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Accounting for business combinations: Being prepared for a deal · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought leadership from PWC.
• 0:06
  SPEAKER_02: Welcome to PWC's Accounting Podcast.
• 0:09
  SPEAKER_02: I'm Heather Horn.
• 0:10
  SPEAKER_02: Thanks so much for joining us today for the next month in our Tuesday series, in which we're shaking things up a bit and bringing in one of our all-star podcast guests to take over the series, picking the topics for the month, and joining me on all the episodes.
• 0:26
  SPEAKER_02: For the month of July, I'm happy to welcome back to the podcast Jay Sulliver, who's one of our favorites and I know a listener favorite as well.
• 0:35
  SPEAKER_02: Jay's a partner in PWC's national office who specializes in business combinations as well as many other topics.
• 0:41
  SPEAKER_02: But this month we'll be taking over the podcast to discuss this highly judgmental topic that may not be top of mind until you meet it.
• 0:49
  SPEAKER_02: And then by then, maybe it's kind of too late to brush up.
• 0:53
  SPEAKER_02: So this is a great set of reminders.
• 0:55
  SPEAKER_01: MA transactions are, of course, often a significant event in a company's life cycle, and they're generally pretty high profile for a company.
• 1:03
  SPEAKER_01: So they get a lot of attention.
• 1:05
  SPEAKER_01: And there's a lot of complexities in the accounting for it.
• 1:08
  SPEAKER_01: And yeah, because you don't often, many companies, anyways, don't have acquisitions on a frequent basis, so listeners may not be so readily familiar with all of the accounting and reporting challenges, because that's something you tend to do every day.
• 1:21
  SPEAKER_02: That was Jay kicking us off for an episode packed with insights on the foundations of acquisition accounting, including key areas of judgment in the accounting model, step acquisitions, and conforming accounting policies.
• 1:34
  SPEAKER_02: Mergers and acquisitions typically represent significant events in a company's life cycle, and therefore they continue to receive a lot of attention.
• 1:43
  SPEAKER_02: So listen in for accounting considerations to help you prepare proactively, or perhaps this is just in time if you're dealing with one of these transactions now.
• 1:58
  SPEAKER_02: Jay, welcome back to the podcast.
• 2:00
  SPEAKER_02: So nice to have you on for your whole month of podcasts, which I'm very much looking forward to, particularly since we're talking about business combinations, which I know is something you're spending a lot of time on.
• 2:12
  SPEAKER_02: So where should we start with thinking about that topic?
• 2:16
  SPEAKER_01: Thank you very much for having me here for the month to uh to talk talk with our listeners about a lot of different topics about business combinations.
• 2:23
  SPEAKER_01: So maybe I'll start with why so chose this topic.
• 2:27
  SPEAKER_01: I would say that MA transactions are, of course, often a significant event in a company's life cycle, and and they're generally pretty high profile for a company.
• 2:37
  SPEAKER_01: So they get a lot of attention.
• 2:39
  SPEAKER_01: And there's a lot of complexities in the accounting for it.
• 2:42
  SPEAKER_01: And you know, because you don't often many companies, anyways, don't have acquisitions on a frequent basis, so listeners may not be so readily familiar with all of the accounting and reporting challenges, because it's not something you tend to do every day.
• 2:55
  SPEAKER_01: And you know, even though there's less activity in the current environment, given some of the economic uncertainties out there, um, this this area tends to be still a pretty high priority.
• 3:05
  SPEAKER_01: And even though M ⁇ A deal activity has been down in all of 22 and the first half so far of 23, maybe compared to the last year or two, which were really high, it's still pretty high by historical standards.
• 3:18
  SPEAKER_01: And you know, there's still been hundreds of billions of dollars of deals that have been going on.
• 3:23
  SPEAKER_01: So a lot of companies are still dealing with it a lot.
• 3:26
  SPEAKER_01: And I would say it's probably anticipated they'll pick up even more once sort of the economy starts to settle down a little bit.
• 3:31
  SPEAKER_02: All right.
• 3:32
  SPEAKER_02: Well, and I think your point about the fact that this is very significant, and it's also for some companies, yes, something they do routinely, but for others, something that it's much more one-off.
• 3:44
  SPEAKER_02: It's a great topic to talk about.
• 3:46
  SPEAKER_02: So with that said, and knowing that all each deal is a little bit different, what are some of the sort of foundational areas that you would think about just if you were introducing this topic sort of for the first time to someone?
• 4:00
  SPEAKER_01: Right.
• 4:01
  SPEAKER_01: Right.
• 4:01
  SPEAKER_01: So I'd say, you know, while this may sound a little almost self-evident, right, if we're talking about business combinations, but in order to be a business combination for accounting, it has to be both a business and there has to be a combination.
• 4:14
  SPEAKER_01: And so both of those are actually talked about in the in the guidance uh a bit.
• 4:17
  SPEAKER_01: So at the end of the day, you have to obtain control, that's the combination part, over a business.
• 4:24
  SPEAKER_01: And while that sounds pretty straightforward, there's a fair bit of guidance about how you determine whether what you've acquired in a deal uh should be treated as a business for accounting purposes.
• 4:36
  SPEAKER_01: And that's different than the SEC's definitions, which we'll talk about in a later episode with Ryan Spencer later on this month.
• 4:43
  SPEAKER_01: Uh but on the accounting side, you know, there's some screen tests that sort of get at is what you're buying substantially all, which we kind of for accounting purposes think of as being 90% or more, is the the substantially all the fair value tied up in one asset or a group of similar assets.
• 5:02
  SPEAKER_01: In that case, you would say it's not a business, it's really just you're acquiring that asset.
• 5:08
  SPEAKER_01: And then if you don't kind of get caught in that screen test, you you look at things like whether the target company has inputs and outputs and processes of, you know, to be able to operate as a business.
• 5:21
  SPEAKER_01: And that's how you decide.
• 5:23
  SPEAKER_01: You go through that evaluation to determine whether what you've acquired is an asset acquisition or a business combination.
• 5:29
  SPEAKER_01: There's quite a lot of judgment in there, and it's probably more that we can really get into here in this podcast.
• 5:34
  SPEAKER_01: But we do have a separate podcast that we've talked about this in the past, and we could definitely include that in the show notes.
• 5:39
  SPEAKER_02: Yes, and actually one of our most popular publications is on this topic.
• 5:43
  SPEAKER_02: So we can include that there as well because I do think it has some helpful background, and so we don't have to talk about it further here.
• 5:51
  SPEAKER_02: But one thing that's interesting, Jay, that really jumped out when you were saying this is that you didn't say that the acquirer buys a business.
• 5:59
  SPEAKER_02: You say that they obtain control of a business.
• 6:03
  SPEAKER_02: And I'm sure those that word choice was very deliberate.
• 6:06
  SPEAKER_02: Uh so why the emphasis there on control?
• 6:09
  SPEAKER_01: Yeah, that that's fair.
• 6:09
  SPEAKER_01: And you're right.
• 6:10
  SPEAKER_01: It was it was deliberate.
• 6:11
  SPEAKER_01: Uh, you know, while we often think of an acquisition being sort of your typical acquirer pays cash or shares in exchange for all the shares or the assets of some target business, that's definitely not the only way that you can obtain control.
• 6:26
  SPEAKER_01: Um, it could be through some other things.
• 6:28
  SPEAKER_01: It could be like you've executed a management contract that gives you sufficient rights over the company to get that control.
• 6:35
  SPEAKER_01: Or it could go the other way.
• 6:37
  SPEAKER_01: It could be the lapsing of some rights.
• 6:39
  SPEAKER_01: Maybe you owned a majority of the company before, but you would granted certain veto rights to the other party, and those expire after a certain period of time.
• 6:47
  SPEAKER_01: So once those expire and they can't stop you from running the business and exercising control, then you have control.
• 6:54
  SPEAKER_01: And sometimes it can even be based on something the target company did.
• 6:58
  SPEAKER_01: So maybe you have a sizable stake, but it isn't quite greater than 50%, majority control.
• 7:04
  SPEAKER_01: But the target company goes out, or your investee in that case goes out and buys back some of their shares from somebody else.
• 7:10
  SPEAKER_01: And now all of a sudden, you've become the greater than 50% owner.
• 7:13
  SPEAKER_01: So you could end up getting control that way as well.
• 7:16
  SPEAKER_01: So there are lots of ways that you can get there.
• 7:18
  SPEAKER_01: And you know, we're looking at it both from under the consolidation guidance and the accounting literature.
• 7:23
  SPEAKER_01: So you have both the voting interest model, the 50% or greater voting interest, as well as all the complex variable interest guidance as well, also way beyond the scope of this podcast.
• 7:32
  SPEAKER_01: But you're looking at all of those to figure out do I have control of the business?
• 7:36
  SPEAKER_01: And if you get control of the business, that's when you have to apply the business combination accounting.
• 7:41
  SPEAKER_02: All right.
• 7:42
  SPEAKER_02: So control and it's a business and not just sort of this traditional, I have a, you know, my purchase contract, I'm buying this company.
• 7:50
  SPEAKER_02: It might be that.
• 7:50
  SPEAKER_02: Yeah, it might be.
• 7:51
  SPEAKER_02: But but it may be other things.
• 7:53
  SPEAKER_02: So, like we said earlier, we'll include some references to those other sort of ideas that a business combination or an asset.
• 8:00
  SPEAKER_02: But assuming we do have a business combination, no matter how we got control, what what comes next?
• 8:07
  SPEAKER_01: So then you're applying what the guidance calls acquisition method accounting, although a lot of people kind of just refer to that as purchase accounting.
• 8:14
  SPEAKER_01: Oh, that's not really the words that are used in the guidance.
• 8:17
  SPEAKER_01: And the first step of that is figuring out and measuring and recognizing all the consideration that you issued to buy the business.
• 8:26
  SPEAKER_01: Now, again, often that's simple, right?
• 8:29
  SPEAKER_01: Because if you're just buying uh buying the business for cash, you probably know what you've paid.
• 8:32
  SPEAKER_01: If you buy 100% of the company for cash, you probably know what you paid.
• 8:35
  SPEAKER_01: Or if you issue some of your stock, you can value your stock.
• 8:38
  SPEAKER_01: But it could also include other things like other assets you might issue to the to the sellers.
• 8:43
  SPEAKER_01: You might give them real estate or equipment.
• 8:45
  SPEAKER_01: Uh, there might be contingent consideration in the deal.
• 8:49
  SPEAKER_01: And you might even do things like, and there's some special discussion in the guidance about if you if you issue some of your stock compensation awards to replace some of the target stock compensation awards.
• 9:00
  SPEAKER_01: We'll probably get into that a little bit more, but but that could end up driving some of the total consideration as well.
• 9:05
  SPEAKER_02: All right.
• 9:05
  SPEAKER_02: And you mentioned cons contingent consideration there.
• 9:08
  SPEAKER_02: And I know that is one we're going to talk about more later.
• 9:11
  SPEAKER_02: And I believe even earlier you mentioned variable um interest accounting or variable interest entities.
• 9:16
  SPEAKER_02: We're going to talk about that a little bit more in a future episode.
• 9:19
  SPEAKER_02: So definitely many interesting episodes coming up there, Jay.
• 9:23
  SPEAKER_01: Yes, I I do.
• 9:24
  SPEAKER_01: Hopefully we will uh be interesting this month.
• 9:27
  SPEAKER_01: Uh for now, let's just say back on your contingent consideration point, you know, that's that's just generally the notion that the acquirer has some contingent uh obligation to have to give additional assets or additional shares to this the sellers if certain things happen in the future associated with the business.
• 9:45
  SPEAKER_01: And generally speaking, this is a gross oversimplification because we will get into a lot of the complexities of it later on this month.
• 9:52
  SPEAKER_01: But generally speaking, the fair value of that obligation at the acquisition date is calculated, and that's included as part of the overall consideration for the deal.
• 10:03
  SPEAKER_02: All right.
• 10:03
  SPEAKER_02: And then the other one you kind of snuck in there at the end was the replacement of stock-based awards.
• 10:09
  SPEAKER_02: And it's probably another one people don't often have on their radar here.
• 10:13
  SPEAKER_02: But how does that fit in when it relates to consideration?
• 10:17
  SPEAKER_01: Sure.
• 10:17
  SPEAKER_01: Yeah.
• 10:18
  SPEAKER_01: So so a lot of times the target company, if you're buying out the whole target company, they may very well have stock comp awards they've issued to their employees or other service providers.
• 10:27
  SPEAKER_01: And obviously there's an incentive to keep the morale up of the employees you're of the company you're acquiring.
• 10:36
  SPEAKER_01: So a lot of times what you, the acquirer, will do is you'll issue stock comp awards on your stock, sort of to replace or an exchange for the awards that the employees had in the target company.
• 10:50
  SPEAKER_01: And yeah, a lot of times just to try to keep them whole.
• 10:52
  SPEAKER_01: So it's might very well be the same terms, just trying to translate sort of for the deal terms to get to the right, the right value, uh to keep the employees whole.
• 11:01
  SPEAKER_01: Although sometimes we see some changes to the terms as well, sometimes to sweeten the pot a little bit or change some of the vesting conditions that uh that that uh are out there to try to manage things as well as you can.
• 11:13
  SPEAKER_01: And from an accounting perspective, it's a little complicated, and we probably I won't go into all the details of it here, although we we do talk about it certainly in our in our guidance, that you know a lot of times that some or all of the value of those replacement stock comp awards gets included in the total amount of consideration that you're paying for the deal.
• 11:35
  SPEAKER_01: Sometimes it's viewed to be attributed to like service before the deal, and that ends up being viewed as part of the residual equity of the company that you're buying, basically, and that goes into purchase price.
• 11:46
  SPEAKER_01: So part of it goes into purchase price, but then part of it is associated with service after the deal, and that's more viewed as compensation cost to you post-deal, just like any other compensation award that you um that you end up doing.
• 11:58
  SPEAKER_01: So it's a little bit complicated.
• 12:00
  SPEAKER_01: There's a lot of calculations and a lot of permutations to the calculations, but the short answer is that what we typically see is that some amount of the value of these awards goes to purchase price and some amount goes to compensation.
• 12:11
  SPEAKER_01: You actually kind of split split the difference a little bit.
• 12:13
  SPEAKER_02: All right.
• 12:14
  SPEAKER_02: And I know I'm I I I know because I'm going to ask the question at the end is where for more guidance.
• 12:19
  SPEAKER_02: But for particular on this topic, is this in our stock-based comp guide, or this would also be hit in our business combination guide?
• 12:27
  SPEAKER_01: I think we've we've included it in the business combination guide, although obviously they interplay, there's a fair bit of interplay between the two, but I think the specifics of this guidance is in our business combination guide.
• 12:36
  SPEAKER_02: So we'll get to that at the end then.
• 12:37
  SPEAKER_02: And then the other thing is you kind of alluded to this earlier, this idea that you maybe could gain control over time.
• 12:44
  SPEAKER_02: So let's say you started with an um equity method investment and you own 30%.
• 12:49
  SPEAKER_02: And then let's say you own you purchase the rest of the company, just to make it simple.
• 12:54
  SPEAKER_02: What should you what, you know, if someone's dealing with like a step acquisition, how should they be thinking about that?
• 13:01
  SPEAKER_01: You know, it's a little weird uh in the guidance, and it's different for those of us who've been around for a long time and have seen the guidance evolve over time.
• 13:09
  SPEAKER_01: Um, in that if if you do that step acquisition, which is what the guidance calls uh achieving a business combination in stages, is the phrasing that they use.
• 13:18
  SPEAKER_01: Uh so you had an equity investment, a previously held equity investment in the company that you just gained control of.
• 13:25
  SPEAKER_01: And how the guidance now views it uh is that you're basically exchanging that sort of equity minority interest in the company that you had before for a controlling stake.
• 13:37
  SPEAKER_01: So in your case, you know, you had that 30% investment and you acquired, let's say, the remaining 70% for cash.
• 13:43
  SPEAKER_01: And so the way the accounting guidance looks at it is it basically says you gave up your 30% interest as well as the cash for the rest of it in order to get 100% of the target company.
• 13:55
  SPEAKER_01: And so that actually is viewed as an economic event that triggers recognizing that investment at fair value, actually write up your investment to fair value so that you know the fair value of the stock you previously held that you kind of handed back in order to get 100% of it, plus the cash, and you add that all together, and that becomes the total purchase price.
• 14:14
  SPEAKER_01: So you so you often result in a gain on that.
• 14:16
  SPEAKER_01: I mean, obviously you can have a loss too, but if if it wasn't you would have already had an impairment, perhaps, if you if it was in a loss situation, but it could be either way.
• 14:24
  SPEAKER_01: But you're basically remeasuring it to fair value and you get a gain.
• 14:28
  SPEAKER_01: So it's kind of weird because you you held it all along, you didn't sell it, you help you still have it afterwards, but you end up recognizing a gain on it.
• 14:35
  SPEAKER_01: So it's a little strange, but it's just it's it's sort of just became how the numbers had to work in order to get 100% of the fair value of the assets and liabilities that you acquired onto your books, you had to get 100% of the total value in there.
• 14:49
  SPEAKER_01: Otherwise, you'd have some some apples and oranges to play with.
• 14:52
  SPEAKER_01: So the way they they they do that is by having to write up the fair value of that investment.
• 14:56
  SPEAKER_02: And Jay, this is not uh a podcast about step acquisitions.
• 15:01
  SPEAKER_02: So we don't have to go into too much detail here.
• 15:04
  SPEAKER_02: But let's say if I had done this in I own 30, then I I purchased 10 more.
• 15:10
  SPEAKER_02: That would not trigger this remeasurement.
• 15:13
  SPEAKER_02: It's only when you get up to the point of control that you would trigger a remeasurement, full remeasurement to fair value.
• 15:19
  SPEAKER_01: That's right.
• 15:20
  SPEAKER_01: That's right.
• 15:20
  SPEAKER_01: The the the guidance sort of views gaining control or losing control as a significant event that triggers remeasurement to fair value.
• 15:27
  SPEAKER_02: All right, and again, we've got other guidance on that, but I just wanted to make that point.
• 15:31
  SPEAKER_02: So I guess the other point here is we said for simplicity's sake, we were going to acquire that whole company.
• 15:38
  SPEAKER_02: So we we bumped all the way to 100%.
• 15:40
  SPEAKER_02: But clearly there's oftentimes when maybe I own 30 and I buy 30 more.
• 15:44
  SPEAKER_02: So now I have 60%.
• 15:46
  SPEAKER_02: So that I control this company, but I don't own all of it.
• 15:50
  SPEAKER_02: So how do you think about that?
• 15:51
  SPEAKER_01: Right.
• 15:52
  SPEAKER_01: Right.
• 15:52
  SPEAKER_01: Now that happens a lot.
• 15:53
  SPEAKER_01: Um could even just be you come along and you buy 80% out of the CMS.
• 15:59
  SPEAKER_01: That's the initial transaction, and you you leave the selling shareholders with a a remaining interest in it.
• 16:04
  SPEAKER_01: Um and and that's referred to as non-controlling interest, which we'll often shorthand as NCI uh along the way.
• 16:12
  SPEAKER_01: And NCI is basically what's held by other people other than you.
• 16:16
  SPEAKER_01: Uh it's still viewed as overall equity in the entity.
• 16:20
  SPEAKER_01: They're equity owners, they're just not part of the controlling stake of the company.
• 16:23
  SPEAKER_01: So it's presented separately within equity, assuming it's equity in the first place, obviously if it's debt or liabilities, and there's some complexities as to what's debt and what's equity.
• 16:33
  SPEAKER_01: But as long as it's equity, it's presented in equity, it's just sort of presented as a separate class of equity.
• 16:38
  SPEAKER_01: But what's sort of relevant from a business combination perspective is that that also gets recognized at 100% of its fair value or its full fair value at the time of the acquisition.
• 16:48
  SPEAKER_01: So if you bought, in that example, 80% of the company and there was still 20% outstanding as a non-controlling interest, when you're thinking about your total consideration as you get through the rest of the process, you'd say, well, I paid X dollars for the 80%.
• 17:03
  SPEAKER_01: And then the fair value of the 20% is Y dollars.
• 17:06
  SPEAKER_01: And so I add the two of those together, and that's the total consideration that I'm kind of using in the rest of the process.
• 17:11
  SPEAKER_02: Well, and I guess, Jay, that goes back to your overall, I want to say theory, but the overall sort of basis here that you want to get 100% of the fair value of the assets and liabilities acquired onto your books.
• 17:24
  SPEAKER_02: And so in order to do that, you have to step up your investment as well as any non-controlling interest.
• 17:31
  SPEAKER_02: All right.
• 17:32
  SPEAKER_02: So now with all of that said, if I go through and think about my journal entries and tea accounts, we've been really focused sort of on this credit side of things and bumping that up.
• 17:43
  SPEAKER_02: But if we focus on the debits and in particular assets acquired, what are what should we be considering?
• 17:50
  SPEAKER_01: Right.
• 17:51
  SPEAKER_01: Well, we'll talk about debits, the assets, although there's also some stuff on the right side of your T accounts for the liabilities that you assume too.
• 17:59
  SPEAKER_01: Um and the general measurement principle in a in a business combination is that you measure pretty much all the identifiable assets that you've acquired and the liabilities that you've assumed at their fair values at the acquisition date.
• 18:14
  SPEAKER_01: Um the assets are at fair value, the liabilities are at fair value, the NCI is at fair value, as we said.
• 18:19
  SPEAKER_01: So everything's at fair value.
• 18:21
  SPEAKER_01: And so those the common things we run into are things like property plan and equipment and inventory, intangible assets, which probably weren't on the target's book, may not have been on the target's books, because you don't get to capitalize those when you develop them yourself, but you do record those in purchase accounting if they meet certain characteristics or so.
• 18:41
  SPEAKER_01: So there's a lot that you do recognize at fair value.
• 18:43
  SPEAKER_01: And fair value here is gap fair value.
• 18:46
  SPEAKER_01: So using the ASC 820 guidance on fair value, which is the price that you could get in the sale and to uh in an orderly transaction between market participants.
• 18:59
  SPEAKER_01: So it's based on market participant value, not necessarily on what you plan to do with the asset.
• 19:05
  SPEAKER_01: And we do run into some cases where maybe you buy a company and maybe the target company has certain intangibles like brands or trademarks or something.
• 19:13
  SPEAKER_01: Maybe they're compete with your products.
• 19:15
  SPEAKER_01: And what you actually want to do is you just want to take them out of the marketplace, and you don't want them to compete with your products anymore.
• 19:21
  SPEAKER_01: So you're not going to actually use that brand or trademark post-deal, uh, but it would still have value to a market participant.
• 19:29
  SPEAKER_01: Maybe it's not direct value to you, kind of indirect through the not cannibalizing your existing products.
• 19:35
  SPEAKER_01: But you you you do get to still calculate a fair value, and not that you you you can, you you have to calculate a fair value and record it as a, I guess almost like a defensive asset.
• 19:44
  SPEAKER_01: I think that's actually the phrase that's in the guidance as a defensive asset uh that you would record.
• 19:48
  SPEAKER_01: So you're you're you are trying to record pretty much everything at fair value.
• 19:52
  SPEAKER_01: That being said, accounting being accounting, there are some exceptions to that, and uh the guidance goes through a number of areas where you don't necessarily use pure fair value, you use some other methods of recognition or models of recognition, somewhere like the stock compensation awards, like we talked about.
• 20:12
  SPEAKER_01: You do that for some parts of lease accounting, you do that for income tax accounting, you do that for contingent liabilities in some cases.
• 20:21
  SPEAKER_01: So there's some specific guidance that that's there about the exceptions to general fair value for a variety of reasons.
• 20:28
  SPEAKER_01: Uh, but for the most part, you do stuff at fair value with a couple of exceptions.
• 20:32
  SPEAKER_02: All right.
• 20:32
  SPEAKER_02: And I know I noticed you didn't mention the most recent one, which was contract assets and liabilities.
• 20:38
  SPEAKER_02: So that guidance was that last year, Jay, that that came out?
• 20:42
  SPEAKER_02: It's very it's very recent.
• 20:44
  SPEAKER_01: Right.
• 20:44
  SPEAKER_01: I think it came out in 2021.
• 20:47
  SPEAKER_01: Um, it was required to be adopted this year for public companies.
• 20:52
  SPEAKER_01: But you're right, and we had done a podcast, I think, together about that.
• 20:56
  SPEAKER_01: Uh so that was one that basically tried to merge together some of the revenue recognition guidance with the the business combination accounting guidance and said that when you um buy a company and they have some we'll call it deferred revenue, contract liabilities, let's say you you look to the the revenue recognition guidance to figure out what your book and purchase accounting, not sort of pure fair value.
• 21:15
  SPEAKER_01: So you're right, that is that is another exception that we see as well.
• 21:18
  SPEAKER_02: Yeah.
• 21:18
  SPEAKER_02: All right.
• 21:19
  SPEAKER_02: And then um we'll definitely make sure we, you know, have links to the business combination guide.
• 21:25
  SPEAKER_02: But I noticed you mentioned uh intangible assets and other identifiable assets, but you uh notably omitted goodwill, which is often one of the biggest assets that's being acquired.
• 21:39
  SPEAKER_02: So what can you share on that?
• 21:41
  SPEAKER_01: Uh yes, goodwill.
• 21:42
  SPEAKER_01: Goodwill.
• 21:43
  SPEAKER_01: You're right.
• 21:43
  SPEAKER_01: Uh we I knew we would get to that here eventually.
• 21:46
  SPEAKER_01: Yeah, that's the asset that it sort of conceptually represents all the acquired future economic benefits that you really can't identify at the acquisition dates of synergies effectively that you think you're gonna get.
• 21:58
  SPEAKER_01: But goodwill can't really.
• 22:00
  SPEAKER_01: Be calculated on its own.
• 22:01
  SPEAKER_01: It's really just a residual after we do all the rest of the process.
• 22:05
  SPEAKER_01: So that's why it kind of comes at the end of the process.
• 22:08
  SPEAKER_01: So you basically take all the consideration you transfer, all those things we we went through, including the NCI's fair value, if it was just a partial acquisition.
• 22:16
  SPEAKER_01: You then subtract the acquisition date values of all of the identifiable assets that you've acquired and liabilities that you've assumed.
• 22:25
  SPEAKER_01: And the difference between those two is the goodwill.
• 22:29
  SPEAKER_01: That's basically just what falls out at the other end of it.
• 22:34
  SPEAKER_01: There is also the possibility of a bargain purchase gain.
• 22:37
  SPEAKER_01: That's where the fair value of the net assets acquired is greater than the total consideration of buy the business.
• 22:44
  SPEAKER_01: It doesn't happen very often.
• 22:45
  SPEAKER_01: And we usually say that if you think you have a bargain purchase gain, you should probably go back and check whether you have identified everything and valued it all correctly.
• 22:53
  SPEAKER_01: But if you do have one, like in a distress sales situation, the guidance says you record a day one gain for the amount of the bargain purchase.
• 23:02
  SPEAKER_01: But maybe back to goodwill since we don't see these very much.
• 23:05
  SPEAKER_01: Once you figure out sort of what amount of goodwill gets recognized, then you do have to go on to start preparing for sort of day two accounting for the goodwill, and you have to think about how you assign the goodwill to reporting units.
• 23:20
  SPEAKER_01: And I I won't spend a lot of time about reporting units, but that sort of falls out from this.
• 23:24
  SPEAKER_01: You start with the segment side of things, and then you kind of go potentially a level below that into uh to uh components, which could be reporting units, and reporting units is kind of the building block of goodwill to unit of account to measure goodwill, and you have to assign the assets and liabilities to different reporting units, and then you also have to assign the goodwill to the different reporting units.
• 23:46
  SPEAKER_01: Although you have some flexibility actually with the goodwill, you know, you can actually kind of think about well, where would the where's the goodwill, where's this business that I'm acquired going to help me in my business?
• 23:57
  SPEAKER_01: And even if there aren't specific assets and liabilities that go to one particular reporting unit, there might be some synergies that that come out of the acquisition that go into the into the reporting unit.
• 24:06
  SPEAKER_01: So you you you know there's some judgment that can be applied there.
• 24:09
  SPEAKER_01: It doesn't really, the guidance doesn't tell you how you have to do it.
• 24:12
  SPEAKER_01: It gives a couple of examples and and the like, but it does leave you some degree of judgment as to how you set it up.
• 24:17
  SPEAKER_01: But however you set it up is what's going to drive your impairment testing going forward.
• 24:22
  SPEAKER_01: So I would say think carefully as you're as you're considering how to allocate it.
• 24:26
  SPEAKER_02: Let me ask you a question.
• 24:27
  SPEAKER_02: I want to come back to this allocation, but when we were talking about the calculation of Goodwill, you mentioned the liabilities assumed.
• 24:35
  SPEAKER_02: And I I think we said this, but just want to be clear.
• 24:39
  SPEAKER_02: We talked about recording the assets of fair value, but the liabilities are being recorded at fair value as well, other than, yeah, I know you mentioned a few things maybe that are opted out, but debt and otherwise.
• 24:50
  SPEAKER_02: Right.
• 24:50
  SPEAKER_01: That's right.
• 24:50
  SPEAKER_01: So any debt that survives the merger, that's its own topic as well as the does it survive or doesn't survive, but any debt that survives the merger, payables, um, you know, not the contingencies that maybe special guidance, but broadly speaking, yes, it's recording at a fair value, all the benefit obligations that the company has, payables, accruals, all that stuff.
• 25:09
  SPEAKER_02: Yeah.
• 25:10
  SPEAKER_02: And then so let me come back though to this idea of the allocation of goodwill, because I do think this is confusing, particularly in a case when, let's say that this um business acquired is continuing to be operated sort of, I don't want to say completely standalone, but it's in its own um what you know, new reporting unit.
• 25:30
  SPEAKER_02: But your point is that doesn't mean all the goodwill just goes there, because the other reporting units in the company may be benefiting from this.
• 25:40
  SPEAKER_01: Yeah, it kind of depends on what the company's doing the deal for in the first place, right?
• 25:44
  SPEAKER_01: And sometimes it is relatively standalone and isolated and can be separated from the rest of the business, but other times there are a lot of synergies that might might result.
• 25:54
  SPEAKER_01: So it it comes back to sort of the premise for the deal in the first place.
• 25:58
  SPEAKER_01: So all this stuff should somewhat align, right, as you're thinking about where's the goodwill go.
• 26:03
  SPEAKER_01: It should be, well, what's what part of my business is gonna be benefited by it, which might be a function of why am I doing the deal in the first place, and how do I justify the price that I'm paying for it in the uh you know, weren't the boards approving it and the like.
• 26:14
  SPEAKER_01: But you do have some flexibility.
• 26:15
  SPEAKER_01: Oh, but again, it's gonna then drive your impairment tests going forward, but you can make some reasonable and um rational allocations amongst different reporting units if that makes sense in your circumstances.
• 26:29
  SPEAKER_02: So, Jay, on that specifically, if on day one, you know, let's say, well, right now I it is its own reporting unit, but then I do plan to sort of better integrate it into the business in the future, is I know this this podcast is not about day two accounting, but uh do you see scenarios when the goodwill gets reallocated later when they actually do fully integrate it and change the business model?
• 26:57
  SPEAKER_01: Well, there is certainly some framework for reallocating goodwill down the road when there's a change in the kind of the reporting structure or the segments and reporting units.
• 27:07
  SPEAKER_01: It's when you get to that point though, it's really more about you've done some change, you've reorganized the business or the reporting structure of the business, as opposed to like, eh, I kind of now I feel like I'm getting some benefit over in reporting C over here that I didn't think I was gonna get before.
• 27:24
  SPEAKER_01: So y yes, you can, but but no, it's not so simple.
• 27:29
  SPEAKER_02: All right.
• 27:29
  SPEAKER_02: And then anything else when you're thinking about how you're actually recording your goodwill as part of this acquisition, any other sort of tips that you would give companies?
• 27:39
  SPEAKER_01: Well, one one that I'd highlight is actually one we've been running into uh on a recurring basis, I would say, and that is thinking about where you actually record the goodwill in your financial systems and records.
• 27:56
  SPEAKER_01: Uh you know, we talked about sort of financial reporting purposes of how you think about it for where what segment is in, but you actually have to get into the you know the nuts and bolts of how are you doing your bookkeeping for it and are you gonna keep up with everything?
• 28:08
  SPEAKER_01: So, for example, oftentimes a company for convenience purposes will just record goodwill at the corporate level, at the parent level, right?
• 28:18
  SPEAKER_01: Um necessarily, there's no requirement in standalone reporting and the like in your internal financials to have to push it down to different levels.
• 28:26
  SPEAKER_01: So a lot of times, just for convenience, a lot of companies do it that way.
• 28:29
  SPEAKER_01: We see that a lot.
• 28:30
  SPEAKER_01: That's fine.
• 28:31
  SPEAKER_01: But if the goodwill relates to a foreign entity, you have to still think of it uh like it's denominated in the currency of that foreign entity.
• 28:41
  SPEAKER_01: Uh so even if you're recording it in sort of the corporate ledger, you have to kind of think about it as if it was pushed down into that currency of whatever whatever currency it is that the foreign entity is using.
• 28:53
  SPEAKER_01: And that of course becomes important when you're doing your foreign currency accounting and your cumulative translation adjustment accounting, you have to think about it as as if it was in that that country.
• 29:03
  SPEAKER_01: And sometimes that's somewhat evident, like you know, a US company buys a European company, and you know, you can tell it all relates to the euro and it should all relate to that.
• 29:13
  SPEAKER_01: But it could even be cases where maybe a US-based company buys another US-based multinational company that has significant operations in South America and Asia Pacific and Australia and Europe, and so a lot of that goodwill is still associated with these different parts of the business.
• 29:30
  SPEAKER_01: You still have to kind of allocate it or push it down for the sort of the CTA accounting into those different pieces.
• 29:37
  SPEAKER_01: So it's one that we see unfortunately pop up a bunch, because it's not something that's always self-evident based on how a company is doing its bookkeeping.
• 29:45
  SPEAKER_01: And that's true for intangibles too.
• 29:46
  SPEAKER_01: It's not just goodwill, it's intangible assets as well.
• 29:49
  SPEAKER_01: Same concept basically applies.
• 29:51
  SPEAKER_01: If you if there's an intangible associated with a European trademark or something like that, you gotta think of it like it's denominated in Euros, regardless of what general ledger you have it uh in your company's books.
• 30:02
  SPEAKER_02: All right, definitely a good reminder there.
• 30:04
  SPEAKER_02: So, Jay, let me ask you another question on this, because when you were describing measured the measuring things at the acquisition date fair value, you made it sound so easy.
• 30:14
  SPEAKER_02: So those are just readily available, no work to be done to get those.
• 30:18
  SPEAKER_02: But obviously, anyone who has done an acquisition knows that's not the case.
• 30:22
  SPEAKER_02: And so we do have in here this concept of a measurement period.
• 30:27
  SPEAKER_02: So can you remind listeners what that is and then how that fits into this accounting model?
• 30:32
  SPEAKER_01: Right.
• 30:33
  SPEAKER_01: And it's exactly for the point you're you're uh humorously getting at there, that sometimes it can take a while to determine the fair values of all these assets acquired and liabilities assumed or contingent consideration that you've issued.
• 30:47
  SPEAKER_01: And of course, a lot of times you you have to wait until the deal closes to really get into the company's, uh the target company's books to figure out what those valuations may be.
• 30:57
  SPEAKER_01: So it takes some time, it can take some time to do it.
• 31:00
  SPEAKER_01: Um and so the guidance does have this notion of a measurement period that basically give you a period of time to finalize the accounting for a business combination, you know, to figure out the fair values of all these um these complicated things.
• 31:15
  SPEAKER_01: And so you gotta make your best effort, sort of the good college try to get at the you know what you think is the preliminary allocation of fair value.
• 31:24
  SPEAKER_01: You can't just sort of make up a number out of thin air, right?
• 31:26
  SPEAKER_01: You have to take your best shot at what the value is.
• 31:30
  SPEAKER_01: But if it's gonna take some more time to get the final valuations in and the like, you can you can disclose that and say that's the case.
• 31:37
  SPEAKER_01: Uh and then if and when the final valuations come in and they're different, you basically record a true-up at that time.
• 31:44
  SPEAKER_01: So you just do it in the period, which could be like a couple of quarters later, you know, you may get a final valuation.
• 31:49
  SPEAKER_01: You would do a catch-up, so true-up at that time to sort of say, where would I be today if I had known back at the acquisition date, all these final numbers.
• 32:00
  SPEAKER_02: So I know uh companies in some cases may not like this idea of sort of these moving parts to this, but in practice, do you see people just kind of take this as like a do-over or how how do people handle it?
• 32:15
  SPEAKER_01: Well, do-over might be a strong, strong word, I guess, Heather.
• 32:18
  SPEAKER_01: Um we certainly see it the concept utilized, but maybe for certain types of assets and liabilities only, right?
• 32:27
  SPEAKER_01: Some are more accessible than others, and or some are more complicated to get than others.
• 32:34
  SPEAKER_01: And so we don't necessarily see a blanket approach to it.
• 32:38
  SPEAKER_01: It's more of a targeted approach.
• 32:39
  SPEAKER_01: And you're actually, I think, supposed to disclose in the period you do the acquisition if you have some preliminary uh valuations that you're utilizing, you're supposed to say that and say these particular valuations are still preliminary and we're waiting for the final, the final um valuations of those.
• 32:58
  SPEAKER_01: So it's not really supposed to be a blanket um idea.
• 33:02
  SPEAKER_01: And the other thing I think that we often talk about with with companies is the period of time that you have to do it.
• 33:08
  SPEAKER_01: A lot of people think, oh, I just have a year.
• 33:10
  SPEAKER_01: The guidance sort of had references a year to do it.
• 33:12
  SPEAKER_01: So I have a year to get it done.
• 33:14
  SPEAKER_01: Again, it's not quite so simple.
• 33:15
  SPEAKER_01: It the guidance says is it's the measurement period goes until you get all of the information that you're waiting for, but no longer than a year.
• 33:23
  SPEAKER_01: So yes, it can't go longer than a year, but it really we don't tend to see it even go that far in many cases.
• 33:29
  SPEAKER_01: So it's really you're supposed to be trying to as soon as reasonably possible get those final value evaluations done.
• 33:35
  SPEAKER_01: And as soon as you get the final information, that's sort of the end of the uh of the measurement period, and and you can't um you can't reopen it again later, or can't just say, Oh, I'm just gonna wait and do everything a year later.
• 33:46
  SPEAKER_01: And it also has to be, of course, stuff that's finalization of values based on the information that it you know existed as of the acquisition date.
• 33:55
  SPEAKER_01: You you know can't reflect subsequent changes, right?
• 33:58
  SPEAKER_01: If a significant economic event happens along the way and the value of some asset or liability changes afterwards, you can't push that back as a measurement period adjustment.
• 34:07
  SPEAKER_01: And you know, as I said, it has to be like a good college try.
• 34:10
  SPEAKER_01: Your best estimate of what it was, if it turns out you just made a flat out error and something, right?
• 34:16
  SPEAKER_01: It's like, oh, I forgot to even include something in here, which we see come up, right?
• 34:20
  SPEAKER_01: You've you might come across it's like, well, we bought a company and they've got five.
• 34:24
  SPEAKER_01: We thought they had five pension plans and we valued all those, but it turns out they had seven.
• 34:28
  SPEAKER_01: And we can't those came up as the uh the actuaries were doing final valuations later, and we just didn't include them at the time.
• 34:34
  SPEAKER_01: That's not a measurement period adjustment.
• 34:35
  SPEAKER_01: If it's material, that's that's perhaps an error.
• 34:38
  SPEAKER_02: All right.
• 34:38
  SPEAKER_02: So definitely sounds like you want to be as close as you possibly can be in that in that first, you know, first attempt.
• 34:47
  SPEAKER_02: And then to your point, it's just really refining.
• 34:49
  SPEAKER_02: So you don't wind up in the situation where you are dealing with an error or you know, is something subsequent information?
• 34:57
  SPEAKER_02: Should you have known at the time, is it's better if you're just done and then you know it's all subsequent information.
• 35:03
  SPEAKER_02: So, one other thing then is uh, Jay, if we're thinking about business combinations that I know comes up a lot, is this idea of conforming accounting policies.
• 35:13
  SPEAKER_02: So I'm the parent, I do things one way.
• 35:16
  SPEAKER_02: Sub does something, or the new sub does something a different way, maybe, or new subs does something a different way, also acceptable under GAAP.
• 35:26
  SPEAKER_02: How do you think about that as you are doing your purchase accounting?
• 35:30
  SPEAKER_01: Yeah, that does come up a lot.
• 35:32
  SPEAKER_01: And the guidance says that you are supposed to conform accounting policies to the buyer's accounting.
• 35:38
  SPEAKER_01: And so that means that both when you're doing your initial purchase accounting, acquisition accounting, as well as all the day two accounting going forward.
• 35:48
  SPEAKER_01: In your example where the parties were using different policies, you're supposed to adjust or conform the target company, the acquired company, to what the buyer is doing to the extent they're the same kinds of transactions.
• 36:01
  SPEAKER_01: That's the general situation, the general idea.
• 36:04
  SPEAKER_01: There's times, of course, where the target is doing something and has some policies that the buyer doesn't have any of those transactions.
• 36:11
  SPEAKER_01: And so in that case, interestingly, because it's viewed as the target company as a new accounting entity in the acquisition, it's a new basis of accounting for them, all the old stuff is sort of dissipates away and they're a new company for accounting purposes.
• 36:25
  SPEAKER_01: So they can actually adopt a different policy if they wanted to in the acquisition accounting as well as all the day two accounting going forward.
• 36:32
  SPEAKER_01: Well, you get sort of a free one-time chance to adopt a new policy.
• 36:36
  SPEAKER_01: It's not viewed as a change in accounting to the target because you know the old target pre-acquisition and the post-acquisition subsidiary of that comp that was that company are viewed as two different accounting entities.
• 36:49
  SPEAKER_01: So that basically gets a chance to start over and pick a pick a new policy.
• 36:53
  SPEAKER_01: Every so often we run into ones where the the buyer says, I actually like that policy for whatever the reason may be that the target has.
• 37:01
  SPEAKER_01: And so in that case, the buyer wants to change to do what the target has.
• 37:06
  SPEAKER_01: Well, that would be viewed as a change in accounting principle, because now the buyer, which is viewed as the ongoing accounting entity, wants to change its accounting principle, and then you'd go through the same process that you would for any potential change in accounting principle, preferability, all that stuff.
• 37:21
  SPEAKER_02: All right.
• 37:21
  SPEAKER_02: Well, this and this is definitely, I think, a case overall, this idea of conforming policies that you really don't want to wait on because I think this is one where, you know, if you get one or two quarters down the road, you don't want to realize that there was something that wasn't conformed.
• 37:39
  SPEAKER_02: Right.
• 37:39
  SPEAKER_01: No, that's that's a good point.
• 37:40
  SPEAKER_01: We do run into that where it's like, ooh, we've we found out a couple at the end of the year, right?
• 37:44
  SPEAKER_01: We're doing the year-end audit that that stuff is going differently.
• 37:47
  SPEAKER_01: It also affects, you know, we'll we'll talk in a later on this month about pro forma disclosures.
• 37:53
  SPEAKER_01: This that's all part of the pro forma stuff as well, you know, to the extent the target was doing it one way and the buyer's doing it another way.
• 37:59
  SPEAKER_01: That's apples and oranges, your pro forma are ideally trying to show things on an apples and apples basis, so that you'd have to adjust, even in the pro forma information, the target's numbers to reflect what their numbers would have been had they been following the buyer's accounting policies in that case.
• 38:15
  SPEAKER_01: So it's something you want to hopefully identify during the due diligence process and all of that cycle, because yes, you want you once the deal closes, um, now all of a sudden, if you aren't doing the same thing, you've got you might have a problem on your hands.
• 38:27
  SPEAKER_02: Right.
• 38:27
  SPEAKER_02: Definitely a good reminder.
• 38:28
  SPEAKER_02: So, Jay, overall, lots of good content here.
• 38:32
  SPEAKER_02: And I know we're going to dive deeper into a few of the subtleties of business combination accounting in the rest of our series this month.
• 38:40
  SPEAKER_02: But in the meantime, any broad pieces of advice you would give to our listeners if they are dealing with an acquisition?
• 38:50
  SPEAKER_01: Well, I would say definitely stay tuned for the uh the rest of the month as we get into some of these areas.
• 38:56
  SPEAKER_01: Um But I'd say it is a it's a very complex area of gap, as I said, especially if you're not a highly acquisitive company that does this all the time.
• 39:03
  SPEAKER_01: It's always worth brushing up on the guidance.
• 39:07
  SPEAKER_01: And I would say, you know, if you're whichever part of the business that you're in for our listeners, uh try to stay close to other parts of the business.
• 39:16
  SPEAKER_01: Or if you're on the financial reporting side and you're going to be the some of the people involved in doing all of this acquisition accounting, stay close to your deal people and vice versa, I guess, so that uh as you're structuring deals, you don't end up with accounting answers that you didn't expect or things of that nature.
• 39:34
  SPEAKER_01: So the more the company as a whole, everyone can kind of uh be comparing notes and connecting the dots on the front end from the deal structuring side and the treasury side and the foreign currency side and the accounting side, the the better.
• 39:49
  SPEAKER_02: All right, I feel like that's advice we could give with practically any type of transaction that companies are doing.
• 39:54
  SPEAKER_01: Aaron Powell But these are big, often very transformative types of transactions.
• 39:57
  SPEAKER_01: I mean, sometimes you're changing the whole company around, the whole structure of the company around.
• 40:01
  SPEAKER_01: It's a it's a big deal and it takes a lot of um management attention, and they'll be looking at it at all our listeners to help make sure that the stuff gets done, gets done timely, and gets done right.
• 40:11
  SPEAKER_02: Aaron Powell Excellent advice there.
• 40:13
  SPEAKER_02: So, where if someone wants to have more information, where's the best place to go?
• 40:17
  SPEAKER_01: A lot of the stuff that we talked about is all in our business combinations guide.
• 40:22
  SPEAKER_01: Most of it's in chapter two, is where we're talking about this, the acquisition method, although some of the other chapters as well for things like the replacement stock compensation awards are in a different chapter.
• 40:33
  SPEAKER_01: Um we've talked about a few other podcasts uh along the way that that uh you know talk about things like asset acquisition versus business combination.
• 40:42
  SPEAKER_01: So we can refer to those and then of course stay tuned for uh the next couple of weeks worth of worth of my podcasts uh that we'll we'll do together.
• 40:49
  SPEAKER_01: We'll bring in a few a few friends to talk about some of these topics in more detail.
• 40:53
  SPEAKER_02: All right, well, definitely a great topic, Jay.
• 40:55
  SPEAKER_02: And it is always such a pleasure to have you on.
• 40:57
  SPEAKER_02: So thanks so much for joining me.
• 40:59
  SPEAKER_01: Of course.
• 40:59
  SPEAKER_01: Thanks for having me.
• 41:01
  SPEAKER_02: That's our show for today.
• 41:03
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• 41:09
  SPEAKER_02: Follow the PWC Accounting Podcast wherever you listen to your podcasts.
• 41:13
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• 41:23
  SPEAKER_02: From Thought Leadership at PwC, I'm Heather Horn.
• 41:27
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