FAS 141 Business Combinations December 3, 2003 Business Valuation Committee 1
FAS 141 Overview The Need For FAS 141 Need For Consistent Reporting In Business Combinations / Mergers And Acquisitions Pooling Of Interests Had Become The Method Of Choice, Especially For The Big Deals Business Valuation Committee 2
FAS 141 Overview The Problem With Pooling The 12 Criteria Used Under The Pooling Method Did Not Distinguish Dissimilar Transactions. Similar Business Combinations Were Accounted For Using Different Methods That Produced Dramatically Different Financial Statement Results. Business Valuation Committee 3
FAS 141 Overview FAS 141 Level The Playing Field All Business Combinations Must Use The Purchase Method Pooling-of-interests Method Is Prohibited Goodwill Continues To Be Excess Cost Of Assets Acquired And Liabilities Assumed Intangible Assets must be recognized separate from goodwill Business Valuation Committee 4
FAS 141 Overview Objectives of 141 Better Reflect Investments Made In Acquired Entities Based On Values Exchanged Improved Comparability Of Reported Financial Information More Complete Information About The Assets Acquired And Liabilities Assumed In Business Combinations Business Valuation Committee 5
FAS 141 Overview Purchase Method Virtually All Business Combinations Are Acquisitions And, Thus, All Businesses Combinations Should Be Accounted For In The Same Manner That Other Asset Acquisitions Are Accounted For based On The Values Exchanged Business Valuation Committee 6
FAS 141 Overview Major Steps Identify Acquiring Entity what Assets Are Acquired And Which Liabilities Are Assumed Measure Fair Value Of Acquisition Consideration Identify And Value Intangible Assets Identification Of Goodwill Business Valuation Committee 7
FAS 141 Overview Goodwill The Fundamentals Of Purchase Accounting Are Unchanged Under 141 Goodwill Represents The Amount Remaining After Allocating The Purchase Price To The Fair Market Values Of The Assets Acquired, Including Recognized Intangibles, And Assumed Liabilities. Business Valuation Committee 8
FAS 141 Overview What Has Changed Is The Amount Of Effort Companies Must Exercise In Identifying Assets That Must Be Broken-out Of Goodwill And Amortize Separately Business Valuation Committee 9
FAS 141 Overview Intangible Assets Must be separated if: Arises From Contractual Or Other Legal Rights Can Be Separated (Sell, Transfer, License, Rent, Or Exchange) For Example: Databases, Contracts, Patented And Unpatented Technology, Operating Leases, Licenses, Trademarks, Brands Business Valuation Committee 10
FAS 141 Overview Business Valuation Committee 11
FASB 141 Purchase, Price, and Allocation December 3, 2003 Business Valuation Committee 12
FASB 141 Purchase, Price, and Allocation Identification of the Acquiring Entity 1. Distributes cash or other assets or incurs liabilities 2. Issues the equity interests (except Reverse Acquisitions) 3. Larger entity (however, consider all facts and circumstances a. Relative voting rights including any unusual or special voting arrangements, options, warrants, or convertible securities b. Large Minority voting interest when no other has a significant voting interest c. Composition of the governing body of the combined entity d. Composition of senior management of combined entity e. Terms of exchange of equity securities Business Valuation Committee 13
FASB 141 Purchase, Price, and Allocation Some combinations involve more than 2 entities 1. Also consider which entity initiated the combination 2. Whether the assets, revenues, and earnings of one significantly exceeds the others Business Valuation Committee 14
FASB 141 Purchase, Price, and Allocation If a new entity is formed to effect the combination, one of the existing entities shall be determined to be the acquiring entity on the basis of evidence available. Business Valuation Committee 15
FASB 141 Purchase, Price, and Allocation Determining the cost of the acquired entity 1. Same accounting principles apply as in determining the costs of assets acquired individually, in a group, and in a combination 2. Cash payments, fair values of other assets, and fair values of liabilities incurred by an acquiring entity shall be used to measure the cost of an acquired entity Business Valuation Committee 16
FASB 141 Purchase, Price, and Allocation If preferred shares are given 1. Consider the characteristics of the preferred shares 2. It may be that the shares are more equivalent to debt, and it may be that the shares are more equivalent to common stock Business Valuation Committee 17
FASB 141 Purchase, Price, and Allocation Securities traded in the market 1. Value generally more clearly evident than fair value of an acquired entity 2. Consider the market price for a reasonable period before and after the date that the terms of the acquisition are agreed to and announced Business Valuation Committee 18
FASB 141 Purchase, Price, and Allocation If the quoted market price is not the fair value of the equity securities, the consideration received should be estimated even though estimating the fair values of net assets received is difficult. 1. Consider net assets received, goodwill, extent of adjustment to quoted market price 2. Consider all aspects of the acquisition, including negotiations 3. Independent appraisals may be used 4. Other forms of consideration distributed may provide evidence of the total fair value received Business Valuation Committee 19
FASB 141 Purchase, Price, and Allocation Cost of the combination 1. Registering and issuing equity securities are recognized as a reduction of the otherwise determinable fair value of the securities 2. Indirect and general expenses shall be expensed as incurred Business Valuation Committee 20
FASB 141 Purchase, Price, and Allocation Contingent consideration 1. Include all amounts that are determinable at the date of acquisition. 2. If consideration is issued or issuable at the expiration of the contingency period or held in escrow, disclose, but do not record amounts as a liability unless the outcome of the contingency is determinable beyond a reasonable doubt 3. Should be recorded when the contingency is resolved and consideration is issued or becomes issuable. Business Valuation Committee 21
FASB 141 Purchase, Price, and Allocation Contingencies based on earnings shall result in an additional element of cost of an acquired entity Contingencies based on security prices do not result in changes of the recorded cost of the acquired entity Business Valuation Committee 22
FASB 141 Purchase, Price, and Allocation Independent appraisals and actuarial or other valuations may be used as an aid in determining the fair value of assets acquired and liabilities assumed Tax basis of an asset or liability shall not be a factor in determining its estimated fair value Business Valuation Committee 23
FASB 141 Purchase, Price, and Allocation General guidance for assigning amounts to assets acquired 1. Marketable securities at fair values 2. Receivables at present values of amounts to be received less allowances for uncollectibility and collection costs 3. Inventories A. Finished goods and merchandise at estimated selling prices less costs of disposal and a reasonable profit allowance B. Work in process also gets reduced for cost to complete as well as costs of disposal and a reasonable profit C. Raw Materials at current replacement costs Business Valuation Committee 24
FASB 141 Purchase, Price, and Allocation 4. Plant and equipment A. To be used current replacement cost unless expected future use indicates a lower value B. To be sold at fair value, less cost to sell 5. Intangible assets at estimated fair values 6. Other assets at appraised values Business Valuation Committee 25
FASB 141 Purchase, Price, and Liabilities Allocation 1. Accounts and notes payable, long term debt, and other claims payable at present values of amounts to be paid 2. FASB 87 and FASB 106 with regards to pensions and post retirement benefits applies 3. Accruals for warranties, vacation pay, and deferred compensation at present values of amounts to be paid 4. Other liabilities and commitments unfavorable leases, contracts, commitments, and plant closing expense at present values of amounts to be paid Business Valuation Committee 26
FASB 141 Purchase, Price, and Allocation Do not recognize the goodwill amount from a previous entity. Do not recognize the deferred taxes. Deferred taxes are recognized in accordance with FASB 109, Accounting for Income Taxes Business Valuation Committee 27
FASB 141 Purchase, Price, and Allocation Preacquisition contingencies 1. Can the fair value be determined during the allocation period? 2. If not: A. Information indicates that it is probable that one or more future events will occur confirming the existence of the asset, liability, or impairment B. The amount of the asset or liability can be reasonably estimated C. After the end of the allocation period, any adjustment would be included in net income in the period in which the adjustment is determined Business Valuation Committee 28
FASB 141 Purchase, Price, and Allocation Research and development projects that have no alternative future use shall be charged to expense at the acquisition date. Business Valuation Committee 29
FASB 141 Purchase, Price, and Allocation Excess of costs over the fair value of acquired net assets shall be recognized as goodwill. However, acquired intangible assets should also be considered. Business Valuation Committee 30
FASB 141 Purchase, Price, and Allocation If the sum of the amounts assigned to assets acquired and liabilities assumed exceeds the cost of the acquired entity then do a pro rata reduction of the amounts that are assigned to all of the assets except A. financial assets other than investments accounted for by the equity method B. Assets to be disposed of by sale C. Deferred tax assets D. Prepaid assets relating to pension or other post retirement benefit plans E. Any other current assets F. If you get to zero on all of the items that you are reducing recognize the remainder as an extraordinary gain Business Valuation Committee 31
FASB 141 Purchase, Price, and Allocation A B C D Red Company (Purchasing) Blue Company (Acquired) Purple Company (Merged) January 1, 2004 BOOK VALUE BOOK VALUE FAIR VALUE Cash & receivables $ 250,000 $ 180,000 $ 170,000 $ 420,000 Inventories 260,000 116,000 146,000 406,000 Land 600,000 120,000 400,000 1,000,000 Buildings 800,000 1,000,000 1,600,000 1,800,000 Accumulated depreciation-bldgs. (300,000) (400,000) (600,000) (300,000) Equipment 180,000 120,000 140,000 240,000 Accumulated depreciation-equip. (90,000) (40,000) (80,000) (90,000) Technology patents 15,000 15,000 Trademarks 17,000 17,000 Copyrights 10,000 10,000 Customer list 13,000 13,000 Favorable lease 28,000 28,000 Non-compete agreement 17,000 17,000 Goodwill 45,179 45,179 Total Assets $ 1,700,000 $ 1,096,000 $ 1,921,179 $ 3,621,179 Business Valuation Committee 32
FASB 141 Purchase, Price, and End of this section Allocation Business Valuation Committee 33
FASB 141 Intangible Assets & Goodwill The next step is to allocate the remaining purchase price to the intangible assets. Allocation is based upon fair value Allocation to separately identified intangible assets must be as of the acquisition Business Valuation Committee 34
FASB 141 Intangible Assets & Goodwill Reasons the FASB gives for issuing FASB 141 include comparability of financial statements, competition for mergers and acquisitions and more recognition of intangible assets Intangibles have become more important drivers of wealth for the U.S. economy Intangible assets are an increasing portion of business combinations Users of financial statements want better information about intangibles Business Valuation Committee 35
U.S. Capitalization FASB 141 Intangible Assets & Goodwill Intangible assets as a percent of U.S. capitalization Source: Licensing Executive Society 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 80% 20% 54% 46% 1978 1988 1997 27% 73% Tangible Assets Intangible Assets Business Valuation Committee 36
FASB 141 Intangible Assets & Goodwill FASB 141 defines an intangible asset as Assets that lack physical substance. Think of intangible assets as Human capital Structural capital Customer capital Intellectual property Business Valuation Committee 37
FASB 141 Intangible Assets & Goodwill Impact of FASB 141 on intangible assets No pooling, so all acquired intangibles are recognized in the business combination Intangible assets that meet the criteria of FASB 141 paragraph 39 are recognized apart from goodwill Business Valuation Committee 38
FASB 141 Intangible Assets & Goodwill Bases for recognizing intangibles apart from goodwill Contractual-legal criterion Separability criterion Business Valuation Committee 39
FASB 141 Intangible Assets & Goodwill Contractual-legal criterion If an intangible asset arises from a contract or legal right it is recognized apart from goodwill Non-transferable favorable lease License to operate a nuclear power plant Technology patent Business Valuation Committee 40
FASB 141 Intangible Assets & Goodwill Separability criterion Capable of being separated from the acquired entity Sold, transferred, licensed, rented or exchanged Transactions are evidence of separability Business Valuation Committee 41
FASB 141 Intangible Assets & Goodwill FASB 141 asset categories Marketing related Customer related Artistic related Contract based Technology based Assembled workforce is always goodwill Business Valuation Committee 42
FASB 141 Intangible Assets & Goodwill Allocation of the purchase price to intangible assets is based upon fair value Value as of the date of acquisition Value of intangibles based upon future economic benefits Allocation of purchase price to individual intangible assets is similar to tangible assets Business Valuation Committee 43
FASB 141 Intangible Assets & Goodwill FASB 141 s definition of fair value The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between parties, that is, other than in a forced or liquidated sale. Business Valuation Committee 44
FASB 141 Intangible Assets & Goodwill FASB 141 s definition of fair value Includes synergies and attributes of the purchasing and acquired entities FASB s fair value is not the same as that used by the valuation community to describe State courts standard of value Business Valuation Committee 45
FASB 141 Intangible Assets & Goodwill Methods used to value intangible assets Cost, Market & Income Income method most often used Relief from royalty Excess earnings approach Business Valuation Committee 46
FASB 141 Intangible Assets & Goodwill Recognition of goodwill The excess of cost of the acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed shall be recognized as an asset referred to as goodwill. Business Valuation Committee 47
FASB 141 Intangible Assets & Goodwill A B C D Red Company (Purchasing) Blue Company (Acquired) Purple Company (Merged) January 1, 2004 BOOK VALUE BOOK VALUE FAIR VALUE Cash & receivables $ 250,000 $ 180,000 $ 170,000 $ 420,000 Inventories 260,000 116,000 146,000 406,000 Land 600,000 120,000 400,000 1,000,000 Buildings 800,000 1,000,000 1,600,000 1,800,000 Accumulated depreciation-bldgs. (300,000) (400,000) (600,000) (300,000) Equipment 180,000 120,000 140,000 240,000 Accumulated depreciation-equip. (90,000) (40,000) (80,000) (90,000) Technology patents 15,000 15,000 Trademarks 17,000 17,000 Copyrights 10,000 10,000 Customer list 13,000 13,000 Favorable lease 28,000 28,000 Non-compete agreement 17,000 17,000 Goodwill 45,179 45,179 Total Assets $ 1,700,000 $ 1,096,000 $ 1,921,179 $ 3,621,179 Business Valuation Committee 48
FASB 141 Intangible Assets & Goodwill Goodwill and intangible assets recognized apart from goodwill must be recorded separately at the time of acquisition Failure to do so can result in a significant write-down of goodwill in later periods. Intangibles and goodwill thrown together at acquisition cannot be carved out later. Business Valuation Committee 49
FASB 141 Intangible Assets & Goodwill FASB Staff Announcement, Topic # D-100, Clarification of Paragraph 61(b) of FASB 141 To be recognized apart from goodwill in subsequent periods, an intangible must: Meet the criteria in paragraph 39 Must have been assigned an amount equal to its fair value at the date of the business combination Must have been accounted for separately from goodwill on general and subsidiary ledgers Business Valuation Committee 50
FASB 141 Intangible Assets & Goodwill After the initial recording of the acquisition, intangibles and goodwill assets shall be accounted for in accordance with FASB 142 Business Valuation Committee 51
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