Business Combinations

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 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. Before adoption of ASU 2025-03, the ASC master glossary defines an acquirer as follows:

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, when a business combination is effected primarily by exchanging equity interests, the determination of which entity is the acquirer requires careful evaluation of the relevant facts and circumstances. In some cases, 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

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. 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.

 

Changing Lanes

On May 12, 2025, the FASB issued ASU 2025-03, which revises the guidance in ASC 805 on identifying the accounting acquirer in a business combination in which the legal acquiree is a VIE. The ASU is intended to improve comparability between business combinations that involve VIEs and those that do not.

Before adoption of ASU 2025-03, ASC 805-10-25-5 states that in a business combination in which a VIE is acquired, the primary beneficiary of the legal acquiree is always the accounting acquirer. Conversely, for a business combination in which the acquired entity is determined not to be a VIE and it is not clear which of the combining entities is the acquirer after applying the voting interest entity (VOE) model, a reporting entity is required to consider the factors in ASC 805-10-55-11 through 55-15 when determining which legal entity is the accounting acquirer. As a result, in an acquisition transaction effected primarily by exchanging equity interests, a reporting entity may reach different conclusions related to determining the accounting acquirer in a business combination involving a legal acquiree that is a VIE than in a combination in which the legal acquiree is a VOE. That is, having considered the factors in ASC 805-10-55-12 through 55-15, a reporting entity might not identify the primary beneficiary of the legal acquiree that is a VIE as the accounting acquirer of the combining entities.

The identification of the accounting acquirer establishes which entity in the business combination will have its assets and liabilities remeasured in accordance with ASC 805-20 (generally at fair value) and creates a new basis of accounting. Accordingly, the comparability of similar transactions under existing GAAP can be greatly affected by the structure of the legal acquiree and whether such entity qualifies as a VIE or a VOE.

ASU 2025-03 is effective for fiscal years beginning after December 15, 2026, including interim periods within those fiscal years. Early adoption is permitted. The amendments in ASU 2025-03 must be applied prospectively to any business combination that occurs after the initial adoption date.

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.

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.”