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Significant Changes to Business Combination and Noncontrolling Interest Accounting

Dec. 1, 2008

As initially communicated in the December 2007 edition of the MHM Messenger, the Financial Accounting Standards Board (FASB) issued Statements 141(R) on Business Combinations and 160 on Noncontrolling Interests in Consolidated Financial Standards. These statements will significantly change the accounting, as well as the presentation and disclosure for business combinations and noncontrolling (i.e., minority) interests.

Both statements are effective as of the beginning of annual periods beginning on or after December 15, 2008. Early adoption is prohibited. Statement 141(R) will be applied to business combinations for which the acquisition date is during a fiscal year beginning on or after the effective date.

Thus, for an entity with a June 30 year end, FAS 141(R) would only apply when the acquisition date is July 1, 2009 or later. Statement 160 will be applied prospectively to all noncontrolling interests, including any that arose before the effective date.

There are significant changes to key definitions, the recognition and measurement of assets acquired and liabilities assumed under the new "acquisition method" (formerly the purchase method), as well as presentation and disclosure issues for business combinations and noncontrolling interests. As with FAS 141, FAS 141(R) applies to acquisitions of businesses through asset acquisitions, as well as stock acquisitions.

Key Definitions and Scope

Business combination - A transaction or other event in which an acquirer obtains control of one or more businesses.

The new definition expands the applicability of business combination accounting, since control can be obtained through ways other than purchasing equity interests or net assets (i.e., by contract alone, through the lapse of minority veto rights, etc.). See Accounting Research Bulletin (ARB) 51 for further guidance on control.

Business - An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.

A set of activities and assets may be considered a business even if it currently does not have customers or is in the early development stage. Business combination accounting applies to all business entities, including mutual entities, except for the following:

  • The formation of a joint venture.
  • The acquisition of an asset or group of assets that does not constitute a business.
  • A combination between entities or businesses under common control.
  • A combination between not-for-profit organizations or the acquisition of a for-profit business by a not-for-profit organization.

Mutual entity - An entity other than an investor-owned entity that provides dividends, lower costs, or other economic benefits directly to its owners, members, or participants. Mutual insurance companies, credit unions and cooperative entities are all considered mutual entities.

The Acquisition Method

One significant change is that the acquisition method is much more fair value focused than the previous "purchase method". FAS 141(R) uses the FAS 157 definition of fair value, which is based on a market participant's perspective rather than the acquirer's specific planned use or non-use of the asset. See further discussion on this key concept in the Recognizing and measuring assets, liabilities and noncontrolling interests section.

The acquisition method requires the following to be performed and documented:

  • Identify the acquirer.
  • Determine the acquisition date.
  • Determine the consideration paid for the acquiree (i.e., purchase price).
  • Recognize and measure the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree.
  • Recognize and measure goodwill or a gain from a bargain purchase.

Identifying the Acquirer

Acquirer - The entity that obtains control over the acquiree. In a business combination in which a variable interest entity is acquired, the primary beneficiary of that entity always is the acquirer.

The guidance in ARB 51 should be used to identify the acquirer. If it is still unclear who the acquirer is, the guidance in FAS 141(R) Appendix A, paragraphs A11 - A15 should be used.

Determining the Acquisition Date

The determination of the acquisition date is extremely important because it is the date at which items (i.e., assets acquired, liabilities assumed, consideration paid, etc.) are recognized and measured at fair value.

Acquisition Date - The date on which the acquirer obtains control over the acquiree.

The date on which the acquirer obtains control of the acquiree generally is the date on which the acquirer legally transfers the consideration, if any, acquires the assets and assumes the liabilities of the acquiree (i.e. the closing date). However, the acquirer might obtain control 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 controls of the acquiree on a date before the closing date. However, the control obtained would need to be in fact and not just for convenience as implied by simply designating an "effective date."

Determining the consideration paid for the acquire (i.e., purchase price)

One significant change is that acquisition costs (i.e., finder's fees, due diligence costs, certain legal and accounting costs, appraisals, etc.) are excluded when determining the consideration paid under the acquisition method, but were previously included under the "purchase method." Instead, these costs are accounted for under other generally accepted accounting principles (GAAP) and generally will be expensed as incurred, unless they are associated with debt issuance costs or the issuance of equity securities.

When costs are incurred by the acquiree for the benefit of the acquirer, the acquirer should record a pre-acquisition prepaid asset. Post acquisition, the asset would be eliminated and the expense recognized.

All consideration paid for the acquiree should be measured at fair value as of the acquisition date. Consideration paid can include cash, other assets, equity interests, member interests in mutual entities, contingent consideration, etc. The assets or liabilities transferred as part of the consideration paid may have carrying amounts that differ from their fair values at the acquisition date. If so, the acquirer shall remeasure the transferred assets or liabilities to their fair values as of the acquisition date and recognize the resulting gains or losses, if any, in earnings. If the acquirer issues equity instruments, as full or partial payment for the acquiree, the fair value of the acquirer's equity instruments will be measured at the acquisition date.

If any share-based payment awards are exchanged by the acquirer for awards held by the acquiree's employees, they should be recorded as a liability or equity in accordance with FAS 123R Share-Based Payments and included in the consideration paid or recognized, in part or in full, as compensation expense. The accounting is dependent on evaluating the awards and segregating them into the following two categories, based on the proportion of the requisite service period and the service required post acquisition:

  1. Acquisition consideration
  2. Post-acquisition compensation

However, unlike prior GAAP, the portion of the sharebased payment that is part of the consideration paid is a temporary difference between the tax basis and the reported amount. Therefore, a deferred tax asset should be recognized as part of the acquisition accounting. Statement 141(R) paragraphs 43 - 46 and A91 - A106 provide additional guidance.

Contingent consideration - Usually is an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met.

Contingent consideration is occasionally used in acquisition transactions and are commonly referred to as "earn-out" provisions. It's used in situations when the price for the acquiree is subjective, due to potential industry conditions, growth projections, emerging technologies and products, lack of historical financial information, etc. Thus, if the company performs as expected post acquisition, the sellers receive additional purchase price. These "earn-out" provisions can include financial or nonfinancial measures or both.

Prior GAAP requires recognizing the cost of the contingent consideration only when it is reasonably assured that the payments will be made to the selling shareholders. Typically this would have been recorded as additional goodwill.

New GAAP may reduce the attractiveness of using contingent consideration in acquisitions, because it requires the contingent consideration to be recorded at fair value as of the acquisition date and there may be significant risks and uncertainty at the acquisition date as to whether any of the contingent consideration will ever be earned or if so, for how much will be paid. In any event, an estimate of the fair value of the contingent consideration arrangement must be made, which factors in the probability of the estimated payments.

The acquirer shall classify an obligation to pay any contingent consideration as a liability or as equity in accordance with FAS 150 Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity or other applicable GAAP.

If the contingent consideration is a liability, at each subsequent reporting date the fair value is required to be revalued, until the contingency is resolved. Any changes would generally be recorded directly to earnings, unless the arrangement is a hedging instrument or if the changes in fair value are the result of additional information about the facts and circumstances that existed at the acquisition date, that are determined during the measurement period. See the Measurement Period section.

Equity settled contingent consideration arrangements do not require any subsequent fair value adjustments and shall be accounted for within equity.

The new GAAP with regards to contingent consideration presents challenges, because of the difficulty in determining the fair value of any contingent consideration. The FASB suggests that buyers may look to negotiations with the sellers to assist in quantifying the fair value. However, this will be a complex calculation and will likely require the advice or use of a valuation specialist for the initial measurement, as well as for valuation during any subsequent periods until the contingent consideration is resolved.

Any funds held in escrow, as specified by the purchase agreement, may or may not be deemed to be contingent consideration. The underlying reasons and requirements for the escrow funds to be disbursed should be evaluated as to whether they meet the definition of contingent consideration.

Example - Contingent Consideration

At Acquisition: Company A acquires 100% of Company B. The acquisition price includes an earn-out provision that may allow Company B's owners collect a total of $3 million over the next 3 years, by earning $1 million each year, if Company B achieves annual budgeted growth. The fair value of the contingent consideration to be paid over the next three years is determined to be $2 million at the acquisition date.

End of Year 1: Company B significantly exceeded budgeted growth and earned the $1 million earn-out and was paid. The fair value of the remaining contingent consideration was revalued at the end of year 1 to be $2 million. As result the following entries were recorded:

End of Year 2: Company B barely met budgeted growth and earned the $1 million earn-out and was paid. The fair value of the remaining contingent consideration was revaluated at the end of the year 2 to be $500,000. As a result the following entries were recorded:

End of Year 3: Company B did not meet budgeted growth and thus did not earn the $1 million earn-out.

As a result the following entries were recorded:

Other Factors Impacting Consideration

When part of the combination or transactions of the acquiree are done for the benefit of the acquirer or the combined entity, these actions should be accounted for separately from the business combination, such as for:

  • A preexisting relationship or arrangement is settled.

For example, the acquirer is being sued by the acquiree for patent infringement. The acquirer eliminates the lawsuit by buying the acquiree. The acquirer would account for the lawsuit separately and record the fair value of contingent liability at the acquisition date with an offsetting charge to P&L and allocate a part of the consideration paid to the settlement of the liability

For example, the acquirer has a long-term contract to buy materials from the acquiree. The contract price is unfavorable compared to the current market price available to the acquirer and there is no settlement provision in the contract. The acquirer eliminates the unfavorable contract by buying the acquiree. The acquirer would accountfor the settlement of the purchase contract separately and record a loss for the difference between the unfavorable contract and market as of the acquisition date and allocate part of the consideration paid to the settlement of the liability. If the contract provided for a settlement amount, the loss recorded separately would be the lesser of the settlement amount or market adjustment.

  • Compensation for future services is provided.

Contingent consideration arrangements that require the receiver to provide services to the post acquisition entity are usually compensation arrangements rather than consideration paid.

For example, the acquiree revises the CEO's employment contract to provide for a change-incontrol payment while negotiating to be acquired. The payment is made by the acquiree before the acquisition date. This is probably a postcombination severance payment rather than an acquiree expense. The acquirer would record a prepayment asset during the acquisition. The post acquisition entity would record a severance expense and eliminate the prepayment asset.

For every transaction related to a business combination, the following factors should always be evaluated:

  1. The reason for the transaction
  2. Who initiated the transaction
  3. The timing of the transaction

This evaluation is needed to determine which transactions should be accounted for separate from the consideration transferred.

Recognizing and Measuring Assets, Liabilities and Noncontrolling Interests

Fair Value - The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

As indicated earlier, one significant change is that FAS 141(R) uses the FAS 157 definition of fair value for measurement, which is based on the market participant's perspective rather than the acquirer's specific planned use or non-use of the asset. The asset's highest or best use would be used when measuring its fair value, regardless of the acquirer's plans for the asset.

For example, the acquirer purchases the acquire because the acquiree's technology competes with the acquirer's product. The acquirer decides not to sell the technology or use it internally. The acquirer should record an asset for the technology at its market price fair value; regardless of whether the acquirer's use. Subsequent to the acquisition date, the asset should not be written down, unless it is deemed impaired under FAS 142.

Under prior GAAP (i.e., the "purchase method") the cost of the consideration paid was accumulated and allocated to the individual assets acquired and liabilities assumed based on their estimated fair values.

While, the acquisition date is the date at which the assets acquired, liabilities assumed and any noncontrolling interests are recognized and measured at fair value, some limited exceptions to the recognition, fair value measurement or both, exist for specific types of identifiable assets and liabilities. For these exceptions, the acquirer shall apply specified existing GAAP. The following is a list of some of these specific types of exceptions:

  • Assets held for sale - The acquired long-lived assets (or disposal group) classified as held for sale in accordance with FAS 144 Accounting for the Impairment or Disposal of Long-Lived Assets, shall be measured at fair value less cost to sell as of the acquisition date, in accordance with paragraphs 34 and 35 of that Statement.
  • Employee benefits - The liability should be recognized and measured in accordance with existing applicable GAAP (i.e., FAS 43, 106, 112, 158, etc.)

FAS141(R) retains the significant guidance in FAS 141 on recognizing any intangible assets acquired, separately from goodwill, with only minor changes. This includes the continuation of the concepts of "contractual or other legal rights" and "separability" in determining what intangibles should be recognized.

Contractual or other legal rights - Arises from contractual or other legal rights regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

Separable - Capable of being separated or divided from the entity and sold, transferred licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so.

To qualify, the assets and liabilities must meet the definition of such under FASB Concepts Statement 6.

In addition, they must be solely part of the exchange for the business combination. In certain cases the asset or liability may not have been previously recognized by the acquiree. FAS 141(R) also points out that there can be identifiable intangible assets associated with other assets being recorded.

For example, operating leases of a lessor may also give rise to a customer list and/or customer relationship that should be recorded as an intangible asset.

The acquirer shall classify or designate the identified assets and liabilities assumed in accordance with acquirer's operating and accounting policies and the contractual terms, economic conditions and other pertinent conditions as they existed at the acquisition date. However, two exceptions apply:

  1. Lease contracts - operating or capital
  2. Contracts written by insurance enterprises

For these items, the acquirer shall classify those contracts based on the contractual terms and other factors at the contract's inception date in accordance with FAS 13 or FAS 60. For instance, if the acquiree classified a lease as an operating lease, that classification/designation would be retained by the acquirer and would not need to be reevaluated. This is a recognition principle and should not be confused with measurement of the fair value as of the acquisition date.

However, if the terms of the contract have been modified due to the acquisition in a manner that would change its classification, the modification date should be used in the determination.

FAS 141(R)'s measurement principles present challenges because of the difficulty in determining "fair value." These will inevitably result in complex calculations and will require advice or use of a valuation specialist.

The changes in the recognition principles, as well as the requirements for fair value measurement, will significantly change accounting practices for the following acquired items:

  • Contingencies
  • Income taxes
  • Indemnification assets
  • In-process research and development (IPR&D)
  • Reacquired rights
  • Restructuring costs

Contingencies in business combination accounting are more likely to exist with respect to liabilities assumed than assets because the conditions for recognition of a contingent asset generally are not met at the date of acquisition. Under the new GAAP, contingencies are bifurcated into two categories, with the accounting being different for each.

1. ) Contractual contingencies are recognized at fair value at the acquisition date and may result from any of the following, but are not limited to:

  • Licensing and royalty agreements
  • Lease agreements
  • Service agreements
  • Warranty agreements
  • Employment contracts

2. ) Noncontractual contingencies are recognized at fair value at the acquisition date if it is "more-likelythan- not" that the contingency meets the accounting definition of an asset or liability. Morelikely- than-not is defined to mean greater than 50 percent likelihood of occurrence. An example of a noncontractual contingency is a lawsuit.

The measurement of a contingency post acquisition depends on whether the contingency is an asset or a liability.

Contingent assets are measured at the lower of:

  1. Acquisition date fair value
  2. Best estimate of the future settlement amount.

Contingent liabilities are measured at the higher of:

  1. Acquisition date fair value
  2. Amount that would be recognized if measured under FAS 5.

Changes in the measurement of the contingency post acquisition would be recorded directly to earnings.

Contingent liabilities can be increased subsequent to the acquisition, but cannot be decreased until settlement. A noncontractual contingency that did not qualify for the "more-likely-than-not" recognition at the acquisition date, could in fact be recognized and measured post acquisition if it met the FAS 5 requirements.

The new GAAP will put greater pressure to identify potential contingencies in due diligence, since the post acquisition measurement adjustment would impact earnings. Contractual contingences that existed at the acquisition date that are not identified until after the initial accounting may represent an error and, depending on the magnitude and materiality, may require restatement of previously issued financial statements. As a result, more detailed procedures may be necessary by acquirers to identify material contingencies.

On October 29, 2008, the FASB added a project to its technical agenda to reconsider the guidance in FAS 141(R) related to contingencies. The Board authorized the staff to draft a proposed FASB Staff Position (FSP) revising the initial recognition and measurement of assets and liabilities arising from contingencies to a model similar to the one in FAS 141. The FSP is currently expected to retain the subsequent measurement and accounting guidance in FAS 141(R) with additional clarification to address derecognition and require disclosure of the measurement attribute applied; and, if not measured at fair value, the reason that fair value could not be reasonably estimated. This Substance of the Standard will be updated by a MHM Messenger upon completion of this FASB project.

Income taxes with regards to the acquirer's unrecognized tax benefits (i.e., net operating losses) that are recognizable as a result of the acquisition are not to be included in the acquisition accounting, as required by prior GAAP. Instead, the amounts should be recognized in income tax expense.

Adjustments for recognized tax benefits related to the acquiree (i.e., adjustments to a valuation allowance) that are recognized subsequent to the acquisition date, generally will be recognized in income, not as an adjustment to the acquisition accounting, as required by prior GAAP.

Indemnification assets are assets the acquirer obtains if the seller has contractually indemnified the acquirer for the outcome of a contingency or uncertainty related to all or a part of a specific asset or liability.

The acquirer recognizes an asset at the same time it recognizes the indemnified item, which shall be measured initially and subsequently on the same basis as the indemnified item, subject to the need for a valuation allowance for non-collectibility. The acquirer derecognizes an indemnification asset only when it collects the asset, sells it or otherwise loses the right  to it.

For example, the seller has guaranteed that the acquirer's liability will not exceed $100,000 for an environmental liability (noncontractual contingency). At initial measurement, the fair value of the contingency is deemed to be $500,000. The acquirer would recognize an asset for $400,000 at the same time it recognizes the liability for $500,000.

In-process research and development (IPR&D) projects of the acquiree are measured at fair value and recognized as an asset rather than expensed on the acquisition date as required by prior GAAP. The asset is treated as an indefinite-lived intangible asset as of the acquisition date. Post acquisition, the intangible asset is subject to impairment testing and fully expensed if abandoned. Upon completion of the project, the asset will be amortized. However, post acquisition research and development costs will continue to be expensed as incurred in accordance with FAS 2.

Reacquired rights may exist when an acquire obtained the right to use an asset of the acquirer, prior to the business combination (i.e., franchise right, technology licensing agreement, etc.). In addition to the acquirer recording a settlement gain or loss outside of recording the business combination (see the Other Factors Impacting Consideration section), the acquirer also records an intangible asset for the reacquired right as part of the business combination.

The reacquired right is measured based on the remaining contractual terms of the contract giving the acquiree the right. Potential contractual or noncontractual renewals that a market participant would consider in estimating the rights are excluded. The intangible asset for the reacquired right is amortized over the remaining contract period for the right or is used in determining the gain or loss if the reacquired right is subsequently sold to another party.

Restructuring costs under FAS141(R) that are associated with restructuring or exit activities, but that do not meet the recognition criteria in FAS 146 as of the acquisition date, are required to be subsequently recognized as post acquisition expenses once the recognition criteria is met.

Other Measurement Considerations

Allowances for loan losses or bad debts relating to receivables are not carried forward. Instead, the receivables are recorded at the acquisition date fair value, which factors in both current interest rates and credit quality.

Operating leases already in force almost certainly contain terms that are different from the terms that would be available in the marketplace as of the acquisition date, which would result in an asset or liability being recorded in conjunction with the assumption of this obligation.

If the acquiree is the lessor in the operating lease, the acquirer recognizes an asset if the existing lease terms are favorable to the acquiree/lessor.

For example, assume a lease has a remaining lease term of 4 years and the market rate for such a lease is lower than the rate in the existing lease. The acquirer would record an asset for the favorable lease and amortize it over the remaining lease term.

In addition, the acquirer would recognize the asset for the property subject to the operating lease as of the acquisition date fair value, without regard to the effect of the lease contract.

If the acquiree is the lessee in the operating lease, the acquirer recognizes a liability if the existing lease terms are unfavorable to the lessee/acquiree or an asset if the existing lease terms are favorable, each of which is amortized over the remaining lease term.

Thus, an asset (if favorable) or liability (if unfavorable) would be amortized over the remaining lease term as a credit or debit to lease expense, respectively.

Capital leases of the acquiree, irrespective of whether the acquiree is the lessor or lessee, result in the acquirer recognizing the various assets and any related liabilities assumed at their acquisition date fair values

Noncontrolling Interests

All noncontrolling interests should be reflected at fair value as of the acquisition date. The fair value of the noncontrolling interest could very likely be different, on a per share basis, compared to the parent company holding the controlling interest. This is because of a control premium and/or a non-control discount.

As is the case with determining fair values of the assets acquired, determining the fair value of any noncontrolling interests as of the acquisition date could result in complex calculations and require advice or use of a valuation specialist.

Parent - An entity that has a controlling financial interest in one or more subsidiaries (also an entity that is the primary beneficiary of a variable interest entity).

Subsidiary - An entity, including an unincorporated entity such as a partnership or trust, in which another entity, known as the parent holds a controlling financial interest (also a variable interest entity that is consolidated by a primary beneficiary).

Only a financial instrument issued by the subsidiary that is classified as equity in the subsidiary's financial statements can be a noncontrolling interest. Additionally, it may be possible that all of the subsidiary's equity is noncontrolling interest if the parent company controls it by other means and consolidates the entity (i.e., contract, nonequity VIE under FIN 46R). See the Accounting and Presentation of Noncontrolling Interests section for further information on noncontrolling interests Recognizing and Measuring Goodwill or a Gain from a Bargain Purchase

Goodwill - An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

Goodwill is the excess of the consideration paid over the recognized net assets acquired and liabilities assumed in a 100% acquisition of the acquiree.

Assume Company A acquires 100% of Company B, as an asset purchase, for $10 million in cash, plus additional consideration if certain requirements are met in the next year. The fair value of the contingent consideration at the acquisition date is determined to be $1.5 million. The fair value of the net assets acquired and liabilities assumed, including a contractual contingency, are valued at $8.5 million at the acquisition date.

Example 1- 100% of the business acquired

When less than 100% of an acquiree is acquired, but control is obtained, the noncontrolling interest is taken into account during the calculation of goodwill. The accounting for this partial acquisition under FAS 141(R) is substantially different than prior GAAP.

Goodwill is instead allocated to the controlling and noncontrolling interests. The amount of goodwill allocated to the controlling interest is the difference between the fair value of the controlling interest and the controlling interest's share in the fair value of the recognized net assets acquired.

Example 2 - 60% of the Business Acquired

Assume the same facts as in Example 1, except that Company A paid $8 million in cash for a 60% interest, which includes a control premium, and the fair value of the remaining 40% noncontrolling interest is valued at $2,000,000.

Bargain purchases occur when the recognized net assets acquired exceed the fair value of the consideration paid plus the fair value of any noncontrolling interest.

Before recognizing a gain, the acquirer should reassess whether it has identified all of the assets acquired and liabilities assumed and should then review the procedures used to measure the amounts recognized. This reassessment should be documented.

If no adjustments are necessary, or if an excess remains after the adjustments, the acquirer should recognize the excess as a gain at the acquisition date A bargain purchase should be rare. The reasons for a bargain purchase (i.e., forced sale, acquiree wanting to quickly sell the business for health or other personal reasons, etc.) should be understood and documented. In addition, the reasons are required to be disclosed in the financial statements. Under prior GAAP, the reported amounts of the long lived assets are reduced to zero before any remaining amount is recognized as an extraordinary gain.

Measurement Period

Because of the timing of an acquisition in relation to a financial statement reporting date and/or limitation of the acquirer's access to the acquiree, the acquirer may need to record provisional amounts for the business combination. Like FAS 141, FAS 141(R) allows for a certain period of time to make any necessary adjustments to the provisional amounts during the measurement period.

Measurement period - The period after the acquisition date during which the acquirer may make adjustments to the "provisional" amounts recognized at the acquisition date.

The measurement period ends as soon as the acquirer receives the necessary information about facts and circumstances that existed at the acquisition date or concludes that the information cannot be obtained. However, this period may not exceed one year from the acquisition date. Any adjustments to the provisional amounts shall be made retrospectively by restating the prior period information.

Judgment is necessary to determine what information obtained during the measurement period indicates the existence of an asset or liability as of the acquisition date and the amount to be recorded as of that date.


The required disclosures for FAS 141(R) and 160 are voluminous and focus on transparency in the financial statements. Some of the more significant disclosure requirements are as follows:

  • Information about the acquired receivables by major classes, including:
    • Fair value of the acquired receivables.
    • Gross contractual amount of the receivables.
    • Best estimate at the acquisition date of the contractual cash flows that are NOT expected to be collected.
  • Information about the assets/liabilities arising from acquired contingencies, including:
    • Amounts recognized or an explanation of why no amount was recognized.
    • The nature of the recognized and unrecognized contingencies.
    • An estimate of the range of outcomes (undiscounted) of recognized or unrecognized contingencies or why a range cannot be provided.
  • Periods subsequent to the acquisition,information about changes to provisional amounts, contingent consideration and assets and liabilities for recognized contingencies.
  • Information on transactions recognized separately, including:
    • Description of the transaction.
    • How each transaction was accounted for.
    • The amounts and line item for each transaction.
    • If the transaction is a "settlement" amount, how it was determined.
      • How the amounts and where acquisition costs are accounted for.
      • Bargain purchase gain amount and line item and why the transaction was a bargain purchase.
      • The amount and how the fair value of noncontrolling interest was determined.
      • The fair value and any gain or loss recognized (and line item) to adjust a previously owned  investment in the acquiree.
  • Public companies - The impact of the acquisition on the consolidated financial statements, including:
    • Revenue and earnings included subsequent to the acquisition
    • Various supplemental pro forma information

Accounting and Presentation of Noncontrolling Interests

FAS 160 requires noncontrolling interests to be treated as a separate component of equity, not as a liability or other item outside equity, and should be clearly identified and labeled (i.e., noncontrolling interest in subsidiaries).

Because noncontrolling interests are an element of equity, increases and decreases in the parent's ownership interest that leave control intact are accounted for as capital transactions rather than as step acquisitions or dilution gains or losses. Thus, any subsequent acquisitions of ownership or reductions in ownership by the parent will be accounted for in the equity section, assuming the parent retains control (i.e., does not result in deconsolidation).

For these types of noncontrol changes in ownership, the carrying amount of the noncontrolling interests is adjusted to reflect the change in ownership interests, and any difference between the amount by which the noncontrolling interests are adjusted and the fair value of the consideration paid or received is recognized directly in equity attributable to the noncontrolling interest (i.e., additional paid-in capital).

Example 3 - Control Retained

Assume the same facts in Example 2 and that one year later Company A purchases an additional 20% of Company B (half of the outstanding noncontrolling interest) for $600,000. Company B's net income and comprehensive income during the year was zero. Since Company A had control both before and after the transaction, the transaction is recorded as an equity transaction. The noncontrolling interest is reduced by the carrying amount of the proportionate interest relinquished ($2,000,000 x 20% / 40%).

The difference between the carrying amount of the noncontrolling interests acquired ($1,000,000) and the amount paid ($600,000) is reported as an adjustment to paid-in capital. The entries would be as follows:

DR Noncontrolling Interest $1,000,000

CR Additional paid in Capital $ 400,000

CR Cash $ 600,000

Allocation of Net Income or Loss

Net income or loss and comprehensive income or loss, shall be attributed to the parent AND the noncontrolling interest. Thus, there should no longer be a charge or credit in the income statement to arrive at net income for the portion attributed to the noncontrolling interest. Examples from the Consolidated Statement of Income are as follows:

Under prior GAAP this portion of equity was usually reported outside the consolidated entity's equity section and the amounts of earnings and comprehensive income attributable to minority interest were treated as a charge or credit to arrive at the consolidated entity's net income or comprehensive income.

One significant change from FAS 160 is that the noncontrolling interest shall continue to be attributed its share of losses even if the attribution results in a deficit noncontrolling interest balance in the equity section.

Changes in Ownership

A gain or loss is only reported in earnings if the parent ceases to control the subsidiary (i.e., deconsolidates the subsidiary) as a result of a single transaction, or as a result of a series of transactions that are to be considered a single transaction. The gain or loss is calculated as follows:

Any retained investment in the former subsidiary is recorded by the former parent at its deconsolidation date fair value. Thus, the gain or loss recognized in income includes the realized gain or loss related to the portion of the ownership interest sold AND the gain or loss on the remeasurement to fair value of the interest retained. In subsequent periods, the retained investment is accounted for under the other applicable GAAP for such investments, such as APB 18.

Example 4 - Loss of Control

Assume the same facts in Example 3 and that one year later, Company A sells 55% of its interest in Company B, leaving Company A with a 25% interest. Thus, a change in control occurred. The 55% interest in Company B is sold for $5,000,000. Company B's net income and comprehensive income for the year is zero. The fair value of the 25% retained interest in Company B is determined to be $1,500,000. The carrying amount of Company B's net assets is $11,500,000 ($8,500,000 net assets + $3,000,000 goodwill). Company A would recognize a loss on the date of the sale computed as follows:

Step Acquisitions

Unplanned step acquisitions may result in a business combination being achieved in stages. Under FAS 141(R), the acquirer's interest in the acquire includes the acquisition date fair value of the equity interest the acquirer held in the acquiree before control is obtained. Therefore, the carrying amounts of the previously acquired tranches are adjusted to fair value as of the date control is obtained (i.e., acquisition date). Also, the acquirer recognizes the differences as a gain or loss in income at the acquisition date.

Amounts the acquirer previously recognized in accumulated other comprehensive income (i.e., cumulative translation adjustments recognized during the period the equity method was used to account for the investment tranches) would be included in the gain or loss recognized in income at the date control is obtained.

Under prior GAAP, each investment tranche is reflected in the financial statements at its cost either through the application of the equity method or in consolidation once control is obtained.

Planned series of transactions are addressed in FAS 160, to prevent manipulation of income through a series of planned acquisitions designed to take advantage of the remeasurement event through earnings when obtaining or surrendering control. The statement identifies the following four conditions, one or more of which may indicate that multiple arrangements should be accounted for as a single transaction:

  • The arrangements are entered into at the same time or in contemplation of one another.
  • They form a single transaction designed to achieve an overall commercial effect.
  • The occurrence of one arrangement depends on the occurrence of at least one other arrangement.
  • One arrangement considered on its own is not economically justified, but the arrangements are economically justified when considered together.

Summary of Significant Changes - Prior GAAP vs. New GAAP

The Substance of the Standard is a publication of the Professional Standards Group of Mayer Hoffman McCann P.C. This publication is designed to provide accurate information in regard to the subject matter covered. It is provided with the understanding that it does not constitute legal, accounting or other professional advice. Please contact your MHM service provider for more information.

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