Mergers and acquisitions (M&A) can be transformative, offering companies opportunities to expand strategically, align with complementary businesses, and increase market share. However, with the potential rewards come significant risks and complexities, particularly regarding accounting practices. The Financial Accounting Standards Board (FASB) created Accounting Standards Codification Topic 805 (ASC 805) to guide companies in accounting for business combinations.

Below, we’ll explore key points in ASC 805, drawn from BDO’s Blueprint on Business Combinations, to help organizations navigate the post-transaction accounting landscape.

 

Scope of ASC 805

Not all transactions fall under ASC 805’s business combination guidelines. For instance, joint ventures, not-for-profit mergers, and transactions between commonly controlled entities are outside its scope. When joint ventures meet specific FASB criteria, ASC 805 provides accounting guidance upon formation, aligning it closely with business combination accounting.

 

Identifying the Acquirer

In straightforward cases, the acquirer is easy to identify. However, complexities arise when only part of a company’s equity is acquired or when transactions involve equity swaps. In these instances, legal acquirers and accounting acquirers may differ, potentially leading to a “reverse acquisition.” When the acquiree is a Variable Interest Entity (VIE), determining the acquirer requires additional analysis under ASC 810, Consolidation.

 

Defining a Business

One critical step is determining whether the acquired assets and liabilities meet the definition of a business under ASC 805. A business must include inputs and processes capable of producing outputs. ASC 805 further provides a “screen test” to evaluate cases where an acquisition might not meet this definition, affecting how the transaction is accounted for—either as a business combination or an asset acquisition.

 

Recognizing Assets, Liabilities, and Noncontrolling Interests

ASC 805 mandates that acquired assets, assumed liabilities, and noncontrolling interests be measured at fair value. Exceptions exist, such as contract assets and liabilities recognized under ASC 606, which are accounted for at non-fair-value levels. This valuation process demands significant time and accuracy, ensuring all items are appropriately measured and disclosed.

 

Recognizing Goodwill or Bargain Purchase Gain

Typically, a business combination will recognize goodwill when the acquisition price exceeds the fair value of net assets. Occasionally, a “bargain purchase gain” occurs if the purchase price is less than the fair value of the acquired net assets. ASC 805 requires entities to reassess asset completeness and valuations when this occurs. Complex factors, such as earnouts, employee stock awards, or seller-related costs, can complicate the calculation.

 

Separate Transactions

Additional transactions between buyer and seller can often accompany a business combination, and ASC 805 provides guidelines on whether these should be accounted for separately from the primary transaction.

 

Other Topics

ASC 805 also addresses accounting for the following topics:

  • Pushdown accounting: the recognition of the acquirer’s new basis in the acquiree’s standalone financial statements.
  • Common control transactions: transfers of assets or businesses between entities that are controlled by the same ultimate parent.
  • Asset acquisitions and recapitalizations: the acquisition of a group of assets that is not a business combination.
  • Joint venture formations: the initial accounting by a joint venture at its formation date.

 

Presentation and Disclosure

ASC 805 establishes detailed requirements for presenting and disclosing business combinations. Even smaller combinations, when aggregated, may require substantial reporting to ensure transparency in financial statements.

Business combinations involve nuanced and intricate accounting procedures. For companies unfamiliar with M&A transactions, the risk of misstatements in financial reporting increases. ASC 805 provides essential structure, but applying its standards demands expertise and meticulous attention. BDO’s Blueprint on Business Combinations offers comprehensive guidance to ensure compliance and accurate financial reporting. Their advisors are equipped to support your accounting team through these demanding transactions, meeting both internal and regulatory deadlines.

This post was created in collaboration with BDO. For more in-depth insights, visit BDO’s Blueprint on Business Combinations under ASC 805.