A great deal of authoritative and interpretive technical literature exists on applying the “business combination” guidance to mergers and acquisitions under ASC 805. The following does not attempt to explore the accounting guidance but rather is intended as a practical roadmap for controllers, CFOs and directors of technical accounting who are responsible for overseeing the accounting for a transaction identified as a business combination under ASC 805. This article also does not attempt to address incremental filing and disclosure requirements for public companies.
Closing the Target’s Books
The process begins by closing the books of the target company as of the acquisition date. This set of financials serves as the baseline for the “bridge” to the post-acquisition opening balance sheet. Although in preparing an opening balance sheet, certain types of assets and liabilities are often valued by a specialist, there are numerous acquired assets and assumed liabilities for which the acquirer’s GAAP basis will frequently be the same as the target’s on the closing date. If the acquirer’s books and records were maintained on a basis other than US GAAP, such as the cash basis of accounting or International Financial Reporting Standards (IFRS), the acquirer should work to determine necessary adjustments. It may also be necessary to evaluate the target’s accounting policies and practices and conform these to those of the acquirer.
Net Working Capital Similar Contractual Adjustments
Most acquisition agreements provide for a final payment from the buyer to the seller or vice versa based on a comparison of contractually defined working capital, indebtedness or similar items to a target or estimated amount. This usually involves the preparation and delivery of a statement outlining what one party believes the final payment should be to the other party, which can then be accepted or disputed. Accounting balances as of the closing date are typically used to prepare these statements, and it is not unusual for parties to seek advice from accounting and legal personnel when preparing these documents. Typical contractual time for preparation and submission is between 60 and 120 days from the closing, depending on deal size and complexity. For accounting purposes, this step represents a component of the amount payable to or from the seller for items that are known or knowable as of the acquisition date and is generally treated as a component of the GAAP purchase price.
Engaging Valuation Specialists
A crucial step is engaging valuation specialists. These professionals are vital for determining the fair value of assets such as inventories and personal property, as well as assets that may not have been previously recognized on the target’s balance sheet, including intangible assets like trade names, customer relationships, and developed technology. Certain liabilities, if assumed, may also be valued by a specialist. A specialist may also be engaged to value components of the purchase price, such as stock in a privately held corporation issued to the target’s owners, contingent consideration arrangements (“earn-outs”), debt issued by the acquirer to the sellers, or warrants. Valuation teams will build valuation models using management-supplied information, including cash flow projections (referred to as ‘prospective financial information’) as well as available market data. Auditors will spend significant effort auditing the significant inputs and estimates used in prospective financial information, as these inputs drive the financial outputs embodied in valuation reports. Because this process can take time, it may be advantageous to engage a valuation specialist before or immediately after closing to help management move the purchase accounting process forward and give the company’s auditors the information they need for their review.
Documenting the Application of US GAAP to the Facts and Circumstances of the Acquisition
The application of purchase accounting often involves the adoption of accounting principles, the use of judgment and the application of technical accounting guidance. It is common practice to document all relevant matters and considerations in a technical purchase accounting memorandum. Due to the vast and technical nature of applying US GAAP to business combinations, many acquirers engage accounting advisory experts to advise on the application of GAAP to the transaction and assist with the preparation of the technical memo, thereby reducing the burden on a buyer’s internal accounting department.
Receiving and Reviewing Valuation Reports
Valuation reports prepared by the specialist and detailing the estimated fair value of assets acquired, liabilities assumed, and consideration transferred should be thoroughly reviewed by company management, and any questions or concerns should be brought to the specialist’s attention. Once management has reviewed these reports, they are generally forwarded to the acquirer’s auditors for them to commence procedures.
Finalization of the Opening Balance Sheet, Consolidation and Auditor Interaction
With valuation reports in hand, the next step is to integrate these values into the opening balance sheet along with working capital and other necessary purchase accounting adjustments. This is also an area where an accounting advisory expert can significantly facilitate the process.
The next step is to incorporate the adjusted opening balance sheet into the consolidated financial statements of the acquiring entity. Thereafter, the consolidated financial statements of the acquirer will reflect the activities of the target and any other consolidated entities.
It is typical to provide the opening balance sheet for the target, along with the memorandum mentioned in Step 4, to the Company’s auditors for review, after which it may be reviewed by the audit firm’s national office or a business combination accounting subject-matter expert. The auditors may accept the deliverables as provided or may provide feedback, which may take the form of requests for further information or documentation on certain matters.
Entities that furnish financial statements with footnotes will also be subject to business combination – specific disclosure requirements.
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