I recently wrote about one of the most dramatic changes since the inception of the fair value concept for financial reporting imposed by Statement of Financial Accounting Standards No. 157 (“FAS 157”). Nearly a year since the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, accounting standards have been codified and the nomenclature used when referring to FASB statements has changed. FASB Statement No. 157 is now encompassed in Accounting Standards Codification (“ASC”) 820.
Another sweeping change was initiated in 2007 when the FASB issued a revision to Statement 141 regarding business combinations, commonly referred to as FAS 141r and found in ASC 805. One of the most frequently encountered situations requiring fair value accounting is the business combination, when the fair value of the intangible assets acquired by the buyer must be determined. Intangible assets usually present in a business combination are customer related assets, such as customer contracts and/or customer relationships, marketing related intangibles, such as non-competition agreements, trademarks and trade names, technology-based intangibles, such as patents, copyrights, and trade secrets, and, finally, goodwill.
The process is simply to first apply the consideration paid for the business unit to the tangible assets, such as cash, accounts receivable, and fixed assets, based upon the fair value of each asset class. Next the fair value of the specifically identifiable intangible assets with a definite useful life is determined on an asset-by-asset basis. Any remaining consideration is allocated to goodwill. This is referred to as the residual method of determining the fair value of goodwill.
In a business combination, there are two important concepts of which the buyer must be aware, and for which the treatment under FAS 141r is different from the treatment under FAS 141. The first is the “bargain purchase” and the second is the determination of the fair value of non-controlling interests.
A “bargain purchase” occurs when the fair value of the assets acquired exceeds the consideration paid. The original FAS 141 required any excess of the fair value of the assets purchased over the consideration paid, to be allocated on a pro-rata basis to the long term assets acquired, effectively reducing the fair value of those assets. An extraordinary gain was recognized in the period if, after reducing the long-term assets to zero, there remained any excess value above the consideration paid. This treatment effectively reduced the long term tangible and intangible assets below their respective fair value. When this situation occurred, the objective of fair value reporting was undermined.
Under FAS 141r, this treatment has changed. The fair value of all assets acquired is the amount at which the assets are recorded. The difference is that the entire amount of the “bargain purchase” is recognized as a gain. This follows the objective of fair value reporting, measuring and recording the resulting assets at fair value as of the acquisition date.
When the controlling interest in a business enterprise is acquired, the treatment of remaining non-controlling interests has been clarified in FAS 141r. The previous FAS 141 did not provide guidance on the measurement of the non-controlling interest. Under FAS 141r, the non-controlling interest in an acquired business must be valued at fair value as of the acquisition date. Consideration must be given to the lack of prerogatives of control, if present, which may result in the downward adjustment of the fair value of the non-controlling interest.
The treatment of the non-controlling interest more closely follows the concept of fair value reporting in that it allows for the recognition of the goodwill of both the controlling and non-controlling interest at fair value.
The overall approach to the determination of the value of intangible assets, goodwill and non-controlling interest has changed with the revision of FAS 141. Under the former FAS 141, the concept was more of an allocation of the consideration paid. Under FAS 141r, the concept has changed to that of a valuation of the intangible assets, goodwill, and non-controlling interest.
The valuation contemplated by FAS 141r will typically require assistance from an independent valuation consultant.