Business merger and acquisition (M&A) transactions have significant financial reporting implications. Notably, the company’s balance sheet will look markedly different than it did before the business combination. Here’s some guidance on reporting business combinations under U.S. Generally Accepted Accounting Principles (GAAP).
Allocating the purchase price
GAAP requires a buyer to allocate the purchase price to all acquired assets and liabilities based on their fair values. This process starts by estimating a cash equivalent purchase price.
If a buyer pays 100% cash up front, the purchase price is already at a cash equivalent value. But the cash equivalent price is less clear if a seller accepts noncash terms, such as an earnout that’s contingent on the acquired entity’s future performance or stock in the newly formed entity.
The next step is to identify all tangible and intangible assets and liabilities acquired in the business combination. The seller’s presale balance sheet will report most tangible assets and liabilities, including inventory, equipment and payables. However, intangibles are reported only if they were previously purchased by the seller. Most intangibles are generated in-house, so they’re rarely included on the seller’s balance sheet.
Assigning fair value
Acquired assets and liabilities are then added to the buyer’s balance sheet, based on their fair values on the acquisition date. The difference between the sum of these fair values and the purchase price is reported as goodwill.
Goodwill and other indefinite-lived intangibles — such as brand names and in-process research and development — usually aren’t amortized for GAAP purposes. Instead, companies generally must test goodwill for impairment each year. Impairment testing also may be necessary when certain triggering events happen. Examples of triggering events include the loss of a major customer or enactment of unfavorable government regulations. If a borrower reports an impairment loss, it could mean that the business combination has failed to achieve management’s expectations.
Rather than test for impairment, private companies may elect to amortize goodwill straight-line, generally over 10 years. However, companies that elect this alternate method must still test for impairment when certain triggering events occur.
In rare instances, a buyer negotiates a bargain purchase. Here, the fair value of the net assets exceeds the fair value of consideration transfer (the purchase price). Rather than book negative goodwill, the buyer reports a gain from the purchase on the income statement.
Get it right
Accurate purchase price allocations are essential to minimizing write-offs and restatements in subsequent periods. Contact a trusted Axley & Rode advisor to get M&A accounting right from the start. We can help ensure your fair value estimates are supported by market data and reliable valuation techniques.