If you’re following along with our series on common issues when accounting for business combinations in accordance with ASC 805, we’ve now:
- Determined we have a business combination, not an asset acquisition,
- Measured all of the assets and liabilities acquired at fair value, including those that weren’t previously recorded,
- Determined our management review controls over business combinations are effective and operating at the right level of precision; and
- Considered whether or not contingent consideration should be included in the purchase price.
This brings us to our final consideration when thinking about the five issues related to business combinations under ASC 805 – measurement period adjustments.
Many companies believe they have up to one year to finalize the purchase price allocation. This is not exactly true. While acquirers do potentially have up to one year to make certain adjustments, it’s not a blank check. As we’ll soon see, the only items that qualify are those that existed at the acquisition date and were provisionally accounted for at that time.
Measurement Period Adjustments: The Basics
When the initial accounting for a business combination is not complete by the end of that reporting period, the acquirer reports provisional amounts for any incomplete items. During the measurement period, the acquirer then retrospectively adjusts those provisional amounts as it obtains the necessary information or, alternatively, determines that the necessary information will not be obtainable by the end of the measurement period.
Measurement period adjustments are only meant to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. These adjustments can be as a result of incomplete initial accounting for the business combination or to reflect new information that is obtained about facts and circumstances that existed at the acquisition date. Adjustments may be made to:
- Assets acquired, liabilities assumed, and non-controlling interests
- Consideration transferred
- If a business combination is achieved in stages, the equity interest in the acquiree previously held by the acquirer
- The resulting goodwill recognized or the gain on a bargain purchase
Under current GAAP, measurement period adjustments are made retrospectively by “recasting” prior periods that are presented in the financial statements with the impact of the change going through goodwill instead of through the income statement.
For example, if the fair value of an intangible asset or item in PP&E is revised in the accounting period following the period in which the acquisition was made due to subsequent facts about the asset’s condition at the acquisition date, the acquirer should also adjust the previous period for the resulting changes in depreciation, amortization, or other income effects recognized in completing the initial accounting and apply that change against goodwill. In other words, redo the initial accounting as if you had this missing knowledge and adjust the item in question and goodwill accordingly.
However, as we note below, this process could be getting a bit easier with the issuance of ASU 2015-16!
What is the Measurement Period?
If the accounting for a business combination is not complete by the end of the reporting period in which the combination took place, the acquirer has a period of time to finalize its accounting. The period during which adjustments can be made to the amounts originally recorded at the acquisition date is known as the measurement period. So how long is the measurement period? One year from the acquisition date, right? Well, maybe.
The measurement period is not a fixed period for all business combinations, or even for all aspects of a particular business combination. The measurement period ends once the acquirer is able to determine that it has obtained all necessary information that existed as of the acquisition date or has determined that such information is not available. In practice, the acquirer determines the information that it is seeking on an item-by-item basis and must document the information that it has not yet obtained, but has arranged to obtain, for each reporting period that the measurement period remains open.
Because of the number of comments related to measurement period adjustments, the SEC staff clarified that the measurement period ends when the acquiring company obtains the necessary additional information or determines that additional information is unobtainable. In either case, the measurement period cannot exceed one year from the acquisition date. So, “one year” is really the measurement period’s ceiling, but the measurement period could be even shorter than that if the company obtains the information it is missing, or determines that it is unobtainable.
So, What’s the Big Deal?
In order to be classified as a measurement period adjustment, as opposed to the correction of an error, there are three strict criteria that must be met:
- The acquirer obtains new information about facts and circumstances that existed at the time of the acquisition that, if known then, would have impacted the amounts recognized;
- The company’s initial disclosures indicate that the accounting for the acquired assets and liabilities assumed is incomplete; and
- The measurement period has not ended.
If this new information did not qualify as a measurement period adjustment by meeting the criteria above, it would instead be accounted for as an error correction or post-acquisition item, which means the corresponding entry would be to the income statement, and not to goodwill.
The SEC staff has commented on entities that report measurement period adjustments for information about facts and circumstances that did not exist at the acquisition date. Additionally, the SEC staff frequently challenge measurement period adjustments when prior disclosures failed to indicate that the acquirer was waiting on the specific information that led to the adjustment. In those circumstances, the SEC typically expects adjustments to carrying amounts to be recognized in the statement of operations in the current period (i.e. as a change due to error correction).
New! ASU 2015-16 Makes Measuring Adjustments Simple
As part of the FASB’s Simplification Initiative, the FASB issued ASU 2015-16, which requires that an acquirer in a business combination recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The ASU requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In other words, the acquirer still reports for the measurement period adjustment as if it had this information all along, but instead of going back to “recast” past reporting periods, it applies the entire effect in the current reporting period.
It also requires an entity to present separately on the face of the income statement, or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date.
The ASU was effective for public entities for periods beginning after December 15, 2015 and is effective for all other entities for annual periods beginning after December 15, 2016 and interim periods after December 15, 2017. Early adoption of the standard is permitted for all entities.
When measurements related to a business combination are not complete by the end of the reporting period, make sure your company/your clients are taking the right steps to avoid SEC comment letters! Document which amounts are provisional and what remaining documentation or information is yet to be obtained. Remember the three criteria for classifying the subsequent adjustment as a measurement period adjustment.
If these criteria are met, the corresponding entry to the measurement period adjustment is to goodwill. If these criteria are not met, treat the adjustment as a change in estimate due to an error, with the corresponding entry to the statement of operations.