Business combinations: requiring the acquisition method.
Well, it's time to pay attention again as FASB Statement No. 141 is likely to be replaced by the recently Proposed Statement of Financial Accounting Standards, Business Combinations. The International Accounting Standards Board has issued a proposed statement that would replace IASB Statement No. 3, concurrently with the FASB effort. The two proposed statements would generally bring international and U.S. standards into harmony.
The most significant change from FAS 141 is to require the acquisition method of accounting for business combinations, which is the focus of this article. FAS 141 requires the use of the purchase method of accounting for all business combinations and prohibits the pooling of interests method.
In the spirit of principles-based accounting standards, the standard itself comprises only 21 of the exposure draft's 234 pages. The proposed statement applies to all business combinations other than those involving not-for-profit organizations. The proposed statement also does not apply to formations of joint ventures or combinations involving businesses under common control, which would continue to be accounted for at their carrying amounts.
APPLYING THE ACQUISITION METHOD
There are four steps to applying the acquisition method:
* Identify the acquirer;
* Determine the acquisition date;
* Measure the fair value of the acquiree; and
* Measure and recognize the assets acquired and liabilities assumed.
>Identify the Acquirer In identifying the acquirer, the proposed statement makes reference to another exposure draft, Consolidated Financial Statements, Including Accounting and Reporting of Noncontrolling Interests in Subsidiaries. That exposure draft refers to the parent (acquirer) as an entity having controlling financial interest in another.
In addition, the proposed statement refers to FASB Interpretation No. 46 and notes that the primary beneficiary in a variable interest entity is always the acquirer.
Generally, the proposed statement notes that the acquirer is the entity that gives up consideration (in the form of cash or other assets, or issues equity interests) and receives control of the combined entity (through voting rights or management control). Size of the entity may provide some insight into the acquirer, but not always.
>Determine the Acquisition Date The acquisition date may be the closing date (the date that the acquirer obtains the assets and assumes the liabilities of the acquiree) or another date. The key is to determine the date the acquirer obtains control, whether the acquirer has obtained that control in one transaction or over time.
The acquisition date may result from a transaction that does not involve the transfer of consideration to the acquiree. For example, the acquiree may repurchase some of its equity securities and, as a result, the acquirer that previously held a noncontrolling interest obtains control. In such instances, the acquisition date and the acquisition accounting required thereby results from a transaction in which the acquirer did not directly participate.
>Measure Fair Value of the Acquiree Measuring the fair value of the acquiree represents the most significant change from the purchase method of accounting used today.
In the acquisition method, the fair value of the acquiree as a whole is determined and forms a basis for subsequent accounting measurements. Accordingly, the fair value of the acquiree held by noncontrolling interests (currently referred to as minority interests) is reported in the consolidated financial statements of the combined entity following the acquisition date.
In the absence of evidence to the contrary, consideration transferred by the acquirer at the acquisition date is presumed to be the best evidence of the fair value of the acquirer's interest in the acquiree. Consideration transferred is measured as:
* The fair value of assets transferred by, liabilities assumed by, and equity interests issued by the acquirer; and
* The fair value of any noncontrolling interest in the acquiree held by the acquirer immediately preceding the acquisition date.
If the portion of the consideration on the acquirer's books immediately preceding the acquisition date is not carried at fair value, a gain or loss will result from acquisition accounting. However, if the revalued assets or liabilities remain within the combined entity after acquisition, those gains or losses are eliminated in consolidation.
Consideration includes contingent consideration, such as payments required only if certain financial performance is met. In many cases, the actual payments required will differ from the acquisition date estimates of fair value.
Remeasurement of consideration, if required, may occur anytime during the measurement period, which cannot exceed one year, with such adjustments generally affecting goodwill. Consideration does not include costs incurred in connection with the business combination (such as legal, accounting, valuation and other fees), which are expensed or deferred as required by existing accounting standards.
In cases when less than 100 percent of the acquiree is obtained on the acquisition date, the consideration transferred may not be indicative of the fair value of the acquiree as a whole. In those cases, other valuation techniques are necessary to establish the fair value of the acquiree as a whole.
MEASURE AND RECOGNIZE THE ASSETS ACQUIRED AND LIABILITIES ASSUMED
FASB Concept Statement No. 6 (CON 6) defines assets as probable future economic benefits, and liabilities as probable future sacrifices of economic benefits arising from present obligations. These definitions are to be used in identifying assets acquired and liabilities assumed.
For example, certain research and development costs that meet the definition of an asset in CON 6--but are currently not recognized as assets pursuant to FASB statements 141 and 142--are to be valued and recognized. Similarly, certain contingent liabilities that meet the definition of liabilities in CON 6--but are currently not recognized pursuant to FASB statement 141--are to be valued and recognized.
Since assets and liabilities are measured at fair value, there is no separately identified valuation allowance, such as a provision for bad debts for acquired accounts receivable or a provision for obsolescence for acquired inventories. In essence, acquisition accounting establishes new cost bases for these assets.
There are also other special provisions for asset and liability recognition and measurement included in the proposed statement that depart somewhat from pure fair-value accounting.
Goodwill is recognized as the excess of the fair value of the acquiree as a whole over the fair value of the assets acquired and liabilities assumed by the acquirer. Accordingly, goodwill of the acquiree as a whole will be recognized, including any goodwill attributable to noncontrolling interests.
In rare circumstances, the fair value of the acquirer's interest in the acquiree exceeds the fair value of consideration transferred. Such cases, referred to as bargain purchases, may result in a gain to the acquirer.
As with consideration, remeasurement of the fair values of assets acquired and liabilities assumed, as well as the fair value of the acquiree as a whole, may occur during the measurement period, but any required adjustment thereafter only would be made to correct an error.
HIGHLIGHTS FROM IMPLEMENTATION GUIDANCE
The implementation guidance provides examples of how to account for different business combinations and explanations of topics, such as definition of a business; measuring the fair value of the acquiree; intangible assets; illustration of disclosure requirements; and reverse acquisitions. Following are some highlights:
>Measuring the Fair Value of the Acquiree The implementation guidance describes various methods of measuring the fair value of the acquiree. In situations when the fair value of the acquiree should not be based on the consideration transferred, the guidance provides alternative valuation techniques, such as market approach and income approach, to determine the fair value of the acquiree.
>Intangible Assets This section offers a comprehensive list of identifiable intangible assets that should be recognized separately from goodwill. The implementation guidance describes several types of identifiable intangible assets, which include marketing-related, customer-related, artistic-related, contract-based, and technology-based intangible assets.
>Examples of Business Combinations One of the interesting examples in the implementation guidance concerns business combinations when the fair value of the consideration transferred for the equity interests in the acquiree is less than the fair value of that interest, resulting in a gain from the bargain purchase. Recognizing gains on acquisitions is not permitted using current accounting standards.
DISCLOSURES AND EFFECTIVE DATE
The proposed statement specifies a host of disclosures designed to enable financial statement users to evaluate the nature and effect of business combinations that occur during the reporting period and after the balance sheet date, but before financial statements are issued.
Also, disclosures are required to enable users to evaluate the impact of adjustments currently recognized relating to business combinations, whether such combinations occurred in the current period or some prior period. There also are required disclosures regarding changes in the carrying amount of goodwill.
The proposed statement would apply to business combinations during fiscal years beginning on or after Dec. 15, 2006.
Stuart Harden is a director in the San Francisco office of Hemming Morse, Inc. Kevin Chiu and Frances Franco-Valdez are managers in the San Francisco and Los Angeles offices of Hemming Morse, respectively. The authors can be reached at www.hemming.com/profiles.html.
By STUART HARDEN, CPA, KEVIN CHIU, CPA & FRANCES FRANCO-VALDEZ, CPA
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|Date:||Oct 1, 2005|
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