If your company plans to buy or merge with another business, you’re probably focusing your attention on negotiating deal terms and conducting due diligence. However, you’ll also want to address the transaction’s post-closing financial reporting requirements—otherwise, you may face disappointing financial results, potential lawsuits, and restatements in the future.
The following guidance will help you correctly account for M&A transactions using U.S. Generally Accepted Accounting Principles (GAAP).
Accounting for assets and liabilities
Certain intangible assets and contingencies, such as internally developed patents, brands, customer lists, pending lawsuits, and environmental claims may be excluded from a seller’s GAAP balance sheet—but failing to account for identifiable assets and liabilities can result in the inaccurate reporting of goodwill from the sale.
Private companies may elect to combine customer-related intangibles and noncompete agreements with goodwill. However, customer-related intangibles that can be sold or licensed separately from the business are specifically excluded from this alternative.
If arrangements are made in the terms of the deal to compensate the seller or existing employees for future services, these payments and payments for pre-existing arrangements aren’t considered to be part of the business combination—instead, they must be accounted for separately and expensed as incurred. Acquisition-related costs including finder’s fees and professional fees are also excluded from the business combination and should also be accounted for separately.
Ascertaining purchase price
The purchase price, also known as the “fair value of consideration transferred,” is obvious when the buyer pays in cash. However, consideration exchanged may include stock, stock options, contingent payments, and replacement awards—and these other types of consideration can make determining purchase price more complex.
It can be difficult, for example, to assign fair value to contingent consideration—such as earnouts which are payable only if predetermined financial benchmarks are achieved by the acquired entity. If the buyer will be required to pay more if it achieves the benchmark, contingent consideration may be reported as a liability or equity. However, it may also be reported as an asset if the buyer will be reimbursed for consideration already paid.
In addition, if new facts are obtained during the measurement period or for events that occur after the acquisition date, it may be necessary to remeasure contingent consideration that’s reported as an asset or liability each period
Estimating fair value and assigning goodwill
The next step is to divide the purchase price among the liabilities assumed and assets acquired. First, you’ll need to estimate the fair value of each item, then assign any leftover amount to goodwill. Goodwill is essentially the “premium” the buyer is willing to pay for expected synergies and growth opportunities related to the business combination, above the fair value of the acquired net assets.
Though this occurs rarely, a buyer will sometimes negotiate a “bargain” purchase. In these instances, the fair value of the net assets exceeds the purchase price, and the buyer reports a gain on the purchase, rather than reporting negative goodwill.
Contact us today
Many buyers have little previous experience with M&A transactions and the accompanying financial reporting requirements. Contact us before you close the deal—we can help you understand the fair value of the acquired assets and liabilities and relevant accounting rules before closing.