New Developments Summary

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1 April 15, 2008 NDS Revised for FASB Codification July 1, 2009 New Developments Summary Business combinations FASB Statement 141 (revised 2007) (ASC 805) Summary On December 4, 2007, the FASB issued Statement 141 (revised 2007), Business Combinations (FASB Accounting Standards Codification TM (ASC or Codification) 805, Business Combinations), which will change how a reporting enterprise accounts for the acquisition of a business in fiscal years beginning after December 15, When effective, Statement 141R (ASC 805) will replace existing Statement 141 (not included in Codification) in its entirety, and will carry forward the existing requirements to account for all business combinations using the acquisition method (formerly called the purchase method). Under ASC 805, business combination accounting will apply to a wider range of transactions and events, including acquisitions of some development stage companies, combinations of mutual entities, acquisitions without the exchange of consideration, and the initial consolidation of a variable interest entity that is a business. ASC 805 will eliminate the current cost-based purchase method under Statement 141, which recognizes the acquired business as the sum of (a) separately valued individual purchase layers (as in a step acquisition) and (b) the carryover of the acquiree s basis for any remaining noncontrolling ownership interest in the acquiree. In general, ASC 805 will require acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree. Under ASC 805, the value of the business acquired usually will be measured as the sum of the acquisition-date values (measured at fair value, with a few exceptions) of the following: Consideration transferred for the acquiree Equity interests in the acquiree held by the acquirer immediately before the acquisition date (for an acquisition achieved in stages, also known as a step acquisition) Noncontrolling interests in the acquiree held by third parties (in a partially owned subsidiary) The new measurement requirements will result in the recognition of the full amount of acquisition-date goodwill including amounts attributable to noncontrolling interests. The acquirer will recognize in income any gain or loss due to remeasurement to acquisition-date fair value of consideration transferred or of previously acquired equity interests in the acquiree. Neither the direct acquisition-related costs incurred to

2 Grant Thornton LLP 2 effect a business combination nor any costs the acquirer expects but is not obligated to incur under a plan to restructure an acquired business will be included as part of the business combination accounting. ASC 805 applies prospectively to business combinations with an acquisition date on or after the beginning of the first annual reporting period beginning on or after December 15, The acquisition method under ASC 805 will not apply to subsequent acquisitions of some or all of the noncontrolling interest in a subsidiary after the date of the business combination. FASB Statement 160, Noncontrolling Interests in Consolidated Financial Statements: an amendment of ARB No. 51 (ASC , Consolidation), issued concurrently with Statement 141R (ASC 805), provides new guidance on the accounting for changes in the acquirer s ownership interests in a consolidated subsidiary and the presentation of noncontrolling equity interests in consolidated financial statements. ASC is effective for fiscal years beginning on or after December 15, 2008 (see NDS , Noncontrolling interests in consolidated financial statements: FASB Statement 160 ). This bulletin highlights the provisions in ASC 805 that will change business combination accounting. It is not a substitute for reading and applying the specific guidance in ASC 805 and other applicable accounting literature. Contents A. Background... 3 B. Overview... 4 C. Scope... 6 Definition of a business combination... 6 Definition of a business... 7 Scope exclusions... 7 D. Acquisition method... 8 Identification of the acquirer... 8 Reverse acquisition... 8 Acquisition date... 9 Measurement period... 9 What is part of the business combination transaction? Acquisition-related (transaction) costs Compensation to employees or former owners of the acquiree Effective settlement of a preexisting relationship Identifiable assets acquired, liabilities assumed, and noncontrolling interests: general principles Recognition principle Classification principle Measurement principle Identifiable assets acquired and liabilities assumed: specific guidance Assets and liabilities arising from contingencies Assets held for sale Assets with uncertain cash flows (valuation allowances) Employee benefits Income taxes Indemnification assets Insurance and reinsurance contracts Leases Reacquired rights Research and development Restructuring costs... 21

3 Grant Thornton LLP 3 Acquisition-date value of the acquiree Business combination achieved in stages (step acquisition) Noncontrollng interests in a partially owned acquiree Goodwill or gain on a bargain purchase Goodwill impairment testing Consideration transferred for the acquiree Acquisition-date measurement gains and losses Equity securities issued Contingent consideration Replacement share-based payment awards Mutual entities Fair value measurement Full adoption of ASC 350 for goodwill and intangible assets Transition E. Disclosures Disclosure objectives Amended disclosure requirements in other pronouncements SAB 74 (Topic 11:M) disclosures for SEC registrants F. Effective date and transition Transition for amendments to ASC G. International convergence Appendix A Amendments of other accounting standards [appendix E of Statement 141R] Amendments to level (a) GAAP discussed in this New Developments Summary Other level (a) GAAP pronouncements amended in appendix E of Statement 141R FASB Statements, Interpretations, Technical Bulletin, and Staff Position nullified Appendix B: Disclosure supplement A. Background On December 4, 2007, the FASB issued Statement 141 (revised 2007), Business Combinations (FASB Accounting Standards Codification TM (ASC or Codification) 805, Business Combinations), which will change how a reporting enterprise accounts for the acquisition of a business in fiscal years beginning after December 15, In 2001, the FASB issued Statement 141, Business Combinations (not included in Codification), to require that all business combinations be accounted for using the purchase method and to provide new guidance on the recognition of intangible assets separately from goodwill. Statement 141 carried over the purchase method measurement and recognition provisions from Accounting Principles Board (APB) Opinion 16, Business Combinations (not included in Codification), without reconsideration. After issuing Statement 141, the FASB addressed purchase method procedures as part of a joint project with the IASB to develop a converged standard for business combinations accounting. The Boards reached the same conclusions on most, but not all, of the issues addressed in the project. As a result of this project, the FASB issued Statement 141R (ASC 805) Statement 160, Noncontrolling Interests in Consolidated Financial Statements: an amendment of ARB No. 51 (ASC , Consolidation) (see NDS )

4 Grant Thornton LLP 4 In January 2008, the IASB issued the following corresponding international standards: International Financial Reporting Standard 3 Business Combinations (revised 2008) (IFRS 3) International Accounting Standard 27 Consolidated and Separate Financial Statements (revised 2008) (IAS 27) This bulletin highlights the provisions in ASC 805 that will change business combinations accounting. It is not a substitute for reading and applying the specific guidance in ASC 805 and other applicable accounting literature. B. Overview When effective, Statement 141R (ASC 805) will replace existing Statement 141 in its entirety. ASC 805 carries forward the existing requirements: To account for all business combinations using the acquisition method (formerly called the purchase method) To identify the acquirer for every business combination To recognize intangible assets acquired separately from goodwill based on contractual and separability criteria. The FASB reaffirmed that an assembled workforce acquired in a business combination is subsumed into goodwill. ASC 805 expands the scope of business combination accounting to include more transactions and events, and provides new measurement, recognition, and disclosure requirements. ASC 805 will supersede the cost accumulation and allocation approach to business combinations accounting under Statement 141 and step acquisition accounting, which results in recognizing the acquired business (acquiree) as the sum of (a) separately valued individual purchase layers, one for each separate equity acquisition and (b) the carryover of the acquiree s basis for any remaining noncontrolling ownership interests in a partially owned subsidiary. Instead, ASC 805 will require 1. Recognition of the full acquisition-date value of identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree, all measured at fair value with a few exceptions 2. Measurement of the total value of the acquiree as the sum of the acquisition-date values (generally fair values) of a. The consideration transferred for the acquiree b. Any equity interests in the acquiree held by the acquirer immediately before the acquisition-date if the acquisition was achieved in stages (a step acquisition) c. The noncontrolling interests in the acquiree 3. Recognition of goodwill (or a gain on a bargain purchase) measured as the difference between the total value of the acquiree (item 2 above) and the acquisition-date value of the identifiable assets acquired and liabilities assumed (item 1 above). The result of these new measurement requirements

5 Grant Thornton LLP 5 will be the recognition of acquisition-date goodwill amounts attributable to noncontrolling interests in addition to the amounts attributable to the acquirer s controlling interest. Significant amendments to other accounting standards Readers should be aware that appendices E and F of Statement 141R (appendices are not included in the Codification) contain significant amendments to other accounting standards and authoritative literature, some of which are not fully described in the standard section of Statement 141R. In addition, although Statement 141R (ASC 805) will not retrospectively change the accounting for previous business combinations, it will prospectively affect the accounting for some items recognized in previous business combinations. Therefore, some of those amendments will affect companies, regardless of whether they have a business combination transaction accounted for under ASC 805. For example, companies should consider the following: Both Statement 141R (ASC 805) and Statement 160 (ASC ) amend ASC 350, Intangibles Goodwill and Other (FASB Statement 142, Goodwill and Other Intangible Assets), to change the impairment test for goodwill, including goodwill recognized before the effective date of the new statements (see Goodwill impairment testing ). Statement 141R (ASC 805) also amends ASC 350 To require additional disclosures about changes in the carrying amount of goodwill during a period To limit the amortization period for a reacquired right that the acquirer previously granted to the acquiree (see Reacquired rights ) To incorporate consideration of market participant assumptions for an asset s highest and best use when measuring assets at fair value (consistent with ASC 820, Fair Value Measurements (FASB Statement 157, Fair Value Measurements)) for all acquired intangible assets, including those acquired outside of a business combination (see Measurement principle for a discussion of ASC 820 examples on the highest and best use in fair value measurements) Statement 141R (ASC 805) amends the requirements in ASC , Income Taxes (FASB Statement 109, Accounting for Income Taxes), and in the uncertain tax position guidance of ASC 740, Income Taxes (FASB Interpretation 48, Accounting for Uncertainty in Income Taxes), for recognizing changes in a valuation allowance for an acquired entity s deferred tax asset or changes in an acquired tax position, when those changes occur after the effective date of ASC 805 (see Income taxes ). In an SEC registrant s disclosure of the impact that the adoption of Statement 141R (ASC 805) and Statement 160 (ASC ) will have on its financial statements, the registrant should include consideration of the potential impact of Statement 141R (ASC 805) (and Statement 160 (ASC )) amendments to other accounting standards. Appendix A to this bulletin identifies some of the significant amendments to FASB Statements and Interpretations contained in Statement 141R (ASC 805).

6 Grant Thornton LLP 6 C. Scope Definition of a business combination ASC Glossary redefines a business combination as a transaction or other event in which an acquiring entity obtains control of one or more businesses. The definition explicitly includes a merger of equals. Throughout ASC 805, the term control has the meaning of controlling financial interest, as that term is used in ASC (Accounting Research Bulletin (ARB) 51, Consolidated Financial Statements). (The FASB defined the term control in ASC Glossary by reference to controlling financial interest in ASC to maintain consistency between the business combinations and consolidation guidance. However, ASC provides guidance on the application of the controlling financial concept but does not specifically define the term.) Other events that qualify as business combinations under ASC 805, but not under Statement 141, include when an entity Obtains control of a business without exchange of consideration or other direct involvement by the acquirer. For example, the holder of a majority of voting equity might obtain control when participating rights held by minority interests expire. Obtains control of a business by contract alone, without holding any ownership interest in that business or holding only a minority ownership interest Becomes the primary beneficiary of a variable interest entity that is a business, in accordance with ASC Variable Interest Entities subsections (FASB Interpretation 46 (revised December 2003), Consolidation of Variable Interest Entities (Interpretation 46R)) Initial measurement of variable interest entities ASC currently requires that the primary beneficiary of a variable interest entity initially measure at fair value the newly consolidated entity s assets, liabilities, and noncontrolling interests, except for entities under common control or for assets and liabilities transferred by the primary beneficiary to the entity shortly before consolidation. Under ASC , Variable Interest Entitites as amended by ASC 805, the initial consolidation of a variable interest entity that is a business will be accounted for as a business combination in accordance with ASC 805. For a variable interest entity that is not a business, the acquisition date measurement and recognition provisions of ASC 805, including the exceptions to fair value measurement at the acquisition-date, will apply to the initial consolidation of any variable interest entity that is not under common control with its primary beneficiary. However, the primary beneficiary of a variable interest entity that is not a business: Would measure assets and liabilities transferred to the entity shortly before consolidation as if they had not been transferred and would not recognize a gain or loss on the transfer Would recognize a loss instead of goodwill Would not separately remeasure and recognize a gain or loss on the primary beneficiary s equity interests in the variable interest entity acquired before becoming the primary beneficiary. Instead, any such amounts would be included in the total gain or loss recognized on initial consolidation.

7 Grant Thornton LLP 7 Definition of a business ASC Glossary also redefines a business as an integrated set of assets and activities capable of being conducted and managed for the purpose of providing a return in the form or dividends, lower costs, increased share prices, or other economic benefits to investors, owners, or participants. The new definition effectively extends business combinations accounting to include Combinations of two or more mutual entities, such as mutual insurance companies, credit unions, and farm and electric cooperatives. Before the effective date of ASC 805, such combinations are accounted for under APB Opinion 16 or FASB Statement 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions (not included in Codification) Acquisitions of certain development-stage companies or other entities that meet the new broader definition of a business in ASC Glossary but that would be accounted for as asset acquisitions in transactions that occur before the effective date of ASC 805 ASC through 55-9 includes the following guidance on applying the new definition of a business: A business consists of inputs and processes that have the ability to produce outputs. Thus, a development-stage company that has not yet begun producing outputs may be a business. Accounting, billing, payroll, and other administrative systems are generally not considered to be processes used to create outputs. The determination of whether an integrated set of assets and activities is a business should be based on whether that set could be conducted and managed as a business by a market participant (as defined in ASC Glossary). However, a business need not include all of the inputs and processes used by the seller to produce outputs if market participants are capable of acquiring the business and continuing to produce outputs by integrating the acquired set with their own inputs and processes. The existence of goodwill in a particular set of assets and activities creates a presumption that the set is a business, absent contrary evidence. The new definition of a business and related guidance in ASC Glossary and ASC through 55-9 replaces the definitions in EITF Issue 98-3, Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business, (not included in Codification) and in Interpretation 46R (definition not in Codification). ASC 805 does not carry forward from those definitions (a) the requirement that a business must have outputs to continue normal operations and sustain a revenue stream and (b) the presumption that a development stage company is not a business. Scope exclusions ASC 805, like Statement 141, does not apply to The formation of a joint venture A combination between entities under common control. ASC , Transactions between Entities under Common Control subsections, carries forward the guidance from Statement 141 on accounting for transactions between entities under common control. ASC , Transactions between Entities under Common Control clarifies that an entity that receives the net assets or equity interests of an entity under common control should adjust comparative information for prior years presented in the financial statements only for periods during which the entities were under common control.

8 Grant Thornton LLP 8 A combination between two or more not-for-profit organizations or the acquisition of a for-profit business by a not-for-profit organization The acquisition of a group of assets that is not a business The acquisition of all or part of the remaining noncontrolling interest in a consolidated subsidiary after the date of the business combination (see Noncontrolling interests in a partially owned subsidiary ) Not-for-profit organizations: mergers and acquisitions The FASB has begun redeliberations on proposed new standards for not-for-profit organizations on accounting for (a) mergers and acquisitions, (b) noncontrolling interests in consolidated entities, and (c) goodwill and other intangible assets acquired in a merger or acquisition. Until these new standards are finalized and effective, not-for-profit organizations should continue to apply the guidance in APB Opinion 16 and in other authoritative literature, as it was before the amendments and nullifications in Statement 141 and Statement 141R (ASC 805). The acquisition method procedures in ASC 805 do not apply to the parent s acquisition of some or all of the noncontrolling interest in a subsidiary after the date of the business combination. ASC , which has the same effective date as ASC 805, addresses how to account for subsequent changes in the acquirer s ownership interests in a consolidated subsidiary (see NDS ). D. Acquisition method Identification of the acquirer ASC continues the existing requirement to identify one of the combining entities in each business combination as the acquirer. ASC indicates that the acquirer should be determined in accordance with the guidance in ASC Accordingly, the acquirer is the entity that obtains control (a controlling financial interest) of the other entity or entities in a business combination, usually through direct or indirect ownership of a majority voting interest. However, the primary beneficiary of a variable interest entity, determined in accordance with ASC , Variable Interest Entities, is the acquirer of that entity. ASC through provides additional factors to consider (similar to those in Statement 141) if the guidance in ASC does not clearly indicate which entity is the acquirer. However, those additional factors do not apply to the determination of the acquirer for initial consolidation of a variable interest entity. Reverse acquisition If a business combination is effected primarily by the exchange of equity interests, the entity that issues its equity interests is usually the acquirer. However, in a reverse acquisition, the entity that issues securities to effect a combination (the legal acquirer) is determined to be the acquiree for accounting purposes, and the entity whose equity interests are acquired (the legal acquiree) is the acquirer for accounting purposes. ASC , Reverse Acquisitions, provides an example on how to account for a reverse acquisition.

9 Grant Thornton LLP 9 Reverse acquisition or recapitalization: SEC staff views The following guidance is from Frequently Requested Accounting and Financial Reporting Interpretations and Guidance (March 31, 2001), prepared by accounting staff members in the SEC Division of Corporation Finance: The merger of a private operating company into a non-operating public shell corporation with nominal net assets typically results in the owners and management of the private company having actual or effective operating control of the combined company after the transaction, with shareholders of the former public shell continuing only as passive investors. These transactions are considered by the staff to be capital transactions in substance, rather than business combinations. That is, the transaction is equivalent to the issuance of stock by the private company for the net monetary assets of the shell corporation, accompanied by a recapitalization. The accounting is identical to that resulting from a reverse acquisition, except that no goodwill or other intangible should be recorded. Acquisition date ASC requires using the acquisition date the date the acquirer obtains control of the acquired business to measure and recognize a business combination, eliminating the acquirer s option under Statement 141 to designate, for convenience, an effective date at the end of an accounting period between the dates the business combination is initiated and consummated. Consolidation in the year of the business combination Under ASC , the acquirer s financial statements for the period in which a business combination occurs will include only the cash inflows and outflows, revenues and expenses, and other effects of the acquiree s operations after the acquisition date. In contrast, regardless of whether the acquirer designates a convenient effective date under Statement 141, ARB 51, paragraph 11 (not included in Codification), currently permits a subsidiary that was purchased during the year to be included in the consolidated financial statements as of the beginning of the year, with an adjustment in the consolidated income statement to remove preacquisition earnings. When effective, ASC (Statement 160) will amend paragraph 11 in ARB 51 so it is consistent with the acquisition-date recognition requirements of ASC 805. Measurement period ASC 805 provides for a measurement period after the acquisition date. Under ASC through 25-19, the acquirer retrospectively adjusts the business combination accounting for information obtained during the measurement period about facts and circumstances that existed as of the acquisition date. Because the accounting is adjusted as though the information were available at the acquisition date, comparative information for prior periods presented must be revised as necessary. The measurement period ends as of the earlier of (a) one year from the acquisition date or (b) the date when the acquirer receives the information necessary to complete the business combination accounting. The business combination accounting is not revised in the following situations:

10 Grant Thornton LLP 10 At any time for information obtained after the acquisition date that is not about facts and circumstances that existed as of the acquisition date After the measurement period ends, except for error corrections in accordance with ASC 250, Accounting Changes and Error Corrections (FASB Statement 154, Accounting Changes and Error Corrections) For business combinations occurring before ASC 805 is effective, Statement 141 provides for an allocation period that is similar to the measurement period in ASC 805. However, Statement 141 is silent about whether allocation period adjustments should be recorded retrospectively. What is part of the business combination transaction? ASC through requires the acquirer to identify any amounts that are not part of what the acquirer and the acquiree exchanged in the business combination. The accounting for a business combination includes only the consideration transferred for the acquiree, and the assets acquired and the liabilities assumed or incurred by the acquirer in exchange. A transaction is likely to be separate from the business combination if it is entered into by, on behalf of, or primarily for the benefit of either the acquirer or the combined entity rather than primarily for the benefit of the acquiree or its former owners. Acquisition-related (transaction) costs Costs that the acquirer incurs to effect a business combination are not part of the consideration transferred in exchange for the acquiree under ASC Therefore, ASC requires that such costs be accounted for separately from the business combination transaction. They are to be charged to expense when incurred, except for debt or equity issuance costs, which are accounted for in accordance with other generally accepted accounting principles. The acquirer s reimbursement of amounts paid by the acquiree or its former owners for acquisitionrelated costs of the acquirer should also be accounted for separately from the business combination. Such costs are incurred primarily for the benefit of the acquirer rather than the acquiree or its former owners, and therefore are not part of the business combination transaction. Acquisition-related costs The ASC 805 requirement to exclude all acquisition-related costs from the measurement of a business combination transaction is a significant change from the long-standing requirement in both APB Opinion 16 and Statement 141. Under these standards, the acquirer would recognize the direct costs of the combination as part of the cost of the acquired entity. Compensation to employees or former owners of the acquiree Compensation paid to the employees or former owners of the acquiree for future services is not accounted for as part of the business combination transaction. ASC through provides guidance on Determining whether contingent payments to employees or former shareholders of the acquiree represent contingent consideration transferred for the acquiree or compensation paid for future services (see Contingent consideration ) Calculating the compensation portion, if any, of a share-based payment award that the acquirer is obligated to issue to replace the acquiree s awards (see Replacement share-based payment awards )

11 Grant Thornton LLP 11 Effective settlement of a preexisting relationship ASC through incorporates the guidance in EITF Issue 04-1, Accounting for Preexisting Relationships between the Parties to a Business Combination (not included in Codification). Accordingly, the effective settlement of a preexisting relationship between the acquirer and the acquiree as a result of a business combination is accounted for separately from the business combination. However, consistent with EITF Issue 04-1, the business combination transaction under ASC 805 includes recognition of a reacquired right, such as a franchise right, that the acquirer had previously granted to the acquiree to use the acquirer s assets (see Reacquired rights ). Identifiable assets acquired, liabilities assumed, and noncontrolling interests: general principles Under ASC 805, identifiable assets acquired and liabilities assumed must be accounted for in accordance with general principles for recognition, classification, and measurement unless ASC 805 provides an exception in the guidance for a specific item. Recognition principle Recognition conditions Under ASC through 25-3, the acquirer recognizes the assets acquired and liabilities assumed in a business combination if, as of the acquisition date, both of the following conditions are met: The item is part of the business combination transaction (see What is part of the business combination transaction? ). The item meets the definition of an asset or liability in FASB Concepts Statement 6, Elements of Financial Statements, which defines assets and liabilities as follows: Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events [paragraph 24, footnote references omitted]. Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events [paragraph 35, footnote references omitted]. In those definitions, probable is intended to acknowledge that few outcomes of economic activity are certain, not to prescribe a recognition threshold as in ASC 450, Contingencies (FASB Statement 5, Accounting for Contingencies). Classification principle Under ASC through 25-8, identifiable assets acquired and liabilities assumed are classified based on the conditions, policies, contract terms, and other relevant factors that exist as of the acquisitiondate. For example, the acquirer must consider acquisition-date factors to determine the following: Classification of investments in accordance with ASC 320, Investments Debt and Equity Securities, through (FASB Statement 115, Accounting for Certain Investments in Debt and Equity Securities) Designation of hedging relationships in accordance with ASC 815, Derivatives and Hedging, 20, Hedging General (FASB Statement 133, Accounting for Derivative Instruments and Hedging Activities) Assessment of hybrid instruments in accordance with ASC , Embedded Derivatives

12 Grant Thornton LLP 12 ASC provides exceptions to the classification principle for classifying (a) an acquired lease as operating or capital (see Leases ) and (b) a contract written by an entity within the scope of ASC 944, Financial Services Insurance (FASB Statement 60, Accounting and Reporting by Insurance Enterprises), as an insurance or reinsurance contract or as a deposit contract (see Insurance and reinsurance contracts ). Measurement principle ASC requires the acquirer to measure the identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree at their acquisition-date fair values. Highest and best use Fair value measurements in accordance with ASC 820 require the use of market participant assumptions about an acquired asset s highest and best use, regardless of the acquirer s intended use of that asset. ASC clarifies that market participant assumptions about an acquired asset s highest and best use are the basis of fair value measurements for both initially recognizing and subsequently testing the asset for impairment. Examples: highest and best use in fair value measurements ASC through illustrate the application of the highest-and-best-use valuation concept in business combinations. ASC through illustrate circumstances in which individual assets provide maximum value as part of a group. In those circumstances, market participant assumptions about the highest and best use of the asset group as a whole would determine the fair value of an individual asset that is part of the group. ASC illustrates the acquisition of an in-process research and development project that the acquirer does not intend to complete. The acquirer s plan to lock up the project for competitive reasons is expected to provide defensive value, for example, by protecting the value of the acquirer s existing products. However, the fair value of the acquired project should be based on its highest and best use for market participants, not on the acquiring entity s intended use. Therefore, how an acquirer measures, recognizes, and subsequently accounts for an acquired asset that it intends to lock up or abandon will require careful consideration of all relevant facts and circumstances. Identifiable assets acquired and liabilities assumed: specific guidance Assets and liabilities arising from contingencies ASC Glossary defines a contingency as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an entity that will ultimately be resolved when one or more future events occurs or fails to occur. Under ASC 450, contingencies would be recognized as follows: Contingencies that might result in gains usually are not recognized as assets, since doing so might result in recognizing revenue before realization A loss contingency liability is recognized when the amount of loss can be reasonably estimated and it is probable that An asset has been impaired or a liability has been incurred

13 Grant Thornton LLP 13 Future events will occur confirming the loss However, the recognition and measurement guidance in ASC 450 does not apply to the acquisition-date accounting for contingencies in a business combination. Instead, ASC 805 provides new measurement and recognition guidance for assets and liabilities arising from contingencies, a new term that is more descriptive of the new accounting requirements for business combinations. Recognition ASC requires a new approach for recognizing an asset or liability arising from a contingency and establishes different recognition thresholds for contractual and noncontractual contingencies, as follows: Contractual contingencies: Assets and liabilities that arise from acquired contingencies related to contracts are recognized at fair value on the acquisition date. Noncontractual contingencies: For all other (noncontractual) contingencies, the acquirer recognizes the asset or liability only if it is more likely than not that the contingency gives rise to an asset or liability, as defined in Concepts Statement 6, as of the acquisition date. For example, a liability arising from a noncontractual contingency would be recognized as part of the business combination if, as of the acquisition date, it is more likely than not that the entity has incurred a present obligation to pay if a specified contingent event occurs. The probability that the entity will incur a gain or loss if the contingent event occurs would be reflected in the measurement of the fair value of the asset or liability to be recognized. In contrast, before ASC 805 is effective, Statement 141 requires that the purchase price of the acquired entity include the fair value of a preacquisition contingency if the fair value can be determined during the allocation period, which is similar to the measurement period under ASC 805. If the fair value cannot be determined during the allocation period, then a contingent asset or liability would be recognized based on the guidance in ASC 450. The Statement 141R basis for conclusions indicates that, under Statement 141, acquirers in business combinations have seldom recognized the acquisition-date fair value of assets or liabilities arising from preacquisition contingencies. Instead, the amount recognized has often been the best estimate of the expected settlement amount, which could be zero if the ASC 450 probability recognition threshold has not been met. Measurement Assets and liabilities arising from either contractual or noncontractual contingencies that are recognized as of the acquisition date are measured at acquisition-date fair value. Example: recognition of a liability arising from a noncontractual contingency ASC through provide the following example of a noncontractual contingency assessment. Company AC acquires company TC. As of the acquisition date, TC is subject to a lawsuit, in its discovery stage, alleging that TC violated employment discrimination laws. TC management asserts that its policies and procedures complied with all applicable laws and regulations. Under ASC 805, AC would recognize a liability measured at its acquisition-date fair value if AC concludes that it is more likely than not that TC violated the employment discrimination law. That conclusion would be based on consideration of all relevant facts and circumstances that were known as of the acquisition date, such as the following:

14 Grant Thornton LLP 14 Results of discovery to date Advice from AC s lawyers about whether TC would be found liable based on facts known as of the acquisition date Other relevant information gathered during due diligence or other procedures Neither the past practice of settling similar lawsuits, nor the consideration of an out-ofcourt settlement, would provide by itself a conclusive basis for recognizing a liability. Settlement information would be considered along with other information to determine whether it is more likely than not that TC violated the law and is likely to be found liable under the lawsuit. If a liability is recognized, the possibility of an out-of-court settlement would be reflected in the fair value measurement of the liability. Subsequent accounting Under ASC 805, the recognition and measurement of assets and liabilities arising from contingencies recognized as part of the entity s business combinations should be retrospectively adjusted as of the acquisition date if the conditions for a measurement-period adjustment are met (see Measurement period ). Assets and liabilities arising from contingencies that were recognized at fair value as of the acquisition date in accordance with ASC , but would have been accounted for under ASC 450 outside a business combination, will not be adjusted (except for certain measurement-period adjustments) until new information about the possible outcome of the contingency is obtained. When new information about the outcome of the contingency is obtained, the acquirer would measure A liability at the higher of Its acquisition-date fair value The amount that would be recognized by applying ASC 450 An asset at the lower of Its acquisition-date fair value The best estimate of its future settlement amount Acquired noncontractual contingencies that do not meet the more-likely-that-not recognition threshold as of the acquisition date are subsequently accounted for in accordance with other generally accepted accounting principles, as appropriate. The provisions of ASC 805 will not apply to the recognition or measurement of those contingent assets or liabilities after the acquisition date. Derecognition Assets and liabilities arising from contingencies that are recognized as of the acquisition date are derecognized only when the contingency is resolved, for example, when the acquirer Collects, sells, or loses the right to the asset Settles the liability or is no longer obligated to settle the liability

15 Grant Thornton LLP 15 The effect of new information about the outcome of a contingency An asset or liability arising from a contingency that is recognized on the acquisition date under ASC 805 will not be adjusted in subsequent periods until new information about the possible outcome of the contingency is obtained. That requirement might reduce the risk of recognizing a loss immediately after the acquisition-date solely because the acquisition-date fair value is less than the amount that would have been recognized under ASC 450. However, judgment may be required to determine whether new information about a contingency is of such a nature or significance that it would trigger a remeasurement adjustment. Further, it may be difficult to determine whether the new information received during the measurement period should result in a measurementperiod adjustment as of the acquisition date or in a subsequent-period adjustment. Under ASC 805, the carrying amount of a liability arising from a contingency will not be reduced below the amount recognized as of the acquisition date until derecognition, regardless of whether new information indicates that both the fair value and the ASC 450 measurement of the liability would be significantly less than its carrying amount. The carrying amount of an asset arising from a contingency may not be increased over the amount recognized as of the acquisition date. Assets held for sale Measurement ASC provides an exception to its general acquisition-date fair value measurement principle for acquired long-lived assets classified as held-for-sale at the acquisition date, in accordance with ASC , Property, Plant, and Equipment, Impairment or Disposal of Long-Lived Assets subsections (FASB Statement 144, Accounting for the Impairment or Disposal of Long-Lived Assets). Therefore, such assets are measured at fair value, less cost to sell. Assets with uncertain cash flows (valuation allowances) Measurement Under ASC , no separate valuation allowance is recognized as of the acquisition date for acquired assets measured at acquisition-date fair value because the uncertainty of future cash flows is reflected in the fair value measurement. However, assets that are not measured at fair value, such as deferred tax assets and some indemnification assets, may be subject to valuation allowances (see Indemnification assets and Income taxes ). Disclosures To help financial statement users assess considerations of credit quality included in the fair value measures of acquired receivables, ASC requires disclosures about acquired receivables that are not subject to ASC 310, Receivables, 30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer). Employee benefits ASC refers to guidance in other accounting standards for the acquisition-date measurement and recognition of assets and liabilities related to the acquiree s employee benefit arrangements for deferred compensation, compensated absences, termination, pension, postretirement, and postemployment benefits. Statement 141R (ASC 805) amends the provisions on business combinations accounting in ASC (FASB Statement 87, Employers Accounting for Pensions), and in ASC

16 Grant Thornton LLP 16 (FASB Statement 106, Employers Accounting for Postretirement Benefits), to provide the following guidance: For an acquiree-sponsored, single-employer defined benefit pension or postretirement plan, the acquirer recognizes an asset or liability for the funded status of the plan as part of the business combination. The measurement of the asset or liability recognized excludes the effects of expected plan amendments, terminations, or curtailments that the acquirer has no obligation to make as of the acquisition date. However, the projected benefit (or postretirement benefit) obligation assumed should reflect any changes in assumptions necessary to reflect the acquirer s assessment of other relevant future events. If an acquiree participates in a multiemployer plan and it is probable as of the acquisition date that the acquirer will withdraw from that plan, the acquirer would recognize a withdrawal liability in accordance with ASC 450 as part of the business combination. Income taxes Under ASC , deferred taxes and uncertain tax positions in a business combination are accounted for in accordance with ASC 740, as amended by ASC 805. Also, Statement 141R (ASC 805) will nullify EITF Issue, 93-7, Uncertainties Related to Income Taxes in a Purchase Business Combination (not included in Codification). Acquisition-date change in acquirer s valuation allowance Under ASC 740, as amended by Statement 141R (ASC 805), a change in the acquirer s valuation allowance on its previously existing deferred tax asset as a result of a business combination will not be accounted for as part of the business combination and therefore, will not be accounted for as an adjustment to goodwill. Business combination accounting under ASC 805 will exclude the effects of an acquisition-date reduction of the valuation allowance on the acquirer s previously recognized deferred tax asset for net operating loss carryforwards, even if the allowance was reduced because the related tax benefits may be used against future taxable profits of the acquiree. In contrast, before the effective date of ASC 805, such changes in a valuation allowance would be accounted for as part of the business combination. Deferred tax asset for excess of tax-deductible over accounting goodwill Under ASC and 25-9, as amended by Statement 141R (ASC 805), the tax benefit for any excess of tax-deductible goodwill over the amount of goodwill for financial reporting will be a temporary difference at the acquisition date. A deferred tax asset would be recognized as an adjustment to goodwill reported in the financial statements. In contrast, before the effective date of ASC 805, such tax benefits would be recognized as reductions of goodwill when realized on the tax return. As illustrated in ASC through (the Statement 141R amendments to Statement 109), the acquisition-date deferred tax asset on the excess of tax-deductible goodwill over book goodwill and the goodwill recognized for financial reporting are calculated as follows: Preliminary temporary difference = tax-deductible goodwill book goodwill (before adjustment for the deferred tax asset associated with goodwill) Deferred tax asset = (tax rate (1 tax rate)) preliminary temporary difference Goodwill recognized for financial reporting = book goodwill (before adjustment for the associated deferred tax asset) the associated deferred tax asset

17 Grant Thornton LLP 17 Subsequent change in the acquired entity s valuation allowance or tax position ASC amends the guidance in Statement 109 and in Interpretation 48 (ASC 740) on accounting for changes in (a) the valuation allowance on an acquired entity s deferred tax asset or (b) an acquired tax position. The amendments change the guidance in ASC 740 to be consistent with the ASC 805 conditions for a measurement period adjustment and measurement of identifiable assets acquired. Accordingly, a change in a valuation allowance for an acquired entity s deferred tax asset (or a change in an acquired tax position) will be recognized as follows: A change in the acquiree s valuation allowance (or in an acquired tax position) will be recognized through a corresponding change in goodwill if the change occurs (a) during the measurement period and (b) as a result of new information about facts and circumstances that existed as of the acquisition date. If goodwill is reduced to zero, any additional decrease in the valuation allowance (or in an acquired tax position) would be recognized as a gain on a bargain purchase. The fair values of acquired noncurrent intangible assets would not be reduced prior to recognizing a gain. All other changes would be adjustments to income tax expense or contributed capital, as appropriate, and would not be recognized as adjustments to the acquisition-date accounting for the business combination. Income tax effects of replacement share-based payment awards ASC through provides guidance on accounting for the income tax effects of the acquirer s replacement award of an acquiree s share-based payment award (replacement award) that is classified as equity and issued in a nontaxable business combination (see Replacement share-based payment awards ). Transition The amendments to ASC 740 will be applied prospectively to business combinations with acquisition dates before the effective date of ASC 805. Therefore, ASC 805 will not change the accounting for (a) previously recognized business combinations or (b) previously recognized changes in valuation allowances on an acquired deferred tax asset (or changes in an acquired tax position). Deferred tax assets and tax positions acquired before Statement 141R (ASC 805) Until the effective date of ASC 805 all subsequent period changes to a valuation allowance on an acquired entity s deferred tax asset would first reduce related goodwill to zero, then reduce to zero any other noncurrent intangible assets related to the acquisition, and finally reduce income tax expense. The ASC 805 amendments to ASC 740 will require that all changes in a valuation allowance for an acquired deferred tax asset or in an acquired tax position that occur after the effective date of ASC 805 will be recognized in accordance with the amended guidance. Therefore, except for certain measurement period adjustments, all such changes that occur after the effective date of ASC 805 will be recognized as adjustments to income tax expense or contributed capital, as appropriate, even if the deferred tax asset or tax position was initially acquired prior to the effective date of ASC 805. Indemnification assets Indemnification assets arise from the seller s complete or partial indemnification of the acquirer for the outcome of a particular uncertainty, such as an uncertain tax position. ASC 805 provides the following guidance on accounting for indemnification assets acquired in a business combination.

18 Grant Thornton LLP 18 Recognition and measurement Under ASC through 25-28, the acquirer recognizes an indemnification asset at the same time that it recognizes the indemnified item. Therefore, an indemnification asset would be recognized as of the acquisition date only if the indemnified item is recognized as of the acquisition date. For example, if a noncontractual loss contingency does not give rise to a liability that meets the more-likely-than-not recognition threshold on the acquisition date, the acquirer would not recognize an asset on the acquisition date for the seller s indemnification of that loss contingency. An indemnification asset recognized under ASC through is measured on the same basis as the indemnified item according to the contractual terms of the agreement using assumptions consistent with those used to measure the indemnified item. Therefore, the indemnification asset may not be measured at its acquisition-date fair value. The amount recognized for an indemnification asset is subject to management s assessment of collectibility. A valuation allowance may be recognized at the acquisition date for an indemnification asset that is not measured at fair value, but no valuation allowance would be recognized for indemnification assets that are measured at fair value. Subsequent accounting An acquired indemnification asset recognized as of the acquisition date under ASC through is subsequently remeasured each reporting date on the same basis as the indemnified asset or liability, subject to any contractual limitations on its amount. Amounts that are subsequently measured on a basis other than fair value are also subject to management s assessment of collectibility. Derecognition An indemnification asset is derecognized only when the acquirer collects it, sells it, or loses the right to it. Example: indemnification of an uncertain tax position The seller agrees to fully indemnify the acquirer for an uncertain tax position for which the acquirer recognizes an acquisition-date liability in accordance with the uncertain tax position guidance of ASC 740, as amended by Statement 141R (ASC 805). As of the acquisition date, the acquirer would recognize an indemnification asset for the same amount as the related liability, based on the acquirer s assessment that the asset is fully collectible. If the buyer agrees to indemnify only a portion of the liability, the asset is measured on the same basis used to measure the indemnified liability, but the indemnification asset is limited to the amount indemnified. Insurance and reinsurance contracts Statement 141R (ASC 805) amends Statement 60 (ASC through 25-5 and 30-1 through 30-2) to provide the following guidance on an insurer s accounting for insurance and reinsurance contracts acquired in a business combination. The acquirer considers the acquired contracts to be new contracts for accounting and measurement purposes, but not for classification purposes. Measurement The acquirer measures the assets and liabilities related to the acquired insurance and reinsurance contracts at their acquisition-date fair values.

19 Grant Thornton LLP 19 Recognition The acquirer separately recognizes the following components of the fair value measurement of an insurance or reinsurance contract: Assets and liabilities arising from the contract measured in accordance with the accounting policies used by the acquirer for contracts it issues or holds. Those asset and liabilities do not include the acquiree s deferred acquisition costs or unearned premiums. An intangible asset (or liability) measured as the difference between (a) the fair value of the contractual insurance or reinsurance rights acquired and obligations assumed and (b) the amount recognized for the assets and liabilities arising from the contract that are measured in accordance with the acquirer s accounting policies Classification The acquirer will carry forward the acquiree s classification of an acquired contract as an insurance (or reinsurance) contract or deposit contract. Reassessment of that classification is required as of the acquisition date only if the contract is modified at the acquisition date in a manner that would change the classification. Subsequent accounting After the acquisition date, the intangible asset is measured on a basis consistent with the related insurance or reinsurance liability. Leases ASC 805 provides guidance on accounting for an acquiree s leases that is consistent with the existing accounting requirements for leases. Recognition of operating leases Regardless of whether the acquiree is the lessee or lessor in an operating lease, the acquirer recognizes either (a) an intangible asset if the terms of an acquiree s operating lease are favorable to market terms at the acquisition date or (b) a liability if the terms of the operating lease are unfavorable to market terms. The acquirer would also recognize an identifiable intangible asset for an operating lease at market terms if the lease has value for market participants. For an operating lease in which the acquiree is the lessee, the acquirer would not recognize any assets or liabilities other than those described in the preceding paragraph. For operating leases in which the acquiree is the lessor, the acquisition-date fair value of an intangible asset or liability recognized for the operating lease is not part of the acquisition-date fair value of the asset subject to the lease. The acquirer measures and recognizes the asset subject to the lease separately from any intangible asset or liability arising from the lease contract. Recognition of capital leases in which the acquiree is the lessee For capital leases in which the acquiree is the lessee, the acquirer would separately recognize the leased asset and the related financial obligation at their fair values. Measurement ASC 805 s general fair value measurement principle applies to lease contracts.

20 Grant Thornton LLP 20 Classification ASC provides an exception to its general acquisition-date classification principle for acquired leases. Therefore, in accordance with ASC 840, Leases (FASB Interpretation 21, Accounting for Leases in a Business Combination), the acquiree s classification of a lease as operating or capital in accordance with the criteria of ASC (FASB Statement 13, Accounting for Leases), would not change as a result of a business combination, unless the provisions of the lease are modified. Statement 141R (ASC 805) amends Interpretation 21 (ASC ) to clarify that lease modifications planned at the acquisition date, but made after the acquisition date, are accounted for as postcombination events. Reacquired rights The acquirer in a business combination may reacquire a right that was previously granted to the acquiree to use the acquirer s recognized or unrecognized asset. Recognition ASC through incorporates the existing provision in EITF Issue 04-1 that requires the acquirer to recognize the reacquired right as an identifiable intangible asset. Measurement ASC establishes the requirement to measure the acquisition-date value of the reacquired right based on the remaining contractual term of the related contract without consideration of potential contract renewals. In addition, as currently required under EITF Issue 04-1 (ASC ), if the contract is favorable or unfavorable compared to similar current market transactions, the acquirer recognizes a gain or loss on the effective settlement of a preexisting relationship (see Effective settlement of a preexisting relationship ). Subsequent accounting ASC requires that the reacquired right be amortized over the remaining contractual period of the contract granting the right, without consideration of potential renewals. If the acquirer reissues the reacquired right to a third party, the carrying amount of the reacquired right is included in the determination of any gain or loss on reissuance. Research and development Recognition and measurement ASC 805 does not provide an exception to its general recognition and measurement principle for research and development assets. Therefore, in a business combination under ASC 805, tangible and intangible assets used in research and development are recognized at their acquisition-date fair values and are not immediately charged to expense, regardless of whether they have any alternative future use in another research and development project or otherwise (see Measurement principle for a discussion of the use of market-participant assumptions for highest and best use in measuring the fair value of an acquired inprocess research and development project). Accordingly, ASC 805 nullifies FASB Interpretation 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method (not included in Codification), and amends the following statements: FASB Statement 2, Accounting for Research and Development Costs (ASC 730, Research and Development, 10) FASB Statement 68, Research and Development Arrangements (ASC , Research and Development Arrangements )

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