ASC 805

Also known as: Business Combinations

framework · accounting · regulatory-standard

FASB topic governing the acquisition method of accounting for business combinations including goodwill and intangible asset recognition.

ASC 805 (Business Combinations) is the FASB Accounting Standards Codification topic governing the accounting for business combinations under the acquisition method. Issued initially as SFAS 141(R) in December 2007 jointly with the IASB's revised IFRS 3, it eliminated the pooling-of-interests method, required fair value measurement of acquired assets and assumed liabilities, mandated expensing rather than capitalizing acquisition-related transaction costs, and established a recognition framework for contingent consideration. Goodwill remains an asset that is not amortized; it is tested for impairment under ASC 350. ASC 805 also defines what constitutes a business (significantly tightened in ASU 2017-01 to reduce the population of transactions accounted for as business combinations) and addresses partial acquisitions, step acquisitions, noncontrolling interest measurement, and bargain purchases.

Originators

FASB and IASB joint Business Combinations project teams (Phase II issued December 2007 as SFAS 141(R) and revised IFRS 3); predecessor SFAS 141 (2001) eliminated pooling and required purchase method high

Year / Decade

2001 (SFAS 141 ended pooling); 2007 (SFAS 141(R) acquisition method); 2017 (ASU 2017-01 definition of a business) high

Primary sources

FASB (2007). SFAS 141(R), Business Combinations, FASB. ASC 805 (continuously updated codification), FASB (2017). ASU 2017-01, Clarifying the Definition of a Business, Ramanna, K. & Watts, R.L. (2012). 'Evidence on the use of unverifiable estimates in required goodwill impairment', Review of Accounting Studies high

Core components

Acquisition method: identify acquirer, determine acquisition date, recognize and measure acquired identifiable assets and assumed liabilities at fair value, recognize and measure goodwill or bargain purchase gain
Definition of a business (ASU 2017-01 screen test for substantially all fair value concentrated in a single asset or group)
Contingent consideration classification (asset/liability vs equity) and subsequent measurement
Noncontrolling interest measurement options
Step acquisition fair-value remeasurement of previously held equity interest
Acquisition-related costs expensed
Subsequent-period measurement-period adjustments (one year max)

Primary use case

Acquisition-method accounting for mergers, acquisitions, and business combinations under US GAAP; purchase price allocation work commonly performed by valuation specialists; input to goodwill impairment testing under ASC 350; input to intangible asset amortization and post-deal financial reporting; reference framework in M&A due diligence and SPAC de-SPAC accounting.

Common criticisms

Goodwill impairment testing under ASC 350 (the post-deal continuation of ASC 805) has been substantially criticized — Karthik Ramanna's research (Ramanna and Watts 2012, and Ramanna's broader work on goodwill politics) documented evidence that managers exercise discretion in impairment timing in ways consistent with earnings management, and the FASB's 2014 private-company amortization election and continuing public-company-amortization debate reflects regulator skepticism
fair-value measurement of acquired intangibles (customer relationships, technology, trade names) produces estimates with wide judgment ranges that academic studies have shown are systematically biased across acquirers
the contingent consideration recognition framework produces earnings volatility from period-to-period fair value remeasurement that some argue obscures operating performance
the acquired-business definition prior to ASU 2017-01 produced asset purchases being incorrectly accounted as business combinations, prompting the 2017 tightening that itself created new boundary problems
the IFRS 3 / ASC 805 difference on goodwill amortization (IFRS does not amortize, US GAAP does not for public companies but does for private companies electing the alternative) produces inconsistency.

Lineage

Child of: US GAAP
Siblings: ASC 606, ASC 842, ASC 815