Week 007

RECOGNIZING AND MEASURING

THE IDENTIFIABLE ASSETS
ACQUIRED AND LIABILITIES ASSUMED PART 2
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Learning objectives

At the end of this module, the students will learn the following:

• Exceptions to recognition, measurement, and designation or classification of assets or

liabilities
• Working capital
• Assets with uncertain cash flows (Valuation Allowances)
• Financial instruments
• Inventory
• Property, plant, and equipment
• Assets that the acquirer does not intend to use, or intends to use in a manner other than
their highest and best use
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Exceptions to Recognition, Measurement, and Designation or

Classification of Assets or Liabilities
• Purchased Financial Assets with Credit Deterioration
• The ASC master glossary defines purchased financial assets with credit
deterioration as “acquired individual financial assets (or acquired groups of
financial assets with similar risk characteristics) that as of the date of acquisition
have experienced a more-than-insignificant deterioration in credit quality since
origination, as determined by an acquirer’s assessment” (pending content).
• Leases
• Leases — After Adoption of ASC 842 “Leases (including contracts that contain a
lease) acquired in a business combination may result in the recognition of various
assets or liabilities, depending on the classification of the lease and whether the
acquiree is the lessee or the lessor under the lease contract.”
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Working Capital
• ASC 805 requires the components of working capital (e.g., accounts receivable,
accounts payable, and accrued liabilities) to be recorded at their acquisition-date fair
values. An acquirer cannot recognize a separate valuation allowance as of the
acquisition date for assets initially recognized at fair value. Before the FASB
incorporated this guidance into ASC 805, an entity generally recorded working
capital as the present value of amounts to be received or paid, determined at current
interest rates. Because of the short duration in expected cash flows, acquired
working capital was often recorded at the acquiree’s carrying value as of the
acquisition date.
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Assets with Uncertain Cash Flows (Valuation Allowances)

• 30-4 The acquirer shall not recognize a separate valuation allowance as of the
acquisition date for assets acquired in a business combination that are measured at
their acquisition-date fair values because the effects of uncertainty about future cash
flows are included in the fair value measure. For example, because this Subtopic
requires the acquirer to measure acquired receivables, including loans, at their
acquisition-date fair values, the acquirer does not recognize a separate valuation
allowance for the contractual cash flows that are deemed to be uncollectible at that
date.
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Financial Instruments
• Acquiree’s Equity Investments
• An acquiree’s equity investments are measured and recognized at fair value on the
acquisition date in accordance with ASC 820. If the equity securities do not have a
readily determinable fair value (i.e., are not exchange traded), an acquirer must use
other valuation techniques to measure the fair value as of the acquisition date.
According to ASC 805-20-25-6, an acquirer must classify the assets acquired and
liabilities assumed in a business combination on the basis of the “contractual terms,
economic conditions, its operating or accounting policies, and other pertinent
conditions as they exist at the acquisition date”.
• Derivatives
• An acquiree will often have outstanding financial instruments that meet the
definition of a derivative or are designated in a hedging relationship under ASC 815.
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Inventory
• Inventory acquired in a business combination must be measured at its acquisition-date
fair value — that is, the price at which market participants would be willing to sell or
buy the inventory. Neither ASC 805 nor ASC 820 provides detailed guidance on
measuring the fair value of inventory, but carryover of the book basis of the acquiree’s
inventories is not permitted. Because there are many acceptable methods for
accounting for inventory, an acquirer and acquiree often have different policies for
doing so. The method used to account for inventory (e.g., FIFO, LIFO, or average cost)
does not affect its fair value measurement.
• Finished Goods
• The fair value of finished goods inventory is often measured by using a top-down
approach, which starts with a market participant‘s estimated selling price, adjusted
for both (1) the costs of the selling effort and (2) an approximately normal profit for
the selling effort. The acquirer’s results of operations after the business
combination should reflect the costs and profits of the selling effort after the
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

• Work in Process
• An acquirer generally measures the fair value of acquired work-in-process inventory
similarly to the way it measures the fair value of finished goods inventory, except that
the measure also includes estimates for completing the production process.
• Raw Materials
• Raw materials must be measured at fair value as of the acquisition date from the
perspective of a market participant; an acquiree’s cost cannot be presumed to be an
item’s fair value.
• Supply Inventory
• Supplies used in the manufacturing process are measured at fair value as of the
acquisition date, in a similar manner to raw materials inventory.
• LIFO Inventories
• Inventory should be measured at fair value as of the acquisition date. Neither the
acquirer’s future method of accounting nor the acquiree’s past method is relevant in
the fair value determination.
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Property, Plant, and Equipment

• PP&E that is acquired in a business combination and classified as held and used by the
acquirer should be measured at fair value. The acquiree’s accumulated depreciation is
not carried over into the acquirer’s financial statements; rather, the acquirer’s financial
statements should reflect only the accumulated depreciation since the acquisition date.
• PP&E Subject to Asset Retirement Obligations
• ASC 410-20 provides guidance on accounting for AROs and, as indicated in ASC 410-
20-15-2(a), its scope includes “[l]egal obligations associated with the retirement of
a tangible long-lived asset that result from the acquisition, construction, or
development and (or) the normal operation of a long-lived asset, including any legal
obligations that require disposal of a replaced part that is a component of a tangible
long-lived asset.”
• Mineral Rights and Mining Assets
• The ASC master glossary defines mineral rights as “[t]he legal right to explore,
extract, and retain at least a portion of the benefits from mineral deposits.”
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

Assets That the Acquirer Does Not Intend to Use, or Intends to Use
in a Manner Other Than Their Highest and Best Use
• To protect its competitive position, or for other reasons, the acquirer may intend not
to use an acquired nonfinancial asset actively, or it may not intend to use the asset
according to its highest and best use. For example, that might be the case for an
acquired research and development intangible asset that the acquirer plans to use
defensively by preventing others from using it. Nevertheless, the acquirer shall
measure the fair value of the nonfinancial asset in accordance with Subtopic 820-10
assuming its highest and best use by market participants in accordance with the
appropriate valuation premise, both initially and for purposes of subsequent
impairment testing.
Week 007: RECOGNIZING AND MEASURING THE IDENTIFIABLE ASSETS ACQUIRED AND LIABILITIES
ASSUMED PART 2

References and Supplementary Materials

Book and Journals

Deloitte’s A Roadmap to Accounting for Business Combinations
Authors: Michael Morrissey and Stefanie Tamulis
Contributors: Ashley Carpenter, Sandie Kim, Christine Mazor, Stephen
McKinney, Morgan Miles, Lisa Mitrovich, Ignacio Perez, Michael Scheper,
Jonathan Tambourine, Curt Weller, Amy Winkler, and Andy Winters, Lynne
Campbell, Diane Castro, Geri Driscoll, and Jeanine Pagliaro