What’s Fair About Fair Value Acquisition Accounting?

What’s Fair AboutFair Value Acquisition

Accounting?

September 18, 2014

Presented by W. Michael Wolfe, CPA/ABV, CVAFesnak, LLP

[email protected]

Main Line Association forContinuing Education

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Evolution of Acquisition Accounting Evaluating the Acquisition Recording the Acquisition Subsequent Impairment Testing What’s Fair About “Fair Value”

Acquisition Accounting ???

Acquisition Accounting – Topics for Today

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Corporate Finance Business (Enterprise) Valuation Intangible Asset Valuation Negotiating Accounting

Acquisition Accounting Skillsets

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Evolution of Acquisition Accounting

Acquisition Accounting

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Pre-2002 Purchase Method (treated all intangibles as goodwill) Pooling-of-Interests Method (combining of balance

sheets) Goodwill amortized up to 40 years

2002 SFAS 141 Issued – Required Purchase Method Accounting

(with identifiable intangibles recorded at fair value and the residual recorded as goodwill) Goodwill not longer amortized. Instead tested

annually for impairment Finite-lived intangible assets amortized Indefinite-lived intangible assets tested periodically

for impairment SFAS 142 Issued – 2 Step Annual Impairment testing

required with no amortization of Goodwill allowed SFAS 157 Issued – Concept of “Fair Value” introduced


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2011Step 0 Introduced – Qualitative Assessment

2012Private Company Council (PCC) formed – first agenda items included Purchase Accounting and Goodwill Impairment

2013AICPA issues “FRF for SMEs” – An optional, non-GAAP accounting framework issued for small/medium sized businesses not needing to comply with GAAP.Private Company Council (PCC) Issues Exposure Drafts on “Accounting Alternatives” for private companies under GAAP for Business Combinations and Goodwill for FASB consideration. AICPA issues Accounting and Valuation Guide - Testing Goodwill for Impairment


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What is the PCC? Formed in 2012 under authorization of Financial

Accounting Foundation (FAF) Board A new body established to improve the process of

setting accounting standards for private companies Will issue accounting alternatives to GAAP for private

companies Will not apply to public companies or non-profits

2 Principal Responsibilities: Work jointly with the FASB to decide whether and when

alternatives to US GAAP are warranted for private companies.

Act as primary advisory body to FASB for appropriate treatment for private company’s of items under consideration under FASB technical agenda.

Issued 2 Exposure Drafts in July 2013 related to Purchase Accounting and GW Impairment.

Private Company Council (PCC)

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PCC Issue No. 13-01A – Accounting for Identifiable Intangible Assets in a Business Combination (Topic 805) Would allow private companies to elect to only recognize those

intangibles arising from non-cancellable contractual terms or those arising from other legal rights.

PCC Issue No. 13-01B – Accounting for Goodwill (Topic 350) Written into accounting standards early 2014 Test for goodwill impairment only when a triggering event

occurs rather than the current annual impairment test Testing will occur at the enterprise level, not at reporting unit

level 2 Step approach replaced by 1 Step approach Goodwill will be amortized not to exceed 10 years Effective date - years beginning after 12/15/14. Early adoption is permitted. May not be appropriate for certain companies, especially those

contemplating an IPO.

Private Company Council (PCC)

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FRF for SMEs = “Financial Reporting Framework for Small and Medium-Sized Entities”

Issued by AICPA in 2013 Intended to be responsive to the financial reporting needs of small

and medium-sized entities Special purpose framework - no official or authoritative status –

purely optional Financials prepared under this framework may assert that such

financials have been prepared in accordance with the AICPA’s FRF for SMEs accounting framework.

RFR for SMEs is NOT GAAP. Intangible Assets acquired in Business Combinations – entities

should make an accounting policy choice: Separately recognize Intangible Assets as Identifiable

Intangible Assets or Subsume identifiable Intangible Assets into Goodwill

Goodwill: Amortize over same period as that used for federal income tax If not amortized for tax, then amortize over 15 years

FRF for SMEs

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Evaluating the Acquisition


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Read the LOI Discuss evolution of acquisition with transaction

team Read the Confidential Memorandum Understand the methodology used to determine the

offer and final price including any forecasts utilized Identify the most important asset acquired Read the APA or SPA

Purchase price Purchase price adjustments Earn-outs Identify assets acquired/liabilities assumed Review the Addendums (this is where the IP detail

usually resides)


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How will the Purchase Price be paid? Cash Notes Earn-out payments Securities

Is Purchase Price a Market Participant price? Is there a perception that deal was a

bargain purchase? Any warrants/options/puts/calls issued at

time of transaction?


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Recording the Acquisition


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Objectives: Record assets acquired and liabilities assumed at fair

value via a Purchase Price Allocation Pass the review process of the external auditors

Tangible assets: Accounts receivable – fair value usually book value Inventory – fair value is not book value! Fixed Assets – fair value may require appraisals

Intangible Assets: Identifiable intangibles – Fair value determination of

each is required Goodwill – residual value


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Common Identifiable Intangible Assets: Trade Names/Trademarks (indefinite or finite) Patents (finite) Trade Secrets (indefinite or finite) Developed Software (finite) Customer Relationships (finite) Noncompetition Agreements (finite)

Useful life of finite-lived intangibles must be established for GAAP amortization purposes


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PPA Process Establish the IRR inherent in the Transaction. WACC analysis – should approximate the IRR. Select Risk Rate for each intangible - should be

north of IRR. Value the identifiable intangibles. Perform a WARA analysis - should result in lowest

returns for tangible assets, higher returns for identifiable intangibles and highest return for goodwill.

WARA, IRR and WACC should all agree. Proves that the intangible values are reasonable.


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Valuation of Identifiable Intangibles Most important intangible should be

valued using the MPEEM method (a modified DCF).

Other methods should be used for other intangibles. Example methods: Relief from Royalty Cost Replication With and Without


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Subsequent Impairment Testing


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Goodwill Impairment Testing Process (ASC 350): Step 0 – Qualitative Assessment – May eliminate

need for Step 1 Step 1 – Test for Goodwill Impairment – Compare

Enterprise Value to Carrying Value. If EV is less than CV, proceed to Step 2. If not, GW is assumed not impaired.

Step 2 – Determine amount of Impairment – Purchase accounting exercise “as if” company was re-acquired. If residual goodwill is less than its carrying value, an impairment charge is recorded.

Test by Reporting Unit Test Annually


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Impairment Testing – Other Intangibles: Indefinite-lived intangibles - ASC 350 contains

more procedures than just a goodwill test: Indefinite lived assets (such as trade names) are

tested directly for impairment annually (or upon a triggering event). If FV is less than CV, impairment is indicated, and the asset is written down to its fair value

Finite-lived intangibles – tested under ASC 360: If sum of undiscounted cash flows is greater than

CV, no impairment is assumed to exist. If sum of undiscounted cash flows is less than CV,

value is determined by discounted cash flow. If value is less than CV, then impairment is indicated. May be tested with an asset group.


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Thank You for Attending !!!


Documents

What’s Fair About Fair Value Acquisition Accounting?