TOPIC: Reverse Acquisitions References so far for everyone to look at: Reverse Mergers: Advantages and Disadvantages https://www

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TOPIC: Reverse Acquisitions References so far for everyone to look at: Reverse Mergers: Advantages and Disadvantages https://www.investopedia.com/articles/stocks/09/introduction-reverse-mergers.asp How special purpose acquisition companies (SPACs) work https://www.pwc.com/us/en/services/auditassurance/accounting-advisory/spac-merger.html Comparing a Reverse Merger and a SPAC Business Combination https://www.jdsupra.com/legalnews/comparing-a-reverse-merger-and-a-spac-26176/ The SPAC Bubble Is About to Burst https://hbr.org/2021/02/the-spac-bubble-is-about-toburst#:~:text=Remember%20Reverse%20Mergers%3F,rigors%20of%20a%20traditional%20IPO. Spacs and Reverse Mergers: What’s Different This Time? https://www.sia-partners.com/en/news-andpublications/from-our-experts/spacs-and-reverse-mergers-whats-different-time SEC Financial Reporting Manual Topic 12 - Reverse Acquisitions and Reverse Recapitalizations https://www.sec.gov/corpfin/cf-manual/topic-12 Financial Reporting and Auditing Considerations of Companies Merging with SPACs https://www.sec.gov/news/public-statement/munter-spac-20200331 A Roadmap to Accounting For Business Combinations (especially pp. 219-229) https://www2.deloitte.com/content/dam/Deloitte/us/Documents/audit/ASC/Roadmaps/us-aers-a-roadmapto-accounting-for-business-combinations.pdf Subtopics to consider: (business combination versus asset acquisition) (what is acquiree/acquirer, legal vs accounting, who is eligible) (valuation of tangible and intangible assets, complications) (Process of the reverse acquisition) (any example) (meeting the definition of a business) (effects on financial statements, consolidated) (preparedness of private acquired company to meet SEC reporting requirements) Introduction Reverse acquisition is the process that helps the private company to become a public company at a lower cost and a shorter registration process when it is acquired. The logic behind this is that a private operating company may exchange its cash, assets, equity or a combination thereof with a public company in order to gain access to the public market. The advantage of doing this is to avoid going through an IPO (initial public offering) process which can be lengthy and frustrating. However, reverse acquisition has its own rules and conditions to filter the qualified acquirees and acquirers. The process includes the transactions that may lead to recapitalization. In that case, we would like to discuss how reverse acquisition works by referring to the Accounting Standard Codification and the related scholar articles. Also, we would like to dig deeper into the possible effects on company’s financial statements that the reverse acquisition causes. Relevant ASC codification and language Primary ASCs - 805-40-05, 805-40-25, 805-40-30, 805-40-45, 805-40-55, 805-10-25, 805-20-25, 80530-25 805-40 05-1 This Subtopic provides incremental guidance on the application of the acquisition method (as described in paragraph 805-10-05-4) to a business combination that is a reverse acquisition. 05-2 As one example of a reverse acquisition, a private operating entity may want to become a public entity but not want to register its equity shares. To become a public entity, the private entity will arrange for a public entity to acquire its equity interests in exchange for the equity interests of the public entity. In this situation, the public entity is the legal acquirer because it issued its equity interests, and the private entity is the legal acquiree because its equity interests were acquired. However, application of the guidance in paragraphs 805-10-55-11 through 55-15 results in identifying: a. The public entity as the acquiree for accounting purposes (the accounting acquiree) b. The private entity as the acquirer for accounting purposes (the accounting acquirer). 25-2 For a business combination transaction to be accounted for as a reverse acquisition, the accounting acquiree must meet the definition of a business. All of the recognition principles in Subtopics 805-10, 805-20, and 805-30, including the requirement to recognize goodwill, apply to a reverse acquisition. > Noncontrolling Interest 25-2 In a reverse acquisition, some of the owners of the legal acquiree (the accounting acquirer) might not exchange their equity interests for equity interests of the legal parent (the accounting acquiree). Those owners are treated as a noncontrolling interest in the consolidated financial statements after the reverse acquisition. That is because the owners of the legal acquiree that do not exchange their equity interests for equity interests of the legal acquirer have an interest in only the results and net assets of the legal acquiree?not in the results and net assets of the combined entity. Conversely, even though the legal acquirer is the acquiree for accounting purposes, the owners of the legal acquirer have an interest in the results and net assets of the combined entity. 30-1 All of the measurement principles applicable to business combinations in Subtopics 805-10, 805-20, and 805-30 apply to a reverse acquisition. > Measuring the Consideration Transferred 30-2 In a reverse acquisition, the accounting acquirer usually issues no consideration for the acquiree. Instead, the accounting acquiree usually issues its equity shares to the owners of the accounting acquirer. Accordingly, the acquisition-date fair value of the consideration transferred by the accounting acquirer for its interest in the accounting acquiree is based on the number of equity interests the legal subsidiary would have had to issue to give the owners of the legal parent the same percentage equity interest in the combined entity that results from the reverse acquisition. Example 1, Case A (see paragraph 805-40-55-8) illustrates that calculation. The fair value of the number of equity interests calculated in that way can be used as the fair value of consideration transferred in exchange for the acquiree. > Noncontrolling Interest 30-3 The assets and liabilities of the legal acquiree are measured and recognized in the consolidated financial statements at their precombination carrying amounts (see paragraph 805-40-45-2(a)). Therefore, in a reverse acquisition the noncontrolling interest reflects the noncontrolling shareholders’ proportionate interest in the precombination carrying amounts of the legal acquiree’s net assets even though the noncontrolling interests in other acquisitions are measured at their fair values at the acquisition date. > Consolidated Financial Statements Following a Reverse Acquisition 30-4 Paragraph 805-40-45-1 provides guidance on required adjustments to the accounting acquirer's legal capital to reflect the legal capital of the legal parent (accounting acquiree) in the consolidated financial statements following a reverse acquisition. Preparation and Presentation of Consolidated Financial Statements 45-1 Consolidated financial statements prepared following a reverse acquisition are issued under the name of the legal parent (accounting acquiree) but described in the notes as a continuation of the financial statements of the legal subsidiary (accounting acquirer), with one adjustment, which is to retroactively adjust the accounting acquirer’s legal capital to reflect the legal capital of the accounting acquiree. That adjustment is required to reflect the capital of the legal parent (the accounting acquiree). Comparative information presented in those consolidated financial statements also is retroactively adjusted to reflect the legal capital of the legal parent (accounting acquiree). 45-2 Because the consolidated financial statements represent the continuation of the financial statements of the legal subsidiary except for its capital structure, the consolidated financial statements reflect all of the following: a. The assets and liabilities of the legal subsidiary (the accounting acquirer) recognized and measured at their precombination carrying amounts. b. The assets and liabilities of the legal parent (the accounting acquiree) recognized and measured in accordance with the guidance in this Topic applicable to business combinations. c. The retained earnings and other equity balances of the legal subsidiary (accounting acquirer) before the business combination. d. The amount recognized as issued equity interests in the consolidated financial statements determined by adding the issued equity interest of the legal subsidiary (the accounting acquirer) outstanding immediately before the business combination to the fair value of the legal parent (accounting acquiree) determined in accordance with the guidance in this Topic applicable to business combinations. However, the equity structure (that is, the number and type of equity interests issued) reflects the equity structure of the legal parent (the accounting acquiree), including the equity interests the legal parent issued to effect the combination. Accordingly, the equity structure of the legal subsidiary (the accounting acquirer) is restated using the exchange ratio established in the acquisition agreement to reflect the number of shares of the legal parent (the accounting acquiree) issued in the reverse acquisition. e. The noncontrolling interest’s proportionate share of the legal subsidiary’s (accounting acquirer’s) precombination carrying amounts of retained earnings and other equity interests as discussed in paragraphs 805-40-25-2 and 805-40-30-3 and illustrated in Example 1, Case B (see paragraph 805-40-5518). > EPS 45-3 As noted in (d) in the preceding paragraph, the equity structure in the consolidated financial statements following a reverse acquisition reflects the equity structure of the legal acquirer (the accounting acquiree), including the equity interests issued by the legal acquirer to effect the business combination. 45-4 In calculating the weighted-average number of common shares outstanding (the denominator of the earnings-per-share [EPS] calculation) during the period in which the reverse acquisition occurs: a. The number of common shares outstanding from the beginning of that period to the acquisition date shall be computed on the basis of the weighted-average number of common shares of the legal acquiree (accounting acquirer) outstanding during the period multiplied by the exchange ratio established in the merger agreement. b. The number of common shares outstanding from the acquisition date to the end of that period shall be the actual number of common shares of the legal acquirer (the accounting acquiree) outstanding during that period. 45-5 The basic EPS for each comparative period before the acquisition date presented in the consolidated financial statements following a reverse acquisition shall be calculated by dividing (a) by (b): a. The income of the legal acquiree attributable to common shareholders in each of those periods b. The legal acquiree’s historical weighted-average number of common shares outstanding multiplied by the exchange ratio established in the acquisition agreement. 55-1 This Section is an integral part of the requirements of this Subtopic. This Section provides illustrations that address the application of accounting requirements for business combinations to reverse acquisitions. > >> Illustrations Example 1: Reverse Acquisitions 55-2 The following Cases illustrate the guidance in this Subtopic on accounting for a reverse acquisition: a. A reverse acquisition if all the shares of the legal subsidiary are exchanged (Case A) b. A reverse acquisition if not all of the shares of the legal subsidiary are exchanged and a noncontrolling interest results (Case B). 55-3 In these Cases, Entity B, the legal subsidiary, acquires Entity A, the entity issuing equity instruments and therefore the legal parent, on September 30, 20X6. These Cases ignore the accounting for any income tax effects. Cases A and B share all of the following information and assumptions. 55-4 The statements of financial position of Entity A and Entity B immediately before the business combination are as follows. 55-5 On September 30, 20X6, Entity A issues 2.5 shares in exchange for each common share of Entity B. All of Entity B’s shareholders exchange their shares in Entity B. Therefore, Entity A issues 150 common shares in exchange for all 60 common shares of Entity B. 55-6 The fair value of each common share of Entity B at September 30, 20X6, is $40. The quoted market price of Entity A’s common shares at that date is $16. 55-7 The fair values of Entity A’s identifiable assets and liabilities at September 30, 20X6, are the same as their carrying amounts, except that the fair value of Entity A’s noncurrent assets at September 30, 20X6, is $1,500. >>> Case A: All the Shares of the Legal Subsidiary Are Exchanged 55-8 This Case illustrates the accounting for a reverse acquisition if all of the shares of the legal subsidiary, the accounting acquirer, are exchanged in a business combination. The accounting illustrated in this Case includes the calculation of the fair value of the consideration transferred, the measurement of goodwill and the calculation of earnings per share (EPS). 55-9 The calculation of the fair value of the consideration transferred follows. 55-10 As a result of the issuance of 150 common shares by Entity A (legal parent, accounting acquiree), Entity B’s shareholders own 60 percent of the issued shares of the combined entity, that is, 150 of 250 issued shares. The remaining 40 percent are owned by Entity A’s shareholders. If the business combination had taken the form of Entity B issuing additional common shares to Entity A’s shareholders in exchange for their common shares in Entity A, Entity B would have had to issue 40 shares for the ratio of ownership interest in the combined entity to be the same. Entity B’s shareholders would then own 60 of the 100 issued shares of Entity B—60 percent of the combined entity. As a result, the fair value of the consideration effectively transferred by Entity B and the group’s interest in Entity A is $1,600 (40 shares with a per-share fair value of $40). The fair value of the consideration effectively transferred should be based on the most reliable measure. In this Case, the quoted market price of Entity A’s shares provides a more reliable basis for measuring the consideration effectively transferred than the estimated fair value of the shares in Entity B, and the consideration is measured using the market price of Entity A’s shares?100 shares with a per-share fair value of $16. 55-11 Goodwill is measured as follows. 55-12 Goodwill is measured as the excess of the fair value of the consideration effectively transferred (the group’s interest in Entity A) over the net amount of Entity A’s recognized identifiable assets and liabilities, as follows. 55-13 The consolidated statement of financial position immediately after the business combination is as follows. 55-14 In accordance with paragraph 805-40-45-2(c) through (d), the amount recognized as issued equity interests in the consolidated financial statements ($2,200) is determined by adding the issued equity of the legal subsidiary immediately before the business combination ($600) and the fair value of the consideration effectively transferred, measured in accordance with paragraph 805-40-30-2 ($1,600). However, the equity structure appearing in the consolidated financial statements (that is, the number and type of equity interests issued) must reflect the equity structure of the legal parent, including the equity interests issued by the legal parent to effect the combination. 55-15 The calculation of EPS follows. 55-16 Entity B’s earnings for the annual period ended December 31, 20X5, were $600, and the consolidated earnings for the annual period ended December 31, 20X6, are $800. There was no change in the number of common shares issued by Entity B during the annual period ended December 31, 20X5, and during the period from January 1, 20X6, to the date of the reverse acquisition on September 30, 20X6. EPS for the annual period ended December 31, 20X6, is calculated as follows. 55-17 Restated EPS for the annual period ending December 31, 20X5, is $4.00 (calculated as the earnings of Entity B of 600 divided by the 150 common shares Entity A issued in the reverse acquisition). >>> Case B: Not All the Shares of the Legal Subsidiary Are Exchanged 55-18 This Case illustrates the accounting for a reverse acquisition if not all of the shares of the legal subsidiary, the accounting acquirer, are exchanged in a business combination and a noncontrolling interest results. 55-19 Assume the same facts as in Case A except that only 56 of Entity B’s 60 common shares are exchanged. Because Entity A issues 2.5 shares in exchange for each common share of Entity B, Entity A issues only 140 (rather than 150) shares. As a result, Entity B’s shareholders own 58.3 percent of the issued shares of the combined entity (140 of 240 issued shares). The fair value of the consideration transferred for Entity A, the accounting acquiree, is calculated by assuming that the combination had been effected by Entity B’s issuing additional common shares to the shareholders of Entity A in exchange for their common shares in Entity A. That is because Entity B is the accounting acquirer, and paragraphs 80530-30-7 through 30-8 require the acquirer to measure the consideration exchanged for the accounting acquiree. 55-20 In calculating the number of shares that Entity B would have had to issue, the noncontrolling interest is ignored. The majority shareholders own 56 shares of Entity B. For that to represent a 58.3 percent equity interest, Entity B would have had to issue an additional 40 shares. The majority shareholders would then own 56 of the 96 issued shares of Entity B and, therefore, 58.3 percent of the combined entity. As a result, the fair value of the consideration transferred for Entity A, the accounting acquiree, is $1,600 (that is, 40 shares each with a fair value of $40). That is the same amount as when all 60 of Entity B’s shareholders tender all 60 of its common shares for exchange. The recognized amount of the group’s interest in Entity A, the accounting acquiree, does not change if some of Entity B’s shareholders do not participate in the exchange. 55-21 The noncontrolling interest is represented by the 4 shares of the total 60 shares of Entity B that are not exchanged for shares of Entity A. Therefore, the noncontrolling interest is 6.7 percent. The noncontrolling interest reflects the noncontrolling shareholders’ proportionate interests in the precombination carrying amounts of the net assets of Entity B, the legal subsidiary. Therefore, the consolidated statement of financial position is adjusted to show a noncontrolling interest of 6.7 percent of the precombination carrying amounts of Entity B’s net assets (that is, $134 or 6.7 percent of $2,000). 55-22 The consolidated statement of financial position at September 30, 20X6, reflecting the noncontrolling interest is as follows. 55-23 The noncontrolling interest of $134 has 2 components. The first component is the reclassification of the noncontrolling interest’s share of the accounting acquirer’s retained earnings immediately before the acquisition ($1,400 × 6.7% or $93.80). The second component represents the reclassification of the noncontrolling interest’s share of the accounting acquirer’s issued equity ($600 × 6.7% or $40.20). 805-10-25 25-1 An entity shall determine whether a transaction or other event is a business combination by applying the definition in this Subtopic, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition. An entity shall account for each business combination by applying the acquisition method. 25-2 Paragraph 805-10-05-4 summarizes the four steps in the acquisition method. This Section establishes the requirements for the following two of the four steps: a. Identifying the acquirer b. Identifying the acquisition date. 25-3 This Section also provides guidance on all of the following: a. Particular types of business combinations b. The measurement period c. Determining what is part of the business combination transaction. > Identifying the Acquirer 25-4 For each business combination, one of the combining entities shall be identified as the acquirer. 25-5 The guidance in the General Subsections of Subtopic 810-10 related to determining the existence of a controlling financial interest shall be used to identify the acquirer—the entity that obtains control of the acquiree. If a business combination has occurred but applying that guidance does not clearly indicate which of the combining entities is the acquirer, the factors in paragraphs 805-10-55-11 through 55-15 shall be considered in making that determination. However, in a business combination in which a variable interest entity (VIE) is acquired, the primary beneficiary of that entity always is the acquirer. The determination of which party, if any, is the primary beneficiary of a VIE shall be made in accordance with the guidance in the Variable Interest Entities Subsections of Subtopic 810-10, not by applying either the guidance in the General Subsections of that Subtopic, relating to a controlling financial interest, or in paragraphs 805-10-55-11 through 55-15. > Identifying the Acquisition Date 25-6 The acquirer shall identify the acquisition date, which is the date on which it obtains control of the acquiree. 25-7 The date on which the acquirer obtains control of the acquiree generally is the date on which the acquirer legally transfers the consideration, acquires the assets, and assumes the liabilities of the acquiree—the closing date. However, the acquirer might obtain control on a date that is either earlier or later than the closing date. For example, the acquisition date precedes the closing date if a written agreement provides that the acquirer obtains control of the acquiree on a date before the closing date. An acquirer shall consider all pertinent facts and circumstances in identifying the acquisition date. > Particular Types of Business Combinations 25-8 The following guidance describes the accounting for a business combination achieved in stages and a business combination achieved without the transfer of consideration. >> A Business Combination Achieved in Stages 25-9 An acquirer sometimes obtains control of an acquiree in which it held an equity interest immediately before the acquisition date. For example, on December 31, 20X1, Entity A holds a 35 percent noncontrolling equity interest in Entity B. On that date, Entity A purchases an additional 40 percent interest in Entity B, which gives it control of Entity B. This Topic refers to such a transaction as a business combination achieved in stages, sometimes also referred to as a step acquisition. 25-10 In a business combination achieved in stages, the acquirer shall remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognize the resulting gain or loss, if any, in earnings. In prior reporting periods, with respect to its previously held equity method investment, the acquirer may have recognized amounts in other comprehensive income in accordance with paragraph 323-10-35-18. If so, the amount that was recognized in other comprehensive income shall be reclassified and included in the calculation of gain or loss as of the acquisition date. If the business combination achieved in stages relates to a previously held equity method investment that is a foreign entity, the amount of accumulated other comprehensive income that is reclassified and included in the calculation of gain or loss shall include any foreign currency translation adjustment related to that previously held investment. For guidance on derecognizing foreign currency translation adjustments recorded in accumulated other comprehensive income, see Section 830-30-40. >> A Business Combination Achieved Without the Transfer of Consideration 25-11 An acquirer sometimes obtains control of an acquiree without transferring consideration. The acquisition method of accounting for a business combination applies to those combinations. Such circumstances include any of the following: a. The acquiree repurchases a sufficient number of its own shares for an existing investor (the acquirer) to obtain control. b. Minority veto rights lapse that previously kept the acquirer from controlling an acquiree in which the acquirer held the majority voting interest. c. The acquirer and acquiree agree to combine their businesses by contract alone. The acquirer transfers no consideration in exchange for control of an acquiree and holds no equity interests in the acquiree, either on the acquisition date or previously. Examples of business combinations achieved by contract alone include bringing two businesses together in a stapling arrangement or forming a dual-listed corporation. 25-12 In a business combination achieved by contract alone, the acquirer shall attribute to the equity holders of the acquiree the amount of the acquiree’s net assets recognized in accordance with the requirements of this Topic. In other words, the equity interests in the acquiree held by parties other than the acquirer are a noncontrolling interest in the acquirer’s postcombination financial statements even if the result is that all of the equity interests in the acquiree are attributed to the noncontrolling interest. > The Measurement Period 25-13 If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, the acquirer shall report in its financial statements provisional amounts for the items for which the accounting is incomplete. During the measurement period, in accordance with paragraph 805-10-25-17, the acquirer shall adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. 25-14 During the measurement period, the acquirer also shall recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period ends as soon as the acquirer receives the information it was seeking about facts and circumstances that existed as of the acquisition date or learns that more information is not obtainable. However, the measurement period shall not exceed one year from the acquisition date. 25-15 The measurement period is the period after the acquisition date during which the acquirer may adjust the provisional amounts recognized for a business combination. The measurement period provides the acquirer with a reasonable time to obtain the information necessary to identify and measure any of the following as of the acquisition date in accordance with the requirements of this Topic: a. The identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree (see Subtopic 805-20) b. The consideration transferred for the acquiree (or the other amount used in measuring goodwill in accordance with paragraphs 805-30-30-1 through 30-3) c. In a business combination achieved in stages, the equity interest in the acquiree previously held by the acquirer (see paragraph 805-30-30-1(a)(3)) d. The resulting goodwill recognized in accordance with paragraph 805-30-30-1 or the gain on a bargain purchase recognized in accordance with paragraph 805-30-25-2. 25-16 The acquirer recognizes an increase (decrease) in the provisional amount recognized for an identifiable asset (liability) by means of a decrease (increase) in goodwill. However, new information obtained during the measurement period sometimes may result in an adjustment to the provisional amount of more than one asset or liability. For example, the acquirer might have assumed a liability to pay damages related to an accident in one of the acquiree’s facilities, part or all of which are covered by the acquiree’s liability insurance policy. If the acquirer obtains new information during the measurement period about the acquisition-date fair value of that liability, the adjustment to goodwill resulting from a change to the provisional amount recognized for the liability would be offset (in whole or in part) by a corresponding adjustment to goodwill resulting from a change to the provisional amount recognized for the claim receivable from the insurer. 25-17 During the measurement period, the acquirer shall recognize adjustments to the provisional amounts with a corresponding adjustment to goodwill in the reporting period in which the adjustments to the provisional amounts are determined. Thus, the acquirer shall adjust its financial statements as needed, including recognizing in its current-period earnings the full effect of changes in depreciation, amortization, or other income effects, by line item, if any, as a result of the change to the provisional amounts calculated as if the accounting had been completed at the acquisition date. Paragraph 805-10-5516 and Example 1 (see paragraph 805-10-55-27) provide additional guidance. 25-18 Paragraphs 805-10-30-2 through 30-3 require consideration of all pertinent factors in determining whether information obtained after the acquisition date should result in an adjustment to the provisional amounts recognized or whether that information results from events that occurred after the acquisition date. 25-19 After the measurement period ends, the acquirer shall revise the accounting for a business combination only to correct an error in accordance with Topic 250. > Determining What Is Part of the Business Combination Transaction 25-20 The acquirer and the acquiree may have a preexisting relationship or other arrangement before negotiations for the business combination began, or they may enter into an arrangement during the negotiations that is separate from the business combination. In either situation, the acquirer shall identify any amounts that are not part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination, that is, amounts that are not part of the exchange for the acquiree. The acquirer shall recognize as part of applying the acquisition method only the consideration transferred for the acquiree and the assets acquired and liabilities assumed in the exchange for the acquiree. Separate transactions shall be accounted for in accordance with the relevant generally accepted accounting principles (GAAP). 25-21 A transaction entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer or the combined entity, rather than primarily for the benefit of the acquiree (or its former owners) before the combination, is likely to be a separate transaction. The following are examples of separate transactions that are not to be included in applying the acquisition method: a. A transaction that in effect settles preexisting relationships between the acquirer and acquiree (see paragraphs 805-10-55-20 through 55-23) b. A transaction that compensates employees or former owners of the acquiree for future services (see paragraphs 805-10-55-24 through 55-26) c. A transaction that reimburses the acquiree or its former owners for paying the acquirer’s acquisitionrelated costs (see paragraph 805-10-25-23). 25-22 Paragraphs 805-10-55-18 through 55-26, 805-30-55-6 through 55-13, 805-740-25-10 through 25-11, 805-740-45-5 through 45-6, and Example 2 (see paragraph 805-10-55-30) provide additional guidance for determining whether a transaction is separate from the business combination transaction. > Acquisition-Related Costs 25-23 Acquisition-related costs are costs the acquirer incurs to effect a business combination. Those costs include finder’s fees; advisory, legal, accounting, valuation, and other professional or consulting fees; general administrative costs, including the costs of maintaining an internal acquisitions department; and costs of registering and issuing debt and equity securities. The acquirer shall account for acquisitionrelated costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities shall be recognized in accordance with other applicable GAAP. 805-20-25 25-1 As of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. Recognition of identifiable assets acquired and liabilities assumed is subject to the conditions specified in paragraphs 805-20-25-2 through 25-3. However, an entity (the acquirer) within the scope of paragraph 805-20-15-2 may elect to apply the accounting alternative for the recognition of identifiable intangible assets acquired in a business combination as described in paragraphs 805-20-25-29 through 25-33. >> Recognition Conditions 25-2 To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements, at the acquisition date. For example, costs the acquirer expects but is not obligated to incur in the future to effect its plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. Therefore, the acquirer does not recognize those costs as part of applying the acquisition method. Instead, the acquirer recognizes those costs in its postcombination financial statements in accordance with other applicable generally accepted accounting principles (GAAP). 25-3 In addition, to qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must be part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination transaction rather than the result of separate transactions. The acquirer shall apply the guidance in paragraphs 805-10-25-20 through 25-23 to determine which assets acquired or liabilities assumed are part of the exchange for the acquiree and which, if any, are the result of separate transactions to be accounted for in accordance with their nature and the applicable GAAP. 25-4 The acquirer’s application of the recognition principle and conditions may result in recognizing some assets and liabilities that the acquiree had not previously recognized as assets and liabilities in its financial statements. For example, the acquirer recognizes the acquired identifiable intangible assets, such as a brand name, a patent, or a customer relationship, that the acquiree did not recognize as assets in its financial statements because it developed them internally and charged the related costs to expense. 25-5 Paragraphs 805-20-25-11 through 25-13 provide guidance on recognizing operating leases and paragraphs 805-20-55-2 through 55-45 provide guidance on recognizing other intangible assets. Paragraphs 805-20-25-17 through 25-28 specify the types of identifiable assets and liabilities that include items for which this Subtopic and Subtopic 805-740 provide limited exceptions to the recognition principle and conditions in paragraphs 805-20-25-1 through 25-3. Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 Paragraphs 805-20-25-11 through 25-12 provide guidance on recognizing operating leases and paragraphs 805-20-55-2 through 55-45 provide guidance on recognizing intangible assets. Paragraphs 805-20-25-17 through 25-28B specify the types of identifiable assets and liabilities that include items for which this Subtopic and Subtopic 805-740 provide limited exceptions to the recognition principle and conditions in paragraphs 805-20-25-1 through 25-3. > > Classifying or Designating Identifiable Assets Acquired and Liabilities Assumed in a Business Combination 25-6 At the acquisition date, the acquirer shall classify or designate the identifiable assets acquired and liabilities assumed as necessary to subsequently apply other GAAP. The acquirer shall make those classifications or designations on the basis of the contractual terms, economic conditions, its operating or accounting policies, and other pertinent conditions as they exist at the acquisition date. 25-7 In some situations, GAAP provides for different accounting depending on how an entity classifies or designates a particular asset or liability. Examples of classifications or designations that the acquirer shall make on the basis of the pertinent conditions as they exist at the acquisition date include but are not limited to the following: a. Classification of particular investments in securities as trading, available for sale, or held to maturity in accordance with Section 320-10-25 b. Designation of a derivative instrument as a hedging instrument in accordance with paragraph 815-1005-4 c. Assessment of whether an embedded derivative should be separated from the host contract in accordance with Section 815-15-25 (which is a matter of classification as this Subtopic uses that term). 25-8 This Section provides the following two exceptions to the principle in paragraph 805-20-25-6: a. Classification of a lease contract as either an operating lease or a capital lease in accordance with the guidance in paragraph 840-10-25-27 b. Classification of a contract written by an entity that is in the scope of Subtopic 944-10 as an insurance or reinsurance contract or a deposit contract. The acquirer shall classify those contracts on the basis of the contractual terms and other factors at the inception of the contract (or, if the terms of the contract have been modified in a manner that would change its classification, at the date of that modification, which might be the acquisition date). Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 This Section provides the following two exceptions to the principle in paragraph 805-20-25-6: a. Classification of a lease of an acquiree shall be in accordance with the guidance in paragraph 842-1055-11 b. Classification of a contract written by an entity that is in the scope of Subtopic 944-10 as an insurance or reinsurance contract or a deposit contract. The acquirer shall classify that contract on the basis of the contractual terms and other factors at the inception of the contract (or, if the terms of the contract have been modified in a manner that would change its classification, at the date of that modification, which might be the acquisition date). > Recognizing Particular Assets Acquired and Liabilities Assumed 25-9 Guidance on recognizing identifiable intangible assets, including operating leases and reacquired rights, follows. Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 Guidance on recognizing identifiable intangible assets, including reacquired rights, follows. >> Identifiable Intangible Assets 25-10 The acquirer shall recognize separately from goodwill the identifiable intangible assets acquired in a business combination. An intangible asset is identifiable if it meets either the separability criterion or the contractual-legal criterion described in the definition of identifiable. Additional guidance on applying that definition is provided in paragraphs 805-20-25-14 through 25-15, 805-20-55-2 through 55-45, and Example 1 (see paragraph 805-20-55-52). For guidance on the recognition and subsequent measurement of a defensive intangible asset, see Subtopic 350-30. 25-10A Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 An identifiable intangible asset may be associated with a lease, which may be evidenced by market participants’ willingness to pay a price for the lease even if it is at market terms. For example, a lease of gates at an airport or of retail space in a prime shopping area might provide entry into a market or other future economic benefits that qualify as identifiable intangible assets, such as a customer relationship. In that situation, the acquirer shall recognize the associated identifiable intangible asset(s) in accordance with paragraph 805-20-25-10. >> Operating Leases 25-11 The acquirer shall recognize no assets or liabilities related to an operating lease in which the acquiree is the lessee except as required by paragraphs 805-20-25-12 through 25-13. Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 The acquirer shall recognize assets or liabilities related to an operating lease in which the acquiree is the lessee as required by paragraphs 805-20-25-10A and 805-20-25-28A. 25-12 Regardless of whether the acquiree is the lessee or the lessor, the acquirer shall determine whether the terms of each of an acquiree’s operating leases are favorable or unfavorable compared with the market terms of leases of the same or similar items at the acquisition date. The acquirer shall recognize an intangible asset if the terms of an operating lease are favorable relative to market terms and a liability if the terms are unfavorable relative to market terms. Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 Regardless of whether the acquiree is the lessee or the lessor, the acquirer shall determine whether the terms of each of an acquiree’s operating leases are favorable or unfavorable compared with the market terms of leases of the same or similar items at the acquisition date. If the acquiree is a lessor, the acquirer shall recognize an intangible asset if the terms of an operating lease are favorable relative to market terms and a liability if the terms are unfavorable relative to market terms. If the acquiree is a lessee, the acquirer shall adjust the measurement of the acquired right-of-use asset for any favorable or unfavorable terms in accordance with paragraph 805-20-30-24. 25-13 An identifiable intangible asset may be associated with an operating lease, which may be evidenced by market participants’ willingness to pay a price for the lease even if it is at market terms. For example, a lease of gates at an airport or of retail space in a prime shopping area might provide entry into a market or other future economic benefits that qualify as identifiable intangible assets, such as a customer relationship. In that situation, the acquirer shall recognize the associated identifiable intangible asset(s) in accordance with paragraph 805-20-25-10. Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 Paragraph superseded by Accounting Standards Update No. 2016-02. >> Reacquired Rights 25-14 As part of a business combination, an acquirer may reacquire a right that it had previously granted to the acquiree to use one or more of the acquirer’s recognized or unrecognized assets. Examples of such rights include a right to use the acquirer’s trade name under a franchise agreement or a right to use the acquirer’s technology under a technology licensing agreement. A reacquired right is an identifiable intangible asset that the acquirer recognizes separately from goodwill. Paragraph 805-20-30-20 provides guidance on measuring a reacquired right, and paragraph 805-20-35-2 provides guidance on the subsequent accounting for a reacquired right. 25-15 If the terms of the contract giving rise to a reacquired right are favorable or unfavorable relative to the terms of current market transactions for the same or similar items, the acquirer shall recognize a settlement gain or loss. Paragraph 805-10-55-21 provides guidance for measuring that settlement gain or loss. >> Contingent Consideration Arrangements of an Acquiree Assumed by the Acquirer 25-15A Contingent consideration arrangements of an acquiree assumed by the acquirer in a business combination shall be recognized initially at fair value in accordance with the guidance for contingent consideration arrangements in paragraph 805-30-25-5. > Exceptions to the Recognition Principle 25-16 This Topic provides limited exceptions to the recognition and measurement principles applicable to business combinations. Paragraphs 805-20-25-17 through 25-28 specify the types of identifiable assets and liabilities that include items for which this Subtopic provides limited exceptions to the recognition principle in paragraph 805-20-25-1. The acquirer shall apply the specified GAAP or the specified requirements rather than that recognition principle to determine when to recognize the assets or liabilities identified in paragraphs 805-20-25-17 through 25-28. That will result in some items being recognized either by applying recognition conditions in addition to those in paragraphs 805-20-25-2 through 25-3 or by applying the requirements of other GAAP, with results that differ from applying the recognition principle and conditions in paragraphs 805-20-25-1 through 25-3. Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 This Topic provides limited exceptions to the recognition and measurement principles applicable to business combinations. Paragraphs 805-20-25-17 through 25-28B specify the types of identifiable assets and liabilities that include items for which this Subtopic provides limited exceptions to the recognition principle in paragraph 805-20-25-1. The acquirer shall apply the specified GAAP or the specified requirements rather than that recognition principle to determine when to recognize the assets or liabilities identified in paragraphs 805-20-25-17 through 25-28B. That will result in some items being recognized either by applying recognition conditions in addition to those in paragraphs 805-20-25-2 through 25-3 or by applying the requirements of other GAAP, with results that differ from applying the recognition principle and conditions in paragraphs 805-20-25-1 through 25-3. 25-17 Guidance is presented on all of the following exceptions to the recognition principle: a. Assets and liabilities arising from contingencies b. Income taxes c. Employee benefits d. Indemnification assets. Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 Guidance is presented on all of the following exceptions to the recognition principle: a. Assets and liabilities arising from contingencies b. Income taxes c. Employee benefits d. Indemnification assets e. Leases. 25-18 >> Paragraph not used. Assets and Liabilities Arising from Contingencies 25-18A The following recognition guidance in paragraphs 805-20-25-19 through 25-20B applies to assets and liabilities meeting both of the following conditions: a. Assets acquired and liabilities assumed that would be within the scope of Topic 450 if not acquired or assumed in a business combination b. Assets or liabilities arising from contingencies that are not otherwise subject to specific guidance in this Subtopic. >>> Acquisition Date Fair Value Determinable during Measurement Period 25-19 If the acquisition-date fair value of the asset or liability arising from a contingency can be determined during the measurement period, that asset or liability shall be recognized at the acquisition date. For example, the acquisition-date fair value of a warranty obligation often can be determined. >>> Acquisition Date Fair Value Not Determinable during Measurement Period 25-20 If the acquisition-date fair value of the asset or liability arising from a contingency cannot be determined during the measurement period, an asset or a liability shall be recognized at the acquisition date if both of the following criteria are met: a. Information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date. It is implicit in this condition that it must be probable at the acquisition date that one or more future events confirming the existence of the asset or liability will occur. b. The amount of the asset or liability can be reasonably estimated. 25-20A The criteria in the preceding paragraph shall be applied using the guidance in Topic 450 for application of similar criteria in paragraph 450-20-25-2. >>> Recognition Criteria Not Met during Measurement Period 25-20B If the recognition criteria in paragraphs 805-20-25-19 through 25-20A are not met at the acquisition date using information that is available during the measurement period about facts and circumstances that existed as of the acquisition date, the acquirer shall not recognize an asset or liability as of the acquisition date. In periods after the acquisition date, the acquirer shall account for an asset or a liability arising from a contingency that does not meet the recognition criteria at the acquisition date in accordance with other applicable GAAP, including Topic 450, as appropriate. >> Income Taxes 25-21 Section 805-740-25 establishes the recognition guidance for accounting for income taxes in a business combination. >> Employee Benefits 25-22 The acquirer shall recognize a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accordance with other GAAP. For example, employee benefits in the scope of the guidance identified in paragraphs 805-20-25-23 through 25-26 would be recognized in accordance with that guidance and as specified in those paragraphs. >>> Pension and Postretirement Benefits Other than Pensions 25-23 Guidance on defined benefit pension plans is presented in Subtopic 715-30. If an acquiree sponsors a single-employer defined benefit pension plan, the acquirer shall recognize as part of the business combination an asset or a liability representing the funded status of the plan (see paragraph 71530-25-1). Paragraph 805-20-30-15 provides guidance on determining that funded status. If an acquiree participates in a multiemployer plan, and it is probable as of the acquisition date that the acquirer will withdraw from that plan, the acquirer shall recognize as part of the business combination a withdrawal liability in accordance with Subtopic 450-20. 25-24 The Settlements, Curtailments, and Certain Termination Benefits Subsections of Sections 71530-25 and 715-30-35 establish the recognition guidance related to accounting for settlements and curtailments of defined benefit pension plans and certain termination benefits. 25-25 Guidance on defined benefit other postretirement plans is presented in Subtopic 715-60. If an acquiree sponsors a single-employer defined benefit postretirement plan, the acquirer shall recognize as part of the business combination an asset or a liability representing the funded status of the plan (see paragraph 715-60-25-1). Paragraph 805-20-30-15 provides guidance on determining that funded status. If an acquiree participates in a multiemployer plan and it is probable as of the acquisition date that the acquirer will withdraw from that plan, the acquirer shall recognize as part of the business combination a withdrawal liability in accordance with Subtopic 450-20. >>> Other Employee Benefit Arrangements 25-26 See also the recognition-related guidance for the following other employee benefit arrangements: a. One-time termination benefits in connection with exit or disposal activities. See Section 420-10-25. b. Compensated absences. See Section 710-10-25. c. Deferred compensation contracts. See Section 710-10-25. d. Nonretirement postemployment benefits. See Section 712-10-25. >> Indemnification Assets 25-27 The seller in a business combination may contractually indemnify the acquirer for the outcome of a contingency or uncertainty related to all or part of a specific asset or liability. For example, the seller may indemnify the acquirer against losses above a specified amount on a liability arising from a particular contingency; in other words, the seller will guarantee that the acquirer’s liability will not exceed a specified amount. As a result, the acquirer obtains an indemnification asset. The acquirer shall recognize an indemnification asset at the same time that it recognizes the indemnified item, measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts. Therefore, if the indemnification relates to an asset or a liability that is recognized at the acquisition date and measured at its acquisition-date fair value, the acquirer shall recognize the indemnification asset at the acquisition date measured at its acquisition-date fair value. 25-28 In some circumstances, the indemnification may relate to an asset or a liability that is an exception to the recognition or measurement principles. For example, an indemnification may relate to a contingency that is not recognized at the acquisition date because it does not satisfy the criteria for recognition in paragraphs 805-20-25-18A through 25-19 at that date. In those circumstances, the indemnification asset shall be recognized and measured using assumptions consistent with those used to measure the indemnified item, subject to management’s assessment of the collectibility of the indemnification asset and any contractual limitations on the indemnified amount. >> Leases 25-28A Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 The acquirer shall recognize assets and liabilities arising from leases of an acquiree in accordance with Topic 842 on leases (taking into account the requirements in paragraph 805-20-25-8(a)). 25-28B Pending Content: Transition Date: (P) December 16, 2018; (N) December 16, 2021 Transition Guidance: 842-10-65-1 For leases for which the acquiree is a lessee, the acquirer may elect, as an accounting policy election by class of underlying asset and applicable to all of the entity’s acquisitions, not to recognize assets or liabilities at the acquisition date for leases that, at the acquisition date, have a remaining lease term of 12 months or less. This includes not recognizing an intangible asset if the terms of an operating lease are favorable relative to market terms or a liability if the terms are unfavorable relative to market terms. Accounting Alternative Combine Subsections COMBINE SUBSECTIONSCombine Subsections 25-29 The guidance in this Subsection applies to entities within the scope of paragraph 805-20-15-2 that elect the accounting alternative for the recognition of identifiable intangible assets acquired in a business combination. > Identifiable Intangible Assets 25-30 An intangible asset is identifiable if it meets either the separability criterion or the contractuallegal criterion described in the definition of identifiable. However, under the accounting alternative, an acquirer shall not recognize separately from goodwill the following intangible assets: a. Customer-related intangible assets unless they are capable of being sold or licensed independently from other assets of a business b. Noncompetition agreements. 25-31 Customer-related intangible assets often would not meet criterion (a) in paragraph 805-20-25-30 for recognition. Customer-related intangible assets that would meet that criterion for recognition under this accounting alternative are those that are capable of being sold or licensed independently from the other assets of a business. Examples of customer-related intangible assets are listed in paragraph 805-2055-20. Many of the customer-related intangible assets that would meet criterion (a) for recognition also would be considered contract-based intangible assets as described in paragraph 805-20-55-31. Customerrelated intangible assets that may meet that criterion for recognition include but are not limited to: a. Mortgage servicing rights b. Commodity supply contracts c. Core deposits d. Customer information (for example, names and contact information). 25-32 Contract assets, as used in Topic 606 on revenue from contracts with customers, are not considered to be customer-related intangible assets for purposes of applying this accounting alternative. Therefore, contract assets are not eligible to be subsumed into goodwill and shall be recognized separately. 25-33 A lease is not considered to be a customer-related intangible asset for purposes of applying this accounting alternative. Therefore, favorable and unfavorable leases are not eligible to be subsumed into goodwill and shall be recognized separately. 805-30-25 25-1 The acquirer shall recognize goodwill as of the acquisition date, measured as described in paragraph 805-30-30-1. > Gain from Bargain Purchase 25-2 Occasionally, an acquirer will make a bargain purchase, which is a business combination in which the amount in paragraph 805-30-30-1(b) exceeds the aggregate of the amounts specified in (a) in that paragraph. If that excess remains after applying the requirements in paragraph 805-30-25-4, the acquirer shall recognize the resulting gain in earnings on the acquisition date. The gain shall be attributed to the acquirer. Example 1 (see paragraph 805-30-55-14) provides an illustration of this guidance. 25-3 A bargain purchase might happen, for example, in a business combination that is a forced sale in which the seller is acting under compulsion. However, the recognition or measurement exceptions for particular items identified in paragraphs 805-20-25-16, and 805-20-30-10 also may result in recognizing a gain (or change the amount of a recognized gain) on a bargain purchase. 25-4 Before recognizing a gain on a bargain purchase, the acquirer shall reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed and shall recognize any additional assets or liabilities that are identified in that review. See paragraphs 805-30-30-4 through 30-6 for guidance on the review of measurement procedures in connection with a reassessment required by this paragraph. > Contingent Consideration 25-5 The consideration the acquirer transfers in exchange for the acquiree includes any asset or liability resulting from a contingent consideration arrangement. The acquirer shall recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquiree. 25-6 The acquirer shall classify an obligation to pay contingent consideration as a liability or as equity in accordance with Subtopics 480-10 and 815-40 or other applicable generally accepted accounting principles (GAAP). For example, Subtopic 480-10 provides guidance on whether to classify as a liability a contingent consideration arrangement that is, in substance, a put option written by the acquirer on the market price of the acquirer’s shares issued in the business combination. 25-7 The acquirer shall classify as an asset a right to the return of previously transferred consideration if specified conditions are met. Works Cited Financial Accounting Standards Board. “ASC 805-10-25.” https://asc.fasb.org/. FASB, n.d. Web. Retrieved on 04 May 2021. Financial Accounting Standards Board. “ASC 805-20-25.” https://asc.fasb.org/. 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