Significant Changes Ahead for Business
Combinations - Understanding FASB No. 141 (R)

The Financial Accounting Standards Board’s new standard (No. 141) is intended to simplify the accounting for business mergers and acquisitions on the international stage. Announced in 2007, they became effective for fiscal years beginning after Dec. 15, 2008.

In a press release, FASB member G. Michael Crooch said: “The new standards represent the completion of the FASB’s first major joint project with the International Accounting Standards Board, as well as a significant convergence milestone. These standards and the counterpart standards issued by the IASB will improve reporting while eliminating a source of some of the most significant and pervasive differences between International Financial Reporting Standards and U.S. Generally Accepted Accounting Principles.”

The new standard makes significant changes to current practices and will have a substantial impact on accounting and reporting for business combinations. Most notably, it is a major shift from an accumulated cost basis to fair value, with many implications.

New Definitions – FASB 141 (R) is a broader definition for what constitutes both a “business” and a “business combination.”  Whether or not a combination actually has occurred will be determined by the extent of who has “control.”  For example, if a transaction includes a corresponding shift in management of the business, this is the deciding factor that a combination indeed has taken place.

Changes in Effective Dates – A new measurement date established by the new standard may impact the dollar value of a transaction. Previously, the effective date of a combination was the closing date of the transaction. Now, the effective date is the one on which the acquirer takes official control. As a result, any equity securities exchanged must be valued on the change-of-control date instead of the closing date. 

R&D Costs – Under FASB 141(R), research and development costs that are in progress at the time of the acquisition date must now be capitalized and carried at their fair value as indefinite-lived intangibles.  Impairment testing will be necessary until the R&D intangibles are abandoned or activities are complete.  After that, the capitalized amount will need to amortize over the useful life.   

Contingent Assets and Liabilities – The new standard expands the accounting for contingent assets and liabilities in two ways. First, it distinguishes between contractual and non-contractual assets and liabilities. Secondly, it lowers the threshold of certainty for contingencies from “probable” to “more likely than not.”  When business combinations occur, more contingent assets and liabilities will now need to be accounted for, meaning a greater cost and resource-allocation burden upon companies.

Value Measurements – Fair value measurements are no longer determined by entry prices or the acquirer’s intent to abandon an acquired asset; however, the measurements are influenced by exit prices.  The new standard makes the acquirer account for assets at fair value, even if they have no intention of using the assets after the merger.

Acquisition Costs – Currently, direct acquisition costs, such as accounting and lawyer fees as well as advice from consultants, are included in the purchase price paid to acquire a business.  FASB 141 (R) requires deal costs to be expensed as they are acquired. The financial impact of this means greater costs captured by the income statement as they are obtained. 

Recording of Gains – It is possible that the purchase price paid to obtain a business may be less than fair value of the net assets acquired. In these rare cases, the beginning balance sheet would not properly state the fair value of the long-lived assets.  FASB 141 (R) now requires that a gain be recorded in all bargain purchase situations to avoid the improper fair value of the assets acquired.

Fair Value and Historic Costs – Under current practice, when one entity acquires another in successive stages, they must maintain the historic book value of the parts of the company gained in the combination. This determines the total purchase price to be paid.  Once control is achieved, the financial statements of the acquirer contain both fair value and historic cost. This combination of fair value and historic cost may fall short from the true value of the business combination. FASB 141 (R) resolves this issue by requiring all assets and liabilities of the acquired company to be recognized at their fair value, including all investments in the acquiree held prior to the business combination.

Other Considerations – FASB 141 (R) imposes other amendments to a wide area of topics from taxes and restructuring charges to share-based payment awards.  Businesses should familiarize themselves with the influence 141 (R) will have on a sampling of historic acquisitions.  SRAS 141(R) requirements will allow businesses to get an opportunity to see how the new standard will impact prior acquisitions. By gaining a thorough knowledge of the new standard, companies can identify problematic issues before they take place during an actual combination.

Timing – FASB 141 (R) applies to combinations with an acquisition date on or after the beginning of the first annual reporting period beginning on or after Dec. 15, 2008 (Jan. 1, 2009 for calendar year-end companies).