When entering into a business combination, companies often overlook certain areas in the accounting guidance that can significantly impact the financial results of all parties involved. It is important to familiarize yourself with the accounting guidance found in ASC Topic 805 to better understand the nuances and what impact the guidance has on the transaction.
Based on my experience with assisting companies in accounting for a merger or acquisition, I have identified the following five areas that often prove to be challenging.
1 – Does the Transaction Represent a Business Combination?
While on the surface this may seem straightforward, the overall principle in ASC 805 is that a new accounting basis is established when an entity takes control of another entity and defines this as a business combination. This can be in the form of a formal acquisition, but it is not uncommon for a change in capitalization to also trigger the business combination accounting rules.
2 – Fair Value Considerations
For those assets, liabilities and operations for which the acquirer takes ownership, the acquirer measures at their full fair values. Certain assets and liabilities transferred in the combination should be analyzed closely according to the guidance as fair value will often differ from an existing carrying value. Examples include:
- Intangible assets
- Deferred revenue
- Deferred rent
- Deferred commissions
3 – Determination of Consideration Transferred
Consideration may take many forms in a business combination. It is important to understand the transaction agreement and identify what the acquirer is transferring in terms of cash or equity. Additionally, quantifying the total consideration transferred can sometimes be challenging due to the payment of certain transactional expenses by either party. Careful attention and judgement should be focused on transactional expenses to determine the proper accounting treatment.
4 – Settlement of Share-based Awards
The settlement of share-based awards to employees is often included in a business combination. Whether it be the issuance of replacement awards, new awards or cancelling old awards, accounting for such events can be challenging. A clear understanding of existing share-based arrangements at the date of the business combination, as well as understanding the intention of the acquirer in settling those awards, is important in concluding on the accounting treatment.
5 – Disclosure Requirements
Aside from accounting for the business combination, the reporting requirements on the combination can prove challenging in a complex transaction. Careful consideration of disclosure requirements are necessary to ensure all aspects of the transaction are properly reported.
Mergers and acquisitions can range from the simplest of transactions to very complex arrangements and can differ greatly. Use this list to highlight certain areas that should be on your radar when contemplating a business combination, to illustrate the need to dig further into ASC Topic 805 or to seek outside consultation as necessary.