ASC 805 E&Y White Paper

Financial reporting developmentsBusiness combinationsAccounting Standards Codification 805Revised October 2010

To our clients and other friendsTo our clients and other friends

In December 2007, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 141(R), Business Combinations [Statement 141(R)(codified in ASC Topic 805, Business Combinations], and FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statement, an amendment to ARB No. 51 [(Statement 160)(codified primarily in FASB ASC Topic 810, Consolidations). Statements 141(R) and 160 significantly changed the accounting and reporting for business combinations and any noncontrolling (or minority) interests in consolidated financial statements. These standards represented the culmination of the first major collaborative convergence project with the International Accounting Standards Board (IASB). This publication provides our views on the application of the guidance in ASC 805. Our views on the application of the accounting for noncontrolling interest guidance in ASC 810 are contained in a separate publication, Financial reporting developments, Accounting for Noncontrolling Interests in Consolidated Financial Statements. In October 2008, we issued the First Edition of this publication. We have updated the First Edition to include the excerpts from and references to the FASB Accounting Standards Codification. In addition to updating the Third Edition for the FASB Accounting Standards Codification, we have also updated this publication to incorporate changes resulting from the issuance of FASB Staff Position (FSP) No. FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination (codified in ASC 805). In April 2009, the FASB issued FSP FAS 141(R)-1. The FSP amended Statement 141(R), significantly changing the accounting for pre-acquisition contingencies that was required by Statement 141(R). The FSP was issued by the FASB to address concerns raised by constituents about the application of the guidance in Statement 141(R) to assets and liabilities arising from contingencies in a business combination. In response to the application issues raised, the FASB amended the initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. This publication is designed to assist professionals in understanding the guidance in ASC 805. This publication reflects our current understanding of the guidance based on our experience with financial statement preparers and related discussions with the FASB and SEC staffs. Practice continues to form and additional authoritative guidance interpreting the provisions of ASC 805 could be issued subsequent to the release of this publication. While we will update this publication as additional authoritative guidance is issued, preparers of financial statements should closely monitor developments in this area. Ernst & Young professionals are prepared to help you identify and understand the issues related to the accounting for business combinations.

October 2010

Financial reporting developments Business combinations ASC 805

Contents

Contents

B1

Overview of accounting for business combinations .................................................. 1 B1.1 Overview ....................................................................................................... 1 B1.2 Background ................................................................................................... 8 B1.3 The overall principle in ASC 805: obtaining control results in a new basis .......... 9 B1.4 Scope: identifying business combination transactions ...................................... 9 B1.4.1 Definition of a business ................................................................. 10 B1.5 Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree................................. 10 B1.6 Consideration transferred ............................................................................. 12 B1.7 Recognizing and measuring goodwill or a gain from a bargain purchase .......... 12 B1.7.1 IFRS alternative for recognition of goodwill on noncontrolling interest ................................................................. 13 B1.7.2 Bargain purchases ........................................................................ 13 B1.7.3 A business combination achieved in stages .................................... 13 B1.7.4 Measurement period..................................................................... 14 B1.7.5 Assessing what is part of the exchange for the acquiree ................. 14 B1.8 Disclosure requirements ............................................................................... 15 B1.9 Effective date and transition considerations................................................... 15 Identifying business combination transactions ...................................................... 16 B2.1 What is a business combination? ................................................................... 16 B2.1.1 Control obtained without transferring consideration....................... 18 B2.1.1.1 Lapse of participating rights held by minority shareholders.............................................................. 18 B2.1.1.2 Investee share repurchase transactions....................... 19 B2.1.1.3 Control obtained by contract alone ............................. 19 B2.1.1.3.1 Control by contract ................................ 19 B2.1.1.3.2 Dual-listed corporation and stapling arrangements ........................................ 20 B2.1.2 Variable interest entities ............................................................... 20 B2.1.3 Definition of a business ................................................................. 21 B2.1.3.1 Capable of from the viewpoint of a market participant ................................................................. 23 B2.1.3.2 Development stage enterprises ................................... 24 B2.1.3.2.1 Examples Development stage enterprises ............................................ 26 B2.1.3.3 Presence of goodwill .................................................. 27 B2.1.3.4 Application of the definition of a business .................... 27 B2.1.3.4.1 Examples Application of the definition of a business ........................... 28 B2.1.3.4.2 Industry examples Application of the definition of a business ..................... 29

B2


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Contents

B2.2

B2.1.3.5 Effect of the change in the definition of a business on other GAAP ........................................................... 32 Limitations in the scope of ASC 805 .............................................................. 33 B2.2.1 Joint ventures .............................................................................. 33 B2.2.2 The acquisition of an asset or group of assets that does not constitute a business .................................................................... 34 B2.2.3 A combination between entities or businesses under common control ........................................................................... 34 B2.2.3.1 Definition of common control ...................................... 36 B2.2.3.2 Procedural guidance for combining entities under common control ......................................................... 37 B2.2.3.2.1 Receiving entitys basis in the net assets transferred .................................. 37 B2.2.3.2.2 Periods when the combining entities were not under common control.............. 38 B2.2.3.2.3 Noncontrolling interests in a common control transaction ................... 39 B2.2.3.3 Accounting by the transferor in a common control transaction ..................................................... 39 B2.2.3.4 Transactions involving common ownership .................. 40 B2.2.3.4.1 Example Transactions involving common ownership ................................ 40 B2.2.3.4.2 Transactions involving identical common ownership ................................ 41 B2.2.3.4.3 Example Transactions involving identical common ownership ................... 41 B2.2.4 Change of accounting basis in master limited partnerships ............. 41 B2.2.5 Not-for-profit organizations .......................................................... 43 B2.2.6 Mutual entities ............................................................................. 44 B2.2.6 Other scope considerations ........................................................... 44

B3

The acquisition method ......................................................................................... 45 B3.1 Identifying the acquirer................................................................................. 46 B3.1.1 Identifying the acquirer if the acquiree is a VIE ............................... 47 B3.1.2 Identifying the acquirer if the acquiree is a voting interest entity............................................................................... 47 B3.1.2.1 Example Identifying the acquirer if the acquiree is a voting interest entity............................................. 48 B3.1.2.2 Identifying the acquirer when the acquirer is not obvious ............................................................. 49 B3.1.2.2.1 Examples of identifying the accounting acquirer when the acquirer is not obvious......................... 52

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Contents

B3.2 B3.3

B3.4

B3.1.2.3 Reverse acquisitions .................................................. 53 B3.1.2.3.1 Measuring the consideration transferred in a reverse acquisition ......... 55 B3.1.2.3.2 Share-based payments in a reverse acquisition ............................................. 56 B3.1.2.3.3 Noncontrolling interests in a reverse acquisition ............................................. 57 B3.1.2.3.4 Financial statement presentation ............ 58 B3.1.2.3.5 Examples reverse acquisition accounting ............................................ 61 B3.1.2.3.6 Transactions involving public shell companies ............................................. 64 B3.1.2.4 Combinations of more than two entities ...................... 66 B3.1.2.4.1 Example roll-up transaction .............. 66 B3.1.2.5 Combinations involving a Newco .............................. 67 B3.1.2.5.1 Examples Combinations involving a Newco ............................................. 68 Determining the acquisition date ................................................................... 69 Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree................................ 70 B3.3.1 Recognition concepts ................................................................... 71 B3.3.1.1 Meaning of An asset or liability at the acquisition date ........................................................ 71 B3.3.1.2 Meaning of Part of the business combination ............ 73 B3.3.1.3 Classification or designation of assets acquired and liabilities assumed................................................ 76 B3.3.2 Measurement concepts................................................................. 77 B3.3.3 Exceptions to the recognition and measurement concepts .............. 78 Recognizing and measuring goodwill or a gain from a bargain purchase .......... 79 B3.4.1 Goodwill ....................................................................................... 79 B3.4.2 Bargain purchase ......................................................................... 81

B4

Recognizing assets acquired, liabilities assumed, and any noncontrolling interest ......................................................................................... 82 B4.1 Assets acquired............................................................................................ 82 B4.1.1 Assets the acquirer does not intend to use to their highest and best use ....................................................................................... 82 B4.1.1.1 Subsequent accounting for assets the acquirer does not intend to use to their highest and best use ............. 83 B4.1.2 Assets with uncertain cash flows (valuation allowances) ................. 84 B4.1.3 Inventories ................................................................................... 84 B4.1.3.1 Finished goods ........................................................... 86 B4.1.3.2 Work-in-process ......................................................... 87


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B4.1.4

B4.1.5

B4.1.6

B4.1.3.3 Raw materials ............................................................ 87 B4.1.3.3.1 Example recognition of raw materials.... 87 B4.1.3.4 Supply inventories ...................................................... 87 B4.1.3.5 Acquired last-in, first-out (LIFO) inventories ................. 88 B4.1.3.5.1 Effect on purchase accounting of LIFO election for income tax purposes ............. 88 B4.1.3.6 Lower of cost or market considerations ....................... 89 Plant and equipment ..................................................................... 89 B4.1.4.1 Plant and equipment to be used................................... 89 B4.1.4.1.1 Example plant and equipment to be used .................................................. 90 B4.1.4.2 Spare parts inventories ............................................... 90 B4.1.4.3 Mineral rights ............................................................. 90 B4.1.4.4 Acquired tangible assets to be abandoned.................... 91 B4.1.4.5 Acquired assets to be sold........................................... 91 B4.1.4.6 Plant and equipment subject to retirement obligations ................................................ 92 Intangible assets........................................................................... 92 B4.1.5.1 Recognition of identifiable intangible assets ................. 93 B4.1.5.1.1 Contractual-legal criterion ...................... 93 B4.1.5.1.2 Separability criterion .............................. 94 B4.1.5.2 Examples of intangible assets that meet the recognition criteria ..................................................... 97 B4.1.5.2.1 Marketing-related intangible assets ......... 98 B4.1.5.2.2 Customer-related intangible assets .......... 99 B4.1.5.2.3 Artistic-related intangible assets............ 105 B4.1.5.2.4 Contract-based intangible assets ........... 105 B4.1.5.2.5 Technology-based intangible assets ....... 106 B4.1.5.2.6 Assembled workforce ........................... 107 B4.1.5.2.7 Reacquired rights ................................. 108 B4.1.5.2.8 Other examples of intangible assets....... 110 B4.1.5.3 Measurement of identifiable intangible assets ............ 112 B4.1.5.4 Acquired intangible assets to be sold ......................... 112 Research and development assets ............................................... 112 B4.1.6.1 R&D definitions and scope ......................................... 113 B4.1.6.1.1 Research ............................................. 113 B4.1.6.1.2 Development........................................ 113 B4.1.6.1.3 Examples of research and development costs ............................... 113 B4.1.6.2 Application of IPR&D technical practice aid................. 115 B4.1.6.2.1 Control and Economic Benefit ............... 116 B4.1.6.2.2 Specific IPR&D ..................................... 117

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B4.2

B4.3

Measurement ...................................... 118 Future R&D projects ............................. 118 Subsequent accounting for IPR&D acquired in a business combination ....... 119 B4.1.6.2.6 IPR&D acquired in an asset acquisition ... 120 B4.1.6.2.7 Acquired IPR&D assets to be sold .......... 120 B4.1.6.2.8 IPR&D assets to be held for defensive purposes .............................. 120 B4.1.6.2.9 Subsequent accounting for IPR&D assets to be held for defensive purposes .............................. 121 B4.1.7 Indemnification assets ................................................................ 122 B4.1.7.1 Subsequent accounting for indemnification assets ..... 124 B4.1.7.1.1 Example subsequent accounting for indemnification assets..................... 125 B4.1.7.1.2 Indemnification assets not meeting the recognition criteria as of the acquisition date ................................... 125 B4.1.8 Debt issue costs ......................................................................... 126 B4.1.9 Equity method investments......................................................... 126 Liabilities assumed ..................................................................................... 127 B4.2.1 Pension and post retirement obligations ...................................... 127 B4.2.1.1 Modifications to pension and OPEB obligations in connection with a business combination .................... 130 B4.2.1.1.1 Modifications the acquirer is not obligated to make ................................ 130 B4.2.1.3 Effect of employee terminations on obligations for pension benefits, other postretirement benefits and postemployment benefits ................................... 130 B4.2.1.3 Multi-employer pension plans.................................... 131 B4.2.2 Deferred revenue of an acquired company................................... 131 B4.2.2.1 Unit of account when measuring the fair value of deferred PCS revenue in a business combination ....... 132 B4.2.3 Cost of restructuring an acquired company.................................. 134 B4.2.3.1 Example cost of restructuring an acquired company ................................................................. 136 B4.2.3.2 Cost of restructuring initiated by the acquiree ........... 136 B4.2.4 Guarantees ................................................................................ 136 B4.2.5 Instruments indexed to or settled in shares and classified as liabilities ................................................................................ 137 Amounts that might be assets or liabilities ................................................... 137 B4.3.1 Preacquisition contingencies ....................................................... 137

B4.1.6.2.3 B4.1.6.2.4 B4.1.6.2.5


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Contents

B4.4

B4.3.1.1 What is considered a preacquisition contingency? ...... 139 B4.3.1.1.1 Example Preacquisition contingency ... 139 B4.3.1.2 Initial recognition and measurement guidance ............ 140 B4.3.1.2.1 Fair value can be determined ................ 140 B4.3.1.2.2 Fair value cannot be determined .............. 140 B4.3.1.3 Subsequent accounting for preacquisition contingencies ........................................................... 141 B4.3.1.3.1 Pre-acquisition contingencies recognized at fair value......................... 141 B4.3.1.3.1 Pre-acquisition contingencies recognized pursuant to the guidance in ASC 450 .......................................... 142 B4.3.1.4 Adjustment to preacquisition contingencies during the measurement period ........................................... 142 B4.3.1.4.1 Examples Adjustment to preacquisition contingencies during the measurement period ....................... 142 B4.3.1.5 Pre-acquisition contingencies that are not recognized in a business combination ........................ 143 B4.3.1.5.1 Contingencies that are not considered pre-acquisition contingencies ................ 143 B4.3.1.9 Escrow payments ..................................................... 144 B4.3.2 Income taxes .............................................................................. 145 B4.3.3 Long-term construction contracts ............................................... 145 B4.3.3.1 Completed-contract method...................................... 145 B4.3.3.1.1 Example Completed contract method ................................................ 146 B4.3.3.2 Percentage-of-completion method............................. 146 B4.3.3.2.1 Example Percentage of completion method ................................................ 147 B4.3.4 Executory contracts ................................................................... 148 B4.3.4.1 Leases ..................................................................... 150 B4.3.4.1.1 Lessee accounting ................................ 151 B4.3.4.1.2 Lessor accounting ................................ 153 B4.3.4.1.4 Acquired leasehold improvement........... 155 B4.3.4.2 Derivatives............................................................... 155 B4.3.4.3 Employment contracts .............................................. 155 Preexisting relationships between parties to a business combination............. 156 B4.4.1 Settlements of contractual relationships in a business combination ............................................................................... 157 B4.4.1.1 Examples of settlements of contractual relationships in a business combination...................... 158

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B4.5

B4.6 B5 B6

B4.4.1.2 Settlement provisions that are available only in the future ................................................................ 159 B4.4.1.2.1 Example Settlement provisions that are available only in the future ....... 160 B4.4.1.3 Settlements of preexisting relationships for which an acquirer had previously recognized assets or liabilities .................................................... 161 B4.4.1.3.1 Example Settlements of preexisting relationships for which an acquirer had previously recognized assets or liabilities............... 161 B4.4.2 Settlement of a noncontractual relationship (e.g., a lawsuit) in a business combination ........................................................... 161 B4.4.2.1 Example Settlement of a noncontractual relationship (e.g., a lawsuit) in a business combination ............................................................ 162 B4.4.3 Reacquired rights in a business combination ................................ 162 B4.4.3.1 Examples Reacquired rights in a business combination ............................................... 163 Noncontrolling interests ............................................................................. 165 B4.5.1 What is noncontrolling interest? .................................................. 165 B4.5.2 Estimating the fair value of noncontrolling interests ..................... 166 B4.5.2.1 Noncontrolling interests share of goodwill ................. 167 B4.5.3 Accounting for noncontrolling interests after the business combination ................................................................. 167 Subsequent accounting for assets acquired and liabilities assumed in a business combination ................................................................................. 167

Income tax considerations .................................................................................. 170 Consideration transferred ................................................................................... 171 B6.1 Measurement of consideration transferred .................................................. 171 B6.1.1 Items included in consideration transferred ................................. 171 B6.1.1.1 Financial instruments entered into by the acquirer to hedge risks associated with a business combination ... 172 B6.1.2 Equity instruments issued (including measurement date).............. 172 B6.1.2.1 Measurement date for equity instruments issued ....... 172 B6.1.2.2 Issuance of preferred shares as consideration............ 173 B6.1.2.3 Issuance of subsidiary shares as consideration ........... 173 B6.1.3 Debt instruments issued ............................................................. 174 B6.1.3.1 Valuing convertible debt and debt issued with warrants .......................................................... 174


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B6.1.4

B6.2

B6.3

Recognizing gains or losses on non-cash assets transferred .......... 175 B6.1.4.1 Recognizing gains or losses on transfers of assets that remain under the acquirers control .................... 176 B6.1.4.2 Example Recognizing gains or losses on noncash assets transferred............................................. 176 B6.1.5 Consideration transferred in a business combination achieved without the transfer of consideration ........................................... 176 Acquisition-related costs............................................................................. 177 B6.2.1 Costs deferred for an in-process business combination prior to the effective date of the guidance in ASC 805 .............................. 178 B6.2.2 Allocating transaction costs to the business combination and financing transactions................................................................. 178 B6.2.3 Equity issuance costs .................................................................. 179 B6.2.4 Costs incurred by the sellers of an acquired company ................... 180 B6.2.4.1 Costs incurred by the sellers of an acquired company on behalf of the acquirer............................. 180 B6.2.5 Examples Transaction costs ..................................................... 181 B6.2.6 Costs incurred in connection with asset acquisitions ..................... 182 Exchange of share-based payment awards in a business combination............ 182 B6.3.1 Measurement of share-based payment awards............................. 182 B6.3.2 Replacement of share-based payment awards.............................. 183 B6.3.2.1 Acquirer is obligated to replace acquirees sharebased payment awards ............................................. 184 B6.3.2.1.1 Graded vesting ..................................... 187 B6.3.2.1.2 Forfeiture estimates ............................. 188 B6.3.2.1.3 Accelerated vesting based on change in control provisions ............................. 189 B6.3.2.1.6 Exchange of awards with market conditions................................. 191 B6.3.2.2 Acquirer is not obligated to replace acquirees share-based payment awards .................................... 191 B6.3.2.3 Predecessor share-based payment awards expire as a result of the business combination ...................... 192 B6.3.2.4 Income tax effects of replacement awards classified as equity ................................................... 193 B6.3.2.5 Settlement of share-based payment awards held by target company employees ........................................ 194 B6.3.2.6 Last-man-standing arrangements .............................. 195 B6.3.3 Examples Accounting for share-based payments in a business combination ................................................................. 196

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B6.4

Contingent consideration ............................................................................ 202 B6.4.1 Recognition and measurement of contingent consideration .......... 202 B6.4.1.1 Consideration held in escrow for general representations and warranties ................................ 203 B6.4.2 Classification of contingent consideration .................................... 203 B6.4.2.1 Application of ASC 480 to classification of contingent consideration .......................................... 204 B6.4.2.2 Application of ASC 815 to classification of contingent consideration .......................................... 205 B6.4.3 Determining the fair value of contingent consideration ................. 206 B6.4.4 Contingent payments to employees or selling shareholders .......... 207 B6.4.4.1 Continuing employment ........................................... 207 B6.4.4.1.1 Effect of forfeitable shares ................... 208 B6.4.4.2 Duration of continuing employment .......................... 209 B6.4.4.3 Level of compensation ............................................. 209 B6.4.4.4 Differential payments ............................................... 210 B6.4.4.5 Relative stock ownership .......................................... 210 B6.4.4.6 Factors involving reasons for contingent payment arrangements ............................................ 211 B6.4.4.7 Factors involving a formula for determining contingent consideration .......................................... 211 B6.4.4.8 Factors involving other agreements and issues .......... 212 B6.4.4.9 Examples of arrangements with contingent payments to employees or selling shareholders ......... 212 B6.4.5 Accounting for contingent consideration after initial recognition ... 215 B6.4.5.1 Contingent consideration classified as equity ............. 215 B6.4.5.2 Contingent consideration classified as liabilities ......... 216 B6.4.6 Effect of contingent consideration classified as equity on earnings per share computations ................................................ 216 B6.4.6.1 Basic earnings per share........................................... 216 B6.4.6.2 Diluted earnings per share ........................................ 217 B6.4.7 Assumed contingent consideration obligations ................................. 218

B7

Other matters (including goodwill, measurement period and acquisitions achieved in stages) ............................................................................................. 219 B7.1 Recognizing and measuring goodwill ........................................................... 219 B7.1.1 Recognition................................................................................ 219 B7.1.2 Measurement ............................................................................. 220 B7.2 Recognizing and measuring a gain from a bargain purchase ......................... 221 B7.2.1 Reassessment of identification of assets acquired and liabilities assumed ...................................................................... 222 B7.2.2 Bargain purchase example .......................................................... 223


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B7.3

B7.4

Bargain purchase in an acquisition of less than 100% controlling interest ..................................................................... 224 Measurement period................................................................................... 224 B7.3.1 Measurement period defined ....................................................... 224 B7.3.2 Provisional amounts recognized .................................................. 226 B7.3.3 Adjustments to provisional amounts recognized........................... 227 B7.3.3.1 Retrospective application in registration statements filed with the SEC .................................... 229 B7.3.4 Adjustments to provisional amounts subsequent to the measurement period .................................................................. 229 B7.3.5 Measurement period example ..................................................... 229 Business combinations achieved in stages ................................................... 230 B7.4.1 Accounting prior to obtaining control .......................................... 231 B7.4.2 Accounting for a pre-existing investment when control is obtained ................................................................................. 231 B7.4.2.1 Remeasurement of previously held interest................ 231 B7.4.2.2 Control premium in a business combination achieved in stages .................................................... 232 B7.4.2.2.1 Examples control premium in a business combination achieved in stages .............................................. 233 B7.4.2.3 Subsequent purchases of subsidiary shares when control is retained .................................................... 234

B7.2.3

B8

Presentation and disclosure ................................................................................ 235 B8.1 Gain recognized in a bargain purchase ......................................................... 235 B8.2 Cash paid to acquire a business ................................................................... 235 B8.3 Other presentation matters ........................................................................ 235 B8.3.1 Transaction costs ....................................................................... 236 B8.3.1.1 Classification in the statement of operations .............. 236 B8.3.1.2 Classification in the statement of cash flows............... 236 B8.3.2 Contingent consideration ............................................................ 236 B8.3.2.1 Contingent consideration classified as equity ............. 236 B8.3.2.2 Remeasurement of contingent consideration ............. 237 B8.4 General disclosure requirements ................................................................. 237 B8.4.1 Overview.................................................................................... 238 B8.4.2 When to disclose a business combination ..................................... 239 B8.4.3 Aggregation of immaterial business combinations ........................ 239 B8.5 Specific disclosure requirements ................................................................. 240 B8.5.1 Intangible assets disclosures in period of acquisition ..................... 240 B8.5.2 Additional pro forma disclosures required for public entities ......... 241 B8.5.2.1 Public business entity definition.............................. 242

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B8.6 B8.7 B8.8 B9

B8.5.2.2 Effect of adjustment in the measurement period on the pro forma disclosures..................................... 243 B8.5.2.3 Pro forma information for a business combination computation and presentation in MD&A .................................................................. 243 B8.5.3 SEC reporting requirements for business combinations ................ 244 B8.5.3.1 Financial statements of businesses acquired or to be acquired ............................................................. 244 B8.5.3.2 Pro forma financial information ................................ 244 B8.5.3.2.1 Article 11 pro forma financial income statement treatment of changes in the fair value of contingent consideration related to a business combination ........................... 245 B8.5.4 Business combinations after the balance sheet date ..................... 246 B8.5.5 In what periods are the disclosures required?............................... 246 B8.5.6 Initial accounting for a business combination is incomplete ........... 246 B8.5.7 ASC 820 disclosure considerations.............................................. 247 B8.5.8 Retention of an investment banker .............................................. 247 B8.5.9 Transaction costs transition disclosure requirements ................... 247 B8.5.10 Disclosures related to acquired IPR&D assets ............................... 248 Amendments to ASC 805 disclosure requirements....................................... 249 SAB Topic 11M (SAB 74) disclosure considerations...................................... 249 Conforming accounting policies................................................................... 250

Effective date and transition ............................................................................... 251 B9.1 Transition considerations for prior business combinations ............................ 251 B9.1.1 Liabilities for certain restructuring activities ................................ 251 B9.1.2 Resolution of contingent consideration ........................................ 252 B9.1.3 Purchase price allocation period ending after the effective date of the guidance in ASC 805 ................................................. 252 B9.2 Deferred tax asset valuation allowances and liabilities for tax uncertainties .............................................................................................. 253 B9.3 Tax benefits of tax deductible goodwill in excess of goodwill for financial reporting ................................................................................................... 254 B9.4 Income tax effects of replacement awards classified as equity issued in a business combination ................................................................................. 254 B9.5 Transaction costs incurred prior to the effective date of Statement 141(R) ...................................................................................... 255 B9.6 Effect of adoption on identification of reporting units and assessment of goodwill impairment ................................................................................... 256 B9.7 Goodwill impairment testing subsequent to adoption.................................... 257 B9.8 Mutual entities ........................................................................................... 257


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B9.8.1 B9.8.2 B9.8.3 B9.8.4

Reclassification of intangible assets ............................................. 258 Effect of deferred income taxes................................................... 261 Business combinations resulting in a bargain purchase (negative goodwill) ..................................................................... 261 Transitional intangible asset impairment testing........................... 262

Appendix A: Differences between ASC 805 and IFRS 3 (as revised) .............................. 263 Appendix B: Accounting for asset acquisitions .............................................................. 269 BB1 Scope ........................................................................................................ 269 BB1.1 Settlements of preexisting relationships in asset acquisitions ........ 269 BB2 Measurement of the cost of an asset acquisition .......................................... 270 BB2.1 Transaction costs ....................................................................... 271 BB2.2 Nonmonetary assets as consideration transferred........................ 271 BB2.3 Fair value measurements ............................................................ 272 BB3 Allocation of consideration transferred in asset acquisitions ......................... 272 BB3.1 Cost assignment in asset acquisitions .......................................... 272 BB3.1.1 Intangible assets, including goodwill .......................... 272 BB3.1.1.1 Assembled workforce ........................... 273 BB3.1.1.2 In-process research and development ........................................ 273 BB3.1.2 Deferred income tax accounting ................................ 274 BB3.1.3 Acquired contingencies ............................................. 274 BB3.1.4 Accounting for leases in asset acquisitions ................. 274 BB3.1.4.1 Asset Acquisition Lessor .................... 274 BB3.1.4.2 Asset acquisition lessee ..................... 274 BB3.2 Excess of cost over the fair value of acquired assets ..................... 275 BB3.2.1 Example of accounting for an excess of cost over the fair value of acquired assets ................................ 276 BB3.3 Excess of fair value of acquired assets over cost (bargain purchase) ...................................................................... 277 BB3.3.1 Example A accounting for an excess of the fair value of acquired assets over cost ....................... 278 BB3.3.2 Excess of fair value over cost of acquired assets with contingent consideration and IPR&D ................... 279 BB3.3.2.1 Example Excess of fair value over cost of acquired assets with contingent consideration and IPR&D ...... 279 BB4 Subsequent accounting .............................................................................. 279 BB5 Disclosure considerations ........................................................................... 280 BB5.1 Intangible assets......................................................................... 280 BB5.2 Tangible assets........................................................................... 280 BB5.3 Nonmonetary assets ................................................................... 280

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Appendix C.1: Illustrative comprehensive disclosure .................................................... 281 Acquisition of less than 100% of the stock of the acquired company ......................... 284 Business combination achieved in stages ................................................................ 284 Bargain purchase................................................................................................... 285 Appendix C.2: SEC Rule 3-05 flowchart........................................................................ 286 Appendix D: Glossary................................................................................................... 288 Appendix E: Abbreviations used in this publication ....................................................... 297 Appendix F: Index of ASC References in this publication ............................................... 304


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This publication has been carefully prepared, but it necessarily contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decision. Certain abbreviations of accounting standards are used throughout this publication. Those abbreviations are defined in Appendix E.

Portions of FASB Statement No. 141(R), FASB Staff Positions, and other FASB publications reprinted with permission. Copyright Financial Accounting Standards Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116, U.S.A. Portions of AICPA Statements of Position, Technical Practice Aids, and other AICPA publications reprinted with permission. Copyright American Institute of Certified Public Accountants, 1211 Avenue of the Americas, New York, NY 10036-8875, USA. Copies of complete documents are available from the FASB and the AICPA.

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B1 Overview of accounting for business combinationsB1 Overview of accounting for business combinations

B1.1

Overview

On 4 December 2007, the Financial Accounting Standards Board (FASB) issued Statement No. 141(R), Business Combinations (codified primarily in ASC 805), and Statement No. 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (codified primarily in ASC 805). These new standards significantly changed the financial accounting and reporting of business combinations and noncontrolling (or minority) interests in consolidated financial statements. Issuance of these standards also was noteworthy in that they represented the culmination of the first major collaborative convergence project between the International Accounting Standards Board (IASB) and the FASB. International Financial Reporting Standard No. 3(R), Business Combinations, and International Accounting Standard No. 27 (Amended), Consolidated and Separate Financial Statements, are similar to ASC 805 and the consolidation guidance in ASC 810 and were issued by the IASB in January 2008. This Financial Reporting Developments (FRD) publication provides guidance and our observations on the application of the guidance in ASC 805. A separate FRD entitled, Noncontrolling Interests in Consolidated Financial Statements, provides guidance and our observations on the application of ASC 810. The guidance in ASC 805 is required to be adopted concurrently with the guidance in ASC 810 and, with limited exceptions for certain income tax accounting changes, is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 15 December 2008. Early adoption is prohibited.


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Overview of accounting for business combinations

The following table summarizes and compares the major provisions of ASC 805 and Statement 141 (including related authoritative literature):Provision Scope: Identifying a business combination1

Statement 141 Effective date of Statement 141 was deferred for combinations involving only mutual entities. A business combination occurs when an entity acquires net assets that constitute a business or acquires equity interests of one or more other entities and obtains control over that entity or entities. Statement 141 does not address transactions in which control is obtained through means other than an acquisition of net assets or equity interests, although other GAAP addressed certain other transactions in which control is obtained.

ASC 805 The acquisition method of accounting is required for all business combinations including those involving mutual entities. A business combination includes any transaction or other event in which the acquirer obtains control of one or more businesses.

Definition of a business Under EITF 98-3, a transferred set had to contain substantially all of the elements (i.e., inputs, processes and outputs) necessary for it to conduct normal operations after it is separated from the transferor (i.e., it must be a self-sustaining set of activities and assets). A development stage enterprise was not considered a business.

The definition of a business is broadened and clarified with additional application guidance. In order to be considered a business, the acquired set of activities and assets is not required to include outputs and the acquired inputs and processes need only be capable of being operated as a business, from the viewpoint of a market participant (i.e., a market participant is able to replace any missing elements in order to operate the acquired set as a business). As a result, more acquisitions (e.g., development stage entities) likely will be accounted for as business combinations rather than asset acquisitions. ASC 805 requires that the business combination be accounted for on the acquisition date (i.e., the date control is obtained). This date may be earlier or later than the closing date if control is evidenced by a written agreement.

Determining the acquisition date

Statement 141 requires business combinations to be accounted for on the closing (or consummation) date, or the date that effective control of the acquiree changes pursuant to a written agreement.

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Note that combinations between not-for-profit organizations or acquisitions of a for-profit business by a not-forprofit business are not within the scope of either Statement 141 or ASC 805. Refer to section B2.2.4 for further discussion.

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Provision Assets and liabilities subject to contingencies

Statement 141 Recognized during allocation period and measured at the fair value or, if fair value is not determinable, then consistent with the guidance in Statement 5.

ASC 805 Would have required the use of FV on the acquisition date for: (1) all contractual preacquisition contingencies and (2) noncontractual pre-acquisition contingencies that are determined to be more-likely-thannot of materializing. On 1 April 2009, the FASB issued FSP 141(R)-1, which basically aligns the requirements under ASC 805 with those previously required under FAS 141, with the likely exception of warranty obligations. Changes in an acquirers deferred tax asset valuation allowance that result from a business combination are accounted for as an element of income tax expense. Post-acquisition adjustments (except for qualifying measurement period adjustments) to a deferred tax asset valuation allowance or tax uncertainties that were recognized in business combination accounting are recognized in income tax expense. A deferred tax asset is recognized in business combination accounting for tax benefits arising from tax deductible goodwill that is in excess of goodwill for financial reporting purposes.

Income taxes

Decreases in an acquirers deferred tax asset valuation allowance that result from a business combination are included as part of the business combination accounting (usually, decreasing goodwill). Reductions to a deferred tax asset valuation allowance that was recognized in business combination accounting are first applied to reduce goodwill to zero, then to reduce other noncurrent intangibles to zero and lastly to reduce income tax expense. Additionally, for changes in liabilities for income tax uncertainties, reductions are recognized similar to reductions in deferred tax asset valuation allowances as described above, while increases are recognized as additional goodwill. A deferred tax asset is not recognized in business combination accounting for tax benefits arising from tax deductible goodwill that is in excess of goodwill for financial reporting purposes. The tax benefit of that excess is recognized when realized as a tax deduction by increasing goodwill. Deferred tax assets are not recognized for anticipated income tax deductions for share-based payments issued in a business combination. All subsequent tax benefits are recognized as adjustments to goodwill or additional paid-in capital.

Deferred tax assets are recognized for the portion of the fair value of tax deductible share-based payments recognized in the business combination. Subsequent accounting for tax benefits of share-based payments issued in a business combination is the same as for all other share-based payments.


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Provision

Statement 141

ASC 805 Restructuring costs are recognized separately from the business combination accounting as post-combination expenses of the combined entity unless the criteria in ASC 420 are met on the acquisition date by the target entity. Acquired in-process R&D assets are recognized and measured at acquisitiondate fair value. After initial recognition, acquired in-process R&D assets are accounted for as indefinite-lived intangible assets in accordance with ASC 350. Development costs incurred after acquisition on acquired developmental projects are charged to expense as incurred. Upon completion of development, acquired in-process R&D assets are considered amortizable finitelived assets. ASC 805 requires all assets to be measured at fair value from a market participants perspective in accordance with ASC 820, without regard to acquirer intent. The effect of an expected termination, curtailment or other amendment of an acquirees plan is not considered in measuring acquisition-date projected and accumulated post-retirement benefit obligations assumed by an acquirer. Valuation allowances are not recognized for acquired assets that are recognized at fair value. Noncontrolling interests are recognized at fair value as of the acquisition date. Fair value of the noncontrolling interests usually is not derived by an extrapolation of consideration transferred by the acquirer.

Restructuring activities Costs of an acquirers plan to exit an activity of the acquiree or to involuntarily terminate or relocate employees of the acquiree are recognized as liabilities assumed and included in the purchase price allocation if the conditions in EITF 953 are satisfied. Research and development assets Acquired in-process research and development (R&D) assets that have no alternative future use are measured at fair value and charged to expense as of the acquisition date.

Assets the acquirer does not intend to use or use to the extent of highest and best use.

Before adoption of Statement 157, it has been acceptable to use entity-specific assumptions to value assets that will be abandoned or not fully utilized, often resulting in either a transitional value or no value being allocated to such assets. If it is expected that the acquirees plan will be terminated or curtailed, effects of those actions are considered in measuring the acquisition-date projected and accumulated post-retirement benefit obligations assumed by an acquirer. Valuation allowances are recognized in a purchase price allocation for uncollectible loans and accounts receivable. The historical cost basis of the assets acquired and liabilities assumed is carried over to the extent of the noncontrolling interests in the acquired entity.

Pension and other postretirement benefit obligations

Assets with uncertain cash flows (Valuation allowances) Noncontrolling interests

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Provision Goodwill

Statement 141 Goodwill is recognized as the excess of the cost of an acquirers interest in an acquired entity over the acquirers interest in the fair values of the net identifiable assets.

ASC 805 Goodwill is recognized as the extent by which (a) the aggregate of the acquisitiondate fair value of (1) the consideration transferred, (2) any noncontrolling interests in the acquiree and (3) in a business combination achieved in stages, the acquirers previously held equity interests in the acquiree exceeds (b) the recognized bases of the identifiable assets acquired, net of assumed liabilities. In other words, goodwill is the excess of the fair value of the acquiree over the recognized bases of net identifiable assets acquired. A bargain purchase, representing the excess of 100% of the recognized bases of identifiable assets acquired, net of assumed liabilities, over the aggregate of the acquisition date fair values of (1) the acquirers interest in the acquiree, (2) any noncontrolling interests in the acquiree, is recognized as an ordinary gain and (3) any equity interest held in the acquiree by the acquirer immediately before the acquisition date. The fair value of all consideration transferred is measured as of the acquisition date.

Bargain purchase transactions

Negative goodwill, representing the excess of the acquirers interest in the fair values of the identifiable net assets over the cost of acquirers interest in the acquired entity, reduces the acquirers basis in certain acquired long-lived assets to zero before an extraordinary gain is recognized.

Marketable equity securities of the acquirer

The fair value of an acquirers marketable equity securities that are issued as consideration in a business combination is measured as of the date the terms of the acquisition are agreed to and announced (as defined in EITF 99-12) if certain conditions are met, or on the acquisition date if the conditions are not met before then. The fair value of all other consideration transferred is measured as of the acquisition date.


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Provision Contingent consideration

Statement 141 Recognized as an additional element of the cost of the acquisition when the contingency is resolved beyond a reasonable doubt and the additional consideration is issued or becomes issuable.

ASC 805 Recognized and measured at fair value at the acquisition date and classified as either a liability or equity based on existing GAAP. After initial recognition, contingent consideration obligations that are classified as: (1) equity are not subsequently remeasured, (2) liabilities that are financial instruments within the scope of ASC 815 are accounted for pursuant to that standard and (3) liabilities that are not within the scope of ASC 815 are remeasured at fair value with changes in fair value recognized in income. The portion of the fair value of the acquirers replacement awards included as part of the consideration transferred is the fair value of the replaced acquirees award multiplied by the ratio of the past service period to the greater of the total service period or the original service period. The fair value of the acquirers replacement award less the portion of the fair value of the acquirers replacement awards included as part of the purchase consideration is recognized by the acquirer as compensation cost over the postacquisition service period. An acquirers decision to accelerate vesting in connection with the exchange of awards will result in increased compensation cost for the acquirer as compared to Statement 141. Any excess fair value of acquirer awards exchanged for acquired company awards will continue to be recognized as compensation cost by the acquirer.

Share-based payment awards exchanged for awards held by the acquirees employees

The portion of the fair value of the acquirers replacement awards included as part of the consideration transferred is the amount attributable to the portion of any service period that has transpired before the acquisition date (exclusive of any excess of the fair value of the replacement awards over the fair value of the exchanged acquiree awards). The portion of the award attributable to prior service is measured based on the terms of the replacement award (e.g., if the replacement award is fully vested, all of the service is attributed to the period prior to the business combination, even if the replaced awards were not fully vested on the date of the business combination). The portion of the fair value of the replacement awards that is recognized as compensation cost by the acquirer is the amount attributable to the portion of service period that has not transpired before the acquisition date plus any excess of the fair value of the replacement awards over the fair value of the exchanged acquiree awards.

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Provision

Statement 141

ASC 805 An acquirer recognizes its acquisition of an acquiree, as a whole, and the assets acquired and liabilities assumed at the full amount of their fair values (with certain exceptions) as of the acquisition date (the date an acquirer takes control and begins to consolidate an acquiree). Any noncontrolling equity investment in an acquiree owned by the acquirer immediately before obtaining control of the acquiree is remeasured at fair value with the unrealized holding gain or loss recognized in income. Acquisitions by the parent of additional equity interests in a subsidiary after taking control of the subsidiary are considered to be equity transactions and do not result in new bases in the acquired net assets. Adjustments are permitted to be made to (i) the identifiable assets acquired, liabilities assumed and any noncontrolling interest, (ii) the acquirers previous interest in the acquiree, (iii) the consideration transferred and (iv) goodwill recognized during the measurement period. Adjustments to preliminary values assigned at the acquisition date are pushed back to the date of acquisition. Thus, comparative information for prior periods would be adjusted (e.g., by changes to depreciation or amortization expense) retroactively. Acquisition-related costs are not considered part of the fair value exchange between the buyer and seller for the acquired business and, therefore, are expensed as incurred.

Business combinations Assets and liabilities of an acquiree are achieved in stages recognized at a mixture of current exchange prices and historical book values. (step acquisitions) For an acquirer, each incremental acquisition creates a new basis in each acquired net asset or liability to the extent of the increase in the acquirers ownership interest.

Measurement period

Adjustments during the purchase price allocation period to preliminary values assigned at the acquisition date generally are accounted for on a prospective basis.

Acquisition-related costs

Direct costs incurred in connection with a business combination, such as finders fees, advisory, accounting, legal, valuation and other professional fees, are included as part of the cost of the acquired business.


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B1.2

Background

The FASB added the business combinations project to its agenda in August 1996 to reconsider the guidance contained in APB 16 and APB 17. The first phase of the project was completed in June 2001 with the issuance of Statement 141 and Statement 142. Key aspects of Statement 141 included the elimination of the pooling-of-interests method of accounting for business combinations, expanded guidance on recognizing intangible assets apart from goodwill in a business combination and increased disclosures about business combinations. Key aspects of Statement 142 included replacing the amortization of goodwill and indefinitelived intangibles with annual impairment tests and increased disclosures about goodwill and other intangible assets. The issuance of Statements 141 and 142 resulted in significant changes to the accounting for business combinations, goodwill and other intangible assets. However, substantially all of the guidance for applying the purchase method of accounting in APB 16 (including its amendments and interpretations), as well as the guidance in Statement 38, were carried forward in Statement 141 without reconsideration. After the issuance of Statements 141 and 142, the FASB began deliberating the second phase of its business combinations project. The objectives of the second phase of the project were to reconsider the guidance on applying the purchase method of accounting that Statement 141 carried forward from APB 16 and Statement 38, and to address other related issues that were not considered in the first phase of the project, including business combinations that are achieved through means other than purchasing the net assets or equity interests in a business, acquisitions of less than 100 % of the equity ownership interests in an acquiree (i.e., partial acquisitions) and the accounting for business combinations achieved in stages (commonly referred to as step acquisitions). The deliberations on partial and step acquisitions led the FASB to comprehensively reconsider the accounting for and reporting of noncontrolling interests, resulting in the issuance of a consolidation and noncontrolling interest accounting exposure draft concurrently with a business combination accounting exposure draft in June 2005. The FASB partnered with the IASB on the second phase of the project to promote the international convergence of accounting and reporting standards for business combinations. The FASB and IASB developed common exposure drafts that incorporated the decisions reached in their joint project. The FASB and IASB concurrently deliberated and reached the same conclusions on the fundamental issues that were considered in the second phase of the project, with only limited exceptions. The final FASB and IASB standards on business combination and noncontrolling interests accounting are similar to those proposed in the exposure drafts and, as mentioned above, are substantially the same, except as outlined Appendix A of this FRD.

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B1.3

The overall principle in ASC 805: obtaining control results in a new basis

Under Statement 141 the accounting for a business combination involves accumulating costs of acquiring a target entity and allocating those costs to individual assets acquired and liabilities assumed. In step acquisitions and partial acquisitions, this process generally results in recognizing the acquirees assets and liabilities at a mixture of values at the acquisition date (or dates) and, to the extent of interests in the acquiree not held by the acquirer, historical carrying values (i.e., accounting bases established before the acquirer made its acquisition(s)). Those historical carrying values are attributed to the noncontrolling interests (previously referred to as minority interests) in the acquiree. That is, only the pro-rata portion of the business purchased by the acquirer was subject to purchase accounting. The acquirer did not recognize and measure 100% of the assets acquired, liabilities assumed and noncontrolling interests at their full fair values. These practices have been criticized by financial statement users as resulting in information that lacks consistency and understandability. The FASB concluded that accounting bases relating to transactions or events occurring before the acquired companys inclusion in the acquirers consolidated financial statements are not relevant to users of those consolidated financial statements. Instead, the overall principle underlying the decisions reached in the second phase of the business combinations project, and reflected in ASC 805, is the belief of the FASB and the IASB that because a business combination is a transaction in which an entity (the acquirer) takes control of another entity (the target), the fair value of the underlying exchange transaction should be used to establish a new accounting basis of the acquired entity. Furthermore, because obtaining control leaves the acquirer responsible and accountable for all of the acquirees assets, liabilities and operations, the acquirer should recognize and measure the assets acquired and liabilities assumed at their full fair values2, 3 as of the date control is obtained, regardless of the percentage ownership in the acquiree or how the acquisition was achieved (e.g., a step acquisition, a single purchase resulting in control, or a change in control without a purchase of equity interests). ASC 805 refers to this method as the acquisition method.

B1.4

Scope: identifying business combination transactions

Under Statement 141, a business combination occurs when an entity obtains control of a business by acquiring its net assets, or some or all of its equity interests. During the second phase of the business combinations project, the FASB concluded that all transactions or events in which an entity obtains control of a business are economically similar transactions or events2 3

The term fair value as used in ASC 805 has the same meaning as in ASC 820. As discussed in section B3.3 of this FRD, ASC 805 provides certain exceptions to the fair value measurement principle.


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and, therefore, the accounting for a change in control should not differ based on the means by which control is obtained. Thus, although a business combination typically occurs through the purchase of the net assets or equity interests of a business, a business combination could also occur without the transfer of consideration (e.g., through a contractual arrangement).

B1.4.1

Definition of a business

During the deliberations leading to Statement 141(R), the FASB reconsidered the definition of a business and related guidance provided in EITF 98-3. The FASB noted that EITF 98-3 is sometimes interpreted inconsistently and can be overly restrictive in terms of limiting the scope of transactions that are accounted for as business combinations (e.g., when applied to development stage enterprises). As a result, the guidance in ASC 805 broadens the definition of a business. Based on the new definition of a business and the related implementation guidance in ASC 805, we expect there will be an increase in the relative number of acquisition transactions that will be accounted for as business combinations under ASC 805 compared with prior practice under Statement 141 and EITF 98-3. Further, the expanded definition of a business will affect the application of other U.S. GAAP. For example, the analysis of a variable interest entity (VIE) pursuant to ASC 810 and the determination of a reporting unit pursuant to ASC 350-20, both of which reference the definition of a business, might be affected.

B1.5

Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree

ASC 805 requires that identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree be recognized and measured as of the acquisition date at fair value (with certain limited exceptions). The FASB observed that to fairly represent economic circumstances at the acquisition date, in principle, all assets acquired and liabilities assumed should be recognized at the acquisition date and measured at fair value. In addition, although the objectives of the second phase of the business combinations project were not directly related to day 2 accounting for assets acquired and liabilities assumed, ASC 805 provides guidance on accounting for certain acquired assets and assumed liabilities after the business combination. Some of the most significant changes in recognition and measurement practices compared with Statement 141, as well as the more significant recognition and measurement exceptions included in ASC 805 are as follows:

Income taxes are recognized and measured in accordance with ASC 740. Under the amended standards, (a) changes that result from a business combination transaction in an acquirers existing deferred income tax asset valuation allowances and (b) changes in an acquired companys deferred income tax asset valuation allowances and income tax uncertainties that occur subsequent to the business combination, in most cases are recognized as adjustments to income tax expense. Under Statement 141, reductions in an acquirers valuation allowance as a result of the business combination were recognized in purchase accounting and, related to an acquired company, reductions in income taxFinancial reporting developments Business combinations ASC 805

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valuation allowances and changes in income tax uncertainties subsequent to the business combination were subject to backwards tracing to the original purchase price allocation. As a result, such adjustments generally did not affect income tax expense.

Recognition of liabilities for restructuring activities in the accounting for the business combiantion is limited to restructuring obligations assumed by the acquiring entity from the target entity. The concept in EITF 95-3 that permitted the acquirer a reasonable period of time to complete a restructuring plan and recognize the resulting liability as a liability assumed in the business combination has been eliminated. In-process research and development assets are measured at fair value, capitalized as indefinite-life intangible assets and tested for impairment pursuant to the guidance in ASC 350-30. Acquired IPR&D assets that have no alternative future use are no longer permitted to be written-off upon acquisition, as was done under Statement 141. Assets the acquirer does not intend to use to its highest and best use are required to be measured at fair value, as defined in ASC 820. In contrast, under Statement 141, it generally was acceptable to allocate either a transitional value or a zero value in the purchase price allocation to assets the acquirer does not intend to use. The recognition and measurement criteria for assumed pension and postretirement benefit obligations generally are consistent with practice under Statement 141. That is, such obligations should be measured and recognized in accordance with the guidance in ASC 715. However, the effects of expected terminations, curtailments or amendments of an assumed acquiree benefit plan are no longer included in purchase accounting. Indemnification assets relating to liabilities recognized in the business combination should be recognized and measured using assumptions consistent with those used to measure the liabilities to which they relate, subject to any contractual limitations as to the indemnification amount and managements assessment of collectability. A reacquired right should continue to be recognized as an identifiable intangible asset; however, from a measurement perspective, ASC 805 precludes accounting for the value of any renewal rights (both explicit and implicit renewal rights) in determining the fair value allocated to the intangible reacquired right asset. This is one of the few exceptions to the use of market-participant assumptions in the fair value concepts included in ASC 805. In acquisitions of less than 100 % of a targets ownership interests, the assets acquired, liabilities assumed and any remaining noncontrolling (formerly minority) interests are recognized at their full acquisition-date fair values. Under Statement 141, any noncontrolling interests were recognized based on the minority shareholders interests in the predecessor cost basis of the assets acquired and liabilities assumed.


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B1.6

Consideration transferred

ASC 805 requires that all consideration transferred (i.e., the purchase price) be measured at its acquisition-date fair value. Under ASC 805, consideration transferred is comprised of the acquisition-date fair values of:

Assets transferred, Liabilities incurred,4 including contingent consideration obligations and Equity interests issued by the acquirer.

Consideration transferred may take many forms, including cash, tangible and intangible assets, a business or subsidiary of the acquiring entity, securities of the acquiring entity (e.g., common stock, preferred stock, options, warrants and debt instruments) or other promised future payments of the acquiring entity, including contingent payments. Irrespective of the form, the fair value of all consideration transferred should be recognized at the acquisition date. Note that, as discussed in Section B6.4.5, ASC 805 also provides guidance on the day 2 accounting for contingent consideration that is recognized as consideration transferred in the business combination. All consideration transferred is measured at its acquisition-date fair value, in contrast to certain measurement exceptions that were permitted under Statement 141. Statement 141 provided measurement exceptions for marketable equity securities, which often were measured prior to the acquisition date based on the market price of those securities over a reasonable period of time (i.e., a few days before and after the terms of the acquisition are agreed to and announced), and contingent consideration, which was not recognized until the consideration was issued or became issuable.

B1.7

Recognizing and measuring goodwill or a gain from a bargain purchase

Under ASC 805, an acquirer in a business combination recognizes 100 % of the fair value of the business acquired (i.e., the full fair value of the assets acquired, liabilities assumed and any noncontrolling interests) as of the acquisition date. This is referred to as the fullgoodwill approach and is applicable without regard to the actual controlling ownership interest acquired. This principle applies whether control is obtained by purchasing an acquirees net assets, purchasing some (or all) of the acquirees equity interests, by contract alone or by other means. As noted previously, this approach contrasts with prior practice under Statement 141 of step-acquisition accounting, under which acquired assets and assumed liabilities were recognized at their historical cost bases to the extent of the4

Liabilities incurred refers to obligations of the acquirer to former owners of a target company and not to liabilities of the acquiree assumed in a business combination by an acquirer. Liabilities assumed are not considered an element of consideration transferred.

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noncontrolling interest in an acquired company. The result under ASC 805 is that recognized goodwill will represent all of the goodwill of the acquired business, not just the acquirers share.

B1.7.1

IFRS alternative for recognition of goodwill on noncontrolling interest

In accounting for partial acquisitions, the IASB decided to permit an alternative to the recognition of 100 % of residual goodwill. In addition to the approach described above and required by ASC 805, IFRS 3, as revised, also permits recognition of only the acquirers share of goodwill. Accordingly, IFRS 3, as revised, provides for an acquirer to recognize noncontrolling interest at either full fair value or its proportionate interest in the net identifiable assets recognized. Recognized goodwill, under the partial recognition alternative, will essentially be equivalent to the amount of goodwill recognized by an acquirer under Statement 141 and IFRS 3 (before its revision). This alternative is not permitted under ASC 805.

B1.7.2

Bargain purchases

In rare circumstances the fair value of consideration transferred for an acquirers interest in a business is less than the fair value (or other recognized value for the exceptions to fair value recognition) of the net assets acquired. Such a transaction results in an economic gain to the acquiring entity. Under ASC 805, a gain is recognized for (a) the amount by which the acquisition-date fair value (or other amounts recognized in accordance with the guidance in ASC 805) of the identifiable net assets acquired exceeds (b) the acquisition-date fair value of the acquirers interest in the acquiree plus the recognized amount of any noncontrolling interest in the acquiree. Any such gain should not be classified as extraordinary, and is recognized only after a thorough reassessment of all elements of the accounting for the acquisition. In previous practice under Statement 141, certain long-lived assets were reduced to zero before an extraordinary gain could be recognized.

B1.7.3

A business combination achieved in stages

An acquirer may obtain control of an acquiree through a series of acquisitions of two or more different investments. Such a transaction was commonly referred to in prior GAAP as a step acquisition transaction and in ASC 805 as a business combination achieved in stages. If the acquirer holds a noncontrolling equity investment in the acquiree immediately before obtaining control, the acquirer should, under the guidance in ASC 805, re-measure that investment to fair value as of the acquisition date and recognize any remeasurement gains or losses in earnings. As such, the step acquisition (i.e., cost accumulation) model under Statement 141 has been eliminated. After taking control of a target company, further acquisitions of ownership interests (i.e., acquisitions of noncontrolling ownership interests) are accounted for after the guidance in ASC 850 becomes effective as transactions among shareholders. Accordingly, neither step


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acquisition nor business combination accounting principles will apply to accounting for such transactions. These transactions will be accounted for as equity transactions pursuant to the guidance in ASC 810.

B1.7.4

Measurement period

Statement 141 provided for a period of time, referred to as the allocation period, during which the acquirer may adjust provisional amounts recognized at the acquisition date in the acquirers purchase price allocation to their subsequently determined acquisition-date fair values. ASC 805 provides for a similar period of time to adjust provisional amounts after the acquisition date, referred to as the measurement period. However, under ASC 805, adjustments during the measurement period are not limited to just those relating to acquired assets and assumed liabilities, but apply to all aspects of business combination accounting (e.g., the consideration transferred). Adjustments to the provisional values during the measurement period should be pushed back to the date of acquisition. Thus, comparative information for periods after acquisition but before the period in which the adjustments are identified should be adjusted (e.g., by changes to depreciation or amortization expense recognized in the intervening periods) to reflect the effects of the adjustments as if they were taken into account as of the acquisition date in the provisional accounting for the business combination. Statement 141 is silent about the treatment of such adjustments; however, in practice, they generally have been accounted for prospectively.

B1.7.5

Assessing what is part of the exchange for the acquiree

To distinguish elements that should be accounted for as part of the business combination from elements that should be accounted for outside of the business combination, ASC 805 requires an acquirer to assess if any assets acquired, liabilities assumed or portion of the transaction price are not part of the exchange for the acquiree. Exchanged values of any portion of the assets acquired, liabilities assumed or transaction price that is not part of the exchange for the acquiree should be accounted for separately from the business combination and may increase or decrease the consideration transferred in the business combination. Examples of payments or other arrangements that would not be considered part of the exchange for the acquiree, and thus not part of the accounting for the business combination, include payments that effectively settle preexisting relationships between the acquirer and acquiree, payments to compensate employees or former owners of the acquiree for future services, acquirer share-based payments exchanged for acquiree awards that are determined not to be part of the consideration transferred, and costs incurred in connection with a business combination (i.e., transaction costs, which generally were included in the cost of the business combination under Statement 141, if certain conditions were met).

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B1.8

Disclosure requirements

Although, for the most part, the specific disclosure requirements in ASC 805 are similar to those required by Statement 141, the FASB, like the IASB, developed overall objectives for disclosure of information related to a business combination. ASC 805 provides specific, detailed disclosure requirements that are intended to facilitate meeting these disclosure objectives (and exceed the disclosures previously required by Statement 141). However, ASC 805-10-50-7 states that if these specific disclosure requirements, and those required by other GAAP, do not meet the overall disclosure objectives of the standard, an acquirer should disclose any additional information necessary to meet those objectives.

B1.9

Effective date and transition considerations

The guidance in ASC 805 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 15 December 2008 (e.g., 1 January 2009 for calendar-year companies). Earlier application is prohibited. Application of the guidance in ASC 805 is prospective. Thus, business combination consummated before the adoption of the guidance in ASC 805 should be accounted for in accordance with Statement 141. However, after the guidance in ASC 805 is adopted, all changes to tax uncertainties and deferred tax asset valuation allowances established in business combination accounting (whether the combination was accounted for under APB 16, Statement 141 or ASC 805) should be recognized in accordance with the requirements in ASC 740 (generally as an adjustment to income tax expense). See our Income tax FRD for further discussion.


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B2 Identifying business combination transactionsB2 Identifying business combination transactions

B2.1

What is a business combination?

Excerpt from Accounting Standards CodificationBusiness Combinations Overall Recognition 805-10-25-1 An entity shall determine whether a transaction or other event is a business combination by applying the definition in this Subtopic, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. An entity shall account for each business combination by applying the acquisition method. Implementation Guidance and Illustrations 805-10-55-2 Paragraph 805-10-25-1 requires an entity to determine whether a transaction or event is a business combination. In a business combination, an acquirer might obtain control of an acquiree in a variety of ways, including any of the following: a. b. c. d. e. By transferring cash, cash equivalents, or other assets (including net assets that constitute a business) By incurring liabilities By issuing equity interests By providing more than one type of consideration Without transferring consideration, including by contract alone (see paragraph 805-10-25-11).

805-10-55-3 A business combination may be structured in a variety of ways for legal, taxation, or other reasons, which include but are not limited to, the following: a. b. c. One or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer. One combining entity transfers its net assets or its owners transfer their equity interests to another combining entity or its owners. All of the combining entities transfer their net assets or the owners of those entities transfer their equity interests to a newly formed entity (sometimes referred to as a rollup or put-together transaction). A group of former owners of one of the combining entities obtains control of the combined entity.

d.

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B2

Identifying business combination transactions

A glossary of key terms, which are bolded throughout ASC 805 and included in Appendix D, Glossary of this publication. These key terms include modified definitions of a business combination and a business (refer to Section B2.1.3 for a discussion of the definition of a business). ASC 805 defines a business combination as A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as true mergers or mergers of equals also are business combinations. In ASC 805, the FASB concluded that al l transactions in which an entity obtains control of a business are economically similar transactions or events and, therefore, the accounting for a change in control should not differ based on the means in which control5 is obtained. The result of the FASBs conclusion is that ASC 805 broadens the current definition of a business combination to include all transactions or other events in which control of one or more businesses is obtained. Therefore, although a business combination typically occurs through the purchase of the net assets or equity interests of a business, a business combination could also occur without the transfer of consideration. Examples of such circumstances, which are discussed in greater de

ASC 805 E&Y White Paper

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