BUSINESS COMBINATIONS PURCHASE METHOD PROCEDURES BACKGROUND Financial Accounting Standards Advisory Council September 2003 In 1996, the Board added a project to its agenda to broadly reconsider the accounting for business combinations and intangible assets. In the first phase of the project, which ended with the issuance of FASB Statements. 141, Business Combinations, and. 142, Goodwill and Other Intangible Assets, the Board reconsidered the methods of accounting for business combinations and the accounting for goodwill and other intangible assets. In the second phase of the project (referred to as the Purchase Method Procedures project), the Board and the IASB are jointly reconsidering issues related to the application of purchase method accounting. The Board and the IASB will discuss certain remaining issues at their joint meeting in October 2003 and expect to finalize their deliberations in the fourth quarter of 2003. The Board and the IASB plan to issue their Exposure Drafts on this phase of the project in the first quarter of 2004. For informational purposes, Appendix B includes a summary of certain significant proposed changes to the accounting for business combinations. The Board discussed those issues with FASAC at the March 2003 meeting. For more detailed information on this project, see the Purchase Method Procedures section of the FASB website: http://www.fasb.org/project/bc_purchmethod.shtml DISCUSSION AT THE SEPTEMBER COUNCIL MEETING At the September Council meeting, the Board would like to discuss the following topics with FASAC: 1. The operationality and costs associated with certain proposed changes to present practice in the accounting for and reporting of noncontrolling interests. 2. Whether Council members believe that the noncontrolling interest decisions reached should be reexposed or issued as a final standard only. 1
3. The views of Council members about whether and how the Board should resolve certain areas of potential divergence from the IASB in accounting for business combinations. CERTAIN PROPOSED CHANGES TO PRESENT PRACTICE FOR THE ACCOUNTING AND REPORTING OF NONCONTROLLING INTERESTS On August 12, 2003, the Board met with a group of financial statement users to discuss the Board s decisions on the accounting for and display of noncontrolling interests in consolidated financial statements. 1 In general, the Board s objective for that meeting was to learn whether existing practice or the proposed accounting and reporting for noncontrolling interests better met the needs of financial statement users for purposes of evaluating the equity interests of the parent. 2 The pre-meeting materials and minutes of that meeting are available on the FASB website: http://www.fasb.org/board_meeting_minutes/08-12- 03_bcpm_users_mtg.pdf. The Board would like Council members to consider the following significant changes to current practice: Recognition of assets acquired (including goodwill) and liabilities assumed at full fair value if a less than 100 percent ownership interest is acquired Revaluation of (1) preacquisition investment to fair value in a step acquisition and (2) retained investment in a subsidiary to fair value on the date that control of the subsidiary is sold or otherwise disposed Presentation of noncontrolling interests in the consolidated financial statements under the economic unit concept rather than the parent company concept. Recognition of Assets Acquired (Including Goodwill) and Liabilities Assumed at Full Fair Value If a Less Than 100 Percent Ownership Interest Is Acquired The Board has decided that in the acquisition of less than 100 percent of the acquired entity, the assets and liabilities of the acquired entity should be recorded at full fair value. The current practice of considering the subsidiaries 1 FASAC members Janet Pegg and Rita Spitz participated in that meeting. 2 On April 1, 2003, the Board held a similar meeting with auditors and preparers and other members of its business combinations resource group. 2
carryover basis to the extent of the noncontrolling interest should be eliminated. This decision also applies to goodwill (full goodwill method). Overall, the users supported the Board s proposals. Below are excerpts from the minutes of that meeting: In general, the users agreed with the Board s decision to require that 100 percent of the fair values of the assets acquired and liabilities assumed be recorded on the acquisition date (the date the parent obtains control). The users also discussed whether the full amount of goodwill should be recognized in an acquisition of a less than 100 percent controlling interest. ne of the users were troubled by recognizing the full amount of goodwill. Ms. McConnell stated that she believes full goodwill may cause measurement issues, but she believes that full goodwill is more appropriate. Similarly, Mr. Sondhi (A.C. Sondhi & Associates) acknowledged that there are estimations involved in the full goodwill method but noted that measuring the fair values of assets (goodwill) approximately right is better than a precisely wrong measure. Revaluation of (1) Preacquisition Investment to Fair Value on the Acquisition Date in a Step Acquisition and (2) Retained Investments in a Subsidiary to Fair Value on the Date That Control of a Subsidiary Is Sold or Otherwise Disposed The Board has decided the following: If an acquirer obtains control of an acquiree in a step acquisition, preacquisition investments held by the acquirer at the acquisition date should be remeasured at their fair value and any unrealized holding gains or losses should be recognized in consolidated net income for the period. If a parent loses control of a subsidiary, whether through a sale of ownership interests or otherwise, any gain or loss should be recognized in the income statement for the period, and calculated as the difference between: a. The proceeds, if any, from the sale of ownership interests in the subsidiary that resulted in the loss of control, and b. The parent s share of the carrying amount of the subsidiary s net assets in the consolidated financial statements less the fair value of any investment remaining in the former subsidiary. The users generally supported the Board s decisions. They did not have significant concerns with the changes to present practice as long as the amounts are clearly disclosed in the financial statements or in the notes. To address the 3
users concerns about clear disclosure, the Board decided to require the disclosure of any gain or loss recognized and the line item in the income statement in which that gain or loss is recognized if an entity: 1. Obtains control of a business in a step acquisition and remeasures any preacquisition investment in that business to fair value on the acquisition date 2. Sells or otherwise loses control of a subsidiary, either in whole (disposes of its entire ownership interest) or in part (disposes of its controlling ownership interest but retains a noncontrolling ownership interest). The Board also decided that if a subsidiary is disposed of but a noncontrolling ownership interest is retained, the portion of the gain or loss related to the remeasurement of the retained interest to fair value should be separately disclosed. Presentation of ncontrolling Interests in the Consolidated Financial Statements under the Economic Unit Concept Rather Than the Parent Company Concept In its redeliberations of the October 2000 Exposure Draft, Accounting for Financial Instruments with Characteristics of Liabilities, Equity, or Both, the Board affirmed that noncontrolling interests are part of the equity of the consolidated group. That decision is consistent with guidance in paragraph 254 of FASB Concepts Statement. 6, Elements of Financial Statements, which states that noncontrolling interests are equity because they do not represent obligations of the enterprise to pay cash or distribute other assets to noncontrolling shareholders (paraphrased). Thus, noncontrolling shareholders have ownership or residual interests in components of the consolidated enterprise. That decision leads to consolidated financial statements that emphasize more of an economic unit perspective rather than a parent company perspective. Under the economic unit concept, consolidated financial statements would present net income and consolidated income for the entity as a whole, including amounts attributable to both controlling and noncontrolling interests. In addition to the amounts reported for the consolidated entity as a whole, the proposed model would require, for certain key information (for example, equity, net income, comprehensive income, and capital transactions), presentation of amounts applicable to the controlling shareholders group and the noncontrolling shareholders in all subsidiaries as a group. 4
Current consolidation accounting and reporting practices tend to be derived from a mixture of both economic unit and parent company concepts, with an emphasis on a parent company perspective. Under the parent company concept, noncontrolling interests are generally presented as liabilities and the consolidated income statement is presented at amounts that exclude the noncontrolling interest. Board members have concerns that the consolidated income statement presented under the economic unit concept may not provide sufficient information for users to evaluate the equity interest of the controlling shareholders in the consolidated entity. Therefore, the Board discussed with the users a proposal that would require inclusion of an additional schedule. That schedule would illustrate (1) the effects of all equity transactions with noncontrolling shareholders on the recorded amounts of equity available to the controlling shareholders of the parent and (2) the per-share change in amounts available to common shareholders of the parent (see the following page). For (1) above, that same information would be presented in a consolidated statement of changes in equity. However, a consolidated statement of changes in equity is not required under US GAAP (only required for SEC registrants). Therefore, the Board decided to require presentation of this additional statement since not all entities would be required to present the information in (1) otherwise. 5
Consolidated Statement of Income Year Ended December 31, 2004 Revenue $ 87,000 Expenses 50,700 Income from continuing operations before tax 36,300 Income tax expense 12,400 Income from continuing operations 23,900 Discontinued operations, net of tax (6,200) Consolidated net income $ 17,700 Less: Net income attributable to the noncontrolling interests (490) Net income attributable to the controlling interest $ 17,210 Amounts attributable to controlling equity: Income from continuing operations $ 23,410 Discontinued operations (6,200) Net income attributable to the controlling interest $ 17,210 Earnings per share for the common shares of the controlling interest, basic and diluted: Income from continuing operations $ 4.48 Net income $ 3.24 ADDITIONAL SCHEDULE Net Income Attributable to Common Shares of Controlling Interest, Transfers (To) From ncontrolling Interest Equity and Per Share Data Proposed Amounts attributable to controlling equity: Income from continuing operations $ 23,410 Dividends to preferred shareholders (1,000) Income from continuing operations attributable to common stock 22,410 Discontinued operations (6,200) Net income attributable to common shareholders of the controlling interest $ 16,210 Transfers (to) from noncontrolling interests equity: Premium paid to acquire noncontrolling interests equity (260) Premium received from sale of controlling equity 493 Net transfers from the noncontrolling interests 233 Change from net income attributable to common shareholders of the controlling interest and net transfers from the noncontrolling interests $ 16,443 Per share data for the common shares of controlling interest: Income from continuing operations $ 4.48 Discontinued operations Net income attributable to common shareholders of the controlling interest (1.24) 3.24 Net transfers from the noncontrolling interests Net income attributable to common shareholders of the controlling 0.05 interest and net transfers from noncontrolling interests $ 3.29 The shaded portion is how the consolidated income statement would be presented under the Board s tentative decisions (economic unit concept). Only consolidated net income would be broken down between the controlling and noncontrolling interests. Each income statement line item and subtotal would be presented at consolidated amounts. 6
The additional schedule is intended to provide sufficient information so that users are able to evaluate the interest of the controlling shareholders in the consolidated entity. Also, entities that present earnings per share would be required to disclose in this additional schedule an additional per share metric that includes in the numerator the effects of equity transactions with noncontrolling shareholders. 3 Overall, the feedback received from the users at the August 12, 2003 meeting was positive. The users supported the economic unit concept, the Board s proposal for disclosure of the additional schedule, and the additional per-share metric that includes in the numerator the effects of equity transactions with noncontrolling shareholders. Below are excerpts from the minutes of that meeting: The financial statement users ( users ) that participated in the meeting expressed general support for the proposed accounting for noncontrolling interests and the economic unit concept that underlies it. Users did not anticipate any problems interpreting financial statements prepared under the proposed accounting as long as the proposed principles are applied consistently over time and across entities. The users then discussed a proposal for the presentation of minority interests in the consolidated financial statements. One of the Board members suggested adding a schedule.that would provide details about wealth transfers between controlling and minority equity holders. 2 This schedule also would provide per share data that would include the effects of those wealth transfers. In general, the users were in favor of adding this schedule. They 3 The Board has decided that the purpose of the earnings per share metrics should not change as a result of the decision to present all income statement subtotals (income from continuing operations, discontinued operations, extraordinary items, and cumulative effect of a change in accounting principle) at consolidated amounts rather that at amounts that exclude the noncontrolling interests portion. Earnings per share will continue to provide information about the common shares of the controlling interest. Therefore, a reconciliation of the numerators used in earnings per share computations will be required, since that information will not be readily determinable from the face of the income statement when an entity has one or more partially owned subsidiaries. This additional schedule also could be used to provide the required reconciliation. 7
believe the schedule would be useful and add transparency to these transactions. However, Janet Pegg, Bear Stearns, suggested that this schedule not be included as an additional statement because it may cause confusion about actual net income. 2 Transfers of wealth between equity holders take the form of premiums or discounts in the sale (or purchase) of subsidiary shares to (or from) minority interests. The premium or discount is calculated as the difference between the proceeds from sale (or amount paid) and the carrying amount of the proportionate interest sold (or purchased). The premium or discount would be accounted for as a transfer of equity to (or from) the noncontrolling interest. Therefore, the Board decided to require this additional schedule to be disclosed in the notes to the consolidated financial statements. The Board also decided that entities that present earnings per share also should present the additional per-share metric. This decision will result in divergence in disclosure requirements from the IASB. Since the information about wealth transfers presented in the additional schedule (excluding the per share data) also would be presented in a statement of changes in equity and, under international standards, a statement of changes in equity is a required statement, the IASB has not expressed interest in requiring this additional statement. SHOULD THE NONCONTROLLING INTERESTS DECISIONS REACHED BE REEXPOSED OR ISSUED AS A FINAL STANDARD ONLY? Both the project on Purchase Method Procedures and the project on Liabilities and Equity include issues related to the accounting for and reporting of noncontrolling (minority) interests. In the fourth quarter of 2002, the Board and the IASB decided to address all those issues concurrently through deliberations led by a single project team (the business combinations team). One issue that the Board has yet to resolve is whether the noncontrolling interest decisions should be reexposed or issued in a final standard. Certain noncontrolling interest decisions reached affirm or modify tentative conclusions that the Board proposed and exposed for comment in its: October 2000 Exposure Draft, Accounting for Financial Instruments with Characteristics of Liabilities, Equity, or Both, (2000 Liabilities & Equity ED) or 8
October 1995 Exposure Draft, Consolidated Financial Statements: Policy and Procedures (1995 Consolidations ED). Included in Appendix A is a table that lists the decisions reached in this project, whether the decision was previously exposed in either the 2000 Liabilities & Equity ED or the 1995 Consolidations ED, and, if so, the tentative decision exposed at that time. Some of the decisions have been previously exposed twice, some only once, and some are modifications or additions to the previous decisions that were developed during the Board s redeliberations. For most, if not all, of the decisions reached, it is not clear that any new significant information will be gained by asking constituents to comment again on these proposals. Also, this may be perceived as a nuisance to those who continue to disagree with the decisions reached and perceive that the Board is not listening to them. However, considerable time has passed since the prior Exposure Drafts. Some constituents, especially those that did not comment previously, may want another opportunity to provide their comments. OTHER AREAS OF POTENTIAL DIVERGENCE FROM THE IASB The Board and the IASB have reached differing conclusions for the following items: Amendments to postemployment benefit plans as a condition of the business combination. This issue is whether amendments to the acquiree s postemployment benefit plan that are a condition of the business combination should be considered a postcombination event or an assumed liability recognized as part of the business combination accounting (measured in accordance with FASB Statement. 87, Employers Accounting for Pensions, or. 106, Employers Accounting for Postretirement Benefits Other Than Pensions). Under the IASB s decisions to date, those amendments would be considered postcombination events; under the FASB s decisions to date, those amendments would be considered part of the assumed benefit plan liabilities. Constructive obligation that is a liability of the acquirer as a result of the business combination (and is not a liability of the acquiree before the business combination). This issue is whether constructive obligations that are not liabilities of the acquiree before the business combination and are liabilities of the acquirer as a result of the business combination should be considered a postcombination event or assumed liabilities. Under the IASB s 9
decisions to date, those liabilities would be recognized as a postcombination event if and when the recognition criteria in IAS 37, Provisions, Contingent Liabilities and Contingent Assets, are met; under the FASB s decisions to date, those liabilities would be recognized as assumed liabilities in the business combination. Constructive obligation that is not a liability of the acquirer at the date of acquisition (but is a liability of the acquiree before the business combination). This issue is whether constructive obligations that are liabilities of the acquiree before the business combination but, as a result of the combination, are not liabilities of the acquirer at the acquisition date should be considered assumed liabilities. Under the IASB s decisions to date, those liabilities would be recognized as an assumed liability, although the IASB acknowledged that the fair value of those liabilities would be close to zero. Under the FASB s decisions to date, if potential constructive obligations are not liabilities of the acquirer at the date of acquisition, they would not be recognized as assumed liabilities in the business combination. In analyzing the Board s and the IASB s decisions, the different tentative conclusions stem from two distinct views about which assets and liabilities should be included as part of the business combination. Those views lead to the following question: Is a particular asset or liability that arises at the date of acquisition part of the business combination transaction or part of a separate transaction or event? Whether an item is part of the business combination is significant because it has direct consequences on the calculation of goodwill. The differences in views have been described as follows: Acquiree View Recognition of assets and liabilities focuses on the assets and liabilities of the business over which control is obtained (acquiree). Acquirer View Recognition of assets and liabilities focuses on the assets acquired and liabilities assumed by the acquirer at the date of acquisition as part of the business combination (that includes, for example, assets acquired or liabilities assumed directly from the seller or a third party as a condition of the business combination agreement). The IASB has emphasized the acquiree view, and the Board has emphasized the acquirer view in this joint project. In most cases, the assets acquired and liabilities assumed in a business combination are the assets owned and liabilities incurred by the acquiree, 10
whether or not recorded (albeit at different amounts fair value versus carrying value). However, in certain limited circumstances, the acquirer view results in an asset or liability being recorded as part of the combination that was not an asset or liability of the acquiree prior to the acquisition date. An illustration of the differences in these views is as follows: To induce an acquisition of an acquiree (Weak Bank), as a condition of a combination agreement a regulatory authority agrees to provide financial assistance in the form of cash, a receivable, or guarantees. That assistance is transferred to the acquirer (Strong Bank) or to the newly merged combined entity upon the closing of the combination agreement. Under the acquiree view, the financial assistance would be treated as income of the combined entity recognized outside the business combination accounting because the asset was not an asset of the acquiree just prior to the acquisition. However, under the acquirer view, because the financial assistance is received as a condition of the combination agreement, it would be treated as an identifiable acquired asset at the acquisition date and recognized as part of the business combination accounting. Thus, all other things being equal, the amount recognized as goodwill would be higher under the acquiree view than under the acquirer view. The IASB is concerned that the acquirer view could lead to significant abuses (that is, anything could be added to a purchase agreement and it would become part of the business combination accounting). However, the IASB has expressed interest in further exploring the acquirer view and converging with the FASB as long as the guidance can be drafted in such a way that it sufficiently limits opportunities for abuse. The FASB staff is in the process of drafting that language. Questions for Council Members 1. If you have concerns about any of the significant changes to current practice for the accounting for and reporting of noncontrolling interests, what are they and how should the Board respond to those concerns? For example, do you have concerns (a) that the proposed changes are expensive to implement, 11
(b) that the information needed to implement the changes would not be available, (c) about the ability to audit fair value measurements, and so on? 2. Do you foresee any difficulties in preparing the information that would be included in the additional schedule that the Board is proposing? 3. Based on the information in the table in Appendix A, should the Board reexpose the entire package of noncontrolling interest decisions, or should the Board issue a final standard only? 4. If those decisions should be reexposed, should they be combined with the business combinations decisions and exposed in one document, or should those decisions be exposed in a separate document (perhaps as an amendment to ARB 51)? 5. Which do you believe provides the more useful information and why, the acquirer view or the acquiree view? 6. Do you have concerns that the acquirer view could be subject to abuse? How would you propose to limit opportunities for abuse? 7. Do you have any other practical concerns about adopting the acquirer view and what would you do to resolve those concerns? 12
ncontrolling Interest Issues Addressed in Phase II Issue Addressed in the 2000 Liabilities & Equity ED? Issue Addressed in the 1995 Consolidations ED? Issue Addressed in Phase II and Conclusion Reached Yes/ Comments Yes/ Comments Classification of ncontrolling Interests (NCI) in the Balance Sheet 1 NCI should be classified in equity separately from the parent shareholders equity. Yes Same conclusion ( 36) Yes Same conclusion ( 22) Recognition of Assets and Liabilities (Including Goodwill) in a Less Than 100 Percent Acquisition 2 Identifiable assets and liabilities of the acquiree should be recorded at full fair value if a less than a 100 percent controlling interest (CI) is acquired. 3 The full goodwill method should be used in the acquisition of a less than 100 percent CI in an acquiree. Yes Same conclusion ( 27) Yes Different conclusion Concluded that goodwill should not be attributed to the NCI [Purchased goodwill method] ( 27) Step Acquisitions 4 In a step acquisition, preacquisition investments held by the acquirer should be remeasured at their fair value at the acquisition date. Any gains or losses on the remeasurement should be recognized in net income for the period. Yes Different conclusion Purchase price was deemed to be the carrying amounts of earlier investments plus the amount paid for control ( 28) Changes in Ownership without a Change in Control 5 Subsequent changes in the ownership interests of the subsidiary by members of the consolidated group while the parent controls the subsidiary should be accounted for as capital transactions with any premiums or discounts over the carrying basis recognized directly in equity (paid-incapital). Increases Decreases Yes 37 only addressed sales of a sub s shares, and the same conclusion was reached. Increases were not addressed. Yes Same conclusion ( 29) Sale or Loss of Control 6 Any gain or loss on the disposition of a subsidiary (whether by sale or other means) should be recognized in consolidated net income of the period. Yes Same conclusion ( 38) Yes Same conclusion ( 30) 13
Issue Addressed in the 2000 Liabilities & Equity ED? Issue Addressed in the 1995 Consolidations ED? Issue Addressed in Phase II and Conclusion Reached Yes/ Comments Yes/ Comments 7 Any retained investment in a subsidiary in which control Yes Different conclusion Yes Different conclusion was sold or otherwise lost should be remeasured at its fair Retained investment would Retained investment value at the date control is lost. Any gains or losses on the not be remeasured ( 38) would not be remeasurement should be recognized in net income for the remeasured ( 30) period. Allocation of Goodwill and Subsequent Goodwill Impairment Losses 8 The goodwill initially allocated to the CI should be calculated as the difference between the fair value of the ownership interest acquired 4 and the CI s share in the fair value of the identifiable net assets acquired. The remainder of the goodwill should be allocated to the NCI. 9 Goodwill impairment losses should be allocated on a pro rata basis using the relative carrying values of goodwill: First, to the components of the reporting unit, if the partially owned subsidiary is part of a larger reporting unit, and also To the CI and NCI of the partially owned subsidiary. N/A since the conclusion was that goodwill would not be attributed to the NCI t addressed (and would have been before Statements 141/142) Before Statements 141/142 Display Requirements 10 The amount of net income attributable to the CI and NCI should be presented on the face of the consolidated income statement in addition to presenting consolidated net income. Yes But amounts attributable to the CI and NCI were required to be disclosed not presented on the face of a statement ( 46) Yes Same conclusion ( 24) 11 The amount of comprehensive income attributable to the CI and NCI should be presented on the face of the financial statement in which comprehensive income is presented in addition to presenting consolidated comprehensive income. Yes But amounts attributable to the CI and NCI were required to be disclosed not presented on the face of a statement ( 46) Before Statement 130 4 The fair value of the ownership interest acquired should be measured as: The fair value of the consideration paid by the acquirer on the acquisition date, if any Plus the fair value at the acquisition date of the acquirer s previous investment in the acquiree, if any. 14
Issue Addressed in the 2000 Liabilities & Equity ED? Issue Addressed in the 1995 Consolidations ED? Issue Addressed in Phase II and Conclusion Reached Yes/ Comments Yes/ Comments 12 Individual line items in the consolidated income statement should be presented on a consolidated basis in the consolidated financial statements. 13 Components of OCI should be presented on a consolidated basis in the consolidated financial statements. 14 Income and losses of a subsidiary should be attributed to both the CI and NCI on the basis of their ownership interests and contractual rights and obligations, if any, even if losses exceed the NCI investment. 15 The objective of the earnings per share (EPS) metric (income per share available to the common shareholders of the parent) will not change. Yes Same conclusion ( 41)? ED implies the same conclusion although not explicit ( 23) Yes Decided that amounts attributable to both the CI and NCI should be presented for the components of OCI ( 42) Before Statement 130 Yes Different conclusion Concluded that excess losses would be attributed to the CI ( 22) Yes Same conclusion ( 43) Yes Same conclusion ( 25) Disclosure Requirements 16 The following income statement subtotals attributable to the CI should be disclosed: Income from continuing operations Discontinued operations Extraordinary items Cumulative effect of changes in accounting principle Components of OCI. 17 A reconciliation of the amounts of NCI reported in equity as of the beginning and the end of the period. 18 In the notes, an additional schedule that illustrates the effects of transactions with noncontrolling shareholders on the equity attributable to common shareholders. Entities that present earnings per share also would be required to disclose in that schedule an additional per share metric that includes in the calculation the effects of equity transactions with noncontrolling shareholders. Yes Same conclusion ( 46) 15
Issue Addressed in the 2000 Liabilities & Equity ED? Issue Addressed in the 1995 Consolidations ED? Issue Addressed in Phase II and Conclusion Reached Yes/ Comments Yes/ Comments 19 Any gain or loss recognized and the line item in the income statement in which that gain or loss is recognized if an entity: Remeasures any preacquisition investment in a step acquisition to fair value on the acquisition date Sells or otherwise loses control of a subsidiary, either in whole (disposes of its entire ownership interest) or in part (disposes of its controlling ownership interest but retains a noncontrolling ownership interest). If a subsidiary is disposed of but a noncontrolling ownership interest is retained, the portion of the gain or loss related to the remeasurement of the retained interest to fair value should be disclosed separately t addressed since the Board concluded that preacquisition or retained investments would not be remeasured. t addressed since the Board concluded that preacquisition or retained investments would not be remeasured. 16
SIGNIFICANT PROPOSED CHANGES TO PRESENT PRACTICE IN THE ACCOUNTING FOR BUSINESS COMBINATIONS The following significant changes to accounting for business combinations were previously discussed with FASAC at the March 2003 meeting. These items have been included for informational purposes. 1. Under the working principle, the total amount to be recognized by the acquirer should be the fair value of the business acquired. There may be more instances in which a direct measurement of the fair value of the business acquired is used to measure the fair value of the business acquired, rather than basing the measurement on the fair value of the consideration paid. For example, a direct measurement of the fair value of the business acquired would be used in circumstances in which an entity obtains control over a business through means other than a transaction involving an acquisition of the net assets or equity interests in that business. Additionally, a direct measurement of the fair value of the business acquired would be used when the consideration paid represents the consideration for a small amount of the equity (for example, 10 percent) of the business acquired (often referred to as step acquisitions). Under current practice, the total amount that is recognized for a step acquisition is the incremental cost layers for each equity purchase. 2. The initial measurement objective in a business combination is the fair value of the acquired business, which often is represented by the exchange price paid between the buyer and the seller. Because direct acquisition-related costs (such as advisory and professional fees) are not part of the exchange price paid, they would be expensed as incurred. Under current practice, those costs are considered part of the cost of the acquired enterprise and are generally included in the amount recorded as goodwill. 3. Contingent consideration given in exchange in a business combination would be recognized at fair value as part of the purchase price on the acquisition date. Under current practice, contingent consideration is disclosed but not recorded as a liability (or shown as outstanding securities) unless the outcome of the contingency is determinable beyond a reasonable doubt. 4. Preacquisition contingencies (contingent assets and contingent liabilities) of the acquired entity should initially be recognized at fair value. Under current practice, many contingent assets and liabilities are recognized only if it is probable that the assets existed or the liabilities had been incurred. 5. Negative goodwill would be recognized as a gain in the income statement. Under current practice, negative goodwill is first accounted for as a reduction of the amounts that otherwise would have been assigned to long-term, nonfinancial assets of the acquired company. 17
6. Acquired in-process research and development (IPR&D) assets would be recognized as assets; however, consistent with present accounting requirements, research and development expenditures related to those assets incurred subsequent to the date of acquisition would not be capitalized. As with any other asset of a reporting entity, acquired IPR&D assets would be evaluated for impairment in periods subsequent to their acquisition. Under current practice, immediately subsequent to the acquisition of a business, the costs assigned to acquire IPR&D assets that have no alternative future use are charged to expense. 7. Costs expected to be incurred by the acquiring company to restructure the acquired entity would not be recorded when the business combination is initially recorded (as is the case under current practice). Rather, the costs of those restructuring activities would be included in the post-acquisition income statement of the combined entity in the period in which they are incurred. 18