United States

Business combinations: In motion

INSIGHT ARTICLE

RSM US LLP’s (RSM) A Guide to Accounting for Business Combinations was developed and designed to help assist middle market companies in their application of Topic 805, Business Combinations, of the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC). The third edition of the guide is currently available and its content is based on information existing at June 1, 2016.

Given the continuing evolution of U.S. generally accepted accounting principles (GAAP) (including ASC 805), we have created this summary to highlight those standard-setting activities of the FASB that affect, or could affect, the content in the guide. Standard-setting activities highlighted in this summary are related to the following topics:

Provided in the table that follows for each of these topics is: (a) a description of the significant standard-setting activities that have taken place thus far and where related information can be found in the guide, (b) links to additional information about those activities and (c) the status of those activities or the effective date of any final Accounting Standards Update (ASU) resulting from those activities. The table will be updated as additional significant standard-setting activities occur.

Description

Additional information

Status or effective date

Scope exception for not-for-profit entities

There is currently a scope exception to ASC 805 for a transaction or other event in which a not-for-profit entity gains control of another not-for-profit entity, but is permitted or required not to consolidate the entity as discussed in ASC 958-810-25. The FASB has proposed clarifying the nature of that scope exception by referring specifically to ASC 958-810-25-4 for purposes of identifying those situations in which a not-for-profit entity gains control of another not-for-profit entity, but does not consolidate that entity.

For additional information about how not-for-profit entities should account for mergers or acquisitions of not-for-profit entities, refer to Section 3.3 of the guide.

FASB’s project update page for Technical Corrections and Improvements

Proposed ASU issued in April 2016.

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Definition of a business

The FASB has proposed clarifying the definition of a business such that to be considered a business, what was acquired would have to include, at a minimum, an input and a substantive process that together contribute to the ability to create outputs. In addition, the FASB has proposed that if the fair value of what was acquired is concentrated in a single (or group of similar) identifiable asset(s), it would not be considered a business.

For information about the current definition of a business and where it is used in U.S. GAAP, refer to Section 4.1 of the guide. For information about how the definition of a business is used in identifying reporting units, which are used for goodwill impairment testing purposes, refer to Section 12.8 of the guide.

FASB’s project update page for Clarifying the Definition of a Business

Proposed ASU issued in November 2015.

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Recognition of identifiable intangible assets in a business combination

The FASB has a project on its agenda in which it will consider whether certain intangible assets acquired in a business combination by public business entities (PBEs) and not-for-profit entities should be subsumed into goodwill. The FASB may work jointly with the International Accounting Standards Board (IASB) on this project.

For information about the recognition of intangible assets acquired in a business combination under current U.S. GAAP, refer to Sections 10.2, 10.3 and 10.6 of the guide. For information about the private-company intangible asset alternative (the election of which generally results in certain intangible assets being subsumed into goodwill), refer to Section 18.1 of the guide.

FASB’s project update page for Accounting for Identifiable Intangible Assets in a Business Combination for Public Business Entities and Not-for-Profit Entities

Deliberations are ongoing.

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Accounting for leases

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which replaces the legacy U.S. GAAP lease guidance (ASC 840, Leases) with new lease guidance (ASC 842, Leases). In addition, ASU 2016-02 amends ASC 805 primarily to provide exceptions to its overall recognition and measurement principles for acquired leases.

ASU 2016-02 revised the guidance addressing the classification of an acquired lease by requiring the buyer to retain the target’s lease classification as of the acquisition date unless the lease is modified in conjunction with the business combination and the modification is not accounted for as a separate contract, in which case the classification of the lease should be reassessed on the acquisition date.

With respect to acquired leases for which the target is the lessee, ASU 2016-02 amended ASC 805 to:

  • Allow the buyer to elect an accounting policy (applicable to all acquisitions) by class of underlying asset to not recognize either of the following: (a) right-of-use assets and lease liabilities for acquired leases with a remaining lease term of 12 months or less or (b) an intangible asset or liability for short-term leases with terms that are favorable or unfavorable compared to market
  • Require the buyer to recognize right-of-use assets and lease liabilities for acquired leases with a remaining lease term of more than 12 months and acquired leases for which the short-term lease accounting policy discussed in the previous bullet point has not been elected
  • Require measurement of the lease liability at the present value of the remaining lease payments as if the lease were new on the acquisition date
  • Require measurement of the right-of-use asset by starting with the amount of the lease liability and adjusting it for the intangible asset or liability arising from the acquired lease having favorable or unfavorable terms compared to market
  • Clarify whether an identifiable intangible asset (other than the one that arises from favorable lease terms compared to market [see previous bullet point]) should be recognized
  • Provide various factors that should be taken into consideration in establishing the amortization period for acquired leasehold improvements

With respect to acquired leases for which the target is the lessor:

  • If the lease is classified as an operating lease, ASU 2016-02 retained the requirements related to the buyer: (a) recognizing an intangible asset or liability arising from the lease having favorable or unfavorable terms compared to market and (b) considering whether any other identifiable intangible assets arise from the lease, such as a customer relationship intangible asset.
  • If the lease is classified as a sales-type or direct-financing lease, ASU 2016-02 amended ASC 805 to include explicit guidance on how to measure the net investment in the lease and to observe that the net investment in the lease should equal the fair value of the underlying asset on the acquisition date. These amendments require the buyer to use the terms and conditions of the lease in calculating the acquisition-date fair value of the underlying asset. In addition, the buyer is required to consider whether any other identifiable intangible assets arise from the lease, such as a customer relationship intangible asset.

For information about the guidance that should be used to account for leases acquired in a business combination before the effective date of ASU 2016-02, refer to Sections 9.1, 10.2, 10.11, 10.12 and 10.16 of the guide.

Our white paper, Leases: New accounting requirements for lessees

ASU 2016-02 is first effective for calendar-year PBEs (and certain not-for-profit entities and employee benefit plans) on January 1, 2019 and for all other calendar-year entities in the year ending December 31, 2020.

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Hedge accounting

The FASB has a project on its agenda to simplify hedge accounting. Numerous tentative decisions have been reached thus far, including: (a) subsequent quantitative effectiveness testing would be required only if facts and circumstances change, (b) component hedging would be permitted for nonfinancial items and (c) for those hedges that are highly effective, ineffectiveness would no longer be separately recognized.

For information about the transactions, instruments or agreements that the buyer may need to reclassify or redesignate as of the acquisition date in the accounting for a business combination, refer to Section 9.1 of the guide.

Our summary, FASB/IASB joint project: Financial instruments

FASB’s project update page for Accounting for Financial Instruments—Hedge Accounting

The proposed ASU is expected to be issued in the third quarter of 2016.

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Accounting for long-duration insurance contracts

In connection with a joint project with the IASB, the FASB issued a proposed ASU in 2013 that, if finalized, would have comprehensively changed the accounting for insurance contracts. Based on the feedback received, the FASB scaled back its project to only make targeted improvements to existing U.S. GAAP applicable to the accounting for insurance contracts. For short-duration insurance contracts, those improvements only involved enhancing disclosures. For long-duration contracts, the FASB has made numerous tentative decisions involving: (a) periodically updating assumptions used in measuring recorded amounts, (b) the discount rate used for measurement purposes, (c) the accounting for participating life insurance contracts and (d) the accounting for market risk benefits.

For information about the guidance currently applicable to insurance contracts acquired in a business combination, refer to Sections 9.1 and 10.13.

FASB’s project update page for Insurance—Targeted Improvements to the Accounting for Long-Duration Contracts

The proposed ASU is expected to be issued in the third quarter of 2016.

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Credit losses on financial assets measured at amortized cost

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changes the accounting for credit losses on financial assets measured at:

  • Amortized cost (e.g., accounts receivable, held-to-maturity debt securities): For those financial assets measured at amortized cost, the allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of the financial assets. This is in contrast to current U.S. GAAP, which generally calls for credit losses to be recognized when they are incurred. With the exception of purchased financial assets with a more than insignificant amount of credit deterioration since origination (PCD assets), the initial allowance, as well as subsequent increases or decreases in expected credit losses, are recognized as credit loss expense.
  • Fair value through other comprehensive income (e.g., available-for-sale debt securities): For those financial assets measured at fair value through other comprehensive income, the allowance for credit losses will continue to be measured in a manner similar to current U.S. GAAP. However, the credit losses are recorded through an allowance rather than as a direct write-down to the securities. In addition, subsequent increases and decreases in expected cash flows are recognized immediately through credit loss expense.

The accounting for financial assets acquired in a business combination after the effective date of ASU 2016-13 depends on whether the assets meet the definition of PCD assets:

  • Do not meet the definition of PCD assets: These acquired financial assets are measured at their acquisition-date fair value. In addition, for those financial assets within the scope of ASC 326, Financial Instruments—Credit Losses, an allowance for credit losses (and credit loss expense) is recognized and measured in accordance with ASC 326 on the reporting date. Given the difference between the fair value measurement used in the accounting for a business combination and the measurement of current expected credit losses used in ASC 326, a day-one loss could result when accounting for acquired financial assets that do not meet the definition of PCD assets.
  • Do meet the definition of PCD assets: These acquired financial assets are measured at their amortized cost on the acquisition date plus an allowance for credit losses measured in accordance with: (a) ASC 326-20-30 for PCD assets measured at amortized cost and (b) ASC 326-30-30 for PCD assets that are available-for-sale debt securities. This approach prohibits accreting into interest income the credit losses embedded in the purchase price for these assets.

In addition, ASU 2016-13 also changes how to account for indemnification assets arising from government-assisted acquisitions of financial institutions. For information about the recognition of accounts or loans receivable in the accounting for a business combination prior to the effective date of ASU 2016-13, refer to Sections 10.14.2 and 10.17 of the guide.

Our summary, FASB issues final standard on credit losses

FASB’s page for its Transition Resource Group for Credit Losses

The final ASU is first effective for calendar-year entities as follows:

  • SEC filers on January 1, 2020
  • PBEs other than SEC filers on January 1, 2021
  • All other entities for the year ending December 31, 2021

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Accounting for purchased credit impaired (PCI) assets

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which introduces a new accounting model for PCD assets. This new accounting model is discussed in the previous topic.

For information about the recognition of PCI loans in the accounting for a business combination and the subsequent accounting for those loans prior to the effective date of ASU 2016-13, refer to Sections 10.14.2 and 10.17 of the guide.

Our summary, FASB issues final standard on credit losses

FASB’s page for its Transition Resource Group for Credit Losses

The final ASU is first effective for calendar-year entities as follows:

  • SEC filers on January 1, 2020
  • PBEs other than SEC filers on January 1, 2021
  • All other entities for the year ending December 31, 2021

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Classification of contingent consideration payments in the cash flow statement

The FASB has decided that cash payments by the buyer in a business combination for contingent consideration that are not paid soon after the acquisition date should be classified as: (a) financing activities up to the amount recognized as contingent consideration in the accounting for the business combination and (b) operating activities for any amount paid in excess of the amount recognized as contingent consideration in the accounting for the business combination. Cash payments made within three months of the consummation date for the business combination will be considered paid soon after the business combination’s consummation date.

For information about how cash payments for contingent consideration are classified in the cash flow statement under current U.S. GAAP, refer to Section 12.4.6 of the guide.

FASB’s project update page for Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments

The final ASU is expected to be issued in the third quarter of 2016 and is expected to be first effective for calendar-year entities as follows:

  • PBEs on January 1, 2018
  • All other entities for the year ending December 31, 2019

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Accounting for sales of nonfinancial and in-substance nonfinancial assets

The FASB has proposed clarifying the scope of its asset derecognition guidance and the accounting for partial sales of nonfinancial assets in conjunction with the new revenue recognition guidance taking effect (see Section 10.15.2 of the guide). As it relates to content in the guide, the proposal would change the scope of the following guidance discussed in Section 17.1 of the guide: (a) the deconsolidation or derecognition of a subsidiary and (b) a decrease in the parent’s controlling ownership interest in a subsidiary (but not a decrease that results in loss of control). The proposal would change the scope of this guidance such that it would apply to a decrease in the ownership interest of (i.e., the sale or partial sale of):

  • A subsidiary or group of assets that is a business or nonprofit activity, except if the decrease represents: (a) the conveyance of oil and gas mineral rights or a related transaction within the scope of ASC 932-360, Extractive Industries—Oil & Gas – Property, Plant, and Equipment, or (b) a contract with a customer within the scope of ASC 606, Revenue from Contracts with Customers
  • A subsidiary that is not a business or nonprofit activity only if the substance of the decrease is not already addressed directly by guidance elsewhere in the Codification, which would include, for example, the newly proposed guidance in ASC 610-20, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets, related to the transfer of an ownership interest in a subsidiary that meets the proposed definition of in-substance nonfinancial assets

The proposal would eliminate the need to account for the transfer of a subsidiary or group of assets that meets the definition of a business differently than when it represents the transfer of in-substance nonfinancial assets (such as in-substance real estate).

With only the limited exceptions discussed earlier, the proposal would clarify that the seller in a business combination would apply the deconsolidation and derecognition guidance discussed in Section 17.1 of the guide. This clarification may result in the seller recognizing any contingent consideration at fair value in its accounting for the sale of a business. For information about the seller’s accounting for contingent consideration under current U.S. GAAP, refer to Section 12.4.10 of the guide.

FASB’s project update page for Clarifying the Scope of Subtopic 610-20 and Accounting for Partial Sales of Nonfinancial Assets

Proposed ASU issued in April 2016.

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Subsequent accounting for goodwill

The FASB is reconsidering the subsequent accounting for goodwill using a phased approach.

In connection with the first phase, the FASB has proposed simplifying the goodwill impairment model applicable to PBEs, private companies that have not elected the private-company goodwill alternative and not-for-profit entities. The proposed simplification would require entities to test and measure goodwill for impairment by comparing the fair value of the reporting unit to its carrying amount. While the existing goodwill impairment model includes a step to test goodwill for impairment by comparing the fair value of the reporting unit to its carrying amount, it also includes a step to measure goodwill impairment (when the carrying amount of the reporting unit is more than its fair value) by performing hypothetical business combination accounting. The FASB has tentatively decided to eliminate the need to perform hypothetical business combination accounting, along with the related cost and complexity of doing so.

In connection with the second phase, the FASB will consider whether any further changes should be made to the subsequent accounting for goodwill. The FASB may work jointly with the IASB in this phase of the project. The FASB’s work in this phase could affect the private-company goodwill alternative.

For information about assigning goodwill to reporting units for purposes of goodwill impairment testing, refer to Section 12.8 of the guide. For information about the private-company goodwill alternative, refer to Section 19.1 of the guide.

Our article, Goodwill impairment: FASB proposes simplifications

FASB’s project update page for Accounting for Goodwill Impairment

FASB’s project update page for Subsequent Accounting for Goodwill for Public Business Entities and Not-for-Profit Entities

Proposed ASU resulting from phase 1 was issued in May 2016.

Initial deliberations are in process for phase 2.

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Accounting for replacement share-based payment awards

In March 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which, among other things: (a) simplifies the accounting for the income tax effects of replacement awards classified as equity and (b) allows an entity to elect an accounting policy related to how it accounts for forfeitures.

Under ASU 2016-09, the tax effect of the difference between the deduction reported on a tax return for a replacement share-based payment award classified as equity and its ASC 718 value (i.e., the fair-value-like measurement used for accounting purposes in ASC 718, Compensation—Stock Compensation) should be recognized as income tax expense or benefit in the buyer’s income statement.

Under ASU 2016-09, an entity is allowed to elect an accounting policy with respect to certain awards to either: (a) estimate the number of forfeitures (i.e., awards that will not vest because employees do not provide the necessary service to earn the awards) or (b) recognize forfeitures as they occur. Regardless of the accounting policy elected, for purposes of determining the portion of a nonvested replacement share-based payment award that a buyer issues in conjunction with a business combination that should be included in the consideration transferred, the buyer must still estimate the number of awards for which the requisite service is expected to be rendered (which requires estimating forfeitures).

For information about the current accounting for replacement share-based payment awards, refer to Section 13.4 of the guide.

Our article, Improvements to employee share-based payment accounting

ASU 2016-09 is first effective for calendar-year PBEs on January 1, 2017 and for all other calendar-year entities in the year ending December 31, 2018.

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Accounting for investments in equity securities when the investor loses significant influence

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which, among other things, eliminated the available-for-sale classification for equity securities and added a new requirement to carry those equity securities with readily determinable fair values at fair value through net income. A practicability exception from fair value accounting may be applied to equity securities that do not have readily determinable fair values.

For information about how an investor accounts for an investment in equity securities when it loses significant influence over the investee, refer to Section 16.1.5 of the guide.

Our white paper, Financial instruments: FASB issues standard on recognition and measurement

ASU 2016-01 is first effective for calendar-year PBEs on January 1, 2018 and for all other calendar-year entities in the year ending December 31, 2019.

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