The merger and acquisition market remains healthy, especially in the private equity arena. Lost in the rush of tight reporting deadlines, seemingly endless communication with multiple parties and planning for the integration of two companies and cultures are the prescribed generally accepted accounting principles for business combinations. An oft-overlooked step in this business combination accounting is the treatment of the related-transaction expenses incurred in the deal. Difficulties arise due to the availability and completeness of data, determining the correct period and manner of recording costs and determining the responsible party for the costs.
Common acquisition-related costs addressed in Accounting Standards Codification (ASC) 805, Business Combinations are:
- Accounting and due diligence
- Investment banking/broker/finder’s fees
- Debt or equity issuance costs
- Other consulting/advisory costs
These costs are generally to be expensed in the period incurred and are not included in the business combination accounting. With the exception of the costs of registering and issuing debt or equity securities (which are typically recognized in accordance with other applicable accounting guidance), these costs are considered expenses because they don’t represent acquired value under the acquisition method of accounting.
The first step in tackling this issue is gathering the necessary information from all parties. Management, the acquirer and the seller typically each possess critical transactional data that should be aggregated in the funds flow documentation when feasible.
The second step is to determine who will bear the burden of these costs and in which period the costs shall be reported. These issues often are addressed in the terms of the merger or purchase agreement, but the guidance in ASC 805 does prescribe the following guidelines:
- Which party do these costs benefit?
- When were the costs incurred or services provided to the buyer or seller?
In some cases, this may be a straightforward assessment. However, the following arrangements are relatively common and may change the accounting conclusions for these costs:
- If the ultimate buyer (often a private equity group (PEG)) creates a substantive legal entity (buyer) to complete the acquisition, the PEG will sometimes fund certain buyer costs, i.e., PEG pays the vendor directly. In this scenario, the buyer benefits from these costs and should record the expense on its books with a corresponding credit to equity.
- If the buyer pays certain costs incurred for the seller’s benefit, these costs should not be expensed or capitalized. Instead, these costs are treated as consideration paid to the seller (which is included in purchase price).
- If the seller pays certain costs incurred for the buyer’s benefit, these costs should be expensed by the buyer in the period incurred (not as an increase to purchase price).
Next, the parties should be aware of the tax ramifications of transaction expenses. The deductibility of these costs is affected by the structure of the deal, safe harbor laws and many other factors.
Finally, if material, the buyer must disclose the nature and amounts of transaction costs, as well as the income statement line items in which the costs are recognized.
Contact Ashton or your trusted BKD advisor for specific consultation on your facts and circumstances or other assistance with this topic.