ASC 805 Business Combinations for Private Companies: Acquisition Method, Goodwill and Intangibles

A private company buys a competitor, a book of customers, a franchise or a subsidiary. The purchase price has to be allocated to what was acquired, and the difference ends up in goodwill. ASC 805, Business Combinations, sets the rules. Private companies also have accounting alternatives, developed by the Private Company Council, that reduce the number of intangible assets recognized separately.

This guide covers the scope question, the acquisition method, goodwill, the alternatives, and the procedures auditors perform on a purchase price allocation.

Business or asset acquisition

ASC 805 applies when an entity acquires control of a business. A business is an integrated set of activities and assets capable of being conducted and managed to provide a return. Buying a single building or a group of similar assets is an asset acquisition, and the accounting differs: cost is allocated to assets on a relative fair value basis, no goodwill is recognized, and transaction costs are generally capitalized.

ASU 2017-01 added a screen test. If substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. If the screen is not met, the entity assesses whether the set includes at minimum an input and a substantive process that together significantly contribute to the ability to create outputs. Document the conclusion, because it determines whether goodwill and the other ASC 805 requirements apply.

The acquisition method

All business combinations use the acquisition method. The steps:

1. Identify the acquirer. Usually the entity that obtains control. In a transaction with a new entity or a reverse acquisition, assess who holds the voting rights, board and management, and who pays.
2. Determine the acquisition date. The date the acquirer obtains control, normally the closing date.
3. Recognize and measure identifiable assets acquired, liabilities assumed and any noncontrolling interest. The general principle is fair value at the acquisition date, with exceptions for items such as deferred taxes (ASC 740), employee benefits and leases (ASC 842), and indemnification assets.
4. Recognize and measure goodwill or a gain from a bargain purchase.

Consideration transferred

Consideration includes cash, other assets, equity issued and contingent consideration, measured at fair value. Items that are not part of the exchange for the business are accounted for separately. Examples are payments that primarily benefit the acquirer, such as compensation for future services to selling owners who remain as employees, and settlement of preexisting relationships.

Acquisition-related costs, such as legal and advisory fees, are expensed as incurred. Costs to issue debt or equity are accounted for under other guidance.

Contingent consideration (earnouts) is recognized at acquisition-date fair value. It is classified as a liability or equity under ASC 480 and ASC 815-40. Liabilities are remeasured to fair value each period with changes in earnings. Judgment is needed in separating earnouts that are really compensation, especially if payment is tied to continued employment.

Identifiable assets, including intangibles

An intangible asset is identifiable if it arises from contractual or legal rights or is separable. Typical intangibles in small and mid-sized deals include customer relationships and contracts, trade names, noncompete agreements, developed technology, backlog, favorable and unfavorable contracts and licenses.

Other measurement points:

• Receivables and inventory at fair value, not the seller's carrying amount. For acquired loans and receivables with credit deterioration, ASC 326 adds specific treatment for purchased financial assets. See the CECL guide.
• Property and equipment at fair value, often from an appraisal.
• Deferred taxes on the difference between the book and tax bases of acquired assets and assumed liabilities. See the income taxes guide.
• Contract liabilities. ASU 2021-08 requires acquirers to recognize and measure acquired contract assets and contract liabilities under ASC 606 as if the acquirer had originated the contracts, instead of at fair value. For entities other than public business entities, it is effective for fiscal years beginning after December 15, 2023, applied prospectively to business combinations after adoption.
• Contingencies are recognized at fair value if the acquisition-date fair value can be determined during the measurement period, and otherwise under ASC 450 criteria. See loss contingencies.

Goodwill and bargain purchase

Goodwill is the excess of the sum of consideration transferred, the fair value of any noncontrolling interest and the fair value of any previously held equity interest, over the net identifiable assets acquired at fair value. If the net identifiable assets exceed that sum, the acquirer first reassesses whether it has correctly identified and measured all assets, liabilities and consideration. Any remaining excess is a bargain purchase gain recognized in earnings.

Measurement period

If the initial accounting is incomplete at the end of the reporting period, the acquirer reports provisional amounts and adjusts them as new information about facts at the acquisition date emerges. The measurement period ends when the acquirer receives the information it was seeking or concludes that it cannot get more, and cannot exceed one year from the acquisition date. Adjustments are recognized in the period determined.

Private company alternatives

Two accounting alternatives developed by the Private Company Council matter in practice. Both are elections for entities that are not public business entities, and the first is a precondition for the second.

Goodwill alternative (ASU 2014-02, ASC 350-20)

A private company may elect to amortize goodwill on a straight-line basis over 10 years, or less if the entity demonstrates a shorter useful life is more appropriate, and to test goodwill for impairment only when a triggering event indicates that the fair value of the entity (or the reporting unit, if elected) may be below its carrying amount. The entity makes an election to test at the entity level or reporting unit level. ASU 2021-03 permits evaluating triggering events as of the end of the reporting period rather than throughout. The election applies to existing goodwill and all future goodwill. Impairment accounting itself is covered in the ASC 360 and ASC 350 guide.

Alternative on identifiable intangibles (ASU 2014-18)

A private company that elects it does not recognize separately from goodwill:

• customer-related intangible assets that cannot be sold or licensed independently from other assets of the business, and
• noncompete agreements.

Customer-related intangibles that can be sold or licensed independently, such as mortgage servicing rights or commodity supply contracts, are still recognized. A company that makes this election must also adopt the goodwill alternative, as it was designed as a package. The election is made at the time of the first business combination after adoption, and applies prospectively. Some assets previously recognized are left in place, and the alternative affects only future combinations.

The effect is a larger goodwill balance and fewer intangibles to value and amortize. The cost is less information in the statements for users who value customer relationships separately, and a potential difference from what lenders or investors expect, so discuss it with the client before electing.

Disclosures

Disclosures include the name and description of the acquiree, the acquisition date, the percentage of voting interests acquired, the primary reasons, the fair value of consideration by major class, the amounts recognized for each major class of assets and liabilities, the nature of goodwill, and contingent consideration terms and range of outcomes. Supplemental pro forma revenue and earnings disclosures apply to public business entities, and nonpublic entities have other reduced disclosures. A GAAP disclosure checklist can be used to track the requirements.

What auditors test

Business combinations can be a significant risk. Risk factors include subjectivity (fair values, useful lives), complexity (earnouts, deferred taxes) and management's incentive to allocate between goodwill and depreciable assets.

Planning and transaction understanding

• Read the purchase agreement, disclosure schedules, closing statement, any side letters and board minutes. Identify consideration, earnouts, escrows, working capital adjustments, employment and noncompete agreements.
• Confirm the acquisition date and that control transferred.
• Consider whether the acquired entity needs audit procedures on opening balances; this ties to AU-C 510 for initial engagements where the acquiree had another auditor.

Business vs asset acquisition and the allocation

• Evaluate management's conclusion and the screen test.
• Evaluate whether all identifiable assets were considered, including intangibles, with reference to the purchase agreement and the acquiree's business.
• Test the fair value measurements. Where a third-party valuation was obtained, evaluate it under AU-C 501 (management's specialist) or AU-C 620 (your own specialist), including source data and key assumptions such as discount rates, attrition and royalty rates. Fair value concepts are in the ASC 820 guide.
• Recalculate goodwill and test the deferred tax effects.
• Evaluate the estimates under AU-C 540.

Consideration and costs

• Agree cash paid to bank statements and wire confirmations. Agree equity issued to the cap table.
• Test the fair value of contingent consideration and its classification, and at later dates its remeasurement.
• Verify that acquisition costs were expensed and that nothing was capitalized into the allocation.

Subsequent accounting

• Test amortization of finite-lived intangibles and of goodwill if the alternative was elected.
• Evaluate triggering events for goodwill impairment.
• Test adjustments during the measurement period and the support.
• Evaluate subsequent events that give evidence about acquisition-date fair values.

Consolidation

The acquiree is consolidated from the acquisition date. Test intercompany eliminations and the noncontrolling interest as described in the ASC 810 guide.

Common issues

• No documented business vs asset conclusion.
• Intangibles lumped into goodwill without an election, or the election applied to the wrong combination.
• Earnout classified incorrectly, especially when tied to continued employment.
• Acquisition costs capitalized.
• Deferred taxes omitted from the opening balance sheet.
• Valuation report not read, with the specialist's assumptions unchallenged.
• Working capital true-up not reflected in consideration.

FAQ

What is the acquisition method?

The acquisition method identifies the acquirer and acquisition date, recognizes and measures the identifiable assets acquired and liabilities assumed at fair value (with specified exceptions), and recognizes goodwill or a bargain purchase gain.

What is the private company alternative for intangible assets?

An election under ASU 2014-18 not to recognize separately from goodwill certain customer-related intangibles that cannot be sold or licensed independently, and noncompete agreements. It requires adopting the goodwill alternative as well.

Can a private company amortize goodwill?

Yes, under the goodwill alternative a private company may amortize goodwill, generally over 10 years or less, and test for impairment only on a triggering event. It is an accounting policy election.

How long is the measurement period?

It ends when the acquirer has the information it needs about acquisition-date facts, and cannot exceed one year from the acquisition date.

Are transaction costs part of the purchase price?

In a business combination, no. They are expensed as incurred. In an asset acquisition, they are generally capitalized.

CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.

Sources

• FASB ASC 805, Business Combinations (805-10, 805-20, 805-30, 805-50)
• FASB ASU 2017-01, Clarifying the Definition of a Business
• FASB ASU 2014-02 and ASU 2014-18 (Private Company Council alternatives); ASU 2021-03 (triggering event evaluation)
• FASB ASU 2021-08, Accounting for Contract Assets and Contract Liabilities from Contracts with Customers
• FASB ASC 350-20, 450-20, 480, 740, 815-40
• AICPA, AU-C Section 501 (management's specialist), 510, 540 and 620

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error