International Convergence: The Case of Accounting for Business Combinations

CPA Journal, The, Apr 2008 by Dorata, Nina T, Badawi, Ibrahim M

On June 30, 2005, FASB and the International Accounting Standards Board (IASB) each issued exposure drafts dealing with both business combinations and consolidation procedures. FASB's exposure drafts included "Business Combinations" and "Consolidated Financial Statements, Including Accounting and Reporting of Noncontrolling Interests in Subsidiaries." The lASB's related exposure drafts included proposed amendments to International Financial Reporting Standard (IFRS) 3, Business Combinations; proposed amendments to International Accounting Standard (IAS) 27, Consolidated and Separate Financial Statements; and proposed amendments to IAS 37, Provisions, Contingent Liabilities and Contingent Assets, and IAS 19, Employee Benefits.

The FASB and IASB exposure drafts on business combinations were developed jointly, and contain virtually the same accounting concepts. They represent a major joint convergence project between these two boards. The objectives of this project are twofold: to provide a single high-quality standard for accounting for business combinations that could be used for both domestic and international financial reporting; and to promote the international convergence of accounting standards.

Working Toward Convergence

The jointly developed standards for business combinations were a product of two phases. During the first phase, FASB and the IASB separately deliberated the issue of accounting for business combinations. FASB concluded the first phase in June 2001 by issuing SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets. The IASB concluded its first phase in March 2004 by issuing IFRS 3, Business Combinations. In these standards, both boards required the use of the purchase method as the single method of accounting for business combinations.

During the second phase, FASB and the IASB simultaneously addressed the guidance for applying the acquisition method, and decided to conduct this phase as a joint effort with the objective of reaching the same conclusions and similar standards for accounting for business combinations. Accordingly, the joint standards replace the existing requirements of SFAS 141 and IFRS 3. Furthermore, FASB requires simultaneous adoption of SFAS 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin (ARB) 51, Consolidated Financial Statements, issued in August 1959.

FASB and the IASB believe that the new standards will help users and preparers by improving the comparability and transparency of financial information reported by companies that engage in business combinations and issue consolidated financial statements in accordance with either U.S. GAAP or the IFRS.

The revised standards for business combinations retain the fundamental requirement of SFAS 141 and of IFRS 3, which is to account for all business combinations using a single method (acquisition), where one party (the acquirer) is always identified as acquiring the other entity (the acquiree). However, the revised standards include procedures that drastically alter previous guidance, including considerably altering immediate and future charges to the income statement in connection with business combinations. The following discusses the revisions to accounting procedures and financial statement presentations for business combinations. The Exhibit presents the highlights of the revised standards and disclosures.

Acquisition Method, Goodwill, and Noncontrolling Interest

The guidance in SFAS 141(R) applies to transactions in which an acquirer obtains control of one or more businesses. Business combinations must be accounted for using the acquisition method, where the acquirer measures and recognizes the acquiree as a whole, and the assets acquired and liabilities assumed (including all identifiable contingent assets and liabilities) are recognized at their fair values as of the acquisition date. The acquisition date is the date the acquirer obtains control of the acquired business (the closing date). No longer may an acquirer designate an effective date of the business combination to the beginning of the period and avoid the presentation of preacquisition earnings of the acquiree.

The fair value as a whole is measured as the aggregate of: 1) the fair value of the consideration transferred; 2) the fair value of any noncontrolling interest in the acquiree; and 3) the fair value of the acquirer's previously held equity interest in the acquiree. Excluded from the fair value measurement are assets held for sale, deferred taxes, indemnification assets, employee benefit plans, reacquired rights, share-based payment awards, and goodwill. For business combinations where control is achieved in stages, any previously held equity interest must be remeasured to fair value as of the acquisition date; together with any prior periods' other comprehensive income, any resulting gains or losses are included in earnings.

Goodwill is still an unidentifiable residual value but is computed as the excess of the fair value of the acquiree as a whole over the fair value of the identifiable net assets acquired. The goodwill measurement differs from the measurement prescribed by the purchase method, in which goodwill equals the difference between the cost of acquisition and the acquirer's share of the fair values of the identifiable net assets acquired. Any negative goodwill created in a bargain purchase must be recognized as a gain in income from continuing operations following a reassessment of fair value measurements used in the computation.