When buyers and sellers of a business negotiate a transaction, one of the critical questions is whether the transaction will qualify as an asset acquisition or a business combination for accounting purposes. The actual legal agreement could refer to the deal as an asset acquisition, but that may not be the proper accounting conclusion.

As the buyer, determining whether your transaction is an asset acquisition or a business combination is important because accounting for a business combination differs significantly from purchasing another entity's assets. Accounting for the transaction can also impact both parties' tax liabilities and the acquiring company's future earnings.

Below, we explain the difference between the two types of transactions and summarize the accounting differences.

Asset Acquisition vs. Business Combination

Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 805 (ASC 805), Business Combinations, provides the criteria for evaluating whether a transaction is an asset acquisition or a business combination.

In an asset acquisition, the acquirer purchases an asset or group of assets (and their related liabilities) that does not meet the definition of a business under U.S. Generally Accepted Accounting Principles (GAAP).

ASC 805 provides a screen test for determining when a set of activities and assets do not constitute a business. If substantially all of the fair value of the acquired assets is concentrated in a single identifiable asset or group of similar identifiable assets, you meet the screen test, and you have an asset acquisition — not a business combination.

Under ASC 805, a business is defined as an integrated set of activities and assets consisting of, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. Identifying whether the criteria are met can be complex and challenging, depending on the nature of what was acquired.

Accounting for Asset Acquisitions

If the transaction is an asset acquisition, as the buyer, you must account for the transaction using the cost model outlined in ASC 805-50.

Accounting for an asset purchase involves:

• Valuation. Valuation methods will likely differ, and an ASC 805 valuation report might not be necessary, resulting in cost savings.
• Capitalize transaction costs. Direct and incremental costs incurred for an asset acquisition are included in the cost of the purchased asset(s). This results in less expense in the acquisition period than a business combination but higher depreciation expense over the life of the acquired asset.
• Do not recognize goodwill. For any excess of the cost of the acquisition over the fair value of the asset acquired, the acquirer allocates it to the assets acquired based on their relative fair values. This could result in a higher asset basis that is depreciated or amortized over the asset's useful life.
• Expense in-process research and development (IPR&D) costs if they have no alternative future use. It's rare for an acquired entity's in-process research and development activities to have alternative future uses, and therefore, it is typically expensed in an asset acquisition.
• Account for changes to contingent consideration as adjustments to the cost basis of the acquired assets. Contingent consideration is usually an obligation of the acquirer to transfer additional assets or equity interest to the former owners of an acquiree if specified future events occur or conditions are met. Changes to contingent consideration are accounted for as an adjustment to the cost basis of the acquired assets.
• Reclassify leases (potentially). ASC 805-50 does not explicitly address the reclassification of leases in an asset acquisition. Acquirers can follow the guidance in ASC 842-10-35-3, which specifies that for leases under ASC 842, the acquirer retains the acquiree’s previous lease classification unless it has been modified and not accounted for as a separate contract under ASC 842-10-25-8. Another approach is to consider each lease acquired as a new lease on the acquisition date. Under this alternative, the acquirer would reassess lease classification as of the acquisition date.

Accounting for Business Combinations

If the acquisition meets the definition of a business combination, you are required to apply the acquisition method described by ASC 805-10, measuring assets and liabilities at fair value.

Accounting for a business combination also involves:

• Expense transaction costs on or before the acquisition date. The acquirer expenses its acquisition-related transaction costs, such as legal and advisory fees. As a result, business combinations have expenses in the acquisition period as compared to an asset acquisition.
• Record IPR&D costs as indefinite-lived intangible assets. These amounts are measured at fair value using market participant assumptions. The acquirer expenses the asset if it abandons the project or upon completion of the associated R&D efforts.
• Recognize goodwill as an asset. The acquirer typically recognizes goodwill as an indefinite-lived intangible asset and tests it at least annually for impairment.
• Record changes in contingent consideration through earnings. The acquirer records contingent consideration at fair value on the date of acquisition, and subsequent changes in the fair value classified as a liability or an asset are recognized in earnings until settled.
• Lease classification is retained. Acquirers retain the acquiree’s lese classification unless the lease contract has been modified.
• Recognize provisional amounts on the acquisition date. When the initial accounting for a business combination is not complete at the end of the reporting period, the acquirer reports provisional amounts for those incomplete items. They then have up to a year to adjust those provisional amounts. This time frame is referred to as the measurement period.

Get clarity around accounting for asset acquisitions and business combinations

Accounting for M&A transactions is a complicated process that can significantly impact your financial statements and tax accounting. It's essential to get trusted advice from your accountant and legal counsel before deciding whether to purchase a target's assets or its business, while structuring the transaction, allocating the purchase price, and valuing the tangible and intangible assets acquired and liabilities assumed.

If you're considering an M&A transaction, contact CBIZ ARC. We can help you consider all the facts and circumstances and help you develop a solution tailored to your business needs.

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