ASC 805 – Business Combinations
When a business acquisition occurs, the accounting is governed by ASC 805 вЂ“ Business Combinations (formerly SFAS 141R). ASC 805 requires that each asset and liability acquired in a business combination be recorded at fair value (as defined in ASC 820) as of the acquisition date, including internally-developed intangible assets of the target company that may not have been previously reflected on the books.
For tangible assets, such as cash, accounts receivable and prepaid expenses, the process of determining their fair value is relatively straightforward. Things get more complicated when dealing with intangible assets since one cannot simply point to a bank statement or general ledger balance to determine their value as of the acquisition date. It is the process of valuing a companyвЂ™s intangible assets that often requires the assistance of a valuation expert given the complexity associated with valuing intangibles and the documentation required by audit firms to support the purchase price allocation for an acquisition.
One of the first steps in valuing an acquired company’s intangible assets is determining what intangibles may be present. We have compiled a list of potential intangible assets for companies to consider along with a summary of the intangible assets we see recorded most often in practice, found in the intangible assets tab. Gone are the days when all of the purchase price in excess of a target company’s net tangible assets in an acquisition could be allocated to вЂњgoodwillвЂќ вЂ” this amount must now first be allocated to specifically identifiable intangible assets with only the remaining residual balance allocated to goodwill.
While the valuation of intangible assets in an acquisition is the most notable requirement of ASC 805, it reaches into other areas of business combination accounting, as well. For instance, ASC 805 requires the valuation of earnouts (when present in an acquisition), which must be presented at fair value as a liability on the balance sheet. This can make the determination of the purchase price in an acquisition a much more complex process than simply identifying the amount of cash paid at closing. However, when earnouts are contingent on the continued employment of one of the sellers after the transaction, it may be required that these вЂњearnoutвЂќ payments be expensed as incurred rather than reflected as part of the purchase price. There are many unique factors such as this that must be considered in business combination accounting вЂ“ see the Scope of ASC 805 and Resources tabs for more information.
Given the complexity of ASC 805, it is a best practice for companies to get out in front of the accounting for business combinations before their year-end audit begins. Companies should discuss acquisitions with their auditors as they occur and determine the level of analysis that will be required to document/support the value of any acquired intangible assets and whether the use of a third-party valuation expert will be necessary. Proactively addressing these issues can lead to a much smoother audit process and avoid potential delays that may be encountered otherwise.
ASC 805 provides guidance on a number of topics encountered in accounting for business combinations. Some of the more common issues encountered in purchase accounting that are governed by ASC 805 are summarized below:
- Definition of a business
- Identifying business combinations
- Identifying the acquirer and the acquisition date
- Recognizing and measuring the fair value of the assets acquired and liabilities assumed
- Recognizing and measuring any non-controlling interest in the target company
- Recognizing and measuring goodwill or bargain purchase gain
- Determining the amount of purchase consideration
- Employee compensation arrangements
- Recognizing and measuring contingent consideration
- Accounting for share-based payment awards (pre-and post-acquisition)
- Income tax considerations in business combination accounting
- Valuing intangible assets acquired
- Determining the useful life of acquired intangible assets
- Accounting for partial acquisitions, step acquisitions and changes in non-controlling interests
- Disclosure requirements
ASC 805 states that an intangible asset should be recognized and recorded as an asset separate from goodwill when it:
- Arises from contractual or other legal rights; or
- Is вЂњseparable,вЂќ meaning it can be separated from the other assets of the acquired entity (i.e., the assets can be separated and sold, transferred, licensed, rented or exchanged, regardless of whether there is an intent to do so).
Below are examples of intangible assets which, according to ASC 805, meet the criteria for recognition as assets apart from goodwill (the list is not intended to be all-inclusive, so other intangible assets which are not included below may also be recognized as assets separate from goodwill if the contractual or separability tests are met):
- Artistic-related intangible assets
- Contract-related intangible assets
- Licensing, royalty, standstill agreements
- Advertising, construction, management, service or supply contracts
- Lease agreements
- Construction permits
- Franchise agreements
- Operating and broadcasting rights
- Use rights such as drilling, water, air, mineral, timber cutting, and route authorities
- Servicing contracts such as mortgage servicing contracts
- Employment contracts
- Noncompetition agreements
- Customer-related intangible assets
- Customer lists
- Order or production backlog
- Customer contracts and related customer relationships
- Non-contractual customer relationships
- Marketing-related intangible assets
- Trademarks, trade names
- Service marks, collective marks, certification marks
- Trade dress (unique color, shape or package design)
- Internet domain names
- Technology-related intangible assets
- Patented technology
- Computer software and mask works
- Unpatented technology
- Databases, including title plants
- Trade secrets, such as secret formulas, processes, recipes
Some of the most commonly recorded intangibles assets in business combinations under ASC 805 include the following:
- Customer Relationships вЂ“ Most companies have repeat customers that continue to return time and time again for goods or services. To the extent that these customers can be identified, the customer relationships have intangible value since the purchaser can expect the customers to continue to do business with the acquired company after the deal has closed.
- Trademarks вЂ“ Trademarks include registered trademarks, trade names and related items that identify a company. The existence of a well-known trademark may cause a person to purchase a particular item, which generates cash flow for the company providing the goods or services.
- Noncompetition Agreements вЂ“ A noncompetition agreement prevents key employees from competing against the newly acquired company for a period of time after the acquisition, which protects the revenue and margins of the company from the dilution that could have resulted from the competition of those key persons.
- Technology вЂ“ While technology often results in the creation of tangible products, a company’s technological know-how is another commonly recorded intangible asset. If a companyвЂ™s technology allows it to offer products or services that meet or create customer demand, it may be an intangible asset with material value.