The new guidance under Statement of Financial Accounting Standards (SFAS) No. 141(R) – Business Combinations is a major change in the accounting treatment of acquisitions and mergers of businesses. Effective for fiscal years beginning after December 15, 2008 (early adoption is prohibited), the revised statement includes changes that could have a large impact on the timing, structure, and certainly the accounting treatment of transactions.
A business combination is a transaction or other event in which an acquirer obtains control of a business. SFAS 141(R) requires the acquiring company to recognize the assets, assumed liabilities, and non-controlling interests at their fair market value at the acquisition date. This may include assets or liabilities not previously recorded on the acquiree’s books. Such items may include:
- The acquisition-date fair value of inventory or equipment in excess of book value; any excess value of equipment recorded above the book value will result in higher depreciation over the remaining useful lives of the asset. Oppositely, if the book value of inventory is higher than the fair value at the acquisition date, the difference should be expensed shortly after the acquisition through cost of goods sold.
- Intangible assets not previously recorded by the acquired company, which would be recorded at their fair value and expensed over the life of the asset. An example of this would be an operating lease in which the terms of the acquiree’s lease are favorable relative to market terms of similar items (oppositely a liability would be recorded in the terms are unfavorable relative to market terms).
- Contingent consideration, such as earnouts based on the achievement of post-acquisition operating results, should be recorded at the fair value as of the acquisition date as part of the total consideration transferred.
- Goodwill is to be recognized as of the acquisition date, in most cases as the excess of the consideration transferred plus the fair value of any non-controlling interest in the acquiree at the acquisition date over the fair value of the net assets acquired. The difference in treatment under the revised guidance is the affect of including contingent consideration as part of the consideration transferred as opposed to recognizing it when it becomes payable. A bargain purchase, when the fair value of the assets acquired on the acquisition date exceeds the fair value of the consideration paid, requires the acquirer to recognize that excess in earnings as a gain (rather than being allocated as a pro rata reduction of the value of the assets acquired under SFAS 141).
One of the major changes of the pronouncement is the accounting treatment of transaction costs. Direct costs of the acquisition must be expensed by the acquirer in the period in which they are incurred and are not included in the calculation of the purchase price. This includes fees paid to attorneys, accountants, investment bankers, and other professionals.
SFAS 141(R) is a substantial change in accounting for business combinations. Please consult us or your financial advisor prior to entering into business acquisition transactions.
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