For the record, I'm not a fan of the term “fake news” (or using it to discredit honest journalists) and I'm fairly certain POTUS hasn't got a clue about the accounting for business combinations under U.S. GAAP. However, every so often I see something in the headlines, especially related to accounting, that makes me wonder if the reporter did their homework (and, to be honest, I wanted to play with my Mematic app). The headlines that I read on February 7, 2019 was a case in point. They were so misleading that it prompted me to write this post on how to identify the acquirer in a business combination in accordance with U.S. GAAP (ASC 805) and IFRS (IFRS 3).
I was cruising Twitter on February 7 and noted this tweet from MarketWatch:
SunTrust Banks and BB&T combining in merger of equals worth about $66 billion
Merger of equals? That term hasn’t been used since before FASB Statement No. 141 Business Combinations was issued back in 2001 (man, I’m getting old). This must have been misprint from an ill-informed reporter.
However, another tweet, this one from the official SunTrust Twitter account, made me think that perhaps it wasn’t the reporter’s fault:
Combining 275 years of history and experience, SunTrust and BB&T are excited to announce a merger of equals.
A quick look at BB&T’s official Twitter account noted a tweet that used the same language! As a client of BB&T, I also received an email announcing the merger with the following subject line:
BB&T and SunTrust Bank Combine in a Merger of Equals
This misinformation was coming from the inside!
And there it was! A link in the mail led me to a website dedicated to this so-called merger of equals. The misleading term was used generously in the Fact Sheet and in the official Press Release. The term “merger of equals” was even cited by the CEOs within the first 18 seconds of a video announcing the deal. The video ends with what I believe is the first ever public fist bump of Fortune 100 CEOs and the immortal first words of Tone Loc’s Wild Thing – “Let’s do it!”
Merger of Equals – There’s No Such Thing!
Just to be crystal clear – there is no such thing as a merger of equals under either U.S. GAAP (ASC 805) or IFRS (IFRS 3). Both standards provide guidance on the accounting and reporting for transactions that represent business combinations to be accounted for under the acquisition method.
A business combination is a transaction or other even in which an acquirer obtains control of one or more businesses. ASC 805 notes that “transactions sometimes referred to as true mergers or mergers of equals also are business combinations.”
In a business combination, the acquirer:
- Recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquire;
- Recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and
- Determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.
Both standards require, that for each business combination, one of the combining entities shall be identified as the acquirer.
Identifying the Acquirer
We must first go to the guidance within ASC Subtopic 810-10, Consolidation (or IFRS 10) related to determining the existence of a controlling financial interest to identify the acquirer. The acquirer is the entity that obtains control of the acquiree. Control is defined as the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.
Usually this settles it. However, if applying the guidance within ASC Subtopic 810-10 (or IFRS 10) does not clearly indicate which of the combination entities is the acquirer, then we need to consider the factors within ASC 805-10-55-11 through 55-15 (IFRS 3 lists similar factors in paragraphs B14-B18):
- In a business combination effected by transferring cash or other assets or incurring liabilities, the acquirer is usually the entity that transfers the cash or other assets or incurs the liabilities.
- In a business combination effected primarily by exchanging equity interests, the acquirer is usually the entity that issues its equity interests.
- Other factors:
- The relevant voting rights in the combined entity after the business combination. The acquirer usually is the combining entity whose owners as a group retain or receive the largest portion of the voting rights in the combining entity.
- The existence of a large minority voting interest in the combined entity if no other owner or organized group of owners has a significant voting interest. The acquirer usually is the combining entity whose single owner or organized group of owners holds the largest minority voting interest in the combined entity.
- The composition of the governing body of the combined entity. The acquirer usually is the combining entity whose owners have the ability to elect or appoint or to remove a majority of the members of the governing body of the combined entity.
- The composition of the senior management of the combined entity. The acquirer usually is the combining entity whose former management dominates the management of the combined entity.
- The terms of the exchange of equity interests. The acquirer usually is the combining entity that pays a premium over the precombination fair value of the equity interests of the other combining entity or entities.
- The acquirer usually is the combining entity whose relative size is significantly larger than that of the other combining entity or entities.
- In a business combination involving more than two entities, determining the acquirer shall include a consideration of, among other things, which of the combining entities initatied the combination, as well as the relative size of the combining entities.
So, which entity is the acquirer?
We encourage you to read the Fact Sheet, Press Release, and the Investor Presentation regarding the transaction. Using the guidance in this post, who do you think is the acquirer? We’ve analyzed the documents and have our thoughts! Check your answer here.
As always, thanks for reading!
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.