
legal subsidiary immediately before the business combination ($600) and the fair value of the consideration
effectively transferred, measured in accordance with paragraph 805-40-30-2 ($1,600). However, the equity
structure appearing in the consolidated financial statements (that is, the number and type of equity interests
issued) must reflect the equity structure of the legal parent, including the equity interests issued by the legal
parent to effect the combination.
55-15 The calculation of EPS follows.
55-16 Entity B’s earnings for the annual period ended December 31, 20X5, were $600, and the consolidated
earnings for the annual period ended December 31, 20X6, are $800. There was no change in the number of
common shares issued by Entity B during the annual period ended December 31, 20X5, and during the period
from January 1, 20X6, to the date of the reverse acquisition on September 30, 20X6. EPS for the annual period
ended December 31, 20X6, is calculated as follows.
55-17 Restated EPS for the annual period ending December 31, 20X5, is $4.00 (calculated as the earnings of
Entity B of 600 divided by the 150 common shares Entity A issued in the reverse acquisition).
Case B: Not All the Shares of the Legal Subsidiary Are Exchanged
55-18 This Case illustrates the accounting for a reverse acquisition if not all of the shares of the legal subsidiary,
the accounting acquirer, are exchanged in a business combination and a noncontrolling interest results.
55-19 Assume the same facts as in Case A except that only 56 of Entity B’s 60 common shares are exchanged.
Because Entity A issues 2.5 shares in exchange for each common share of Entity B, Entity A issues only 140
(rather than 150) shares. As a result, Entity B’s shareholders own 58.3 percent of the issued shares of the
combined entity (140 of 240 issued shares). The fair value of the consideration transferred for Entity A, the
accounting acquiree, is calculated by assuming that the combination had been effected by Entity B’s issuing
additional common shares to the shareholders of Entity A in exchange for their common shares in Entity A.
That is because Entity B is the accounting acquirer, and paragraphs 805-30-30-7 through 30-8 require the
acquirer to measure the consideration exchanged for the accounting acquiree.
55-20 In calculating the number of shares that Entity B would have had to issue, the noncontrolling interest
is ignored. The majority shareholders own 56 shares of Entity B. For that to represent a 58.3 percent equity
interest, Entity B would have had to issue an additional 40 shares. The majority shareholders would then own
56 of the 96 issued shares of Entity B and, therefore, 58.3 percent of the combined entity. As a result, the fair
value of the consideration transferred for Entity A, the accounting acquiree, is $1,600 (that is, 40 shares each
with a fair value of $40). That is the same amount as when all 60 of Entity B’s shareholders tender all 60 of
its common shares for exchange. The recognized amount of the group’s interest in Entity A, the accounting
acquiree, does not change if some of Entity B’s shareholders do not participate in the exchange.
55-21 The noncontrolling interest is represented by the 4 shares of the total 60 shares of Entity B that are
not exchanged for shares of Entity A. Therefore, the noncontrolling interest is 6.7 percent. The noncontrolling
interest reflects the noncontrolling shareholders’ proportionate interests in the precombination carrying
amounts of the net assets of Entity B, the legal subsidiary. Therefore, the consolidated statement of financial
position is adjusted to show a noncontrolling interest of 6.7 percent of the precombination carrying amounts of
Entity B’s net assets (that is, $134 or 6.7 percent of $2,000).
55-22 The consolidated statement of financial position at September 30, 20X6, reflecting the noncontrolling
interest is as follows.
55-23 The noncontrolling interest of $134 has 2 components. The first component is the reclassification
of the noncontrolling interest’s share of the accounting acquirer’s retained earnings immediately before
the acquisition ($1,400 × 6.7% or $93.80). The second component represents the reclassification of the
noncontrolling interest’s share of the accounting acquirer’s issued equity ($600 × 6.7% or $40.20).
6.8.8 Public Shell Corporations and SPACs
ASC 805-40
05-2 As one example of a reverse acquisition, a private operating entity may want to become a public entity
but not want to register its equity shares. To become a public entity, the private entity will arrange for a public
entity to acquire its equity interests in exchange for the equity interests of the public entity. In this situation,
the public entity is the legal acquirer because it issued its equity interests, and the private entity is the legal
acquiree because its equity interests were acquired. However, application of the guidance in paragraphs
805-10-55-11 through 55-15 results in identifying:
- The public entity as the acquiree for accounting purposes (the accounting acquiree)
- The private entity as the acquirer for accounting purposes (the accounting acquirer).
In some cases, a nonoperating public shell company legally
acquires a private operating company by using cash, other assets, equity, or a
combination thereof. A nonoperating public shell company is a registrant that
has no or nominal operations and no or nominal assets (other than possibly
cash). The owners and management of the private company generally have actual or
effective operating control of the combined company after the transaction, and
the private company gains access to the public market without going through an
IPO. The SEC staff considers the acquisition of a private operating company by a
nonoperating public shell company to be, in substance, a capital transaction
rather than a business combination (or asset acquisition). That is, the
transaction is a reverse recapitalization, equivalent to the issuance of shares
by the private operating company for the net monetary assets of the public shell
company accompanied by a recapitalization. The accounting is similar to that
resulting from a reverse acquisition, except that no goodwill or other
intangible assets are recognized.
In other cases, a SPAC, sometimes also called a “blank check”
company, legally acquires a private operating company. A SPAC is a newly formed
company that raises cash in an IPO and uses that cash or the equity of the SPAC,
or both, to fund the acquisition of a target. After a SPAC IPO, the SPAC’s
management looks to complete an acquisition of a target (the “transaction”)
within the period specified in its governing documents (e.g., 24 months). In
many cases, the SPAC and target may need to secure additional financing to
facilitate the transaction. For example, they may consider funding through a
private investment in public equity (PIPE), which will generally close
contemporaneously with the consummation of the transaction. If an acquisition
cannot be completed within the required time frame, the cash raised by the SPAC
in the IPO must be returned to the investors and the SPAC is dissolved (unless
the SPAC extends its timeline via a proxy process).
Before completing an acquisition, SPACs hold no material assets
other than cash; therefore, they are nonoperating public “shell companies,” as
defined by the SEC (see paragraph 1160.2 of the SEC Division of Corporation
Finance’s Financial Reporting Manual [FRM]). However, SPACs engage in
significant precombination activities (e.g., raising cash in public markets,
identifying investment opportunities). Therefore, entities must analyze
transactions in which a SPAC acquires an operating company to determine whether
the SPAC or the operating company is the acquirer for accounting purposes
(“accounting acquirer”).
The ASC master glossary defines an acquirer as follows:
The entity that
obtains control of the acquiree. However, in a business combination in which
a variable interest entity (VIE) is acquired, the primary beneficiary of
that entity always is the acquirer.
Entities must first consider the guidance in ASC 805-10-25-5,
which states, in part, that “in a business combination in which a [VIE] is
acquired, the primary beneficiary of that entity always is the acquirer. The
determination of which party, if any, is the primary beneficiary of a VIE shall
be made in accordance with the guidance in the Variable Interest Entities
Subsections of Subtopic 810-10, not by applying either the guidance in the
General Subsections of that Subtopic, relating to a controlling financial
interest, or in paragraphs 805-10-55-11 through 55-15.” Consequently, entities
must consider whether the legal acquiree (i.e., the operating company) is a VIE
on the basis of the guidance in ASC 810-10-15-14.
To qualify as a VIE, a legal entity needs to have only one of the following characteristics:
- The legal entity does not have sufficient equity investment at risk (see Section 5.2 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
- The equity investors at risk, as a group, lack the characteristics of a controlling financial interest (see Section 5.3 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest). In this assessment, there are specific requirements for entities that are limited partnerships or similar legal entities such as limited liability companies with managing members. Some of these entities may be VIEs depending on what voting rights are provided to limited partners in a limited partnership or to nonmanaging members for certain limited liability corporations (see Section 5.3.1.2 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
- The legal entity is structured with disproportionate voting rights, and substantially all of the activities are conducted on behalf of an investor with disproportionately few voting rights (see Section 5.4 of Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
If the legal acquiree is a voting interest entity rather than a
VIE, entities should identify the acquirer by first considering the guidance in
the general subsections of ASC 810-10 related to determining the existence of a
controlling financial interest. If they cannot identify the acquirer on the
basis of that guidance, they should consider the factors in ASC 805-10-55-11
through 55-15.
ASC 805-10-55-11 states that in an acquisition “effected primarily by
transferring cash or other assets or by incurring liabilities, the acquirer
usually is the entity that transfers the cash or other assets or incurs the
liabilities.” Therefore, if the acquisition is effected primarily by the SPAC’s
transfer of cash or other assets rather than its equity, the SPAC will usually
be identified as the accounting acquirer.
ASC 805-10-55-12 states that in an acquisition “effected primarily by exchanging
equity interests, the acquirer usually is the entity that issues its equity
interests. However, in some business combinations, commonly called reverse
acquisitions, the issuing entity is the acquiree.” That is, if the acquisition
is effected primarily by exchanging equity interests, the SPAC is the entity
that issues its equity interests to effect the transaction and is therefore the
“legal acquirer.” Sometimes, the SPAC may also be identified as the accounting
acquirer. However, in certain transactions, the operating company whose equity
interests are acquired and is therefore the “legal acquiree” is determined to be
the accounting acquirer. Entities should consider the following factors in ASC
805-10-55-12 and 55-13 when identifying the accounting acquirer in business
combinations effected primarily by exchanging equity shares:
- “The relative voting rights in the combined entity after the business combination” (ASC 805-10- 55-12(a)).
- “The existence of a large minority voting interest in the combined entity” (ASC 805-10-55-12(b)).
- “The composition of the governing body of the combined entity” (ASC 805-10-55-12(c)).
- “The composition of the senior management of the combined entity” (ASC 805-10-55-12(d)).
- “The terms of the exchange of equity interests” (ASC 805-10-55-12(e)).
- The “relative size (measured in, for example, assets, revenues, or earnings)” of the combining entities (ASC 805-10-55-13).
See Section 3.1 for more information about
identifying the acquirer.
If the SPAC is determined to be the accounting acquirer, the entities must
determine whether the operating company meets the definition of a business (see
Section 2.4). If it does, the
transaction is a business combination and the SPAC recognizes the operating
company’s assets and liabilities in accordance with the guidance in ASC 805-10,
ASC 805-20, and ASC 805-30, generally at fair value. If the operating company is
determined to be a group of assets that does not meet the definition of a
business, the transaction is an asset acquisition and the SPAC recognizes the
operating company’s assets and liabilities in accordance with the guidance in
ASC 805-50 at relative fair value (see Appendix
C). By contrast, if the operating company is determined to be the
accounting acquirer, generally the SPAC’s only precombination asset is the cash
raised from its investors and the substance of the transaction is a
recapitalization of the operating company (i.e., a reverse recapitalization).
Accordingly, the accounting for the transaction is similar to that of an
acquisition of a private operating company by a nonoperating public shell
company (as described above).
Because a reverse recapitalization is equivalent to the issuance
of shares by the private operating company for the net monetary assets of the
public shell company, the transaction costs incurred to effect the
recapitalization may represent costs related to issuing equity and raising
capital that are recognized as a reduction to the total amount of equity raised
(i.e., reduction of APIC) rather than expensed as incurred.
See Section
5.7 of Deloitte’s Roadmap Initial Public Offerings for more
information about offering costs. Also, for further discussion of reporting
considerations related to acquisitions by public shell companies and SPACs, see
SAB Topic 5.A and Deloitte’s October 2, 2020 (updated April 11, 2022), Financial Reporting
Alert.
Chapter 7 — Disclosure
Chapter 7 — Disclosure
A business combination often results in a significant change in an acquirer’s assets, liabilities, and
operations. ASC 805 describes the overall objectives for disclosing information that permits investors,
creditors, and others to evaluate the financial effects of a business combination. ASC 805-10-50,
ASC 805-20-50, and ASC 805-30-50 provide specific disclosure requirements that are intended to fulfill
those objectives. However, if the information an acquirer discloses under those specific requirements
or other GAAP is not sufficient for meeting the overall objectives in ASC 805, the acquirer must disclose
whatever additional information is necessary to meet those objectives.
7.1 Disclosure Objectives
ASC 805-10
Business Combinations Occurring During a Current Reporting Period or After the Reporting Date
but Before the Financial Statements Are Issued
50-1 The acquirer shall disclose information that enables users of its financial statements to evaluate the
nature and financial effect of a business combination that occurs either:
- During the current reporting period
- After the reporting date but before the financial statements are issued or are available to be issued (as discussed in Section 855-10-25).
The Financial Effects of Adjustments That Relate to Business Combinations That Occurred in the
Current or Previous Reporting Periods
50-5 The acquirer shall disclose information that enables users of its financial statements to evaluate the
financial effects of adjustments recognized in the current reporting period that relate to business combinations
that occurred in the current or previous reporting periods.
Other Disclosures
50-7 If the specific disclosures required by this Subtopic and other generally accepted accounting principles
(GAAP) do not meet the objectives set out in paragraphs 805-10-50-1 and 805-10-50-5, the acquirer shall
disclose whatever additional information is necessary to meet those objectives.
Entities must provide separate disclosures for each material business combination that occurs during
the reporting period. However, certain disclosures may be provided in the aggregate for immaterial
business combinations that are material collectively (see Section 7.1.1).
The disclosure requirements apply to all acquirers, with the exception of the
pro forma disclosures required by ASC
805-10-50-2(h), which apply only to public
entities (see Section 7.9 for
more information). Further, in accordance with ASC
270-10-50-5 and ASC 270-10-50-7(a), the disclosure
requirements in ASC 805 also apply to interim
financial reports.
7.1.1 Individually Immaterial Business Combinations That Are Material Collectively
Specific disclosures are required if an acquirer completes multiple immaterial business combinations
in a reporting period that are material collectively. For such business combinations, ASC 805-10-50-3,
ASC 805-20-50-2, and ASC 805-30-50-2 require entities to disclose, in the aggregate, the information
required by the following:
- ASC 805-10-50-2 (e)–(h) (i.e., the disclosures in ASC 805-10-50-2 (a)–(d) are not required. See Section 7.2).
- ASC 805-20-50-1.
- ASC 805-30-50-1.
See the next section for more information about assessing materiality.
7.1.2 Assessing Materiality
ASC 805 does not provide guidance on differentiating between material and
immaterial business combinations or on evaluating when individually immaterial
business combinations are material collectively, so entities need to apply
judgment. Although SEC Regulation S-X, Rule 3-05, specifies thresholds for
registrants related to significance (see Appendix D), those thresholds are
generally higher than the materiality thresholds under ASC 805. Therefore,
registrants must separately determine which financial statement disclosures are
required under ASC 805 for an individually material business combination (or for
individually immaterial business combinations that are material collectively) in
the period presented.
We believe that in addition to the quantitative considerations involved in the
assessment of materiality, entities should
consider qualitative factors, such as the amount
of discussion about a business combination in an
entity’s MD&A, annual report, or press
release.
Unless otherwise indicated, the following discussion of disclosure requirements
applies to all material business combinations and
individually immaterial business combinations that
are material collectively occurring during the
reporting period.
7.2 General Information to Be Disclosed
ASC 805-10
50-2 To meet the objective in the preceding paragraph [ASC 805-10-50-1], the acquirer shall disclose the following information for each
business combination that occurs during the reporting period:
- The name and a description of the acquiree
- The acquisition date
- The percentage of voting equity interests acquired
- The primary reasons for the business combination and a description of how the acquirer obtained control of the acquiree . . . .
Disclosure of the information provided in ASC 805-10-50-2(a)–(d) is not required for individually
immaterial business combinations that are collectively material (see Section 7.1.1).
7.3 Assets Acquired and Liabilities Assumed
ASC 805-20
50-1 Paragraph 805-10-50-1 identifies one of the objectives of disclosures about a business combination. To
meet that objective, the acquirer shall disclose all of the following information for each business combination
that occurs during the reporting period: . . .
c. The amounts recognized as of the acquisition date for each major class of assets acquired and liabilities
assumed (see Example 5 [paragraph 805-10-55-37]). . . .
The disclosures required by ASC 805-20-50-1(c) are often presented in a tabular format. See
Section 7.14 for a disclosure example.
ASC 805-20-50-1 also includes specific disclosure requirements for certain
acquired assets and liabilities. Those requirements are described in more detail below.
7.3.1 Indemnification Assets
ASC 805-20
50-1 Paragraph 805-10-50-1 identifies one of the
objectives of disclosures about a business combination. To meet that
objective, the acquirer shall disclose all of the following information for
each business combination that occurs during the reporting period:
-
For indemnification assets, all of the following:
-
The amount recognized as of the acquisition date
-
A description of the arrangement and the basis for determining the amount of the payment
-
An estimate of the range of outcomes (undiscounted) or, if a range cannot be estimated, that fact and the reasons why a range cannot be estimated. If the maximum amount of the payment is unlimited, the acquirer shall disclose that fact. . . .
-
7.3.2 Receivables
ASC 805-20
50-1 Paragraph 805-10-50-1 identifies one of the
objectives of disclosures about a business combination. To meet that
objective, the acquirer shall disclose all of the following information for
each business combination that occurs during the reporting period: . . .
b. For acquired receivables not subject to the requirements of Subtopic
326-20 relating to purchased financial assets with credit deterioration,
all of the following:
1. The fair value of the receivables (unless those
receivables arise from sales-type leases or direct financing leases by the
lessor for which the acquirer shall disclose the amounts recognized as of
the acquisition date)
2. The gross contractual amounts receivable
3. The best estimate at the acquisition date of
the contractual cash flows not expected to be collected.
The disclosures shall be provided by major class of receivable, such as
loans, net investment in sales-type or direct financing leases in
accordance with Subtopic 842-30 on leases — lessor, and any other class of
receivables. . . .
7.3.3 Assets and Liabilities Arising From Contingencies
ASC 805-20
50-1 Paragraph 805-10-50-1 identifies one of the objectives of disclosures about a business combination. To
meet that objective, the acquirer shall disclose all of the following information for each business combination
that occurs during the reporting period: . . .
d. For contingencies, the following disclosures shall be included in the note that describes the business
combination:
1. For assets and liabilities arising from contingencies recognized at the acquisition date:
i. The amounts recognized at the acquisition date and the measurement basis applied
(that is, at fair value or at an amount recognized in accordance with Topic 450 and Section 450-20-25)
ii. The nature of the contingencies.
An acquirer may aggregate
disclosures for assets or liabilities arising from
contingencies that are similar in nature.
2. For contingencies that are not recognized at the acquisition date, the disclosures required by Topic
450 if the criteria for disclosures in that Topic are met. . . .
In addition to the requirements in ASC 805, SEC registrants should consider the
disclosure requirements in SAB Topic 5.Y,
which addresses disclosures related to loss contingencies.
7.3.4 Intangible Assets
While ASC 805-20-50-1(c) requires disclosure of “[t]he amounts recognized as of the acquisition date for
each major class of assets acquired and liabilities assumed,” ASC 350-30-50-1 provides more specific
disclosure requirements for acquired intangible assets:
ASC 350-30
Disclosures in the Period of Acquisition
50-1 For intangible assets acquired either individually or as part of a group of assets (in either an asset
acquisition, a business combination, or an acquisition by a not-for-profit entity), all of the following information
shall be disclosed in the notes to financial statements in the period of acquisition:
- For intangible assets subject to amortization, all of the following:
- The total amount assigned and the amount assigned to any major intangible asset class
- The amount of any significant residual value, in total and by major intangible asset class
- The weighted-average amortization period, in total and by major intangible asset class.
- For intangible assets not subject to amortization, the total amount assigned and the amount assigned to any major intangible asset class.
- The amount of research and development assets acquired in a transaction other than a business combination or an acquisition by a not-for-profit entity and written off in the period and the line item in the income statement in which the amounts written off are aggregated.
- For intangible assets with renewal or extension terms, the weighted-average period before the next renewal or extension (both explicit and implicit), by major intangible asset class.
This information also shall be disclosed separately for each material business
combination or acquisition by a not-for-profit entity or in the aggregate for
individually immaterial business combinations or acquisitions by a
not-for-profit entity that are material collectively if the aggregate fair
values of intangible assets acquired, other than goodwill, are
significant.
In addition, ASC 350-30-50-2 through 50-5 provide disclosure requirements for intangible assets in
periods after their acquisition.
7.3.4.1 In-Process Research and Development
Other than the requirement in ASC 805-20-50-1(c) for acquirers to disclose “[t]he amounts recognized
as of the acquisition date for each major class of assets acquired and liabilities assumed,” ASC 805 does
not specifically address disclosures related to IPR&D. However, acquirers must comply with the fair value measurement disclosure requirements in ASC 820-10-50.
7.3.5 Goodwill
ASC 805-30
50-1 Paragraph 805-10-50-1 identifies one of the objectives of disclosures about a business combination. To
meet that objective, the acquirer shall disclose all of the following information for each business combination
that occurs during the reporting period:
a. A qualitative description of the factors that make up the goodwill recognized, such as expected synergies
from combining operations of the acquiree and the acquirer, intangible assets that do not qualify for
separate recognition, or other factors. . . .
d. The total amount of goodwill that is expected to be deductible for tax purposes.
e. If the acquirer is required to disclose segment information in accordance with Subtopic 280-10, the
amount of goodwill by reportable segment. If the assignment of goodwill to reporting units required by
paragraphs 350-20-35-41 through 35-44 has not been completed as of the date the financial statements
are issued or are available to be issued (as discussed in Section 855-10-25), the acquirer shall disclose
that fact. . . .
50-4 Paragraph 805-10-50-5 identifies the second objective of disclosures about the effects of business
combinations that occurred in the current or previous reporting periods. To meet the objective in that
paragraph, the acquirer shall disclose the following information for each material business combination or in
the aggregate for individually immaterial business combinations that are material collectively: . . .
b. A reconciliation of the carrying amount of goodwill at the beginning and end of the reporting period as
required by paragraph 350-20-50-1. . . .
Further, ASC 350-20 requires entities to provide a reconciliation of the carrying amounts of goodwill at
the beginning and end of the reporting period:
ASC 350-20
50-1 The changes in the carrying amount of goodwill during the period shall be disclosed, showing separately
(see Example 3 [paragraph 350-20-55-24]):
- The gross amount and accumulated impairment losses at the beginning of the period
- Additional goodwill recognized during the period, except goodwill included in a disposal group that, on acquisition, meets the criteria to be classified as held for sale in accordance with paragraph 360-10-45-9
- Adjustments resulting from the subsequent recognition of deferred tax assets during the period in accordance with paragraphs 805-740-25-2 through 25-4 and 805-740-45-2
- Goodwill included in a disposal group classified as held for sale in accordance with paragraph 360-10-45-9 and goodwill derecognized during the period without having previously been reported in a disposal group classified as held for sale
- Impairment losses recognized during the period in accordance with this Subtopic
- Net exchange differences arising during the period in accordance with Topic 830
- Any other changes in the carrying amounts during the period
- The gross amount and accumulated impairment losses at the end of the period.
Entities that report segment information in accordance with Topic 280 shall provide the above information
about goodwill in total and for each reportable segment and shall disclose any significant changes in the
allocation of goodwill by reportable segment. If any portion of goodwill has not yet been allocated to a reporting
unit at the date the financial statements are issued, that unallocated amount and the reasons for not allocating
that amount shall be disclosed.
50-1A Entities that have one or more
reporting units with zero or negative carrying amounts of net assets shall
disclose those reporting units with allocated goodwill and the amount of
goodwill allocated to each and in which reportable segment the reporting unit
is included.
In addition, ASC 350-20-50 provides disclosure requirements for goodwill in periods after the business
combination.
As Chapter 8 will
discuss, a private company and not-for-profit entity can elect an alternative to account
for goodwill. In such a case, the entity is required to amortize goodwill over a 10-year
period unless it can demonstrate that a shorter life is more appropriate. A private
company or not-for-profit entity that elects the accounting alternative must provide
disclosures as follows:
ASC 350-20
50-4 The following information shall be disclosed in the notes to financial statements for any additions to
goodwill in each period for which a statement of financial position is presented:
- The amount assigned to goodwill in total and by major business combination, by major acquisition by a not-for-profit entity, or by reorganization event resulting in fresh-start reporting
- The weighted-average amortization period in total and the amortization period by major business combination, by major acquisition by a not-for-profit entity, or by reorganization event resulting in fresh-start reporting.
50-5 The following information shall be disclosed in the financial statements or the notes to financial
statements for each period for which a statement of financial position is presented:
- The gross carrying amounts of goodwill, accumulated amortization, and accumulated impairment loss
- The aggregate amortization expense for the period
- Goodwill included in a disposal group classified as held for sale in accordance with paragraph 360-10-45-9 and goodwill derecognized during the period without having previously been reported in a disposal group classified as held for sale.
50-6 For each goodwill impairment loss recognized, the following information shall be disclosed in the notes to
financial statements that include the period in which the impairment loss is recognized:
- A description of the facts and circumstances leading to the impairment
- The amount of the impairment loss and the method of determining the fair value of the entity or the reporting unit (whether based on prices of comparable businesses or nonprofit activities, a present value or other valuation technique, or a combination of those methods)
- The caption in the income statement or statement of activities in which the impairment loss is included
- The method of allocating the impairment loss to the individual amortizable units of goodwill.
50-7 The quantitative disclosures about significant unobservable inputs used in fair value measurements
categorized within Level 3 of the fair value hierarchy required by paragraph 820-10-50-2(bbb) are not required
for fair value measurements related to the financial accounting and reporting for goodwill after its initial
recognition in a business combination or an acquisition by [a] not-for-profit entity.
7.3.6 Disclosure of Practical Expedients the Acquirer Uses for Recognizing and Measuring an Acquiree’s Contract Assets and Liabilities
ASC 805-20
50-5 Paragraph not used.
Pending content (Transition Guidance: ASC 805-20-65-3)
Editor’s Note:
The content of paragraph 805-20-50-5 will be amended upon
transition, together with the addition of the heading noted
below:
Exceptions to the Measurement Principle
50-5 For any of the practical expedients
in paragraph 805-20-30-29 that an acquirer uses, the acquirer shall
disclose all of the following information:
- The expedients that have been used
- To the extent reasonably possible, a qualitative assessment of the estimated effect of applying each of those expedients.
ASU 2021-08 notes that
upon its adoption, an acquirer is required to disclose any practical expedients it uses in
recognizing and measuring an acquiree’s contract assets and contract liabilities from
revenue contracts with customers and other contracts to which the provisions of ASC 606
apply, such as “contract liabilities from the sale of nonfinancial assets within the scope
of Subtopic 610-20, that are recognized and measured using the guidance in Topic 606.” An
acquirer is also required to disclose “[t]o the extent reasonably possible, a qualitative
assessment of the estimated effect of applying each of those expedients.” See Section 4.3.13 for more information
about the amendments made by ASU 2021-08.
7.4 Consideration Transferred, Including Contingent Consideration
ASC 805-30
50-1 Paragraph 805-10-50-1 identifies one of the objectives of disclosures about a business combination. To
meet that objective, the acquirer shall disclose all of the following information for each business combination
that occurs during the reporting period: . . .
b. The acquisition-date fair value of the total consideration transferred and the acquisition-date fair value
of each major class of consideration, such as the following:
1. Cash
2. Other tangible or intangible assets, including a business or subsidiary of the acquirer
3. Liabilities incurred, for example, a liability for contingent consideration
4. Equity interests of the acquirer, including the number of instruments or interests issued or issuable
and the method of determining the fair value of those instruments or interests.
c. For contingent consideration arrangements, all of the following:
1. The amount recognized as of the acquisition date
2. A description of the arrangement and the basis for determining the amount of the payment
3. An estimate of the range of outcomes (undiscounted) or, if a range cannot be estimated, that fact
and the reasons why a range cannot be estimated. If the maximum amount of the payment is
unlimited, the acquirer shall disclose that fact. . . .
50-4 Paragraph 805-10-50-5 identifies the second objective of disclosures about the effects of business
combinations that occurred in the current or previous reporting periods. To meet the objective in that
paragraph, the acquirer shall disclose the following information for each material business combination or in
the aggregate for individually immaterial business combinations that are material collectively:
- For each reporting period after the acquisition date until the entity collects, sells, or otherwise loses the right to a contingent consideration asset, or until the entity settles a contingent consideration liability or the liability is cancelled or expires, all of the following:
- Any changes in the recognized amounts, including any differences arising upon settlement
- Any changes in the range of outcomes (undiscounted) and the reasons for those changes
- The disclosures required by Section 820-10-50. . . .
ASC 805-30-50-1 requires acquirers to disclose “[t]he acquisition-date fair value of the total
consideration transferred and the acquisition-date fair value of each major class of consideration.”
The consideration transferred from the acquirer to the seller is commonly in the form of cash, equity
instruments of the acquirer, or a combination of both. However, the consideration can take other forms,
such as noncash assets or liabilities incurred (e.g., contingent consideration or a seller note).
Connecting the Dots
Cash flows related to the acquisitions of businesses, PP&E, and other productive assets are
presented as investing activities in the statement of cash flows. For a business combination, all
cash paid to purchase a business is shown as a single line item, net of any cash acquired. After
an acquisition, the cash flows of the acquirer and acquiree are combined and presented in a
consolidated statement of cash flows.
An entity may also need to consider other financial reporting implications of a
business combination, depending on the nature and terms of the transaction. For example,
any noncash effects of an acquisition that involves noncash consideration must be
disclosed in a narrative format or summarized in a schedule.
See Section 7.5 of
Deloitte’s Roadmap Statement of Cash
Flows for more information about
issues related to the presentation of cash flows in
a business combination.
7.5 Bargain Purchase Gains
ASC 805-30
50-1 Paragraph 805-10-50-1 identifies one of the objectives of disclosures about a business combination. To
meet that objective, the acquirer shall disclose all of the following information for each business combination
that occurs during the reporting period: . . .
f. In a bargain purchase (see paragraphs 805-30-25-2 through 25-4), both of the following:
1. The amount of any gain recognized in accordance with paragraph 805-30-25-2 and the line item in
the income statement in which the gain is recognized
2. A description of the reasons why the transaction resulted in a gain.
7.6 Partial Acquisitions and Noncontrolling Interests
ASC 805-20
50-1 Paragraph 805-10-50-1 identifies one of the objectives of disclosures about a business combination. To
meet that objective, the acquirer shall disclose all of the following information for each business combination
that occurs during the reporting period: . . .
e. For each business combination in which the acquirer holds less than 100 percent of the equity interests
in the acquiree at the acquisition date, both of the following:
1. The fair value of the noncontrolling interest in the acquiree at the acquisition date
2. The valuation technique(s) and significant inputs used to measure the fair value of the
noncontrolling interest.
In addition to meeting the requirement in ASC 805-20-50-1(e), entities must
disclose under ASC 810-10-50-1A — either in the statement of changes in equity or in the
notes to the consolidated financial statements — a reconciliation between the beginning
and end of the period carrying amounts of total equity, equity attributable to the
parent, and equity attributable to the noncontrolling interest. For further details on
these required disclosure requirements, see Chapter 8 of Deloitte’s Roadmap Noncontrolling
Interests.
7.7 Business Combinations Achieved in Stages
ASC 805-10
50-2 To meet the objective in the preceding paragraph [ASC 805-10-50-1], the acquirer shall disclose the following information for each
business combination that occurs during the reporting period: . . .
g. In a business combination achieved in stages, all of the following:
1. The acquisition-date fair value of the equity interest in the acquiree held by the acquirer immediately
before the acquisition date
2. The amount of any gain or loss recognized as a result of remeasuring to fair value the equity interest
in the acquiree held by the acquirer immediately before the business combination (see paragraph
805-10-25-10) and the line item in the income statement in which that gain or loss is recognized
3. The valuation technique(s) used to measure the acquisition-date fair value of the equity interest in
the acquiree held by the acquirer immediately before the business combination
4. Information that enables users of the acquirer’s financial statements to assess the inputs used
to develop the fair value measurement of the equity interest in the acquiree held by the acquirer
immediately before the business combination. . . .
7.8 Transactions That Are Separate From the Business Combination
ASC 805-10
50-2 To meet the objective in the preceding paragraph [ASC 805-10-50-1], the acquirer shall disclose the following information for each
business combination that occurs during the reporting period: . . .
e. For transactions that are recognized separately from the acquisition of assets and assumptions of
liabilities in the business combination (see paragraph 805-10-25-20), all of the following:
1. A description of each transaction
2. How the acquirer accounted for each transaction
3. The amounts recognized for each transaction and the line item in the financial statements in which
each amount is recognized
4. If the transaction is the effective settlement of a preexisting relationship, the method used to
determine the settlement amount. . . .
7.8.1 Acquisition-Related Costs
ASC 805-10
50-2 To meet the objective in the preceding paragraph [ASC 805-10-50-1], the acquirer shall disclose the following information for each
business combination that occurs during the reporting period: . . .
f. The disclosure of separately recognized transactions required in (e) [ASC 805-10-50-2(e)] shall include the
amount of acquisition-related costs, the amount recognized as an expense, and the line item or items in
the income statement in which those expenses are recognized. The amount of any issuance costs not
recognized as an expense and how they were recognized also shall be disclosed. . . .
Acquirers typically incur acquisition-related costs — such as third-party costs
for finders’ fees — as well as advisory, legal, accounting, valuation, and other
professional or consulting fees. ASC 805-10-25-23 states, in part, that “[t]he
acquirer shall account for acquisition-related costs as expenses in the periods in
which the costs are incurred and the services are received, with one exception. The
costs to issue debt or equity securities shall be recognized in accordance with
other applicable GAAP” (see Section 5.4.1). ASC 805-10-50-2(f) requires an entity to disclose:
-
“[T]he amount of acquisition-related costs.”
-
“[T]he amount recognized as an expense.”
-
“[T]he line item or items in the income statement in which [the] expenses are recognized.”
-
“The amount of any issuance costs not recognized as an expense and how they were recognized.”
While entities will often incur acquisition-related costs in the reporting periods before an acquisition,
the disclosures specified in ASC 805-10-50-2 are required only for business combinations that occur
during the current reporting period or after the reporting date but before financial statements are
issued unless the initial accounting for the business combination is incomplete at the time the financial
statements are issued or are available to be issued.
7.9 Supplemental Information for Public Entities
ASC 805-10
50-2 To meet the objective in the preceding paragraph [ASC 805-10-50-1], the acquirer shall disclose the following information for each
business combination that occurs during the reporting period: . . .
h. If the acquirer is a public entity, all of the following:
1. The amounts of revenue and earnings of the acquiree since the acquisition date included in the
consolidated income statement for the reporting period.
2. If comparative financial statements are not presented, the revenue and earnings of the combined
entity for the current reporting period as though the acquisition date for all business combinations
that occurred during the year had been as of the beginning of the annual reporting period
(supplemental pro forma information).
3. If comparative financial statements are presented, the revenue and earnings of the combined entity
as though the business combination(s) that occurred during the current year had occurred as of the
beginning of the comparable prior annual reporting period (supplemental pro forma information).
For example, for a calendar year-end entity, disclosures would be provided for a business
combination that occurs in 20X2, as if it occurred on January 1, 20X1. Such disclosures would not be
revised if 20X2 is presented for comparative purposes with the 20X3 financial statements (even if
20X2 is the earliest period presented).
4. The nature and amount of any material, nonrecurring pro forma adjustments directly attributable to
the business combination(s) included in the reported pro forma revenue and earnings (supplemental
pro forma information).
If disclosure of any of the information required by (h) is impracticable, the
acquirer shall disclose that fact and explain why the
disclosure is impracticable. In this context, the term
impracticable has the same meaning as in
paragraph 250-10-45-9.
According to ASC 805-10-50-2(h)(1), an acquirer that meets the definition of a public entity is required
to disclose “[t]he amounts of revenue and earnings of the acquiree since the acquisition date included
in the consolidated income statement for the reporting period.” The FASB limited the period for this
disclosure to the year of acquisition (i.e., the end of the annual reporting period that includes the acquisition date) because the Board believed that it might become impracticable for entities to obtain
this information after the acquiree becomes more integrated into the acquirer’s operations.
In addition, ASC 805-10-50-2(h) requires public entities to disclose
“supplemental pro forma information.” The requirements for this disclosure differ
depending on whether comparative financial statements are presented:
-
If an acquirer presents comparative financial statements, it is required to disclose “the revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period” (emphasis added).
-
If an acquirer does not present comparative financial statements, it is required to disclose “the revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period” (emphasis added).
In addition, in accordance with ASC 805-10-50-2(h)(4), acquirers must disclose
“[t]he nature and amount of any material, nonrecurring pro forma adjustments
directly attributable to the business combination(s) included in the reported pro
forma revenue and earnings.”
Entities must provide pro forma information for business combinations that occur
(1) during the reporting period or (2) after the reporting date but before the
financial statements are issued unless the initial accounting for the business
combination is incomplete at the time the financial statements are issued or are
available to be issued. In addition, if multiple immaterial business combinations
occur that are material collectively, pro forma information should be disclosed in
the aggregate for those business combinations.
The supplemental pro forma information required by ASC 805-10-50-2(h) (i.e., the
revenue and earnings of the acquiree for the periods before the acquisition) does
not need to be audited. Auditors, however, should perform the procedures required by
PCAOB AU Section 558.
SEC Considerations
The SEC rules on pro forma financial information disclosures differ from the guidance in
U.S. GAAP:
- ASC 805-10-50-2(h) requires pro forma financial information to be disclosed in the notes to the historical financial statements.
- SEC Regulation S-X, Article 11, requires pro forma financial information to be presented in certain SEC filings (e.g., Form 8-K, registration statements, and proxy statements).
The pro forma financial information disclosures required by ASC 805 are not
sufficient to satisfy the more extensive presentation requirements of
Article 11. We believe that since that the FASB does not provide detailed
guidance on preparing the pro forma financial information, registrants
preparing such information under ASC 805 may apply the same concepts they
apply when preparing their pro forma information under Article 11 in the
absence of guidance under ASC 805.
See Chapter 4 of
Deloitte’s Roadmap SEC
Reporting Considerations for Business Acquisitions
for more information.
7.9.1 Definition of a Public Entity
The disclosures in ASC 805-10-50-2(h) apply to an acquirer that meets the following definition of a public
entity in the ASC master glossary:
A business entity or a not-for-profit entity that meets any of the following conditions:
- It has issued debt or equity securities or is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets).
- It is required to file financial statements with the Securities and Exchange Commission (SEC).
- It provides financial statements for the purpose of issuing any class of securities in a public market.
The ASC master glossary includes multiple definitions of a public entity, so
entities should ensure that they are applying the correct one when determining
whether ASC 805 pro forma disclosures are required. The definition of public
entity in ASC 805-10-20 is the same as that in ASC 280-10-20 for segment
reporting, but it is different from those in ASC 718-10-20 for share-based
payment awards and ASC 740-10-20 for income taxes. In addition, the definition
of a public entity is different from the definition of a PBE, which is used to
determine whether an entity qualifies for the private-company accounting
alternatives as discussed in Chapter 8.
7.9.2 Periods to Be Presented
The objective of the disclosure requirements in ASC 805-10-50-2(h) is to give financial statement users
a sense of what the acquirer’s revenues and earnings would have been if the acquiree had been part of
the acquirer’s operations in the periods before the acquisition. However, ASC 805-10-50-2(h) requires
disclosure of the supplemental pro forma information only for (1) the year of the acquisition and (2)
the previous year if comparative financial statements are presented, even if the acquirer presents
more than two years of income statements. For example, if an acquirer with a calendar year-end had a
material business combination on July 1, 20X8, it would disclose the following in its December 31, 20X8,
comparative financial statements:
- The revenue and earnings of the acquiree from July 1, 20X8, through December 31, 20X8.
- The revenue and earnings of the combined entity from January 1, 20X8, through December 31, 20X8.
- The revenue and earnings of the combined entity from January 1, 20X7, through December 31, 20X7.
In its December 31, 20X9, comparative financial statements, the acquirer would
carry forward the disclosures from the prior year without revising them. It
would not have to include additional pro forma information for 20X9 because the
acquiree’s results would be included in the consolidated financial
statements.
Example 7-1
Company A acquires Company B in a business combination on April 30, 20X8. Company A has a calendar
year-end, and the acquisition of B is material to A’s financial statements. We believe that in its June 30, 20X8,
interim financial statements, A should present supplemental pro forma financial information for the three
months ended June 30, 20X7 and 20X8, and the six months ended June 30, 20X7 and 20X8. Even though the
business combination did not occur in the first quarter of 20X8, we believe that A should present supplemental
pro forma financial information for the three months ended March 31, 20X8, in its March 31, 20X9, financial
statements because the comparative interim period does not include B’s results.
7.9.3 Preparing Pro Forma Financial Information
ASC 805 does not provide specific guidance on the preparation of pro forma information. The objective
of the ASC 805 pro forma disclosure requirements is to give the acquirer’s financial statement users
a sense of what the acquirer’s revenues and earnings would have been if the business combination
had occurred at the beginning of the current year (or previous year if comparative financial statements
are presented). Typically, the acquiree’s revenues and earnings are added to those of the acquirer for
the period of the year in which the acquiree was not owned by the acquirer. If the acquirer presents
comparative financial statements, the acquiree’s revenues and earnings are added to those of the
acquirer for the previous year. Pro forma information should be adjusted for the following:
- Acquisition-related costs — Costs related to the acquisition are included in earnings as of the beginning of the earliest period (i.e., the beginning of either the current year or the previous year if comparative financial statements are presented).
- Fair value adjustments — Income statement effects of fair value adjustments (e.g., depreciation or amortization) are shown as if those adjustments were recognized at the beginning of either the current year or the previous year if comparative financial statements are presented.
- Income taxes — Tax effects of the business combination are shown as if the acquiree had been part of the entity since the beginning of either the current year or the previous year if comparative financial statements are presented.
- Financing — Adjustments related to obtaining financing, such as new debt and additional interest expense, are presented as if the new debt had been obtained as of the beginning of either the current year or the previous year if comparative financial statements are presented.
- Accounting policies — An acquiree’s pro forma revenues and earnings are adjusted to reflect the accounting policies that will be applied by the acquiree after the business combination. See Section 4.16 for more information about conforming accounting policies.
In accordance with ASC 805-10-50-2(h)(4), acquirers must also disclose “[t]he
nature and amount of any material, nonrecurring pro forma adjustments directly
attributable to the business combination(s) included in the reported pro forma
revenue and earnings.” However, acquirers should not include adjustments that are
not objectively determinable, such as adjustments for costs savings or synergies
resulting from the business combination.
7.9.4 Impracticability Exception
ASC 805-10-50-2 states that “[i]f disclosure of any of the information required by (h) [ASC 805-10-50-2(h)] is
impracticable, the acquirer shall disclose that fact and explain why the disclosure is impracticable.”
ASC 250-10-45-9 clarifies the meaning of impracticability as follows:
It shall be deemed impracticable to apply the effects of a
change in accounting principle retrospectively only if any of the following
conditions exist:
-
After making every reasonable effort to do so, the entity is unable to apply the requirement.
-
Retrospective application requires assumptions about management’s intent in a prior period that cannot be independently substantiated.
-
Retrospective application requires significant estimates of amounts, and it is impossible to distinguish objectively information about those estimates that both:
-
Provides evidence of circumstances that existed on the date(s) at which those amounts would be recognized, measured, or disclosed under retrospective application
-
Would have been available when the financial statements for that prior period were issued.
-
Impracticability is viewed as a high hurdle. Because the ASC 805 pro forma disclosures do not typically
need to include significant estimates or assumptions about management’s intent, it is unusual for
entities to determine that it is impracticable to provide them.
7.10 Fair Value Measurements
The fair value measurement disclosures in ASC 820-10-50 are applicable to the assets and liabilities
acquired in a business combination that are measured at fair value. ASC 820 also requires entities to
disclose certain information if the assets or liabilities are remeasured to fair value on a recurring basis.
7.11 Disclosures Required When the Initial Accounting for the Business Combination Is Incomplete (Measurement-Period Adjustments)
ASC 805-20
50-4A If the initial accounting for a business combination is incomplete (see paragraphs 805-10-25-13
through 25-14) for particular assets, liabilities, noncontrolling interests, or items of consideration and the
amounts recognized in the financial statements for the business combination thus have been determined only
provisionally, the acquirer shall disclose the following information for each material business combination or
in the aggregate for individually immaterial business combinations that are material collectively to meet the
objective in paragraph 805-10-50-5:
- The reasons why the initial accounting is incomplete
- The assets, liabilities, equity interests, or items of consideration for which the initial accounting is incomplete
- The nature and amount of any measurement period adjustments recognized during the reporting period in accordance with paragraph 805-10-25-17, including separately the amount of adjustment to current-period income statement line items relating to the income effects that would have been recognized in previous periods if the adjustment to provisional amounts were recognized as of the acquisition date. Alternatively, an acquirer may present those amounts separately on the face of the income statement.
During the measurement period, the acquirer has time to obtain the information needed to identify and
measure the consideration transferred, the assets acquired, the liabilities assumed, and any previously
held or noncontrolling interests. The objective of this period is to give the acquirer a reasonable
amount of time in which to obtain the information necessary to enable it to complete the accounting
for a business combination while maintaining normal reporting schedules. However, the measurement
period cannot exceed one year from the acquisition date. Entities should disclose the assets, liabilities,
and items of consideration for which the initial accounting is incomplete. See Section 6.1 for more
information about the measurement period.
7.12 Disclosures Related to Business Combinations After the Balance Sheet Date
ASC 805-10
50-4 If the acquisition date of a business combination is after the reporting date but before the financial
statements are issued or are available to be issued (as discussed in Section 855-10-25), the acquirer shall
disclose the information required by paragraph 805-10-50-2 unless the initial accounting for the business
combination is incomplete at the time the financial statements are issued or are available to be issued. In that
situation, the acquirer shall describe which disclosures could not be made and the reason why they could not
be made.
ASC 805-20
50-3 If the acquisition date of a business combination is after the reporting date but before the financial
statements are issued or are available to be issued (as discussed in Section 855-10-25), the acquirer shall
disclose the information required by paragraph 805-20-50-1 unless the initial accounting for the business
combination is incomplete at the time the financial statements are issued or are available to be issued. In that
situation, the acquirer shall describe which disclosures could not be made and the reason why they could not
be made.
ASC 805-30
50-3 If the acquisition date of a business combination is after the reporting date but before the financial
statements are issued or are available to be issued (as discussed in Section 855-10-25), the acquirer shall
disclose the information required by paragraph 805-30-50-1 unless the initial accounting for the business
combination is incomplete at the time the financial statements are issued or are available to be issued. In that
situation, the acquirer shall describe which disclosures could not be made and the reason why they could not
be made.
As indicated in ASC 805-10-50-4, entities are required to disclose the information included in
ASC 805-10-50-2, ASC 805-20-50-1, and ASC 805-30-50-1 “[i]f the acquisition date of a business
combination is after the reporting date but before the financial statements are issued or are available
to be issued.” If the initial accounting for the business combination is incomplete when the financial
statements are issued or are available to be issued, the acquirer should “describe which disclosures
could not be made and the reason why they could not be made,” in accordance with ASC 805-20-50-3.
In addition, as stated in ASC 805-20-50-4A, if an acquirer has recognized only provisional amounts for
“particular assets, liabilities, noncontrolling interests, or items of consideration,” it should disclose the
following, either “for each material business combination or in the aggregate for individually immaterial
business combinations that are material collectively”:
- “The reasons why the initial accounting is incomplete.”
- “The assets, liabilities, equity interests, or items of consideration for which the initial accounting is incomplete.”
- “The nature and amount of any measurement period adjustments recognized during the reporting period in accordance with paragraph 805-10-25-17.”
7.13 Disclosures Related to Business Combinations That Occurred in Previous Reporting Periods
ASC 805-10-50-1 states, in part, that the “acquirer shall disclose information that enables users of its
financial statements to evaluate the nature and financial effect of a business combination that occurs
[during] the current [financial] reporting period.” Therefore, whenever financial statements include the
period in which a business combination occurred, the required disclosures for the acquisition should be
provided. For example, if an entity completed a business combination in 20X0 and presents three years
of income statements in its financial statements, it should include the disclosures related to the 20X0
business combination in its 20X1 and 20X2 financial statements.
7.14 Illustrative Example
The example below is reproduced from ASC 805-10-55-37 through 55-50 and
illustrates some of the disclosure requirements of ASC 805.
ASC 805-10
Example 5: Illustration of Disclosure Requirements
55-37 This Example illustrates some of the disclosure requirements established in the several Subtopics of
this Topic; it is not based on an actual transaction. The Example assumes that Acquirer is a public entity and
that Target is a private entity. The illustration presents the disclosures in a tabular format that refers to the
specific disclosure requirements illustrated. An actual note to financial statements might present many of the
disclosures illustrated in a simple narrative format.
55-38 Paragraph 805-10-50-2(a) through (d)
On June 30, 20X0, Acquirer acquired 15 percent of the outstanding common shares of Target. On June
30, 20X2, Acquirer acquired 60 percent of the outstanding common shares of Target. Target is a provider
of data networking products and services in Canada and Mexico. As a result of the acquisition, Acquirer
is expected to be the leading provider of data networking products and services in those markets. It also
expects to reduce costs through economies of scale.
55-39 Paragraph 805-30-50-1(a) and 805-30-50-1(e)
The goodwill of $2,500 arising from the acquisition consists largely of the synergies and economies of
scale expected from combining the operations of Acquirer and Target. All of the goodwill was assigned to
Acquirer’s network segment.
55-40 Paragraph 805-30-50-1(d)
None of the goodwill recognized is expected to be deductible for income tax purposes.
55-41 Paragraphs 805-10-50-2, 805-20-50-1, and 805-30-50-1
The following table summarizes the consideration paid for Target and the amounts of the assets acquired
and liabilities assumed recognized at the acquisition date, as well as the fair value at the acquisition date of
the noncontrolling interest in Target.
At June 30, 20X2
55-42 Paragraph 805-30-50-1(b)(4)
The fair value of the 100,000 common shares issued as part of the consideration paid for Target ($4,000)
was determined on the basis of the closing market price of Acquirer’s common shares on the acquisition
date.
55-43 Paragraph 805-30-50-1(b)(3) and 805-30-50-1(c), and paragraph 805-30-50-4(a)
The contingent consideration arrangement requires Acquirer to pay the former owners of Target 5 percent
of the revenues of an unconsolidated equity investment, referred to as Investee, owned by Target, in
excess of $7,500 for 20X3, up to a maximum amount of $2,500 (undiscounted). The potential undiscounted
amount of all future payments that Acquirer could be required to make under the contingent consideration
arrangement is between $0 and $2,500. The fair value of the contingent consideration arrangement of
$1,000 was estimated by applying the income approach. That measure is based on significant inputs that
are not observable in the market, which Section 820-10-35 refers to as Level 3 inputs. Key assumptions
include a discount rate range of 20 percent to 25 percent and a probability-adjusted level of revenues
in Investee between $10,000 and $20,000. As of December 31, 20X2, the amount recognized for the
contingent consideration arrangement, the range of outcomes, and the assumptions used to develop the
estimates had not changed.
55-44 Paragraph
805-20-50-1(b)
The fair value of the financial assets
acquired includes receivables under sales-type
leases or direct financing leases of data
networking equipment with a fair value of $2,000.
The gross amount due under the contracts is
$3,100, of which $450 is expected to be
uncollectible.
55-45 Paragraph 805-10-50-6
The fair value of the acquired identifiable intangible assets of $3,300 is provisional pending receipt of the
final valuations for those assets.
55-46 Paragraph 805-20-50-1(d)
A liability of $1,000 has been recognized at fair value for expected warranty claims on products sold by
Target during the last 3 years. Acquirer expects that the majority of this expenditure will be incurred in 20X3
and that all will be incurred by the end of 20X4.
55-47 Paragraph 805-20-50-1(e)
The fair value of the noncontrolling interest in Target, a private entity, was estimated by applying the
income approach and a market approach. This fair value measurement is based on significant inputs that
are not observable in the market and thus represents a fair value measurement categorized within Level
3 of the fair value hierarchy as described in Section 820-10-35. Key assumptions include a discount rate
range of 20 percent to 25 percent, a terminal value based on a range of terminal earnings before interest,
taxes, depreciation, and amortization multiples between 3 and 5 (or, if appropriate, based on long-term
sustainable growth rates ranging between 3 percent and 6 percent), financial multiples of entities deemed
to be similar to Target, and adjustments because of the lack of control or lack of marketability that market
participants would consider when measuring the fair value of the noncontrolling interest in Target.
55-48 Paragraph 805-10-50-2(g)(2)
Acquirer recognized a gain of $500 as a result of remeasuring to fair value its 15 percent equity interest
in Target held before the business combination. The gain is included in other income in Acquirer’s income
statement for the year ending December 31, 20X2.
55-49 Paragraph 805-10-50-2(h)(1) through (h)(3)
The amounts of Target’s revenue and earnings included in Acquirer’s consolidated income statement for the
year ended December 31, 20X2, and the revenue and earnings of the combined entity had the acquisition
date been January 1, 20X2 (if comparative financial statements are not presented), and January 1, 20X1 (if
comparative financial statements are presented), are as follows.
55-50 Paragraph 805-10-50-2(h)(4)
20X2 supplemental pro forma earnings were adjusted to exclude $1,250 of acquisition-related costs
incurred in 20X2 and $650 of nonrecurring expense related to the fair value adjustment to acquisition-date
inventory. 20X1 supplemental pro forma earnings were adjusted to include these charges.
Chapter 8 — Private-Company Accounting Alternatives
Chapter 8 — 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) to improve the process of
setting accounting standards for private companies. As the primary advisory body to
the FASB on private-company matters, the PCC uses the private-company
decision-making framework to guide the FASB on the appropriate accounting treatment
for private companies for items under active consideration on the FASB’s technical
agenda. The framework focuses on user relevance and cost-benefit considerations for
private companies as potential justifications for establishing alternative guidance.
Any proposed changes to GAAP must be endorsed by the FASB.
In 2014, the FASB issued ASUs 2014-02 and 2014-18, which offered
entities other than PBEs and not-for-profit entities simplified accounting
alternatives for certain identifiable intangible assets acquired in a business
combination and the subsequent accounting for goodwill. The alternatives were
initially developed by the PCC on the basis of feedback from private companies and
their stakeholders about the costs and complexities associated with the accounting
for certain identifiable intangible assets and the goodwill impairment test.
When the Board issued ASUs 2014-02 and 2014-18, it was aware that
the issues addressed in them were not limited to private companies but decided not
to extend the alternatives to PBEs or not-for-profit entities at that time. The
Board received feedback from not-for-profit stakeholders that “questioned the
relevance of an impairment-only approach to goodwill as well as input that the
benefits of the current accounting for goodwill and identifiable intangible assets
acquired in an acquisition by a not-for-profit entity do not justify the related
costs.” Accordingly, it added a project to its agenda to determine whether to extend
the private-company alternatives to not-for-profit entities. In May 2019, the Board
issued ASU
2019-06, which gives not-for-profit entities the option to elect
the same alternative approaches to account for certain identifiable intangible
assets acquired in a business combination and goodwill. The guidance in ASU 2019-06
became effective upon its issuance. A not-for-profit entity should apply the
goodwill accounting alternative, if elected, prospectively for all existing goodwill
and for all new goodwill generated in acquisitions. It should apply the intangible
assets accounting alternative, if elected, prospectively upon the occurrence of the
first transaction within the scope of the alternative.
8.1 Definition of a PBE and a Private Company
The first step in determining whether an entity can apply the accounting alternatives is to ensure that the entity is not a PBE. An entity that meets the definition of a PBE cannot apply any of the private-company accounting alternatives.
In December 2013, the FASB issued ASU 2013-12 to incorporate the definition of a PBE into the ASC
master glossary and clarify which entities qualify for private-company financial accounting and reporting
alternatives. The ASU was issued, in part, because the previous guidance in U.S. GAAP contained several
definitions of “nonpublic entity” and “public entity,” which resulted in diversity in practice.
The ASC master glossary defines a PBE as follows:
A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity
nor an employee benefit plan is a business entity.
- It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
- It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
- It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
- It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
- It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly available on a periodic basis (for example, interim or annual periods).
An entity must
meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business entity solely because its financial statements or financial
information is included in another entity’s filing with the SEC. In that case, the entity is only a public business
entity for purposes of financial statements that are filed or furnished with the SEC.
The definition of a PBE excludes not-for-profit entities within the scope of ASC
958 and employee benefit plans within the scope of ASC 960 through ASC 965 on plan accounting. It
does not affect any existing ASC requirements.
The ASC master glossary defines a private company as “[a]n entity other than a
public business entity, a not-for-profit entity, or an employee benefit plan within the scope of
Topics 960 through 965 on plan accounting.”
8.1.1 Entities That File or Furnish Financial Statements With or to a Regulator, and Entities That Have Publicly Traded Securities
The FASB determined in ASU 2013-12 that financial statement users of entities that issue publicly
traded securities generally have less access to management than users of private-company financial
information, and they are typically a broader group with more diverse needs. The Board therefore
concluded that entities should be considered PBEs if they (1) file or furnish financial statements with or
to the SEC or another regulatory agency or (2) issue or trade securities. Further, an entity is considered
a PBE if its financial statements or financial information, such as the following, is required to be or is
included in a registrant’s SEC filing:
- Financial statements of significant acquired or to be acquired businesses under SEC Regulation S-X, Rule 3-05.
- Financial statements of significant equity method investees under SEC Regulation S-X, Rule 3-09.
- Summarized financial information of equity method investees under SEC Regulation S-X, Rule 4-08(g).
To ensure that the definition of a PBE encompassed entities that prepare U.S.
GAAP financial statements in other jurisdictions, the FASB included both foreign and domestic
regulators in it. However, the Board indicated that if an entity is considered a PBE only
because its financial information is included in the financial information of another entity
that furnishes or files financial statements to or with the SEC, the entity is considered a PBE
only for the financial statements filed with the SEC; the entity can apply the private-company
accounting alternatives in its stand-alone financial statements.
Similarly, the FASB concluded that private companies that are consolidated
subsidiaries of PBEs are not considered PBEs for stand-alone reporting purposes and are
therefore able to apply private-company accounting alternatives in their stand-alone financial
statements. This is because the information they provide may be useful to the users of the
stand-alone financial statements.
The FASB also decided that a private company that controls a public subsidiary should not be
considered a PBE. According to ASU 2013-12, “the financial reporting requirements of a public subsidiary
should not preclude a privately held entity from applying financial accounting and reporting alternatives
for private companies in its own financial statements.”
8.1.2 Conduit Bond Obligors
Conduit bond obligors indirectly access the public debt markets. In ASU 2013-12, the FASB noted that
users of such entities’ financial statements may have less access to management and related financial
information than most other private-company financial statement users do and that these entities have
a broad base of financial statement users; therefore, their users’ information needs may be similar to
those of the financial statements of public companies. Consequently, the FASB concluded that conduit
bond obligors should be considered PBEs for financial accounting and reporting purposes.
8.1.3 Employee Benefit Plans
The FASB concluded in ASU 2013-12 that the needs of the financial statement users of employee benefit plans are more focused than those of the financial statement users of public or private companies.
Further, the accounting guidance applied by employee benefit plans is often tailored to the plans. Accordingly, the Board excluded employee benefit plans from the definition of a PBE. Instead, the FASB decided to consider, “on a standard-by-standard basis, whether all, none, or some employee benefit plans should be permitted to apply financial accounting and reporting alternatives under U.S. GAAP, using factors such as user needs and resources.”
8.1.4 Not-for-Profit Entities
The ASC master glossary defines a not-for-profit entity as:
An entity that possesses the following characteristics, in varying degrees, that distinguish it from a business entity:
- Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
- Operating purposes other than to provide goods or services at a profit
- Absence of ownership interests like those of business entities.
Entities that clearly fall outside this definition include the following:
- All investor-owned entities
- Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
The amendments in ASU 2019-06 apply to all not-for-profit entities as defined in
the ASC master glossary, including those that are conduit bond obligors. Paragraph BC14 of ASU
2019-06 notes that “[t]he Board chose not to distinguish between public not-for-profit entities
and nonpublic not-for-profit entities because the informational needs of users of financial
statements of both not-for-profit entity types are the same.”
8.2 Accounting Alternatives for Private Companies and Not-for-Profit Entities
The paragraphs below discuss the accounting alternatives for certain intangible assets and goodwill. Entities do not need to perform a preferability assessment the first time they elect such alternatives; however, any later change to an accounting policy election requires justification that the change is preferable under ASC 250.
Connecting the Dots
Before electing the private-company accounting alternatives, a private company
should consider whether it might become a PBE in
the future (e.g., the entity may file an IPO or
may be required to have its financial statements
included in a registrant’s filing under SEC
Regulation S-X, Rule 3-05). Neither the FASB nor
the SEC has provided relief or transition guidance
for private companies that have elected the
private-company accounting alternatives and later
become PBEs; thus, private companies that might
become PBEs should be cautious about electing
them. Private companies that do apply the
accounting alternatives and later become PBEs
would need to retrospectively remove the effects
of the accounting alternatives in any financial
statements filed with, or furnished to, the SEC.
The removal of such effects could become
increasingly complex as more time passes.
8.2.1 Accounting Alternative for Intangible Assets
ASC 805-20
Accounting Alternative
15-1A Paragraphs 805-20-15-2 through 15-4 and 805-20-25-29 through 25-33 provide guidance for an entity electing the accounting alternative in this Subtopic. See paragraph 805-20-65-2 for transition guidance for private companies and not-for-profit entities on applying the accounting alternative in this Subtopic.
15-2 A private company or not-for-profit entity may make an accounting policy election to apply the accounting alternative in this
Subtopic. The guidance in the Accounting Alternative Subsections of this Subtopic applies when a private
company or not-for-profit entity is required to recognize or otherwise consider the fair value of intangible assets as a result of any one
of the following transactions:
- Applying the acquisition method (as described in paragraph 805-10-05-4 for all entities and Subtopic 958-805 for additional guidance for not-for-profit entities)
- Assessing the nature of the difference between the carrying amount of an investment and the amount of underlying equity in net assets of an investee when applying the equity method of accounting in accordance with Topic 323 on investments — equity method and joint ventures
- Adopting fresh-start reporting in accordance with Topic 852 on reorganizations.
15-3 An entity that elects the accounting alternative shall apply all of the related recognition requirements upon
election. The accounting alternative, once elected, shall be applied to all future transactions that are identified
in paragraph 805-20-15-2.
15-4 An entity that elects
this accounting alternative must adopt the
accounting alternative for amortizing goodwill in
the Accounting Alternatives Subsections of Topic
350-20 on intangibles — goodwill and other. If the
accounting alternative for amortizing goodwill was
not adopted previously, it should be adopted on a
prospective basis as of the adoption of the
accounting alternative in this Subtopic. For
example, upon adoption, existing goodwill should
be amortized on a straight-line basis over 10
years, or less than 10 years if the entity
demonstrates that another useful life is more
appropriate. However, an entity that elects the
accounting alternative for amortizing goodwill is
not required to adopt the accounting alternative
in this Subtopic.
To achieve comparability, an entity should apply the accounting alternative to all eligible intangible assets. That is, if an entity adopts the accounting alternative for intangible assets, it cannot choose to recognize the customer-related intangible assets within its scope but subsume noncompetition agreements into goodwill. Furthermore, an entity that elects the accounting alternative for intangible assets must also adopt the accounting alternative for amortizing goodwill (see Section 8.2.2). “However, an entity that elects the accounting alternative for
amortizing goodwill is not required to adopt the accounting alternative” for intangible assets.
If elected, the accounting alternative would be applied prospectively to (1) all
intangible assets arising from business
combinations occurring after adoption and (2)
future transactions in which fresh-start reporting
is adopted. In addition, when determining basis
differences, an entity would apply it
prospectively to all equity method investments
acquired after adoption. The accounting
alternative cannot be applied to previously
recognized intangible assets (e.g., the option
would not affect intangible assets recognized from
previous business combinations).
8.2.1.1 Customer-Related Intangible Assets
ASC 805-20
25-30 An intangible asset is identifiable if it meets either the separability criterion or the contractual-legal
criterion described in the definition of identifiable. However, under the accounting alternative, an acquirer shall
not recognize separately from goodwill the following intangible assets:
- Customer-related intangible assets unless they are capable of being sold or licensed independently from other assets of a business
- Noncompetition agreements.
25-31 Customer-related intangible assets often would not meet criterion (a) in paragraph 805-20-25-30 for
recognition. Customer-related intangible assets that would meet that criterion for recognition under this
accounting alternative are those that are capable of being sold or licensed independently from the other assets
of a business. Examples of customer-related intangible assets are listed in paragraph 805-20-55-20. Many of
the customer-related intangible assets that would meet criterion (a) for recognition also would be considered
contract-based intangible assets as described in paragraph 805-20-55-31. Customer-related intangible assets
that may meet that criterion for recognition include but are not limited to:
- Mortgage servicing rights
- Commodity supply contracts
- Core deposits
- Customer information (for example, names and contact information).
Before the issuance of ASU 2014-18, many
stakeholders indicated that separately recognizing
customer-related intangible assets does not
provide decision-useful information unless the
contract giving rise to the asset could be sold
separately from the other assets of the business.
As a result, the PCC and FASB concluded that the
benefits of recognizing customer-related
intangible assets separately may not justify the
related costs. Consequently, ASC 805-20-25-30
gives private companies the option to subsume into
goodwill customer-related intangible assets unless
they are capable of being sold or licensed
independently from other assets of a business.
While many customer-related intangible assets
would meet that criterion, ASC 805-20-25-31
provides examples of such assets that generally
could be sold separately, including, but not
limited to, mortgage servicing rights, commodity
supply contracts, core deposits, and customer
information (e.g., names and contact
information).
Under this accounting alternative, favorable customer contracts would be
included in goodwill, but unfavorable customer
contracts would not because they are liabilities
and not within the alternative’s scope. However,
in paragraph BC20 of ASU 2014-18, the FASB noted
that “the concept of ‘at market’ is a broad range
and customer contracts generally are considered to
fall within the range that is considered ‘at
market.’ Therefore, most customer contracts do not
fall under the favorable-unfavorable contract
guidance.” Paragraph BC20 of ASU 2014-18 also
states, in part:
[S]ubsuming
a significant favorable contract into goodwill
will not necessarily create subsequent impairment
issues. FASB Accounting Standards Update No.
2014-02, Intangibles — Goodwill and Other
(Topic 350): Accounting for Goodwill, allows
reporting entities to choose a life for goodwill
that is less than 10 years. The PCC and the Board
concluded that significant favorable contracts
with a life shorter than 10 years may justify a
shorter useful life for goodwill. As a result, the
PCC and the Board concluded that favorable
customer contracts will be included within the
scope of this Update.
8.2.1.2 Noncompetition Agreements
Noncompetition agreements represent another category of intangible assets that are not separately recognized under this accounting alternative. In response to comments by stakeholders that noncompetition agreements are among the most subjective and difficult intangible assets to measure and that their value is disregarded by many users, the FASB determined that the benefits of recognizing them separately may not justify the related costs. Furthermore, the FASB indicates in paragraph BC19 of ASU 2014-18 that the “PCC and the Board chose not to require an assessment of whether a noncompetition agreement is capable of being sold or licensed separately from the other assets of a business because, in their view, noncompetition agreements will seldom, if ever, meet the criteria for recognition.”
8.2.1.3 Contract Assets
ASC 805-20
25-32 Contract assets, as used in Topic 606 on revenue from contracts with customers, are not considered to
be customer-related intangible assets for purposes of applying this accounting alternative. Therefore, contract
assets are not eligible to be subsumed into goodwill and shall be recognized separately.
The ASC master glossary defines a contract asset as “[a]n entity’s right to
consideration in exchange for goods or services
that the entity has transferred to a customer when
that right is conditioned on something other than
the passage of time (for example, the entity’s
future performance).” Contract assets are not
eligible for this accounting alternative. In
paragraph BC21 of ASU 2014-18, the FASB elaborates
on this decision as follows:
The PCC and the Board decided that contract
assets as defined in the Master Glossary and used
in Topic 606, Revenue from Contracts with
Customers, are not considered intangible assets
eligible to be subsumed into goodwill and
therefore are not within the scope of this Update.
In certain situations, an entity satisfies a
performance obligation but does not have an
unconditional right to consideration, for example,
because it first needs to satisfy another
performance obligation in the contract. That leads
to recognition of a contract asset. Once an entity
has an unconditional right to consideration, it
should present that right as a receivable
separately from the contract asset and account for
it in accordance with other guidance (for example,
Topic 310, Receivables). As a result, the PCC and
the Board concluded that it is inappropriate to
classify a contract asset as a customer-related
intangible asset at the acquisition date when the
contract asset will eventually be reclassified as
a receivable.
8.2.1.4 Leases
ASC 805-20
25-33 A lease is not considered to be a customer-related intangible asset for purposes of applying this
accounting alternative. Therefore, favorable and unfavorable leases are not eligible to be subsumed into
goodwill and shall be recognized separately.
ASU 2014-18 clarifies that leases are not
considered to be customer-related intangible assets. Therefore, favorable and unfavorable leases must
be recognized separately from goodwill.
8.2.1.5 Disclosures
There are no incremental disclosure requirements associated with this accounting alternative. As discussed in the Background Information and Basis for Conclusions of ASU 2014-18, the PCC and FASB determined that the disclosure requirements already in ASC 805 were sufficient for intangible assets that do not require separate recognition and that requiring additional disclosures could potentially offset any cost savings associated with an entity’s adoption of the accounting alternative.
8.2.2 Goodwill Accounting Alternative
ASC 350-20
Accounting Alternative
05-5
The Accounting Alternatives
Subsections of this Subtopic provide guidance for
the following:
- An entity within the scope of paragraph 350-20-15-4 that elects the accounting alternative for amortizing goodwill. If elected, this accounting alternative allows an eligible entity to amortize goodwill and test that goodwill for impairment upon a triggering event.
- An entity within the scope of paragraph 350-20-15-4A that elects the accounting alternative for a goodwill impairment triggering event evaluation. If elected, this accounting alternative allows an eligible entity to evaluate goodwill impairment triggering events only as of the end of each reporting period.
05-5A The accounting alternative guidance can be found in the following paragraphs:
- Scope and Scope Exceptions — paragraphs 350-20-15-4 through 15-6
- Subsequent Measurement — paragraphs 350-20-35-62 through 35-86
- Derecognition — paragraphs 350-20-40-8 through 40-9
- Other Presentation Matters — paragraphs 350-20-45-4 through 45-7
- Disclosure — paragraphs 350-20-50-3A through 50-7
- Implementation Guidance and Illustrations — paragraphs 350-20-55-26 through 55-29.
05-6 An entity should
continue to follow the applicable requirements in
Topic 350 for other accounting and reporting
matters related to goodwill that are not addressed
in the Accounting Alternatives Subsections of this
Subtopic.
Entities that elect the goodwill accounting alternative (1) amortize goodwill on
a straight-line basis over a useful life of 10
years, or less than 10 years if they can
demonstrate that a shorter useful life is more
appropriate, (2) test goodwill for impairment only
when a triggering event occurs instead of having
to perform the test at least annually, and (3)
test goodwill for impairment at either the entity
level or the reporting-unit level. In addition,
entities would be required to comply with the
accounting alternative’s requirements related to
subsequent measurement and disclosures.
ASC 350-20 provides the following guidance related to the goodwill accounting
alternative:
ASC 350-20
35-62 The following guidance
for goodwill applies to entities within the scope
of paragraph 350-20-15-4 that elect the accounting
alternative for amortizing goodwill.
35-63 Goodwill relating to
each business combination, acquisition by a
not-for-profit entity, or reorganization event resulting
in fresh-start reporting (amortizable unit of goodwill)
shall be amortized on a straight-line basis over 10
years, or less than 10 years if the entity demonstrates
that another useful life is more appropriate.
35-64 An entity may revise the remaining useful life of goodwill upon the occurrence of events and changes
in circumstances that warrant a revision to the remaining period of amortization. However, the cumulative
amortization period for any amortizable unit of goodwill cannot exceed 10 years. If the estimate of the
remaining useful life of goodwill is revised, the remaining carrying amount of goodwill shall be amortized
prospectively on a straight-line basis over that revised remaining useful life.
35-65 Upon adoption of this accounting alternative, an entity shall make an accounting policy election to
test goodwill for impairment at the entity level or the reporting unit level. An entity that elects to perform
its impairment tests at the reporting unit level shall refer to paragraphs 350-20-35-33 through 35-38 and
paragraphs 350-20-55-1 through 55-9 to determine the reporting units of an entity.
35-66 Goodwill of an entity
(or a reporting unit) shall be tested for
impairment if an event occurs or circumstances
change that indicate that the fair value of the
entity (or the reporting unit) may be below its
carrying amount (a triggering event). Paragraph
350-20-35-3C(a) through (g) includes examples of
those events or circumstances. Those examples are
not all-inclusive, and an entity shall consider
other relevant events and circumstances that
affect the fair value or carrying amount of the
entity (or of a reporting unit) in determining
whether to perform the goodwill impairment test.
For those entities that have elected the
accounting alternative for a goodwill impairment
triggering event evaluation in paragraph
350-20-35-84, a goodwill triggering event
evaluation shall be performed only as of the end
of each reporting period. If an entity determines
that there are no triggering events, then further
testing is unnecessary.
The Goodwill Impairment Test
35-67 Upon the occurrence of a triggering event, an entity may assess qualitative factors to determine whether
it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of the entity (or the
reporting unit) is less than its carrying amount, including goodwill. Paragraph 350-20-35-3C(a) through (g)
includes examples of those qualitative factors.
35-68 Because the examples included in paragraph 350-20-35-3C(a) through (g) are not all-inclusive, an entity
shall consider other relevant events and circumstances that affect the fair value or carrying amount of the
entity (or of the reporting unit) in determining whether to perform the quantitative goodwill impairment test. An
entity shall consider the extent to which each of the adverse events and circumstances identified could affect
the comparison of its fair value with its carrying amount (or of the reporting unit’s fair value with the reporting
unit’s carrying amount). An entity should place more weight on the events and circumstances that most affect
its fair value or the carrying amount of its net assets (or the reporting unit’s fair value or the carrying amount of
the reporting unit’s net assets). An entity also should consider positive and mitigating events and circumstances
that may affect its determination of whether it is more likely than not that its fair value is less than its carrying
amount (or the fair value of the reporting unit is less than the carrying amount of the reporting unit). If an entity
has a recent fair value calculation (or recent fair value calculation for the reporting unit), it also should include
that calculation as a factor in its consideration of the difference between the fair value and the carrying amount
in reaching its conclusion about whether to perform the quantitative goodwill impairment test.
35-69 An entity shall evaluate, on the basis of the weight of evidence, the significance of all identified events
and circumstances in the context of determining whether it is more likely than not that the fair value of the
entity (or the reporting unit) is less than its carrying amount. None of the individual examples of events and
circumstances included in paragraph 350-20-35-3C(a) through (g) are intended to represent standalone events
or circumstances that necessarily require an entity to perform the quantitative goodwill impairment test. Also,
the existence of positive and mitigating events and circumstances is not intended to represent a rebuttable
presumption that an entity should not perform the quantitative goodwill impairment test.
35-70 An entity has an unconditional option to bypass the qualitative assessment described in paragraphs
350-20-35-67 through 35-69 and proceed directly to a quantitative calculation by comparing the entity’s (or the
reporting unit’s) fair value with its carrying amount (see paragraphs 350-20-35-72 through 35-78). An entity may
resume performing the qualitative assessment upon the occurrence of any subsequent triggering events.
35-71 If, after assessing the totality of events or circumstances such as those described in paragraph 350-20-35-3C(a) through (g), an entity determines that it is not more likely than not that the fair value of the entity (or
the reporting unit) is less than its carrying amount, further testing is unnecessary.
35-72 If, after assessing the totality of events or circumstances such as those described in paragraph 350-20-35-3C(a) through (g), an entity determines that it is more likely than not that the fair value of the entity (or the
reporting unit) is less than its carrying amount or if the entity elected to bypass the qualitative assessment in
paragraphs 350-20-35-67 through 35-69, the entity shall determine the fair value of the entity (or the reporting
unit) and compare the fair value of the entity (or the reporting unit) with its carrying amount, including goodwill.
A goodwill impairment loss shall be recognized if the carrying amount of the entity (or the reporting unit)
exceeds its fair value.
35-73 A goodwill impairment
loss, if any, shall be measured as the amount by
which the carrying amount of an entity (or a
reporting unit) including goodwill exceeds its
fair value, limited to the total amount of
goodwill of the entity (or allocated to the
reporting unit). Additionally, an entity shall
consider the income tax effect from any tax
deductible goodwill on the carrying amount of the
entity (or the reporting unit), if applicable, in
accordance with paragraph 350-20-35-8B when
measuring the goodwill impairment loss. See
Example 2A in paragraph 350-20-55-23A for an
illustration.
35-74 The guidance in paragraphs 350-20-35-22 through 35-27 shall be considered in determining the fair
value of the entity (or the reporting unit).
35-75 The guidance in paragraphs 350-20-35-39 through 35-44 shall be considered in assigning acquired
assets (including goodwill) and assumed liabilities to the reporting unit when determining the carrying amount
of a reporting unit.
35-76 For an entity subject to the requirements of Topic 740 on income taxes, when determining the carrying
amount of an entity (or a reporting unit), deferred income taxes shall be included in the carrying amount of
an entity (or the reporting unit), regardless of whether the fair value of the entity (or the reporting unit) will be
determined assuming it would be bought or sold in a taxable or nontaxable transaction.
35-77 The goodwill impairment loss, if any, shall be allocated to individual amortizable units of goodwill of
the entity (or the reporting unit) on a pro rata basis using their relative carrying amounts or using another
reasonable and rational basis.
35-78 After a goodwill impairment loss is recognized, the adjusted carrying amount of goodwill shall be its new
accounting basis, which shall be amortized over the remaining useful life of goodwill. Subsequent reversal of a
previously recognized goodwill impairment loss is prohibited.
Appendix A — Pushdown Accounting
Appendix A — Pushdown Accounting
A.1 Overview of 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. ASC 805-10, ASC 805-20, and ASC 805-30 provide guidance on
accounting for an acquisition of a business in the acquirer’s consolidated financial
statements. Sometimes the acquiree will prepare separate financial statements after
its acquisition. An acquiree in a business combination has the option of whether to
use the parent’s basis of accounting or the acquiree’s historical carrying amounts
for the assets acquired and liabilities assumed in the acquiree’s separate financial
statements. Use of the acquirer’s basis of accounting in the preparation of an
acquiree’s separate financial statements is called “pushdown accounting.”
Under previous guidance, entities applied the pushdown accounting guidance in SAB Topic 5.J, EITF Topic D-97, and comments made by the SEC observer at EITF meetings. In addition, certain accounting practices developed on the basis of SEC staff speeches; the AICPA’s October 30, 1979, issues paper on pushdown accounting; and the FASB’s December 18, 1991, discussion memorandum on this topic. However, such guidance was complicated and incomplete, only applied to SEC registrants, and was based on bright lines that provided opportunities for structuring and misapplication. To address those concerns, the FASB issued ASU 2014-17, which gave an acquiree the option to apply pushdown accounting in its separate financial statements when it has undergone a change in control.
ASU 2014-17 became effective on November 18, 2014, its date of issuance. The guidance in ASU 2014-17 was codified in the ”Pushdown Accounting” subsections of ASC 805-50. An acquiree may elect to apply that guidance to (1) any future transaction or event in which an acquirer obtains control of the acquiree or (2) a past transaction or event in which an acquirer obtains control of the acquiree “when the financial statements of the reporting period that contains the acquisition date have not been issued” (conduit bond obligors or SEC filers) or have not been made available to be issued (all other entities). If the financial statements for the period that includes the most recent event in which an acquirer obtained control of the acquiree already have been issued or made available to be issued, the entity may still apply pushdown accounting; however, in such cases, the event must be accounted for as a change in accounting principle.
In response to the issuance of ASU 2014-17, the SEC staff issued SAB 115 to rescind the guidance in SAB Topic 5.J, and the FASB issued ASU 2015-08 to rescind the remaining guidance on pushdown accounting and collaborative groups in ASC 805-50-S99. As a result, all authoritative guidance related to the application of pushdown accounting is now in the “Pushdown Accounting” subsections of ASC 805-50.
A.2 Scope
ASC 805-50
05-9 The guidance in the Pushdown Accounting Subsections addresses whether and at what threshold an
acquiree that is a business or nonprofit activity can apply pushdown accounting in its separate financial
statements.
15-10 The guidance in the Pushdown Accounting Subsections applies to the separate financial statements of an acquiree and its subsidiaries.
15-11
The guidance in the Pushdown Accounting Subsections does not
apply to transactions in paragraph 805-10-15-4.
ASC 805-10
15-4
The guidance in the Business Combinations Topic does not
apply to any of the following:
- The formation of a joint venture
- The acquisition of an asset or a group of assets that does not constitute a business or a nonprofit activity
- A combination between entities, businesses, or nonprofit activities under common control (see paragraph 805-50-15-6 for examples)
- An acquisition by a not-for-profit entity for which the acquisition date is before December 15, 2009 or a merger of not-for-profit entities (NFPs)
- A transaction or other event in which an NFP obtains control of a not-for-profit entity but does not consolidate that entity, as described in paragraph 958-810-25-4. The Business Combinations Topic also does not apply if an NFP that obtained control in a transaction or other event in which consolidation was permitted but not required decides in a subsequent annual reporting period to begin consolidating a controlled entity that it initially chose not to consolidate.
- Financial assets and financial liabilities of a consolidated variable interest entity that is a collateralized financing entity within the scope of the guidance on collateralized financing entities in Subtopic 810-10.
The pushdown accounting subsections in ASC 805-50 address when an acquiree may elect to apply
pushdown accounting. ASC 805-50-15-10 indicates that the scope of pushdown accounting includes “the
separate financial statements of an acquiree and its subsidiaries” that meet the definition of a business
in ASC 805-10, as indicated in ASU 2014-17, or a nonprofit activity “upon the occurrence of an event in which an acquirer (an individual
or an entity) obtains control of the [acquiree].” The scope includes both public and nonpublic entities.
The EITF considered whether the scope of the pushdown accounting subsections in ASC 805-50 should
be limited to transactions in which an entity becomes substantially wholly owned rather than applying
to all transactions or events in which an acquirer obtains control of a business or nonprofit activity.
The Task Force ultimately decided that the scope of the guidance should be broader and should be
consistent with the scope of ASC 805-10, ASC 805-20, and ASC 805-30, which apply to all transactions
or events in which an acquirer obtains control of a business or nonprofit activity. As indicated in the
Background Information and Basis for Conclusions of ASU 2014-17, the Task Force reasoned that
the FASB had already decided in ASC 805-10, ASC 805-20, and ASC 805-30 that obtaining control of
a business is a significant event for which a new basis of accounting is required “for the net assets
acquired and, in the absence of another distinct threshold that is conceptually grounded in GAAP,
change-in-control events also could serve as the basis for establishing a new basis in an [acquiree’s]
separate financial statements.” The Task Force also decided that a change-in-control threshold for
pushdown accounting could reduce the complexity of the pushdown accounting guidance by eliminating
the need to reconsider or develop collaborative group guidance, under which a group of investors may
be regarded as a single investor in some circumstances.
An acquiree may only elect pushdown accounting if another entity or individual (i.e., an acquirer) has
obtained control of the acquiree. Certain transactions are not within the scope of the pushdown
accounting subsections of ASC 805-50 because they are not transactions in which an acquirer obtains
control of a business or nonprofit activity (i.e., they are not within the scope of ASC 805-10, ASC 805-20,
and ASC 805-30). Such transactions include the formation of a joint venture; combinations between entities, businesses, or
nonprofit activities under common control; and mergers of not-for-profit entities. For example, the
pushdown accounting election does not apply to the formation of a joint venture because, while an
entity loses control of a subsidiary in such a transaction, no other individual or entity obtains control
of it.
A.2.1 Pushdown Accounting for an Asset Acquisition
Since the introduction of the revised definition of a business
and the screen test in ASU
2017-01, certain transactions that formerly would have
constituted business combinations may now be accounted for as asset acquisitions
even though in substance, they are similar in nature. While the scope of the
guidance in ASC 805-10 and ASC 805-50 does not explicitly extend the option to
apply pushdown accounting to asset acquisitions, we do not believe that the
intent of ASU 2014-17 was to preclude it. In addition, we note that if pushdown
accounting was viewed to be prohibited in an asset acquisition, the acquirer
could structure and execute a transaction immediately after the acquisition in
which the acquired assets are transferred to another entity under common control
and such a transfer would require the application of pushdown accounting in
accordance with ASC 805-50-30-5 (see Section A.4). Accordingly, we believe that
it would be acceptable to elect pushdown accounting in the separate financial
statements of an acquired entity that does not meet the definition of a
business. Given that diversity in practice may exist, discussion with accounting
advisers is encouraged.
A.3 Option to Apply Pushdown Accounting Upon a Change in Control
ASC 805-50
25-4 An acquiree shall have the option to apply pushdown accounting in its separate financial statements when
an acquirer — an entity or individual — obtains control of the acquiree. An acquirer might obtain control of an
acquiree in a variety of ways, including any of the following:
- By transferring cash or other assets
- By incurring liabilities
- By issuing equity interests
- By providing more than one type of consideration
- Without transferring consideration, including by contract alone as discussed in paragraph 805-10-25-11.
25-5 The guidance in the General Subsections of Subtopic 810-10 on consolidation, related to determining the
existence of a controlling financial interest shall be used to identify the acquirer. If a business combination has
occurred but applying that guidance does not clearly indicate which of the combining entities is the acquirer,
the factors in paragraphs 805-10-55-11 through 55-15 shall be considered in identifying the acquirer. However,
if the acquiree is a variable interest entity (VIE), the primary beneficiary of the acquiree always is the acquirer.
The determination of which party, if any, is the primary beneficiary of a VIE shall be made in accordance with
the guidance in the Variable Interest Entities Subsections of Subtopic 810-10, not by applying the guidance
in the General Subsections of that Subtopic relating to a controlling financial interest or the guidance in
paragraphs 805-10-55-11 through 55-15.
25-6 The option to apply pushdown accounting may be elected each time there is a change-in-control event
in which an acquirer obtains control of the acquiree. An acquiree shall make an election to apply pushdown
accounting before the financial statements are issued (for a Securities and Exchange Commission (SEC) filer
and a conduit bond obligor for conduit debt securities that are traded in a public market) or the financial
statements are available to be issued (for all other entities) for the reporting period in which the change-in-control
event occurred. If the acquiree elects the option to apply pushdown accounting, it must apply the
accounting as of the acquisition date.
An acquiree can elect to apply pushdown accounting in its separate financial statements each time
another entity or individual obtains control of it. The decision of whether to apply pushdown accounting
upon a change in control is not an accounting policy election. For example, an acquiree may elect to
apply pushdown accounting upon its acquisition in one year and, if it is acquired again in a subsequent
year, may elect not to apply pushdown accounting at that time. An acquiree that elects to apply
pushdown accounting must do so in its separate financial statements as of the date on which the
acquirer obtains control of the acquiree (i.e., the acquisition date). ASC 805-10-25-6 and 25-7 provide
guidance on identifying the acquisition date.
The term “control” is used in both the business combinations guidance and the
pushdown accounting guidance and has the same meaning as the term
“controlling financial interest” in ASC 810-10. ASC 810-10 indicates
that a controlling financial interest generally results when one
entity obtains, either directly or indirectly, more than 50 percent
of the outstanding shares of another entity. However, control can
also be obtained in other ways, such as through a contractual
arrangement or when an entity becomes the primary beneficiary of a
VIE. See Deloitte’s Roadmap Consolidation — Identifying a
Controlling Financial Interest for
more information about determining whether an acquiree has undergone
a change in control.
As noted in the Background Information and Basis for Conclusions of ASU 2014-17, the Task Force
considered whether pushdown accounting should be required or optional. The Task Force ultimately
decided that requiring pushdown accounting may not be beneficial for some users and could be costly
for preparers, since such a requirement would cause many more entities to apply pushdown accounting
and may result in more frequent application of pushdown accounting by the same entity. The Task Force
also noted that users’ views on the benefits and relevance of pushdown accounting differed, with some
indicating that they “prefer not to distort historical trends by establishing a new basis of accounting for
each change-in-control event” and others stressing that they “would prefer a new basis and consider
an [acquiree’s] financial information in the context of its parent.” The Task Force acknowledged that
giving entities an option reduces comparability in this area but decided that “allowing entities to apply
judgment on the basis of their unique set of facts and circumstances” was more important than
achieving such comparability. Before deciding whether to elect pushdown accounting, entities should
consider the information needs and preferences of their financial statement users. When pushdown
accounting is not elected, no adjustment is made to the acquiree’s financial records in connection with
the acquisition. Therefore, in such cases, the acquiree will need to maintain accounting records that are
separate from those of the parent to track items such as depreciation and amortization and will need
to perform separate impairment analyses. It will be more difficult to maintain two sets of accounting records if multiple entities are acquired at different times. However, entities may prefer to carry over the acquiree’s historical basis for financial reporting purposes if carryover basis is being used for tax reporting purposes (i.e., when there is no tax “step-up”). Thus, entities should consider the burden of record keeping and their particular facts and circumstances when deciding whether to apply pushdown accounting.
Example A-1
Loss of Control of a Subsidiary
Company A has a wholly owned subsidiary, X. Company A sells 80 percent of its shares in X to the public in an
initial public offering. The public shareholders are widely dispersed, and no individual shareholder acquires
more than 3 percent of X’s shares. Company A concludes that it no longer controls X.
Company A loses control of X upon the sale of X’s shares to the public. Because no entity or individual obtains
control of X, a new basis of accounting cannot be established in X’s separate financial statements.
If a new legal entity is established to effect an acquisition, one must determine whether that newly
formed entity (commonly called a “newco”) should be identified as the acquirer or whether it should be
disregarded for accounting purposes. If the newco is identified as the acquirer, acquisition accounting,
rather than pushdown accounting, would be applied to establish a new basis of accounting for the
acquiree’s assets and liabilities in the newco’s financial statements. See Section 3.1.5 for further
discussion.
A.4 Common-Control Transactions May Trigger Pushdown Accounting
In a common-control transaction, the receiving entity recognizes the transferred
assets and liabilities at their carrying amounts
on the date of transfer. However, sometimes the
carrying amounts of the assets and liabilities
transferred in the parent’s consolidated financial
statements differ from those in the transferring
entity’s separate financial statements (e.g., if
the transferring entity had not applied pushdown
accounting). ASC 805-50-30-5 states that, in such
cases, the receiving entity’s financial statements
must “reflect the transferred assets and
liabilities at the historical cost of the parent
of the entities under common control.” We believe
that the historical cost of the parent refers to
the historical cost of the ultimate parent or
controlling shareholder. While ASU 2014-17 made it
optional to apply pushdown accounting in an
acquiree’s separate financial statements, it did
not amend the guidance in ASC 805-50-30-5.
A.5 Subsequent Election to Apply Pushdown Accounting
ASC 805-50
25-7 If the acquiree does not elect to apply pushdown accounting upon a change-in-control event, it can elect
to apply pushdown accounting to its most recent change-in-control event in a subsequent reporting period as
a change in accounting principle in accordance with Topic 250 on accounting changes and error corrections.
Pushdown accounting shall be applied as of the acquisition date of the change-in-control event.
An acquiree that does not elect to apply pushdown accounting before the financial statements are
issued (SEC filer) or are available to be issued (other entities) may subsequently elect to apply pushdown
accounting to its most recent change-in-control event in a later reporting period. However, such a later
election is a change in accounting principle and the acquiree would be required to apply the guidance on a change in accounting principle in ASC 250 in such circumstances, including all relevant disclosure
requirements. We believe that an election to apply pushdown accounting would generally be preferable.
ASC 250-10-45-5 requires that an entity “report a change in accounting principle through retrospective
application . . . to all prior periods,” unless doing so would be impracticable. We would expect entities
that elect pushdown accounting on a later date to apply it retroactively to the acquisition date since the
parent generally would be expected to have maintained the records for all prior periods.
An SEC registrant that elects a voluntary change in accounting principle must file a preferability letter
with the SEC (i.e., a letter from the entity’s independent accountant indicating why the new accounting
principle is preferable). Such a letter must be included in the registrant’s first filing under the Securities
Exchange Act of 1934 (i.e., Form 10-Q or Form 10-K) after the date of the accounting change.
A.6 Election to Apply Pushdown Accounting Is Irrevocable
ASC 805-50
25-9 The decision to apply pushdown accounting to a specific change-in-control event if elected by an acquiree is irrevocable.
While an entity can elect to apply pushdown accounting in a subsequent reporting period, it cannot
reverse the application of pushdown accounting in financial statements that have been issued (SEC
filer) or are available to be issued (other entities). In addition, if an acquiree elects to apply pushdown
accounting and that acquiree is subsequently acquired by another entity, the historical cost basis of the
acquiree is based on the “pushed down” amounts. The new acquirer cannot revert to the acquiree’s
historical cost basis that existed before the election to apply pushdown accounting.
According to the Background Information and Basis for Conclusions of ASU 2014-17, the Task Force
decided that an entity should be allowed to apply pushdown accounting on a later date if, for example,
the investor mix changes significantly and “pushdown accounting would be more relevant to the current
investors.” Nonetheless, the Task Force decided that entities should be prohibited from subsequently
reversing the application of pushdown accounting. Because an acquirer applies acquisition accounting
to establish a new basis of accounting in its consolidated financial statements and subsequently
accounts for the related assets and liabilities under GAAP, the acquiree would generally have the
information to apply pushdown accounting on a later date. However, once a new basis is established
in the acquiree’s separate financial statements, the historical cost basis for the acquiree’s assets and
liabilities would often not be available.
A.7 Subsidiary’s Election to Apply Pushdown Accounting
ASC 805-50
25-8 Any subsidiary of an acquiree also is eligible to make an election to apply pushdown accounting to its separate financial statements in accordance with the guidance in paragraphs 805-50-25-4 through 25-7 irrespective of whether the acquiree elects to apply pushdown accounting.
A subsidiary of an acquiree is not constrained by the acquiree’s or a higher-level subsidiary’s decision of
whether to apply pushdown accounting upon a change-in-control event. If multiple entities are acquired
in a business combination, the acquiree and any of its subsidiaries independently have the option to
apply pushdown accounting in their separate financial statements.
The Background Information and Basis for Conclusions of ASU 2014-17 points out that the Task Force
“considered, but ultimately rejected, a view in which an [acquiree] must elect to apply pushdown
accounting in order for its subsidiaries to be able to elect the option to apply pushdown accounting”
because “subsidiaries should reflect their parent’s basis.” The Task Force rejected that view on the
basis that “each entity has different users and their perspectives may be different from one another.”
Therefore, each entity within the group of acquired entities “should be allowed to separately evaluate
whether pushdown accounting applies to their separate financial statements.”
Example A-2
Subsidiary’s Elections to Apply Pushdown Accounting
Company A obtains control of Company B in a transaction accounted for as a business combination, and B
becomes a subsidiary of A. Company B has two wholly owned subsidiaries, Subsidiary X and Subsidiary Y,
each of which has two subsidiaries. Subsidiary X and Subsidiary Y2 each issue separate financial statements,
and each may independently elect to apply pushdown accounting irrespective of whether B, Y, or any other
acquired entity elects to do so. In addition, X’s or Y2’s ability to elect pushdown accounting does not depend on
whether B issues separate financial statements.
A.8 Specific Initial Recognition and Measurement Guidance in an Acquiree’s Separate Financial Statements
ASC 805-50
30-10 If an acquiree elects the option in this Subtopic to apply pushdown accounting, the acquiree shall
reflect in its separate financial statements the new basis of accounting established by the acquirer for the
individual assets and liabilities of the acquiree by applying the guidance in other Subtopics of Topic 805. If the
acquirer did not establish a new basis of accounting for the individual assets and liabilities of the acquiree
because it was not required to apply Topic 805 (for example, if the acquirer was an individual or an investment
company — see Topic 946 on investment companies), the acquiree shall reflect in its separate financial
statements the new basis of accounting that would have been established by the acquirer had the acquirer
applied the guidance in other Subtopics of Topic 805.
If an acquiree elects to apply pushdown accounting, the carrying amounts of its assets and liabilities
in its separate financial statements are adjusted to reflect the amounts recognized in the acquirer’s
consolidated financial statements as of the date on which control was obtained. As discussed in the
paragraphs below, ASC 805-50 contains guidance on the initial recognition and measurement of certain
assets, liabilities, and gains in an acquiree’s separate financial statements. For assets, liabilities, gains,
and losses not specifically addressed in ASC 805-50, we believe that an acquiree should apply the
recognition and measurement guidance in ASC 805-20 and ASC 805-30 that the acquirer applies.
An acquiree that elects pushdown accounting must apply it in its entirety; the
acquiree cannot pick or choose which assets or liabilities to recognize in its
separate financial statements. However, assets or liabilities that are the legal
right or obligation of the parent or acquirer, rather than the acquiree, should not
be pushed down unless they must be recognized in the acquiree’s financial statements
in accordance with other GAAP (see Section A.11). In addition, expenses are not part of the acquirer’s
basis in the assets acquired and liabilities assumed. Expenses incurred by the
acquirer should not be pushed down to the acquiree’s separate financial statements
unless the acquirer incurred such expenses on behalf of, or for the benefit of, the
acquiree (see Section
A.12).
An acquirer sometimes is not required to apply ASC 805-10, ASC 805-20, and ASC 805-30 to the
acquiree’s assets acquired or liabilities assumed (e.g., the acquirer is an individual or an investment
company). In such cases, the acquiree may nonetheless elect to apply pushdown accounting by
recognizing in its separate financial statements the basis the acquirer would have recognized had it
applied ASC 805-10, ASC 805-20, and ASC 805-30.
A.8.1 Measurement Period
ASC 805-10-25-15 states:
The measurement
period is the period after the acquisition date
during which the acquirer may adjust the
provisional amounts recognized for a business
combination. The measurement period provides the
acquirer with a reasonable time to obtain the
information necessary to identify and measure any
of the following as of the acquisition date in
accordance with the requirements of this Topic:
- The identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree (see Subtopic 805-20)
- The consideration transferred for the acquiree (or the other amount used in measuring goodwill in accordance with paragraphs 805-30-30-1 through 30-3)
- In a business combination achieved in stages, the equity interest in the acquiree previously held by the acquirer (see paragraph 805-30-30-1(a)(3))
- The resulting goodwill recognized in accordance with paragraph 805-30-30-1 or the gain on a bargain purchase recognized in accordance with paragraph 805-30-25-2.
We believe that if the
acquiree is acquired in a business combination and elects to apply pushdown accounting,
the acquirer’s measurement period also applies to the acquiree’s separate financial
statements. That is, any adjustments made by the acquirer to the provisional amounts
recognized in the business combination would also be reflected in the acquiree’s separate
financial statements. We believe that the acquiree’s separate financial statements should
also include any relevant disclosures if the initial accounting for the business
combination is incomplete.
See Section 6.1 for more information about the measurement
period and Section 7.11 for
discussion of the disclosure requirements when the initial accounting for the business
combination is incomplete.
A.9 Subsequent Measurement Guidance
ASC 805-50
35-2 An acquiree shall follow the subsequent measurement guidance in other Subtopics of Topic 805 and
other applicable Topics to subsequently measure and account for its assets, liabilities, and equity instruments,
as applicable.
ASC 805-50 contains no specific subsequent-measurement guidance related to an acquiree’s separate
financial statements. An acquiree that elects pushdown accounting should apply the subsequent-measurement
guidance in ASC 805-20 and ASC 805-30 and other applicable GAAP to subsequently
measure and account for its assets, liabilities, and equity instruments.
A.10 Goodwill and Bargain Purchase Gains
ASC 805-50
30-11 An acquiree shall recognize goodwill that arises because of the application of pushdown accounting in
its separate financial statements. However, bargain purchase gains recognized by the acquirer, if any, shall
not be recognized in the acquiree’s income statement. The acquiree shall recognize the bargain purchase
gains recognized by the acquirer as an adjustment to additional paid-in capital (or net assets of a not-for-profit
acquiree).
An acquiree that applies pushdown accounting must recognize the goodwill related
to the acquisition in its separate financial
statements. Certain items, such as liabilities that
are not the legal obligation of the acquiree or
bargain purchase gains, are not pushed down to the
acquiree. Because these items are not pushed down to
the acquiree’s financial statements on the
acquisition date, there will be an adjustment to the
acquiree’s APIC rather than to goodwill. However, a
bargain purchase gain recognized by the acquirer is
not recognized in the acquiree’s separate income
statement even if the acquiree elects to apply
pushdown accounting. An acquiree that elects to
apply pushdown accounting recognizes a bargain
purchase gain as an adjustment to APIC (or net
assets of a not-for-profit acquiree) in its separate
financial statements.
ASC 350-20 requires that an acquirer assign all goodwill acquired in a business combination on the
acquisition date to the acquirer’s reporting units “that are expected to benefit from the synergies of the
combination.” Such an allocation could result in a difference between the amount of goodwill recognized
in the acquiree’s separate financial statements and the amount of goodwill assigned to the acquiree
in the parent’s consolidated financial statements if some of the goodwill is assigned to one or more
reporting units that do not include the assets or liabilities of the acquiree.
A.11 Acquisition-Related Liabilities
ASC 805-50
30-12 An acquiree shall recognize in its separate financial statements any acquisition-related liability incurred by the acquirer only if the liability represents an obligation of the acquiree in accordance with other applicable Topics.
ASC 805-50 provides guidance on applying pushdown accounting to acquisition-related liabilities
that the acquirer (or acquiree) incurs at the time of the acquisition (e.g., acquisition-related debt or
contingent consideration). Such liabilities differ from liabilities assumed, which were liabilities of the
acquiree before the acquisition that the acquirer assumes as part of the acquisition.
The Background Information and Basis for Conclusions of ASU 2014-17 notes that
the Task Force concluded that an acquiree should “recognize a liability incurred by
the acquirer only if that obligation is the [acquiree’s] liability” (i.e., the
liability is the acquiree’s legal obligation even if the acquirer incurred the
liability on behalf of the acquiree). The Background Information and Basis for
Conclusions also cites the guidance in ASC 405-40, which applies to obligations
related to joint-and-several liability arrangements for which the total amount under
the arrangement is fixed as of the reporting date. ASC 405-40-30-1 requires entities
to recognize and measure liabilities resulting from joint-and-several liability
arrangements as the sum of the following:
-
The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors.
-
Any additional amount the reporting entity expects to pay on behalf of its co-obligors. If some amount within a range of the additional amount the reporting entity expects to pay is a better estimate than any other amount within the range, that amount shall be the additional amount included in the measurement of the obligation. If no amount within the range is a better estimate than any other amount, then the minimum amount in the range shall be the additional amount included in the measurement of the obligation.
A.11.1 Acquisition-Related Debt
Acquisition-related liabilities include debt incurred at the time of the acquisition. Under ASC 805-50-30-12, an acquiree must recognize any acquisition-related debt in its separate financial statements only
if it is required to do so under other GAAP. Thus, acquisition-related debt should be recognized in the
acquiree’s separate financial statements only if (1) the debt is the legal obligation of the acquiree or
(2) the acquirer and acquiree are joint and severally liable and the criteria in ASC 405-40 are met. We
believe that if the acquiree recognizes the acquisition-related debt in its separate financial statements, it
should also recognize the related interest expense and debt issue costs.
An acquiree may be required to recognize acquisition-related debt and liabilities in its separate financial
statements as a result of other GAAP even if it does not elect to apply pushdown accounting.
For example, if the acquirer incurs debt to finance the acquisition but the acquiree is named as the legal
obligor, that debt would need to be recognized in the acquiree’s separate financial statements even if
the acquiree does not apply pushdown accounting. This could lead to the acquiree’s presentation of
negative equity in its financial statements if pushdown accounting is not elected.
Before being rescinded by SAB 115, SAB Topic 5.J expressed the SEC staff’s views on the pushdown of
acquisition-related debt to the acquiree’s separate financial statements. SAB Topic 5.J stated that the
parent’s acquisition-related debt, related interest expense, and allocable debt issue costs should be
included in a subsidiary’s financial statements in any of the following circumstances:
- The subsidiary was to assume the parent’s debt “either presently or in a planned transaction in the future.”
- The proceeds of a debt or equity offering of the subsidiary were to be “used to retire all or a part of [the parent’s] debt.”
- The subsidiary guaranteed or pledged “its assets as collateral for [the parent’s] debt.”
Because an acquiree’s assets are often pledged as collateral against an acquirer’s debt, we believe
that the rescission of SAB Topic 5.J will result in fewer instances in which acquisition-related debt is
recognized in the acquiree’s separate financial statements.
A.11.2 Contingent Consideration
ASC 805-10-20 defines contingent consideration as follows:
Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners of
an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions
are met. However, contingent consideration also may give the acquirer the right to the return of previously
transferred consideration if specified conditions are met.
ASC 805-30-25-5 requires that an acquirer recognize any contingent consideration at fair value on the
acquisition date “as part of the consideration transferred in exchange for the acquiree.”
ASC 805-50 does not specify whether contingent consideration should be pushed down to the
acquiree’s separate financial statements. We believe that the general principles for acquisition-related
liabilities incurred by the acquirer apply and that contingent consideration should be recognized in the
acquiree’s separate financial statements only if it is the acquiree’s legal obligation to pay (or legal right to
receive) the contingent consideration. If contingent consideration is not pushed down to the acquiree’s
separate financial statements, the acquiree would not recognize any changes in the fair value of the
contingent consideration in its separate statement of operations.
A.12 Acquisition-Related Costs
ASC 805-10-25-23 states:
Acquisition-related costs are costs the acquirer incurs to effect a business combination. Those costs include finder’s fees; advisory, legal, accounting, valuation, and other professional or consulting fees; general administrative costs, including the costs of maintaining an internal acquisitions department; and costs of registering and issuing debt and equity securities. The acquirer shall account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities shall be recognized in accordance with other applicable GAAP.
We believe that the acquirer’s direct expenses for acquisition-related costs should not be recognized
in the acquiree’s separate financial statements unless the acquirer incurred such costs on behalf of,
or for the benefit of, the acquiree. SAB Topic 1.B states that “[i]n general, the staff believes that the
historical income statements of a registrant should reflect all of its costs of doing business. Therefore,
in specific situations, the staff has required the subsidiary to revise its financial statements to include
certain expenses incurred by the parent on its behalf.” Similarly, SAB Topic 5.T discusses the concept
of reflecting costs incurred by a shareholder on behalf of a company in the company’s financial
statements. SAB Topic 5.T states that a transaction in which “a principal stockholder pays an expense for the company, unless the stockholder’s action is caused by a relationship or obligation completely
unrelated to his position as a stockholder or such action clearly does not benefit the company,” should
be reflected as an expense in the company’s financial statements, with a corresponding credit to APIC.
While the guidance in SAB Topic 1.B and SAB Topic 5.T applies to public companies, we believe that
private companies should also apply this guidance when evaluating the recognition of acquisition-related
costs.
An acquiree will most likely incur acquisition-related costs associated with the business combination, such as legal fees or sell-side due diligence costs. The acquiree should recognize those costs in its separate financial statements in the periods in which the services are received. An acquirer may sometimes pay the liabilities of the acquiree on, or in close proximity to, the acquisition date. In such cases, it is necessary to determine whether the cash distributed should be reported as consideration transferred to effect the acquisition or as cash paid to settle a liability assumed in the acquisition. (See Section 4.12.1 for more information about making this determination.) If it is determined to be a liability assumed, and if the acquiree is the legal obligor for those costs, the liability should be recognized in the acquiree’s separate postacquisition financial statements regardless of whether it elects pushdown accounting.
A.13 Income Taxes
Although the application of pushdown accounting is optional under ASC 805-50, ASC 740-10-30-5
states that deferred taxes must be “determined separately for each tax-paying component . . . in each
tax jurisdiction.” Therefore, to properly determine the temporary differences and to apply ASC 740
accurately, an entity must push down, to each tax-paying component, the amounts assigned to the
individual assets and liabilities for financial reporting purposes. That is, because the cash inflows from
assets acquired or cash outflows from liabilities assumed will be reflected on the tax return of the
respective tax-paying component, the acquirer has a taxable or deductible temporary difference related
to the entire amount recorded under the acquisition method (compared with its tax basis), regardless of
whether such acquisition-method adjustments are actually pushed down and reflected in the acquiree’s
separate financial statements.
An entity can either record the amounts in its subsidiary’s books (i.e., actual pushdown accounting) or
maintain the records necessary to adjust the consolidated amounts to what they would have been had
the amounts been recorded on the subsidiary’s books (i.e., notional pushdown accounting). In many
instances, the latter method can make record keeping more complex.
Further, the entire amount recorded under the acquisition method for a particular asset or liability must
be converted to the currency in which the tax-paying component files its tax return (the “tax currency”)
to properly determine the temporary difference associated with the particular asset or liability and the
corresponding deferred tax asset or deferred tax liability (i.e., deferred taxes are calculated in the tax
currency and then translated or remeasured in accordance with ASC 830).
See Deloitte’s Roadmap Income Taxes for more information.
A.14 Foreign Currency Translation
ASC 830-30-45-11 states that “[a]fter a business combination, the amount assigned at the acquisition
date to the assets acquired and the liabilities assumed (including goodwill or the gain recognized for
a bargain purchase in accordance with Subtopic 805-30) shall be translated in conformity with the
requirements of this Subtopic [ASC 830-30].” This requirement applies regardless of whether the entity elects to apply
pushdown accounting.
See Deloitte’s Roadmap Foreign Currency Matters for more information.
A.15 Disclosures
ASC 805-50
50-5 If an acquiree elects the option to apply pushdown accounting in its separate financial statements, it shall disclose information in the period in which the pushdown accounting was applied (or in the current reporting period if the acquiree recognizes adjustments that relate to pushdown accounting) that enables users of financial statements to evaluate the effect of pushdown accounting. To meet this disclosure objective, the acquiree shall consider the disclosure requirements in other Subtopics of Topic 805.
50-6 Information to evaluate the effect of pushdown accounting may include the following:
- The name and a description of the acquirer and a description of how the acquirer obtained control of the acquiree.
- The acquisition date.
- The acquisition-date fair value of the total consideration transferred by the acquirer.
- The amounts recognized by the acquiree as of the acquisition date for each major class of assets and liabilities as a result of applying pushdown accounting. If the initial accounting for pushdown accounting is incomplete for any amounts recognized by the acquiree, the reasons why the initial accounting is incomplete.
- A qualitative description of the factors that make up the goodwill recognized, such as expected synergies from combining operations of the acquiree and the acquirer, or intangible assets that do not qualify for separate recognition, or other factors. In a bargain purchase (see paragraphs 805-30-25-2 through 25-4), the amount of the bargain purchase recognized in additional paid-in capital (or net assets of a not-for-profit acquiree) and a description of the reasons why the transaction resulted in a gain.
- Information to evaluate the financial effects of adjustments recognized in the current reporting period that relate to pushdown accounting that occurred in the current or previous reporting periods (including those adjustments made as a result of the initial accounting for pushdown accounting being incomplete [see paragraphs 805-10-25-13 through 25-14]).
The information in this paragraph is not an exhaustive list of disclosure requirements. The acquiree shall disclose whatever additional information is necessary to meet the disclosure objective set out in paragraph 805-50-50-5.
The disclosures that an entity applying pushdown accounting is required to provide under ASC 805-50
are generally based on the disclosures that an acquirer is required to provide for a business
combination under ASC 805-10, ASC 805-20, and ASC 805-30. However, the ASC 805-50 requirements
exclude certain disclosures that would only be relevant to users of the acquirer’s consolidated financial
statements. For example, an acquiree is not required to disclose items such as the percentage of voting
equity interests acquired by the acquirer, any transactions the acquirer recognized separately from the
acquisition, and supplemental pro forma information. In subsequent reporting periods, the acquiree
would need to provide any required disclosures for items such as goodwill and intangible assets.
There are no disclosure requirements for an acquiree that does not elect to apply pushdown
accounting. Therefore, an acquiree would not be required to disclose that it was acquired or that it
elected not to apply pushdown accounting.
A.16 Financial Statement Presentation
The application of pushdown accounting and the presentation of a new basis of accounting in a
subsidiary’s separate financial statements are akin to the termination of an old reporting entity and
the creation of a new reporting entity. Therefore, it is not appropriate to combine preacquisition and
postacquisition periods in a single set of financial statements. In both the financial statements and any
footnote disclosures presented in tabular format, the preacquisition and postacquisition periods are
separated by a vertical “black line.” The periods before the acquisition are labeled as the “predecessor”
periods and the periods after the acquisition and the application of pushdown accounting are labeled
as the “successor” periods. Since the application of pushdown accounting is akin to the creation of
a new reporting entity, the predecessor entity’s equity structure is not carried forward and the new
equity structure is presented in the successor period. The footnotes to the financial statements should
include separate footnote disclosures for the preacquisition and postacquisition periods. In addition,
the footnote disclosures should include a description of the acquisition to alert users that pushdown
accounting was applied and that, accordingly, the acquiree’s results of operations and cash flows in the
predecessor and successor periods are not comparable.
A.16.1 Recognizing Expenses on the “Black Line”
In a speech at the 2014 AICPA Conference on Current SEC and PCAOB Developments, an SEC staff
member (Carlton Tartar) discussed whether it is appropriate for an entity that is applying pushdown
accounting to exclude, from both the predecessor and successor income statement periods, certain
expenses triggered by the consummation of a business combination that were incurred by the acquiree.
Examples of such expenses include investment banking fees paid by the acquiree that are contingent
on the closing of the acquisition and share-based compensation awards with a preexisting provision
that accelerated their vesting upon a change in control. While the staff acknowledged that a registrant
needs to consider its specific facts and circumstances, it observed that registrants sometimes exclude
expenses that are contingent on a change-in-control event from the predecessor and successor periods
and record those expenses on the “black line” separating the two periods (i.e., neither the predecessor’s
nor the successor’s financial statements would report the contingent payments as expenses). The staff
encouraged “registrants to evaluate whether it is appropriate to record expenses that are related to
the business combination in either the predecessor or successor periods as appropriate, based on
the specific facts and circumstances underlying each individual transaction.” However, the staff also
noted that it would not object to black line presentation “provided that transparent and disaggregated
disclosure of the nature and amount of such expenses was made.”
This view is supported by analogy to the guidance in ASC 805-20-55-51, which prohibits entities from
recognizing a liability for contractual termination benefits and curtailment losses under employee
benefit plans that will be triggered by a business combination until the business combination is
consummated. Similarly, the argument in support of recognizing expenses on the black line is that
any expenses that do not become payable until the change in control should not be recognized until
consummation occurs and should not be recognized in the period before the business combination
(i.e., the predecessor period).
Another acceptable view is that all of the acquiree’s acquisition expenses, even those that are contingent
on a change in control, should be recognized in the period in which they were incurred. Because the
financial statements present the acquiree’s results of operations for the period up to the acquisition
date, there is no longer a risk that the business combination will not occur. Thus, recognition of the
expenses in the predecessor period is appropriate.
We believe that either alternative is acceptable provided that an acquiree recognizes all expenses
triggered by a change in control consistently, either in the predecessor period or on the black line.
A.16.2 Reflecting Changes by the Successor in the Predecessor Period
Because the application of pushdown accounting is akin to the termination of an
old reporting entity and the creation of a new reporting entity, the successor’s
changes in accounting principle, adoption of new accounting standards that
require retrospective application, reorganizations, or changes in segment
reporting are not “pushed back” into the predecessor period. However,
Section
13210.2 of the FRM does require that the predecessor
financial statements be retrospectively recast to reflect the successor’s
discontinued operations. It states:
Predecessor financial
statements are required to be retrospectively reclassified to reflect the
impact of a successor’s discontinued operations. Registrants should contact
the staff if unusual facts and circumstances may prohibit the company’s
ability to reclassify predecessor fiscal periods.
A.17 Identifying When a Newly Formed Entity to Effect an Acquisition Is the Acquirer
While ASU 2014-17 simplified the application of pushdown accounting, it did not
resolve certain long-standing practice issues related to whether a newly formed
entity (commonly called a “newco”) should be identified as the acquirer in a
business combination. Entities will often establish a newco to effect the
acquisition of a business. If the newco is identified as the acquirer and is the
reporting entity, it would apply acquisition accounting, rather than pushdown
accounting. Therefore, recognizing a new basis for the assets acquired and
liabilities assumed in the newco’s financial statements would not be optional.
ASC 805-10-55-15 provides limited guidance on whether a newco should be identified as the accounting
acquirer and states:
A new entity formed to effect a business combination is not necessarily the acquirer. If a new entity is formed
to issue equity interests to effect a business combination, one of the combining entities that existed before the
business combination shall be identified as the acquirer by applying the guidance in paragraphs 805-10-55-10
through 55-14. In contrast, a new entity that transfers cash or other assets or incurs liabilities as consideration
may be the acquirer.
Entities must use judgment in determining whether a newco should be identified as the acquirer. See
Section 3.1.5 for more information about identifying a newco as the acquirer in a business combination.
A.17.1 Newco and Acquisition-Related Costs
If the newco is identified as the acquirer, the buyer’s acquisition-related
costs should generally be reflected in the newco’s
financial statements in accordance with SAB Topic
1.B and SAB Topic 5.T. If the newco’s parent
incurred costs on the newco’s behalf, such costs
should generally be recognized as an expense in
the newco’s financial statements, with a
corresponding credit to APIC. See Section A.12 for more
information.
A.18 Recapitalization Transactions
A recapitalization is a type of reorganization designed to change an entity’s capital structure (i.e., mix
of debt and equity). Usually, these transactions involve new debt financing, issuing new shares, or
repurchasing outstanding shares. These transactions sometimes result in a change in control of the
entity undergoing the recapitalization and may or may not result in a new basis of accounting at the
entity level.
Example A-3
Recapitalization Transaction Without a Change in Control
Entities A, B, C, D, and E each own 20 percent of Company X’s issued and outstanding shares. None of the
entities has control of X. Company X buys back all of E’s shares, and the ownership of A, B, C, and D increases to
25 percent each. However, no entity obtains control of X. The transaction is a recapitalization transaction for X,
but there is no change in control over X.
Example A-4
Recapitalization Transaction With a Change in Control
Entities A, B, and C own all of Company X’s issued and outstanding shares. Entity A owns 45 percent, B owns
40 percent, and C owns 15 percent. None of the entities has control of X. Company X buys back all of C’s
shares. Entity A’s ownership increases to 53 percent. In the absence of evidence that A does not control X, a
business combination has occurred between A and X. Company X elects not to apply pushdown accounting.
The transaction is a recapitalization transaction for X and, since X elects not to apply pushdown accounting, the
basis of X’s assets or liabilities does not change when A obtains control of X.
A.18.1 Transaction Costs in a Recapitalization
Entities may incur costs related to structuring a recapitalization. An entity undergoing a recapitalization
should account for its costs on the basis of the nature of those costs. For example, costs related to
issuing debt are capitalized as debt issuance costs and amortized over the life of the debt by using
the effective interest method, costs related to issuing equity and raising capital are recognized as a
reduction to the total amount of equity raised, and costs related to advisory or legal services should be
expensed as incurred.
If the costs are billed to the entity as a single amount, we believe that the entity should apply the
guidance in paragraph 6 of SAB Topic 2.A, which states, in part:
When an investment banker provides services in connection with a business combination or asset acquisition
and also provides underwriting services associated with the issuance of debt or equity securities, the total
fees incurred by an entity should be allocated between the services received on a relative fair value basis. The
objective of the allocation is to ascribe the total fees incurred to the actual services provided by the investment
banker.
We believe that the amounts allocated to debt issuance costs should result in an effective interest rate
on the debt that is consistent with an effective market interest rate and that the amounts allocated to
equity issuance costs should be consistent with fees an underwriter would charge.
Further, we believe that if the fees are incurred by a new investor, those costs should not be recognized
in the financial statements of the entity undergoing the recapitalization unless they were incurred by the
investor on the entity’s behalf. We believe that entities should consider the guidance in SAB Topic 1.B
and SAB Topic 5.T in determining whether such costs were incurred on behalf of, and for the benefit of,
the entity. See Section A.12 for more information.
Appendix B — Accounting for Common-Control Transactions
Appendix B — Accounting for Common-Control Transactions
B.1 Overview and Scope
B.1.1 Overview of Common-Control Transactions
A common-control transaction is typically a transfer of net assets or an
exchange of equity interests between entities under the control of the same
parent. While a common-control transaction is similar to a business combination
for the entity that receives the net assets or equity interests, such a
transaction does not meet the definition of a business combination because there
is no change in control over the net assets. Therefore, the accounting and
reporting for a transaction between entities under common control is outside the
scope of the business combinations guidance in ASC 805-10, ASC 805-20, and ASC
805-30 and is addressed in the “Transactions Between Entities Under Common
Control“ subsections of ASC 805-50. Since there is no change in control over the
net assets from the parent’s perspective, there is no change in basis in the net
assets. ASC 805-50 requires that the receiving entity recognize the net assets
received at their historical carrying amounts, as reflected in the ultimate
parent’s financial statements. ASC 805-50 does not specifically address the
accounting by the transferring entity. In the absence of guidance, certain
practices have developed regarding the reporting by the transferring entity in
its separate financial statements.
A common-control transaction has no effect on the parent’s consolidated
financial statements. The net assets are derecognized by the transferring entity
and recognized by the receiving entity at their historical carrying amounts in
the ultimate parent’s or controlling shareholder’s financial statements. 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.
Therefore, the guidance in the “Transactions Between Entities Under Common
Control“ subsections of ASC 805-50 and the following sections of this appendix
applies only to the separate financial statements of an entity that engages in a
common-control transaction.
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. If the
recognition of the net assets results in a “change in the reporting entity,“ the receiving entity presents
the transfer in its separate financial statements retrospectively, similarly to a pooling of interests. If not,
the receiving entity presents the transfer in its separate financial statements prospectively from the
date of the transfer. 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.
B.1.2 Scope
ASC 805-50
05-4 As noted in paragraph 805-10-15-4(c), the guidance related to business combinations does not apply to
combinations between entities or businesses under common control.
15-5 The guidance in the Transactions Between Entities Under Common Control Subsections applies to all
entities.
15-6A The guidance in the Transactions between Entities under Common Control Subsections does not apply
to the initial measurement by a primary beneficiary of the assets, liabilities, and noncontrolling interests of a VIE
if the primary beneficiary of a VIE and the VIE are under common control. Guidance for such a VIE is provided in
Section 810-10-30.
15-6B Mergers and acquisitions between or among two or more NFPs, all of which benefit a particular group of
citizens, shall not be considered common control transactions solely because those entities benefit a particular
group. The mission, operations, and historical sources of support of two or more NFPs may be closely linked to
benefiting a particular group of citizens. However, that group neither owns nor controls the NFPs.
The guidance in the “Transactions Between Entities Under Common Control”
subsections of ASC 805-50 applies to the separate financial statements of an
entity that engages in a common-control transaction. However, ASC 810-10-30-1
addresses how a primary beneficiary of a VIE should initially measure the VIE’s
assets, liabilities, and noncontrolling interests when the primary beneficiary
and the VIE are under common control. That guidance, which states as follows, is
similar to that in ASC 805-50:
If the primary beneficiary of
a variable interest entity (VIE) and the VIE are under common control, the
primary beneficiary shall initially measure the assets, liabilities, and
noncontrolling interests of the VIE at amounts at which they are carried in
the accounts of the reporting entity that controls the VIE (or would be
carried if the reporting entity issued financial statements prepared in
conformity with generally accepted accounting principles [GAAP]).
B.2 Identifying Common-Control Transactions
B.2.1 Meaning of the Term “Common Control”
The term “control” has the same meaning as the term “controlling financial interest” in ASC 810-10-15-8,
which states:
For legal entities other than limited partnerships, the usual condition for a controlling financial interest is
ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity,
directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition
pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for
example, by contract, lease, agreement with other stockholders, or by court decree.
In determining control, an entity cannot consider only voting interests. Control may be established in
other ways, such as:
- Variable interests (see the “Variable Interest Entities” subsections of ASC 810-10 and Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest).
- Contractual arrangements (see the “Consolidation of Entities Controlled by Contract” subsections of ASC 810-10).
While “common control” is not defined, we often think of the term as encompassing situations in which
separate entities were consolidated by the same parent both before and after the transfer (or would
have been consolidated by the same parent if the parent prepared consolidated financial statements).
Example B-1
Entities Under Common Control
Parent controls Subsidiary A with its 60 percent voting equity interest and Subsidiary B with its 100 percent
voting equity interest. Because Parent controls both A and B, they are under the common control of Parent.
ASC 805-50-15-6 gives the following examples of other common-control
transactions:
ASC 805-50
Transactions
15-6 The guidance in the Transactions between Entities under Common Control Subsections applies to
combinations between entities or businesses under common control. The following are examples of those
types of transactions:
- An entity charters a newly formed entity and then transfers some or all of its net assets to that newly chartered entity.
- A parent transfers the net assets of a wholly owned subsidiary into the parent and liquidates the subsidiary. That transaction is a change in legal organization but not a change in the reporting entity.
- A parent transfers its controlling interest in several partially owned subsidiaries to a new wholly owned subsidiary. That also is a change in legal organization but not in the reporting entity.
- A parent exchanges its ownership interests or the net assets of a wholly owned subsidiary for additional shares issued by the parent’s less-than-wholly-owned subsidiary, thereby increasing the parent’s percentage of ownership in the less-than-wholly-owned subsidiary but leaving all of the existing noncontrolling interest outstanding.
- A parent’s less-than-wholly-owned subsidiary issues its shares in exchange for shares of another subsidiary previously owned by the same parent, and the noncontrolling shareholders are not party to the exchange. That is not a business combination from the perspective of the parent.
- A limited liability company is formed by combining entities under common control.
- Two or more not-for-profit entities (NFPs) that are effectively controlled by the same board members transfer their net assets to a new entity, dissolve the former entities, and appoint the same board members to the newly combined entity.
Changing Lanes
In October 2018, the FASB issued ASU
2018-17, which amends the
related-party guidance in ASC 810 to add an
elective private-company scope exception to the
VIE guidance for entities under common control.
For more information, see Deloitte’s Roadmap
Consolidation — Identifying a Controlling
Financial Interest.
EITF Issue 02-5 also provides examples of common-control transactions. Although EITF Issue 02-5 was nullified by FASB Statement 141(R), which was codified in ASC 805-10, ASC 805-20, and ASC 805-30, we believe that the guidance provided by that Issue remains applicable to both public and private companies because of a lack of other authoritative guidance on this topic. While no consensus was reached, the SEC observer stated that the SEC staff believes that common control exists between (or among) separate entities in the following situations:
- An individual or enterprise holds more than 50 percent of the voting ownership interest of each entity.
- Immediate family members hold more than 50 percent of the voting ownership interest of each entity (with no evidence that those family members will vote their shares in any way other than in concert).
- Immediate family members include a married couple and their children, but not the married couple’s grandchildren.
- Entities might be owned in varying combinations among living siblings and their children. Those situations would require careful consideration regarding the substance of the ownership and voting relationships.
- A group of shareholders holds more than 50 percent of the voting ownership interest of each entity, and contemporaneous written evidence of an agreement to vote a majority of the entities’ shares in concert exists.
We understand that the guidance about immediate family members should not be extended to other
family relationships such as shares held by in-laws, cousins, or divorced couples. In addition, we
understand that the SEC staff has objected to assertions that different companies owned by individuals
that are not members of an immediate family are under common control unless there was written
evidence of an agreement in place at the time of the transaction to vote a majority of an entity’s shares
together.
A downstream merger is another example of a common-control transaction. In a downstream merger,
a partially owned subsidiary exchanges its common shares for the outstanding voting common shares
of its parent. As a result, the consolidated net assets are owned by both the former shareholders of the
parent and the former shareholders of the noncontrolling interest in the subsidiary. Regardless of its
legal form, a downstream merger is accounted for as if the parent acquired the shares of its subsidiary.
Therefore, the reporting for a downstream merger is similar to that for a reverse acquisition without a
change in basis for the assets and liabilities. The parent is treated as the ongoing reporting entity from
an accounting perspective. The consolidated financial statements of the surviving entity are those of the
parent, even though the subsidiary is the surviving legal entity. The shareholders’ equity of the surviving
entity is adjusted to reflect the shareholders’ equity of the former parent, after effect is given to the
acquisition of the noncontrolling interest, which is accounted for as an equity transaction in accordance
with ASC 810-10-45-23.
In some cases, judgment must be used in the determination of whether entities are under common
control. An entity should consider all facts and circumstances in making this determination.
B.2.2 Transactions Between Entities With Common Ownership
Common ownership exists when two or more entities have the same shareholders but
no one shareholder controls all of the entities.
Transfers of net assets or equity interests among
entities that have common ownership are not
common-control transactions. However, they may be
accounted for similarly to common-control
transactions if the transfer lacks economic
substance. In prepared remarks at the 1997 Annual
Conference on Current SEC Developments, Donna
Coallier, then professional accounting fellow in
the SEC’s OCA, addressed transactions between
entities with a high degree of common ownership,
stating:
When there is a transaction between entities with a high degree of common ownership, but that are not under common control, the staff assesses the transaction to determine whether the transaction lacks substance. FTB 85-5
provides an example of a similar assessment in an exchange between a parent and a minority shareholder in one of the parent’s partially owned subsidiaries. Paragraph 6 of FTB 85-5 states, in
part:
[I]f the minority
interest does not change and if in substance the
only assets of the combined entity after the
exchange are those of the partially owned
subsidiary prior to the exchange, a change in
ownership has not taken place, and the exchange
should be accounted for based on the carrying
amounts of the partially owned subsidiary’s assets
and liabilities.
Similarly, in a transfer or
exchange between entities with a high degree of
common ownership, the staff compares the
percentages owned by shareholders in the combined
company to the percentages owned in each of the
combining companies before the transaction. When
the percentages have changed or the owned
interests are not in substance the same before and
after the transaction, the staff believes a
substantive transaction has occurred and has
objected to historical cost accounting.
FASB Statement 141(R) nullified FASB Technical Bulletin 85-5. However, in the absence of other authoritative guidance, we believe that it continues to provide relevant guidance on assessing whether a transaction lacks economic substance. On the basis of the guidance in paragraph 6 of Technical Bulletin 85-5 and the
prepared remarks of the SEC staff, for a transaction between entities with
common ownership to be accounted for in a manner consistent with a
common-control transaction, entities are expected to have identical owners and
the ownership percentages would need to be very similar both before and after
the transaction to demonstrate that the transaction lacks economic substance.
Such fact patterns are unusual.
Example B-2
Transfer Between Entities With Common Ownership That Lacks Economic Substance
Investors A and B each have a 35 percent interest and Investor C has a 30 percent interest in Companies
A, B, and C. No individual investor controls any of the companies. The investors agree to merge the three
companies. Further, the investors exchange their shares in each of the three companies for shares of the new,
merged company, Company ABC. After the transaction, A and B each have a 35 percent interest and C has a
30 percent interest in ABC.
Before transfer:
After transfer:
Because A’s, B’s, and C’s ownership interests in the underlying assets are the same before and after the
merger, the transaction lacks economic substance. Thus, the transaction would be accounted for in a manner
consistent with a common-control transaction in accordance with ASC 805-50. As the receiving entity, Company
ABC would recognize the assets and liabilities of A, B, and C at their historical carrying amounts.
Example B-3
Transfer Between Entities With Common Ownership That Has Economic Substance
Investors A, B, C, and D together own Companies A and B. No individual investor controls both A and B. The
investors agree to merge A and B. Further, the investors exchange their shares in each of the two companies
for share of the new, merged company. The number of shares received is based on the relative fair values of
the share held in A and B before the merger.
Company A is significantly larger than B such that after the merger, the
ownership in Company AB is as follows:
Although A and B had identical owners before the merger, given the resulting change in relative ownership,
it would not be appropriate to account for the transaction in a manner consistent with a common-control
transaction.
B.3 Measurement
B.3.1 Measurement by the Receiving Entity
ASC 805-50
Transfer Date Recognition
25-2 When accounting for a transfer of assets or exchange of shares between entities under common control,
the entity that receives the net assets or the equity interests shall initially recognize the assets and liabilities
transferred at the date of transfer. See the Transactions Between Entities Under Common Control Subsection
of Section 805-50-45 for guidance on the presentation of financial statements for the period of transfer and
comparative financial statements for prior years.
Transfer Date Measurement
30-5 When accounting for a transfer of assets or exchange of shares between entities under common control,
the entity that receives the net assets or the equity interests shall initially measure the recognized assets and
liabilities transferred at their carrying amounts in the accounts of the transferring entity at the date of transfer.
If the carrying amounts of the assets and liabilities transferred differ from the historical cost of the parent of
the entities under common control, for example, because pushdown accounting had not been applied, then
the financial statements of the receiving entity shall reflect the transferred assets and liabilities at the historical
cost of the parent of the entities under common control.
Under ASC 805-50-30-5, there is no change in basis for the net assets received because there is no
change in control over the net asset or equity interests from the parent’s perspective. A difference
between any proceeds transferred and the carrying amounts of the net assets received is recognized in
equity (generally APIC) in the receiving entity’s separate financial statements.
B.3.1.1 Difference in Carrying Amounts Between the Parent and Transferring Entity
Sometimes, the carrying amounts of the net assets in the transferring entity’s
financial statements differ from those in the
parent’s consolidated financial statements. This
can occur, for example, if the net assets being
transferred were acquired in a business
combination but the transferring entity did not
apply pushdown accounting at the time of their
acquisition. Under ASC 805-50-30-5, “the financial
statements of the receiving entity shall reflect
the transferred assets and liabilities at the
historical cost of the parent of the entities
under common control.“ As a result, the receiving
entity effectively applies pushdown accounting in
its separate financial statements. We believe that
the historical cost of the parent refers to the
historical cost of the ultimate parent or
controlling shareholder. (See Appendix
A for more information about the
application of pushdown accounting.) Therefore,
the amounts of the net assets derecognized by the
transferring entity will not be consistent with
the amounts of the net assets recognized by the
receiving entity.
Example B-4
Common-Control Transfer That Triggers Pushdown Accounting
Parent transfers its ownership interest in one of its subsidiaries, Subsidiary B, to another of its subsidiaries,
Subsidiary A, in exchange for additional shares of A. The carrying value of B’s net assets in Parent’s consolidated
financial statements is $1,000, and the carrying value of B’s net assets in its separate financial statements
is $500. The carrying value of B’s net assets differs in Parent’s consolidated financial statements and in
B’s separate financial statements because B did not apply pushdown accounting in its separate financial
statements when Parent acquired control of B.
Before transfer:
After transfer:
Subsidiary A’s separate financial statements should reflect B’s net assets at their carrying values, as presented
in Parent’s consolidated financial statements. The nature of the transfer is that Parent is transferring its
investment in B to A.
B.3.1.2 Conforming Accounting Principles
ASC 805-50
30-6 In some instances, the entity that receives the net assets or equity interests (the receiving entity) and the
entity that transferred the net assets or equity interests (the transferring entity) may account for similar assets
and liabilities using different accounting methods. In such circumstances, the carrying amounts of the assets
and liabilities transferred may be adjusted to the basis of accounting used by the receiving entity if the change
would be preferable. Any such change in accounting method shall be applied retrospectively, and financial
statements presented for prior periods shall be adjusted unless it is impracticable to do so. Section 250-10-45
provides guidance if retrospective application is impracticable.
While we generally expect subsidiaries of a common parent to apply the same
accounting principles to similar assets or
liabilities, in limited circumstances it is
acceptable for the accounting policies of
subsidiaries of a common parent to differ. For
example, one subsidiary of a parent may apply the
LIFO method to account for inventory while another
of its subsidiaries may use a different method for
similar inventories. Therefore, in some cases, the
receiving entity and the transferring entity may
use different accounting methods to account for
certain assets or liabilities. ASC 805-50-30-6
states that in a common-control transaction, “the
carrying amounts of the assets and liabilities
transferred may be adjusted to the basis of
accounting used by the receiving entity if the
change would be preferable.“ Thus, if the
receiving entity applies a different accounting
principle and elects to adopt that accounting
principle for the assets or liabilities received,
it must determine that the method it applies is
preferable to the method applied by the
transferring entity and must apply the change in
accounting principle retrospectively in all
periods presented, unless it is impracticable to
do so, in accordance with the guidance in ASC 250.
We believe that, in situations in which the
accounting principle applied by the receiving
entity is not preferable, the receiving entity has
two options: (1) to continue to account for the
transferred assets and liabilities using the
accounting principle applied by the transferring
entity or (2) to voluntarily adopt for its assets
or liabilities the preferable accounting principle
the transferring entity applies in accordance with
ASC 250.
B.3.2 Measurement by the Transferring Entity
ASC 805-50 provides measurement guidance for the receiving entity but not for the transferring entity.
Because of this lack of authoritative guidance, practice has developed such that the transferring entity’s
measurement generally follows the receiving entity’s. That is, the transferring entity derecognizes the net
assets transferred at their carrying amounts and generally recognizes no gains or losses. A difference
between any proceeds received and the carrying amounts of the net assets transferred is recognized in
equity (generally APIC) in the transferring entity’s separate financial statements.
However, in certain circumstances, the transferring entity must remeasure certain assets to fair value
and recognize any gains or losses before they are transferred to the receiving entity. As discussed
below, such circumstances represent exceptions to the principle that assets and liabilities should be
transferred at their historical carrying amounts.
B.3.2.1 Exception for Transfers of Financial Assets
ASC 860-10-55-78 states, in part, that “a transfer [of financial assets] from one subsidiary (the transferor) to another subsidiary (the transferee) of a common parent would be accounted for as a sale in each subsidiary’s separate-entity financial statements” if (1) all the conditions in ASC 860-10-40-5 are met and (2) the receiving entity is not consolidated by the transferring entity. ASC 860-10-40-4 also indicates that “[i]n a transfer between two subsidiaries of a common parent, the [transferring entity] shall not consider parent involvements with the transferred financial assets in applying paragraph 860-10-40-5.“ Therefore, if those conditions are met, the transferring entity recognizes a gain or loss on a sale of financial assets to the receiving entity in its separate financial statements. However, any gain or loss would be eliminated in the parent’s consolidated financial statements.
The guidance in ASC 860-10-40-5 does not apply to transfers of financial assets between a parent and its subsidiaries, only to transfers between subsidiaries of a common parent. Entities should consider the guidance in ASC 860-10-55-17D if the transfer of financial assets is between a parent and its subsidiary.
We believe that the guidance in ASC 860-10 applies to transfers of financial
assets regardless of whether the nature of such transfers is recurring or
nonrecurring. That is, if a transfer’s nature is consistent with that of a
transfer of financial assets, entities should apply the guidance in ASC
860-10 rather than the guidance in the “Transactions Between Entities Under
Common Control“ subsections of ASC 805-50 or the exception for recurring
transactions discussed in the next section. In addition, the guidance in ASC
860-10 does not apply to a transfer of shares or an interest in a subsidiary
unless the subsidiary primarily consists of financial assets (i.e., the
transfer is essentially a transfer of financial assets). In some cases, an
entity may need to use judgment to determine the nature of the transfer
(i.e., financial assets or net assets).
B.3.2.2 Exception for Recurring Transactions for Which Valuation Is Not in Question, Such as Those Involving Inventory
A transfer of net assets between entities under common control is typically nonrecurring. However, for recurring transfers of assets (rather than net assets) whose valuation is not in question, such as routine inventory transfers in the ordinary course of business, the transferring entity typically recognizes a gain in its separate financial statements, and the receiving entity recognizes the assets at their stepped-up values in its separate financial statements. The accounting for routine transfers between entities under common control was addressed in EITF Issue 85-21, which states, in part:
The SEC Observer stated that the SEC staff’s views on carrying over historical cost to record, in the separate
financial statements of each entity, transfers between companies under common control or between a parent
and its subsidiary run primarily to transfers of net assets (as in a business combination) or long-lived assets.
Those views would not normally apply to recurring transactions for which valuation is not in
question (such as routine transfers of inventory) in the separate financial statements of each entity
that is a party to the transaction. [Emphasis added]
Although the EITF did not reach a consensus on this Issue, the above guidance continues to be
applied in practice. Any gain recognized in the transferring entity’s separate financial statements is eliminated in the
parent’s consolidated financial statements unless the sale is to a regulated affiliate and the criteria in
ASC 980-810-45-1 and 45-2 are met.
As described in the SEC Observer’s comments on EITF Issue 85-21, the SEC staff’s views apply to routine transfers of assets rather than transfers of “net assets (as in a business combination) or long-lived assets.” In some cases, an entity may need to use judgment to determine whether a transfer represents a transfer of net assets.
B.3.2.3 Goodwill
If the net assets or equity interest transferred in a common-control transaction constitute a business in
accordance with ASC 805-10 (see Section 2.4), the transferring entity will need to determine how much
goodwill to include with the net assets transferred. If the net assets or equity interest transferred do not
constitute a business, no goodwill would be transferred to the receiving entity.
An entity must often use judgment in determining the amount of goodwill to include with the net assets
transferred. Sometimes this goodwill amount may be specifically identified, while other times it may
be based fully or partially on a relative fair value allocation, in which case the entity would be expected
to consider the guidance in ASC 350-20-40-1 through 40-7. For example, an entity may specifically
identify the goodwill to be included in the net assets transferred when the net assets consist entirely
of a subsidiary previously acquired in a business combination. In this scenario, an entity typically would
identify the goodwill related to the prior acquisition as included in the net assets transferred, regardless
of whether the subsidiary had previously applied pushdown accounting. However, an entity may need
to use greater judgment when assessing transferred assets that do not entirely constitute a subsidiary
previously acquired in a business combination. For example, an entity may transfer a subsidiary that
was acquired in a prior business combination and other businesses that were not. In this scenario, the
entity may specifically identify the goodwill for the subsidiary that was previously acquired and may use
a relative fair value allocation for the rest of the transferred businesses. Alternatively, the entity may
determine that using a relative fair value allocation for the entire transfer is appropriate.
A common-control transfer may also result in a reorganization of reporting structure in the receiving
entity’s, transferring entity’s, or parent’s financial statements. Such a reorganization could result in
changes in operating segments and reporting units (see Section B.3.3.2).
B.3.3 Other Issues That May Affect the Receiving or Transferring Entities
B.3.3.1 Income Taxes
Paragraphs 270–272 of FASB Statement 109 had provided guidance on accounting for income taxes in a business combination accounted for as a pooling of interests. Because FASB Statement 141 eliminated the pooling-of-interests method, the guidance in Statement 109 was nullified and was not codified. However, we believe it is appropriate to continue to apply that guidance to a common-control transfer. That guidance stated:
270. The separate financial statements of combining enterprises for prior periods are restated on a combined
basis when a business combination is accounted for by the pooling-of-interests method. [Footnote omitted]
For restatement of periods prior to the combination date, a combining enterprise’s operating loss carryforward
does not offset the other enterprise’s taxable income because consolidated tax returns cannot be filed for
those periods. However, provisions in the tax law may permit an operating loss carryforward of either of the
combining enterprises to offset combined taxable income subsequent to the combination date.
271. If the combined enterprise expects to file consolidated tax returns, a deferred tax asset is recognized for
either combining enterprise’s operating loss carryforward in a prior period. A valuation allowance is necessary
to the extent it is more likely than not that a tax benefit will not be realized for that loss carryforward through
offset of either (a) the other enterprise’s deferred tax liability for taxable temporary differences that will reverse
subsequent to the combination date or (b) combined taxable income subsequent to the combination date.
Determined in that manner, the valuation allowance may be less than the sum of the valuation allowances in
the separate financial statements of the combining enterprises prior to the combination date. That tax benefit
is recognized as part of the adjustment to restate financial statements on a combined basis for prior periods.
The same requirements apply to deductible temporary differences and tax credit carryforwards.
272. A taxable business combination may sometimes be accounted for by the pooling-of-interests method.
The increase in the tax basis of the net assets acquired results in temporary differences. The deferred tax
consequences of those temporary differences are recognized and measured the same as for other temporary
differences. As of the combination date, recognizable tax benefits attributable to the increase in tax basis are
allocated to contributed capital. Tax benefits attributable to the increase in tax basis that become recognizable
after the combination date (that is, by elimination of a valuation allowance) are reported as a reduction of
income tax expense.
For more information about income tax issues related to common-control
transactions, see Deloitte’s Roadmap Income Taxes.
B.3.3.2 Reorganization of Reporting Structure and Goodwill Impairment Testing
A common-control transfer may result in a reorganization of the reporting structure in the receiving
entity’s, the transferring entity’s, or the parent’s financial statements. Thus, if any of the entities involved
(i.e., the receiving entity, the transferring entity, or the parent) in the common-control transfer is an SEC
registrant, it must assess whether the common-control transfer causes a change in the composition
of its reportable segments. Under ASC 280-10-50-34, “[i]f a public entity changes the structure of its
internal organization in a manner that causes the composition of its reportable segments to change, the
corresponding information for earlier periods, including interim periods, shall be restated unless it is
impracticable to do so.”
Similarly, entities must also assess whether the common-control transfer results in a change in reporting
units. ASC 350-20-35-45 states that “[w]hen an entity reorganizes its reporting structure in a manner
that changes the composition of one or more of its reporting units, the guidance in paragraphs 350-20-35-39 through 35-40 shall be used to reassign assets and liabilities to the reporting units affected [but]
goodwill shall be reassigned to the reporting units affected using a relative fair value allocation approach
similar to that used when a portion of a reporting unit is to be disposed of (see paragraphs 350-20-40-1
through 40-7).” ASC 350-20-40-1 through 40-7 provide guidance on allocating goodwill when a portion of
a reporting unit is disposed of.
We do not believe that the receiving entity, the transferring entity, or the parent needs to retrospectively
test goodwill for impairment in the historical periods before the date of the transfer. However,
ASC 350-20-40-7 requires that when a portion of a reporting unit is disposed of, an entity must test for
impairment any “goodwill remaining in the portion of the reporting unit to be retained.” Therefore, if the
transferred net assets represent a business and only a portion of a reporting unit of the transferring
entity, the transferring entity must test the remaining portion of the goodwill in the reporting unit for
impairment as of the date of the transfer. Similarly, if the transferred net assets represent a business
and only a portion of a reporting unit of the parent, the parent must test the remaining portion of the
goodwill in the reporting unit for impairment as of the date of the transfer. In addition, we believe that
the receiving entity should consider whether, as of the date of the transfer, it is more likely than not that
the fair value of any of its reporting units is below its carrying amount as a result of the transfer. If so, the
receiving entity should test the reporting unit for impairment on the date of the transfer in accordance
with ASC 350-20.
B.3.3.3 Noncontrolling Interests in a Common-Control Transaction
The ASC master glossary defines a noncontrolling interest (which is sometimes called a “minority
interest”) as “[t]he portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a
parent.”
If there is an outstanding noncontrolling interest in either the receiving
entity or the transferring entity, the effect of the transfer on the
noncontrolling interest should be accounted for in accordance with ASC
810-10. Any changes in the parent’s ownership interest in a subsidiary while
it maintains control of the subsidiary are accounted for as an equity
transaction. The carrying amount of the noncontrolling interest is adjusted
to reflect its change in ownership in the subsidiary. See the implementation
guidance in ASC 810-10-55 for examples illustrating how to account for a
change in the parent’s ownership interest in a subsidiary. Also see
Deloitte’s Roadmap Noncontrolling Interests.
B.4 Presentation
B.4.1 Change in the Reporting Entity
ASC 805-50
05-5 Some transfers of net assets or exchanges of shares between entities under common control result in
a change in the reporting entity. In practice, the method that many entities have used to account for those
transactions is similar to the pooling-of-interests method. The Transactions Between Entities Under Common
Control Subsections provide guidance on preparing financial statements and related disclosures for the entity
that receives the net assets.
The presentation of a common-control transfer in the receiving entity’s separate financial statements
differs depending on whether the transfer results in a change in the reporting entity. If the nature of the
net assets transferred does not result in a change in the reporting entity, the receiving entity presents
the net assets received in its separate financial statements prospectively from the date of the transfer.
If the nature of the net assets transferred results in a change in the reporting entity, the receiving entity
presents the net assets received in its separate financial statements retrospectively for all periods during
which the entities or net assets were under common control, similarly to a pooling of interests under
APB Opinion 16.
ASC 250-10-20 provides guidance on accounting for a change in the reporting entity. It defines a “change
in the reporting entity“ as:
A change that results in financial statements that, in effect, are those of a different reporting entity. A change in
the reporting entity is limited mainly to the following:
- Presenting consolidated or combined financial statements in place of financial statements of individual entities
- Changing specific subsidiaries that make up the group of entities for which consolidated financial statements are presented
- Changing the entities included in combined financial statements.
Neither a business combination accounted for by the acquisition method nor the consolidation of a variable
interest entity (VIE) pursuant to Topic 810 is a change in reporting entity.
Although the above guidance is limited, it focuses on combining legal entities
or subsidiaries. However, we do not believe that an entity
should come to a different conclusion solely on the basis of
how the transfer is structured (i.e., an exchange of shares
versus a transfer of net assets). Rather, we believe that
entities should assess the substance of the transfer rather
than simply its legal form.
In addition, we understand that practice has interpreted the guidance as
indicating that if the net assets transferred meet the
definition of a business in either ASC 805-10 or SEC
Regulation S-X, Article 11, the transfer of such net assets
would represent a change in the reporting entity.
Accordingly, we believe that the inclusion of a substantive
new entity that constitutes a business would be likely to
result in a change in the reporting entity, whereas the
transfer of an asset or group of assets typically would not.
For example, the transfer of an asset or a group of similar
assets (e.g., the transfer of one or several parcels of land
with no other assets or liabilities or any related
operations) that do not constitute a business would
generally not be expected to result in a change in the
reporting entity, even if the legal entity has no other
assets and the receiving entity acquires the shares of that
legal entity as a result of a common-control transfer.
However, in light of the disparate outcomes in presentation,
entities should use judgment and consider all relevant facts
and circumstances (including both qualitative and
quantitative considerations) in determining whether the
receiving entity’s financial statements are “in effect”
those of a new reporting entity. Discussion with accounting
advisers is encouraged.
B.4.2 Financial Statement Presentation by the Receiving Entity
ASC 805-50
45-1 Paragraph 805-50-25-2 establishes that the assets and liabilities transferred between entities under common control are to be initially recognized by the receiving entity at the transfer date. This Subsection provides guidance on the presentation of financial statements for the period of transfer and comparative financial statements for prior years.
Financial Statement Presentation in Period of Transfer
45-2 The financial statements of the receiving entity shall report results of operations for the period in which the transfer occurs as though the transfer of net assets or exchange of equity interests had occurred at the beginning of the period. Results of operations for that period will thus comprise those of the previously separate entities combined from the beginning of the period to the date the transfer is completed and those of the combined operations from that date to the end of the period. By eliminating the effects of intra-entity transactions in determining the results of operations for the period before the combination, those results will be on substantially the same basis as the results of operations for the period after the date of combination. The effects of intra-entity transactions on current assets, current liabilities, revenue, and cost of sales for periods presented and on retained earnings at the beginning of the periods presented shall be eliminated to the extent possible.
45-3 The nature of and effects on earnings per share (EPS) of nonrecurring intra-entity transactions involving long-term assets and liabilities need not be eliminated. However, paragraph 805-50-50-2 requires disclosure.
45-4 Similarly, the receiving entity shall present the statement of financial position and other financial information as of the beginning of the period as though the assets and liabilities had been transferred at that date.
Comparative Financial Statement Presentation for Prior Years
45-5 Financial statements and financial information presented for prior years also shall be retrospectively adjusted to furnish comparative information. All adjusted financial statements and financial summaries shall indicate clearly that financial data of previously separate entities are combined. However, the comparative information in prior years shall only be adjusted for periods during which the entities were under common control.
If the common-control transaction does not result in a change in the reporting entity, the receiving
entity begins reporting the net assets transferred in its separate financial statements prospectively from
the date of the transfer. If the common-control transaction results in a change in the reporting entity,
the receiving entity begins reporting the net assets transferred in its separate financial statements on
the date of the transfer and retrospectively adjusts its historical financial statements to include the net
assets received and related operations for all periods during which the entities were under common
control. Regardless of whether the common-control transaction results in a change in the reporting
entity, the receiving entity cannot begin reporting the net assets or operations of the transferring entity
before the transfer date even if it is probable that the transfer will occur.
The requirement in ASC 805-50 to retrospectively adjust the receiving entity’s historical financial
statements is consistent with the guidance in ASC 250-10 on reporting a change in the reporting entity.
ASC 250-10-45-21 states:
When an accounting change results in financial statements that are, in effect, the statements of a different
reporting entity, the change shall be retrospectively applied to the financial statements of all prior periods
presented to show financial information for the new reporting entity for those periods. Previously issued
interim financial information shall be presented on a retrospective basis. However, the amount of interest
cost previously capitalized through application of Subtopic 835-20 shall not be changed when retrospectively
applying the accounting change to the financial statements of prior periods.
B.4.2.1 Pooling-of-Interests Method
The method used to present a common-control transaction that results in a change in the reporting
entity is similar to a pooling of interests. A pooling of interests was a method of accounting for a merger
of two businesses. The assets and liabilities and operations of the two businesses were combined at
their historical carrying amounts, and all historical periods were adjusted as if the businesses had always
been combined. Similarly, in a common-control transaction, the receiving entity retrospectively adjusts
its financial statements to include the transferred net assets and any related operations for all periods
for which the entities or net assets were under common control. If the entities were not under common
control for the entire period being reported on, the receiving entity’s financial statements are adjusted
only retrospectively to the date on which the entities became under common control.
The accounting and reporting guidance on a pooling of interests was established in APB Opinion 16. However, FASB Statement 141 eliminated the pooling-of-interests method of accounting for business combinations and nullified the related guidance. While the guidance in APB Opinion 16 was eliminated, we believe that it continues to provide relevant guidance on presenting common-control transactions that result in a change in the reporting entity. The following bullets summarize how the receiving entity should report the transferred net assets if a change in the reporting entity has occurred and are based on the former guidance in APB Opinion 16 on accounting for a pooling of interests:
- The receiving entity recognizes the transferred net assets at their historical carrying amounts in the ultimate parent’s consolidated financial statements. No new goodwill is recognized. The carrying values of the transferred net assets are added to the carrying values of the receiving entity’s net assets. If the receiving entity and transferring entity applied different accounting principles and the transferred assets or liabilities are adjusted to reflect the method of accounting applied by the receiving entity, the change in accounting principle should be applied retroactively for all periods presented (see Section B.3.1.2).
- The equity accounts of the separate entities are combined:
- If the receiving entity issues shares to effect the combination, the par value of the shares issued by the receiving entity is credited to the receiving entity’s common-stock account. The entity may need to make adjustments to properly reflect the par value of the receiving entity’s common stock. Any adjustments should first be made to combined APIC and then to combined retained earnings.
- The retained earnings (or deficit) of the transferring entity are added to the retained earnings of the receiving entity.
- Any difference between consideration given by the receiving entity and the carrying amounts of the net assets received is recognized in equity (i.e., as a dividend paid or received).
- The receiving and transferring entities’ results of operations are combined in the period in which the transfer occurs as though the entities had been combined as of the beginning of the period (or from the date the entities became under common control if they were not under common control for the entire period).
- Intercompany balances and transactions between the receiving and transferring entities are eliminated.
- Comparative financial statements are retrospectively adjusted as if the receiving and transferring entities had always been combined (or from the date the entities became under common control if they were not under common control for the entire period).
Example B-5
Pooling of Interests
Subsidiary A and Subsidiary B are wholly owned and under the common control of Parent. On January 1,
20X6, A issues 100 of its common shares for all of the outstanding common shares of B. The par value of A’s
common stock is $2 per share. The first two columns summarize the financial information of A and B before
the common-control transfer, and the last three columns illustrate combining the assets, liabilities, and
shareholders’ equity of A and B and the adjustments necessary to state the common stock of the combined
entity at its par value.
B.4.2.2 Identifying the Receiving Entity in a Common Control Transaction
ASC 805-50-30-5 states, in part, that “the
entity that receives the net assets or the equity interests
[i.e., the receiving entity] shall initially measure the
recognized assets and liabilities transferred at [the]
carrying amounts” of the parent of the entities under common
control. Accordingly, we believe that it is typically
acceptable to follow the legal form of the transaction and
to identify the legal receiving entity as the receiving
entity for accounting purposes. However, because the parent
controls the legal form of the transaction, we note that
practice has developed such that, at times, an entity also
considers factors beyond the transaction’s legal form. This
is particularly the case in situations in which (1) the
carrying amount of the assets and the liabilities of one (or
both) of the entities differs from the parent’s historical
cost because pushdown accounting had not been applied (see
Section B.3.1.1) or (2) such entities
have not been under common control throughout the entire
reporting period (see Section B.4.1). In
these cases, entities have sometimes analogized to the SEC
guidance on identifying the predecessor to identify the
receiving entity for accounting purposes, which could result
in identifying an entity other than the legal receiving
entity (see Section B.4.2.3
below) as the receiving entity for accounting purposes.
Because of the judgment involved, discussion with accounting
advisers is encouraged.
B.4.2.3 Identifying the Predecessor in Certain Common-Control Transactions
As discussed in Section B.4.1, a
common-control transaction that results in a change
in the reporting entity requires that the combining
entities be combined, retrospectively, for all
periods in which they were under common control. If
an SEC filing includes additional reporting periods
before the entities were under common control,
Regulation S-X requires the registrant to determine
which entity’s financial statements should be
presented as the predecessor. In some cases, the
entity deemed to be the predecessor may not be the
receiving entity identified for accounting purposes
(see Section
B.4.2.2).
In prepared remarks at the 2006 AICPA Conference on Current SEC and PCAOB
Developments, Leslie Overton, then associate chief
accountant in the SEC’s Division of Corporation
Finance, stated that the predecessor is “normally
going to be the entity first controlled by the
parent of the entities that are going to be
combined.” However, at the 2015 AICPA Conference on
Current SEC and PCAOB Developments, while not
specifically talking about common-control
transactions, the SEC staff further highlighted a
number of factors for registrants to consider in
determining the predecessor, including, but not
limited to (1) the order in which the entities are
acquired, (2) the size of the entities, (3) the fair
value of the entities, and (4) the ongoing
management structure. The staff indicated that no
single factor is determinative on its own, and that
there could also be more than one predecessor. For
instance, if the entity first controlled is
insignificant or lacks substance, or if the entities
were acquired in close proximity to each other, the
first entity controlled by the parent may not be
determined to be the predecessor. Consequently,
entities should consider these other factors and
exercise judgment when identifying the predecessor
in a common-control transaction. Because of the
judgment involved, discussion with accounting
advisers is encouraged.
B.4.3 Financial Statement Presentation by the Transferring Entity
ASC 805-50 only addresses the receiving entity’s presentation. It contains no specific guidance on how
the transferring entity should present a common-control transfer in its separate financial statements.
Although the transferring entity’s measurement generally matches the receiving
entity’s, its presentation typically does not. Entities have
analogized to SAB Topic
5.Z.7 for guidance on whether the
transferring entity may present its separate financial
statements as if a change in the reporting entity has
occurred by derecognizing the transferred net assets and
operations in the historical periods (sometimes referred to
as a “depooling”). SAB Topic 5.Z.7, which addresses whether
an entity may present a spin-off as a change in the
reporting entity and restate its historical financial
statements to exclude the subsidiary, states:
Facts: A
Company disposes of a business through the
distribution of a subsidiary’s stock to the
Company’s shareholders on a pro rata basis in a
transaction that is referred to as a
spin-off.
Question: May the Company
elect to characterize the spin-off transaction as
resulting in a change in the reporting entity and
restate its historical financial statements as if
the Company never had an investment in the
subsidiary, in the manner specified by FASB ASC
Topic 250, Accounting Changes and Error
Corrections?
Interpretive Response: Not
ordinarily. If the Company was required to file
periodic reports under the Exchange Act within one
year prior to the spin-off, the staff believes the
Company should reflect the disposition in conformity
with FASB ASC Topic 360. This presentation most
fairly and completely depicts for investors the
effects of the previous and current organization of
the Company. However, in limited circumstances
involving the initial registration of a company
under the Exchange Act or Securities Act, the staff
has not objected to financial statements that
retroactively reflect the reorganization of the
business as a change in the reporting entity if the
spin-off transaction occurs prior to effectiveness
of the registration statement. This presentation may
be acceptable in an initial registration if the
Company and the subsidiary are in dissimilar
businesses, have been managed and financed
historically as if they were autonomous, have no
more than incidental common facilities and costs,
will be operated and financed autonomously after the
spin-off, and will not have material financial
commitments, guarantees, or contingent liabilities
to each other after the spin-off. This exception to
the prohibition against retroactive omission of the
subsidiary is intended for companies that have not
distributed widely financial statements that include
the spun-off subsidiary. Also, dissimilarity
contemplates substantially greater differences in
the nature of the businesses than those that would
ordinarily distinguish reportable segments as
defined by FASB ASC paragraph 280-10-50-10 (Segment
Reporting Topic).
While this guidance does not specifically address common-control transactions,
both SEC registrants and private companies have analogized
to it in practice. All requirements in SAB Topic 5.Z.7 must
be met for the transferring entity to depool the transferred
net assets. Because it is often difficult to assert that all
of the requirements have been met, the transferring entity
typically accounts for the transfer as a disposal other than
by sale in accordance with ASC 360. Therefore, the
transferring entity should (1) consider whether the
common-control transaction indicates that the long-lived
assets (asset group) to be transferred should be tested for
impairment under the held and used model before the disposal
date and (2) assess, from its own perspective rather than
that of the parent, whether the disposal qualifies for
presentation as a discontinued operation in accordance with
ASC 205-20 as of the disposal date. See Chapter
4 of Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets
and Discontinued Operations for
more information.
B.5 Disclosures
B.5.1 Disclosures by the Receiving Entity
ASC 805-50
50-3 The notes to financial statements of the receiving entity shall disclose the following for the period in which the transfer of assets and liabilities or exchange of equity interests occurred:
- The name and brief description of the entity included in the reporting entity as a result of the net asset transfer or exchange of equity interests
- The method of accounting for the transfer of net assets or exchange of equity interests.
50-4 The receiving entity also shall consider whether additional disclosures are required in accordance with Section 850-10-50, which provides guidance on related party transactions and certain common control relationships.
In addition to the disclosures required by ASC 805-50-50-3 and ASC 850-10-50, if the net assets
transferred result in a change in the reporting entity (see Section B.4.1), the receiving entity must
provide the disclosures required by ASC 250-10-50-6, which states, in part:
When there has been a change in the reporting entity, the financial statements of the period of the change shall
describe the nature of the change and the reason for it. In addition, the effect of the change on income from
continuing operations, net income (or other appropriate captions of changes in the applicable net assets or
performance indicator), other comprehensive income, and any related per-share amounts shall be disclosed
for all periods presented. Financial statements of subsequent periods need not repeat the disclosures required
by this paragraph. If a change in reporting entity does not have a material effect in the period of change but is
reasonably certain to have a material effect in later periods, the nature of and reason for the change shall be
disclosed whenever the financial statements of the period of change are presented.
B.5.1.1 Earnings per Share
ASC 805-50
50-2 The nature of and effects on earnings per share (EPS) of nonrecurring intra-entity transactions involving long-term assets and liabilities is not required to be eliminated under the guidance in paragraph 805-50-45-3 but shall be disclosed.
If the receiving entity is required to disclose EPS in its separate financial
statements and presents the common-control transfer as a change in the
reporting entity (see Section B.4.1), earnings-per-share amounts must be recast to
include the earnings (or losses) of the transferred net assets.
B.5.2 Disclosures by the Transferring Entity
ASC 805-50-50 does not include any specific disclosure requirements for the transferring entity. If
the transferring entity accounts for the transferred net assets as a disposal, it should provide the
disclosures required by ASC 360-10-50 for long-lived assets that are disposed of. If the disposal qualifies
for presentation as a discontinued operation from the perspective of the transferring entity, it should
provide the disclosures required by ASC 205-20-50 in its separate financial statements. In addition,
we believe that the transferring entity should provide disclosures sufficient for users of its separate
financial statements to understand the nature of and accounting for the transfer (to the extent that such
disclosures are not required by other GAAP). We believe that the transferring entity should analogize
to the disclosure requirements for the receiving entity in ASC 805-50-50-3, ASC 850-10-50, and
ASC 250-10-50-6.
B.6 Transactions Involving Master Limited Partnerships
ASC 805-50
Master Limited Partnership Transactions
05-7 Master limited partnerships are partnerships in which interests are publicly traded. Most master limited partnerships are formed from assets in existing businesses. Typically, the general partner of the master limited partnership is affiliated with the existing business (that is, the master limited partnership is usually operated as an extension of or complementary to the business of the general partner). The purposes for forming a master limited partnership vary. They can be formed to realize the value of undervalued assets, to pass income and tax-deductible losses directly through to owners, to raise capital, to combine several existing partnerships, or as a vehicle to enable entities to sell, spin off, or liquidate existing operations. A master limited partnership may be created in a variety of ways. Whether a particular transaction is a business combination that should be accounted for using the acquisition method or a transaction between entities under common control can be determined only after a careful analysis of all facts and circumstances. The Formation of a Master Limited Partnership Subsections identify specific transactions involving master limited partnerships and provide guidance on whether a new basis of accounting is appropriate.
Formation of a Master Limited Partnership
30-7 Because of such factors as the consideration of common ownership and changes in control, a new basis
of accounting is not appropriate for any of the following transactions that create a master limited partnership:
- A rollup in which the general partner of the new master limited partnership was also the general partner in some or all of the predecessor limited partnerships and no cash is involved in the transaction. Transaction costs in a rollup shall be charged to expense.
- A dropdown in which the sponsor receives 1 percent of the units in the master limited partnership as the general partner and 24 percent of the units as a limited partner, the remaining 75 percent of the units are sold to the public, and a two-thirds vote of the limited partners is required to replace the general partner.
- A rollout.
- A reorganization.
30-8 In other situations, it is possible that a new basis of accounting would be appropriate.
30-9 The issuance of master limited partnership units to a general partner of a predecessor limited
partnership who will not be the general partner of the new master limited partnership in settlement of
management contracts or for other services that will not carry over to the new master limited partnership has
characteristics of compensation rather than of equity and shall be accounted for accordingly by the new master
limited partnership.
A master limited partnership (MLP) is a publicly traded partnership that combines the tax benefits of
a limited partnership with the liquidity of publicly traded securities. For the MLP to qualify for the tax
benefits, 90 percent of its income must come from activities related to natural resources, real estate,
or commodities. MLPs commonly engage in petroleum and natural gas extraction and transportation.
There are two classes of MLP owners: (1) the “sponsor“ or the general partner and (2) the limited
partners. The general partner manages the MLP’s day-to-day operations. The MLP technically has no
employees, so all services are provided or managed by the general partner. All other investors are
limited partners and have no involvement in the MLP’s operations. The limited partner units are publicly
traded much like shares in a corporation, while the general partner units usually are not. The general
partner stake is often 2 percent of the partnership, though the general partner can also own limited
partner units to increase its overall ownership percentage.
Example B-6
Illustration of Typical MLP Structure
An MLP may be formed in various ways. ASC 805-50-30-7 contains terms describing some of the ways in
which MLPs may be formed. The ASC master glossary defines these terms as follows:
- Dropdown — “A transfer of certain net assets from a sponsor or general partner to [an MLP] in exchange for consideration.“
- Reorganization — “A way to create [an MLP] in which all of the assets of an entity are placed into [an MLP] and that entity ceases to exist.“
- Rollout — “A way to create [an MLP] in which certain assets of a sponsor are placed into a limited partnership and units are distributed to the shareholders.“
- Rollup — “A way to create [an MLP] in which two or more legally separate limited partnerships are combined into one [MLP].“
Before the adoption of ASU
2015-02, the transfer of assets or net assets to form an MLP and
any subsequent transfers of assets or net assets to the MLP were often accounted for
as common-control transactions because the general partner typically controlled the
net assets before and after the transfer. After the adoption of ASU 2015-02, a
general partner with a 2 percent interest in an MLP may not control the MLP.
Entities should consider all facts and circumstances in determining whether the
formation of an MLP and any subsequent transfers to the MLP should be accounted for
as a common-control transaction in accordance with ASC 805-50 or as a business
combination in accordance with ASC 805-10, ASC 805-20, and ASC 805-30. See
Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial
Interest for more information. In addition, an entity should
consider all facts and circumstances in determining whether the receiving entity
should present the transfer as a change in the reporting entity (see Section B.4.1).
Appendix C — Accounting for Asset Acquisitions
Appendix C — Accounting for Asset Acquisitions
C.1 Overview and Scope
The term “asset acquisition” is used to describe an acquisition of an asset, or a group of assets, that
does not meet the U.S. GAAP definition of a business. An asset acquisition may also involve the
assumption of liabilities. Entities should use the guidance in ASC 805-10 to determine whether the
acquired assets meet the definition of a business. See Section 2.4 for more information.
An asset acquisition is accounted for in accordance with the “Acquisition of Assets Rather Than a
Business” subsections of ASC 805-50 by using a cost accumulation model. In a cost accumulation model,
the cost of the acquisition, including certain transaction costs, is allocated to the assets acquired on
the basis of relative fair values. By contrast, a business combination is accounted for by using a fair
value model under which the assets and liabilities are generally recognized at their fair values, and
the difference between the consideration transferred, excluding acquisition-related costs, and the fair
values of the assets and liabilities is recognized as goodwill. As a result, there are significant differences
between the accounting for an asset acquisition and the accounting for a business combination.
Changing Lanes
The FASB had a project to improve the accounting for asset acquisitions and
business combinations by narrowing the differences
between the two accounting models. However, at its
June 15, 2022, meeting, the FASB decided to remove
this project from its agenda. As a result, the
differences between the two acquisition models
will continue to exist in practice.
C.1.1 Summary of Significant Differences Between the Accounting for a Business Combination and the Accounting for an Asset Acquisition
The table below summarizes the significant
differences between the accounting for a business
combination and that for an asset acquisition.
Each of these differences is described in further
detail in later sections.
Issue | Accounting in a Business Combination | Accounting in an Asset Acquisition |
---|---|---|
General principle | Fair value model: assets and liabilities
are recognized at fair value, with certain
exceptions. | Cost accumulation model: 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. This allocation results
in the recognition of those assets at other
than their fair values (see Sections C.1 and C.3). |
Scope | Acquisition of a business as defined in
ASC 805-10. | Acquisition of an asset or a group of assets (and liabilities) that does not
meet the definition of a business in ASC 805-10 or
qualify as a VIE under ASC 810-10 (see Section
C.1.2). |
Acquisition-related
costs or transaction
costs | Acquisition-related costs are expensed as
incurred, except for costs of issuing debt
and equity securities, which are accounted
for under other GAAP. | Direct and incremental costs are included in the
cost of the acquisition, except for costs of
issuing debt and equity securities, which
are accounted for under other GAAP.
Indirect costs are expensed as incurred (see Section C.2.3). |
Contingent consideration | Recognized at fair value and classified
as a liability, equity, or an asset on the
acquisition date on the basis of the terms
of the arrangement. Subsequently, any
changes in the fair value of contingent
consideration classified as a liability or as
an asset are recognized in earnings until
settled. | Contingent consideration that is accounted for as a derivative is recognized at
fair value under ASC 815. Otherwise, such consideration generally is recognized under ASC 450 when it becomes probable and reasonably estimable or when the contingency is resolved by analogy to FASB Statement 141 (see Section
C.2.2). |
Goodwill | If the sum of the consideration
transferred, the fair value of any
noncontrolling interests, and the fair
value of any previously held interests
exceeds the sum of the identifiable assets
acquired and liabilities assumed, goodwill
is recognized as the amount of the excess. | Goodwill is not recognized. Instead, any
excess of the cost of the acquisition over
the fair value of the net assets acquired is
allocated to certain assets on the basis of
relative fair values (see Section C.3). |
Gain from bargain
purchase | Recognized in earnings on the acquisition
date. | Generally not recognized in earnings.
Instead, any excess of the fair value of the
net assets acquired over the cost of the
acquisition is typically allocated to certain
assets on the basis of relative fair values (see Section C.3). |
Contingencies | Measured at fair value, if determinable;
otherwise, measured at their estimated
amounts if probable and reasonably
estimable. If such assets or liabilities
cannot be measured during the
measurement period, they are accounted
for separately from the business
combination in accordance with ASC 450. | Accounted for in accordance with ASC 450 on the acquisition date and
subsequently. Loss contingencies are recognized
when they are probable and reasonably estimable.
Gain contingencies are recognized on the earlier
of when they are realized or are realizable and
are thus not recognizable in an asset acquisition
(see Section
C.3.2). |
Intangible assets | Recognized at fair value if they are
identifiable (i.e., if they are separable or
arise from contractual rights). | Finite-lived intangible assets recognized on the basis of relative fair value under ASC 350-10 if they meet the asset recognition criteria in FASB Concepts Statement 5.
Indefinite-lived intangible assets are recognized
at amounts that do not exceed fair value (see
Section C.3.4). |
Assembled workforce | Not recognized because it is presumed
not to be identifiable. | Recognized because it is presumed to meet the asset recognition criteria in FASB Concepts Statement 5 (see Section C.3.4.1). |
IPR&D | Measured at fair value and recognized
as an indefinite-lived intangible asset
until completion or abandonment of the
related project, then reclassified as a
finite-lived intangible asset and amortized. | Expensed under ASC 730 unless the
IPR&D has an alternative future use (see Section C.3.4.2). |
Deferred taxes | Generally recognized for most temporary
book/tax differences related to assets
acquired and liabilities assumed under
ASC 740. | Generally recognized for temporary
book/tax differences in an asset
acquisition by using the simultaneous
equations method in accordance with
ASC 740 (see Section C.3.5). |
Lease classification | Under ASC 840-10-25-27, the acquirer
retains the acquiree’s previous lease
classification “unless the provisions of
the lease are modified as indicated in
paragraph 840-10-35-5.” Under ASC 842-10-55-11, the acquirer
retains the acquiree’s previous lease
classification “unless there is a lease
modification and that modification is not
accounted for as a separate contract in
accordance with paragraph 842-10-25-8.” | ASC 805-50 does not provide guidance
on an entity’s classification of a lease
acquired in an asset acquisition (see Section C.3.6). |
Measurement period | In accordance with ASC 805-10-25-13,
the acquirer reports provisional amounts
for the items for which the accounting “is
incomplete by the end of the reporting
period in which the combination occurs”
and is allowed up to one year to adjust
those provisional amounts. This time
frame is referred to as the measurement
period. | ASC 805-50 does not address a
measurement period in the context of an
asset acquisition (see Section C.3.8). |
SEC Considerations
A registrant must also consider certain SEC reporting requirements when it acquires an asset
or a group of assets. For instance, the registrant must separately evaluate whether the asset
or group of assets meets the definition of a business for SEC reporting purposes under SEC Regulation S-X, Rule 11-01(d), since this definition differs from the U.S. GAAP definition of a
business under ASC 805-10. The SEC reporting requirements for an asset acquisition are
addressed in Section C.5.
C.1.2 Scope
ASC 805-50
Entities
15-2 The guidance in the Acquisition of Assets Rather than a Business Subsections applies to all entities.
Transactions
15-3 The guidance in the Acquisition of Assets Rather than a Business Subsections applies to a transaction or
event in which assets acquired and liabilities assumed do not constitute a business.
15-4 The guidance in the Acquisition of Assets Rather than a Business Subsections does not apply to the initial
measurement and recognition by a primary beneficiary of the assets and liabilities of a variable interest entity
(VIE) when the VIE does not constitute a business. Guidance for such a VIE is provided in Section 810-10-30.
The guidance in the “Acquisition of Assets Rather Than a Business” subsections
of ASC 805-50 applies to the acquisition of an
asset or group of assets (and possibly the
assumption of any liabilities) that do not meet
the definition of a business in ASC 805-10 or
qualify as a VIE under ASC 810-10 (see Section C.1.2.1 for
more information). As a result, entities first
need to assess whether the assets acquired and any
liabilities assumed meet the definition of a
business by applying the guidance in ASC 805-10.
See Section 2.4 for
more information about the U.S. GAAP definition of
a business in ASC 805-10.
As discussed in Section
6.8, a reverse acquisition occurs when the entity that issues its
shares or gives other consideration to effect the transaction is determined for
accounting purposes to be the acquiree (also called the accounting acquiree or
legal acquirer), while the entity whose shares are acquired is determined for
accounting purposes to be the acquirer (also called the accounting acquirer or
legal acquiree). We believe that if circumstances suggest the accounting
acquiree/legal acquirer does not meet the definition of a business in ASC 805-10
and the nature of the transaction is an acquisition of assets (rather than a
recapitalization), it is possible for the transaction to be accounted for as a
reverse asset acquisition if the transaction is primarily effected by exchanging
equity interests and the indicators in ASC 805-10-55-11 through 55-15 support
such a conclusion. In the case of a reverse asset acquisition, the accounting
acquiree’s assets and liabilities are measured in accordance with the
subsections in ASC 805-50 related to the acquisition of assets rather than a
business. However, if the entity identified as the accounting acquiree has no
substantive assets other than cash and investments, the nature of the
transaction may be a reverse recapitalization rather than an acquisition. We
believe that this approach (i.e., applying the indicators to identify the
accounting acquirer and then determining the nature of the transaction) would
still be applicable even if the legal acquiree does not constitute a
business.
In addition, the SEC staff considers the
acquisition of a private operating company by a
nonoperating public shell company to be, in
substance, a capital transaction rather than a
business combination or an asset acquisition. Such
a transaction is equivalent to the issuance of
shares by the private company for the net monetary
assets of the shell company, accompanied by a
recapitalization, and is typically referred to as
a reverse recapitalization (see Section 6.8.8 for more
information).
SEC Considerations
SEC registrants are required to use the definition of a business in SEC
Regulation S-X, Rule 11-01(d), when evaluating the
requirements of SEC Regulation S-X, Rule 3-05, and
SEC Regulation S-X, Article 11. The definition of
a business in Rule 11-01(d) is different from the
definition for U.S. GAAP accounting purposes. See
Section C.5 for more information.
Example C-1
Reverse Asset Acquisition
Company A is a publicly traded
entity looking to enter into an M&A
transaction with an interested party. Company B is
a privately held company also considering an
M&A transaction with the goal of becoming a
publicly traded company. Companies A and B
ultimately enter into a transaction in which A
(the legal acquirer) acquires 100 percent of B
(the legal acquiree) via a share-exchange
transaction. Neither A nor B constitutes a
business under ASC 805 (as a result of the
application of the screen test). In addition, A is
not considered to be a nonoperating public shell
company, nor are Company A’s assets primarily cash
or investments. Companies A and B evaluate the
relevant guidance in ASC 805-10-55-11 through
55-15 and determine that B (the legal acquiree) is
the accounting acquirer. Therefore, the
transaction would be accounted for as a reverse
asset acquisition (as opposed to an asset
acquisition or reverse recapitalization), and B
would record A’s assets and liabilities in
accordance with ASC 805-50.
C.1.2.1 Scope Exception for Variable Interest Entities
ASC 805-50-15-4 states that “[t]he guidance in the Acquisition of Assets Rather
than a Business Subsections does not apply to the
initial measurement and recognition by a primary
beneficiary of the assets and liabilities of a VIE
when the VIE does not constitute a business.
Guidance for such a VIE is provided in Section
810-10-30.” ASC 810-10-30-3 and 30-4 provide
guidance on such acquisitions.
ASC 810-10
30-3 When a reporting entity becomes the primary beneficiary of a VIE that is not a business, no goodwill shall
be recognized. The primary beneficiary initially shall measure and recognize the assets (except for goodwill) and
liabilities of the VIE in accordance with Sections 805-20-25 and 805-20-30. However, the primary beneficiary
initially shall measure assets and liabilities that it has transferred to that VIE at, after, or shortly before the date
that the reporting entity became the primary beneficiary at the same amounts at which the assets and liabilities
would have been measured if they had not been transferred. No gain or loss shall be recognized because of
such transfers.
30-4 The primary beneficiary of a VIE that is not a business shall recognize a gain or loss for the difference
between (a) and (b):
- The sum of:
- The fair value of any consideration paid
- The fair value of any noncontrolling interests
- The reported amount of any previously held interests
- The net amount of the VIE’s identifiable assets and liabilities recognized and measured in accordance with Topic 805. . . .
The primary beneficiary of a VIE that does not meet the definition of a business should initially measure
and recognize the assets and liabilities of the VIE in accordance with ASC 805-20-25 and ASC 805-20-30
but should not recognize goodwill. Because goodwill is not recognized, the primary beneficiary
recognizes a gain or loss calculated on the basis of the requirements in ASC 810-10-30-4. The primary
beneficiary recognizes the identifiable assets acquired (excluding goodwill), the liabilities assumed,
and any noncontrolling interests as though the VIE was a business and subject to the guidance on
recognition and measurement in a business combination. As a result, the assets acquired (excluding
goodwill), liabilities assumed, and any noncontrolling interests are measured and recognized the same
way as they would be in a business combination. IPR&D and contingent consideration therefore would
be recognized at fair value upon acquisition, and the applicable recognition and fair value measurement
exceptions would be the same as those for a business combination.
However, to prevent the improper recognition of gains or losses resulting from
transfers of assets and liabilities to VIEs, the
FASB developed the guidance in ASC 810-10-30-3.
Under this guidance, assets and liabilities that a
legal entity transfers to a VIE that is not a
business “at, after, or shortly before the date
that the reporting entity became the [VIE’s]
primary beneficiary [should be measured] at the
same amounts at which the assets and liabilities
would have been measured if they had not been
transferred.” In addition, under ASC 810-10-30-4,
if the VIE is acquired in stages (i.e., step
acquisition), the reported amount of the
previously held interest must be used to calculate
the gain or loss.
A legal entity’s failure to meet the business scope exception in ASC
810-10-15-17(d) does not mean that the legal
entity does not qualify as a business under ASC
805-10. The determination of whether a legal
entity is a business under ASC 810-10-30-2 is
strictly related to whether the legal entity
qualifies as a business under ASC 805-10. That is,
even if the business scope exception is not
applicable because one or more of the four
additional conditions in that paragraph are met,
as long as the definition of a business in ASC
805-10 is met, goodwill, if any, should be
recorded. See Deloitte’s Roadmap Consolidation — Identifying a Controlling
Financial Interest for more
information about the business scope
exception.
C.2 Measuring the Cost of an Asset Acquisition
ASC 805-50
Acquisition Date Recognition of Consideration Exchanged
25-1 Assets commonly are
acquired in exchange transactions that trigger the
initial recognition of the assets acquired and any
liabilities assumed. If the consideration given in
exchange for the assets (or net assets) acquired
is in the form of assets surrendered (such as
cash), the assets surrendered shall be
derecognized at the date of acquisition. If the
consideration given is in the form of liabilities
incurred or equity interests issued, the
liabilities incurred and equity interests issued
shall be initially recognized at the date of
acquisition. However, if the assets surrendered
are nonfinancial assets or in substance
nonfinancial assets within the scope of Subtopic
610-20 on gains and losses from the derecognition
of nonfinancial assets, the assets surrendered
shall be derecognized in accordance with the
guidance in Subtopic 610-20 and the assets
acquired shall be treated as noncash consideration
in accordance with Subtopic 610-20.
Determining Cost
30-1 Paragraph 805-50-25-1
discusses exchange transactions that trigger the
initial recognition of assets acquired and
liabilities assumed. Assets are recognized based
on their cost to the acquiring entity, which
generally includes the transaction costs of the
asset acquisition, and no gain or loss is
recognized unless the fair value of noncash assets
given as consideration differs from the assets’
carrying amounts on the acquiring entity’s books.
For transactions involving nonmonetary
consideration within the scope of Topic 845, an
acquirer must first determine if any of the
conditions in paragraph 845-10-30-3 apply. If the
consideration given is nonfinancial assets or in
substance nonfinancial assets within the scope of
Subtopic 610-20 on gains and losses from the
derecognition of nonfinancial assets, the assets
acquired shall be treated as noncash consideration
and any gain or loss shall be recognized in
accordance with Subtopic 610-20.
30-2 Asset acquisitions in
which the consideration given is cash are measured
by the amount of cash paid, which generally
includes the transaction costs of the asset
acquisition. However, if the consideration given
is not in the form of cash (that is, in the form
of noncash assets, liabilities incurred, or equity
interests issued) and no other generally accepted
accounting principles (GAAP) apply (for example,
Topic 845 on nonmonetary transactions or Subtopic
610-20), measurement is based on either the cost
which shall be measured based on the fair value of
the consideration given or the fair value of the
assets (or net assets) acquired, whichever is more
clearly evident and, thus, more reliably
measurable. For transactions involving nonmonetary
consideration within the scope of Topic 845, an
acquirer must first determine if any of the
conditions in paragraph 845-10-30-3 apply. If the
consideration given is nonfinancial assets or in
substance nonfinancial assets within the scope of
Subtopic 610-20, the assets acquired shall be
treated as noncash consideration and any gain or
loss shall be recognized in accordance with
Subtopic 610-20.
An asset acquisition is an exchange transaction that triggers the acquiring
entity’s initial recognition of the assets
acquired or liabilities assumed and the
derecognition of any consideration given on the
date of the acquisition. ASC 805-50-30-2 provides
the general principle for measuring the cost of an
asset acquisition and specifies, in part, that an
asset acquisition should be recognized at cost,
which is measured on the basis of either (1) “the
fair value of the consideration given,” or (2)
“the fair value of the assets (or net assets)
acquired, whichever is more clearly evident and,
thus, more reliably measurable.”
In many asset acquisitions, the consideration is cash and, therefore,
determining the cost of the acquisition is relatively
straightforward. If the consideration given is wholly in the
form of cash, the cost of the asset acquisition is measured
on the basis of the cash paid plus the direct transaction
costs incurred to effect the acquisition (see Section
C.2.3).
In some asset acquisitions, part or all of the consideration given may consist
of noncash assets, equity interests, or liabilities incurred
by the seller (e.g., contingent consideration). When
consideration other than cash is used, entities should first
determine whether the exchange is within the scope of other
GAAP and, if so, apply the applicable standard’s guidance.
If no other GAAP applies, an entity would refer to the
general principle in ASC 805-50 (i.e., measure cost on the
basis of the fair value of the consideration given or the
assets acquired, whichever is more clearly evident, plus
transaction costs).
The table below provides guidance on determining
the GAAP to apply when the consideration given is not in the
form of cash.
Form of the Consideration Given | Measurement of the Cost of the Assets Acquired |
---|---|
Nonfinancial assets (or in-substance nonfinancial assets) given to a noncustomer, or goods or services given to a customer that do not meet the definition of a business in ASC 805-10 (after adoption of ASC 606-10 and ASC 610-20) | Fair value of the assets acquired in accordance with ASC 606-10-32-21 if their fair value can be reasonably estimated. Otherwise, based on the assets transferred or stand-alone selling price of the goods or services in accordance with ASC 606-10-32-22. See also ASC 610-20-32-3. See Section C.2.1. |
Nonmonetary assets (not within the scope of ASC 606-10 or 610-20) | Fair value of the assets given (i.e., after recognizing a gain or loss) in
accordance with ASC 845-10-30-4 unless the
exchange meets any of the following conditions in
ASC 845-10-30-3:
If any of those conditions are met, then the carrying amount of the assets given
(i.e., no gain or loss recognized). See Section
C.2.1. |
Contingent consideration | See Section C.2.2. |
Acquiring entity’s equity instruments | ASC 805-50-30-2 states, in part, that “if the consideration given is not in the
form of cash . . . and no other generally accepted
accounting principles (GAAP) apply . . . ,
measurement is based on either the cost which
shall be measured based on the fair value of the
consideration given or the fair value of the
assets (or net assets) acquired, whichever is more
clearly evident and, thus, more reliably
measurable.” We are aware of two views in practice
regarding the date upon which the acquiring entity
should measure the equity instruments it issues in
an asset acquisition. The first view is that the
guidance in ASC 805-50-25-1 requires the acquiring
entity’s equity instruments to be measured on the
date of the asset acquisition. The second view is
that the issuance of shares as consideration in an
asset acquisition represents a share-based payment
to nonemployees in exchange for goods. Under that
view, the acquiring entity would apply ASC 718
(after adoption of ASU 2018-07) or ASC 505-50-30-2
(before adoption of ASU 2018-07) when measuring
the equity instruments it issued as consideration
in an asset acquisition. Applying ASC 718 may
result in a measurement date (i.e., the grant
date) that precedes the acquisition date for the
shares issued. At its March 3, 2021, agenda
prioritization meeting, the FASB decided not to
add an agenda item related to the clarification of
guidance on certain asset acquisition and
nonemployee share-based payment transactions.
However, on the basis of the discussion at that
meeting, we believe that either view is acceptable
provided that entities apply a consistent
view. |
Assets (or net assets) that meet the definition of a business in ASC 805-10 | Fair value of the assets acquired in accordance with ASC 810-10-40-5. |
Noncash assets (or liabilities) given as consideration that remain within the combined entity after the acquisition | Carrying amount of the assets (or liabilities) in the acquiring entity’s financial statements immediately before the acquisition by analogy to ASC 805-30-30-8. See Section C.2.7 for more information. |
The acquiring entity applies the guidance in ASC 820 to measure fair value; if
such value differs from the carrying amount of the
noncash assets given, the acquiring entity
remeasures those noncash assets to fair value and
recognizes a gain or loss on the date of
acquisition for the difference (unless any of the
conditions in ASC 845-10-30-3 are met).
A significant difference between the cost of an asset acquisition and the fair value of the net assets
acquired may indicate that not all of the assets acquired or liabilities assumed have been recognized
or that the cost of the asset acquisition includes a payment for something other than the acquired net
assets that should be accounted for separately from the acquisition (see Section C.2.4).
C.2.1 Consideration in the Form of Nonmonetary Assets or Nonfinancial Assets — After Adoption of ASC 606-10 and ASC 610-20
While ASC 805-50 provides a general principle for measuring the cost of an asset acquisition, it refers to other GAAP if the noncash consideration is in the form of nonmonetary assets or nonfinancial assets (or in-substance nonfinancial assets). ASC 805-50-30-1 states, in part:
For transactions involving nonmonetary consideration within the scope of Topic 845, an acquirer must first determine if any of the conditions in paragraph 845-10-30-3 apply. If the consideration given is nonfinancial assets or in substance nonfinancial assets within the scope of Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets, the assets acquired shall be treated as noncash consideration and any gain or loss shall be recognized in accordance with Subtopic 610-20.
Therefore, an entity begins its evaluation by determining whether the transaction meets any of the exceptions in ASC 845-10-30-3, which states:
A nonmonetary exchange shall be measured based on the recorded amount (after reduction, if appropriate, for an indicated impairment of value as discussed in paragraph 360-10-40-4) of the nonmonetary asset(s) relinquished, and not on the fair values of the exchanged assets, if any of the following conditions apply:
- The fair value of neither the asset(s) received nor the asset(s) relinquished is determinable within reasonable limits.
- The transaction is an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of business to facilitate sales to customers other than the parties to the exchange.
- The transaction lacks commercial substance (see the following paragraph [ASC 845-10-30-4]).
We believe that it is unlikely that the condition in ASC 845-10-30-3(a) above
would be met because the fair value of either or
both of the assets that were surrendered or the
assets (or net assets) that were received should
be determinable “within reasonable limits.”
Entities therefore should consider whether the
transaction (1) represents “an exchange of a
product or property held for sale in the ordinary
course of business for a product or property to be
sold in the same line of business to facilitate
sales to customers other than the parties to the
exchange” or (2) lacks commercial substance.
Entities should consider the guidance in ASC
845-10 in making that determination. If the
transaction meets any of the three conditions in
ASC 845-10-30-3, the acquiring entity accounts for
the transaction on the basis of the carrying
amount of the nonmonetary asset given and
recognizes no gain or loss (other than for
impairment, if necessary).
If the transaction does not meet any of the three conditions in ASC 845-10-30-3,
we believe that entities should then consider
whether the consideration given is in the form of
nonfinancial assets (or in-substance nonfinancial
assets). If so, the transaction is within the
scope of ASC 610-20 if the transaction is with a
noncustomer (or ASC 606-10 if the transaction is
with a customer).
ASC 805-50-30-1 states, in part, that “[i]f the consideration given is nonfinancial assets or in substance nonfinancial assets within the scope of Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets, the assets acquired shall be treated as noncash consideration and any gain or loss shall be recognized in accordance with Subtopic 610-20.” Therefore, regardless of whether the assets are being received from a customer or a noncustomer, an entity applies the guidance in ASC 606-10-32-21 and 32-22 for measuring noncash consideration. However, the guidance an entity applies for recognizing the gain or loss depends on whether the assets are being received from a noncustomer or a customer. If the assets are received from a noncustomer, the entity applies the guidance in ASC 610-20 for recognizing the gain or loss, whereas if the assets are received from a customer in exchange for goods or services and the transaction is within the scope of ASC 606-10, the entity applies the guidance in ASC 606-10 on recognizing the gain or loss.
ASC 610-20-15-2 indicates that “[n]onfinancial assets . . . include intangible assets, land, buildings, or materials and supplies and may have a zero carrying value.” In addition, ASC 610-20-15-5 describes an in-substance nonfinancial asset as follows:
[A] financial asset (for example, a receivable) promised to a counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) that are promised to the counterparty in the contract is concentrated in nonfinancial assets. If substantially all of the fair value of the assets that are promised to a counterparty in a contract is concentrated in nonfinancial assets, then all of the financial assets promised to the counterparty in the contract are in substance nonfinancial assets. For purposes of this evaluation, when
a contract includes the transfer of ownership interests in one or more consolidated subsidiaries that is not a
business, an entity shall evaluate the underlying assets in those subsidiaries.
According to ASC 610-20-15-4(g), ASC 610-20 does not apply to a “nonmonetary
transaction within the scope of Topic 845 on
nonmonetary transactions.” Therefore, if the
assets are not nonfinancial assets (or
in-substance nonfinancial assets), entities should
consider whether the assets are nonmonetary
assets. The ASC master glossary defines
nonmonetary assets and liabilities as “assets and
liabilities other than monetary ones” and notes
that examples of such assets and liabilities
include “inventories; investments in common
stocks; property, plant, and equipment; and
liabilities for rent collected in advance.” We
believe that it may be challenging for entities to
determine whether an exchange of noncash assets is
an exchange of nonfinancial assets within the
scope of ASC 610-20 or a nonmonetary exchange
within the scope of ASC 845, and there is no
additional guidance in U.S. GAAP on how to make
this determination. However, we believe that the
definition of nonmonetary assets and liabilities
is broader than the definitions of nonfinancial
assets and in-substance nonfinancial assets.
Entities are required to adopt ASC 610-20 at the same time that they adopt ASC
606. See Deloitte’s Roadmap Revenue
Recognition for more information.
C.2.2 Contingent Consideration
The ASC master glossary defines “contingent consideration” as follows:
Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners of
an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions
are met. However, contingent consideration also may give the acquirer the right to the return of previously
transferred consideration if specified conditions are met.
While that definition applies to contingent consideration issued in a business combination, contingent
consideration may also be issued in an asset acquisition. The acquiring entity should assess the terms of
the transaction to determine whether consideration payable at a future date is contingent consideration
or seller financing. If the payment depends on the occurrence of a specified future event or the
meeting of a condition and the event or condition is substantive, the additional consideration should be
accounted for as contingent consideration. If the additional payment depends only on the passage of
time or is based on a future event or the meeting of a condition that is not substantive, the arrangement
should be accounted for as seller financing.
ASC 805-50 states that any liabilities incurred by the acquiring entity are part of the cost of the asset acquisition, but it does not provide any specific guidance on accounting for contingent consideration in an asset acquisition. However, in EITF Issue 09-2, the Task
Force addressed contingent consideration in an
asset acquisition. While a final consensus was not
reached, the minutes from the September 9–10,
2009, EITF meeting state that “the Task Force
reached a consensus-for-exposure that contingent
consideration in an asset acquisition shall be
accounted for in accordance with existing U.S.
GAAP.” The following examples (not all-inclusive)
were provided:
-
“[I]f the contingent consideration meets the definition of a derivative, Topic 815 (formerly Statement 133) would require that it be recognized at fair value.”
-
“Topic 450 (formerly Statement 5) may require recognition of the contingent consideration if it is probable that a liability has been incurred and the amount of that liability can be reasonably estimated.”
-
“Subtopic 323-10 (formerly [EITF] Issue 08-6) may require the recognition of the contingent consideration if it relates to the acquisition of an investment that is accounted for under the equity method.”
Another example would be if the
contingent consideration arrangement is settleable
in, or is indexed to, the acquirer’s equity
shares, the acquirer may be required to measure
the contingent consideration arrangement at its
acquisition-date fair value in accordance with the
guidance in ASC 480 or ASC 815. See Deloitte’s
Roadmap Contracts on an Entity’s
Own Equity for more
information.
The minutes also state that when contingent consideration related to an asset acquisition is recognized
at inception, “such [an] amount would be included in the initial measurement of the cost of the acquired
assets. . . . However, if the contingent consideration arrangement is a derivative, changes in the carrying
value of a derivative instrument subsequent to inception [would be recognized in accordance with
ASC 815 and] would not be recognized as part of the cost of the asset.”
Connecting the Dots
We understand that in the absence of a final consensus on EITF Issue 09-2,
diversity in practice exists for contingent consideration that is outside the scope of ASC 815 and ASC 323-10 (i.e., contingent consideration that is neither a derivative nor related to the acquisition of an equity method investment). While some practitioners refer to the guidance in ASC 450, others continue to analogize to the guidance in FASB Statement 141, paragraph 27, which states
that “contingent consideration usually should be
recorded when the contingency is resolved and
consideration is issued or becomes issuable.”
Given the lack of authoritative guidance, we
believe that either approach would be
acceptable.
Contingent consideration that is recognized at a later date (i.e., not
recognized as of the acquisition date) should be
capitalized as part of the cost of the assets
acquired and allocated to increase the eligible
assets on a relative fair value basis. However, if
the contingent consideration is related to
IPR&D assets with no alternative future use,
the amount of the contingent payment should be
expensed (see Deloitte’s Life
Sciences Industry Accounting
Guide). Similarly, we believe that
if the acquiring entity receives a payment from
the seller for the return of previously
transferred consideration (i.e., a contingent
consideration asset), the entity should allocate
that amount to reduce the eligible assets on a
relative fair value basis.
Diversity in practice has been observed regarding how entities that recognize
contingent consideration at a later date make the
resulting adjustments to amortizable or
depreciable identifiable assets (e.g., PP&E or
a finite-lived intangible asset). Some entities
have recognized a cumulative catch-up in the
amortization or depreciation of the asset as if
the amount had been capitalized as of the date of
acquisition, and other entities have accounted for
the adjustment prospectively in a manner similar
to a change in estimate. In the absence of
guidance, we believe that either approach is
acceptable.
C.2.2.1 Contingent Consideration When the Fair Value of the Assets Acquired Exceeds the Initial Consideration Paid
We believe that if the fair value of the assets acquired exceeds the initial consideration paid as of the
date of acquisition but includes a contingent consideration arrangement, an entity may analogize to the
guidance in ASC 323-10-25-2A and ASC 323-10-30-2B on recognizing contingent consideration in the
acquisition of an equity method investment (unless the contingent consideration arrangement meets
the definition of a derivative, in which case it would be accounted for in accordance with ASC 815). That
guidance states that if an entity acquires an equity method investment in which the fair value of its share
of the investee’s net assets exceeds its initial cost and the agreement includes contingent consideration,
the entity recognizes a liability equal to the lesser of:
- The maximum amount of contingent consideration.
- The excess of its share of the investee’s net assets over the initial cost measurement.
Like acquisitions of equity method investments, asset acquisitions are accounted
for by using a cost accumulation model. Therefore,
we believe that the guidance above could be
applied to asset acquisitions by analogy.
(However, if the contingent payment is related to
IPR&D assets with no alternative future use,
the amount of the contingent payment would be
expensed. See Deloitte’s Life Sciences Industry
Accounting Guide.) Accordingly, if
an entity acquires a group of assets in which the
fair value of the net assets exceeds its initial
cost and the agreement includes contingent
consideration that does not meet the definition of
a derivative, the entity could recognize a
liability equal to the lesser of:
-
The maximum amount of contingent consideration.
-
The excess of the fair value of the net assets acquired over the initial consideration paid.
Once recognized, the contingent consideration liability is not derecognized until the contingency is
resolved or the consideration is issued. In accordance with the requirements of ASC 323-10-35-14A
for equity method investments, the entity recognizes “any excess of the fair value of the contingent
consideration issued or issuable over the amount that was [initially] recognized as a liability . . . as an
additional cost” of the asset acquisition (i.e., the amount is allocated to increase the eligible assets on a
relative fair value basis). Further, “[i]f the amount initially recognized as a liability exceeds the fair value
of the [contingent] consideration issued or issuable,” the entity recognizes that amount as a reduction
of the cost of the asset acquisition (i.e., the amount is allocated to reduce the eligible assets on a relative
fair value basis).
C.2.3 Transaction Costs, Including Costs of Issuing Debt or Equity Securities
ASC 805-50-30-1 states that in an asset acquisition, “[a]ssets are recognized based on their cost to the acquiring entity, which generally includes the transaction costs.” ASC 805-50 does not, however, define transaction costs. We believe that transaction costs should be limited to the direct and incremental costs incurred to complete the asset acquisition, such as third-party costs for finders’ fees and advisory, legal, accounting, valuation, and other professional or consulting fees. Costs such as general and administrative expenses, and salaries and benefits of the acquiring entity’s employees who work on the acquisition, should not be considered transaction costs.
We also believe that the acquiring entity should recognize the costs of issuing debt or equity securities in an asset acquisition in accordance with applicable GAAP, which is how those costs are recognized in a business combination. SAB Topic 5.A provides guidance on accounting for the costs of issuing equity securities and states, in part, that “[s]pecific incremental costs directly attributable to
a proposed or actual offering of securities may properly be deferred and charged against the gross proceeds of the offering.” Therefore, the costs of issuing equity securities are generally reflected as a reduction of the amount that would have otherwise been recognized in APIC.
If the acquiring entity incurs debt to fund the asset acquisition, it should present the debt issuance costs on the balance sheet as a direct deduction from the face amount of the debt and amortize them as interest expense in accordance with ASC 835-30-45 (unless the debt financing is from a revolving arrangement, in which case the acquiring entity can elect to either deduct the costs from the drawn balance or recognize them as an asset).
See Section 5.4 for more information about accounting for acquisition-related costs in a business combination.
C.2.4 Transactions That Are Separate From an Asset Acquisition
An acquiring entity and the seller of the assets may have a preexisting
relationship or other arrangement before
negotiations for the acquisition begin, or they
may enter into an arrangement during the
negotiations that is separate from the acquisition
of the assets. ASC 805-50 includes only general
principles related to accounting for an asset
acquisition. We believe that those principles
presume that the cost of the acquisition includes
only amounts related to the acquisition of the
asset or group of assets and not amounts related
to separate transactions, even though the guidance
does not explicitly say so. Further, we believe
that in the absence of specific guidance, an
entity should analogize to ASC 805-10-25-20
through 25-22, which provide guidance on
identifying and accounting for transactions that
are separate from a business combination. Under
this guidance, the acquirer must, when applying
the acquisition method, recognize “only the
consideration transferred for the acquiree and the
assets acquired and liabilities assumed in the
exchange for the acquiree.” Any separate
transactions must be accounted for separately from
the business combination in accordance with the
relevant GAAP. See Section 6.2 for
more information about transactions that should be
accounted for separately from a business
combination.
Example C-2
Asset Acquisition and Related Supply Agreement
Company A enters into an agreement with Company B to acquire machinery and equipment that will be
used to manufacture Product X. The machinery and equipment do not meet the definition of a business in
ASC 805-10. In addition to stipulating a cash amount to be paid by A upon transfer of the machinery and
equipment, the agreement specifies that A will provide B with a specified number of units of Product X for two
years after the acquisition at a fixed per-unit price that is determined to be below market.
In determining the cost of the asset acquisition, A should take into account both the amount it paid upon
transfer of the machinery and equipment and the value transferred to B under the below-market fixed-price
supply agreement. Company A would recognize a balance sheet credit on the date of acquisition for the
unfavorable supply contract; the credit would be recognized in income as units of Product X are delivered.
Example C-3
Asset Acquisition That Settles a Dispute
Company A has an agreement with Company B that gives B the exclusive right to distribute A’s goods in a
specific region. Company B asserts that A has inappropriately given the distribution right to B’s competitor.
Company A and B decide to settle the dispute so that A reacquires the distribution right from B. The
distribution right does not meet the definition of a business in ASC 805-10. Company A believes that if it does
not reacquire the distribution right, it is liable to B for breach of contract.
In determining the cost of the asset acquisition, A should exclude from this cost any amount related to the
dispute’s settlement to avoid the capitalization of what would otherwise be an operating expense if paid
separately from the asset acquisition.
In prepared remarks at the 2007 AICPA
Conference on Current SEC and PCAOB Developments,
Eric West, then associate chief accountant in the
SEC’s OCA, discussed a fact pattern in which a
company pays cash and conveys licenses to a
plaintiff to settle a claim related to patent
infringement and misappropriation of trade
secrets. In exchange, the company receives a
promise to drop the patent infringement lawsuit, a
covenant not to sue with respect to the
misappropriation of trade secrets claim, and a
license to use the patents subject to the
litigation. Mr. West notes that “[t]o properly
account for this arrangement, a company must
identify each item given and received and
determine whether those items should be
recognized.” In addition, Mr. West states the
following regarding the valuation of the elements
of the transaction:
[W]e
believe that it would be acceptable to value each
element of the arrangement and allocate the
consideration paid to each element using relative
fair values. To the extent that one of the
elements of the arrangement just can’t be valued,
we believe that a residual approach may be a
reasonable solution. In fact, we have found that
many companies are not able to reliably estimate
the fair value of the litigation component of any
settlement and have not objected to judgments made
when registrants have measured this component as a
residual. In a few circumstances companies have
directly measured the value of the litigation
settlement component. In the fact pattern that I
just described, the company may be able to
calculate the value of the settlement by applying
a royalty rate to the revenues derived from the
products sold using the patented technology during
the infringement period. Admittedly, this approach
requires judgment and we are willing to consider
reasonable judgments.
Accordingly, we believe that the elements of the transaction should be valued on the basis of relative
fair values unless the fair value of one of the elements cannot be estimated. In that case, a residual
approach may be acceptable.
C.2.5 Asset Acquisitions in Which a Noncontrolling Interest Remains
In some asset acquisitions, the acquiring entity may obtain control, but less than 100 percent of the
equity interests, in a legal entity holding only an asset or group of assets such that a noncontrolling
interest in the legal entity remains after the acquisition. We believe that if the legal entity is not a VIE,
the acquiring entity in an asset acquisition should include the fair value of any noncontrolling interests
remaining as of the date of acquisition in determining the cost to allocate to the assets or group of
assets acquired by analogy to the guidance for business combinations in ASC 805-30-30-1. Under that
guidance, an acquirer in a business combination must add the fair value of any noncontrolling interests
remaining as of the date of acquisition to the consideration transferred to determine the amount
recognized for the assets acquired and liabilities assumed. If the acquiring entity in an asset acquisition
does not include the fair value of any noncontrolling interests remaining as of the date of acquisition, the
asset or group of assets acquired may be recognized at an amount lower than their current fair value.
If the acquired legal entity is a VIE, entities should apply the guidance in ASC 810-10-30-4. See
Section C.1.2.1.
Example C-4
Acquisition in Which a Noncontrolling Interest Remains
Company A acquires an 80 percent controlling interest in a legal entity whose only asset is a finite-lived license
for intellectual property. As part of the acquisition, A pays $800,000 in cash and incurs $50,000 in transaction
costs for third-party advisory fees. Company A determines that the license does not meet the definition
of a business in ASC 805-10 and that the entity is not a VIE. The seller of the license retains a 20 percent
noncontrolling interest in the entity. The fair value of the noncontrolling interest is determined to be $195,000.
Although the fair value of the noncontrolling interest is used to measure the cost of the acquisition, A would
recognize the noncontrolling interest at its proportionate share of the relative fair value of the assets (and
liabilities) acquired ($1,045,000 × 20 percent, or $209,000).
C.2.6 Asset Acquisitions in Which the Acquiring Entity Previously Held an Interest
In some asset acquisitions, the acquiring entity may obtain control of an asset or group of assets
that are held in a legal entity in which it held a noncontrolling interest immediately before the date of
acquisition. ASC 805-50 provides no guidance on how an entity should account for a previously held
interest in an asset acquisition when measuring the asset or group of assets acquired. In the absence
of guidance, we believe that there are two alternatives if the legal entity is not a VIE. Under the first
alternative, the acquiring entity in an asset acquisition would include the carrying amount of any
previously held interest along with the consideration paid and transaction costs incurred in determining
the cost to allocate to the assets acquired. This view is consistent with the cost accumulation model
because each step is measured on the basis of the respective cost incurred.
Under the second alternative, the acquiring entity in an asset acquisition would include the fair value
of any previously held interest (after recognizing a gain or loss for the difference between the interest’s
fair value and its carrying value) along with the consideration paid and transaction costs incurred
in determining the cost to allocate to the assets acquired by analogy to the guidance for business
combinations in ASC 805-30-30-1. Under that guidance, an acquirer in a business combination must add
the fair value of any previously held interest to the consideration transferred to determine the amount
recognized for the assets acquired and liabilities assumed.
If the acquired legal entity is a VIE, entities should apply the guidance in ASC 810-10-30-4. See
Section C.1.2.1.
Example C-5
Acquisition in Which the Acquiring Entity Previously Held an Interest
Company A has a 20 percent noncontrolling interest in a legal entity whose only asset is a finite-lived license for
intellectual property. The carrying value of A’s investment is $100,000, and its fair value is $200,000. Company
A acquires the remaining 80 percent interest for $800,000 in cash and incurs $50,000 in transaction costs for
third-party advisory fees. Company A determines that the license does not meet the definition of a business in
ASC 805-10 and that the entity is not a VIE.
Under alternative 1, $950,000 would be allocated to the license as follows:
Under Alternative 2, $1,050,000 would be allocated to the license as follows:
C.2.7 Noncash Assets Given as Consideration That Remain Within the Combined Entity After the Acquisition
In some asset acquisitions, the consideration given may include assets or liabilities that remain within
the combined entity after the acquisition. Therefore, the acquiring entity controls them before and
after the asset acquisition. Under ASC 805-30-30-8, in a business combination, the acquirer must
recognize those assets and liabilities at their carrying amounts immediately before the acquisition date;
the acquirer is precluded from recognizing a gain or loss on assets or liabilities it controls both before
and after the business combination. While ASC 805-50 does not address this issue, we believe that it is
appropriate to apply the guidance in ASC 805-30-30-8 to asset acquisitions by analogy.
In addition, ASC 805-50 does not address the measurement of any noncontrolling
interests, and thus alternatives may exist in
practice, such as those shown in the example
below. In alternative 1 of the example, the fair
value of the noncontrolling interest is used to
measure the cost of the asset acquisition by
analogy to the business combinations guidance
(although the noncontrolling interest is
recognized at its proportionate share of the
relative fair value of the assets and liabilities
acquired). In alternative 2, the noncontrolling
interest is measured at a part fair value and a
part carryover basis.
Example C-6
Assets Transferred as Consideration That Remain Under the Control of the Acquiring Entity
Company A enters into an agreement to acquire an 80 percent interest in Entity B for $875,000 in cash and
equipment; A incurs $50,000 in transaction costs for third-party advisory fees. Entity B’s only assets include
three buildings, which do not meet the definition of a business in ASC 805-10. The equipment A gives as
consideration will be transferred not to the seller but to B and will therefore remain in the combined entity.
This equipment has a carrying value of $500,000 and a fair value of $625,000. The three buildings A acquires
have fair values of $300,000, $500,000, and $450,000, a total of $1,250,000.
C.3 Allocating the Cost in an Asset Acquisition
ASC 805-50
Allocating Cost
30-3 Acquiring assets in groups requires not only ascertaining the cost of the asset (or net asset) group but also
allocating that cost to the individual assets (or individual assets and liabilities) that make up the group. The cost
of such a group is determined using the concepts described in the preceding two paragraphs. The cost of a
group of assets acquired in an asset acquisition shall be allocated to the individual assets acquired or liabilities
assumed based on their relative fair values and shall not give rise to goodwill. The allocated cost of an asset
that the entity does not intend to use or intends to use in a way that is not its highest and best use, such as a
brand name, shall be determined based on its relative fair value. See paragraph 805-50-55-1 for an illustration
of the relative fair value method to assets acquired outside a business combination.
30-4 See paragraphs 740-10-25-49 through 25-55 for guidance on the accounting for acquired temporary
differences in certain purchase transactions that are not accounted for as business combinations.
An acquiring entity allocates the cost of an asset acquisition to the assets acquired (and liabilities
assumed) on the basis of their relative fair values and is not permitted to recognize goodwill. However,
if the fair values of the assets acquired and liabilities assumed are more reliably determinable
(e.g., because the consideration is in the form of noncash assets), the entity measures the cost of the
transaction by using these fair values. Fair value is measured in accordance with ASC 820.
Goodwill is recognized only if a business is acquired. Thus, no goodwill is
recognized in an asset acquisition. If initial indications are that the cost of the
acquisition is in excess of the fair value of acquired assets, an entity should
carefully consider whether the acquired assets represent a business or an asset
acquisition, whether the entity has appropriately identified all assets acquired,
and whether the entity has appropriately measured the cost of the acquisition and
the fair values of assets acquired. If, after this exercise, it is determined that
the cost of the acquisition exceeds the fair value of the assets acquired, the
acquiring entity allocates the difference pro rata on the basis of relative fair
values to increase certain of the assets acquired (see Section C.3.1).
Bargain purchase gains are generally not recognized in an asset acquisition. If
the fair value of the net assets acquired exceeds
the acquiring entity’s cost, the acquiring entity
allocates the difference pro rata on the basis of
relative fair values to reduce certain of the
assets acquired (see Section C.3.1). However, such pro rata
allocation cannot reduce monetary assets below
their fair values. In unusual cases, pro rata
allocation either reduces the eligible assets to
zero or there are no eligible assets to reduce; we
do not believe that an entity should reduce
monetary assets below their fair values in such
circumstances. However, before recognizing a gain,
the entity should consider whether (1) it has
appropriately recognized all of the liabilities
assumed, any contingent consideration, and any
separate transactions or (2) whether the assets
received are more reliably measurable than the
assets given. If only monetary assets are
acquired, the entity should also consider whether
the transaction is, in substance, an asset
acquisition. For example, if the assets being
acquired are primarily cash, the substance of the
transaction may be a recapitalization.
C.3.1 Exceptions to Pro Rata Allocation
Pro rata allocation of the acquiring entity’s cost to the assets acquired on a relative fair value basis
results in the recognition of assets at amounts that are more (or less if a bargain purchase) than their
fair values. In deliberating ASC 805-10, ASC 805-20, and ASC 805-30, the FASB discussed a number of
exceptions to the recognition and fair value measurement principles in a business combination for
assets or liabilities for which the subsequent accounting is prescribed by other GAAP and application
of such GAAP would result in the acquirer’s recognition of an immediate gain or loss. Examples of such
exceptions include assets held for sale, employee benefits, and income taxes. ASC 805-50 provides
only general guidance on allocating cost in an asset acquisition. However, we believe that the same
principles should apply to an asset acquisition. That is, an acquiring entity should not recognize an asset
at an amount that would result in the entity’s recognition of an immediate gain or loss as a result of the
subsequent application of GAAP if no economic gain or loss has occurred (with the exception of IPR&D
assets with no alternative future use, which are discussed in Section C.3.4.2).
Therefore, we believe that certain assets should be recognized at the amounts required by applicable
U.S. GAAP or should not be recognized at amounts that exceed their fair values. Such assets (and
liabilities) include:
- Cash and other financial assets (other than equity method investments).
- Other current assets.
- Assets subject to fair value impairment testing, such as indefinite-lived intangible assets.
- Assets held for sale.
- Income taxes.
- Employee benefits.
- Indemnification assets (see Section C.3.3).
-
Indefinite-lived intangible assets (see Section C.3.4).
-
Contract assets measured in accordance with ASC 606 (after adoption of ASU 2021-08).
Example C-7
Excess of Cost Over the Fair Values of the Assets Acquired
Company A acquires three assets from Company B: machinery and equipment with a fair value of $20,000, a
building with a fair value of $50,000, and an indefinite-lived intangible asset with a fair value of $30,000. The
total cost of the acquisition, including transaction costs, is $120,000. Company A has determined that the
assets do not constitute a business and allocates the cost as follows:
Sometimes the fair value of the net assets acquired exceeds the acquiring entity’s cost (i.e., a bargain purchase), though this is unusual. Allocation of a bargain purchase will reduce assets below their fair values. We believe there are two acceptable views on how to allocate the acquiring entity’s cost in such cases. Under the first alternative, the same assets that are ineligible for pro rata allocation when cost exceeds the fair value of the assets should also be ineligible for pro rata allocation in a bargain purchase.
Example C-8
Excess of Fair Values of the Assets Acquired Over Cost (Alternative 1)
Assume the same facts as in the example above, except that the total cost of the
acquisition, including transaction costs, is
$90,000. Company A’s cost is allocated as
follows:
Under the second alternative, it is appropriate to allocate a bargain purchase to any asset for which
the subsequent application of U.S. GAAP would not result in an immediate gain, such as indefinite-lived
intangible assets or assets held for sale.
Example C-9
Excess of Fair Values of the Assets Acquired Over Cost (Alternative 2)
Assume the same facts as in Example C-6,
except that the total cost of the acquisition,
including transaction costs, is $90,000. Company
A’s cost is allocated as follows:
C.3.2 Contingencies
An entity accounts for gain or loss contingencies acquired or assumed in an
asset acquisition in accordance with ASC 450. A
loss contingency is recognized when it is probable
that a loss has been incurred and the loss can be
reasonably estimated. A gain contingency is not
recognized until the earlier of when the gain is
realized or is realizable and therefore is not
recognizable in an asset acquisition. If an
acquiring entity acquires a gain or loss
contingency in an asset acquisition but the
contingency does not qualify for recognition on
the date of acquisition, the entity would allocate
the cost of the acquisition only to the
recognizable assets acquired and may initially
recognize certain assets at more or less than
their fair values because of the nonrecognition of
the contingency.
C.3.3 Indemnification Assets
The seller in an asset acquisition may contractually indemnify the acquiring entity for the outcome of a
contingency or uncertainty related to all or part of a specific asset or liability. For example, the seller may
indemnify the acquiring entity against losses above a specified amount on a liability that arises from a
particular contingency; in other words, the seller will guarantee that the acquiring entity’s liability will not
exceed a specified amount. As a result, the acquiring entity obtains an indemnification asset.
Under ASC 805-20-25-27, an acquirer in a business combination must “recognize an indemnification
asset at the same time that it recognizes the indemnified item, measured on the same basis as the
indemnified item, subject to the need for a valuation allowance for uncollectible amounts.” We believe
that an entity should also apply this guidance by analogy in an asset acquisition. See Section 4.3.4 for
more information about the accounting for indemnification assets in a business combination.
C.3.4 Intangible Assets
An entity recognizes intangible assets that are acquired in an asset acquisition if they meet the asset recognition criteria in FASB Concepts Statement 5, even if they are not separable or do not arise from contractual rights. There is a lower threshold for recognizing intangible assets in an asset acquisition than in a business combination (with the exception of IPR&D, which is discussed in Section C.3.4.2). In a business combination, if the consideration transferred includes amounts for intangible assets
that do not qualify for recognition (e.g., assembled workforce), those unrecognized intangible assets
are subsumed into goodwill but the assets acquired are still generally recognized at their fair values.
However, in an asset acquisition, no goodwill is recognized. If the consideration paid includes amounts
for intangible assets that were not separately recognized, the cost of the acquisition would be allocated
to the recognizable assets and those assets may be recognized at amounts that exceed their fair values.
Since there is no residual into which unrecognized intangible assets could be subsumed, the FASB
decided that the threshold for recognizing intangible assets in an asset acquisition should be lower than
in a business combination.
Entities recognize finite-lived intangible assets acquired in an asset
acquisition on the basis of relative fair values. However, because indefinite-lived
intangible assets are subject to fair value impairment testing after the acquisition date,
we believe that they should not be recognized at an amount that exceeds fair value, as
discussed in Section C.3.1
and illustrated in Examples C-6 through
C-8.
C.3.4.1 Assembled Workforce
ASC 805-20-55-6 defines an assembled workforce as “an existing collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date.” Under ASC 805-20-55-6, an assembled workforce is not recognized in a business combination because it neither is separable nor arises from contractual rights (i.e., identifiable). However, in an asset acquisition, an assembled workforce would generally meet the asset recognition criteria in FASB Concepts Statement 5 and would be separately recognized. But because an assembled workforce is often associated with substantive processes, the presence of an assembled workforce may indicate that the acquisition involves a business rather than an asset or a group of assets. An entity must evaluate all facts and circumstances in determining whether a group of acquired assets constitutes a business under ASC 805.
C.3.4.2 IPR&D Assets
An acquiring entity must allocate, on the basis of relative fair values, the
cost of the acquisition to both the tangible and
intangible R&D assets acquired. On the date of
acquisition, the acquiring entity expenses
IPR&D assets with no alternative future use
and capitalizes those with an alternative future
use in accordance with ASC 730.
One of the most significant differences between the accounting for an asset acquisition and that for a
business combination lies in the accounting for IPR&D assets. In a business combination, the acquirer
must recognize all IPR&D assets at fair value and initially characterize them as indefinite-lived intangible
assets, regardless of whether the IPR&D assets have an alternative future use. In EITF Issue 09-2, the Task Force considered amending ASC 730 with respect to IPR&D assets acquired in an asset acquisition;
however, the Task Force was unable to reach a consensus and removed the project from its agenda.
Therefore, entities continue to apply the guidance in ASC 730 in accounting for IPR&D assets acquired in
an asset acquisition.
C.3.4.3 Defensive Intangible Assets
ASC 805-20-30-6 states that “[t]o protect its competitive position, or for other reasons, the acquirer
may intend not to use an acquired nonfinancial asset actively, or it may not intend to use the asset
according to its highest and best use.” While such assets are not being actively used, they are most
likely contributing to an increase in the value of other assets owned by the acquiring entity. Common
examples of such assets, which are known as “defensive assets,” include brand names and patents.
While ASC 805-50 does not address the accounting for defensive intangible assets, we believe that because such assets must be recognized under ASC 805-20, they meet the asset recognition criteria in FASB Concepts Statement 5 and therefore should be recognized in an asset acquisition on the basis of their relative fair values. Fair value would be measured in accordance with ASC 820-10, and the asset’s highest and best use by market participants would be assumed, both initially and for subsequent impairment testing. See Section 4.10.4.8 for more information about the accounting for defensive
intangible assets in a business combination.
C.3.5 Deferred Taxes
ASC 740-10-25-49 through 25-54 provide guidance on accounting for acquired
temporary differences in certain purchase transactions that are not accounted for as
business combinations (i.e., asset acquisitions). Because goodwill is not recognized in an
asset acquisition, an entity generally recognizes deferred taxes for temporary book/tax
differences in an asset acquisition by using the simultaneous equations method.
For more information about accounting for income taxes in an asset acquisition,
see Deloitte’s Roadmap Income
Taxes.
C.3.6 Lease Classification
ASC 805-50 does not provide guidance on how an acquiring entity should classify
a lease acquired in an asset acquisition. In the absence of such guidance, one
approach is to analogize to the guidance applied by an acquirer in a business
combination. Specifically, ASC 840-10-25-27 states that for leases under ASC
840, the acquirer retains the acquiree’s previous classification “unless the
provisions of the lease are modified as indicated in paragraph 840-10-35-5,”
whereas ASC 842-10-35-3 specifies that for leases under ASC 842, the acquirer
retains the acquiree’s previous lease classification “unless the lease is
modified and that modification is not accounted for as a separate contract in
accordance with paragraph 842-10-25-8.” Under this approach, an entity would not
reassess the lease classification when a lease is acquired in a business
combination, provided that only the identity of the lessee or lessor, but not
any other lease provision, is changed. This is because ASC 842-20-20 defines a
lease modification as a “change to the terms and conditions of a contract that
results in a change in the scope of or the consideration for a lease.” We do not
believe that a change only in the parties to a lease is contemplated in this
definition since such a change does not alter scope or consideration. Thus, in
these circumstances, an entity would view the asset acquisition as a
continuation of the historical lease agreement. See Section 4.3.11 for further discussion of
the accounting for leases in a business combination.
Another approach to determining the classification of a lease acquired in an
asset acquisition is to apply ASC 840 or ASC 842 (as applicable) and consider
each lease acquired as a new lease on the acquisition dates since the FASB
provided specific guidance related to business combinations but did not extend
that guidance to asset acquisitions. In addition, unlike an acquirer in a
business combination, an acquiring entity in an asset acquisition may not have
the information necessary to determine the original classification of the lease.
Under this alternative, an acquiring entity in an asset acquisition would
reassess lease classification as of the acquisition date since that date marks
the entity’s first involvement with the lease (i.e., it is a new lease from the
acquiring entity’s perspective). Thus, if this alternative is used, an acquiring
entity’s lease classification may be different from that of the seller even in
the absence of a lease modification as defined in ASC 840 or ASC 842.
While either approach to classifying a lease acquired in an asset acquisition is considered acceptable,
application of more than one approach within the same asset acquisition transaction would not be
expected.
If the acquiring entity becomes the lessor in an acquired lease arrangement, the guidance in ASC 350-30
applies. The cost of the acquisition is allocated to tangible assets (e.g., land and buildings) and any
in-place lease intangible asset on the basis of their relative fair values. The fair value of assets does not
incorporate any value from the leases. For example, the fair value of the land and building is measured
as if the building was vacant.
For more information, see Deloitte’s Roadmap Leases.
C.3.7 Purchased Financial Assets — After Adoption of ASU 2016-13
In June 2016, the FASB issued ASU
2016-13, which not only provides a
model for recognizing credit losses on financial
assets held at amortized cost and AFS debt
securities but also amends ASC 805 to provide
guidance on accounting for purchased financial
assets in a business combination. After an entity
adopts ASU 2016-13, the accounting for acquired
financial assets within the scope of ASC 326 will
depend on whether the assets have experienced
more-than-insignificant deterioration in credit
quality since origination.
We believe that the purchased
financial assets acquired in an asset acquisition should be accounted for in the same manner
as in a business combination. Paragraph BC88 of ASU 2016-13 states, in part, that “the Board
concluded that there is no inherent difference between assets acquired in a business
combination and those that are purchased outside a business combination.” See Section 4.3.10 for more information
about the accounting for purchased financial assets in a business combination. Also, see
Deloitte’s Roadmap Current Expected
Credit Losses for more information.
Changing Lanes
As discussed in Section 4.3.10, in June 2023, the FASB issued a proposed ASU that would amend the guidance in ASU 2016-13 on the
accounting upon the acquisition of financial assets acquired in (1) a business
combination, (2) an asset acquisition, or (3) the consolidation of a VIE that is not a
business. For financial assets acquired as a result of an asset acquisition or through
consolidation of a VIE that is not a business, the asset acquirer would apply the
gross-up approach to seasoned assets, which are acquired assets unless the asset is
deemed akin to an in-substance origination. A seasoned asset is an asset (1) that is
acquired more than 90 days after origination and (2) for which the acquirer was not
involved with the origination. Practitioners should monitor the proposed ASU for any
developments that might change the current accounting. See Section 4.3.10 for more information about the
accounting for purchased financial assets in a business combination. Also, see
Deloitte’s Roadmap Current Expected
Credit Losses for more information.
C.3.8 Measurement Period
In a business combination, an acquirer is allowed a period during which it may adjust provisional
amounts recognized as of the acquisition date. This time frame is referred to as the measurement
period. ASC 805-50 does not address the concept of a measurement period and, in practice, entities
have not been provided a measurement period in an asset acquisition. We believe that because asset
acquisitions are generally less complex than business combinations, the acquiring entity should be able
to obtain any valuations and information necessary to complete its accounting for an asset acquisition
before its next reporting date.
C.3.9 Subsequent Accounting for Assets Acquired or Liabilities Assumed in an Asset Acquisition
ASC 805-50
Accounting After Acquisition
35-1 After the acquisition, the acquiring entity accounts for the asset or liability in accordance with the appropriate generally accepted accounting principles (GAAP). The basis for measuring the asset acquired or liability assumed has no effect on the subsequent accounting for the asset or liability.
The initial measurement of an asset acquired or liability assumed in an asset acquisition does not affect
its subsequent accounting. The subsequent accounting for contingent consideration is described in Section C.2.2. Otherwise, the acquirer subsequently accounts for the assets or any liabilities assumed
or incurred in accordance with the appropriate GAAP, as applicable.
C.4 Disclosures
ASC 805-50 does not prescribe any disclosure requirements for asset acquisitions. However, the
acquiring entity will need to provide disclosures in accordance with other GAAP depending on the assets
acquired or the liabilities assumed or incurred. For example:
- ASC 360-10-50-1 requires disclosure of the balances of major classes of depreciable assets, by nature or function, and accumulated depreciation on the balance sheet date; depreciation expense for the period; and a general description of the method or methods used to compute depreciation with respect to major classes of depreciable assets.
- ASC 350-30-50-1 includes disclosure requirements for intangible assets acquired either individually or as part of a group of assets.
- ASC 450-20-50 requires disclosures regarding loss contingencies.
- ASC 845-10-50-1 includes specific disclosure requirements for nonmonetary transactions.
In addition, depending on the size of the asset acquisition, acquiring entities may decide to provide
some of the disclosures prescribed in ASC 805-10-50, ASC 805-20-50, or ASC 805-30-50 for a business
combination. For example, disclosures about the reason for the acquisition, the amounts recognized
as of the date of acquisition for each major class of assets acquired and liabilities assumed, and
information about any separate transactions may enhance users’ understanding of the transaction.
C.5 SEC Reporting Considerations Related to Asset Acquisitions
When an SEC registrant acquires an asset or a group of assets, the registrant
may be required to report the acquisition on Form
8-K, Item 2.01. The nature of the registrant’s
disclosures depends on whether the asset or group
of assets (1) represents a business for SEC
reporting purposes or (2) is significant.
The definition of a business in SEC Regulation S-X, Rule 11-01(d), for SEC
reporting purposes differs from the definition of
a business in ASC 805-10 for U.S. GAAP accounting
purposes. Accordingly, the registrant must perform
a separate evaluation under Rule 11-01(d) to
determine its SEC reporting requirements. See
Section 2.1.1 of Deloitte’s Roadmap
SEC Reporting
Considerations for Business
Acquisitions for discussion of the
definition of a business for SEC reporting
purposes, and see Appendix D of this publication for
further information on SEC reporting requirements
for acquisitions that meet that definition.
If an asset acquisition does
not represent a business for SEC reporting
purposes, a registrant must evaluate the
significance of the transaction by using a
different test, as discussed in Section
2.1.3 of Deloitte’s Roadmap
SEC Reporting
Considerations for Business
Acquisitions.
Under Form 8-K, Item 2.01, the registrant must file a Form 8-K
within four business days after consummation of an
acquisition of a significant amount of assets. Instruction 4 of Item 2.01 discusses
significance and states, in part:
An acquisition or disposition shall be deemed to involve a
significant amount of assets:
(i) if the registrant’s and its other subsidiaries’ equity in the
net book value of such assets or the amount paid or received for the
assets upon such acquisition or disposition exceeded 10% of the
total assets of the registrant and its consolidated subsidiaries . .
. .
Connecting the Dots
A registrant may also be required by Form 8-K, Item 1.01, to
file a Form 8-K when it has entered into a material definitive agreement for
an acquisition (e.g., when it executes a contract for an acquisition). Item
1.01 is generally filed earlier than Item 2.01, which the registrant is not
required to file until the acquisition is consummated.
The required disclosures for acquisitions of significant assets
differ from the disclosures required for a significant business acquisition. Since
Rule 3-05 does not apply, no historical financial statements need to be filed.
However, the disclosures in Item 2.01 of Form 8-K should clearly (1) describe the
assets acquired, (2) describe the anticipated effects on the registrant’s financial
condition, and (3) indicate that the acquisition did not constitute the acquisition
of a business. When such information would be material to investors, the registrant
may consider including limited pro forma balance sheet information reflecting the
effects of the asset acquisition (or include a narrative discussion, for example,
when adjustments are easily understood). See Chapter 4 of Deloitte’s Roadmap SEC Reporting Considerations for
Business Acquisitions for further information.
Appendix D — SEC Reporting Considerations for Business Combinations
Appendix D — 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 or Rule 3-14.
Registrants should carefully evaluate the factors below.
D.1 Definition of a Business
Separate financial statements under Rule
3-05 or Rule 3-14 are required only if the acquiree meets the
definition of a business for SEC reporting purposes. Therefore, a
company must carefully determine whether an acquiree qualifies as
such. The definition of a business for SEC reporting purposes is not
the same as the definition under U.S. GAAP, and financial statements
may be required under Rule 3-05 or Rule 3-14 even if the acquisition
does not meet the U.S. GAAP definition of a business.
The SEC definition of a business, which is
based on Rule 11-01(d), focuses primarily on whether the nature of
the revenue-producing activity generally remains the same after the
acquisition (see Section 2.1.1 of Deloitte’s Roadmap SEC Reporting
Considerations for Business
Acquisitions for further information). The
definition of a business under U.S. GAAP focuses first on whether
substantially all of the fair value of the gross assets acquired is
concentrated in a single identifiable asset or group of similar
identifiable assets (referred to as the “screen”) and, if not, by
further evaluating a “framework” to determine whether an input and a
substantive process were acquired (referred to as the “framework”).
See Section
2.4 for more information about the U.S. GAAP
definition of a business in ASC 805.
D.2 Significance of the Acquired Business
The financial information, if any, that must be included in SEC filings is based
on the size of the acquiree, which the SEC refers to as the acquiree’s
“significance.” To determine the significance of the acquiree, the registrant must
perform the investment test, the asset test, and the income test:
- Investment test — The GAAP purchase price is compared with the aggregate worldwide market value of the registrant’s common equity. If the registrant has no aggregate worldwide market value (e.g., when common equity is not publicly traded, including in an IPO), total assets should be used in the test instead.
- Asset test — The registrant’s share of the acquiree’s total assets is compared with the registrant’s total assets on the basis of the most recent preacquisition annual financial statements of each company.
- Income test — The income test consists of an income
component and a revenue component:
-
Income component — The registrant’s share of the acquiree’s pretax income is compared with the registrant’s pretax income on the basis of the most recent preacquisition annual financial statements of each company. Pretax income is defined in SEC Regulation S-X, Rule 1-02(w), as “consolidated income or loss from continuing operations before income taxes (after intercompany eliminations) attributable to the controlling interests.”
-
Revenue component — If both the registrant and the acquiree have material revenue in each of the two most recently completed fiscal years, the revenue component is calculated by comparing the registrant’s share of the acquiree’s revenue with the registrant’s revenue on the basis of the most recent preacquisition annual financial statements of each company. If either the registrant or the acquiree does not have material revenue for each of the two most recently completed fiscal years, only the income component should be used, which includes the use of five-year income-averaging for the registrant.
-
An acquiree will only be considered significant under the income test if both the income component and the revenue component (if applicable) exceed the significance threshold (i.e., 20 percent). When both components exceed the significance threshold, the lower of the income or revenue component is used to determine significance in accordance with the income test.
-
The financial statement periods of the acquiree that the registrant must present
in a Form 8-K will be based on the test that results in the highest significance
level, generally as follows:
-
Significance does not exceed 20 percent — No financial statements required.
-
Significance exceeds 20 percent but not 40 percent — Financial statements for the most recent fiscal year (audited) and the latest year-to-date interim period that precedes the acquisition date (unaudited).
-
Significance exceeds 40 percent — Financial statements for the two most recent fiscal years (audited), the latest year-to-date interim period that precedes the acquisition date (unaudited), and the corresponding interim period of the prior year (unaudited).
See Section 2.3 of Deloitte’s Roadmap SEC Reporting Considerations for Business
Acquisitions for further information.
D.3 Form of Financial Statements
Preacquisition financial statements of the acquiree are generally prepared on
the same basis as if the acquiree were a registrant. Such acquirees need to comply
with Regulation S-X. In addition, an acquiree that is not a public company does not
need to comply with certain disclosure requirements that apply only to public
companies, such as those related to segments or earnings per share. Also, some
accounting standards differentiate between adoption dates for PBEs and those for
nonpublic entities. Significant acquirees whose financial statements are included in
a registrant’s filing under Rule 3-05 are considered PBEs under U.S. GAAP.
Therefore, such acquirees should use the adoption dates and disclosure requirements
for PBEs when preparing their financial statements. However, the SEC staff announced
that it would not object to elections by certain PBEs to use the non-PBE effective
dates for the sole purpose of adopting the FASB’s standards on revenue (ASC 606) and
leases (ASC 842). In addition, since an acquired business meets the definition of a
PBE, it is not eligible to elect certain accounting and reporting alternatives in
U.S. GAAP, including those developed by the Private Company Council and subsequently
endorsed by the FASB (see Chapter
8 for more information). Also, the effects of any previously elected
private-company alternatives would have to be eliminated in the acquiree’s financial
statements.
Generally, the annual financial statements for a significant
acquisition may be audited in accordance with AICPA standards. If an acquired
company is identified as a predecessor, however, the audit may need to be performed
in accordance with PCAOB standards (in addition to complying with SEC Regulation
S-X, Rule 3-01). In addition, while SEC regulations do not require registrants to
obtain an audit or review of the interim financial statements provided under Rule
3-05, a company’s underwriters will often require that a review of interim
information be performed by an independent auditor for due diligence or comfort
letter purposes.
See Section 2.6 of Deloitte’s Roadmap SEC Reporting Considerations for Business
Acquisitions for further information.
D.4 Pro Forma Financial Information
A pro forma balance sheet and income statement are generally
required under SEC rules if the business acquisition is deemed to be significant.
Such pro forma financial statements are required in Form 8-Ks that report such
acquisitions and in any registration statements filed by the registrant, as follows:
-
Balance sheet — On the basis of the registrant’s latest balance sheet included in the filing, transaction accounting adjustments should be computed by assuming that the transaction was consummated on the balance sheet date. Such adjustments are limited to those that reflect the accounting for the transaction in accordance with U.S. GAAP or IFRS Accounting Standards, as applicable, and may include, among other items, the recognition of goodwill and intangible assets and adjustments of assets and liabilities to fair value on the balance sheet.
-
Income statement — On the basis of the registrant’s latest fiscal year and interim period included in the filing, transaction accounting adjustments should be computed by assuming that the transaction occurred at the beginning of the fiscal year presented (usually the fiscal year before the acquisition year) and was carried forward through any interim period presented in the acquisition year.
For further information, see Chapter 4 of
Deloitte’s Roadmap SEC
Reporting Considerations for Business Acquisitions.
Appendix E — Differences Between U.S. GAAP and IFRS Accounting Standards
Appendix E — Differences Between U.S. GAAP and IFRS Accounting Standards
Although ASC 805 and IFRS 3 were the result of a joint project between the FASB
and the IASB, differences exist between the two standards. Certain differences have
been present from the time the joint project was completed, some of which are
because of differences in other U.S. GAAP or IFRS Accounting Standards. Other
differences have resulted from subsequent standard setting. The table below
summarizes the significant differences between ASC 805 and IFRS 3.
Subject | ASC 805 | IFRS 3 |
---|---|---|
Definition of control | 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,” and
acquirer as “[t]he entity that obtains
control of the acquiree.” ASC 805 refers
to the guidance in ASC 810-10 on
determining the existence of a controlling
financial interest in the assessment of
control. | While IFRS 3 provides the same definitions
of business combination and acquirer as
ASC 805, IFRS 3 refers to the consolidation
guidance in IFRS 10 on determining
control. Differences between IFRS 10 and
ASC 810-10 could lead to differences in the
determination of whether a transaction
is a business combination and in the
identification of the acquirer. |
Identifying the
acquirer if the
acquiree is a VIE | Under ASC 805-10-25-5, “in a business combination in which a variable interest
entity (VIE) is acquired, the primary beneficiary of that
entity always is the acquirer.” | IFRS 3 does not include similar guidance because there is no VIE model under
IFRS Accounting Standards. Therefore, the determination of
the accounting acquirer follows the assessment of factors in
paragraphs B13 through B18 of IFRS 3. |
Definition of a
business — screen
(i.e., concentration
test under IFRS 3) | ASC 805
requires an entity to evaluate whether
substantially all of the fair value of the
gross assets acquired is concentrated
in a single identifiable asset or group of
similar identifiable assets (the “screen”).
If the screen is met, the set would not be
considered a business. The use of the
screen is mandatory. | IFRS 3 includes a
concentration test that is similar to the
screen in ASC 805; however, its use is
optional. |
Definition of a business — substantive processes | Under ASC 805, an acquired contract (e.g., outsourcing arrangement) cannot provide a substantive process if the set does not have outputs. | IFRS 3 allows an acquired contract to be considered a substantive process even if the set does not have outputs if it provides access to an assembled workforce that performs a critical process that the entity controls. |
Noncontrolling
interests and
goodwill — initial
measurement | ASC 805 requires entities to recognize and
measure noncontrolling interests at fair
value. | Under IFRS 3, an entity must make an accounting policy election, on an
acquisition-by-acquisition basis, to measure a
noncontrolling interest either at (1) the noncontrolling
interest’s proportionate share of the net fair value of the
acquiree’s identifiable net assets (referred to as the
“proportionate share method”) or (2) fair value (i.e., the
“full goodwill” approach). The latter approach is consistent
with that in ASC 805. |
Assets and liabilities arising from revenue contracts
|
In October 2021, the FASB issued
ASU
2021-08, which requires entities to
measure assets and liabilities arising from revenue
contracts in accordance with ASC 606. See Section
4.3.13 for more information about the
accounting for contract assets and contract liabilities
after an entity adopts ASU 2021-08.
|
IFRS 3 does not have a similar fair value
measurement exception for contract assets and contract
liabilities.
|
Liabilities arising from contingencies (i.e., contingent liabilities under IFRS
Accounting Standards) — recognition and initial
measurement | Under ASC 805, a liability arising from a contingency is recognized at fair value, if determinable, as of the measurement (acquisition) date. If the fair value cannot be determined, the entity will recognize a liability if both (1) “[i]nformation available before the end of the measurement period indicates that it is probable that . . . a liability had been incurred at the acquisition date” and (2) the “amount of the . . . liability can be reasonably estimated.” | An entity recognizes a liability arising from a contingency at fair value if it (1) is a present obligation that results from a past event and (2) can be measured reliably. |
Assets arising from contingencies (i.e., contingent assets under IFRS Accounting
Standards) — recognition and initial measurement | Under ASC 805, an asset arising from a contingency is recognized at fair value, if determinable, as of the measurement (acquisition) date. If fair value cannot be determined, the entity will recognize an asset if both
(1) “[i]nformation available before the end of the
measurement period indicates that it is probable that an
asset existed . . . at the acquisition date” and (2) the
“amount of the asset . . . can be reasonably estimated.” | An entity is not permitted to recognize a contingent asset in a business combination. |
Liabilities arising from contingencies (i.e., contingent liabilities under IFRS
Accounting Standards) — subsequent measurement | There is no specific guidance in U.S. GAAP on subsequent measurement. ASC
805-20-35-3 requires entities to subsequently account for
liabilities arising from contingencies on a “systematic and
rational basis . . . depending on their nature.” See
Section 4.3.6.2
for more information. | An entity recognizes a contingent liability at the higher of:
|
Assets arising from contingencies (i.e., contingent assets under IFRS Accounting
Standards) — subsequent measurement | There is no specific guidance in U.S. GAAP on subsequent measurement. ASC 805-20-35-3 requires entities to subsequently account for assets arising from contingencies on a “systematic and rational basis . . . depending on their nature.” | Because an entity is not permitted to recognize a contingent asset in a business
combination under IFRS 3, subsequent measurement is not
applicable. After a business combination, recognition is
appropriate only when realization of the income is virtually
certain and, therefore, the related asset is no longer
contingent. |
Operating leases
(after the adoption
of ASC 842) | If the acquiree is the lessor in an operating
lease, the acquirer separately recognizes
an intangible asset or liability if the terms
of the lease are favorable or unfavorable,
respectively, relative to current market
terms. | As indicated in paragraph B42 of IFRS 3, if
the acquiree is the lessor in an operating
lease, any favorable or unfavorable terms
of the operating lease are recognized
as part of the fair value of the leased
asset (i.e., no separate asset or liability is
recognized), which is consistent with the
guidance in IAS 40. |
Operating leases
(before the adoption
of ASC 842) | Regardless of whether the acquiree is the
lessee or the lessor in an operating lease,
ASC 805 requires entities to separately
recognize an intangible asset or liability
if the terms of the lease are favorable
or unfavorable, respectively, relative to
current market terms. | As indicated in paragraph B42 of IFRS 3, if
the acquiree is the lessor in an operating
lease, any favorable or unfavorable terms
of the operating lease are recognized
as part of the fair value of the leased
asset (i.e., no separate asset or liability is
recognized), which is consistent with the
guidance in IAS 40. |
Deferred taxes
and uncertain tax
positions | ASC 805 requires entities to recognize and
measure deferred taxes and uncertain
tax positions in accordance with ASC 740,
which is not converged with IAS 12. | As indicated in paragraphs 24 and 25 of IFRS 3, entities must recognize and
measure deferred taxes and uncertain tax positions in
accordance with IAS 12, which is not converged with ASC 740. |
Employee benefits | Under ASC 805, entities must recognize and measure employee benefits in
accordance with existing standards (e.g., ASC 715), which
are not converged with IFRS Accounting Standards. | Paragraph 26 of IFRS 3 requires entities to
recognize and measure employee benefits
in accordance with IAS 19, which is not
converged with U.S. GAAP. |
Contingent
consideration —
initial classification | Entities must classify contingent consideration as a liability, equity, or an
asset in accordance with U.S. GAAP (e.g., ASC 480-10, ASC
815-10, ASC 815-40), which is not converged with IFRS
Accounting Standards. | Paragraph 40 of IFRS 3 requires entities to classify contingent consideration as
a liability, equity, or an asset in accordance with existing
IFRS Accounting Standards, such as IAS 32. Because U.S. GAAP
and IFRS Accounting Standards are not converged, differences
in the initial classification could lead to differences in
the subsequent accounting. |
Share-based
payment awards —
initial measurement | Entities must initially recognize and
measure share-based payment awards
in accordance with ASC 718, which is not
converged with IFRS 2. The two standards’
implementation guidance also differs. | Paragraphs 30 and B56–B62B of IFRS 3
require entities to initially recognize and
measure share-based payment awards
in accordance with IFRS 2, which is not
converged with ASC 718. Differences
between ASC 718 and IFRS 2 may lead to
differences in the accounting for share-based
payment awards. The two standards’
implementation guidance also differs. |
Measurement-period
adjustments | As a result of the amendments to
ASC 805 made by ASU 2015-16, an
acquirer must recognize adjustments to
provisional amounts identified during the
measurement period in the reporting
period in which the adjustments are
determined rather than retrospectively. | Paragraph 49 of IFRS 3 requires
adjustments to provisional amounts
identified during the measurement period
to be recognized on a retrospective basis
as if the accounting for the business
combination had been completed on the
acquisition date. |
Disclosure of pro
forma financial
information | Required for public entities only:
In accordance with ASC 805-10-50-2(h),
if comparative financial statements are
presented, the acquirer must disclose “the
revenue and earnings of the combined
entity . . . as though the business
combination(s) that occurred during
the current year had occurred as of the
beginning of the comparable prior annual
reporting period.” | Required for all entities: As indicated in paragraph B64(q) of IFRS
3, disclosure of revenue and profit or loss
of the combined entity for the comparable
prior period is not required even if
comparative financial statements are
presented. |
Disclosure of a gain
or loss recognized
after the acquisition
date related to the
identifiable assets
acquired | Under ASC 805, there is no disclosure
requirement for gains or losses recognized
in connection with identifiable assets
acquired in a business combination. | In accordance with paragraph B67(e)
of IFRS 3, an acquirer must disclose
“the amount and an explanation of any
gain or loss recognised in the current
reporting period that both: i. relates to the
identifiable assets acquired or liabilities
assumed in a business combination that
was effected in the current or previous
reporting period; and ii. is of such a size,
nature or incidence that disclosure is
relevant to understanding the combined
entity’s financial statements.” |
Pushdown
accounting | An acquired entity has the option to apply
pushdown accounting in its separate
financial statements. | IFRS Accounting Standards provide no authoritative guidance on the application
of pushdown accounting. In practice, IFRS preparers do not
apply pushdown accounting to the separate financial
statements of an acquiree. |
Common control | Businesses and net assets transferred between entities under common control are
generally recognized at their historical carrying amounts,
as reflected in the parent’s financial statements. | IFRS Accounting Standards provide no authoritative guidance on the accounting
for transfers of businesses between entities under common
control. In practice, entities can elect to apply either the
acquisition method or the predecessor’s historical cost.
However, the IASB has a research project on its agenda to
consider how to fill the gap in IFRS Accounting Standards on
the accounting for business combinations under common
control. The objective of the IASB’s project is “to explore
possible reporting requirements that would reduce the
diversity in practice and improve the transparency and
comparability of the reporting on such combinations.”
Practitioners should monitor this project for any
developments that might change the current accounting. |
Appendix F — Titles of Standards and Other Literature
Appendix F — Titles of Standards and Other Literature
AICPA Literature
Accounting and Valuation Guide
Assets Acquired to Be Used in Research and
Development Activities
Issues Papers
Identification and Discussion of Certain
Financial Accounting and Reporting Issues
Concerning LIFO Inventories
“Push
Down” Accounting
FASB Literature
ASC Topics
ASC 205,
Presentation of Financial Statements
ASC 250,
Accounting Changes and Error Corrections
ASC 260,
Earnings per Share
ASC 270,
Interim Reporting
ASC 280,
Segment Reporting
ASC 310,
Receivables
ASC 320,
Investments — Debt Securities
ASC 323,
Investments — Equity Method and Joint
Ventures
ASC 325,
Investments — Other
ASC 326,
Financial Instruments — Credit Losses
ASC 330,
Inventory
ASC 340,
Other Assets and Deferred Costs
ASC 350,
Intangibles — Goodwill and Other
ASC 360,
Property, Plant, and Equipment
ASC 405,
Liabilities
ASC 410,
Asset Retirement and Environmental
Obligations
ASC 420,
Exit or Disposal Cost Obligations
ASC 450,
Contingencies
ASC 460,
Guarantees
ASC 470,
Debt
ASC 480,
Distinguishing Liabilities From Equity
ASC 505,
Equity
ASC 605,
Revenue Recognition
ASC 606,
Revenue From Contracts With Customers
ASC 610,
Other Income
ASC 710,
Compensation — General
ASC 712,
Compensation — Nonretirement Postemployment
Benefits
ASC 715,
Compensation — Retirement Benefits
ASC 718,
Compensation — Stock Compensation
ASC 730,
Research and Development
ASC 740,
Income Taxes
ASC 805,
Business Combinations
ASC 810,
Consolidation
ASC 815,
Derivatives and Hedging
ASC 820,
Fair Value Measurement
ASC 825,
Financial Instruments
ASC 830,
Foreign Currency Matters
ASC 835,
Interest
ASC 840,
Leases
ASC 842,
Leases
ASC 845,
Nonmonetary Transactions
ASC 850,
Related Party Disclosures
ASC 852,
Reorganizations
ASC 855,
Subsequent Events
ASC 860,
Transfers and Servicing
ASC 930,
Extractive Activities — Mining
ASC 944,
Financial Services — Insurance
ASC 946,
Financial Services — Investment Companies
ASC 958,
Not-for-Profit Entities
ASC 960,
Plan Accounting — Defined Benefit Pension
Plans
ASC 965,
Plan Accounting — Health and Welfare Benefit
Plans
ASC 980,
Regulated Operations
ASUs
ASU
2013-12, Definition of a Public Business Entity —
An Addition to the Master Glossary
ASU
2014-02, Intangibles — Goodwill and Other (Topic
350): Accounting for Goodwill — a consensus of
the Private Company Council
ASU
2014-13, Consolidation (Topic 810): Measuring the
Financial Assets and the Financial Liabilities of
a Consolidated Collateralized Financing Entity
— a consensus of the FASB Emerging Issues Task Force
ASU
2014-17, Business Combinations (Topic 805):
Pushdown Accounting — a consensus of the FASB
Emerging Issues Task Force
ASU
2014-18, Business Combinations (Topic 805):
Accounting for Identifiable Intangible Assets in a
Business Combination — a consensus of the
Private Company Council
ASU
2015-02, Consolidation (Topic 810): Amendments to
the Consolidation Analysis
ASU
2015-03, Interest — Imputation of Interest
(Subtopic 835-30): Simplifying the Presentation of
Debt Issuance Costs
ASU
2015-08, Business Combinations (Topic 805):
Pushdown Accounting — Amendments to SEC Paragraphs
Pursuant to Staff Accounting Bulletin No. 115
(SEC Update)
ASU
2015-16, Business Combinations (Topic 805):
Simplifying the Accounting for Measurement-Period
Adjustments
ASU
2016-02, Leases (Topic 842)
ASU
2016-13, Financial Instruments — Credit Losses
(Topic 326): Measurement of Credit Losses on
Financial Instruments
ASU
2017-01, Business Combinations (Topic 805):
Clarifying the Definition of a Business
ASU
2018-07, Compensation — Stock Compensation (Topic
718): Improvements to Nonemployee Share-Based
Payment Accounting
ASU
2018-17, Consolidation (Topic 810): Targeted
Improvements to Related Party Guidance for
Variable Interest Entities
ASU
2019-06, Intangibles — Goodwill and Other (Topic
350), Business Combinations (Topic 805), and
Not-for-Profit Entities (Topic 958): Extending the
Private Company Accounting Alternatives on
Goodwill and Certain Identifiable Intangible
Assets to Not-for-Profit Entities
ASU 2020-06, Debt —
Debt With Conversion and Other Options (Subtopic
470-20) and Derivatives and Hedging — Contracts in
Entity’s Own Equity (Subtopic 815-40): Accounting
for Convertible Instruments and Contracts in an
Entity’s Own Equity
ASU 2021-08, Business
Combinations (Topic 805): Accounting for Contract
Assets and Contract Liabilities From Contracts
With Customers
ASU
2023-01, Leases (Topic 842): Common Control
Arrangements
ASU
2023-05, Business Combinations — Joint Venture
Formations (Subtopic 805-60): Recognition and
Initial Measurement
Proposed ASUs
No. 2023-ED200,
Intangibles — Goodwill and Other — Crypto Assets
(Subtopic 350-60): Accounting for and Disclosure of
Crypto Assets
No. 2023-ED400, Financial
Instruments — Credit Losses (Topic 326): Purchased
Financial Assets
Concepts StatementS
No. 5,
Recognition and Measurement in Financial
Statements of Business Enterprises
No. 8,
Conceptual Framework for Financial Reporting —
Chapter 4, Elements of Financial Statements
IFRS Literature
IFRS 2,
Share-Based Payment
IFRS 3,
Business Combinations
IFRS 10,
Consolidated Financial Statements
IFRS 15,
Revenue From Contracts With Customers
IAS 12,
Income Taxes
IAS 19,
Employee Benefits
IAS 32,
Financial Instruments: Presentation
IAS 40,
Investment Property
PCAOB Literature
Auditing Standard
AU
Section 558, Required Supplementary
Information
SEC Literature
FRM Topics
Topic 1,
“Registrant’s Financial Statements”
Topic 13, “Effects of Subsequent
Events on Financial Statements Required in Filings”
Regulation M-A
Item
1015, “Reports, Opinions, Appraisals and
Negotiations”
Regulation S-K
Item
601, “Exhibits”
-
Item 601(b), “Description of Exhibits”
Regulation S-X
Rule
1-02, “Definitions of Terms Used in Regulation S-X
(17 CFR part 210)”
-
Rule 1-02(w), “Significant Subsidiary”
Rule 3-01, “Consolidated
Balance Sheets”
Rule
3-05, “Financial Statements of Businesses Acquired
or to Be Acquired”
Rule
3-09, “Separate Financial Statements of Subsidiaries
Not Consolidated and 50 Percent or Less Owned
Persons”
Rule
3-14, “Special Instructions for Real Estate
Operations to Be Acquired”
Rule
4-08, “General Notes to the Financial Statements”
-
Rule 4-08(g), “Summarized Financial Information of Subsidiaries Not Consolidated and 50 Percent or Less Owned Persons”
Article
11, “Pro Forma Financial Information”
-
Rule 11-01, “Presentation Requirements”
SAB Topics
No. 1.B,
“Financial Statements; Allocation of Expenses and
Related Disclosure in Financial Statements of
Subsidiaries, Divisions or Lesser Business
Components of Another Entity”
-
No. 1.B.1, “Costs Reflected in Historical Financial Statements”
No. 2.A,
“Business Combinations; Acquisition Method”
-
No. 2.A.6, “Debt Issue Costs”
No. 5, “Miscellaneous
Accounting”
-
No. 5.A, “Expenses of Offering”
-
No. 5.J, “New Basis of Accounting Required in Certain Circumstances” (rescinded by SAB 115)
-
No. 5.L, “LIFO Inventory Practices”
-
No. 5.T, “Accounting for Expenses or Liabilities Paid by Principal Stockholder(s)”
-
No. 5.Y, “Accounting and Disclosures Relating to Loss Contingencies”
-
No. 5.Z, “Accounting and Disclosure Regarding Discontinued Operations”
-
No. 5.Z.7, “Accounting for the Spin-Off of a Subsidiary”
-
Securities Act of 1933 Rules
Rule
408, “Additional Information”
Rule
436, “Consents Required in Special Cases”
Superseded Literature
AICPA Accounting Principles Board (APB)
Opinion
16, Business Combinations
Opinion
18, The Equity Method of Accounting for
Investments in Common Stock
EITF Issues and Topics
Issue
No. 85-21, “Changes of Ownership Resulting in a New
Basis of Accounting”
Issue
No. 01-10, “Accounting for the Impact of the
Terrorist Attacks of September 11, 2001”
Issue
No. 02-5, “Definition of ‘Common Control’ in
Relation to FASB Statement No. 141”
Issue
No. 02-17, “Recognition of Customer Relationship
Intangible Assets Acquired in a Business
Combination”
Issue
No. 08-6, “Equity Method Investment Accounting
Considerations”
Issue
No. 08-7, “Accounting for Defensive Intangible
Assets”
Issue
No. 09-2, “Research and Development Assets Acquired
in an Asset Acquisition”
Topic
No. D-97, “Push-Down Accounting”
Topic
No. D-108, “Use of the Residual Method to Value
Acquired Assets Other Than Goodwill”
FASB Concepts Statement
No. 6, Elements of
Financial Statements — a replacement of FASB
Concepts Statement No. 3 (incorporating an amendment
of FASB Concepts Statement No. 2)
FASB Statements
No. 87,
Employers’ Accounting for Pensions
No. 106,
Employers’ Accounting for Postretirement
Benefits Other Than Pensions
No. 109,
Accounting for Income Taxes
No. 112,
Employers’ Accounting for Postemployment
Benefits — an amendment of FASB Statements No.
5 and 43
No. 133,
Accounting for Derivative Instruments and
Hedging Activities
No. 141,
Business Combinations
No.
141(R), Business Combinations
No. 142,
Goodwill and Other Intangible Assets
No. 160,
Noncontrolling Interests in Consolidated
Financial Statements — an amendment of ARB No.
51
FASB Interpretation
FIN 45,
Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others — an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34
FASB Staff Position (FSP)
FSP FAS
141(R)-1, Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That
Arise From Contingencies
FASB Technical Bulletin
No.
85-5, Issues Relating to Accounting for Business
Combinations
Appendix G — Abbreviations
Appendix G — Abbreviations
Abbreviation
|
Description
|
---|---|
AFS
|
available-for-sale
|
AICPA
|
American Institute of Certified Public
Accountants
|
APB
|
FASB Accounting Principles Board
|
APIC
|
additional paid-in capital
|
ARO
|
asset retirement obligation
|
ASC
|
FASB Accounting Standards Codification
|
ASU
|
FASB Accounting Standards Update
|
C&DI
|
SEC Compliance and Disclosure
Interpretation
|
CEO
|
chief executive officer
|
EBIT
|
earnings before interest and taxes
|
EBITDA
|
earnings before interest, taxes,
depreciation, and amortization
|
EITF
|
Emerging Issues Task Force
|
EPS
|
earnings per share
|
FASB
|
Financial Accounting Standards Board
|
FCC
|
Federal Communications Commission
|
FDA
|
U.S. Food and Drug Administration
|
FIFO
|
first in, first out
|
FRM
|
SEC Division of Corporation Finance’s
Financial Reporting Manual
|
FSP
|
FASB Statement of Position
|
FTB
|
FASB Technical Bulletin
|
GAAP
|
generally accepted accounting principles
|
IAS
|
International Accounting Standard
|
IASB
|
International Accounting Standards Board
|
IFRS
|
International Financial Reporting
Standard
|
IPO
|
initial public offering
|
IPR&D
|
in-process research and development
|
LIFO
|
last in, first out
|
MD&A
|
Management’s Discussion and Analysis
|
MLP
|
master limited partnership
|
NFP
|
not-for-profit
|
OPEB
|
other postemployment benefits
|
OCA
|
SEC Office of the Chief Accountant
|
PBE
|
public business entity
|
PCAOB
|
Public Company Accounting Oversight
Board
|
PCC
|
Private Company Council
|
PCD asset
|
purchased credit-deteriorated asset
|
PP&E
|
property, plant, and equipment
|
R&D
|
research and development
|
ROU
|
right of use
|
S&P 500 Index
|
Standard and Poor’s 500 stock market index
|
SAB
|
SEC Staff Accounting Bulletin
|
SEC
|
U.S. Securities and Exchange Commission
|
SFAS
|
Statement of Financial Accounting
Standards
|
SPAC
|
special-purpose acquisition company
|
TSA
|
transition services agreement
|
VBPP
|
value beyond proven and probable
reserves
|
VIE
|
variable interest entity
|
VRG
|
FASB’s Valuation Resource Group
|
Appendix H — Roadmap Updates for 2023
Appendix H — Roadmap Updates for 2023
The tables below summarize the
substantive changes made in the 2023 edition of this Roadmap.
New Content
Section
|
Title
|
Description
|
---|---|---|
Digital Assets
|
Added section to clarify that in a business
combination, acquired digital assets classified as
intangible assets, as well as digital assets that meet the
definition of a financial asset, are typically recognized
and measured at fair value as of the acquisition date.
| |
Call Options to Acquire a Controlling
Interest in a Business
|
Added section to clarify that, generally, an
acquirer should account for a freestanding 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 upon exercise.
| |
Pushdown Accounting for an Asset Acquisition
|
Added section to clarify that it may be
acceptable to apply or elect pushdown accounting for an
asset acquisition.
| |
Identifying the Receiving Entity in a Common Control
Transaction
|
Added discussion of considerations in identifying the
receiving entity in a common control transaction.
|
Amended Content
Section
|
Title
|
Description
|
---|---|---|
Updated to note the FASB’s recently issued
guidance in ASU 2023-05 on joint venture formations and its
recently proposed ASU on purchased financial assets.
| ||
Transactions Outside the Scope of ASC
805-10, ASC 805-20, and ASC 805-30
|
Added a Changing Lanes discussion
summarizing the FASB’s newly issued ASU 2023-05, which
provides guidance on the recognition and initial measurement
of joint venture formations.
| |
Step 2 — Combine the Assets Into Similar
Assets
|
Updated to clarify that an entity should
consider the definition of an intangible asset class as well
as its ASC 350-30 disclosures when assessing its major
classes of assets in the application of the screen test.
| |
Composition of the Governing Body of the
Combined Entity
|
Expanded discussion of special
considerations in circumstances in which the composition of
the combined entity's governing body is required to include
certain independent directors. Also added Example 3-1 to
illustrate the consideration of independent directors. All
subsequent examples were renumbered.
| |
Recognition and Measurement Principles
|
Added a Changing Lanes discussion of the FASB’s issuance of Concepts Statement 8, Chapter 4, which supersedes Concepts Statement 6 and includes new definitions
of elements of financial statements, including definitions
of assets and liabilities.
| |
Purchased Financial Assets — After Adoption
of 2016-13
|
Added a Changing Lanes discussion of the
FASB’s proposed ASU that would amend the guidance in ASU
2016-13 on the accounting upon the acquisition of financial
assets acquired in (1) a business combination, (2) an asset
acquisition, or (3) the consolidation of a VIE that is not a
business.
| |
Change in the Reporting Entity
|
Clarified that when determining whether a
change in the reporting entity has occurred, entities should
assess the substance of the transaction.
| |
Identifying the Predecessor in Certain
Common Control Transactions
|
Clarified that if additional periods are
required in an SEC filing for periods before the entities
were under common control, SEC Regulation S-X requires the
registrant to determine which entity’s financial statements
should be presented as the predecessor.
| |
Financial Statement Presentation by the
Transferring Entity
|
Clarified that a transferring entity should
consider whether a common control transaction indicates that
long-lived assets (asset group) to be transferred should be
tested for impairment before the disposal date.
| |
Summary of Significant Differences Between the Accounting for
a Business Combination and the Accounting for an Asset
Acquisition
|
Updated table to clarify treatment of
contingent consideration in an asset acquisition.
| |
Scope
|
Expanded discussion of factors to consider in a reverse asset
acquisition, including the indicators in ASC 805-10-55, in
certain circumstances. Added Example C-1 to illustrate a
reverse asset acquisition. All subsequent examples were
renumbered.
| |
Contingent Consideration
|
Clarified that it would be acceptable for an entity to
account for contingent consideration in an asset acquisition
under a probable and reasonably estimable approach or when
the contingency is resolved approach.
| |
Purchased Financial Assets — After Adoption of ASU
2016-13
|
Added a Changing Lanes discussion of the FASB’s proposed ASU
that would amend the guidance in ASU 2016-13 on the
accounting upon the acquisition of financial assets acquired
in (1) a business combination, (2) an asset acquisition, or
(3) the consolidation of a VIE that is not a business.
|