Chapter 2 — Financial Statement Accounting and Disclosure Topics

2.1 Business Combinations

The SEC staff’s comments about business combinations continue to focus on (1) the evaluation of whether a transaction should be accounted for as a business combination or an asset acquisition, (2) the identification of the accounting acquirer, (3) questions about the allocation of the consideration transferred to identified assets acquired and liabilities assumed, (4) accounting for any contingent consideration, and (5) required disclosures.

2.1.1 Business Combination Versus Asset Acquisition

Examples of SEC Comments

We note that you acquired [Company A] with one drug candidate for which IPR&D of $[X] million was recognized compared to the purchase price of $[Y] million. Please address each of the following:
- Provide us with your analysis of the guidance in ASC 805-10-55-5A through 55-5C, including the calculation of the screen test.
- To the extent that you are able to demonstrate the screen test is not met, provide us with your analysis of [A] meeting the definition of a business based on the guidance in ASC 805-10-55.
We understand . . . that you believe the [Company A] acquisition did not qualify as a business acquisition based on the guidance in FASB ASC 805-10-55-5A, and that you plan to revise your accounting and disclosures to reflect the transaction as an asset acquisition rather than a business acquisition.

However, given your valuation of the consideration and the value ascribed to the property, it appears the value of the property would represent about 68% of the fair value of the gross assets acquired, based on the purchase price allocation shown in the . . . Form 10-Q that you filed . . . .

Please explain to us how you concluded that such value would be properly regarded as substantially all of the fair value of the gross assets acquired, if this is your view. Based on the information that you have disclosed, it appears that you should continue your analysis of the criteria in FASB ASC 805-10-55-3A through 9 in determining whether the transaction should be reported as a business acquisition or an asset acquisition.
You recorded the February and December . . . acquisitions as asset acquisitions. Please tell us, for each acquisition, why you believe the acquisitions are not required to be recorded as an acquisition of a business pursuant to ASU 2017-01. In this [regard], please specifically address the following:
- As it appears you acquired both tangible and intangible assets in the February acquisitions and the December acquisition appears to relate to assets with significantly different risks, please confirm our understanding that the acquisitions did not meet the “practical screen” in ASC 805-10-55-5A through 55-5C as the term is used in ASC 805-10-55-5. Refer also to the example in ASC 805-10-55-68.
- Please address each of the criteria in ASC 805-10-55-5E in determining whether or not a substantive process was acquired, that together with the input acquired, significantly contribute to the ability to create outputs.

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 of assets or of 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 and are expected to result in a reduction in the number of transactions identified as business acquisitions.

ASU 2017-01 introduced 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 is concentrated in a single identifiable asset or group of similar identifiable assets. In accordance with the ASU, 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.” If such a concentration is not found, the screen is not met, and entities must then apply a framework to determine whether the set is a business. Under the framework, a set is considered to be a business if it includes an input and a substantive process that together significantly contribute to the ability to create outputs.

The SEC staff has asked registrants to provide their analysis regarding their conclusion about whether an acquisition meets the definition of a business under ASC 805-10. The correct determination of the nature of the acquisition is critical because there are significant differences between the accounting for a business combination and the accounting for an asset acquisition.

2.1.2 Determining the Accounting Acquirer

Examples of SEC Comments

Please tell us how you determined you were the accounting acquirer in the merger with [Company A] citing authoritative literature that supports your conclusion. Refer to ASC 805-10-25-5 and 805-10-55-11 through 55-15. Among other relevant considerations, please tell us how you considered that [A] shareholders were issued [X million] shares representing 61% of outstanding shares immediately after the acquisition.
We note . . . that upon the completion of the Merger, former [Company A] shareholders own approximately 48.8% of the Surviving Corporation on a fully diluted basis and former [Company B] stockholders hold approximately 51.2% of the Surviving Corporation on a fully diluted basis . . . . We also note you concluded that [Company A] is the accounting acquirer. Please provide us the analysis you performed in making this determination, including your consideration of all of the facts and circumstances outlined in ASC 805-10-55-12 through 55-15.
We note your disclosure that [Company A] was determined to be the accounting acquirer. Please tell us the specific key facts and circumstances related to [A, Company B, and Company C] and how you applied the guidance in ASC 805-10-55-10 through 55-13 in making your determination.

The SEC staff may ask registrants for the analysis on how they determined the accounting acquirer when it is not clear which entity obtained control in accordance with ASC 810.1 For example, the staff may ask registrants to explain how they considered the additional factors in ASC 805-10-55-10 through 55-15 in determining the accounting acquirer if the relative ownership interests held by each party are close to 50 percent or if the entity identified as the acquirer obtained less than 50 percent of the ownership interests in the combined entity. Identification of the acquirer may require the exercise of considerable judgment, and a registrant’s response should include its consideration of all pertinent facts and circumstances as of the acquisition date. The staff may also ask similar questions regarding a probable business combination that is reflected in pro forma financial statements.

2.1.3 Assigning Amounts to Assets and Liabilities

Examples of SEC Comments

Other than for the intangible assets, it appears that you have prepared the allocation of the consideration to the assets acquired and liabilities assumed based on . . . historical carrying values rather than the estimated fair values in accordance with ASC 805-20-30. Please revise the purchase price allocation to include estimates of fair value. Also provide a description of the assumptions used to estimate material assets and liabilities at fair value. Refer to ASC 805-20-50-1 for the required disclosures.
You disclose . . . that you acquired the legal rights, permits, licenses and assets of [various entities]. However, it appears the purchase prices were allocated entirely to licenses. Please tell us why the purchase prices were not allocated to other assets and/or liabilities acquired.
We note your acquisition of [Entity B] and Subsidiaries and your disclosure that it will expand your [product offering] in North America and allow you to diversify your business, leverage your distribution network and infrastructure and increase your market reach. Additionally, you stated the transaction is expected to provide synergies, enhancing your ability to better serve your combined customers’ needs for healthier products. Given the magnitude of the amount of goodwill recognized, please explain further the specific synergies you identified, relative magnitude of each, and consideration for including such discussion in your disclosures. Also, please explain to us in performing the purchase price allocation, how you evaluated the purchase for the existence of any other intangible assets.

The SEC staff frequently asks registrants about their determinations regarding the amounts assigned 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. In addition, the staff may ask detailed questions about how a registrant determined (1) that intangible assets have indefinite useful lives rather than finite lives and (2) the useful lives of finite-lived intangible assets.

The staff may also ask detailed questions about material revisions to the initial accounting for a business combination, including what significant assumptions have changed to support a revision to the value of acquired assets. For example, the staff may ask a registrant the reasons that led to the recognition of a significant amount of intangible assets during the measurement period if no amount, or only an insignificant amount, of intangible assets was recognized as part of the initial accounting for the business combination.

Further, if a registrant sold a recently acquired asset and recognized a significant gain on the sale, the staff may request information about how the registrant determined the fair value of that asset.

2.1.4 Contingent Consideration

Example of an SEC Comment

With respect to the contingent consideration in the arrangement, please respond to the following:

Describe to us the arrangement and the basis for determining the amount of the payment.
Provide us an estimate of the range of outcomes (undiscounted) or, if a range cannot be estimated, tell us the reasons why. If the maximum amount of the payment is unlimited, please explain why.
Revise future filings to provide all of the disclosures required by ASC 805-30-50-1(c). Refer to Example 5 in ASC 805-10-55-37.

The SEC staff may ask registrants to provide additional disclosures about the nature and terms of a contingent consideration arrangement and the conditions that must be met for the arrangement to become payable. Since ASC 805 requires entities to recognize contingent consideration at fair value as of the acquisition date, the staff may ask registrants to disclose how they determined the fair value of the contingent consideration. In addition, the staff may ask whether the change in the fair value of contingent consideration should be reflected as an adjustment to the amount of goodwill (i.e., if the adjustment is due to new information obtained during the measurement period about facts or circumstances that existed as of the acquisition date) or in current earnings. The staff may also ask registrants to disclose the total amount of contingent consideration that could become payable under the terms of the arrangement.

2.1.5 Disclosures

Examples of SEC Comments

We note you completed the acquisition of [Company A] in July [202X]. Please tell us how you considered the disclosure requirements of ASC 805-10-50-2(h) and revise your future periodic filings to include all the required disclosures as applicable including, for instance, the supplemental pro forma information.
We note your disclosure of various acquisitions that the Company has completed during [year 2] and [year 1]. In your future filings, please expand to include all disclosures required by ASC 805-10-50. For example, we refer you to the requirements to disclose acquisition-related costs in accordance with ASC 805-10-50-2(f), as well as amounts of revenue and earnings of the acquiree since the acquisition date and supplemental pro forma information in accordance with ASC 805-10-50-2(h).
Please clarify for us why you were not able to provide the pro forma information for each of the . . . acquisitions pursuant to ASC 805-10-50-2.h.3 which is based on historical information prior to the acquisitions.
The acquisitions of [Entity A] in [year 1] represented approximately [A]% of total assets at June 30, [year 1] and [Entity B] in [year 2] represented approximately [B]% of total assets at December 31, [year 1]. You disclose each acquisition as a factor affecting the variance in results in the applicable periods affected without quantifying the impact of each. You disclose you did not present the pro forma results of the acquisitions because you believe they are not material to your results. Also, you did not disclose the revenue and earnings of each acquiree since the acquisition date included in your consolidated statement of earnings for the applicable periods. Please explain to us your analysis of ASC 805-10-50-2.h.1 and 3 in the preparation of your disclosures. Quantify for us the impact each acquisition had on your results for [year 1] and through June 30, [year 2], as appropriate, as a variance factor and in regard to the amount of revenue and earnings included in the consolidated statement of earnings.
We note your statement . . . that pro forma disclosures were not included as the “impact to the Company’s results of operations [was] not material.” In this regard, we note that the purchase price of $[X] million was material to your balance sheet. Please demonstrate why the impact to the results of operations was not material or alternatively, revise to include the information. In addition, revise to include the amounts of revenue and earnings of the acquiree in accordance with ASC 805-10-50-2.h.1.

ASC 805-10-50-2(h) requires the following disclosures when comparative financial statements are presented, unless disclosure of such information is impracticable:

“The amounts of revenue and earnings of the acquiree since the acquisition date included in the consolidated income statement for the reporting period.”
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).”
“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 ASC 805-10-50-2(h) is impracticable, the registrant must disclose that fact and why the otherwise required disclosure is impracticable.

The SEC staff has commented when a registrant fails to provide pro forma disclosures under ASC 805-10-50. The staff may also ask a registrant to clarify how it determined that disclosure of some or all of the information required by ASC 805-10-50-2(h) is impracticable since use of the impracticability exception is expected to be infrequent.

If certain criteria are met (e.g., if a significant business combination has occurred or is probable), registrants may also be required to (1) comply with Regulation S-X, Rule 3-05, and (2) provide pro forma financial information that complies with Regulation S-X, Article 11, in a registration statement, proxy statement, or Form 8-K. For additional information about significant business acquisitions, see Section 3.2.2.

In addition to inquiring about pro forma disclosures, the SEC staff has asked registrants:

To indicate the item or items for which the measurement period is still open.
To disclose the amount and the income statement classification of acquisition-related costs they incurred (e.g., due diligence fees, legal fees).
Whether individually immaterial acquisitions are collectively material, in which case the registrants would be required to disclose certain information.
Whether a transaction is considered to be an acquisition of an entity under common control.

Other Deloitte Resources

Roadmap, Business Combinations

Footnotes

ASC 810 indicates that one entity controls another if it holds a “controlling financial interest.” In addition, ASC 810 prescribes criteria for determining which entity has obtained control.