Academic journal article Journal of Accountancy

Forecasting Post-Combination Earnings: FASB 141(R) Can Have a Dramatic Effect on Future Income Statements

Academic journal article Journal of Accountancy

Forecasting Post-Combination Earnings: FASB 141(R) Can Have a Dramatic Effect on Future Income Statements

Article excerpt

EXECUTIVE SUMMARY

* Under the acquisition method of financial accounting for business combinations as required by FASB Statement no. 141 (R), the acquiring company should recognize and measure all identifiable assets acquired and liabilities assumed of an acquired company as of the acquisition date at their respective fair values.

* Due to numerous possible factors, the effect of recording the business combination under Statement no. 141(R) on post-combination earnings can be significant. Examples include higher depreciation charges on the excess of acquisition-date fair values of plant and equipment over carrying values and the amortization of intangible assets previously not recorded by the acquiree.

* Because of the potential impact of the recorded business combination on post-acquisition earnings, the acquiring company should develop an acquisition accounting forecast to estimate the income statement effects. The forecast would include estimating the fair value of consideration, including contingent consideration; developing a forecasted historical cost balance sheet of the acquiree and adjusting the balance sheet to fair values; estimating the time periods over which the fair value adjustments will be included in post-combination earnings; and estimating acquisition expenses and other incremental effects of the acquisition.

* By integrating the impact of the acquisition accounting forecast and other effects of the business combination with the forecasted operating results (using carrying values) for the acquired company, the acquirer can obtain a more complete picture of post-combination earnings.

The acquisition method of financial accounting for business combinations under FASB Statement no. 141(R), Business Combinations, requires the acquiring company to recognize and measure all identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquired company as of the acquisition date at their respective fair values. The assets acquired may include assets that are not included on the acquiree's balance sheet because they were expensed or written off before the acquisition date. Additionally, the acquirer may record liabilities arising from contingencies at the acquisition date that were not recorded by the acquiree. This article suggests a method for management to forecast the effects of a business combination on reported earnings.

Due to numerous possible factors, the effect of recording the business combination under Statement no. 141(R) on post-combination earnings can be significant. The following examples illustrate the potential magnitude of this effect:

* Assuming adequate inventory turnover, the entire difference between the acquisition-dam fair value and previously recorded book value of inventory (valued on a FIFO basis) of the acquired company could be charged to cost of sales in the first few months following the business combination.

* The excess of acquisition-date fair values over recorded net book values for plant and equipment would result in higher depreciation charges over the remaining useful lives of the assets after the business combination.

* Intangible assets not previously recorded m the financial statements by the acquired company would be recorded at their respective acquisition-date fair values and amortized over the respective remaining useful economic lives of the intangible assets. An example would be a license (with substantial renewal costs) that was not recognized as an asset by the acquiree before the acquisition because the development costs of the license were internal and charged to expense. Acquired in-process research and development would be recorded at fair value by the acquirer and would be subject to post-combination impairment but would not be amortized.

* If the terms of an acquiree's operating lease are favorable in relation to market terms for a similar lease at the acquisition date, the acquirer would record an intangible asset (in most cases) for the difference between contract terms and market terms. …

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