The acquisition method: scope, the definition of a business and the four steps

• Decide whether a transaction is a business combination or an asset acquisition
• Apply the ASU 2017-01 screen and the input and substantive process test
• List the four steps of the acquisition method in order
• Compute goodwill from consideration, noncontrolling interest and net assets

What ASC 805 covers

Topic 805 applies when an acquirer obtains control of a business. Control is the same concept used in Topic 810: a controlling financial interest, usually a majority voting interest, or primary beneficiary status for a variable interest entity. The transaction can be a purchase of shares, a purchase of net assets, a merger, or control obtained without paying anything, for example when a minority veto right lapses.

Three common transactions sit outside the acquisition method: the formation of a joint venture, the acquisition of an asset or a group of assets that is not a business, and a combination of entities or businesses under common control. Not-for-profit mergers and acquisitions follow Subtopic 958-805.

Business or asset acquisition

The answer drives almost every number that follows. In an asset acquisition, cost is allocated to the assets on a relative fair value basis, no goodwill is recognized, transaction costs are capitalized, and contingent consideration usually waits until it is probable and estimable. In a business combination, assets and liabilities are measured at fair value, goodwill or a bargain purchase gain falls out as a residual, and transaction costs are expensed.

ASU 2017-01 added a screen in 805-10-55-5A. If substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. Gross assets exclude cash, deferred tax assets and goodwill arising from deferred tax liabilities. A building and its in-place leases are treated as one asset for the screen.

If the screen is not met, a set is a business only if it includes, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. When the set has no outputs, the process must be critical and the inputs must include an organized workforce able to perform it. ASU 2017-01 also narrowed the definition of outputs to goods or services provided to customers, investment income and other revenues.

The four steps

805-10-05-4 lists the steps of the acquisition method:

1. Identify the acquirer. One of the combining entities is always the acquirer.
2. Determine the acquisition date. The date the acquirer obtains control, usually the closing date.
3. Recognize and measure the identifiable assets acquired, the liabilities assumed and any noncontrolling interest. The measurement basis is acquisition-date fair value, with listed exceptions such as income taxes (Topic 740), employee benefits, leases where the acquiree is the lessee (Topic 842), and contract assets and liabilities with customers (Topic 606, under ASU 2021-08).
4. Recognize and measure goodwill or a gain from a bargain purchase.

The goodwill equation

805-30-30-1 measures goodwill as the excess of (a) over (b):

• (a) the aggregate of the consideration transferred, the fair value of any noncontrolling interest, and the acquisition-date fair value of any previously held equity interest in the acquiree
• (b) the net of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed

Consideration transferred includes cash, the fair value of equity issued, and the acquisition-date fair value of contingent consideration. It excludes payments that are really for something else: settling a preexisting relationship, paying employees for future service, or reimbursing the acquiree for the acquirer's deal costs.

US GAAP measures the noncontrolling interest at fair value, so goodwill is recognized for the whole acquiree, not only the acquirer's share. A previously held interest is remeasured to fair value at the acquisition date, with any gain or loss in earnings.

Acquisition-related costs

Finder's fees, legal, accounting, valuation and advisory fees are expensed as incurred under 805-10-25-23. The one exception is the cost of issuing debt or equity securities, which follows other applicable GAAP (Subtopic 835-30 for debt) and reduces the carrying amount of the debt or the proceeds of the equity.

The memo that follows

Each step becomes a section of the acquisition memo, and the purchase price allocation workbook carries the numbers. The rest of this track takes each step in turn, then moves to consolidation, the equity method and the audit.

Computing goodwill for an 80 percent acquisition