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Full disclosure: Business combinations · PwC's accounting podcast

• 0:00
  SPEAKER_02: Thought Leadership from PWC.
• 0:07
  SPEAKER_01: Welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_01: I'm Heather Horn.
• 0:12
  SPEAKER_01: Thanks for tuning in to the next episode on our full disclosure series, to show all about presentation and disclosure from the top of the financial statements down to the last footnote.
• 0:23
  SPEAKER_01: What may sound like accounting 101, I guarantee you'll learn something new each episode.
• 0:29
  SPEAKER_01: Today's focus business combinations.
• 0:33
  SPEAKER_00: Contingent consideration or earnouts?
• 0:35
  SPEAKER_00: That tends to be the most common balance sheet question that comes up in a business combination.
• 0:41
  SPEAKER_01: That's my guest, Jay Celeber, PWC National Office Partner.
• 0:45
  SPEAKER_01: Maybe it's because of the layers of complexities business combinations can bring, or perhaps because of the amount of different players that business combinations cross over into.
• 0:55
  SPEAKER_01: Whatever the reason, one thing's for sure, the disclosure and presentation related to BizCom is a topic that's of interest to a lot of people.
• 1:03
  SPEAKER_01: So today, we're going to cover all the details.
• 1:06
  SPEAKER_01: We'll talk about the different scenarios, the judgments that are required, and how connectivity among the players is key.
• 1:12
  SPEAKER_01: So let's get started.
• 1:14
  SPEAKER_01: So, Jay, as always, so nice to have you back on the podcast.
• 1:18
  SPEAKER_01: And today's topic, I think, is one that will be of interest to a lot of people, and that is talking about disclosures and presentation related to business combinations.
• 1:27
  SPEAKER_01: But before we actually dive into the detail, probably helpful to just define what transactions we're specifically talking about, and in particular, if there's any that we're sort of going to leave out of our conversation today.
• 1:39
  SPEAKER_00: Right, sure.
• 1:40
  SPEAKER_00: So well, thanks for having me back.
• 1:42
  SPEAKER_00: I get back in the studio here, Heather.
• 1:44
  SPEAKER_00: So you're right, we're going to talk about business combinations here.
• 1:48
  SPEAKER_00: And so that means it has to meet the accounting definition of a business combination.
• 1:54
  SPEAKER_00: So what we're talking about is when one company gets control of another business, as that's defined in the guidance.
• 2:01
  SPEAKER_00: Now, I'll acknowledge that that definition, which the FASB updated just a few years ago, definitely has its own nuances and complexities that often require judgment that we talk about in our business combinations guide.
• 2:15
  SPEAKER_00: But for purposes of today's podcast, we'll just assume that we're talking about a business, because the stuff we're going to talk about doesn't apply to asset acquisitions or formations of joint ventures or common control transactions, things like that.
• 2:31
  SPEAKER_00: It would apply to gaining control through becoming a primary beneficiary of a variable interest entity, which is a mouthful, but it would apply to that because that's considered a business combination.
• 2:45
  SPEAKER_00: And I do know you often ask this question too, Heather, so I'm going to preempt you by saying that everything that we'll talk about here applies equally to both interim and year-end financial statements.
• 3:00
  SPEAKER_00: Since business combinations tend to be substantive, discrete transactions, it's important to convey all the relevant information that needs to be disclosed on a timely basis to investors.
• 3:11
  SPEAKER_01: All right.
• 3:24
  SPEAKER_01: So then why don't we start things off with presentation and not surprisingly, starting with the balance sheet?
• 3:31
  SPEAKER_01: And I know, you know, acquired assets, assumed liabilities are typically presented in as part of their respective line items.
• 3:39
  SPEAKER_01: But are there any amounts associated with the business combination itself that we would see come onto the balance sheet?
• 3:45
  SPEAKER_01: Any specific requirements?
• 3:47
  SPEAKER_00: Well, probably the big one that we see is contingent consideration or earnouts.
• 3:52
  SPEAKER_00: That tends to be the most common balance sheet question that comes up in a business combination beyond the things you mentioned.
• 4:00
  SPEAKER_00: And if it's a right to potentially receive some consideration back, in other words, it's contingently returnable consideration, then that would be an asset.
• 4:10
  SPEAKER_00: We don't see that all that often.
• 4:12
  SPEAKER_00: What we more commonly see would be an obligation to potentially pay contingent amounts in the future.
• 4:19
  SPEAKER_00: And those would either be classified as a liability or as equity.
• 4:24
  SPEAKER_00: Now, certainly if the earnout's going to be paid in cash, it's definitely a liability.
• 4:28
  SPEAKER_00: But we find that even if the earnout would be settled in additional shares of the buyer stock, that there's a lot of challenging technical areas to consider under both the liabilities and equity guidance in ASC 480 and the derivatives guidance in ASC 815.
• 4:48
  SPEAKER_00: And we talk about this a bunch in chapter two of our business combination guide.
• 4:54
  SPEAKER_00: And I won't get into the details because I know it goes on for pages and pages and pages in the guide there.
• 4:59
  SPEAKER_00: But I will say that we most typically find that these still end up getting classified as a liability because they end up failing one test or another in that guidance.
• 5:11
  SPEAKER_00: So then if it's a liability, you then have to assess whether it's classified as current or long-term.
• 5:16
  SPEAKER_00: And that would depend on the terms of the earnout and when it would ultimately get paid out.
• 5:21
  SPEAKER_01: All right.
• 5:22
  SPEAKER_01: So, Jay, that's helpful.
• 5:23
  SPEAKER_01: And I actually have a question before we go to the income statement.
• 5:26
  SPEAKER_01: When I did my opening question, I sort of presumed that the acquired assets and assumed liabilities are presented together with the existing balances of the acquirer.
• 5:38
  SPEAKER_01: But are there any cases you would see balances presented separately for the acquired company?
• 5:45
  SPEAKER_00: I don't think there's that would be too often the case.
• 5:49
  SPEAKER_00: I mean, normally it's just now viewed to be part of the combined business.
• 5:54
  SPEAKER_00: Uh, there may be certain times you have to make separate disclosures about certain VIEs or or otherwise in the footnotes that might be beyond the scope of what we'll talk about here.
• 6:04
  SPEAKER_00: But I think generally speaking, Heather, the um once you acquire the business, it's now just part of your overall assets and liabilities.
• 6:12
  SPEAKER_01: Yes, and actually Matt Sabatini and I talked last week about the VIE disclosures.
• 6:17
  SPEAKER_01: And I guess to your point, it would be in a case where there's something new that's maybe more material now or otherwise that might show up on your balance sheet.
• 6:26
  SPEAKER_01: So something to think about.
• 6:27
  SPEAKER_01: Okay.
• 6:28
  SPEAKER_01: So then moving on to the income statement, what are some of the things that we should be considering there?
• 6:34
  SPEAKER_00: Well, there's probably more things that we run into here that sort of pop out of a business combination that hit the income statement.
• 6:41
  SPEAKER_00: And they run the gamut of a lot of different kinds of things, not necessarily all one category.
• 6:47
  SPEAKER_00: They could be things like transaction costs to do the deal.
• 6:50
  SPEAKER_00: They could be restructuring charges that get taken right after the deal is done, uh, could be revaluing that contingent consideration that's liability classified, that we'll probably get into a little bit more as we go along.
• 7:04
  SPEAKER_00: Sometimes part of the consideration that's paid to the sellers is not actually viewed to be part of buying the business, it's viewed to be something else that happens concurrently with buying the business, like set like a prior relationship that you might have or a lawsuit that you might have had with the target company, and those get recognized in income right away.
• 7:26
  SPEAKER_00: Sometimes we also see if you previously held an equity interest in the company that you're now buying the rest of, you have to remeasure that to fair value and take that through the income statement.
• 7:40
  SPEAKER_00: You will have, if you're buying a company with receivables that are that aren't credit impaired, you may end up taking an immediate Cecil charge for it.
• 7:49
  SPEAKER_00: And you occasionally could get even bargain purchase gains that pop out of an acquisition, although, again, that's not a common occurrence.
• 7:55
  SPEAKER_00: So there's really a lot of different kinds of income statement items that you could run into.
• 8:00
  SPEAKER_00: And because there really isn't a ton of detailed guidance on where to record things in the income statement in general, the classification of all these items requires judgment based upon the nature of what the item is.
• 8:13
  SPEAKER_00: But generally, we would expect that it should mirror their classification outside of a business combination if you run into any of these items as well.
• 8:22
  SPEAKER_00: We would generally expect them to be recognized in operating income.
• 8:25
  SPEAKER_00: That's probably the one, the one categorical categorical thing that we uh we do see that the guidance does talk about.
• 8:32
  SPEAKER_00: There is maybe one quirky area that pops up, and that is uh related to indemnifications of tax uncertainties.
• 8:41
  SPEAKER_00: So in that case, the seller might have agreed to indemnify the buyer if there is an adverse judgment in the future on some tax issue of the acquired business, for example.
• 8:54
  SPEAKER_00: And if that happens, while the recognition of the tax exposure itself has to go through the income tax line item, the recognition of the indemnification asset or receivable back from the seller, that has to get recorded in pre-tax income.
• 9:10
  SPEAKER_00: So you get a bit of a mismatch there.
• 9:12
  SPEAKER_00: That's that's one very quirky thing we run into, but many of the other areas are a fair bit of judgment to apply.
• 9:19
  SPEAKER_01: All right.
• 9:19
  SPEAKER_01: So that's helpful.
• 9:20
  SPEAKER_01: And then another question, you know, changes in fair value measurements, and you mentioned earlier contingent considerations.
• 9:27
  SPEAKER_01: So often, I know there's a lot of different elements there.
• 9:31
  SPEAKER_01: Do you see what type of classification do you see on the income statement?
• 9:36
  SPEAKER_00: Well, we generally just do see that as one big aggregate change that gets recorded somewhere in operating income.
• 9:43
  SPEAKER_00: Again, there's not a lot of deep clarity as to exactly what line item it goes on.
• 9:47
  SPEAKER_00: But sometimes we get asked, you know, since within the calculation of that fair value number or changes in that fair value number, you have elements of time value of money, right?
• 9:58
  SPEAKER_00: As time goes on, the value changes, but also you might have changes in the estimates that make up what the amount is going to be.
• 10:05
  SPEAKER_00: And we get asked, well, should we look at those separately?
• 10:07
  SPEAKER_00: Should we somehow break those apart and report them independent of each other?
• 10:12
  SPEAKER_00: And our answer is generally no, that's just one big fair value estimate.
• 10:16
  SPEAKER_00: And as that changes, you should reflect that number in a single spot in the income statement.
• 10:21
  SPEAKER_01: All right.
• 10:22
  SPEAKER_01: So then if we turn to, I'm sure you won't be surprised by this, the statement of cash flows next.
• 10:27
  SPEAKER_01: Um, I know there's lots of different scenarios in terms of the way that a business combination could be structured and paid for, but what are some of the things that preparers should be looking out for in terms of the cash flow impacts of these various items?
• 10:43
  SPEAKER_00: Right.
• 10:43
  SPEAKER_00: Well, there's certainly uh lots of things that could come up, as you said, and maybe some of the broad, let me start with maybe the broad principle associated with this.
• 10:53
  SPEAKER_00: So, you know, what the guidance would say is that cash flows from sales or purchases of productive assets, which would include the acquisition or sale of a business, those are presented as investing activities.
• 11:07
  SPEAKER_00: So that's sort of the core approach.
• 11:09
  SPEAKER_00: Uh the unit of account is the acquired business.
• 11:13
  SPEAKER_00: So therefore, all those individual changes in any assets or liabilities acquired, like receivables or inventory or other things, those are not shown on the individual line items in the statement of cash flows.
• 11:27
  SPEAKER_00: You would just have a single line item, which is cash paid to purchase the business, perhaps net of any cash acquired that the target had, that would be an investing outflow.
• 11:40
  SPEAKER_00: Now you would have to disclose, of course, any non-cash effects of the overall transaction, including any non-cash consideration that might be issued to buy the company, like the company stock or other assets that might be given up, as well as those significant assets and liabilities acquired, which I'm sure we'll we'll get to a little bit later in the disclosures.
• 12:01
  SPEAKER_00: But those would all be non-cash items.
• 12:04
  SPEAKER_00: Now we mentioned before that you might have some transaction costs and those hit the income statement.
• 12:09
  SPEAKER_00: So because they're in the income statement, they're considered operating cash outflows.
• 12:14
  SPEAKER_00: But where things start to get a little interesting is if if you're dealing with some debt, and particularly any debt that might be assumed from the target company.
• 12:26
  SPEAKER_00: Now, in this case, if the acquirer legally assumes the debt of the target company, then we believe it'd be appropriate for the buyer to record the debt at fair value as an assumed liability in the acquisition.
• 12:43
  SPEAKER_00: And then any subsequent payments on that debt, at least the principal part of that, would be considered a financing cash outflow since the debt is now considered the legal obligation of the acquirer.
• 12:53
  SPEAKER_00: So like any other debt payment, it would be a financing outflow.
• 12:56
  SPEAKER_00: But if the acquirer doesn't legally assume the target company's debt as part of the deal, and the debt is just extinguished on the acquisition date, maybe through money that the company has funded into the escrow accounts that get paid out to lots of different parties, including the debt holders, then we believe any money that is paid to pay off that debt would just be part of the overall consideration transferred to buy the business.
• 13:26
  SPEAKER_00: And therefore it would be part of the investing cash outflow to buy that company.
• 13:31
  SPEAKER_00: Now, in some limited circumstances, it may be appropriate to consider debt that was legally assumed and then extinguished by the acquirer right afterwards to be part of the consideration transferred and be an investing activity.
• 13:48
  SPEAKER_00: But we generally find that's only when the acquirer extinguishes the debt as part of an integrated element of the closing process, and it happens really quickly, like that day or the next day or something like that, where it's clearly all part of an integrated element of buying the company.
• 14:05
  SPEAKER_00: And you'd have to be clear that the buyer, the acquirer, isn't substantively assuming any of the risks associated with that debt.
• 14:14
  SPEAKER_00: And then, of course, if you do that, if you view it that way, then you you don't want to present any of that debt as being acquired debt in the your list of the assets and liabilities that you picked up in the business combination.
• 14:26
  SPEAKER_01: All right.
• 14:27
  SPEAKER_01: So lots of details there to think about.
• 14:29
  SPEAKER_01: So then you mentioned previously contingent consideration.
• 14:33
  SPEAKER_01: And how would we think about that from a cash flow statement perspective?
• 14:38
  SPEAKER_00: Well, if if the debt was interesting, then the contingent consideration is actually really interesting because uh particularly contingent consideration that's liability classified has this sort of interesting fact pattern that often can trip you up because it's marked to market through the income statement.
• 14:54
  SPEAKER_00: So you get kind of some interesting crossover between pieces.
• 14:59
  SPEAKER_00: So it often comes down to timing.
• 15:01
  SPEAKER_00: If the payoff of the contingent consideration occurs pretty quickly after the acquisition date, like within three months or less, then we generally would say all the payments are just investing cash outflows to buy the business, which would basically be the same that we would treatment we would apply to any upfront cash that may just be paid up shortly after the acquisition, within those first couple of months.
• 15:26
  SPEAKER_00: That's just viewed as uh extended element of paying for the business.
• 15:30
  SPEAKER_00: But as it often is the case, if it goes beyond that reasonably short period of time of a couple of months or so, that's when things, as I said, can get kind of interesting.
• 15:40
  SPEAKER_00: Because invariably the amount you pay is going to be different than the original acquisition date estimated fair value that you recorded.
• 15:50
  SPEAKER_00: And those amounts go up or down, and they go through the income statement if they go up or down.
• 15:56
  SPEAKER_00: So if the ultimate payment you make is less than the original acquisition date fair value because the value came down and you recorded some income for that, then the payment is just viewed to be paying off sort of that financing, the seller provided financing, a deferred payment that we had to make to the seller.
• 16:17
  SPEAKER_00: And then that's all viewed as a financing outflow.
• 16:20
  SPEAKER_00: That's just sort of almost like debt that we had to pay off down the road.
• 16:23
  SPEAKER_00: And in fact, we would do that if it was just a fixed amount of debt.
• 16:26
  SPEAKER_00: If we said we're going to pay X today and Y a year from now, we would treat that payment of Y a year from now as a financing outflow.
• 16:35
  SPEAKER_00: But if the liability that you ultimately pay off is greater than the acquisition date fair value, which means you took some amount through the income statement as a charge, as a as an expense at the time, then we actually say for cash flow purposes, you need to split that payment between the two.
• 16:54
  SPEAKER_00: So the portion that is uh relates to the amount that's greater than the acquisition date fair value, that has to go through operating cash flows because it ran through the income statement.
• 17:06
  SPEAKER_00: And now we're actually paying off that amount that ran through the income statement.
• 17:09
  SPEAKER_00: So that's an operating cash flow.
• 17:11
  SPEAKER_00: And then any of the remaining amount, that would be considered a financing outflow.
• 17:15
  SPEAKER_00: So basically that day one value would be the financing outflow.
• 17:20
  SPEAKER_00: So that's a curious result from any company that you're kind of splitting the baby a little bit between some amount going to operating, some amount going to financing if you're paying in cash.
• 17:30
  SPEAKER_00: Obviously, if it was share settled, that would all be a non-cash transaction to get disclosed.
• 17:34
  SPEAKER_00: But when you're paying with the cash piece, you have to you, you might very well end up in multiple places on the statement of cash flows.
• 17:40
  SPEAKER_01: So, Jay, on that point, this is talking about contingent consideration.
• 17:44
  SPEAKER_01: But what if my original acquisition is for shares?
• 17:47
  SPEAKER_01: Then do I just disclose non-cash and there's nothing that hits my cash flow statement?
• 17:52
  SPEAKER_00: That's right.
• 17:52
  SPEAKER_00: Other than perhaps you have an inflow for investing activities if the target company had some cash on their boards.
• 17:58
  SPEAKER_00: So you know you ended up getting some cash without spending any cash.
• 18:02
  SPEAKER_00: So you could actually have a net uh inflow for investing activities.
• 18:06
  SPEAKER_00: But yes, other than that, if you're just paying shares, that's just a non-cash investing activity to disclose.
• 18:12
  SPEAKER_01: Right.
• 18:13
  SPEAKER_01: And I guess there's many variants of all of these, some cash, some shares, and everything else.
• 18:17
  SPEAKER_01: But I think this is a helpful overall sort of framework.
• 18:20
  SPEAKER_01: So then if we switch to disclosure requirements, uh, when would these apply?
• 18:28
  SPEAKER_00: Well, they apply both to a business combination that happens during the reporting period, uh, but also to those that happen basically in the subsequent events period after the balance sheet date, but before the financial statements go out, you are supposed to uh make these disclosures that we'll get into as part of that, to the extent you you have the relevant information available and complete at that point.
• 18:52
  SPEAKER_00: Uh and then also, you know, um we'll get into this a little bit more, but one of the other, we'll call it, um, principles underlying the disclosure requirements is that you need to disclose any adjustments that are recorded in one reporting period that might relate to acquisitions that took place in a previous reporting period but are now because of the way the guidance works, you're you may end up recording subsequent changes in future periods.
• 19:19
  SPEAKER_00: You have to make disclosures around those two.
• 19:21
  SPEAKER_01: Wow.
• 19:21
  SPEAKER_01: So then depending on the timing of your business combination, this could really uh put some strain from a uh financial reporting perspective.
• 19:30
  SPEAKER_01: So it's definitely something for the accountants to keep an eye on.
• 19:33
  SPEAKER_01: But maybe just then starting off with general, and let's not think about the stress of making these subsequent events.
• 19:40
  SPEAKER_01: Um, what are some of the general requirements for business culmination disclosures?
• 19:46
  SPEAKER_00: Well, companies need to disclose a couple of key baseline things about the merger and the company they bought.
• 19:53
  SPEAKER_00: So you should disclose the name of the company and a description of the company, meaning like the type of business that they're in.
• 20:00
  SPEAKER_00: You should disclose the acquisition date when you gain control of the company, uh, the percentage of the company you acquired, either 100% or something less than 100%.
• 20:12
  SPEAKER_00: You should disclose a description of how you obtain control of that target company.
• 20:18
  SPEAKER_00: Was it through a merger agreement?
• 20:20
  SPEAKER_00: Was it through a change in certain rights, perhaps an effective variable interest entity type of analysis?
• 20:26
  SPEAKER_00: How did you get control of it?
• 20:28
  SPEAKER_00: Uh and then also uh you know qualitative discussion about the primary reasons why you did the acquisition.
• 20:34
  SPEAKER_00: Was it to expand your product line capabilities?
• 20:37
  SPEAKER_00: Was it to uh get into new markets?
• 20:40
  SPEAKER_00: Was it to increase capacity, things like that?
• 20:42
  SPEAKER_00: So actually, some you know, some a little bit of insight as to management's reasons for doing the acquisition in the first place.
• 20:49
  SPEAKER_00: So then you do also need to disclose the total fair value of the consideration transferred to the sellers and its key components.
• 20:58
  SPEAKER_00: So that could include sort of like what you're getting at, right?
• 21:00
  SPEAKER_00: If it's a mixture of different things, that could include cash, could include your shares, it could be other assets that you gave up, a business that you issued an exchange, a note, contingent consideration, all of that.
• 21:12
  SPEAKER_00: You have to kind of break that down into its different different pieces and their fair value.
• 21:17
  SPEAKER_00: And if the acquisition had happened in stages and you previously owned some equity interest in that target company, uh, as I mentioned before, those get remeasured to fair value in acquisition accounting and recognized in income.
• 21:31
  SPEAKER_00: So if that happens, you need to disclose how much that was and the gain or loss that was recognized and where it is in the income statement, along with some information about how that value was determined and any key estimates or judgments that were involved in doing that.
• 21:49
  SPEAKER_00: So all of these types of disclosures and really all the stuff that we're going to talk about here, those are supposed to be disclosed for each material business combination that happens during the Period.
• 22:00
  SPEAKER_00: And if you have multiple immaterial transactions that may very well be aggregated up and combined and disclosed together as well.
• 22:08
  SPEAKER_01: All right.
• 22:09
  SPEAKER_01: So one thing I noticed was mis missing was contingent consideration, which is something we focused on for the balance sheet income statement and cash flow.
• 22:18
  SPEAKER_01: So how about from a disclosure perspective?
• 22:21
  SPEAKER_00: Right, right.
• 22:21
  SPEAKER_00: So I mean I mentioned you need to disclose the amount that you recorded for it, but you need to go a little bit deeper in it because obviously it's a rather judgmental element as well as an exposure to perhaps pay more than when we have whatever amount you've recorded.
• 22:36
  SPEAKER_00: So the guidance does say that you have to disclose a description of the earnout arrangement and the basis for how the ultimate amount of the payment will be determined when you get to the end.
• 22:49
  SPEAKER_00: You have to disclose the amount you've recognized on the acquisition date and where that is on the balance sheet, which could either, as I said before, be a liability or equity.
• 22:59
  SPEAKER_00: And then you also have to disclose an estimate of the range of outcomes that you could have to kind of give people a sense of the potential exposure for either issuing more cash or more shares than is on the balance sheet right now.
• 23:14
  SPEAKER_00: Or if you can't estimate a range, you have to disclose that fact and the reasons why you can't estimate the range.
• 23:21
  SPEAKER_00: And in some cases, the maximum amount may even be unlimited, although that seems like a pretty uh pretty uh interesting situation to be in.
• 23:29
  SPEAKER_00: And if that if you have that situation, you have to disclose that as well.
• 23:33
  SPEAKER_01: Yeah, it's definitely interesting.
• 23:35
  SPEAKER_01: So then how about the items coming onto the balance sheet?
• 23:38
  SPEAKER_01: Because we talked earlier about the fact that once they're acquired, you're not going to see them typically separately on the balance sheet.
• 23:45
  SPEAKER_01: And I know that's something often financial statement users are quite interested in understanding.
• 23:51
  SPEAKER_01: So, what are the exact disclosure requirements around that?
• 23:54
  SPEAKER_00: Sure.
• 23:54
  SPEAKER_00: So what the guidance talks about is that you do need to disclose that the amount you recognized at fair value, or in some cases it's not fair value, mostly fair value, but the guidance has a few exceptions to fair value.
• 24:06
  SPEAKER_00: But you have to show how much has been recognized for any assets acquired and liabilities assumed at the date of the acquisition, along with the fair value of any non-controlling or minority interests that might be out there if you didn't acquire 100% of the company.
• 24:24
  SPEAKER_00: And usually that disclosure would be to show each major class of assets and liabilities.
• 24:30
  SPEAKER_00: And it's usually it in some type of tabular format that reconciles the total consideration transferred to the assets and liabilities that were acquired.
• 24:41
  SPEAKER_00: Now, where that often comes down to is goodwill at the at the end, right?
• 24:45
  SPEAKER_00: As to once you figure out how much you paid and how much all the other identifiable assets and liabilities are, you have goodwill, which is often recorded.
• 24:53
  SPEAKER_00: And there are some additional disclosure requirements specifically associated with goodwill, uh, both qualitative and quantitative.
• 25:00
  SPEAKER_00: One is a qualitative discussion of the factors that are viewed to make up the goodwill.
• 25:07
  SPEAKER_00: Maybe that's things like expected synergies from combining the operations of the two companies, uh maybe certain intangible assets that just don't qualify for separate recognition under the guidance like a workforce in place or things like that, or whatever other factors that you think kind of give rise to the goodwill, even though it's a it's a it's a amorphous number that you can't kind of pinpoint to anything specific and you don't have to do, but you you are supposed to give some qualitative assessment of it.
• 25:35
  SPEAKER_00: Uh, you do need to disclose the total amount of goodwill that will be deductible for tax purposes or is expected to be deductible for tax purposes.
• 25:44
  SPEAKER_00: And then if you're a public company that reports segments, you you also need to do a breakdown of the goodwill by segments to the extent that you've completed that work at this time.
• 25:55
  SPEAKER_00: Then there's also kind of for a number of specific uh assets and liabilities, there are some additional specific disclosure requirements, certain things under the CISO model, or lease receivables, or contingent assets and liabilities, or indemnifications.
• 26:12
  SPEAKER_00: And then those are kind of detailed and a little less common.
• 26:15
  SPEAKER_00: So maybe rather than getting into them here, um I will observe that we do talk about them in chapter 17 of our financial statement presentation guide, which is where all the business combination uh disclosure requirements are.
• 26:28
  SPEAKER_01: All right, and we'll include a note in the show notes to that or a link.
• 26:31
  SPEAKER_01: But so, Jay, before we go on, you start, you preface this discussion with the fact that it doesn't matter if it's in the subsequent events period, you still have to make these disclosures.
• 26:41
  SPEAKER_01: And I kind of alluded to the fact that that could be kind of difficult.
• 26:45
  SPEAKER_01: And in particular, if you know this happens only a few days before you're, let's say, issuing your financial statements.
• 26:52
  SPEAKER_01: Do we see any leeway to do some of these at a more combined level?
• 26:57
  SPEAKER_01: Or is there really an expectation that you're gonna have all this information, even you know, if it's very close to the end of the period or at, sorry, past the end of the period in your subsequent events period?
• 27:10
  SPEAKER_00: Right.
• 27:10
  SPEAKER_00: Well, um the the guidance does give a little bit of an out to say that a temporary out, that if you don't have the information available yet, perhaps because it's so soon uh right before you're going to issue your financial statements that took place, then you can disclose what you can't disclose yet and sort of catch up the next period.
• 27:33
  SPEAKER_00: Uh it's sort of anticipated or expected that you will try to make disclosures, but in if you just can't, then you you don't.
• 27:41
  SPEAKER_00: Uh and we'll probably get into a little bit of um you know other kind of measurement period adjustments, things that change, right?
• 27:49
  SPEAKER_00: Because there's other things even in the accounting for business combinations that gives you a little bit of a window of time to finish the valuation work and the like.
• 27:57
  SPEAKER_00: You know, it's it's acknowledged that valuations are hard and and can't always be done for a lot of assets immediately or you know, very, very quickly.
• 28:05
  SPEAKER_00: And so there is a little bit of leeway built into the guidance.
• 28:08
  SPEAKER_00: And this is one of the areas that that that leeway is built in, that if you just can't get the information uh in time, then you can sort of disclose that point and uh catch up with it the next time around.
• 28:19
  SPEAKER_01: All right.
• 28:19
  SPEAKER_01: And we'll hold that thought on the measurement period adjustments because I do have like one or two other specific questions, then we'll get to that.
• 28:26
  SPEAKER_01: Because you had mentioned previously, and I think this is a great point, that often you know, a company has may have to break out if they had certain transactions outside of a business combination.
• 28:37
  SPEAKER_01: Like, for example, if they had, if you had a pre-existing relationship between the acquirer and the acquiree, um, that maybe you're getting settled or some other payments that are compensatory rather than part of the purchase price.
• 28:51
  SPEAKER_01: So, in the event you have some of those situations, what are the disclosure requirements?
• 28:56
  SPEAKER_00: Right.
• 28:57
  SPEAKER_00: So, so for those, and you mentioned some of the key ones that take place where it's sort of viewed that the transaction maybe was entered into on behalf of the acquirer or for the benefit of the acquirer.
• 29:10
  SPEAKER_00: Uh, and therefore you have to separate it out and you know, either account for it as a settlement of a pre-existing arrangement or compensation for former owners who are also employees that are going to get paid some amounts.
• 29:23
  SPEAKER_00: And you know, that there's some complex accounting, I'll say around that first, that that we talk about in our business combinations guide.
• 29:31
  SPEAKER_00: I think it's in chapters both two and three, because three talks about compensation arrangements and two talks about the topic more broadly that listeners can can look at.
• 29:41
  SPEAKER_00: But if you have one of those, then the guidance does have a couple of specific disclosure requirements.
• 29:46
  SPEAKER_00: Uh, it says you have to describe what they are, you have to describe what the accounting that you've done for that arrangement is, uh, the amount that's been recognized for each of those kinds of transactions, and where in the income statement that that's been presented.
• 30:01
  SPEAKER_00: And if the transaction was the settlement of a pre-existing relationship, like maybe a license agreement or a distribution agreement or a lawsuit, something where you have to kind of calculate an amount.
• 30:15
  SPEAKER_00: Uh, it's not obviously specifically identified.
• 30:18
  SPEAKER_00: You have to kind of figure out how much is the fair value of that settlement or or the amount that you have to recognize based on the guidance.
• 30:26
  SPEAKER_00: So in that case, you'd have to disclose a little bit about how you determine that fair value, considering it's a bit of a judgmental amount.
• 30:32
  SPEAKER_01: All right.
• 30:33
  SPEAKER_01: So then let me go back to what you um mentioned earlier, which is this little bit of flexibility you may have for the fact that sometimes you're uh you make adjustments to your initial business combination accounting or your purchase accounting in a subsequent period, you know, as you get more information or otherwise.
• 30:53
  SPEAKER_01: So obviously today we're focused on disclosure.
• 30:56
  SPEAKER_01: So we won't get too much into these what are called measurement period adjustments.
• 31:02
  SPEAKER_01: But how about from a disclosure, maybe just a brief background on the measurement period and then really hone in on the disclosure requirements in that circumstance?
• 31:11
  SPEAKER_00: Right.
• 31:11
  SPEAKER_00: No, that's definitely true that the guidance does provide a period of time to get the final valuations done as of the acquisition date, or in some cases, complete all the relevant accounting that's necessary.
• 31:24
  SPEAKER_00: And that's described in the guidance as the measurement period.
• 31:28
  SPEAKER_00: And that can be up to a year long, but it's not automatically a year.
• 31:34
  SPEAKER_00: It's supposed to end once you have all the relevant information as of the acquisition date.
• 31:39
  SPEAKER_00: Uh, so it's a little bit gray as to exactly how long that period is.
• 31:43
  SPEAKER_00: Um, if but if you have it, so you maybe you're not quite complete with all of your accounting or valuation as of yet, then what you should do is you should include disclosures about what is incomplete at that time, at the end of the reporting period, and then also any changes that have got uh been made to the amounts once the amounts are actually finalized, if that happened during the current period.
• 32:07
  SPEAKER_00: So all of that would include things like what disclosures can't be made or what amounts are not um final as of yet are still preliminary, maybe the reasons why that is the case.
• 32:21
  SPEAKER_00: You know, why isn't it all complete yet?
• 32:23
  SPEAKER_00: What is it that you're waiting for?
• 32:25
  SPEAKER_00: And then for any actual changes that you record as a measurement period adjustment.
• 32:30
  SPEAKER_00: So maybe you did an acquisition last year, you hadn't finished all the valuations, you finish all the valuations this year, and there's an amount that's different from what you had preliminarily recorded in the original acquisition, then you have to do a catch-up for that in the current period.
• 32:46
  SPEAKER_00: And so you have to disclose how much that was, as well as any amounts that actually ran through the income statement this year that are really just sort of like catching up what say depreciation or amortization would have been had you had the right numbers all along, right?
• 33:03
  SPEAKER_00: And you had been recording different amounts all along.
• 33:06
  SPEAKER_00: You know, now you have to do a catch-up of that.
• 33:07
  SPEAKER_00: You just kind of book it as an out-of-period adjustment, effectively in the period you figure it out, but you do have to disclose what that amount uh is so that people can understand kind of what that out-of-period amount is.
• 33:19
  SPEAKER_00: And if you really wanted to, you could you could uh actually present it separately on the income statement.
• 33:24
  SPEAKER_00: Although I think we more typically just see it disclosed in the notes, unless it's a really, really big number.
• 33:29
  SPEAKER_00: Although, if it's a really, really big number, then you probably have to think about was it an error in the application of your best estimate of preliminary information at the time.
• 33:38
  SPEAKER_00: Um there's no bright lines around that, but but you do have to make a, I'll call it a good college try when um when you're doing your original accounting, and you know, you can't just you can't just pull numbers out of thin air.
• 33:50
  SPEAKER_00: You have to come up with a reasonable estimate, or what you think is a reasonable estimate, not that estimates can't change, but if um if it turns out when you get your final valuations like you were way off and maybe you just completely missed something and how you went about estimating it, then you have to think a little bit about whether that's an error as well.
• 34:10
  SPEAKER_00: But but that's uh that's a topic for another day, I guess, as well.
• 34:12
  SPEAKER_01: All right.
• 34:13
  SPEAKER_01: Well, and good reminder there, but before you go on, do one question, because you mentioned sort of current year versus maybe the prior year, assuming your acquisition was in a prior year.
• 34:23
  SPEAKER_01: But I just wanted to clarify, what if you made your acquisition, let's say, in Q1 and then you made your updates in Q3?
• 34:31
  SPEAKER_01: Would this same sort of thinking apply?
• 34:34
  SPEAKER_01: Or is this really only if it crosses um fiscal years, assuming you're a public company reporting quarterly financial statements?
• 34:41
  SPEAKER_00: Uh I think it would apply to both.
• 34:42
  SPEAKER_00: I think when you're doing the interim period, say that in your example, your Q3 reporting, it is an out-of-period item to Q3.
• 34:50
  SPEAKER_00: And so you should reflect it that way.
• 34:53
  SPEAKER_00: Uh certainly if you get to the end of the year, it's all within the year.
• 34:57
  SPEAKER_00: So maybe it's a little less relevant than.
• 34:59
  SPEAKER_00: But I think when you're doing your interim reporting and you you have a catch-up from a prior interim period in the same year, you you would make this kind of disclosure too.
• 35:07
  SPEAKER_01: Maybe just then we should talk about this if you're making changes to your liability classified contingent consideration, because you also talked about the fact that those get remeasured at fair value.
• 35:18
  SPEAKER_01: So, what types of things should you be thinking about with those?
• 35:21
  SPEAKER_00: Right.
• 35:22
  SPEAKER_00: Um, no, that's certainly fair that that because that's a a um a level three type fair value disclosure uh in the fair value hierarchy, that any changes you make should get disclosed.
• 35:37
  SPEAKER_00: You should make whatever whatever ASCA20 for fair value disclosure requirements uh tell you to do, as well as just reporting, disclosing where how much was the change and where it is recorded in the income statement.
• 35:50
  SPEAKER_00: Uh, and also, since I mentioned before, you're supposed to disclose a range of outcomes.
• 35:55
  SPEAKER_00: If there is a change in those range of outcomes, for for some reason, you should disclose that as well.
• 36:01
  SPEAKER_01: All right, that's helpful clarification, particularly given sort of the dynamic nature of the initial accounting.
• 36:07
  SPEAKER_01: But any other big ticket items that we should be focused on?
• 36:11
  SPEAKER_00: Well, I think we definitely need still to talk about pro forma disclosures and some of the SEC rules that public companies have to deal with.
• 36:21
  SPEAKER_00: But maybe before getting to the public company side of things or public company only side of things, I'll I will mention there's a there's some special provisions and disclosure requirements for certain types of transactions that come up less frequently that we haven't really touched on here, like partial acquisitions and reverse acquisitions and common control mergers and the like, uh that we talk about as well in chapter 17 of our financial statement presentation guide that that uh folks can look at as well.
• 36:50
  SPEAKER_01: So, Jay, um uh you raise a good point here, which is you know, we've been, I think, talking broadly about all the requirements for business combinations and uh definitely a lot to think about.
• 37:01
  SPEAKER_01: But from a public company perspective, there's actually even more to think about, pro formless, but otherwise.
• 37:08
  SPEAKER_01: So can you hit some of the highlights of the additional requirements for public companies?
• 37:13
  SPEAKER_00: Sure.
• 37:13
  SPEAKER_00: No, you're right that public companies do have to include several additional disclosures for acquired companies, and these can definitely be a little challenging to accumulate.
• 37:23
  SPEAKER_00: Uh, one is the amount of revenue and earnings of the acquired company, such as the target company, since the acquisition date that's been included in the consolidated income statements.
• 37:37
  SPEAKER_00: We're just trying to isolate how much is from the acquired company post-acquisition.
• 37:41
  SPEAKER_00: Now, that's not really a pro forma number, it's actual numbers, but it does require keeping track of this information separately for the rest of the fiscal year, which could be a challenge, especially if the goal is to integrate the acquired business into the rest of the company's operations or it's being split up into multiple reporting units, you still have to be able to keep track of the information at least through the rest of the year.
• 38:05
  SPEAKER_00: And then the big one, as you alluded to, that we often run into is the pro forma disclosures.
• 38:10
  SPEAKER_00: And that is a disclosure about the amount of revenue and earnings of the whole company, the combined company, for the current year of the acquisition and the prior comparative year, as if the business combination had occurred as of the beginning of that prior year.
• 38:31
  SPEAKER_00: So it's kind of going backwards and pretending a little bit as if that just that acquisition took place then.
• 38:37
  SPEAKER_00: What would you have been your combined results had that been the case?
• 38:42
  SPEAKER_00: So, and then you also have to disclose the nature of any material pro forma adjustments that you made in getting to those, and what that includes is things like pushing the acquisition date, fair value of long-lived assets or intangible assets back to that initial date, and then computing the hypothetical amount of depreciation or amortization that you would have had, pushing any debt that's issued to complete the acquisition back to that initial date, and computing any hypothetical amount of interest expense that you would have had on that debt.
• 39:19
  SPEAKER_00: Perhaps aligning any different accounting policies between the two companies if there's any differences, eliminating any inter-entity revenue transactions if there's any of those, and then figuring out the income tax effect of all of that.
• 39:31
  SPEAKER_00: So, you know, there's a lot of stuff to be done, and it's all kind of hypothetical because obviously the businesses didn't operate together, they're not gonna reflect those numbers in reality.
• 39:42
  SPEAKER_00: You don't have the synergies that you know you hope to acquire and things like that.
• 39:46
  SPEAKER_00: Um, so it's not easy to go back and get all this information.
• 39:49
  SPEAKER_00: So I guess definitely suggest getting ahead of this early.
• 39:52
  SPEAKER_00: You know, if you're if you're working, if your company is doing an acquisition that, um, particularly if you haven't done one in a while, that this is definitely a topic to get ahead of because it's a lot to accumulate to do to do all these disclosures.
• 40:08
  SPEAKER_00: And I will note that what I just mentioned is just a gap requirement, uh, not any separate SEC requirements.
• 40:15
  SPEAKER_00: Acquisitions often trigger other SEC filing requirements, such as either audited financial statements of the acquired business that have to be filed under Rule 305 of Regulation SX, depending on the significance of the acquisition, as well as different pro forma financial information that's required under Article 11 of Regulation SX.
• 40:39
  SPEAKER_00: And unfortunately, the SEC's rules are different than the gap rules that I just went through.
• 40:44
  SPEAKER_00: Uh, and those rules, the SEC's rules, just changed not too long ago.
• 40:48
  SPEAKER_00: Uh, so there's there's a lot to work through, and that's probably beyond what we can talk about today on this podcast.
• 40:54
  SPEAKER_00: Although we did issue a couple of in-depths uh I had noticed when I was when I was um thinking about this stuff before, one in 2020 and one in 2021, both of which are available on Viewpoint that talk about some of these uh SEC rule changes uh on pro formas and acquired financial statements.
• 41:14
  SPEAKER_01: All right.
• 41:15
  SPEAKER_01: And we will definitely include links to those in the show notes.
• 41:18
  SPEAKER_01: So hitting the home stretch then, Jay, and you sort of answered this question, but I'm going to ask it specifically, is even listening to this podcast kind of raised my stress levels, thinking the difficulty of dealing with business combinations in practice and past experience.
• 41:36
  SPEAKER_01: But I know you you deal with a lot of teams and clients that are kind of in the midst of one of these.
• 41:42
  SPEAKER_01: And so, other than getting ahead of it, any other specific advice that you've seen is sort of best practice uh for companies or or that the auditors to think about?
• 41:54
  SPEAKER_00: Well, certainly working in conjunction with your valuation professionals is a big part of this, right?
• 42:00
  SPEAKER_00: Who whoever you're going to be working with to help do the valuations of the acquired uh intangibles and other things.
• 42:06
  SPEAKER_00: Uh yeah, they're they're they're very helpful in being able to uh kind of think about this information as well.
• 42:13
  SPEAKER_00: Uh part of it is probably thinking about how about how many acquisitions you do, right?
• 42:18
  SPEAKER_00: I mean, we we talk about these sort of the disclosure requirements for each acquisition, but it's even you know multiple layers of complexity if you do a lot of acquisitions during the year, and then kind of thinking about and maybe having some degree of parameters within your organization as to, and you know, working with your auditors, as to um what should get disclosed on its own, you know, what is material enough to get disclosed on its own, what might you aggregate up into the notion of multiple immaterial acquisitions that you could report on a combined basis, uh just trying to take stock of all of these things, as well as, you know, since there's a lot of disclosures that happen on a recurring basis for changes that take place, kind of making sure there's good um good connectivity between the different departments who are probably in the organization that are involved in this, right?
• 43:08
  SPEAKER_00: There's the MA or corporate development department, there's often treasury is involved in some of the financing aspects.
• 43:15
  SPEAKER_00: You've whoever's doing some of the fair value calculations, and you know, somebody's probably keeping track of that earnout, knowing to figure out how much they're gonna have to pay down the road.
• 43:25
  SPEAKER_00: So there's a lot of different players that are that often have their hands in this.
• 43:29
  SPEAKER_00: So just making sure there's good connectivity between everybody, and that's not we I think I probably said that on a number of our podcasts that we've done together, right?
• 43:37
  SPEAKER_00: That there's this is not unique to business combinations, but business combinations does definitely cross over a lot of different uh elements or you know pieces of the organization, including international operations as well.
• 43:49
  SPEAKER_00: We didn't even talk about foreign exchange considerations in here, which is probably uh you know another another element of it as well.
• 43:55
  SPEAKER_00: So there's just a lot of different players to uh to make sure you're you stay connected with.
• 44:00
  SPEAKER_01: Yes, sounds like you need to have a good project management plan.
• 44:03
  SPEAKER_01: So um, all right.
• 44:04
  SPEAKER_01: So then Jade, just to wrap things up, we'll get to the fun part of the podcast.
• 44:08
  SPEAKER_01: And I will be slightly shocked if you can't answer this question, even though it's meant to stump you.
• 44:15
  SPEAKER_01: I think it might be a sign of the age of the people helping me prepare these questions, which are much younger relatively than us.
• 44:24
  SPEAKER_01: So the first one Much less experienced.
• 44:26
  SPEAKER_01: Yes, there you go.
• 44:27
  SPEAKER_01: There you go.
• 44:28
  SPEAKER_01: So, Jay, so when and what statement number from the FASB introduced the purchase method of accounting for business combinations and prohibited the use of pooling of interests?
• 44:41
  SPEAKER_00: Well, I can give you the number.
• 44:42
  SPEAKER_00: That was FAS 141.
• 44:45
  SPEAKER_00: Yes.
• 44:45
  SPEAKER_00: Um, I don't know that I could tell you exactly what year that that was.
• 44:51
  SPEAKER_00: It was probably in the uh the mid-2000s or so that that came out.
• 44:57
  SPEAKER_00: But uh but but I don't remember the exact year.
• 45:00
  SPEAKER_01: So very well, definitely write on the statement number, but it was actually issued according to the facts I have here in 2001.
• 45:08
  SPEAKER_01: So earlier, it's been actually 20 years that we've no pooling of interest.
• 45:13
  SPEAKER_01: So very interesting.
• 45:16
  SPEAKER_00: And back then at the time, I do remember it, and uh I just remember the year, but back then at the time, there was a uh sky is falling kind of mentality that when you know when we went away from the pooling of interests and uh required everybody to record purchase acquisition business combinations at fair value, people were were observed were saying that the um MA world was going to fall apart and no one would do deals anymore.
• 45:42
  SPEAKER_00: Uh and then you throw in things like contingent consideration, which you know creates a lot of those complexities that people were were saying, oh, it'll change the entire MA framework.
• 45:51
  SPEAKER_00: But it did not.
• 45:52
  SPEAKER_00: Um, life life went on.
• 45:53
  SPEAKER_00: We all figured out how to how to handle it and um and do the accounting under that guidance, as well as its successor, which is FAS 141R or FAS 141 revised, which I also couldn't tell you what year exactly that that that came out in either, but uh that that um refined some some of the uh information that we work with as well.
• 46:17
  SPEAKER_01: Fact check.
• 46:19
  SPEAKER_01: So as I mentioned to Jay, he was right on the statement number.
• 46:22
  SPEAKER_01: It was 141, but the date it was issued was 2001.
• 46:27
  SPEAKER_01: So half a point to Jay.
• 46:32
  SPEAKER_01: And then this one I actually don't have the answer to, but it's more reminiscent of the other questions I've asked you, which is what was the first guidance about business combinations?
• 46:43
  SPEAKER_00: Well, what I remember, uh, which was superseded by that FAS 141 guidance, was APB, your accounting principals board statements 16 and 17, one related to acquisitions and talked about pooling of interest as well, and one was about intangible assets.
• 47:01
  SPEAKER_00: That goes back to the 1970s or so.
• 47:04
  SPEAKER_00: Uh, interestingly enough, that guidance, the other thing that changed a fair bit, was that that guidance used used to have you amortize goodwill.
• 47:12
  SPEAKER_00: And as you well know, and many of our listeners do as well, that is on the FASB's agenda, front and center on their agenda right now as well to reconsider whether whether they go back to amortizing goodwill.
• 47:24
  SPEAKER_00: So what what's old is new again sometimes in in this area, like like many parts of a county.
• 47:29
  SPEAKER_01: Exactly.
• 47:30
  SPEAKER_01: So and I bet if we go even further back, there might be something at ARB 43, but we'll check that fact.
• 47:40
  SPEAKER_01: Fact check.
• 47:41
  SPEAKER_01: After the show, Jay shared with me that ARB 48 was a standalone standard on BISCOM issued in 1957.
• 47:49
  SPEAKER_01: And it looks like it superseded a chapter on ARB 432, which was issued back in 1953.
• 47:56
  SPEAKER_01: So, as always, thanks for the extra history lesson, Jay.
• 47:59
  SPEAKER_01: Always appreciate it.
• 48:03
  SPEAKER_01: But anyway, Jay, I should have known, couldn't really stump you on this.
• 48:06
  SPEAKER_01: But as always, I appreciate you having having you on the show.
• 48:10
  SPEAKER_01: Thanks for joining me today.
• 48:12
  SPEAKER_00: Sure, thanks for having me, Heather.
• 48:15
  SPEAKER_01: Join me back here every Tuesday and Thursday for new podcast episodes.
• 48:19
  SPEAKER_01: Next Tuesday, Jay is back with me again.
• 48:22
  SPEAKER_01: This time he and I are talking about segment disclosures.
• 48:25
  SPEAKER_01: The last time we covered this topic was more than two years ago, so it's a good time for a refresher.
• 48:31
  SPEAKER_01: And next Thursday, we're wrapping up our current events update with the latest on tax policy.
• 48:36
  SPEAKER_01: This is definitely a hot topic, so I'm happy to have Rohit Kamar back with me to help us make sense of it all.
• 48:42
  SPEAKER_01: So that you never miss an episode, follow the PWC Accounting Podcast series wherever you listen to your podcasts.
• 48:49
  SPEAKER_01: From Thought Leadership at PWC, I'm Heather Horn.
• 48:53
  SPEAKER_01: Thanks for tuning in.
• 48:59
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• 49:03
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• 49:05
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