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Valuations for Business Combinations

Pursuant to ASC 805, (formerly SFAS 141 R), a transaction or other event is a business combination if assets acquired and liabilities assumed constitute a business. A business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.

In the case of a merger or acquisition involving a business combination, the assets and liabilities of the acquiree must be consolidated into those of the acquirer at their acquisition date fair values, pursuant to specific accounting rules presented in ASC 805.

ASC 805 indicates that an entity shall account for each business combination by applying the acquisition method. Applying the acquisition method requires:

• Identifying the acquirer
• Determining the acquisition date
• Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, measured at their fair value as of the acquisition date.
• Recognizing and measuring goodwill or a gain from a bargain purchase.

ASC 805 provides that an intangible asset will be recognized as an asset apart from goodwill if (a) it arises from contractual or other legal rights, or (b) it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented, or exchanged (regardless of whether there is an intent to do so). Categories of intangible assets that meet the criteria for recognition as assets apart from goodwill include:

• Marketing-related intangible assets such as trademarks and trade names;
• Customer-related intangible assets such as customer contracts and related customer relationships;
• Artistic-related intangible assets;
• Contract-based intangible assets such as licensing, royalty and standstill agreements; and
• Technology-based intangible assets such as patented technology.

ASC 820, (formerly SFAS No. 157), provides guidance as to the definition of fair value, valuation techniques to be applied in fair value measurement, the "fair value hierarchy" and required disclosures. Fair Value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Various valuation techniques are employed in deriving the fair value of intangible assets acquired in a business combination which generally fall under the three principal approaches to value:  income approach, market approach and cost approach.  Specific methodologies include the Multi-Period Excess Earnings Method, Relief from Royalty Method and others.

Goodwill
Differences between the purchase price and the fair value of assets or net assets acquired are recognized as either goodwill or a gain from bargain purchase.  Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. Goodwill is measured at the acquisition date as the excess of the total consideration over the fair value of identifiable tangible and intangible assets acquired.  Any excess of fair value of assets acquired over the purchase price ("negative goodwill") will be recorded as an extraordinary gain under ASC 805.

Changes from Prior Practice
Certain provisions of ASC 805, (formerly SFAS 141(R)), are clearly different from previous accounting rules under SFAS141, which applied to past transactions in which the acquisition date prior to beginning of the first annual reporting period beginning on or after December 15, 2008.  Some of the most significant differences, from a valuation perspective are as follows:

1. Recognize, with certain exceptions, 100 % of the fair values of assets acquired, liabilities assumed, and non-controlling interests.
• This replaces SFAS No. 141’s cost-allocation process, in which the total cost of the acquisition (including transaction costs) were allocated to assets and liabilities based on their estimated fair values
2. Measure acquirer shares issued in consideration for a business combination at fair value on the acquisition date.
• Under SFAS No. 141, equity consideration was measured around the announcement date (all other consideration measured at closing)
3. Recognize contingent consideration arrangements at their acquisition-date fair values, with subsequent changes in fair value generally reflected in earnings. This is to be re-measured at each reporting date.
• Under SFAS No. 141, these items were not measured until the contingency was resolved
4. Capitalize in-process research and development (IPR&D) assets acquired.
• IPR&D was expensed under SFAS No. 141
5. Expense, as incurred, acquisition-related transaction costs.
• These costs were capitalized under SFAS No. 141
6. The excess of fair value of assets acquired over the purchase price ("negative goodwill") will be recorded as an extraordinary gain under ASC 805.
• Under SFAS No. 141, "negative goodwill" was treated as a pro-rata reduction to the preliminary fair value indications to all assets acquired except net working capital and land.
7. Recognition of contingent assets and liabilities if they can be reasonably determined.
   • Not recognized at fair value under SFAS No. 141

The valuation professionals at Hempstead & Co. have extensive experience in dealing with the complex valuation issues related to business combinations. We welcome the opportunity to be of service.