Mergers & acquisitions — a snapshot Change the way you think about tomorrow’s deals

Stay ahead of the accounting and reporting standards for M&A1

December 14, 2011

Did I buy a group of assets or a business? Why should I care?
Determining whether an acquired group of assets is a business has proven to be one of the more challenging aspects of applying the current M&A accounting guidance. For many transactions, the determination will be straightforward. However, the current guidance will cause many transactions that are "on the edge," and previously would have been accounted for as asset acquisitions, to be accounted for as business combinations. Why is this determination important? While the measurement of assets and liabilities in both types of transactions will yield similar results, several differences can arise that can have a significant impact on a company's earnings, financial ratios, and business metrics. This edition of Mergers & acquisitions — a snapshot, identifies relevant considerations in determining whether a business has been acquired and why it matters not only upon acquisition but also for disposals and public company reporting.

What's inside Why does it matter? What is a business? Industry-specific considerations Disposal transactions Public company reporting Conclusion


Accounting Standards Codification 805 is the US standard on M&A, and Accounting Standards Codification 810 is the US standard on noncontrolling interests.

M&A snapshot


when probable and reasonably estimable Subsumed within goodwill Cannot be recognized Generally record when probable and reasonably estimable IPR&D Goodwill Acquired contingencies Assembled workforce Recognize as standalone asset M&A snapshot 2 . and 3) assess the impact of any missing elements on a market participant's ability to generate economic benefits. the acquisition of an operating company active in the marketplace will qualify as a business. In many transactions. the asset or business determination will be straightforward. Business combination Key business processes acquired A market participant could manage the assets to provide a return to its owners Key elements are missing but can be easily replicated or obtained Key employees hired Able to produce "Day 1" outputs Presence of liabilities and/or goodwill Asset acquisition No processes acquired or only administrative processes acquired A market participant could not manage the assets to provide a return to its owners without combining them with other assets Key elements are missing and cannot be easily replicated or obtained No employees hired Not able to create economic benefits No goodwill present Expense Generally record at fair Generally record when value. mark to market probable and through P&L postreasonably estimable close if a liability Capitalize as an Expense assuming no indefinite lived asset alternative future use until project completed or abandoned Recognize as standalone asset Recognize at fair value if determinable. otherwise. in other instances.e. this assessment can become more complex and judgmental. Businesses consist of assets/resources. the table below outlines some of the key areas where the accounting treatment can differ. or protocols applied to those assets/resources.. standards. it is important to: 1) identify the elements in the acquired group (i. whereas the purchase of a single machine will be accounted for as an asset acquisition. In making this determination. A business is an integrated set of assets and activities capable of being managed to provide a return to its owners. However. that have the ability to create economic benefits. 2) assess the capability of those elements to generate economic benefits. For example. The table below outlines some factors that may distinguish business combinations from asset acquisitions.Why does it matter? Determining whether a business has been acquired has far reaching business and accounting implications. such as revenues or lower costs. and systems. To illustrate. Area Measurement of assets and liabilities Transaction costs Contingent consideration Business combination Fair value Asset acquisition Allocate purchase consideration based on relative fair values Capitalize What is a business? The M&A standards contain a definition of a business that can result in a broad range of transactions qualifying as business acquisitions. the assets purchased and processes transferred).

Considerations relevant to some of these industries are discussed below. Additionally. this transaction may have been treated as the acquisition of property. Company W decides to purchase a commercial office property in San Francisco. and property management can vary significantly in the purchase of an empty building versus a building with multiple tenants. the existing property management agreement will be terminated and Company W will undertake all property management functions. However. a real estate investment entity. properties acquired for extractive activities vary significantly in terms of their stage of development and viability. it is important to consider the stage of development of IPR&D and the level of expertise of any employees hired in connection with the transaction. Company L is an oil and gas production company that operates a large portfolio of producing properties. Example 1 — acquisition of oil and gas exploration company Facts: Company K is an oil and gas exploration company. M&A snapshot 3 . and Company W will become a party to the lease agreements upon acquisition. The existing property is 90% occupied. Oil and gas industry In the oil and gas industry. For example. under the current guidance it is likely a business has been acquired. Company W will also hire leasing managers and other management personnel involved with the operations of the property. Example 2 — acquisition of commercial properties Facts: Company W. Company W acquired assets (commercial property. Analysis: In the past. the necessary operational processes to manage the acquired group in a way that would provide a return to investors. Company W concluded that other market participants would have existing property management expertise. Real estate industry Acquired properties vary as to the level of business processes that are needed to yield a return and the degree to which those processes are present at acquisition. this transaction may have been Analysis: In the past. the nature of tenant solicitation. Company L acquires Company K. under the current guidance. While there are missing elements (other infrastructure and developed reserves). treated as the acquisition of real estate. However. rental income is present immediately after the acquisition. However. Company L determined that likely market participants would have. Due to the differing stages of development and exploration. Company W will replace existing security. it is likely a business has been acquired.Industry-specific considerations Determining whether a business has been acquired can be particularly challenging in certain industries. or could easily obtain. IPR&D and contingent consideration arrangements are prevalent. Properties may be completely unexplored and undeveloped on one extreme. An example of a transaction in this industry is described below. This concept is highlighted in the following example. Further. and other contracts) and hired key leasing and management personnel. cleaning. making the stakes particularly high for determining what constitutes a business. and may be actively producing on the other. In making this determination. such as collecting rent and supervising maintenance work. However. lease agreements. Company K has constructed transportation infrastructure that will be used to transport the mineral reserves. The acquisition includes assets (property and transportation infrastructure) and systems/protocols (supporting exploration activities). but has not yet begun to extract the mineral reserves from the property. this infrastructure has not yet been placed into operation. In connection with the transaction. Technology industry In the technology industry. maintenance. Company K owns a proven but undeveloped property. and maintenance contracts with new contracts. Company K has performed enough exploration activities to determine that the property is proven. judgment is required to determine whether many properties are businesses or assets. owns and manages a group of commercial properties across the United States.

there are likely to be more processes associated with later stage drug compounds than those in earlier stages. While Big Pharma Co. processes. Disposal transactions The business versus asset determination is also relevant for disposal transactions. A key difference between an asset sale and a business sale is that in the latter case goodwill needs to be allocated to the business sold. testing. and development equipment) and the operating protocols and procedures established by the scientists. Allocation of goodwill to the business sold would also trigger the need for an impairment assessment of the remaining goodwill in the reporting unit. Development Inc. did not acquire a manufacturing facility or a sales force. IPR&D and contingent consideration arrangements can constitute a significant portion of a transaction in the pharmaceutical and life sciences industry. such as some worldwide perpetual licenses in which employees. acquires the rights to certain of the product candidates as well as testing and development equipment from Development Inc. this arrangement may have been treated as an executory contract. computer equipment. Company O acquires a building. While all employees of Firm P working in this area have been hired by Company O in the transaction. the acquired group is capable of providing a return to its owners. M&A snapshot 4 . may be business acquisitions. Analysis: This transaction would likely have been accounted for as an asset acquisition in the past (acquisition of a pre-revenue development company). Analysis: In the past. Company O plans to initiate a restructuring. IP) and systems/protocols (computer systems. As part of the agreement. It offers to provide services to Firm P under a 20 year agreement. In most cases. which will eliminate headcount and improve efficiency. owns the right to several product (drug compound) candidates. computer equipment. under the current guidance. An example illustrating the application of this guidance to an outsourcing arrangement is presented below. Big Pharma Co. also hires the scientists formerly employed by Development Inc. Big Pharma acquired assets (product candidates. and certain intellectual property ("IP") held by Firm P. it is likely a business has been acquired. Its only activities consist of research and development that is being performed on the product candidates. However. who are developing the acquired candidates. Pharmaceutical & life sciences industry Similar to the technology sector. Example 4 — acquisition of research and development company Facts: Development Inc. This allocation could have a significant impact on the gain or loss recognized from the sale. it is likely a business has been acquired. employs management and administrative personnel as well as scientists that are vital to performing the R&D. In addition. certain licensing arrangements. or other assets have been acquired. Big Pharma Co. Company O acquired assets (building. it determined that the likely market participants are other large pharmaceutical companies that already have these items or could easily replicate them. knowledge resident in employees). Example 3 — outsourcing arrangement Facts: Company O is in the business of providing information technology outsourcing services. Further. The following example illustrates the application of this guidance in the pharmaceutical industry. The following example highlights these considerations for a disposal transaction. Now.Outsourcing arrangements are common in the technology industry because they allow companies to lower their fixed costs. Some relevant factors to consider in determining whether a business has been acquired include the stage of development of any drug compounds acquired and any processes attached to the acquired assets.

US Fair value Net assets (excluding goodwill) Goodwill Total book value $3.000 $1. The widget reporting unit comprises two plants .000) of the total widget reporting unit goodwill to the European plant.000. Making these judgments will not be easy but buyers will want to avoid post-deal "surprises" by addressing this issue early in the deal process. Company V will test the remaining amount of goodwill for $500 $3. Financial information for the widget reporting unit and its two plants prior to the disposal is provided in the table below.200 and Company V will record a gain of $800 based on a sales price of $ M&A snapshot 5 .p.mcmanus@us. the SEC rules require financial statements for acquired businesses that are considered significant.000 $2. for the most part.000 $ Principal authors: Lawrence Henri Leveque Accounting Advisory Services Leader (678) 419-3100 h.500 In summary There are no "bright lines" that can be used in determining whether a business has been acquired.leveque@us. For more information on this publication please contact one of the following individuals: John Glynn Valuation Services Leader (646) 471-8420 that sources US subsidiaries and one that sources European subsidiaries.000.glynn@us. there is no such requirement for asset acquisitions.500 Europe $2.000 Total $ John Vanosdall National Professional Services Group Director (973) 236-4030 john. Company V decides to sell the plant in Europe for $ Dodyk US Business Combinations Leader (973) 236-7213 lawrence. or $200. the book value of the European plant is $1. In contrast. the asset versus business determination can also impact SEC reporting requirements. be the same for Kevin McManus Assurance Senior Manager (704) 344-4320 Often times. what constitutes a business will.dodyk@us. Public company reporting For public companies. this determination is judgmental and can have a significant impact on a buyer's financial reporting. Specifically.Example 5— disposal of a plant Facts: Company V is a diversified manufacturing company that has a widget reporting This results in an allocation of 40% ($2.a. Absent the allocation of goodwill to the European plant. As a result. While the SEC's rules are different from the M&A rules. The plant is also currently producing widgets. Company V would allocate a portion of the total widget reporting unit goodwill upon disposal based on the relative fair values of the US and European plants. In addition. Company V would have recorded a gain of $ such as manufacturing protocols and knowledgeable employees.000 Analysis: The plant in Europe likely qualifies as a business because it has tangible and intangible assets and processes.000/$5.vanosdall@us.p.

No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication. each member firm of which is a separate legal entity. and does not constitute professional advice on facts and circumstances specific to any person or entity. covering topics relevant to a broad range of constituents. PwC. You should not act upon the information contained in this publication without obtaining specific professional advice. which can be found at www. GAAP and IFRS Standards—for accounting professionals and deal makers Dataline 2008-01: FAS 141(R). All rights reserved. which is a member firm of PricewaterhouseCoopers International Limited. for purposes of avoiding penalties or sanctions imposed by any government or other regulatory body. The information contained in this material was not intended or written to be used. Classification and Measurement of Redeemable Securities—for accounting professionals and deal makers Dataline 2009-16: New Guidance for Acquired Contingencies—for accounting professionals and deal makers Dataline 2009-34: Accounting for Contingent Consideration Issued in a Business Combination—for accounting professionals and deal makers Dataline 2011-20: Goodwill Impairment—FASB proposes changes to impairment test—for accounting professionals and deal makers Dataline 2011-28: FASB issues guidance that simplifies goodwill impairment test and allows early adoption—for accounting professionals and deal makers PwC clients who would like to obtain any of these publications should contact their engagement partner. and cannot be used. employees and agents shall not be responsible for any loss sustained by any person or entity who relies on this publication. . "PwC" refers to PricewaterhouseCoopers LLP. Business Combinations—for accounting professionals and deal makers Dataline 2008-02: FAS 160.PwC has developed the following publications related to business combinations and noncontrolling interests. Noncontrolling Interests in Consolidated Financial Statements—for accounting professionals and deal makers Dataline 2008-30: Key Considerations for Implementing FAS 141(R) and FAS 160—for accounting professionals and deal makers Dataline 2008-35: Nonfinancial Asset Impairment Considerations—for accounting professionals and deal makers Dataline 2009-08: Revisions to EITF Topic D-98. 10Minutes on Mergers and Acquisitions—for chief executive officers and board members What You Need to Know about the New Accounting Standards Affecting M&A Deals—for senior executives and deal makers Mergers & acquisitions—a snapshot—a series of publications for senior executives and deal makers on emerging M&A financial reporting issues Business Combinations and Consolidations…the new accounting standards—an executive brochure on the new accounting standards A Global Guide to Accounting for Business Combinations and Noncontrolling Interests: Application of U. Prospective clients and friends should contact the managing partner of the nearest PwC office. a Delaware limited liability This publication has been prepared for general information on matters of interest only.S. © 2011 its members.

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