An increase in merger and acquisition activity in recent years has highlighted the need for private companies to understand how to account for the business combinations they pursue. There are an assortment of reasons why a company may seek a business combination, like strategic needs to achieve synergy, to increase revenue or market share, to expand into other locations or lines of services, or to achieve economies of scale, to name a few.
Accounting Standards Codification (ASC) 805, “Business Combinations,” which provides guidance in accounting for business combinations, can be challenging to navigate. In this three-part series, we will highlight key elements of the guidance to be aware of, covering:
- Part 1 – Business combinations – An overview for private companies
- Part 2 – Identifying a business combination or asset acquisition using the screen test
- Part 3 – Private company alternatives to goodwill and business combinations
ASC 805: An overview
ASC 805 discusses accounting for a business combination using the acquisition method. Read on for a summary and brief description of the key elements of the acquisition method.
- Identifying the acquirer – The Glossary of ASC 805 defines the acquirer as “the entity that obtains control of the acquiree” in a business combination. To determine the acquirer, the primary guidance to follow is ASC 810, “Consolidation,” which provides guidance related to identifying the entity that obtains financial control. Generally, the entity that directly or indirectly holds greater than 50% of the voting shares has control. If the acquiree is a variable interest entity (VIE) and meets the definition of a business, then the entity considered to be the primary beneficiary of the VIE is the acquirer. ASC 805 provides additional guidance for identifying an acquirer that should be considered if, after ASC 810 is considered, it is not clear which entity is the acquirer.
- Determining the acquisition date – The acquisition date is when control is obtained by the acquirer, which is usually when consideration is transferred, the assets are acquired, and liabilities assumed – also referred to as the closing date. The acquisition date is the measurement date of when the acquired assets and liabilities are recorded. According to ASC 805, the acquisition date can also be 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.” Consideration of all relevant facts and circumstances is needed to properly identify the acquisition date.
- Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree – When applying ASC 805, an acquirer will recognize the identifiable assets acquired (both tangible and intangible), liabilities assumed, and any noncontrolling interest in the acquiree separately from goodwill, and measure them at their acquisition-date fair values. Depending on the complexity of the entity, its assets acquired and liabilities assumed, acquirers should consider whether a valuation specialist is needed to assist with the determination of and concluding on acquisition-related fair value measurements.
- Recognizing and measuring goodwill or a gain from a bargain purchase – Simply, goodwill is the difference between the purchase price and the fair value of the assets acquired and the liabilities assumed – goodwill is the residual asset. A bargain purchase occurs in rare circumstances when the purchase price is less than the fair value of the assets acquired and the liabilities assumed – essentially, the acquirer purchased the acquiree for a price less than the fair market value of its net assets. ASC 805-30-25-4 indicates that before recognizing a gain on a bargain purchase, the acquirer should reassess whether it has correctly identified all of the acquired assets or assumed liabilities to confirm that the conclusion of a bargain purchase gain is accurate. We will discuss private company alternatives related to a private entity’s accounting for goodwill in Part 3 of this series.
The acquisition method has many aspects to consider when accounting for a business combination. Management should understand the complete facts and circumstances of the business they acquired to appropriately apply the accounting guidance. In addition, valuation specialists will most likely be needed to assist management in determining the fair value of the net assets acquired. Understanding ASC 805 and the acquisition method will provide management the tools needed to appropriately account for and provide effective financial statement disclosures related to a business combination.
Click to continue on to our next article in this series, in which we discuss the framework for identifying a business combination compared to an asset acquisition.
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CPA, Partner - National Accounting
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