Businesses enter into acquisitions for a multitude of reasons. For example, a company may be looking to grow, expand product offerings, or open distribution channels in new markets. In a market that has seen immense growth in the private equity firm industry and businesses selling at record prices, a common topic that our current and potential clients seek advice on is how to account for these business combinations. As a firm, understanding the complexity of acquisitions can offer a unique service to our clients and present potential opportunities in new markets.

Business combination accounting is referred to as the "acquisition method" and under U.S. Generally Accepted Accounting Principles ("U.S GAAP"), are accounted for in accordance with the guidance within Accounting Standards Codification ("ASC") Topic 805: Business Combinations ("ASC 805"). The accounting is usually complex and typically begins with the "Screen Test", which determines if the transaction constitutes a business combination. ASC 805 defines a business combination as a transaction or event in which an acquirer obtains control over a business, generally through equity interest or asset purchase. If the acquired entity is determined to not be a business, the transaction is not a business combination, and would be accounted for as an asset acquisition.

Once you have determined that the transaction has resulted in a business combination, ASC 805 requires the acquirer to account for the transaction by using the acquisition method of accounting. Application of this method requires the following four step process:

• 1. IDENTIFY THE ACQUIRER:

  
  One of the combining entities must be identified as the acquirer. The acquirer is generally defined as the entity that obtains control of the acquiree. The general rule is the party that holds over 50% interest and is often the entity that pays the consideration for the business combination. It is not always clear which party is considered the acquirer in the acquisition, which is why it is important to read the purchase agreement and all relevant schedules in making this determination.

• 2. DETERMINE THE ACQUISITION DATE:

  
  The acquisition date is determined on the date the acquirer obtains control of the acquiree. This is generally the "Closing Date" and usually coincides with the date the acquirer transfers consideration. Occasionally, the acquisition date can be before or after the closing date and is commonly done out of convenience for reporting purposes. Determining the acquisition date is important because on this date, the acquirer is required to begin recognizing and the fair value measurement of the combination.

• 3. RECOGNITION AND MEASUREMENT OF ASSETS, LIABILITIES ASSUMED, AND NON-CONTROLLING INTERESTS:

  
  Under ASC 805, an acquirer must recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree, separately from goodwill. Additionally, at the acquisition date, the acquirer must measure these interests in the acquiree at their fair values. Fair value is defined as the price received to sell an asset or paid to transfer a liability in a transaction between market participants. Proper recognition and measurement defined in this step is critical in accurately accounting for a business combination.

• 4. RECOGNIZE AND MEASURE GOODWILL OR BARGAIN PURCHASE GAIN:

  
  The ASC defines goodwill as an asset representing future economic benefits that are not individually identified and separately recognized in combination. Goodwill is measured at the fair value of consideration transferred, less the fair value of net assets acquired. Conversely, a bargain purchase gain occurs when the fair value of net assets acquired exceeds the value of consideration transferred.
  
  It usually takes time for an acquirer to obtain all information to recognize and measure all the items from the acquisition. The acquirer may report provisional amounts for certain items and is allowed a period to complete its accounting for the acquisition, referred to as the "measurement period", and cannot exceed one year after the acquisition date.

Extensive disclosures are required in the financial statements to provide users with sufficient detail about the effects of the business combination. Accounting for business combinations under ASC 805 can be quite complex, but can be a valuable resource to your clients, as they are typically not applying acquisition accounting on a day-to-day basis. It is important to note that accounting standards are subject to change and is recommended to review the latest version of ASC 805, whenever providing advice to your clients.