On the Radar
Business Combinations
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.
In special-purpose
acquisition company (SPAC) transactions, private
operating companies (“targets”) raise 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.
On January 24, 2024,
the SEC issued a final rule on
financial reporting and disclosures for SPACs that
aims to “enhance investor protections in [IPOs] by
[SPACs] and in subsequent business combination
transactions between SPACs and [target]
companies.”
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
In October 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, as amended by ASU 2023-05, defines goodwill as “[a]n
asset representing the future economic benefits arising from other assets
acquired in a business combination, acquired in an acquisition by a
not-for-profit entity, or recognized by a joint venture upon formation 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
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.
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. 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.
Deloitte’s Roadmap Business Combinations 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
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Matt Himmelman
Audit &
Assurance
Partner
Deloitte &
Touche LLP
+1 714 436
7277
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James Webb
Audit &
Assurance
Partner
Deloitte &
Touche LLP
+1 415 783
4586
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For information about Deloitte’s
service offerings related to business combinations, please contact:
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Emily Matthews
Audit &
Assurance
Senior Manager
Deloitte &
Touche LLP
+1 213 553
1340
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