ASC 805 Business Combinations A Refresher 2015...ASC 805 Business Combinations A Refresher March 24, 2015. Agenda ⸗Basic concepts in accounting for business ... ⸗Condensed balance

Proprietary & Confidential – Accretive Solutions, Inc.

ASC 805 Business CombinationsA Refresher

March 24, 2015

Agenda

⸗ Basic concepts in accounting for business combinations

⸗ Applying the acquisition model

⸗ Recent developments in accounting

⸗ Considerations to structuring a transaction

⸗ Other considerations

2 Proprietary & Confidential – Accretive Solutions, Inc.

Basic Concepts


Basic Concepts


⸗ Business combination vs asset acquisition

⸗ Definition of a business – ASC Section 805-10-55

⸗ Examples⸗ Producing properties within oil & gas industry

⸗ Consumer product operations

⸗ Hotel

⸗ Identification of the acquirer ⸗ “Controlling financial interest” – ASC Subtopic 810-10

⸗ Additional factors – ASC Section 805-10-55

⸗ Acquisition and measurement date ⸗ The date control is obtained

Basic Concepts


Dry Well Company is an oil and gas exploration and production company that owns a proven but undeveloped property. Dry Well Co. has performed enough exploration activities to determine that the property is proven, but has not yet begun to extract the mineral reserves from the property.

Additionally, Dry Well Co. has constructed transportation infrastructure that will be used to transport the mineral reserves. However, this infrastructure has not yet been placed into operation. Success Oil Co. is an oil and gas production company that operates a large portfolio of producing properties. Success Oil Co. acquires Dry Well Co.

Acquisition of Business or Group of Assets?

Basic Concepts


Consumerco manufactures and distributes a number of nutritional products and brands. One of the products it manufactures and sells is a weight-loss drink. Acquisition Co. acquires the weight-loss drink brand and its formulation from Consumerco, including customer relationships and hires certain employees, but does not acquire any of the manufacturing capabilities. Instead, Acquisition Co. contracts with a third-party co-packer to manufacture the product on behalf of Acquisition Co.

Acquisition of Business or Group of Assets?

Basic Concepts


⸗ Transaction costs ⸗ Expense as incurred ⸗ Debt and equity issuance costs are capitalized when

permitted by other GAAP

⸗ Contingent consideration ⸗ Generally measured at fair value initially and

subsequently⸗ Equity vs liability classification ⸗ Examples

⸗ Earn-outs

⸗ Other performance based payouts

Basic Concepts


“Step” acquisitions

⸗ Partial Acquisition—Control is Obtained, but Less than 100 Percent of Business is Acquired

⸗ Step Acquisition—Control is Obtained where there is a Previously Held Equity Interest

⸗ Additional Interest Obtained—Control is Maintained

Basic Concepts


⸗ Bargain purchases ⸗ If the net assets acquired exceed the purchase price,

recognize a bargain purchase gain

⸗ While permitted, such gains are expected to be rare should usually have an identifiable cause for the circumstance

⸗ Purchase price allocation ⸗ Replaced by acquisition method

⸗ No longer an “allocation” of the purchase price

Applying the Acquisition Model




Identify assets acquired and liabilities assumed ⸗ Assets acquired and liabilities assumed are generally measured at fair value

⸗ Certain exceptions (ASC Section 805-20-30) ⸗ Income taxes ⸗ Employee benefits ⸗ Indemnification assets ⸗ Reacquired rights ⸗ Share-based payment awards ⸗ Assets held for sale ⸗ Certain assets and liabilities arising from contingencies



Identify assets acquired and liabilities assumed ⸗ Recognize intangible assets

⸗ An intangible asset is identifiable if it meets either the separability criterion or the contractual-legal criterion

⸗ Contingencies (ASC Sections 805-20-25 and 805-20-30)

⸗ Recognize if: ⸗ Acquisition date fair value can be determined during the

measurement period

⸗ Probable that an asset or liability existed at acquisition date, and the amount can be reasonably estimated

⸗ Initial measurement at fair value

⸗ Indemnification assets



Purchase consideration ⸗ Fair value of consideration transferred ⸗ Cash ⸗ Equity issuance ⸗ Contingent consideration ⸗ Other assets or instruments transferred

Noncontrolling interest ⸗ Recognize and initially measure at fair value



Goodwill or bargain purchase gain⸗ Residual of purchase consideration plus noncontrolling

interest less the fair value of net assets acquired

⸗ Bargain purchase gains are rareA should be a reason

Measurement period ⸗ Ends upon receipt of the necessary facts and

circumstances that existed as of the acquisition date

⸗ Maximum of one year

⸗ Disclosure of provisional accounting

⸗ Adjustments to provisional amounts are retrospective and require restatement



Example intangible assets to recognize

⸗ Common intangible assets: ⸗ Contractual customer relationships⸗ Trademarks, or trade names⸗ Leases (or other contracts) with favorable or unfavorable

terms compared to current market transactions ⸗ Non compete agreements

⸗ Less common intangible assets: ⸗ Lease contracts at market terms⸗ For example, asset management contracts



Other items to consider

⸗ What is part of the business combination and what is a separate transaction?

⸗ Principle to apply: Does the transaction benefit the acquirer or post-combination entity? (ASC Section 805-10-25)

⸗ Examples

o Integration (or other) costs paid by the acquiree

o Debt refinancing/retirements

o Pre-existing contracts or other relationships

o Compensation of employees or former owners for future service



Other items to consider

⸗ Taxes ⸗ Same principle as overall deferred income tax principle –

recognize temporary differences between book and tax basis as deferred tax asset or liability

⸗ Taxable vs nontaxable transactions

⸗ Income tax allocation of purchase price may differ from financial reporting (book) allocation

⸗ Similar to other acquisition accounting adjustments, changes in valuation allowances or deferred taxes are recognized in the income statement after the measurement period closes and for event that arise after the acquisition date



Potential resource needs: ⸗ Valuation or appraisal professional

⸗ How complex is the transaction? ⸗ How much internal expertise?

⸗ Accounting advisors / consultants⸗ Advising on inputs, methodologies and judgments in preparation

for audit by external auditors ⸗ Assistance with purchase accounting including disclosure

requirements

Other professionals ⸗ Tax accountants

⸗ Type of combination ⸗ NOL limitation study ⸗ Stock option and other incentive plans or payments

Recent Developments in Accounting


Recent Developments


⸗ Accounting for Goodwill & Intangible Assets

⸗ Reporting Discontinued Operations (new standard)

⸗ Pushdown Accounting

Considerations in Structuring a Transaction


Considerations


Compensation arrangements

⸗ Contingent consideration payments that are automatically forfeited if employment terminates is considered compensation expense (ASC 805-10-25)

⸗ Share-based payments (ASC 805-30-30)⸗ Generally treated as replacement awards (similar

to modification accounting) ⸗ Consider fair value of old and new award, vesting

conditions, service provided

Considerations


Compensation arrangements

⸗ Retention or severance payments ⸗ What’s the context of the arrangement? ⸗ Which entity initiated and is benefiting from the

transaction?

⸗ Examples ⸗ Executive severance payment as part of a pre-

existing employment agreement ⸗ Staff employee severance payment to continue

through the acquisition date

Considerations


Example 3

ABC Co., an east coast maker of widgets, decides to expand its market by acquiring a west coast widget maker for $10 million cash plus an additional cash payment if certain volume and profitability targets are met at the end of year 2. The west coast widget maker’s sole owner (and CEO) will be employed by the post-acquisition entity as president of the west coast division.

Considerations


Scenario 1:

The terms of the additional payment require the former owner/CEO of the west coast widget maker to be employed at the newly formed division to earn the consideration.

Analysis and Answer: The requirement for the former owner/CEO to be employed to receive the payment precludes it from being contingent consideration. The expense associated with the payment is recognized as compensation expense in the post-acquisition period.

Considerations


Scenario 2:

The terms of the additional payment permit the former owner/CEO of the west coast widget maker to be paid regardless of his employment status.

Analysis and Answer: The payment is likely considered contingent consideration. The acquirer would also need to analyze factors such as the former owner’s compensation level and whether the payment is linked to the valuation.

Considerations


Other areas to consider:

⸗ Indemnifications

⸗ How should a buyer account for an indemnification from the seller when the indemnified item has not met the criteria to be recognized on the acquisition date?

⸗ Answer: If the indemnified item has not met the recognition criteria as of the acquisition date, an indemnification asset should not be recognized.

Considerations


Business combination presentation and disclosure

⸗ When to report

⸗ General disclosures

⸗ Other disclosures

⸗ Consideration transferred

⸗ Contingent consideration and indemnification assets

⸗ Acquired receivables

⸗ Condensed balance sheet

⸗ Other

Considerations


SEC Considerations

⸗ Acquiree financial statements and significance test

⸗ Pro forma financial statements

⸗ 8-K’s

Considerations


Reporting units and goodwill impairment ⸗ Goodwill is assigned to a reporting unit

⸗ Tested annually for impairment o Qualitative assessment

o Quantitative assessment

Internal control considerations⸗ Merger and acquisition activities

⸗ Target business’ internal controls

⸗ First year exception for SOX compliance

⸗ Controls over acquisition accounting and consolidations

Other Considerations




Acquisition Integration

⸗ Overlooked part of the business combination process

⸗ Most business combinations fail to meet expectations

⸗ Integration plans can be minimal or robust

⸗ Integration plans have many owners

⸗ Key steps to successful integration



ValuationsThe standard of value for business combinations in accordance withASC 805 is Fair value (as defined by ASC 820, Fair ValueMeasurements):

⸗ The price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. (ASC 820-10-35-2)

⸗ A fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either in the principal market or most advantageous market. (ASC 820-10-35-5)

⸗ In all cases, a reporting entity shall maximize the use of relevant observable inputs and minimize the use of unobservable inputs to meet the objective of a fair value measurement. (ASC 820-10-35-16AA)

⸗ In many cases, the transaction price (entry price) will equal the fair value (exit price). (ASC 820-10-30-3)



ValuationsFair value framework:

In-Use Premise– The highest and best use of a nonfinancial asset might provide

maximum value to market participants through its use incombination with other assets as a group (as installed or otherwiseconfigured for use) or in combination with other assets andliabilities (for example, a business). (ASC 820-10-35-10Ea)

In-Exchange Premise– The highest and best use of a nonfinancial asset might provide

maximum value to market participants on a standalone basis. If thehighest and best use of the asset is to use it on a standalone basis,the fair value of the asset is the price that would be received in acurrent transaction to sell the asset to market participants thatwould use the asset on a standalone basis). (ASC 820-10-35-10Eb)



ValuationsUse of Third-Party Specialists

⸗ Many companies engage third-party specialists, or subject matter experts, to assist with the fair value determinations.

⸗ Auditors will typically perform the following procedures:⸗ Evaluate the specialist’s professional credentials (MAI,

licensed appraiser)

⸗ Assess the specialist’s professional reputation

⸗ Assess the validity, completeness, and accuracy of the specialist’s work

⸗ Maintain controls to ensure that complete and accurate data is provided to the specialist and that the specialist’s findings are reviewed and approved

Documents

ASC 805 Business Combinations A Refresher 2015...ASC 805 Business Combinations A Refresher March 24, 2015. Agenda ⸗Basic concepts in accounting for business ... ⸗Condensed balance