Key takeaways
If you’re conducting, or considering, a business combination, you may be wondering how to handle an important step—determining the fair value of assets, liabilities, and noncontrolling interests. If so, look no further than Accounting Standards Codification (ASC) 805, Business Combinations, issued by the Financial Accounting Standards Board (FASB). This essential guidance provides the framework for this type of valuation and provides investors with a more accurate picture of the value of assets purchased and liabilities assumed in a merger or acquisition.
Fair value is the price in an orderly transaction between market participants based on an asset's or liability's highest and best use, which differs from fair market value that considers hypothetical buyers.
ASC 805 requires your company to ascertain the fair value of all acquired assets and assumed liabilities as of the acquisition date. But what exactly is fair value? According to ASC 820, Fair Value Measurement, it represents the price you would obtain if you were to sell an asset or the price you would pay to transfer a liability in an orderly transaction between market participants.
Fair value is calculated based on best use of the asset or liability by “market participants”—that is, buyers and sellers in the asset’s or liability’s principal market—distinguishing it from fair market value, which considers all hypothetical buyers.
The definitions and distinctions reflect established fair value principles and widely accepted financial reporting frameworks used in practical valuation engagements.
Determining fair value under ASC 805 involves identifying acquired assets and assumed liabilities, selecting appropriate valuation approaches, measuring each item at acquisition-date fair value, and allocating any residual to goodwill.
Now, let’s delve into the process of determining fair value in accordance with ASC 805. Whenever your company gains control of or merges with another business, you must perform a purchase price allocation (PPA) for financial reporting purposes. This exercise allocates the purchase price among all the acquired assets and assumed liabilities. You’ll need to consider both tangible assets, such as property, plant, and equipment (PP&E), and intangible assets, like patents, trademarks, and customer relationships. The liabilities you’ve assumed might include contractual obligations, debt, or contingent liabilities.
Refer to financial accounting valuation fresh start reporting for related methodologies used in purchase price allocation and post-acquisition reporting
Once you’ve identified all the assets and liabilities, you must determine their fair value as of the transaction date. Remember, fair value is determined based on the highest and best use of the asset or liability by market participants. You can choose from among several valuation methods, including market approaches, income approaches, and cost approaches, to determine fair value. Although there are several valuation methods to choose from, there are certain methods that are commonly used and widely accepted for certain types of assets. Moreover, when determining the fair value of the primary asset in a business combination, guidance suggest that appraisers consider a very specific type of valuation methodology. It is important to consult with valuation experts and your accounting professionals for best practices in all circumstances.
After the fair value of each asset and liability is calculated, any residual value between the total consideration paid and the sum of the net assets acquired is allocated to goodwill. Goodwill is an asset representing future economic benefits like synergies. Depending on the circumstances, you might not amortize goodwill, but you’ll need to test for impairment annually.
The described PPA steps align with professional valuation practice and common financial reporting workflows used across business-combination engagements.
Purchase price allocation requires assigning acquisition-date fair values to all forms of consideration and to each acquired asset and assumed liability so that the excess consideration is recognized as goodwill.
But how do you determine the purchase price in dollars and cents, since cash is often not the only payment form used in acquiring businesses and their assets? The crucial first step in any PPA exercise is to ascertain the fair value of all forms of consideration paid. That means you’ll tally not only cash paid, but all other elements of payment as well, such as contingent consideration, promissory notes, equity instruments (common or preferred), options, and warrants.
See the valuation process for detailed context on steps used to determine acquisition-date fair value and supporting analyses.
Furthermore, the FASB mandates that the consideration transferred to the seller must be recorded at its acquisition-date fair value, regardless of its form. Determining the cash value of all elements of payment at that date entails meticulous analysis and, often, complex valuation models. However, it’s worth doing right; starting out with the correct consideration paid is vital to ensuring accuracy in your company’s financial statements.
The allocation guidance reflects documented approaches used in transactional valuation work and the supporting analyses typically required for acquisition accounting.
If your business is a private company, you can explore a compelling alternative to the extensive, costly PPA process. Many business owners and investors have questioned whether this long, complex process is justified. In response, in December 2014, the FASB issued ASU 2014-18 – Business Combinations, which offers an accounting alternative to traditional GAAP (generally accepted accounting principles) standards for private companies. This alternative aims to reduce costs and complexity associated with measuring certain intangible assets without compromising the usefulness of financial statements.
More detail is available on the accounting alternative for goodwill that explains the interaction between ASU 2014-18 and the private-company goodwill alternative.
Under ASU 2014-18, if you opt for the private company accounting alternative, you will not need to separately recognize customer-related assets (unless they can be sold or licensed independently) or noncompetition agreements. Instead, most, if not all, of these assets will be subsumed into goodwill. Keep in mind that if you adopt the private company accounting alternative, you must also use the private company alternative to amortize goodwill (ASU 2014-02). (On the other hand, selecting ASU 2014-02 does not necessarily mandate the adoption of ASU 2014-18.)
The summary is consistent with the professional accounting alternatives considered by private-company advisors when evaluating recognition and amortization choices.
Q: What does ASC 805 require when a company acquires another business?
A: ASC 805 requires the acquirer to recognize and measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest at their acquisition-date fair values, and to allocate the purchase price among those items with any excess recorded as goodwill.
Q: How is fair value different from fair market value?
A: Fair value, as defined under ASC 820, reflects the price in an orderly transaction between market participants based on the asset's or liability's highest and best use, whereas fair market value can consider a broader set of hypothetical buyers and conditions.
Q: What valuation methods are commonly used under ASC 805?
A: Common approaches under ASC 805 include market, income, and cost approaches, selected based on asset characteristics and available data; specific methods are applied where they provide the most relevant measure of acquisition-date fair value.
Q: How is purchase price allocated in a business combination?
A: Purchase price allocation assigns acquisition-date fair values to all identified assets and liabilities, including non-cash forms of consideration, with any residual consideration recognized as goodwill; each element of consideration is measured at its fair value at the acquisition date.
Q: What GAAP alternative is available for private companies under ASU 2014-18?
A: ASU 2014-18 allows eligible private companies to subsume certain customer-related intangible assets and noncompetition agreements into goodwill rather than separately recognizing them, and that election affects subsequent goodwill amortization and disclosure choices.
In conclusion, performing an ASC 805 valuation is a complex endeavor requiring specialized knowledge and expertise in valuation and accounting. To ensure compliance with ASC 805 and to obtain accurate and reliable valuations, consider the benefits of consulting with accounting professionals or valuation experts. Doing so will enable you to unlock the secrets of ASC 805 valuations, navigate the intricate world of fair value determination with confidence, and make informed business decisions, all while knowing your financial reporting is accurate and transparent.
Paul Vogt
Paul Vogt is a Managing Director at PCE and leads the firm’s valuation practice from its Atlanta office. With over 20 years of experience, he specializes in business valuations for financial reporting, tax planning, litigation support, and corporate strategy across a wide range of industries.