Business combinations may take a number of legal forms, but whatever the form, all combinations will be accounted for as either purchases (now referred to as “acquisitions”) or poolings of interests (now referred to as “mergers”). This chapter will provide some of the basic theory and requirements to address those infrequent times when they do combine operations. Chapter 11, Affiliated Organizations, describes potential relationships between not-for-profit organizations and between not-for-profit organizations and for-profit organizations. That chapter provides information as to when an affiliation is accounted for as a business combination. This chapter describes how to account for transactions that are business combinations.
The FASB issued ASU 2010-07 (Not-for Profit Entities [Topic 958] Not-for-Profit Entities: Mergers and Acquisitions) which incorporated the GAAP requirements for not-for-profit entity mergers and acquisitions into FASB ASC 958-805.
FASB ASC 958-805 may not be applied to mergers and acquisitions before those dates. (This is important news for not-for-profit organization financial statement preparers and auditors as there was some concern that the new requirements would have to be applied retrospectively. This is not the case, although there is transition guidance for previously recognized goodwill.)
FASB ASC 958-805 requires not-for-profit organizations first to determine whether a combination is a merger or an acquisition. For mergers, the carryover method is used. The carryover method is similar to what had been the pooling-of-interests method. For acquisitions, the acquisition method of accounting is used. The acquisition method is similar to that used by commercial organizations under FASB ASC 805 and previously referred to as the purchase method of accounting.
The requirements promulgated by FASB ASC 958-805 apply to transactions or other events that meet the definitions of a merger or an acquisition, which are provided as follows:
The following are specifically excluded from the scope of FASB ASC 958-805:
FASB ASC 958-805 provides guidance on distinguishing between a merger and an acquisition.
In a merger, the governing bodies of two or more not-for-profit organizations cede control of those entities to create a new not-for-profit organization. If the participating entities retain shared control of the new entity, they have not ceded control.
In an acquisition, the acquirer obtains control of one or more nonprofit activities or businesses. The formation of a new entity is not considered a significant factor in assessing whether one entity has obtained control over another.
Ceding control to a new entity is the sole definitive criterion for identifying a merger and, accordingly, FASB ASC 958-805 provides guidance on how to determine whether control has been ceded to a new entity. The following characteristics should be assessed:
FASB ASC 958-805 states that in a merger, generally no one party dominates or is capable of dominating the negotiations and process leading to the formation of the combined entity. (In an acquisition, on the other hand, one party—the acquirer—often dominates that process, and sometimes may, in effect, dictate the terms of the transaction, including the date the combination occurs.)
In an acquisition, one party obtaining control over the other is the sole definitive criterion. FASB ASC 958-805 provides that the characteristics of the entities participating in a combination and of the resulting combined entity that can help to distinguish between a merger and an acquisition fit into two groups:
The following examples are included in the guidance:
FASB ASC 958-805 provides, however, that relative size, like relative financial strength and the other indicators discussed, is only one characteristic that may help to distinguish between a merger and an acquisition in particular situations—none of the indicators, by itself, is determinative.
A merger generally is accomplished by combining all of the assets and liabilities of the merging entities into a newly formed entity that assumes all of the assets and liabilities of the participating entities without a transfer of cash or other assets to those entities or any of their owners, members, sponsors, or other designated beneficiaries. The creators of the merged entity cease to exist as autonomous entities and do not hold financial interests in the merged entity.
The not-for-profit entity that results from a merger (i.e., the new entity) should account for the merger by applying the carryover method. The carryover method requires combining the assets and liabilities of the merging entities as of the merger date, with certain adjustments which are described below. Accordingly the new entity recognizes in its financial statements the assets and liabilities reported in the separate financial statements of the merging entities as of the merger date. A few specifics pointed out by FASB ASC 958-805 are as follows:
In keeping with the concept that a merger results in a new reporting entity, the initial reporting period of the new entity begins with the merger date, and the merger itself should not be reported as an activity of the new entity's initial reporting period. The combined assets, liabilities, and net assets of the merging entities are included as of the beginning of the initial reporting period.
The accounting for an acquisition of a not-for-profit organization is likely to be more complex than the accounting for a merger. The acquisition method used in FASB ASC 958-805 is the same as the acquisition method described in FASB ASC 805. However, acquisitions in the not-for-profit organization environment can be fundamentally different from acquisitions in the commercial enterprise environment. For example, consideration (cash, securities, etc.) is not often exchanged in the acquisition of one not-for-profit organization by another not-for-profit organization. The purchase price forms a large piece of the accounting for an acquisition under FASB ASC 805 and accordingly, the additional guidance provided in FASB ASC 958-805 helps apply the acquisition method to the not-for-profit environment.
In FASB ASC 958-805, the following are the steps in applying the acquisition method to not-for-profit organizations:
Each of these steps will be discussed below.
Identifying the acquirer. The guidance in FASB ASC 958-810, or, for a health-care-related acquirer, FASB ASC 954, should be used to identify the acquirer, which is the entity that retains control. If the acquiring entity is not clear from this existing guidance, FASB ASC 958-805 provides the following additional guidance:
FASB ASC 958-805 provides that the following factors be considered in assessing which entity is able to select or to dominate the process of selecting the governing body:
Determining the acquisition date. The acquisition date is the date on which the acquiring organization obtains control of the organization that it is acquiring. This may likely be the date any consideration is transferred and/or the date one organization becomes the sole member of the other. SFAS 164 focuses on when control is obtained, which may be a specific “closing” date, but may also be obtained before such closing date, depending on the facts and circumstances of the individual transaction.
Recognizing and measuring assets acquired and liabilities assumed. As of the acquisition date, the acquiring organization recognizes the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the organization acquired. These recognized items are measured at their fair value.
FASB ASC 958-805 specifies that to qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must be part of what the acquiring organization and the acquired organization exchanged (or contributed) in the acquisition transaction rather than the result of separate transactions. In addition, the acquiring organization's application of FASB ASC 958-805's recognition principle and conditions may result in recognizing some assets and liabilities that the acquired organization had not previously recognized as assets and liabilities in its financial statements. For example, the acquiring organization would recognize the acquired identifiable intangible assets, such as a brand name, a patent, or a customer relationship, that the acquired organization did not recognize as assets in its financial statements because it developed them internally and charged the related costs to expense.
FASB ASC 958-805 includes specific guidance on numerous specific accounting topics relative to determining the assets and liabilities that would be recognized in an acquisition. These include:
FASB ASC 958-805 specifies certain exceptions to its recognition and/or measurement principles that are described above. These exceptions might result in certain assets or liabilities being recognized differently than what is described in general terms above. The exceptions also might result in assets or liabilities being measured at a value other than fair value. The following is a general discussion of the exceptions specified in FASB ASC 958-805:
Recognizing and measuring goodwill acquired or a contribution received. FASB ASC 958-805 provides that, unless the operations of the acquired organization as part of the combined entity are expected to be predominantly supported by contributions and returns on investments (see below), the acquiring organization should recognize goodwill as of the acquisition date, measured as the excess of 1. over 2. below:
If the operations of the acquired organization as part of the combined entity are expected to be predominantly supported by contributions and returns on investments, the acquiring organization should recognize the amount computed above as a separate charge in its statement of activities as of the acquisition date rather than as goodwill. “Predominantly supported by” means that contributions and returns on investments are expected to be significantly more than the total of all other sources of revenue.
The acquiring organization must consider all relevant qualitative and quantitative factors in determining the expected nature of the predominant source of support for an acquired organization's operations as part of the combined entity. For example, an acquirer shall consider qualitative and quantitative information about all forms of contributed support, including contributions that are precluded from being recognized or are not required to be recognized in the financial statements (such as certain contributed services and collection items and conditional promises to give).
In practice, this is likely to result in few not-for-profit organization acquisitions resulting in the recognition of goodwill, as reliance on contribution revenue and investment earnings as a predominant revenue source is common. On the other hand, not-for-profit organizations that derive a large part of their revenues from contractual activities or government grants that are acquired are more likely to result in goodwill being recognized, dependent, obviously, on the calculation described above.
In some acquisitions by not-for-profit entities, no consideration is transferred (and there are no previously held interests or noncontrolling interests). In that situation, the result of the above will be to measure goodwill or the separate charge to the statement of activities as the excess of liabilities assumed over assets acquired.
In some cases, the amount calculated as item 2. above will exceed the amount calculated in item 1. In that instance, the acquiring organization should recognize the excess as a separate credit in its statement of activities as of the acquisition date. This effectively treats the acquisition as a contribution received. In essence, the acquiring organization is receiving more in net assets than it is giving up in consideration. The difference is considered a contribution.
The calculation described above to determine the amount of goodwill, charge to the activities statement, or contribution received in accounting for an acquisition includes as a component “consideration transferred.” FASB ASC 958-805 has specific guidance as to how to arrive at this amount. Specifically, the consideration transferred in an acquisition should be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values of the assets transferred by the acquiring organization and the liabilities incurred by that organization. The acquiring organization might transfer consideration to the former owner of the acquired organization or to a designee of the former owner. The acquirer also might receive assistance from an unrelated third party, which shall be taken into account in measuring consideration transferred. Examples provided of potential forms of consideration include cash, other assets, a business or a nonprofit activity of the acquiring organization, and contingent consideration. For contingent consideration, the acquiring organization should recognize the acquisition-date fair value of contingent consideration as part of the consideration transferred in exchange for the acquired organization.
FASB ASC 958-805 specifies that an asset transferred by the acquiring organization to an unrelated third party as a required condition of an acquisition should be accounted for as consideration transferred for the acquired organization unless the acquirer retains control over the transferred assets. An acquirer that retains control over the transferred assets should measure those assets and liabilities at their carrying amounts immediately before the acquisition date and shall not recognize a gain or loss in the statement of activities on assets or liabilities it controls both before and after the acquisition. Examples provided in FASB ASC 958-805 of asset transfers in which control over the future economic benefits of the transferred assets is retained by the acquirer include the following:
The initial accounting for an acquisition may not be complete by the end of the fiscal year in which the acquisition occurred. In this case FASB ASC 958-805 specifies that the acquiring organization should report “provisional” amounts for the items for which the accounting is incomplete. During what is defined as the “measurement period” the acquiring organization should retrospectively adjust the provisional amounts to reflect new information obtained about the facts and circumstances that existed as of the acquisition date. FASB ASC 958-805 also provides that during the measurement period, the acquiring organization should also recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period ends as soon as the acquirer receives the information it was seeking about facts and circumstances that existed as of the acquisition date or learns that more information is not obtainable. However, the measurement period shall not exceed one year from the acquisition date.
FASB ASC 958-805 requires that the amounts calculated above be reflected in the statement of activities as separate line items. Examples of how the computed charge to the statement of activities discussed above would be labeled are “excess of consideration paid over net assets acquired in acquisition of Entity X” or “excess of liabilities assumed over assets acquired in acquisition of Entity X.” If a contribution is recorded, it might be labeled “contribution received in donation of Entity X” or “excess of fair value of net assets acquired over consideration paid in acquisition of Entity X.” This latter example is a bit more descriptive of what is actually being recorded and would likely be helpful to the financial statement reader. In reporting this contribution, the acquiring organization will need to examine whether there are any restrictions on the contribution received which would affect the net asset classification of the contribution received.
FASB ASC 958-805 specifies that the guidance of FASB ASC 350 should be applied in subsequent accounting for goodwill and other intangible assets recognized in the acquisition of a business or a nonprofit activity.
A not-for-profit organization that is predominantly supported by contributions and returns on investments is required to write off previously recognized goodwill by a separate charge in the statement of activities for the effect of the accounting change. An entity that is not predominantly supported by contributions and returns on investments should follow the guidance of FASB ASC 350 as to accounting for goodwill by reporting units and should subject goodwill in each reporting unit to a transitional impairment evaluation.
In November 2014 the FASB issued ASU 2014-17 Business Combinations (Topic 805) Pushdown Accounting to address whether an acquired entity can reflect the acquirer's accounting and reporting basis (pushdown accounting) in its separate financial statements. This guidance only impacts separately issued financial statements of the acquired entity. If separately issued financial statements of the acquired entity are not issued, there is no impact of ASU 2014-17.
ASU 2014-17 provides that an acquired entity may elect the option to apply pushdown accounting in the reporting period in which the change-in-control event occurs. An acquired entity should determine whether to elect to apply pushdown accounting for each individual change-in-control event in which an acquirer obtains control of the acquired entity.
If pushdown accounting is not applied in the reporting period in which the change-in-control event occurs, ASU 2014-17 provides that an acquired entity will have the option to elect to apply pushdown accounting in a subsequent reporting period to the acquired entity's most recent change-in-control event. ASU 2014-17 provides that an election to apply pushdown accounting in a reporting period after the reporting period in which the change-in-control event occurred should be considered a change in accounting principle in accordance with Topic 250, Accounting Changes and Error Corrections. If pushdown accounting is applied to an individual change-in-control event, that election is irrevocable.
Further, ASU 2014-17 provides that if an acquired entity elects the option to apply pushdown accounting in its separate financial statements, it should disclose information in the current reporting period that enables users of financial statements to evaluate the effect of pushdown accounting.
ASU 2014-17 became effective on November 18, 2014.
FASB ASC 958-805 has extensive disclosure requirements for both mergers and acquisitions. These are listed below.
The new entity should disclose the following information for the merger that resulted in its formation:
If disclosure of any of the information required by this subparagraph is impracticable, the entity shall disclose that fact and explain why the disclosure is impracticable.
FASB ASC 958-805 provides that the acquiring organization should disclose information that enables users of its financial statements to evaluate the nature and financial effect of an acquisition that occurs either
To meet these, the acquiring organization should disclose the following information for each acquisition that occurs during the reporting period:
The disclosures shall be provided by major class of receivable, such as loans, contributions, direct finance leases in accordance with FASB ASC 840, and any other class of receivables.
An acquirer may aggregate disclosures for assets and liabilities arising from contingencies that are similar in nature.
If disclosure of any of the information required by this subparagraph is impracticable, the acquirer shall disclose that fact and explain why the disclosure is impracticable.
For individually immaterial acquisitions occurring during the reporting period that are material collectively, the acquiring organization should disclose the information required by 5. through 20. above in the aggregate.
If the date of an acquisition is after the reporting date but before the financial statements are issued or available for issue, the acquirer shall disclose the information required above unless the initial accounting for the acquisition is incomplete at the time the financial statements are issued or are available to be issued. In that situation, the acquirer shall describe which disclosures could not be made and the reason that they could not be made.
The acquiring organization should disclose information that enables users of its financial statements to evaluate the financial effects of adjustments recognized in the current reporting period that relate to acquisitions that occurred in the current or previous reporting periods. To meet these objectives, the acquiring organization should disclose the following information for each material acquisition or in the aggregate for individually immaterial acquisitions that are material collectively:
FASB ASC 958-805 provides guidance to not-for-profit organizations that either merge with or acquire another organization. The requirements are relatively complex and specific; however, the resulting accounting treatment of these types of transactions brings consistency to how these transactions are accounted for and reported by not-for-profit organizations.