One common challenge in accounting for a merger or acquisition is how to record the transaction on the buyer’s financial statements. The first step is to determine whether the buyer has acquired a business or simply purchased a group of assets. The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The ASU provides guidance on the definition of a business and assists in evaluating whether a set of transferred assets constitutes a business.
Why Does It Matter?
Business combination accounting differs significantly from accounting for a purchase of assets. Among other consequences, the resulting accounting can have a direct impact on lender and/or investor agreements and their corresponding expectations at inception and in future reporting years. The following table summarizes the key differences between accounting for a business combination and accounting for an asset purchase.
|Item||Business Combination||Asset Acquisition|
|Transaction Costs||Expensed as incurred||Capitalized to cost of asset(s) acquired|
|Measurement of Acquired Assets||Generally recognized at fair value||Recognized in accordance with other applicable GAAP|
|Goodwill||Recognized to the extent purchase price exceeds fair value of net assets acquired||Not recognized. Any purchase price in excess of fair value is allocated to assets acquired on a relative fair value basis|
|Bargain Purchase||Recognized as a gain in net income in year of acquisition||Not recognized in earnings. Any fair value in excess of purchase price is allocated to assets acquired on a relative fair value basis.|
|Contingent Consideration||Recognized as additional consideration at acquisition||Generally recognized when the contingency is resolved|
|Measurement Period||Buyer has up to one year to true-up fair values as of acquisition date and adjust provisional amounts previously recorded||No measurement period|
As you can see, the accounting treatment differs significantly depending on whether the transaction is treated as the acquisition of a business or simply an acquisition of assets.
What Is Considered a Business?
Under the new guidance, a company must first determine whether substantially all of the fair value of the assets acquired is concentrated in a single identifiable asset (or a group of similar identifiable assets). If this threshold is met, the set is NOT a business. If the threshold is not met, the entity determines whether the set meets the definition of a business.
ASC 2017-01 defines a business as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. ASC 2017-01 further states, A business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs.
It should be noted that not all inputs or processes need to exist if a buyer could replace one or more of the missing inputs or processes. Also, a company is not required to have outputs (for example a start-up that has not generated revenues), but must show an ability to create an output. The new accounting guidance provides criteria to determine if a set of assets constitutes a business when an input, process or output are not present.
ASU 2017-01 is effective for public business entities for fiscal years beginning after December 15 2017 (generally 2018). For all other entities, it is effective for fiscal years beginning after December 15, 2018 (generally 2019). Early adoption is permitted within certain parameters.
The changes the Financial Accounting Standards Board (FASB or Board) made to the definition of a business could very likely result in more acquisitions being accounted for as asset acquisitions rather than business combinations. Careful consideration should be made to determine proper accounting treatment for all transactions occurring after the effective date of ASU 2017-01. Feel free to reach out if you are contemplating a merger or acquisition.
Tad N. Render, CPA leads the M&A practice at Miller, Cooper & Co., Ltd., a Chicago-based accounting and consulting firm. Contact him via email or at 847-205-5000.