New Accounting for Business Combinations and Minority Interests

Transcription

1 New Accounting for Business Combinations and Minority Interests John Scott Senior Manager, Enterprise Group Travis Wolff January 19, 2010

2 Agenda Overview and background of the new standards- ASC 805 (FAS 141R) and ASC 810 (FAS 160) Business Combinations- Major Changes Acquisition Method Steps Use of Fair Value in Business Combination Selected Examples Disclosures Non-controlling interest Questions

3 Overview of business combination- ASC 805 (FAS 141R) Extensive changes to the business combination standards, which will make M&A much more complicated Accounting rules will become a significant factor in M&A: Deal planning Deal structure Deal timing Significant impact to financial statement post-deal

4 Overview, cont. Changes accounting for minority interest (non-controlling interest) Does not apply to not-for-profits (Not-for-profits should continue to apply ARB 51) Also does not apply to: The formation of joint ventures The acquisition of an asset or a group of assets that do not constitute a business A combination between entities or businesses under common control

5 Effective Dates Effective January 1, 2009 for calendar year-end companies (for fiscal years beginning after December 15, 2008) Applied prospectively as of beginning of fiscal year, and earlier adoption is prohibited.

6 Business Combinations - Major Changes New definition of a business and business combination Measurement date Measurement period Deal costs Restructuring activities Contingent consideration (earn-outs) Contingencies

7 Major Changes (continued) Recognizing and measuring In process R&D Income taxes Increase in ownership interest Significantly incorporates fair value into recording of business combination

8 Business Combinations Acquisition Method: Identify the acquiree Determine the acquisition date Recognize and measure the Net assets Liabilities assumed Any non-controlling interest Recognize and measure goodwill Potential gain from bargain purchase

9 Use of Fair Value in Business Combination Acquirer shall record assets acquired and liabilities assumed and noncontrolling interest at acquisition date fair value ASC 820 (FAS157). Clarification of fair value fair value in distressed markets including use of multiple valuation techniques and building liquidity risk into discount rate. Asset reserves and allowances are unnecessary with fair value measurements. Fair value calculation is not related to the intended use of the asset.

10 Selected Examples 100% Acquisition DB Assets Acquired (100% FV) DB Goodwill (100% FV) CR Liabilities Acquired (100% FV) CR Cash (consideration given) XXXX DB Acquisition related costs XXXX CR Cash XXXX

11 Selected Examples 70% Acquisition DB Assets Acquired (100% FV) DB Goodwill (100% FV) CR Liabilities Acquired (100% FV) CR Non-controlling interest (FV) CR Cash (consideration given) XXXX DB Acquisition related costs XXXX CR Cash XXXX

12 Selected Examples Staged Acquisition Facts F Inc. acquires 40% of M Company on January 1, 20X1 for $2,000,000. The 40% does not constitute control. On January 1, 20X3, F Inc. acquires an additional 25% of M Company for $3,000,000. F Inc. now has control of M Company. On January 1, 2003, the fair value of F s initial investment of 40% is $4,800,000 when its book value $2,300,000. On January 1, 2003, the fair value of M s net assets is $9,000,000. On January 1, 2003, the fair value of M s non-controlling interest (35%) is $4,000,000 (considers minority discount).

13 Selected Examples (continued) Staged Acquisition Journal Entries 1/1/20X1 DB Investment (40%) 2,000,000 CR Cash 2,000,000 20X1 and DB Investment (40%) 300,000 20X2 Adj. CR Net Income 300,000

14 Selected Examples (continued) Staged Acquisition Journal Entries 1/1/20X3 DB Investment (25%) 3,000,000 CR Cash 3,000,000 1/1/2003 DB Investment (40%) 2,500,000 CR Gain 2,500,000 (Adjust initial investment to fair value)

15 Selected Examples (continued) Staged Acquisition Journal Entries Business combination entry: 1/1/2003 DB Net Assets (FV) 9,000,000 DB Goodwill (FV) 2,800,000 CR Investment 7,800,000 CR Non-controlling Interest (FV) 4,000,000

16 Selected Examples (continued) When a business combination effectively settles a pre-existing contractual relationship, the acquirer should recognize a gain or loss based on the lesser of: The amount of the favorable or unfavorable contract compared to current market prices for the same or similar transactions, or The amount of any settlement provision in the contract if the contract is unfavorable.

17 Selected Examples (continued) Favorable or unfavorable operating leases at fair value facts: Acquiree has a favorable lease when compared to market rates for comparable space The lease has 24 remaining payments at $3,000 a month while comparable lease terms would be $4,000 a month The acquirer in a business combination is acquiring an asset equal to the present value of the difference in payment terms for the remaining lease term

18 Selected Examples (continued) Favorable or unfavorable operating lease at fair value: If the entry was booked separately, the business combination journal entry for the favorable lease assuming the present value of the $1,000 a month difference for twenty-four months is $22,500: DB Favorable Lease Asset $22,500 CR Goodwill $22,500 NOTE Total assets is unchanged; goodwill is adjusted for the fair value of the favorable lease (A LIABILITY IS RECOGNIZED FOR AN UNFAVORABLE LEASE)

19 Disclosures The acquirer should disclose information that enables the users of its financial statements to evaluate the financial effects of adjustments recognized in the current reporting period that relate to business combinations that occurred in current or prior reporting periods.

20 Definitions attributable to SFAS 160 Noncontrolling Interest: The portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. A noncontrolling interest is sometimes called a minority interest. Parent: An entity that has controlling financial interest in one or more subsidiaries. (Also, an entity that is the primary beneficiary of a variable interest entity).

21 Differences between SFAS 160 and ARB 51 Name ARB 51- Minority Interest SFAS 160-Noncontrolling Interest Balance Sheet Presentation ARB 51- Mezzanine (between liabilities and equity) SFAS 160 Separate component of equity

22 Differences between ARB 51 and SFAS 160 (continued) Income Statement Presentation ARB 51-bottom line is net income after deducting minority interest SFAS 160-bottom line is net income attributable to controlling interest after subtracting net income attributable to the noncontrolling interest. However, a total net income from the entire company is reflected before net income from noncontrolling interests.

23 Differences between ARB 51 and SFAS 160 (continued) Accumulated Losses ARB 51-accumulated losses were suspended with minority interest rarely reflected as an asset SFAS 160-noncontrolling interest could have a negative balance or a debit balance in equity

24 Differences between ARB 51 and SFAS 160 (continued) Parent s ownership in subsidiary changes but there is no change in control (Parent still owns more than 50%) ARB 51-can recognize gain or loss SFAS 160-equity transaction (changes in additional paid in capital)

25 Impact The following are among the more significant changes from current practice introduced by FAS 160: Noncontrolling interest (previously referred to as minority interest) is recognized in the equity section, presented separately from the controlling interest s equity Losses will continue to be allocated to the NCI even if the NCI is placed in a deficit position.

26 Impact (continued) If control is maintained, changes in ownership interests will be treated as equity transactions. Upon a loss of control, any gain or loss on the interest sold will be recognized in earnings. Additionally, any ownership interest retained will be remeasured at fair value on the date control is lost, with any gain or loss recognized in earnings.

27 Impact (continued) Despite the new net income amount, earnings attributable to the parent company will be presented in the income statement, which will be consistent with net income as previously reported. Earnings Per Share will still be calculated based on earnings attributable to the parent company shareholders.

28 FAS 160 Balance Sheet Placement Old mezzanine Now separate component of equity Old Now Total liabilities $500 $500 Minority interest 50 - Equity: Stock Retained earnings Controlling interest Noncontrolling interest - 50 Total equity Total $1,000 $1,000

29 FAS 160 Income Statement Old bottom line is net income after deducting minority interest Now bottom line is net income attributable to controlling interest after subtracting net income attributable to the noncontrolling interest. However, a total net income for entire entity is shown before net income from noncontrolling interests. Old Now Pre-tax income $200 $200 Tax (80) (80) Less minority interest (30) - Net/for entire company $90 $120 Less attributed to noncontrolling interest - (30) Net attributable to controlling interest - $90

30 Losses to NCI results in a debit balance in stockholder s equity Losses from NCI are recorded, even if it results in a deficit The Company must prospectively attribute any future losses to the NCI if in the past the Company stopped attributing losses to the NCI because losses exceeded the NCI s carrying amount.

31 Losses to NCI results in a debit balance in stockholder s equity The Company should not revise prior years (no restatement) consolidated net income attributable to the parent to deduct losses. Rather, on the date of adoption, the NCI should be recorded at zero (i.e. the previous carrying amount for the minority interest), and earnings or losses after that date should be attributable to the NCI.

32 Changes in ownership no loss of control Changes in ownership interests in a subsidiary that don t lose control are equity transactions Issuing shares to a third party, thereby diluting the controlling interest s ownership percentage, will be an equity transaction and no gain or loss will be recognized (assuming the Parent retains control)

33 Events that trigger a control loss A parent should deconsolidate a subsidiary at the date the parent losses control of the subsidiary. Events include: A parent sells all or part of its ownership in its subsidiary, thereby losing control A contractual agreement giving control over the subsidiary expires The subsidiary issues shares, thereby reducing the parent s ownership interest so that the parent no longer has a controlling financial interest in the subsidiary

34 Control is Lost and Noncontrolling Investment Remains Change the classification and measurement of the investment (deconsolidate) Cease consolidation accounting and begin accounting for the investment under other applicable literature (any retained equity investment is remeasured at fair value) Recognize in earnings realized gains and losses and holding gains and losses

35 Disclosure requirements: Companies are required to present on the face of the financial statements net income or loss and consolidated comprehensive income or loss: For the consolidated entity Attributable to the parent Company Attributable to the noncontrolling interest

36 Q&A

37 Impact of ASC 805 (Statement 141R) Page 1 of 2 Definition of a business Measurement Acquisitionrelated costs Restructuring costs Contingent consideration Recognizing and measuring assets acquired, liabilities assumed, and noncontrolling interest Statement 141 & ARB 51 A business is defined as a selfsustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to investors. An early-state development state entity is not resumed to be a business. Measurement date Stock used as consideration is measured at the announcement date (when agreement is reached). Measurement period An allocation period (generally one year) was allowed to record estimates to preacquisition contingencies. Adjustments were made prospectively. The purchase price includes the direct costs of the business combination (including legal, accounting, investment banking, consulting, and due diligence), which were added to the deal consideration and were capitalized (goodwill). The cost of an acquirer s planned restructuring of the acquired company s operations (employee termination, facility shut-down) were recorded as a liability as part of the acquisition, resulting in higher goodwill. Contingent consideration based on earnings is recognized as an adjustment to the purchase price when the contingency is resolved and consideration is issued or issuable. Contingent consideration based on the acquirer s security price is recognized as an adjustment to paid in capital when the contingency is resolved and the consideration is issued or issuable. The assets acquired and liabilities assumed are adjusted only for the acquirer s share of the fair value. Noncontrolling interest and their share of the acquirer s assets and liabilities are measured based on the carrying amount of the recognized assets and liabilities in the acquirer s financial statements. Statement 141R The definition is expanded. A business or group of assets no longer must be self-sustaining to be a business; it must be capable of generating a revenue stream. The previous presumption that an early-stage development state entity is not a business has been removed. Measurement date All consideration must be measured at the closing date (i.e., in stock for stock deals the purchase price will not be known until the day of the closing). Measurement period Acquirers will have a period of time after the acquisition to true-up accounting; however 141R required restatement of prior period financial statements for materials adjustments. Deal costs must be expensed as incurred. Generally precluded acquirer from recording a liability related to planned restructuring of the acquired company s operations unless certain stringent criteria are met. Contingent consideration is recognized and measured at fair value on the acquisition date. Subsequent changes in fair value of liabilityclassified contingent consideration are recognized in earnings and not as an adjustment to the purchase price. Equity classified contingent consideration is not measured after the acquisition date. Whether the acquirer acquires all or a partial interest in the acquiree, the full fair value of the assets acquired, liabilities assumed, and noncontrolling interests is recognized. The carrying amounts of previously acquired tranches are adjusted to fair value at the date control is obtained, and the acquirer recognized the differences as a gain or loss in income at the acquisition date. Impact Expands the types of transactions that would be considered business combinations. Measurement date Timing of purchase could affect the amount paid and the market s reaction to the deal. Measurement period Large increase in acquisition-related restatements. May negatively impact pre-deal earnings. Financial covenants may be affected. Expensing of restructuring costs results in an increased charges to earnings. Earnings will be affected by changes in contingent consideration. Any bargain purchase gain is recognized immediately rather than over time.

38 Impact of ASC 805 (Statement 141R) Page 2 of 2 Contingencies IPR&D Tax benefits Increases in ownership interest Statement 141 & ARB 51 The fair value of a contingent liability is recognized at the date of acquisition only if it is probably and reasonably estimable. It is measured at the best estimate of the settlement amount, rather than its fair value. The fair value of intangible assets to be used in IPR&D projects that have no alternative future use is charged to expense at the acquisition date. The acquirer s unrecognized tax benefits that are recognizable as a result of an acquisition are recorded in purchase accounting at the acquisition date. A decrease in a valuation allowance related to the acquirer s tax benefits is an adjustment to the purchase accounting. The cost of each investment tranche is reflected in the financial statements with a separate purchase adjustment and goodwill amount related to each tranche. Statement 141R Contractual contingencies are recognized and measured at fair value on acquisition date of the acquisition date fair value of that asset or liability can be determined during the measurement period. If fair value cannot be determined during measurement period, it can only be recognized if: (1) Probably asset or liability existed at acquisition date. (2) Amount can be reasonably estimated. The acquirer s IPR&D projects are recognized as an intangible asset and measured at fair value. The IPR&D asset is treated as an indefinite-lived intangible asset and therefore is capitalized, but it not subject to amortization until the project is completed or abandoned. The prior requirement that the asset be completed or have an alternative use is eliminated. The acquirer s unrecognized tax benefits that are recognizable as a result of an acquisition are recognized as a reduction of income-tax expense. Adjustments to recognized tax benefits related to the acquiree that are recognized subsequent to the acquisition date are generally recognized as income rather than as an adjustment to the acquisition accounting. Increases in the parent s share of ownership after control is obtained are accounted for as capital transactions. Impact Contingent liabilities expense will be higher based upon fair value versus best estimate of settlement cost. IPR&D assets are capitalized at fair value at acquisition date rather than expensed as is currently required. Tax benefits are shifted to the company as they occur following the transaction date. Under current requirements, each investment tranche is reflected in the financial statements with a separate purchase adjustment and goodwill amount. Under 160, when less than 100% controlling interest is acquired, 100% of the net assets of the acquired business (including goodwill) are recorded at fair value. This will have implications on financial ratios and net income.

39 Impact of ASC 810 (Statement 160) Page 1 of 3 Summary of Accounting for Changes in Ownership Interests Type of Change in Ownership Interests Partial acquisition: Control is obtained, but less than 100 percent of the business is acquired (FAS 141(R), pars ). Partial acquisition: The previously held equity interest is increased to a controlling investment (i.e., a step acquisition). 3 Reduction in parent's ownership interest: Control is maintained. 4 Reduction in parent's ownership interest: Control is maintained. 4 Result Consolidate as of the date control is obtained. Recognize the NCI in equity. Change the classification and measurement of previously held equity interest. Consolidate as of the date control is obtained. Remeasure previously held equity interest at fair value. Recognize in earnings holding gains and losses. If less than 100 percent of the business is acquired, recognize the NCI in equity. Account for as an equity transaction. Account for as an equity transaction. Impact 100 percent of identifiable assets and liabilities are recognized at fair value. Goodwill attributable to both the controlling and noncontrolling interests is recognized. The NCI is recognized at fair value in equity. 100 percent of identifiable assets and liabilities are recognized at fair value. Previously held equity interest of the acquirer is remeasured at fair value, and any difference between the fair value and the carrying value is recognized as a gain or loss in earnings. Goodwill attributable to both the controlling and noncontrolling interests is recognized. The NCI is recognized at fair value in equity. Additional interest in subsidiary assets acquired and liabilities assumed is not remeasured. Differences between the fair value of the consideration paid and the related carrying value of the NCI acquired are recognized in the controlling interest s equity (e.g., additional paid-in capital). Reclassification of the carrying value of the NCI obtained from the NCI to the controlling interest's equity. Accumulated other comprehensive income (AOCI) is reallocated proportionately between the controlling interest and the NCI (i.e., classification is changed from additional paid-in capital to AOCI). No gain or loss is recognized in earnings. The difference between the fair value of the consideration received and the related carrying value of the controlling interest sold is recognized in the controlling interest s equity (e.g., additional paid-in capital).

40 Type of Change in Ownership Interests Reduction in parent's ownership interest: Control to noncontrolling investment. 4 Result Change the classification and measurement of the investment. Cease consolidation accounting and begin accounting for the investment under other applicable literature. Recognize in earnings realized gains and losses and holding gains and losses. Impact of ASC 810 (Statement 160) Impact The investment is deconsolidated. Any retained equity investment is remeasured at fair value. Page 2 of 3 Recognize gain or loss on interest sold and holding gain or loss on the equity interest retained in earnings. 3. Meets the definition of a business combination, as discussed in FAS141R. 4. Reduction in a parent s ownership interest may occur for different reasons, including (1) the parent sells a portion of the subsidiary s shares that it holds, or (2) the subsidiary issues additional shares [FAS 160.A1, par.32].

41 Impact of ASC 810 (Statement 160) Page 3 of 3 Summary of Changes in Key Provisions Key Provision Current GAAP FAS 160 Implication In general, the minority The NCI is recognized interest or the NCI is in the equity section, recorded in the presented separately mezzanine section. from the controlling The NCI is recognized in the equity section. Losses are allocated to noncontrolling interest. A change in interest occurs after control is obtained. Ownership interest is retained after control is lost. Net Income includes earnings attributable to the parent and the NCI. Earnings Per Share is calculated based on earnings to the parent company shareholders. Losses are not allocated to the NCI if it would place the NCI in a deficit position and there is no obligation for the NCI to fund the losses. Increases in the parent's equity interest are accounted for by the purchase method. Depending upon the nature of the transaction, decreases in the parent's equity interest is accounted for either as an equity transaction or as a transaction with gain or loss recognition. Any retained ownership interest is not remeasured. Net income excludes earnings attributable to the NCI. Net income excludes earnings attributable to the NCI. No adjustments to income available to common shareholders are necessary for earnings attributable to the NCI. interest s equity. Losses will continue to be allocated to the NCI even if the NCI is placed in a deficit position. Subsequent increases or decreases of interest that do not result in a change in control are accounted for as equity transactions. Any retained ownership interest is remeasured at fair value on the date control is lost, and any gains or losses are recognized in earnings. Net income includes earnings attributable to the NCI. Net income includes earnings attributable to the NCI. An adjustment to net income for earnings attributable to the NCI is necessary to determine income available to common shareholders of the controlling interest. Because the NCI will be reported as part of equity, the NCI is likely to increase the consolidated equity balance on the date of adoption. The controlling interest will record only its proportionate share of losses, even if the NCI is in a deficit position, resulting in potentially fewer losses being recognized by the controlling interest. Changes in the NCI balance will affect the controlling interest s equity balance. Differences between the fair value of the consideration received or paid and the related carrying value of the NCI will be recognized in the controlling interest s equity. Recognition of holding gains and losses may result in more volatility in earnings. Despite the new net income amount, earnings attributable to the parent company will be presented in the income statement, which will be consistent with net income as previously reported EPS will still be calculated based on earnings attributable to the parent company shareholders.