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.
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.