FASB Issues Revolutionary New Business Combination Rules  
By Kristine Hoefler
Community Bank Advisor, 2008 Winter

Hot off the presses is a new business combination pronouncement – FASB Statement No. 141R, Business Combinations – that will go into effect in 2009. This new statement is the first issued in a joint effort of the Financial Accounting Standards Board and the International Accounting Standards Board. A long-term goal of having one set of international accounting standards drives this joint effort.

The key objectives of this new standard are:

• Develop a single, high-quality business combination standard that can be used for cross-border financial reporting.
• Improve the completeness, relevance, and comparability of financial information provided about business combinations.
• Simplify the accounting for business combinations.

Fundamental principles of the new standard as compared to existing practice include:

• Out-of-pocket external costs (e.g., professional fees, such as investment banking, legal and accounting fees) will be expensed as incurred instead of being capitalized into the cost of the deal.
• The acquirer will measure the assets acquired, the liabilities assumed and any non-controlling interests (NCI) at fair value. The current rules follow a cost-accumulation approach where the acquirer’s total costs are allocated to the target.
• Contractual contingencies will be measured at fair value and recorded at the acquisition date. Non-contractual contingencies will also be measured at fair value and, if it is more likely than not that the contingencies will result in an asset or liability, such contingencies will be recorded at the acquisition date. Current GAAP requires recognition of contingencies at the time of acquisition if they are probable and reasonably estimable.
• Restructuring costs generally will not be assumed liabilities, but recorded as period costs. Current practice does not result in such activities impacting earnings.
• Goodwill will be calculated as the sum of the fair value of the consideration given, the NCI and the previously held equity interests in the target, less the net identifiable assets.
• A bargain purchase will result in current gain recognition, instead of reducing the long-term assets by the excess of fair value of the net assets over cost.
• The contingent purchase consideration (i.e., earn-out) will be measured and recorded at fair value at the acquisition date. Currently, earn-outs are generally not recognized until the contingency is resolved, and then it is recorded as part of the purchase price.
• Step and partial acquisitions will result in a currently recognized gain or loss. The portion previously owned will be revalued with a gain or loss recognized. Previously, fair value would only be recognized to the extent acquired.

The new rules significantly change purchase accounting, and they have more applicability. Currently, the rules define a business as a self-sustaining entity. The new rules define a business as an integrated set of activities that will provide a return to investors, pay dividends, lower costs, or provide economic benefits. This definition of a business could apply to many purchases. With this broad business definition, it is likely that goodwill will be recorded in transactions that would not have resulted in goodwill in the past.

This statement was released in December 2007 and is quite lengthy. While the details of the statement are still being analyzed, it is safe to say that those working on deals and preferring current purchase accounting rules will be motivated to close the transaction in 2008.