Fair Value for Allocation of Purchase Price (ASC 805)
What is ASC 805?
In 2008, Accounting Standards Codification (ASC) 805 replaced existing Statement on Financial Accounting Standards 141 and became the source of requirements for reporting enterprises to account for the acquisition of a business. All business combinations are now required to be accounted for using the acquisition method (which had been formerly called the purchase method).
Does ASC 805 apply to my business and its business combination?
The ASC defines a business as “an integrated set of assets and activities capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, increased share prices, or other economic benefits to investors, owners, or participants.”
This new, broader definition now includes combinations of mutual entities. Since the definition includes those that have the ability to produce outputs, certain development-stage companies that would not have been previously accounted for are now included as well. However, this also means that accounting, billing, payroll, and other administrative systems that generally do not create outputs would not be included.
The ASC defines a business combination as “a transaction or other event in which an acquiring entity obtains control of one or more businesses.” Although control is not specifically defined, ASC 810-10-15-8 provides guidance on this issue, indicating that it means a controlling financial interest.
This definition explicitly includes a merger of equals. It also includes situations in which a business obtains control without exchange of consideration or other direct involvement by the acquirer as well as situations where a business becomes the primary beneficiary of a variable interest entity that is a business.
How does the acquisition date affect the measure and recognition of a business combination?
ASC 805-10-25-6 requires using the acquisition date (the date the acquirer obtains control of the acquired business) to measure and recognize a business combination. The acquirer no longer has the option, as it did under Statement 141, to designate an effective date at the end of an accounting period.
There is however a measurement period, after the acquisition date, in which the acquirer retrospectively adjusts the business combination accounting for information obtained during this measurement period. This measurement period ends as of the earlier of (a) one year from the acquisition date or (b) the date when the acquirer receives the information necessary to complete the business combination accounting. Adjustments to the business combination accounting are only made for information that is about facts and circumstances that existed as of the acquisition date.
How do transaction and restructuring costs affect the measurement of a business combination transaction?
Costs that the acquirer incurs in order to complete the business combination are not part of the consideration transferred in exchange for the acquiree. This means that transaction related costs are to be charged to expense when incurred, except for debt to equity issuance costs, which are accounted for in accordance with other generally accepted accounting principles.
The reimbursement of amounts paid by the acquiree or its former owners for acquisition-related costs of the acquirer should also be accounted for separately from the business combination. These costs are primarily for the benefit of the acquirer rather than the acquiree or its former owners, so they are not considered parted of the business combination transaction.
Costs that an acquirer expects, but is not obligated, to incur in the future, either to exit an acquired activity or to terminate or relocate the acquiree’s employees, are not accounted for as part of the business combination. An exit or disposal plan by itself does not create a present obligation to incur costs under the plan. Therefore, the expectation of incurring such costs would not meet the definition of a liability as of the acquisition date.
How will in-process research and development affect the measurement of a business combination transaction?
In-process research and development acquired in a business combination is generally recognized as an asset and not to be charged immediately to expense. The reasoning is that in-process research and development, at the acquisition date, provides evidence that future economic benefits are expected to result from the research and development.
Can a company have a negative goodwill situation? How can I tell if such a situation has occurred?
A “negative goodwill” situation is referred to as a “bargain purchase.” In order to determine if a bargain purchase must be recognized, you must first determine the difference between (1) the total acquisition-date value of the acquiree and (2) the net of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed in the combination.
If (2) exceeds (1), then a bargain purchase has occurred. ASC 805 requires the acquirer to reassess whether it has identified all assets acquired and liabilities assumed and its measurement procedures before recognizing a gain on a bargain purchase. A bargain purchase gain is attributed to the acquirer.
How can I determine if a reassessment of all assets acquired and liabilities assumed indicates that a goodwill impairment assessment is necessary?
There is a two-step process to determining impairment of goodwill. In the first step the fair value of the invested capital of a reporting unit is compared with its book value, otherwise known as the carrying value. If the appraised value is less than the carrying value, then you must proceed to the second step where the value of the impairment will be determined. This will require independent valuation of the business or group of assets at a reporting unit level. The impairment is equal to the difference between the book value of goodwill and the value of goodwill determined by the valuation.
What is fair value under ASC 805?
Fair value, as stated by ASC 820, Fair Value Measurements and Disclosures, is defined as: “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
Can the company performing the audit also perform the valuation?
The AICPA’s Code of Professional Conduct, Section 101 states that “a member in public practice shall be independent in the performance of professional services…” It is imperative that auditors and valuation professionals be independent.
A firm cannot perform a valuation service such as a valuation for an audit client since the auditor would be reviewing its own work. Section 201 of the Sarbanes-Oxley Act amended the Securities Exchange Act of 1934 to include prohibited activities for an auditor and specifically lists “appraisal and valuation services, fairness opinions, or contribution-in-kind reports” as prohibited.
TFG Strategies is well-qualified and experienced in handling ASC 805 valuations as well as valuations for most other business purposes. While this may answer some of your questions regarding a valuation, it is important to consult with a qualified valuation professional to ensure that your needs are properly met. Feel free to contact us with any follow-up questions or to schedule a free consultation.