FAS 141R - Business Combinations
By Linda Cavanaugh, CPA - This new Statement was a lot more involved than I thought at first glance. Here is the first installment.
FAS 141R –"Business Combinations" was issued to improve relevance, representational faithfulness and comparability of the information surrounding business combinations.
The first step to applying this Statement is to determine whether a transaction is a business combination by applying the definition in Paragraph 3. FAS 141R defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. This includes a merger of equals.
A business is defined 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. The entity does not have to be producing outputs; it just has to be capable of producing outputs. This definition does not include joint ventures, acquisition of an asset or a group of assets, a combination between entities under common control, or a combination between not-for-profit organizations or the acquisition of a for-profit business by a non-profit.
A developmental stage entity may not have outputs and other factors need to be assessed to determine whether the developmental stage entity is a business. The factors include but are not limited to, whether the set: 1) has begun planned principal activities, 2) has employees, intellectual property, and other inputs and processes that could be applied to those inputs, 3) is pursuing a plan to produce outputs, and 4) will be able to obtain access to customers that will purchase the outputs.
This definition will cause more entities to be classified as businesses and be subjected to the guidance in this Statement.
As with FAS 141, the acquisition method is used to account for the business combination. To apply the acquisition method an entity must 1) identify the acquirer, 2) determine the acquisition date, 3) recognize and measure the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree, and 4) recognize and measure goodwill or gain from a bargain purchase (negative goodwill).
1) Identify the acquirer.
The guidance in ARB 51 as amended is used to identify the acquirer and paragraphs A11-A15 are to be used if ARB 51 does not clearly indicate who the acquiring party is. However, if the entity being combined is a variable interest entity under FIN 46, then the primary beneficiary is always the acquirer.
ARB 51 says that the acquirer is the entity that has ownership of the majority voting interest or over 50% of the outstanding voting shares.
Other factors to be considered in determining the acquirer include: the relative voting rights in the combined entity after the business combination, the existence of a large minority voting interest, the composition of the governing body, the composition of the senior management, or the terms of exchange of equity interests.
2) Determine the acquisition date.
The acquisition date is the date that the acquirer obtains control of the acquiree and is not necessarily the traditional closing date. For example if a written contract provides for a change of control before the consideration is legally transferred.
3) Recognize and measure the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree.
This is where most of the revisions took place.
An asset or liability must meet the definition in Concept Statement 6 to be recognized as an identifiable asset or liability in the acquisition. Expected future costs to exit an activity, to terminate employees, or relocate employees are no longer recognized as part of the acquisition costs. These costs are to be recognized per other applicable GAAP.
If there is a pre-existing arrangement or other arrangement before or during negotiations these arrangements are not considered part of the business combination transaction and are accounted for under other applicable GAAP.
A transaction for the benefit of the acquirer is likely to be a separate transaction, such as
1. a transaction that in effect settles pre-existing relationships between the acquirer and acquiree (more guidance in paragraphs A78-A85)
2. a transaction that compensates employees or former owners of the acquiree for future services (more guidance in paragraphs A86-A90)
3. a transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisition related costs.
The acquirer’s acquisition related costs are to be expensed in the period costs are incurred and benefits received. These costs may include advisory fees, legal, accounting, valuation, and the costs of registering debt or equity securities. The exception to this rule is the costs to issue debt and equity securities which are to be accounted for under other applicable GAAP.
Assets such as brand names, patents, or customer relationships that the acquiree could not recognize because it had developed them internally, could be recognized by the acquirer under the new guidelines.
Paragraphs A16-A56 provide additional guidance on recognizing leases and intangible assets acquired in a business combination.
At the acquisition date, the assets and liabilities need to be classified or designated according to other applicable GAAP, such as available for sale or trading under FAS 115. However, leases and certain insurance contracts are to be classified as of the contract date unless they are modified, then the modification date is used.
The assets, liabilities and non-controlling interest are to be measured at fair value using the guidance in FAS 157. This is a change from past guidance, where some items were measured at historical costs.
And of course there are exceptions and the following are not measured at fair value:
1. Assets and liabilities arising from contingencies
2. Income taxes
3. Employee benefits
4. Indemnification assets
5. Reacquired rights
6. Share-based payment awards
7. Assets held for sale
Each of the above are to measured in accordance with the guidance of the Statements that they currently fall under. (I.e. Share-based payment awards follow the guidance in FAS123R)
4.) Recognize and measure goodwill or a gain from a bargain purchase (negative goodwill)
Goodwill is now measured as:
1. the consideration transferred (measured at fair value)
2. the fair value of any non-controlling interest in the acquiree
3. the acquisition date fair value of the acquirer’s previously held equity interest in the acquiree (control achieved in stages)
1. the net of the acquisition date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this Statement.
If only equity interests are transferred, the fair value may be more reliably measured using the acquiree’s equity interests.
If no consideration is transferred, the acquisition date fair value of the acquirer’s interest in the acquiree determined using a valuation technique in place of the acquisition date fair value of the consideration transferred should be used.
When a bargain purchase is made, as in a forced sale, and the fair value of the identifiable assets and liabilities is greater than the consideration transferred, the acquirer must first re-assess whether it has correctly identified the assets acquired and the liabilities assumed. The acquirer must then re-assess the measurement of the identified assets and liabilities, any non-controlling interest in the acquiree, any previously acquired interests in the acquiree, and the consideration transferred.
If the fair value of the identifiable assets and liabilities is still greater than the consideration transferred, then the acquirer is to recognize a gain for the difference on the acquisition date. This is different from previous guidance, where the fair value of the identifiable assets and liabilities would have been reduced by the difference.
That is the basic concept of FAS 141R. The main difference between the previous guidance and the new guidance is what is being measured and how it is being measured. FAS 141R has 7 appendices that provide further guidance on how to implement this new Statement.
Stay tuned to the same bat channel and the same bat time for further blogs on this issue.
Linda is a CPA living in Southwestern Ohio, working as a research accountant for an investor-owned publicly traded utility company. She specializes in implementing new FASB and SEC requirements and FAS 133 derivative issues. In her role at the utility she has encountered many issues and written many memos, so send in your implementation and derivative issues and Linda will help figure out an answer.