ASC 805 Valuations

A Guide to ASC 805 Valuations

In the world of business and accounting, ASC 805 valuation does not need an introduction. This code is talked about by just about every appraiser—and rightly so. If you are confused about what this means for you and your purchases, it is time to stop worrying. 

Here are the most straightforward answers to the most common queries about ASC 805 valuations. These explanations will help you out throughout your accounting procedure:

What Are ASC 805 Valuations?

To understand ASC 805 valuation and other codifications, you need first to understand what PPA is. Purchase Price Allocation (PPA) is a process wherein an entity purchases a new company. The purchaser is referred to as the acquirer. Likewise, the company that is purchased is known as the target. Now, per PPA, the purchasing price for this new company is set based on the accumulated worth of all the target’s assets and liabilities

Additionally, these transactions are not independent deals. Rather, the Financial Accounting Standards Board (FASB) overlooks these purchases. There are numerous rules set by the FASB that are implemented in such transactions. The FASB currently sets all accounting standards under one code, ASC 805. This rule applies to all transactions in which one company acquires one or more new companies. 

ASC 805 valuation ensures that tangible, as well as intangible, assets, factor into the total purchase price, based on the fair value (or FV) of each of these assets. To clarify further, tangible assets typically consist of land, buildings, and other similar possessions. On the other hand, intangible assets are comprised of copyrights, website domains, customer lists, intellectual property, and similar resources.

It is rather complex and tricky to follow these rules yourself. If you need help understanding all of the technicalities, you can contact us. 

Business Combination Under GAAP

The business combination is, as its name suggests, a term for the combination of businesses. When an acquirer merges with or purchases another company, it is known as a business combination. However, since definitions under generally accepted accounting principles (GAAP) are different, whether or not a purchase is considered a business combination can vary.

GAAP defines a business as a group of assets which conducts activities that, in turn, generate an outcome that makes the group self-sustaining, while offering a return to investors, as well. A business must include three basic elements: inputs, processes, and outputs. Unless the company being purchased meets these requirements, the purchase of its assets and liabilities by an acquirer is merely a transaction, not a business combination.

Contingent Consideration

Contingent consideration is a type of payment that an acquirer has to pay to the former owner of the target company. This payment is dependent on the occurrence of certain future events. It is calculated based on various factors, including taxation, revenue, earnings, and more. 

Contingent consideration is documented at the time the target company is purchased. It is listed as an equity or liability as per its fair value. The acquirer pays the contingent consideration either in one lump sum or through a series of payments. This payment may be completed in cash or equity shares, depending on the preferences of the acquirer and the acquiree. 

What Is FAS 141?

FAS 141 is now known as ASC 805 valuation. The major difference between ASC 805 and FAS 141 has to do with contingencies. Under FAS 141, contingencies were dealt with later in agreements. Under ASC 805, calculation and a listing of the contingencies is completed on the date of acquisition. 

What Does ASC Stand For?

ASC stands for Accounting Standards Codification. It restructured existing FASB and GAAP accounting standards. As a result, ASC is a much more user-friendly approach that has made information more accessible and understandable for the public.

Calculating Fair Value of Consideration Transferred

To calculate the transferred consideration amount, fair values must be measured and compared. This calculation starts by summing up the fair values of the transferred liabilities and assets to the acquirer. Next, the fair value of the equity shares transferred from the acquirer to the acquiree is measured. The difference between these values is the fair value of transferred consideration. 

What Constitutes a Business Combination?

In a business combination, an acquirer gains control over another company, this is called a target. This is a purchase or merger done for the increase in size and growth. A business combination is only done if the target is a company that has inputs, processes, and outputs. Unless a business is producing outputs for the investors in terms of reduced costs or increased economic benefits, the purchase is not a business combination.

Accounting for Acquisition

Say an acquirer decided to purchase a target company’s assets. A business combination is clear, but how do you account for it? Well, it is actually pretty simple. The first step is to identify the business combination. The next step is determining the acquirer. 

If only some assets and liabilities were purchased, it can be confusing to tell whether the purchaser is technically the acquirer or the former owner. If there is a significant disparity between the fair values of the parties, the acquirer is the one with a higher fair value. In other cases, the group that makes payment or has a dominant role in the deal is considered the acquirer. Once these roles have been established, the transaction cost is measured. On the date of the acquisition, the cost of the business combination should also be measured. Lastly, it is important to account for goodwill. This process can be quite thorough and requires precise calculations, which is why it is best to hire the Strategies Equity Group and let the professionals handle it.

Deferred Consideration

The buyer pays a deferred consideration paid to the former owner of the assets over a set time period. This amount and time frame are decided during the acquisition. The payment can be done in the form of cash or as a transfer of shares.

Contingent Payments

Contingent payments are very similar to deferred consideration. A contingent payment is a payment that the buyer makes to the seller after the acquisition. However, instead of setting a time period, this payment depends on whether certain events transpire. Basically the deal has been finalized, but payment will only be issued after a specific occurrence takes place. This contingency can also simply refer to a certain level of performance for the business.

SFAS 412

SFAS stands for Statement of Financial Accounting Standards. SFAS 412 is one of 168 standards put forth by this category.  

Above Market Lease

Generally, there is a set market rate for leases. If a lease is finalized in accordance with ongoing market rates, it is said to be “on market.” On the other hand, if the lease rate is less than the market standard, it is referred to as “below market.” A lease that is greater than the established market rate is  “above market.”

GAAP and Its 4 Principles

Under GAAP, there are defined rules that every corporate financial and accounting transaction must follow. There are four basic principles of GAAP: objectivity, materiality, consistency, and prudence. Per these principles, all purchases should be objective, the true financial state of the business should be stated, a consistent standard should be followed, and reported facts should be authentic and genuine.

ASC 842

ASC 842 is also labeled ASU 2016-02. This is the latest lease accounting standard, as defined by the FASB. The previous standard that covered this area was ASC 840, which had issues regarding the rule for off-balance sheet operating leases. Under the ASC 842, all leases (with the exception of short-term leases) are capitalized on the balance sheets. Previously, there was no such obligation and operating leases only had to be reported in the footnotes of corporate financial statements. 

Goals of FASB ASC

The main intention for the introduction of ASC was to serve as a restructuring of existing rules and regulations. ASC is no different from FASB or GAAP, except that the way its system is codified has made it an easy system to research. Users of ASC can attain official information on over 90 topics, all of which are documented and categorized within it for easy access. With ASC, accounting standards are easier to implement since knowledge is more widespread.

Fair Value Consideration

The entire accounting system of FASB relies on the measurement of fair values. Fair value is defined as the price of any asset or liability that the seller will receive if the relative asset or liability were transferred to a market participant on that same day. 

How Do You Find the Fair Value of Noncontrolling Interest?

SFAS 412 (R) and SFAS 160 have defined how to account for noncontrolling interest or NCI. According to these codifications, the fair value of NCI is the same as the noncontrolling equity. Therefore, the fair value will be equal to the amount you would get if you were to sell this equity in the marketplace the same day. To properly calculate NCI, you must add fair adjustments to the calculated fair value. Then, the prorate income is added, and prorate shares are subtracted. This final total represents the fair value of the noncontrolling interest.

Fair Value Accounting

By now, you already know what fair value is. Fair value accounting uses the fair values of each specified assets or liabilities in its final measurements. In this accounting process, prevailing market values are used to estimate the number of assets and liabilities in a business combination. This is a step taken by FASB to yield standardized calculations.

Why Do You Need to Identify the Acquirer in a Business Combination?

Every business combination must identify which agent is acting as the acquirer. This is mandatory for accounting, per the standards set by FASB. Because the acquirer gains control over the assets and liabilities, identifying which party is acting in that role is important. In addition, fair value has to be calculated in accordance with what the acquirer accounts for.

Business Combination vs. Consolidation

In a business combination, two companies come together at the same level. One does not excel over the other, and there is no controlling or parent entity. Instead, both companies are under common control. The acquirer and the acquiree both have equity shares. 

On the contrary, business consolidation has one controlling entity. The other group loses power. The parent company is the major beneficiary. The company or companies that are acquired are recognized by the parent organization’s name. 

Advantages of Business Combination

Business combinations are highly beneficial. First, they cause an instant boost in the size of the company without any internal activities. Moreover, business combinations squash competitor threats and competition as far as the two companies in question are considered. Purchasing the goods in bulk reduces the overall cost, as well. This further leads to upscale production, reaping higher economic benefits. The capital of the business grows, while management costs are minimized. Business combinations are a step towards stability and success. In addition to all these advantages, business combinations also help maintain a stable price of producing goods. Since research opportunities dramatically increase with minimal cost, the chances of growth are multiplied even further.

Conclusion

Under FASB, there are many authorities to turn to for information on business and accounting, such as GAAP and SFAS. These codifications aim to standardize business mergers and acquisitions. Although ample material is out there, it can be hard to absorb it all before making deals. This is where our appraisers come in. We guarantee foolproof services that align with the standards set by the authorities. 

Why wait when you can rely on professionals to take care of your workload? Contact us today for your accounting solutions!