New FASB rules for acquisitions and valuation: 141R, 160.
In general, FAS 141R will require measuring and recognizing the business acquired at full acquisition-date fair value. In that respect, the acquirer's consolidated balance sheet at the acquisition date will more accurately capture current value of the assets and liabilities of the acquired business than it would under the traditional cost-based approach.
The value of the business acquired under the new standard will usually be measured as the sum of the acquisition-date fair values of the following three items: Consideration transferred for the acquiree; for step acquisitions (those achieved in stages), equity interests in the acquiree held by the acquirer immediately before the acquisition date; and for a partially owned subsidiary, noncontrolling interests in the acquiree held by third parties.
There are five specific areas where FAS 141R has changed acquisition-date fair value accounting and their specific impacts (see below for elaboration on each):
1. accounting for transaction costs; 2. contingency consideration (earn-outs); 3. in-process research and development (IPR & D); 4. acquired contingencies; and 5. partial or step acquisitions.
Broader Scope than Predecessor
Under FAS 141R, business combination accounting will apply to a wider range of transactions or events than FAS 141, including the following:
- The acquirer obtains control of a business without exchange of consideration; or by contract alone (without holding any ownership interest in the acquired business).
- The acquirer becomes the primary beneficiary of a variable interest entity.
- The acquirer combines two or more mutual entities (such as credit unions).
- The acquirer obtains control of certain development-stage companies.
- The new standard continues to exclude joint ventures, common control transactions and mergers and acquisitions between not-for-profit organizations.
* TRANSACTION COSTS. Under FAS 141R, the direct costs of a business combination--such as transaction fees, due diligence, consulting services and the buyer's cost of issuing debt or equity securities--will no longer be included in measurement of the business acquired. Instead. Tthose direct costs will be recognized as expenses of the period in which they are incurred and the services received, except for the costs of issuing debt and equity securities, which shall be recognized in accordance with other applicable generally accepted accounting principles (GAAP). So, the buyer's income statement takes a bigger hit right away.
Even if the buyer incurs debt or equity issuance costs that are not expensed when incurred, such costs will not be treated as consideration transferred for the acquired business. Under Statement 141R, the acquisition-date fair value of consideration transferred used to measure the business acquired will not include costs or obligations that are not part of that business itself. Accordingly, expected restructuring costs and termination liabilities (like severance pay) for which the acquirer is not obligated as of the acquisition date will be recognized as post-combination costs when incurred.
* EARN-OUTS. Under FAS 141R, contingent consideration, commonly structured as earn-outs, will be measured at acquisition-date fair value rather than when a future financial goal is met, resulting in additional payments to the seller. Fair value of contingent consideration will therefore be included in the total amount of consideration transferred for the acquiree in the business combination.
Under FAS 141, contingent consideration is recorded when the contingency is resolved. Determining fair value will probably introduce more subjectivity and complexity in the accounting process and make pre- and post-combination earnings slightly less predictable.
* IN-PROCESS RESEARCH AND DEVELOPMENT (IPR & D). The new standard will have a greater accounting impact for the acquisition of companies that are heavily involved in conducting large, ongoing research and development projects, such as high-technology companies that have more research requirements than non-technology companies.
IPR & D projects will be capitalized as indefinite-lived intangible assets at fair value (subject to impairment testing), even before they reach the point of technical feasibility--that is, if they have no alternative future use outside the acquired IPR & D project. The useful life of the intangible asset recognized will be reconsidered if and when an IPR & D project is completed or abandoned. (Under FAS 141, R & D expenses are written off immediately on acquisition). Under FAS 141R, fair value of the acquired IPR & D assets will impact earnings after rather than on the acquisition date.
* CONTINGENCIES. FAS 141R will require the acquisition-date recognition of the fair value of assets and liabilities arising from acquired contract-related contingencies and provide a new subjective threshold for recognizing assets and liabilities for noncontractual contingencies. Currently, under FAS 141, a contingent liability would be recognized only if meets the probability criteria in FASB Statement 5, Accounting for Contingencies, and is seldom recognized at acquisition-date fair value.
The new requirements will result in recognizing more contingent assets and liabilities as of the acquisition date. However, it may be challenging to identify such assets and liabilities, to determine whether they are contractual or noncontractual, to determine whether they meet the new recognition criteria and to estimate their fair value.
* PARTIAL AND STEP ACQUISITIONS. In a step acquisition, one in which the acquirer obtains control of a business in which it already holds an equity interest, under FAS 141R, the acquirer will re-measure that previously acquired interest at fair value as of the date of the business combination. The acquirer will recognize any resulting gain or loss in earnings of the period.
Also, the value of a noncontrolling equity interest in the acquiree will be recognized at its acquisition-date fair value. In the absence of a market price in an active market for the equity shares not held by the acquirer, other valuation techniques would be used to measure the acquisition-date fair value of the noncontrolling interests.
On a per share basis, the acquisition-date fair values of the acquirer's interest in the acquiree and the noncontrolling interests may differ because of the existence of a control premium in the acquirer's interest or a minority interest discount in the noncontrolling interest.
U.S. and IFRS: Small Differences
On Jan. 10, 2008, the International Accounting Standards Board (IASB) issued its own revised standard for business combinations, International Financial Reporting Standard 3 (IFRS 3R). FASB and IASB reached the same conclusions on most but not all of the issues addressed in Statement 141R and the revised IFRS 3R. Some differences remaining between the U.S. and international business combination standards include:
The definition of fair value. The definition and guidance in FASB Statement 157, Fair Value Measurements, which will apply to fair value measurements under FAS 141R, have not been adopted by IASB.
The measurement of noncontrolling interests. Unlike FAS 141R, the revised IFRS 3 will permit noncontrolling interests to be measured at either its acquisition-date fair value, including inherent goodwill, or the noncontrolling interests' proportionate share of the acquisition-date values of the acquired net assets, excluding goodwill.
The effective date. The international standard takes effect six months later than the U.S. standard. Early adoption of FAS 141R is prohibited and early application of the revised IFRS 3 is permitted.
Most of the remaining differences arise from differences between other related FASB and IASB standards, and may be resolved in future joint convergence projects.
Noncontrolling Interests in Consolidated Subsidiaries
On the same day FASB issued FAS 141R, it also issued Statement 160, Noncontrolling Interests in Consolidated Financial Statements, which will change the accounting for, and the financial statement presentation of, noncontrolling interests (previously called "minority interests") in a consolidated subsidiary. FAS 160 replaces the existing minority-interest provisions of Accounting Research Bulletin 51, Consolidated Financial Statements, by establishing noncontrolling interests in a consolidated subsidiary as a component of the equity of a consolidated entity.
The underlying principle of this new standard is that both the controlling and noncontrolling interests are part of the equity of a single economic entity, the consolidated reporting entity. The entity is required to clearly identify parent and noncontrolling equity interests and to present them separately in the consolidated statement of financial position. FAS 160 is effective for fiscal years beginning on or after Dec. 15, 2008. Early application is not permitted.
Focus on Strategic Objectives
Before 2001, accounting objectives may have driven some acquisitions and strongly influenced the way they were structured--but that is not the case today. When considering acquisitions, the focus should be on strategic objectives--how a deal will affect future earnings.
So, the revisions in the national and international accounting standards for business combinations should not materially change the way one approaches a prospective acquisition. The standards apply primarily to the way the acquisitions are accounted for after the decision is made to acquire the strategic advantages.
Neil Beaton is the Partner in Charge of Grant Thornton's Valuation Services within the Advisory Group. He is based in Seattle and can be contacted at 206.398.2487 or firstname.lastname@example.org.
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|Title Annotation:||financial reporting|
|Date:||Mar 1, 2008|
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