Business Combination Accounting: Focus on the Buyer’s Needs to Move Transaction Forward
By Mike French, CPA, ABV, CFE, Managing Director
When an entity changes hands there are many moving parts. One of the most important considerations revolves around the potential buyer’s need for information that will help move the process along, particularly the question of whether the transaction will be subject to business combination accounting.
Fast Track the Transaction
This is critical because understanding the requirements of business combination accounting enables the seller and sell-side advisors to anticipate the needs of the buyer, provide information the buyer needs, and potentially make the transaction proceed on a faster track – thereby saving time and costs.
The definition of a business combination is a transaction in which an acquirer gains control over a business. That could describe just about any merger or acquisition. But to be subject to the requirements of business combination accounting, a determination must be made as to whether the acquirer is buying a business that may include a group of assets or buying just a group of assets. If it’s a business with assets, the transaction may be subject to business combination accounting rules.
Inputs, Processes and Outputs
To be subject to business combination accounting rules, a transaction must involve an entity that has inputs and processes that contribute to the potential for outputs. This definition was revised in Accounting Standards Update No. 2017-01 to help entities distinguish between transactions that are business combinations and those that are asset acquisitions.
Under Topic 805, Business Combinations, of the FASB Accounting Standards Codification, which governs business combinations, an acquirer accounts for a business combination using the acquisition method. The four basic steps in the acquisition method are as follows:
- Determine the acquirer
- Determine the acquisition date
- Recognize and measure the assets, liabilities and noncontrolling interest
- Recognize and measure any goodwill or gain from a bargain purchase
All assets acquired and liabilities assumed in a business combination must be recognized by the buyer in financial statements. This may result in the acquirer recognizing an asset or liability that was not previously recognized in the seller’s financial statements, such as a brand name, patent, customer relationship or other intangible asset developed internally by the seller. The acquirer must recognize 100% of the seller’s net assets, even when other parties retain a noncontrolling interest.
Key Pieces of the Puzzle
To understand what the buyer’s needs are, a seller should put key pieces of the puzzle in place before going to market with a transaction:
- Hire the consultants who will help bring the transaction to fruition.
- Understand the value of the entity. This may require a Quality of Earnings Study, which will separate out extraordinary revenues and expenses that would not accrue to the new owner. It also will determine your company’s EBITDA – Earnings Before Income Taxes, Depreciation and Amortization – which will identify the entity’s earnings potential.
- Talk to the advisors and consultants about how to present this kind of information and insight in a way that will help the buyer make a better, faster decision.
Generally, buyers are interested in two things – whether the seller will accept their price and what they will have to deal with when the transaction is complete, meaning financial, operational and regulatory realities. By going into a business combination negotiation with that understanding and providing a buyer with the best information, a seller can ease the process along and reach a faster successful outcome.
For more information about business combination accounting or assistance with preparing for a business sale, contact your PKF Advisory team member or:
Mike French, CPA, ABV, CFE