ASC 805 Business Combinations
A Refresher
March 24, 2015
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Agenda
Basic concepts in accounting for business
combinations
⸗ Applying the acquisition model
⸗ Recent developments in accounting
⸗ Considerations to structuring a transaction
⸗ Other considerations
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Basic Concepts
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Basic Concepts
⸗ Business combination vs asset acquisition
⸗ Definition of a business – ASC Section 805-10-55
⸗ Examples
Producing properties within oil & gas industry
⸗ Consumer product operations
⸗ Hotel
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⸗ Identification of the acquirer
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“Controlling financial interest” – ASC Subtopic 810-10
Additional factors – ASC Section 805-10-55
⸗ Acquisition and measurement date
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The date control is obtained
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Basic Concepts
Dry Well Company is an oil and gas exploration and
production company that owns a proven but undeveloped
property. Dry Well Co. has performed enough exploration
activities to determine that the property is proven, but has
not yet begun to extract the mineral reserves from the
property.
Additionally, Dry Well Co. has constructed transportation
infrastructure that will be used to transport the mineral
reserves. However, this infrastructure has not yet been
placed into operation. Success Oil Co. is an oil and gas
production company that operates a large portfolio of
producing properties. Success Oil Co. acquires Dry Well
Co.
Acquisition of Business or Group of Assets?
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Basic Concepts
Consumerco manufactures and distributes a
number of nutritional products and brands. One of
the products it manufactures and sells is a weightloss drink. Acquisition Co. acquires the weightloss drink brand and its formulation from
Consumerco, including customer relationships and
hires certain employees, but does not acquire any
of the manufacturing capabilities. Instead,
Acquisition Co. contracts with a third-party copacker to manufacture the product on behalf of
Acquisition Co.
Acquisition of Business or Group of Assets?
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Basic Concepts
⸗ Transaction costs
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Expense as incurred
Debt and equity issuance costs are capitalized when
permitted by other GAAP
⸗ Contingent consideration
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Generally measured at fair value initially and
subsequently
⸗ Equity vs liability classification
⸗ Examples
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Earn-outs
Other performance based payouts
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Basic Concepts
“Step” acquisitions
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Partial Acquisition—Control is Obtained, but Less than
100 Percent of Business is Acquired
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Step Acquisition—Control is Obtained where there is a
Previously Held Equity Interest
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Additional Interest Obtained—Control is Maintained
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Basic Concepts
⸗ Bargain purchases
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If the net assets acquired exceed the purchase price,
recognize a bargain purchase gain
While permitted, such gains are expected to be rare
should usually have an identifiable cause for the
circumstance
⸗ Purchase price allocation
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Replaced by acquisition method
No longer an “allocation” of the purchase price
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Applying the Acquisition Model
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Applying the Acquisition Model
Identify assets acquired and liabilities assumed
Assets acquired and liabilities assumed are
generally measured at fair value
⸗ Certain exceptions (ASC Section 805-20-30)
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Income taxes
Employee benefits
Indemnification assets
Reacquired rights
Share-based payment awards
Assets held for sale
Certain assets and liabilities arising from contingencies
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Applying the Acquisition Model
Identify assets acquired and liabilities assumed
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Recognize intangible assets
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Contingencies (ASC Sections 805-20-25 and 805-2030)
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An intangible asset is identifiable if it meets either the
separability criterion or the contractual-legal criterion
Recognize if:
⸗ Acquisition date fair value can be determined during the
measurement period
⸗ Probable that an asset or liability existed at acquisition
date, and the amount can be reasonably estimated
⸗ Initial measurement at fair value
Indemnification assets
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Applying the Acquisition Model
Purchase consideration
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Fair value of consideration transferred
Cash
Equity issuance
Contingent consideration
Other assets or instruments transferred
Noncontrolling interest
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Recognize and initially measure at fair value
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Applying the Acquisition Model
Goodwill or bargain purchase gain
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Residual of purchase consideration plus noncontrolling
interest less the fair value of net assets acquired
Bargain purchase gains are rareA should be a reason
Measurement period
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Ends upon receipt of the necessary facts and
circumstances that existed as of the acquisition date
Maximum of one year
Disclosure of provisional accounting
Adjustments to provisional amounts are retrospective
and require restatement
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Applying the Acquisition Model
Example intangible assets to recognize
⸗ Common intangible assets:
Contractual customer relationships
Trademarks, or trade names
Leases (or other contracts) with favorable or unfavorable
terms compared to current market transactions
⸗ Non compete agreements
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Less common intangible assets:
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Lease contracts at market terms
For example, asset management contracts
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Applying the Acquisition Model
Other items to consider
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What is part of the business combination and what is
a separate transaction?
Principle to apply: Does the transaction benefit the acquirer
or post-combination entity? (ASC Section 805-10-25)
⸗ Examples
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Integration (or other) costs paid by the acquiree
Debt refinancing/retirements
Pre-existing contracts or other relationships
Compensation of employees or former owners for future
service
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Applying the Acquisition Model
Other items to consider
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Taxes
Same principle as overall deferred income tax principle –
recognize temporary differences between book and tax
basis as deferred tax asset or liability
⸗ Taxable vs nontaxable transactions
⸗ Income tax allocation of purchase price may differ from
financial reporting (book) allocation
⸗ Similar to other acquisition accounting adjustments,
changes in valuation allowances or deferred taxes are
recognized in the income statement after the measurement
period closes and for event that arise after the acquisition
date
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Applying the Acquisition Model
Potential resource needs:
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Valuation or appraisal professional
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How complex is the transaction?
How much internal expertise?
Accounting advisors / consultants
Advising on inputs, methodologies and judgments in preparation
for audit by external auditors
⸗ Assistance with purchase accounting including disclosure
requirements
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Other professionals
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Tax accountants
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Type of combination
NOL limitation study
Stock option and other incentive plans or payments
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Recent Developments in Accounting
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Recent Developments
⸗ Accounting
for Goodwill & Intangible
Assets
⸗ Reporting
Discontinued Operations (new
standard)
⸗ Pushdown
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Accounting
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Considerations in Structuring a
Transaction
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Considerations
Compensation arrangements
⸗ Contingent consideration payments that are
automatically forfeited if employment
terminates is considered compensation
expense (ASC 805-10-25)
⸗ Share-based payments (ASC 805-30-30)
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Generally treated as replacement awards (similar
to modification accounting)
Consider fair value of old and new award, vesting
conditions, service provided
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Considerations
Compensation arrangements
⸗ Retention or severance payments
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What’s the context of the arrangement?
Which entity initiated and is benefiting from the
transaction?
⸗ Examples
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Executive severance payment as part of a preexisting employment agreement
Staff employee severance payment to continue
through the acquisition date
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Considerations
Example 3
ABC Co., an east coast maker of widgets, decides to
expand its market by acquiring a west coast widget
maker for $10 million cash plus an additional cash
payment if certain volume and profitability targets are
met at the end of year 2. The west coast widget
maker’s sole owner (and CEO) will be employed by
the post-acquisition entity as president of the west
coast division.
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Considerations
Scenario 1:
The terms of the additional payment require the former
owner/CEO of the west coast widget maker to be
employed at the newly formed division to earn the
consideration.
Analysis and Answer: The requirement for the former
owner/CEO to be employed to receive the payment
precludes it from being contingent consideration. The
expense associated with the payment is recognized as
compensation expense in the post-acquisition period.
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Considerations
Scenario 2:
The terms of the additional payment permit the former
owner/CEO of the west coast widget maker to be paid
regardless of his employment status.
Analysis and Answer: The payment is likely
considered contingent consideration. The acquirer
would also need to analyze factors such as the former
owner’s compensation level and whether the payment
is linked to the valuation.
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Considerations
Other areas to consider:
⸗ Indemnifications
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How should a buyer account for an indemnification
from the seller when the indemnified item has not
met the criteria to be recognized on the acquisition
date?
Answer: If the indemnified item has not met the
recognition criteria as of the acquisition date, an
indemnification asset should not be recognized.
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Considerations
Business combination presentation and disclosure
When to report
⸗ General disclosures
⸗ Other disclosures
⸗ Consideration transferred
⸗ Contingent consideration and indemnification
assets
⸗ Acquired receivables
⸗ Condensed balance sheet
⸗ Other
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Considerations
SEC Considerations
⸗ Acquiree financial statements and significance test
⸗ Pro forma financial statements
⸗ 8-K’s
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Considerations
Reporting units and goodwill impairment
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Goodwill is assigned to a reporting unit
Tested annually for impairment
o
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Qualitative assessment
Quantitative assessment
Internal control considerations
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Merger and acquisition activities
Target business’ internal controls
⸗ First year exception for SOX compliance
Controls over acquisition accounting and
consolidations
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Other Considerations
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Other Considerations
Acquisition Integration
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Overlooked part of the business combination
process
Most business combinations fail to meet
expectations
Integration plans can be minimal or robust
Integration plans have many owners
Key steps to successful integration
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Other Considerations
Valuations
The standard of value for business combinations in accordance with
ASC 805 is Fair value (as defined by ASC 820, Fair Value
Measurements):
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The price that would be received to sell an asset or paid to transfer a
liability (exit price) in an orderly transaction between market
participants at the measurement date. (ASC 820-10-35-2)
⸗ A fair value measurement assumes that the transaction to sell
the asset or transfer the liability takes place either in the principal
market or most advantageous market. (ASC 820-10-35-5)
⸗ In all cases, a reporting entity shall maximize the use of relevant
observable inputs and minimize the use of unobservable inputs
to meet the objective of a fair value measurement. (ASC 820-1035-16AA)
⸗ In many cases, the transaction price (entry price) will equal the
fair value (exit price). (ASC 820-10-30-3)
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Other Considerations
Valuations
Fair value framework:
In-Use Premise
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The highest and best use of a nonfinancial asset might provide
maximum value to market participants through its use in
combination with other assets as a group (as installed or otherwise
configured for use) or in combination with other assets and
liabilities (for example, a business). (ASC 820-10-35-10Ea)
In-Exchange Premise
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The highest and best use of a nonfinancial asset might provide
maximum value to market participants on a standalone basis. If the
highest and best use of the asset is to use it on a standalone basis,
the fair value of the asset is the price that would be received in a
current transaction to sell the asset to market participants that
would use the asset on a standalone basis). (ASC 820-10-3510Eb)
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Other Considerations
Valuations
Use of Third-Party Specialists
⸗ Many companies engage third-party specialists, or subject
matter experts, to assist with the fair value determinations.
⸗ Auditors will typically perform the following procedures:
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Evaluate the specialist’s professional credentials (MAI,
licensed appraiser)
Assess the specialist’s professional reputation
Assess the validity, completeness, and accuracy of the
specialist’s work
Maintain controls to ensure that complete and accurate data
is provided to the specialist and that the specialist’s findings
are reviewed and approved
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