Revisions to a key U.S. accounting standard governing business combinations have great potential to affect deal making, deal flow and overall strategy in 2009. In an effort to improve financial reporting and harmonize U.S. and international accounting standards, the Financial Accounting Standards Board recently updated Statement of Financial Accounting Standards (SFAS) No. 141 to emphasize fair value accounting. This is the first significant product of converging FASB and International Accounting Standards Board agendas for the benefit of global business.
SFAS 141(R) imposes several changes in the way purchasers must account for businesses acquired based on the business' fair value on the acquisition date. Changes take effect for companies with reporting periods beginning on or after Dec. 15, 2008. Below is a summary of major provisions.
Fair Value of Acquired Business
Under current generally accepted accounting principles (GAAP), purchasers of businesses are required to account for the purchase price paid (including transaction, integration and restructuring costs) and allocate such purchase price among the assets acquired and liabilities assumed based on respective fair values. If less than 100 percent of a business is purchased, only the portion acquired is recorded by the purchaser. Consequently, the purchaser's financial statements will include only the acquired portion of any excess fair value over the historical cost of assets held in the target business. SFAS 141(R) mandates that the acquirer measure and account for the fair value of the entire business—even if only a portion of the business is purchased—so long as the purchaser acquires control. Consequently, the purchaser's financial statements will reflect 100 percent of any excess fair value over the historical cost of the target's assets.
Transaction, Integration and Restructuring Costs
GAAP permits purchasers to capitalize certain transaction costs, such as investment banking, legal and accounting fees, in the acquisition cost to be allocated among assets acquired through the business combination. Existing GAAP also allows purchasers to accrue for, and capitalize, business integration and restructuring costs anticipated in connection with acquisitions. SFAS 141(R) concludes that transaction business integration and restructuring costs are irrelevant to the acquired business' fair value and mandates that such costs be expensed in the period incurred.
Contingent Purchase Consideration
SFAS 141(R) provides that contingent purchase consideration must be measured at its fair value and recorded on the purchase date. In measuring the fair value of contingent consideration, the probability and timing of contingent payments will be taken into account. Subsequent events affecting fair value of contingent payment obligations are to be recognized through the purchaser's income statement. Existing GAAP defers recognition of contingent payments until all uncertainties pertaining to the payment obligations have been resolved.
Current GAAP does not permit an acquiring entity to record contingent assets, such as pending claims against third parties, until all material uncertainties have been resolved. Loss contingencies are recognized if "probable" and estimable upon the acquisition date.
SFAS 141(R) splits contingencies into two groups: contractual and other (e.g., litigation). Contractual contingencies are to be recorded at their fair value upon the acquisition date. SFAS 141(R) mandates that non-contractual contingent assets and liabilities must be recognized at fair value, but only if it is more likely than not (greater than 50 percent probability) that an asset or liability exists at the acquisition date. The determination of fair value of a contingent asset or liability necessarily takes into consideration the probability and timing of future payments. Recognized assets and liabilities are to be remeasured (at fair value) as contingencies are resolved or removed, or other new information is made available. Contingent assets are to be stated at the lower of the existing balance and the re-measured fair value (i.e., contingent assets will not be "written up"); contingent liabilities must be stated at the higher of the existing balance and re-measured fair value (no write down).
Other Noteworthy Provisions
Also contained in SFAS 141(R):
- The fair value of in-process research and development activities must be capitalized, subject to impairment assessments made at subsequent dates (current GAAP: capitalization is not permitted);
- Bargain purchase gains, where the fair value of assets acquired exceeds purchase price paid, are recognized in the acquirer's earnings (current GAAP: requires that the target's noncurrent assets must be reduced to zero before any excess bargain purchase gain is reflected in the purchaser's income statement); and
- Recognition of the entire goodwill associated with the business acquired is mandatory (current GAAP: only goodwill attributable to the portion of a business acquired in the purchase transaction is recorded by the purchaser).