Business Combinations Under ASC 805
Accounting for business combinations can be complex. Make sure you get it right using BDO's "Blueprint" publication.
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BDO's Blueprint publication guides professionals through the application of the FASB’s Accounting Standards Codification Topic 805, Business Combinations (“ASC 805”). Summarizing key aspects of ASC 805, this Blueprint provides guidance with respect to accounting for business combinations. It includes practical examples and interpretive guidance to assist companies and practitioners in their continued application of ASC 805. Divided into chapters focused on key aspects of accounting for a business combination, the Blueprint is organized in the order a reporting entity applies ASC 805 and the corresponding questions the reporting entity may need to address. The Blueprint also provides guidance for pushdown accounting, common control transactions, asset acquisitions, and the initial accounting by a joint venture.
Scope of ASC 805, Business Combinations
First things first: ASC 805 applies to public and privately held entities and is applicable to all transactions or other events that meet the definition of a business combination or an acquisition by a not-for-profit entity. A business combination is defined as:
“A transaction or event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as true mergers or mergers of equals are also business combinations.”
Identifying the Acquirer and the Acquisition Date
Sometimes identifying the acquirer is straightforward, but in some cases it may be less clear. In most cases, the entity that transfers consideration (for example, cash, other assets, or equity interests) in exchange for ownership of assets or equity of another entity is the acquirer. However, this is not always true; in some transactions, the legal acquiree gains control of the legal acquirer. In such cases, the legal acquirer would be deemed the acquiree for accounting purposes (the accounting acquiree) and the legal acquiree would be deemed the acquirer for accounting purposes (the accounting acquirer). Such transactions are referred to as “reverse acquisitions” or “reverse mergers.”
Definition of a Business
Once an acquirer has been identified, it evaluates whether the acquired group of assets and liabilities (the acquired set) meets the definition of a business. If so, the transaction is accounted for as a business combination; if not, it must be accounted for as an asset acquisition or recapitalization. This distinction is important because there are several differences in accounting for a business combination and for an asset acquisition or recapitalization.
To determine whether the transaction is accounted for as a business combination, an asset acquisition, or a recapitalization, the acquirer must assess:
- Whether substantially all the value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets (the screen test)
- Whether the acquired set includes the required elements of a business under the framework in ASC 805
Recognizing Assets Acquired, Liabilities Assumed, and Non-Controlling Interests
If the acquired set meets the definition of a business, the acquirer must recognize and measure the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at fair value (with some exceptions), as well as goodwill or a bargain purchase gain. The acquirer must also determine the appropriate classification of the assets acquired and liabilities assumed and the accounting policies to apply. In some cases, the accounting for a business combination may be incomplete at the end of the interim or annual financial reporting period in which the combination occurs. Business combination guidance allows an acquirer to recognize provisional amounts for which the accounting is incomplete for up to one year after the acquisition date (the measurement period).
Recognizing Goodwill or a Bargain Purchase Gain and Consideration Transferred
The final step in the acquisition method is to recognize and measure goodwill or a gain from a bargain purchase. The acquirer recognizes goodwill if the consideration transferred (plus the fair value of any noncontrolling interest in the acquiree and the fair value of previously held equity interests, if applicable) exceeds the acquired net assets (assets acquired less liabilities assumed). Most business combinations result in the recognition of goodwill. Goodwill is not a separately identifiable asset; rather, it is an asset representing the future economic benefits that are not directly attributable to other identifiable assets.
Contingent consideration payable to the sellers is part of the consideration transferred. Contingent consideration usually involves the acquirer making future payments, or transferring additional equity interests, to the sellers, if a future event occurs or a specified condition is met. Such arrangements are often referred to as “earn-out” provisions. However, in some cases, contingent consideration involves the sellers returning a portion of the consideration previously paid. Regardless of the direction of the payments, contingent consideration is recognized at its acquisition-date fair value. The subsequent accounting for contingent consideration depends on whether it is classified as a liability (or asset) or as equity.
Transactions Separate from the Business Combination
An acquirer may enter arrangements with the sellers or the acquiree in connection with a business combination. Such arrangements require analysis to determine whether they should be accounted for as part of, or separate from, the business combination. ASC 805 provides a framework to assist the acquirer in identifying transactions that are separate from the business combination. Generally, arrangements that primarily benefit the acquirer or the combined entity are accounted for as separate transactions. Conversely, transactions that primarily benefit the acquiree or its former owners are typically part of the business combination.
Presentation and Disclosures
ASC 805 provides disclosure objectives and specific disclosure requirements designed to help users of the financial statements understand the effects of a business combination. Disclosures are required for material business combinations, as well as for immaterial business combinations that in the aggregate are material to the financial statements.
Pushdown Accounting
When an acquirer accounts for a business combination, it recognizes the acquiree’s assets and liabilities at fair value (with limited exceptions) rather than at their previous carrying amounts. This change in the amounts of the assets and liabilities is commonly referred to as a “step-up” or a “new basis”. For an acquirer’s financial statements, the recognition of a new basis for the acquired assets and liabilities is not optional.
The use of the acquirer’s basis in the preparation of an acquiree’s separate financial statements is called “pushdown accounting.” Pushdown accounting guidance is optional and can be elected for the separate financial statements of an acquiree (and its subsidiaries) when an acquirer obtains control of the acquiree that is a business or a nonprofit activity.
Common Control Transactions
Unlike accounting for business combinations, accounting for common control transactions does not typically result in a step-up in basis; rather, common control transactions are accounted for at the ultimate parent’s carrying amount of the net assets or equity interests transferred. Further, the common control transfer of a business may result in a change in reporting entity, which may require retrospective adjustments to the receiving entity’s financial statements.
Asset Acquisitions
The term “asset acquisition” is used to describe the acquisition of an asset or group of assets that does not meet the definition of a business under U.S. GAAP. Asset acquisitions (other than the initial consolidation of a VIE) are accounted for under a cost accumulation model, with the cost being allocated to the acquired assets and liabilities assumed, based on relative fair values (with some exceptions).
Initial Accounting by a Joint Venture
A joint venture (as defined in U.S. GAAP) applies a new basis of accounting at its formation date, in which it recognizes and initially measures its assets and liabilities at fair value (with exceptions consistent with the business combinations guidance). The joint venture recognizes goodwill if the fair value of the joint venture as a whole exceeds the total identifiable assets and liabilities recognized by the joint venture at the formation date.