When acquiring all or part of a company, the purchaser must follow guidelines laid out in Financial Accounting Standards Board Statement FAS 141R, Business Combinations regarding asset values.
Specifically, FAS 141R requires that buyers recognize a target’s asset values and liabilities at their fair market value on the date of the transaction.
The guidelines define a business combination as a transaction or other event in which a business obtains control of one or more enterprises. This includes a merger of equals.
The rules don’t apply to joint ventures, common control transactions and acquisitions between not-for-profit organizations, but they do include transactions where the purchaser:
-Obtains control of a business by contract alone (without holding any ownership interest).
-Becomes the primary beneficiary of a variable interest entity.
-Combines two or more mutual entities (such as credit unions).
-Takes control of certain development-stage companies.
While FAS 141R generally requires fair valuations of assets and liabilities as of the acquisition date, there are exceptions, which include assets and liabilities arising from contingencies, income taxes, employee benefits, indemnification assets, reacquired rights, share-based payment awards and assets held for sale. These are dealt with under other FASB guidelines.
Determining an Asset’s Value
A) Market – If there is sufficient data available, the asset is valued against recent transactions in similar markets or by benchmarks of comparable assets.
B) Income – This method is often used for intangibles and bases value on the expected discounted future cash flow derived from the asset. The two steps involved in this type of valuation are identifying and quantifying the expected cash flows and capitalizing those cash flows or earnings.
C) Cost – This bases asset values on the cost of replacing or reproducing the asset.
Valuing Intangible Assets
When you prepare for an acquisition, your company needs valuations of intangible assets that will be part of the deal, such as intellectual property, brand identity, customer relationships, research and development, technology and contracts.
Valuation requires determining an asset’s useful life and value. Useful life is the amount of time the asset is expected to contribute cash flow to your company, and it is amortized over that period. Intangible assets also have remaining life, which is indefinite. The asset is unamortized and is tested annually for decreased value, or impairment.
A Few More Details
Deal-related costs and expenses must be accounted for when they are incurred. This means that expenses such as legal fees and accounting due diligence charges are not capitalized or included in the purchase price.
In addition, restructuring costs that the buyer expects, but is not required to incur, must be recognized separately from the transaction – rather than as an assumed liability – and cannot be accrued on the closing date.
Future contingency payments in cash must be accounted for at acquisition-date fair value rather than when future goals are met. When the earnout is settled, the purchaser will have to account for the difference between the estimates and the actual payouts as an expense or gain.
3. Step and Partial Acquisitions
If the buyer obtains less than 100 percent of a target or achieves control in stages, it must post 100 percent of the acquisition-date fair values of all of the seller’s assets and liabilities. Because of this, the purchaser has to recognize full fair value of any non-controlling interests.
If, for example, your company holds a 25 percent stake in an enterprise that was purchased for $75 million, and you expand that holding with another 25 percent stake for $100 million, your company must revalue the original stake at $100 million and report a $25 million gain. The entire stake is then carried on the books at $200 million.
4. Bargain Purchases
The guidelines define a bargain purchase as a business combination in which the total acquisition-date fair value of identifiable net assets acquired exceeds the fair value of the consideration transferred plus any non-controlling interest in the target. The buyer must recognize the excess in earnings as a gain.
5. Contingent Liabilities and Assets
Such contractual liabilities as warranty obligations and non-contractual liabilities as litigation or possible product recalls must be recognized at the acquisition-date fair value. Acquirers must measure those liabilities under FAS 5 and at fair value, and book the larger amount.
The same two measures will be used for contingent assets, but companies will post the smaller number. This means the purchaser must perform adequate due diligence on the target company’s assets and liabilities to obtain sufficient information about them.
Consult a valuation specialist and be sure your enterprise’s auditors agree with the results.
6. In-Process Research and Development
The buyer must recognize separately from goodwill the acquisition-date fair values of research and development assets. These assets will remain on the books as an indefinite-lived, intangible asset and regularly assessed for impairment, or decreased value.
If the projects are completed, the assets must be amortized through earnings. If the projects are abandoned, the assets must be written off.