Negotiations have been finalized and the purchase agreement has been signed and executed. Now the real fun begins – accounting for the acquisition! Navigating the guidance in ASC 805, Business Combinations, is not for the faint of heart. As indicated in this blog post, there is no shortage of issues and challenges, and in this post, we will discuss one common issue: asset purchases vs. business combinations and why the determination matters.
We accountants and auditors are a hard working bunch. Acquisition? No problem; we got this! Let’s identify the intangibles, record the assets and liabilities of the acquiree at fair value, and determine how much goodwill we need to recognize. That's how accountants and auditors roll – we dive in and get to work! Not so fast! The issue? We skipped the first step in the process, which is critical to determining the proper accounting.
The first step
The first step in accounting for an acquisition is to determine what you’ve acquired or purchased. Have you acquired a “business” or have you purchased an asset or group of assets? Why does this matter, you may ask – because accounting for a business combination is different than accounting for an asset purchase. Before we walk through those accounting differences, let’s first figure out what constitutes a business in the eyes of the Financial Accounting Standards Board (FASB).
What is a business combination and how does the FASB define a business?
Note this portion of the post has been deleted as a result of the issuance of ASU 2017-01 Business Combinations (Topic 805): Clarifying the Definition of a Business. Please see this post for updated guidance regarding the definition of a business.
How is Accounting for a business combination different from accounting for the purchase of an asset or group of assets?
Now that we have established what constitutes a business, let’s explore how business combination accounting differs from accounting for an asset purchase. The distinction is important because it affects the recognition and measurement of assets acquired and liabilities assumed, both initially and subsequently. The table below summarizes accounting differences for asset purchases vs. business combinations.
|Item||Business Combination||Asset Purchase|
|Transaction costs||Expense as incurred||Capitalize as a component of the cost of assets acquired|
|In-process research and development (IPR&D) assets||Capitalize as indefinite-lived intangible asset, regardless of whether the IPR&D asset has an alternative future use||Expense unless IPR&D has an alternative future use|
|Purchase price allocation||Allocate to assets acquired and liabilities assumed based on their fair values||Allocate on a relative fair value basis to non-current, non-financial assets|
|Goodwill||Recognize to extent that purchase price exceeds assets and liabilities assumed||Do not recognize in an asset purchase. Any excess consideration transferred over the fair value of the net assets acquired is allocated on a relative fair value basis to the identifiable net assets (other than “non-qualifying” assets).|
|Contingent Consideration||Recognize at its acquisition-date fair value as part of the consideration transferred||Generally recognize when the contingency is resolved (i.e., when the contingent consideration is paid or becomes payable)|
As you can see from the table above, the accounting can be significantly different. The next time you are tasked with accounting for or auditing an acquisition, make sure you take that critical – often overlooked – first step and determine whether your company or client has acquired a business or has simply purchased an asset or group of assets.
Over the next several weeks we will be publishing additional insights on properly accounting for and auditing business combinations and navigating some of the complexities of ASC 805. Stay tuned!