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Issues Surrounding the Treatment of Business Combinations

In December of 2007, the Financial Accounting Standards Board (FASB) issued Statement No. 141(R), Business Combinations. This standard is now referred to as ASC 805 given the recently introduced FASB Codification. These rules have generated a significant level of discussion over the past two years as, among other things, they mandate a shift in the treatment of acquisition expenses. Implementation is required for fiscal years beginning after December 15, 2008, so for all organizations with recent acquisitions the time has arrived to follow this new standard. In addition to considering the impact on financial statements, management teams should also think about whether new timing differences between book and tax income may arise as a result of ASC 805.

To some degree, accounting for business combinations has been controversial as views vary widely on how to provide the most useful information. Given the unique features of each acquisition, a shift in the rules governing how business combinations are accounted for is not likely to end the controversy surrounding this area. It will, however, change the conversation as CFOs and others in the marketplace see the reality of immediately expensing transaction costs and the other changes that have come about as a result of ASC 805.

There are a number of significant features regarding how acquisitions are now accounted for. They include, but may not be limited to, changes in:

• The treatment of transaction costs
• Bargain purchase gains
• Financial statement disclosures
• Step acquisitions
• Contingent considerations and other contingencies
• Goodwill measurement
• Measurement periods

Further, the scope of business combination accounting was expanded to include transactions that occur without the transfer of consideration.

Legal and other transaction costs were formerly capitalized as part of a purchase price. Most often, this led to recording a higher level of goodwill. This resulted in transaction costs sitting on balance sheets (often for many years) until impairment was recognized. Although certain transaction costs are necessary, they do not generally add value to the acquired assets and they are not assets on their own. Because transaction costs are not assets, they are now required to be expensed when incurred. While the US GAAP has changed, tax rules related to transaction costs remain the same. For income tax purposes, such costs must continue to be amortized over a 15-year period. No change to the income tax rules in this area is on the horizon.

At times, an acquirer may enter into a favorable deal and pay less than the fair value of the purchased net assets. One example of this may be when assets are being purchased from a distressed seller, which, in the current market, is quite conceivable. Under the old rules, certain asset carrying values (often property and equipment) were reduced until the total equaled the purchase price. Under ASC 805 acquired tangible and intangible assets and liabilities are recorded at fair value and any excess is recorded as a bargain purchase gain. Fortunately, such gains are not recorded for income tax purposes. Acquirers’ tax basis in the assets purchased will be lower than their book basis and therefore there will be an add-back to taxable income for those related assets over a period of years.

Given the far-reaching impact ASC 805 is expected to have on accounting for acquisitions, it comes as little surprise that the new standard includes some significant disclosure requirements. Several pages in the published guidance outline a variety of the acquisition’s qualitative and quantitative effects that must be disclosed to financial statement readers. For example, management teams will have to describe marketplace factors that validate recorded amounts of goodwill. The standard’s intent is to prevent organizations from assigning a value to goodwill that fails to reflect reality. Further, ASC 805 indicates that acquirers must disclose “whatever additional information is necessary” to ensure that readers of a financial statement are informed about new combinations. It is left up to CFOs and other members of management teams to interpret what additional disclosures are needed in order to adhere to the standard. This is yet another indication of a move away from rules-based accounting in US GAAP.

This article focuses on some specific aspects of ASC 805. Questions regarding step acquisitions, contingencies, goodwill measurement, measurement periods, and other matters should be directed to Kevin Loudon, Senior Manager, at 312-980-3358 or your Blackman Kallick representative.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.