CFC Merger & Acquisition Accounting 5 — Questions and Answers
Question 1: An earnout agreement requires an additional payment of up to $10M based on three-year post-acquisition EBITDA. After the acquisition date, the estimated fair value of the earnout increases by $1M due to better-than-expected performance. How is this change recorded?
- As an adjustment to goodwill
- As a charge to earnings in the period of change (Correct answer)
- As an increase to additional paid-in capital
- As an adjustment to the purchase price allocation within the measurement period
Correct answer: As a charge to earnings in the period of change
Post-acquisition changes in the fair value of contingent consideration classified as a liability are recognized in earnings, not as adjustments to goodwill (unless within the measurement period and related to new information about facts existing at the acquisition date).
Question 2: In a cross-border acquisition, the target operates in a functional currency different from the acquirer's reporting currency. How are the target's assets and liabilities translated for consolidation?
- At the historical exchange rate on the acquisition date for all items
- Monetary items at the current rate and nonmonetary items at historical rates
- At the current exchange rate at each reporting date (current rate method) (Correct answer)
- At the average exchange rate for the reporting period
Correct answer: At the current exchange rate at each reporting date (current rate method)
Under ASC 830, a foreign subsidiary's assets and liabilities are translated at the current (closing) exchange rate at each balance sheet date, with translation adjustments recorded in OCI.
Question 3: Which of the following would NOT be recognized as a separate intangible asset in a business combination purchase price allocation?
- Favorable operating lease agreements
- Assembled workforce (Correct answer)
- Patent portfolio with remaining legal life
- Customer contracts with contractual backlog
Correct answer: Assembled workforce
An assembled workforce does not meet the contractual-legal or separability criterion because it cannot be separated from the entity and sold or transferred; it is subsumed into goodwill.
Question 4: After a business combination, the acquirer discovers that the target had an unrecorded contingent liability related to a lawsuit that existed at the acquisition date. How should this be handled?
- Expensed immediately in the post-acquisition period as a prior-period error
- Recognized at fair value as part of the purchase price allocation (retroactively if within the measurement period) (Correct answer)
- Recorded only when the liability becomes probable and estimable
- Disclosed but not recognized since it was not on the target's books
Correct answer: Recognized at fair value as part of the purchase price allocation (retroactively if within the measurement period)
Under ASC 805, contingent liabilities that existed at the acquisition date should be recognized at fair value in the purchase price allocation; if discovered within the measurement period, the PPA is adjusted retrospectively.
Question 5: In a merger of equals where determining the acquirer is unclear, which indicator is given the MOST weight under ASC 805 guidance?
- Which entity is larger by total assets
- Which entity's former management dominates the combined entity's senior leadership (Correct answer)
- Which entity initiated the merger discussions
- Which entity's name is used for the combined company
Correct answer: Which entity's former management dominates the combined entity's senior leadership
ASC 805 considers which entity's former owners or management controls the combined entity's board and senior leadership as a key indicator for identifying the acquirer.
Question 6: A company disposes of a reporting unit that contains goodwill. How is the goodwill allocated to the disposed unit for calculating the gain or loss on disposal?
- No goodwill is allocated; all goodwill remains with the continuing entity
- Goodwill is allocated based on the relative fair values of the portion disposed and the portion retained (Correct answer)
- All goodwill is written off immediately upon announcement of the disposal
- Goodwill is allocated based on the historical book values of assets transferred
Correct answer: Goodwill is allocated based on the relative fair values of the portion disposed and the portion retained
When a portion of a reporting unit is disposed, goodwill is allocated to the disposed component based on relative fair values of the disposed portion versus the retained portion.
Question 7: Under ASC 805, which of the following represents the correct definition of a 'business' for purposes of determining whether acquisition method accounting applies?
- Any set of assets purchased together in a single transaction
- An integrated set of activities and assets capable of being conducted and managed to provide a return to investors (Correct answer)
- Any legal entity acquired through a stock purchase or merger agreement
- A set of assets that includes at least one tangible fixed asset and one identifiable intangible asset
Correct answer: An integrated set of activities and assets capable of being conducted and managed to provide a return to investors
ASC 805 defines a business as an integrated set of activities and assets that is capable of being conducted and managed to provide economic benefits such as returns to investors.
CFC Merger & Acquisition Accounting 5
An earnout agreement requires an additional payment of up to $10M based on three-year post-acquisition EBITDA.
After the acquisition date, the estimated fair value of the earnout increases by $1M due to better-than-expected performance.
How is this change recorded?