ACCOUNTING FOR BUSINESS COMBINATIONS: BIG CHANGES AHEAD

The relative uniqueness of each business combination has resulted in diverse and inconsistent practices in accounting and reporting for business combinations, mainly surrounding goodwill, other intangibles assets, and non-controlling interests. As a result, the Financial Accounting Standards Board (FASB) issued a revision to Statement of Financial Accounting Standard (SFAS) No.141. SFAS 141-R will be effective for fiscal years beginning after December 15, 2008. This article discusses several, but not all, important changes to generally accepted accounting principles (GAAP) found in SFAS 141-R.

Acquisition costs will no longer be capitalized as part of the acquisition price.

Current GAAP requires that direct and indirect costs incurred as part of the identification, analysis and acquisition of potential targets to be deferred by adding them to the purchase price. The FASB has determined that these costs do not add value to the assets acquired and thus should not be added to the balance sheet. Under SFAS 141-R, these costs will be included as expenses in the period they were incurred.

Contingent consideration must be estimated and recorded at acquisition.

The FASB recognized that contingent consideration is often included in business combinations. Generally, this takes the form of the buyer paying an additional amount, or the seller agreeing to a refund, depending on future events. Currently, the accounting standards ignore these contingencies in determining the initial recorded price. Any additional payment or refunds are recorded as an adjustment to goodwill at the time of occurrence. Under the revised standards, the estimated fair value of contingent consideration will be recorded as a contingent asset or liability as part of the acquisition price. These will be re-measured annually through the year of actual settlement with any adjustments flowing through the income statements as a gain or loss.

The estimated value of in-process research and development will be recorded as an intangible asset.

Current practices essentially ignore the potential value of acquired in-process research and development in a business combination. Generally, such assets are captured as part of goodwill under the current "residual value" approach to recording goodwill. The revised standards will require a buyer to place a value on the research and development in process at the acquired company. This estimated value will be recorded as an intangible asset until the R&D phase is completed or abandoned; subsequent R&D expenditures will be expensed, not capitalized. The in-process R&D asset will not be amortized but will be subject to tests for impairment.

Contingent assets and liabilities must be recorded at estimated fair value.

Currently, accounting for contingencies is governed by SFAS 5, which requires the recognition of contingent losses if the loss is deemed to be probable and is subject to reasonable estimation. Contingent gains are ignored. The new standards will require that all contractual contingent assets and liabilities be recorded at estimated fair value if it is "more likely than not" that such an asset or liability exists as discussed in Concepts Statement No. 6 Elements of Financial Statements.

"Negative goodwill" will result in a recognized gain.

Under current GAAP, "negative goodwill" (the rare situation where the acquisition price is less than the aggregate fair value of net assets purchased) reduces certain asset values until the aggregate total equals the acquisition cost. Under SFAS 141-R, "negative goodwill" reflects management's successful negotiations and should be reflected as a bargain purchase gain on the income statement.

Non-controlling interest must be measured at fair value and will be reported as part of stockholders' equity.

Under current GAAP, non-controlling interest (i.e., minority interest) is essentially the amount of the purchased entity's equity not acquired by the new parent. It is reported on the consolidated balance sheet between liabilities and equity. SFAS 141-R requires that the initial measurement of non-controlling interest be its estimated fair value on the date of acquisition. Concurrent with SFAS 141-R, the FASB issued SFAS 160, "Accounting for Non-Controlling Interest," which requires non-controlling interest to be reported on the consolidated balance sheet as part of stockholders' equity, adjusted for it share of consolidated net income or loss.

The Source will have additional guidance as the implementation date for the new standards draws closer. If you have questions or would like additional information, please contact Robert Gray at rgray@rubino.com or Patrick Curtis at pcurtis@rubino.com. In addition, please feel free to contact the shareholder or manager that your Company interacts with on a regular basis at (301) 564-3636. For more information about Rubino & McGeehin, please visit http://www.rubino.com/.