8/22/2011. Mayer Hoffman McCann P.C. s Executive Education Series Business Combinations AGENDA. History of Business Combinations.

Transcription

1 Mayer Hoffman McCann P.C. s Executive Education Series Business Combinations August 2011 AGENDA Background/Basics of Accounting for Business Combinations The Acquisition Method the Basics Common Non-controlling Interests 2 History of Business Combinations PHASE 1 The first phase of the project was completed in June 2001 with the issuance of Statement 141 and Statement 142. PHASE 2 Reconsider the guidance on applying the purchase method of accounting, and to address other related issues. This led the FASB to comprehensively reconsider the accounting for and reporting of non-controlling interests (Statement 160). FIRST CONVERGENCE PROJECT - Partner with the IASB to promote the international convergence of accounting and reporting standards for business combinations. The FASB and IASB concurrently deliberated and reached the same conclusions on the fundamental issues with only limited exceptions. 3 1

2 Change in Principle - ASC 805 (SFAS 141R) COST ACCUMULATION Previously accounting for a business combination involves accumulating costs of acquiring a target entity and allocating those costs to individual assets acquired and liabilities assumed. ACQUISITION METHOD The FASB and the IASB in ASC 805 determined that because a business combination is a transaction in which an entity (the acquirer) takes control of another entity (the target), the fair value of the underlying exchange transaction should be used to establish a new accounting basis of the acquired entity. The acquirer should recognize and measure the assets acquired and liabilities assumed at their full fair values as of the date control is obtained, regardless of the percentage ownership in the acquiree or how the acquisition was achieved. 4 ASC 805 Definition of a Business Combination A transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as true mergers or mergers of equals also are business combinations. The FASB concluded that all transactions in which an entity obtains control of a business are economically similar transactions or events and, therefore, the accounting for a change in control should not differ based on the means in which control is obtained. 5 ASC 805 Control A business combination typically occurs through the purchase of the net assets or equity interests of a business. A business combination could also occur without the transfer of consideration. Examples of such circumstances include: The lapse of minority participating rights that previously prevented a majority owner from controlling (and therefore consolidating) a business. An investee s purchase of its shares that results in an existing investor obtaining control of the investee s business. Control of a business is obtained pursuant to a contractual arrangement. 6 2

3 Definition of a Business: ASC Scope A business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. Capable of is from the viewpoint of a market participant (as defined in ASC 820) which means replaced or replicated elements would likely be supplied by a market participant therefore meeting the definition of a business. 7 Scope Definition of a Business A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business. The three elements of a business are as follows: Input: Any economic resource that creates, or has the ability to create, outputs when one or more processes are applied to it. Process: Any system, standard, protocol, convention, or rule that when applied to an input, or inputs, creates or has the ability to create outputs. Output: The results of inputs and processes applied to those inputs that provide or have the ability to provide a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. 8 Scope Transactions excluded from ASC 805: 1. The formation of a joint venture (per ASC). 2. Acquisitions of an asset or a group of assets that does not constitute a business. 3. A combination between entities or businesses under common control. 4. A combination between not-for-profit entities (NFPs) or the acquisition of a for-profit business by an NFP. 9 3

4 The Acquisition Method Applying the acquisition method requires execution of each of the following steps: 1. Identifying the acquirer 2. Determining the acquisition date 3. Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; and 4. Recognizing and measuring goodwill or a gain from a bargain purchase. 10 Acquisition Method Identify the Acquirer In business combinations that involve consideration other than common stock, the company that pays cash, distributes assets or incurs debt likely is the acquirer. If one combining company is significantly larger than the other, that entity likely is the acquirer. In a business combination involving the exchange of equity interests, the entity that issues the equity interests generally is the acquirer. As a general rule, direct and indirect ownership of more than 50% of the outstanding voting shares is a condition that suggests control. However, this is not considered a presumptive factor in determining the accounting acquirer. 11 Acquisition Method Determine the Acquisition Date The acquisition date is the date control is obtained and is ordinarily the date that assets are received and other assets are given, liabilities are assumed or incurred, or equity interests are issued (i.e., the closing date or consummation date). For business combinations that do not have a consummation date (i.e., business combinations that occur without the transfer of consideration), the acquisition date is the date on which control is first obtained. 12 4

5 Acquisition Method Recognizing & measuring the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree A primary principle of ASC 805 is that obtaining control is a new basis resulting in a recognition event. The assets acquired and liabilities assumed, including any non-controlling interests, are recognized at 100% of their fair value, with limited exceptions, regardless of the percentage of the equity interests acquired. 13 Recognition Principle ASC 805 emphasizes two fundamental conditions. To recognize an asset or liability when applying the acquisition method, the item acquired or assumed must: 1. Meet the definition iti of an asset or liability at the acquisition iti date (as defined in Concept Statement 6), and 2. Be part of the business combination rather than the result of a separate transaction. 14 Recognition Principle Determine Components of the Business Combination The acquirer shall apply the guidance in paragraphs through to determine : which assets acquired or liabilities assumed are part of the exchange for the acquiree and; which, if any, are the result of separate transactions to be accounted for in accordance with their nature and the applicable GAAP. 15 5

6 Part of Business Combination The following are examples of separate transactions that are not to be included in applying the acquisition method: A. A transaction that in effect settles preexisting relationships between the acquirer and acquiree (paragraphs through 55-23). B. A transaction that compensates employees or former owners of the acquiree for future services (paragraphs through 55-26). C. A transaction that reimburses the acquiree or its former owners for paying the acquirer s acquisition-related costs (paragraph ). 16 : Unique Considerations: Assets not intended to be used Intangible assets Defensive intangible assets Customer contracts Non-compete agreements Overlapping customers Valuation allowances Inventory Property, Plant, & Equipment Research & development assets In-process research & development Deferred revenue Payables & debt Debt issuance costs Guarantees Non-controlling interests Bargain purchase Measurement period Contingent consideration Pre-acquisition contingencies Assets that the Acquirer Does Not Intend to Use An acquirer, for competitive or other reasons, may not use an acquired asset or may intend to use the asset in a way that t is not its highest h and best use (i.e., different from the way other market participants would use the asset). ASC 820 states that the intended use (entity-specific utilization) of an asset by the acquirer would not affect its fair value. Example: Trademark 18 6

7 Intangible Assets ASC 805 includes a listing of examples of intangible assets which the FASB believes meet the criteria for recognition apart from goodwill and provides guidance in applying the recognition criteria. If an intangible asset that appears within the examples exists among the assets acquired in a business combination and is material, it should be measured and recognized apart from goodwill. However, the list is not intended to be all-inclusive. 19 Defensive Intangible Assets Defensive intangible assets include assets that the acquirer will never actively use, as well as assets that will be actively used by the acquirer only during a transition period. Examples of defensive intangible assets include brand names and trademarks. When determining the fair value of defensive intangible assets, an acquirer should utilize market participant assumptions, not acquirer-specific assumptions. The requirement to apply the concepts of ASC 820 (SFAS 157) to assets that an acquirer does not intend to fully utilize can raise questions regarding Day 2 accounting for the assets. 20 Customer Contracts and Related Customer Relationships A customer relationship exists between a company and its customer if: the company has information about the customer and has regular contact with the customer and the customer has the ability to make direct contact with the company. If the entity has a practice of establishing relationships with its customers through contracts, the customer relationship would meet the contractual-legal criterion for separate recognition as an intangible asset, even if no contract (e.g., purchase order or sales order) is in place on the acquisition date. A customer relationship may indicate the existence of an intangible asset that should be recognized if it meets the contractual-legal or separable criteria. 21 7

8 Non-compete Agreements A non-compete agreement negotiated as part of a business combination generally prohibits former owners or key employees from competing with the combined entity. A non-compete agreement negotiated as part of a business combination will typically be initiated by the acquirer to protect the interests of the acquirer and the combined entity. Transactions are to be treated separately if they are entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer. As such, non-compete agreements negotiated as part of a business combination should generally be accounted for as transactions separate from the business combination. 22 Overlapping Customers An asset should be established for acquired intangible customer relationships despite an acquirer s pre-established relationship with the target s customer. In the SEC staff s view, an acquired customer relationship that overlaps an existing customer relationship has value because the acquirer, as a result of the acquisition, has the ability to generate incremental cash flows, such as the ability to sell new products to the customer and/or to increase its shelf space with the customer. However, that value may appropriately be reflected in the recognition of other intangible assets, such as trade names or proprietary technologies that drive customer loyalty. 23 Asset Valuation Allowances An acquirer should not recognize a valuation allowance as of the acquisition date for assets acquired in a business combination that are initially recognized at fair value. Accounts and loans receivable acquired in a business combination should be recognized and measured at fair value at the acquisition date Any uncertainty about collections and future cash flows should be included in the fair value measurement. Separate valuation allowances are permitted to be recognized for assets that are not required to be measured at their acquisition-date fair values. For example, valuation allowances are permitted for deferred income tax assets. 24 8

9 Inventory Inventories should be recognized at fair value pursuant to the guidance in ASC 820. Ordinarily, the amount recognized for inventory at fair value by the acquirer will be higher than the amount recognized by the acquiree before the business combination. The concept should result in little margin on sale of the inventory in the future (i.e. limited to future increases in price or time value) 25 Property, Plant and Equipment Fair value should be based on the value of comparable new property, plant and equipment, less depreciation and obsolescence (i.e., decreases in value due to physical depreciation, functional obsolescence or economic obsolescence). The recorded carrying amount of the asset should be the net value. Accumulated depreciation and amortization do not carry over in basis 26 Research and Development Assets Acquired in-process research and development (IPR&D) assets are not permitted to be written-off upon acquisition, as has been required for acquired IPR&D without an alternative future use by Statement 141 and FIN 4. Examples of IPR&D assets include patents, blueprints, formulae and designs associated with a specific IPR&D project and the associated values derived from productive results of target company R&D activities conducted before the acquisition. 27 9

10 In-Process Research and Development IPR&D is used to describe research and development projects, not products or processes already in service or being sold. IPR&D is not amortized as it is not yet ready for use. It is tested annually for impairment or when there are indicators of impairment. 28 Deferred Revenue Recognized only if it relates to a legal performance obligation assumed by the acquiring entity. Obligations to provide goods or services, the right to use an asset(s), grant concessions to customers (such as credits in the event that a customer decides to return product) or other consideration to a customer after the date of acquisition are examples of legal performance obligations. The measurement of the assumed performance obligation should be measured at fair value at the date of acquisition 29 Payables and Debt An acquiree s payables and debt assumed by the acquirer are recognized at fair value in a business combination. Short-term payables may be recorded based on their settlement amounts in most situations. However, the measurement of debt at fair value will typically result in an amount different from what was recognized by the acquiree before the business combination. Difference between fair value and carrying value is treated like a premium or discount, however, should include an assessment of credit risk 30 10

11 Debt Issue Costs Acquired Companies frequently incur debt issuance costs that are capitalized for accounting purposes. Similar to virtually all assets acquired and liabilities assumed in a business combination, outstanding debt assumed in the business combination is recognized at fair value. Debt issue costs do not meet the definition of an asset in Concepts Statement 6. As such, unamortized debt issue costs of an acquired entity should not be recognized in a business combination and would not affect the estimate of fair value of the recognized debt. 31 Guarantees All guarantees assumed in a business combination are recognized at fair value, including guarantees issued before December 31, Under ASC 460, an acquirer would relieve the guarantee liability through earnings on a systematic and rational manner as it is released from risk. 32 Non-controlling Interest If an acquirer obtains control of a business through the acquisition of less than 100% of the business ownership interests, noncontrolling interests remain in the acquired entity. Non-controlling interests are recognized in an initial consolidation by an acquirer and measured at acquisition-date fair value. It often is not appropriate to extrapolate the fair value of an acquirer s interest or use the acquirer s per-share price to determine the fair value of the noncontrolling interests because consideration transferred by the acquirer generally will include a control premium. Under Statement 141, any minority (noncontrolling) interests were recognized based on the minority shareholders interests in the predecessor cost basis of the assets acquired and liabilities assumed

12 Bargain Purchase In rare circumstances the fair value of consideration transferred for an acquirer s interest in a business is less than the fair value of the net assets acquired, resulting in a gain to the acquiring entity. A gain is recognized for (a) the amount by which the acquisition-date fair value of the identifiable net assets acquired exceeds (b) the acquisition-date fair value of the acquirer s interest in the acquiree plus the recognized amount of any non-controlling interest in the acquiree. Any such gain should not be classified as extraordinary, and is recognized only after a thorough reassessment of all elements of the accounting for the acquisition. In previous practice under Statement 141, certain long-lived assets were reduced to zero before an extraordinary gain could be recognized. 34 Measurement Period ASC 805 provides for a similar period of time to adjust provisional amounts after the acquisition date, referred to as the measurement period. However, under ASC 805, adjustments during the measurement period are not limited to just those relating to acquired assets and assumed liabilities, but apply to all aspects of business combination accounting (e.g., the consideration transferred). Adjustments to the provisional values during the measurement period should be pushed back to the date of acquisition. Thus, comparative information for periods after acquisition but before the period in which the adjustments are identified should be adjusted to reflect the effects of the adjustments as if they were taken into account as of the acquisition date in the provisional accounting for the business combination. 35 Pre-Acquisition Contingencies Record at fair value if fair value can be determined during the measurement period. If the acquisition-date fair value can not be determined during the measurement period, the asset or liability should be recognized at the acquisition date if both of the following criteria are met: Information available before the end of the measurement period indicates that it is probable that an asset existed or a liability had been incurred at the acquisition date. The amount of the asset or liability can be reasonably estimated

13 Contingent Consideration Meets the definition of a liability under FASB Concept Statement #6 Recognized at the acquisition date at its fair value as part of the consideration o paid in connection o with the business combination Can be classified as either equity or a liability (in rare cases an asset) Contingent consideration classified as equity is not remeasured after the acquisition date Contingent consideration classified as a liability is remeasured at fair value for each reporting date until resolved (through income) 37 Non-Controlling Interests Subtopic The non-controlling interest shall be reported in the consolidated statement of financial position within equity, separately from the parent s equity Clearly identified and labeled, for example, as non-controlling interest in subsidiaries Results in a separate column on the statement of stockholder s equity Can represent 100% of the consolidated entity s equity if it is a Variable Interest Entity Net income or loss and comprehensive income or loss, shall be attributed to the parent and the noncontrolling interest Attribution may result in a deficit non-controlling interest balance 38 Non-Controlling Interests Changes in a parent s ownership interest while the parent retains its controlling financial interest in its subsidiary shall be accounted for as equity transactions No gain or loss shall be recognized in consolidated net income or comprehensive income The carrying amount of the non-controlling interest shall be adjusted to reflect the change in its ownership interest in the subsidiary Any difference between the fair value of the consideration received or paid and the amount by which the non-controlling interest is adjusted shall be recognized in equity attributable to the parent 39 13

14 Non-Controlling Interest A parent shall deconsolidate a subsidiary as of the date the parent ceases to have a controlling financial interest in the subsidiary Shall recognize a gain or loss in net income, measured as the difference between: A. The aggregate of: 1. The fair value of any consideration received 2. The fair value of any retained noncontrolling investment in the former subsidiary at the date the subsidiary is deconsolidated 3. The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated B. The carrying amount of the former subsidiary s assets and liabilities 40 Non-Controlling Interests Disclosures If a subsidiary is deconsolidated, the parent shall disclose: a. The amount of any gain or loss recognized b. The portion of any gain or loss related to the remeasurement of any retained investment in the former subsidiary to its fair value c. The caption in the income statement in which the gain or loss is recognized unless separately presented on the face of the income statement. 41 QUESTIONS? 42 14

15 THANK YOU Please contact: James Comito / Mike Loritz/ Keith Peterka Mayer Hoffman McCann P.C. Professional Standards Group jcomito@cbiz.com mloritz@cbiz.com kpeterka@cbiz.com