Simplifying Business Combinations: A Quick Guide to ASC 805

Business combinations are a common occurrence in corporate strategy, with mergers, acquisitions and consolidations driving growth and transformation. While the idea behind these transactions is straightforward — combining two entities into one — the accounting can often seem complex. ASC 805 provides a framework to simplify the process, making it easier to approach business combinations with confidence.

What is a Business Combination?

A business combination occurs when one company acquires control over another, resulting in the combination of their assets, liabilities and operations. These transactions typically involve purchasing the entire entity of a target company or a controlling interest within it.

Under ASC 805, business combinations are accounted for using the purchase method, meaning the acquiring company must recognize the fair value of the assets and liabilities of the acquired company on its balance sheet at the acquisition date.

Key Steps in Accounting for a Business Combination:

1. Identify the acquirer

The first step is determining which company is the acquirer. The acquirer is typically the company that obtains control over the other company — this is usually determined based on factors like voting rights, management control and the ability to make decisions for the combined entity.

2. Measure the consideration transferred

The acquiring company must measure the fair value of what it paid for the acquired company. This includes cash, stock, debt or any other consideration (such as contingent payments) given in exchange for control of the target company.

3. Recognize and measure the identifiable assets and liabilities

The acquirer must recognize all assets acquired and liabilities assumed in the combination at their fair values on the acquisition date. This includes tangible assets like property and equipment, as well as intangible assets such as trademarks, customer relationships and goodwill.

4. Goodwill or gain from a bargain purchase

If the acquirer’s consideration exceeds the fair value of the acquired company’s identifiable assets and liabilities, the difference is recorded as goodwill. Goodwill represents the intangible value of the company’s brand, customer base or future earnings potential.

However, if the fair value of the acquired assets exceeds the consideration paid, the acquirer must recognize a gain from a bargain purchase — essentially a profit from acquiring the company at a price lower than its net asset value.

5. Subsequent accounting for goodwill

Once goodwill is recorded, it is not amortized but is tested annually for impairment. If the fair value of the reporting unit falls below its carrying value, goodwill may need to be written down.

The Importance of ASC 805

While business combinations can be complex, ASC 805 ensures transparency and consistency in accounting for these transactions. By using fair value measurements, companies can accurately report the assets and liabilities they’ve acquired and provide stakeholders with a clear picture of the financial health of the combined entity.

Understanding the core principles of ASC 805 — identifying the acquirer, measuring the consideration and recognizing assets and liabilities at fair value — can demystify the accounting process for business combinations. By simplifying these steps, companies can better navigate mergers and acquisitions and ensure accurate financial reporting for all stakeholders.

Key Takeaways:

• Business combinations occur when one company gains control of another.
• ASC 805 requires the acquirer to recognize assets, liabilities and goodwill at fair value.
• If the acquisition price exceeds the fair value of assets, goodwill is created.
• If the assets exceed the price paid, a bargain purchase gain is recognized.

By following these key principles, companies can accurately account for business combinations and ensure they meet the necessary financial reporting standards. Contact us to learn more about ASC 805. We are here to help.

Authored by Austin Hatley

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