Nearly every organization will be affected by the major changes in acquisition accounting introduced by new accounting standards under Financial Accounting Standards Board Statement No. 141 (revised 2007), Business Combinations. The changes introduced by FAS 141(R) — which are effective for transactions that occur in fiscal years beginning after December 15, 2008 — will affect how companies account for and report business acquisitions and will impact the financial statement reporting at the acquisition date and in subsequent periods. In issuing FAS 141(R), the FASB’s goals were to improve the purchase method of accounting for business combinations (now called the acquisition method) and align the accounting for business combinations under US GAAP and international financial reporting standards, together with greater use of fair values in financial reporting and expanded disclosures. FAS 141(R) requires all business combinations (any event in which the acquirer obtains “control” of a “business”) to be accounted for using the acquisition method. Highlighted Areas of Change for M&A Deals under the New Accounting Standards Deal Costs Transaction costs related to an acquisition will generally be expensed as incurred. Typical deal costs include fees paid to bankers, attorneys, accountants and valuation specialists. These deal costs will be expensed as the professional fees are incurred, affecting the income statement of such period. The FASB’s thinking for this change is that these costs are not part of the fair value of the target company but rather are costs of acquiring the business. Accounting for deal costs under the new standards will have an immediate impact on earnings, reducing reported earnings in the period prior to the transaction’s closing date. Restructuring Costs Costs related to the planned restructuring of the target’s operations will generally be recorded in the earnings in the post-acquisition period. Under the new standards, the restructuring costs can be recognized as a liability under acquisition accounting only if certain conditions are met as of the acquisition date. For example, before a liability can be recorded, the acquirer’s restructuring plan must be approved and brought into effect, and the facilities must be abandoned. Acquired Contingencies Contingencies are assets or liabilities with uncertainty as to their future outcome and costs. Examples of common contingencies include pending legal claims, tax disputes and environmental liabilities. The acquirer must determine the nature of the contingency and the likelihood of the outcome, and record acquired contingent assets and liabilities at fair value as of the acquisition date. FAS 141(R) requires assets or liabilities resulting from contractual contingencies to be recognized at fair value as of the acquisition date. Assets or liabilities resulting from all other contingencies (non-contractual in nature) must also be recognized on the acquisition date and measured at fair value as of the acquisition date, only if they meet the “more likely than not” standard of FASB Concepts Statement No. 6, Elements of Financial Statements. If new information becomes available after the acquisition, the acquirer will need to evaluate the new information. The acquirer must then measure a liability at the higher of its acquisition-date fair value or the amount determined under existing guidance for non-acquired contingencies (i.e., applying FAS 5), and measure the asset at the lower of its acquisition-date fair value or the best estimate of its realizable amount. Acquired Tax Reserves and Unrecognized Tax Benefits Adjustments to acquisition-related tax reserves (e.g., valuation allowance or uncertain tax position) will now be recorded in earnings when occurred, instead of adjusting goodwill as was done under the prior purchase accounting standards. While the application of FAS 141(R) is generally prospective (affecting periods after its effective date), the provision related to income tax accounting is retrospective, applying to acquisitions prior to the effective date of FAS 141(R). Adjustments to Acquisition-Date Accounting Estimates Companies will continue to have a period of time after the acquisition date to true-up acquisition accounting estimates, similar to the current standard. However, under FAS 141(R), the treatment of these adjustments will differ from prior standards, where they generally were reflected in the period of the change. Under FAS 141(R), companies will be required to revise prior-period financial statements to record material adjustments to acquisition-date accounting estimates. Income Taxes — Significant Changes to Accounting for Income Taxes as Related to Business Acquisitions Transition provisions for the adoption of FAS 141(R) are generally prospective in their application, with the exception of accounting for changes in the valuation allowance of acquired deferred tax assets and the resolution of uncertain tax positions under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FAS 141(R) requires retrospective application in accounting for adjustments to valuation allowances and tax uncertainties attributable to prior business combinations. An acquirer will need to recognize and measure the tax effect of all the temporary differences (tax benefit), carryforwards (deferred tax assets and liabilities) and income tax uncertainties of an acquired company in a business combination in accordance with FAS 109, Accounting for Income Taxes, and FIN 48. While the basic concepts of FAS 109 remain, FAS 141(R) changes certain provisions, resulting in significant changes to the tax accounting of acquisitions. Release of Valuation Allowance FAS 141(R) amends the income tax accounting guidance of FAS 109 to require that post-acquisition adjustments of valuation allowances no longer reduce goodwill or non-current assets. Instead, a reversal of a valuation allowance relating to acquired deferred tax assets will be recognized in income tax expense. An acquisition may also trigger a change in the assessment of recoverability for the buyer’s pre-acquisition-date deferred tax assets. Under FAS 141(R), such changes will be recognized through the income statement and recorded in the income tax provision. As a result, they will directly affect a company’s effective tax rate. Adjustments to Uncertain Tax Positions FAS 141(R) nullifies EITF 93-7, Uncertainties Related to Income Taxes in a Purchase Business Combination. Prior to FAS 141(R), adjustments to acquired tax liabilities were recorded as an adjustment to goodwill, irrespective of the time between the adjustment and the acquisition date. Under FAS 141(R), adjustments to acquisition-related uncertain tax reserves (e.g., FAS 5 or FIN 48 liabilities) will be recorded in earnings as part of the provision for income taxes, directly affecting a company’s effective tax rate. Exception for Qualified Measurement Period Adjustments The measurement period gives the acquirer up to one year after the acquisition date to obtain information and adjust the initial amounts recognized for a business combination. During the measurement period, any changes to a valuation allowance or uncertain tax position that was recorded as part of the acquisition as a result of additional insight into the facts and circumstances that existed at the acquisition date are recorded as an adjustment to goodwill. Adjustments after the measurement period, or based on new information uncovered within the measurement period, will be recorded in earnings as part of the provision for income taxes. Excess Tax-Deductible Goodwill FAS 141(R) also calls for recognition of a deferred tax asset equaling the income tax benefit of tax-deductible goodwill in excess of book goodwill at the acquisition date. Under prior rules, such a tax benefit was only recognized in the reporting period during which the deduction was actually taken on the company’s tax return. Recording the deferred tax asset for the excess tax goodwill on the acquisition date correspondingly increases the fair value of acquired net assets and decreases goodwill recorded under acquisition accounting for financial reporting purposes. What Your Tax Department Should Understand

  1. Effective tax rate volatility — Under FAS 141(R), except for certain qualified measurement period adjustments, changes to tax reserves will now be recorded in earnings, directly affecting a company’s income tax expense and effective tax rate. Additionally, nontaxable transactions and related costs, such as a tax-free stock acquisition, are often treated as part of the cost of the acquired entity for tax purposes and increase the tax basis of the acquired shares. Under FAS 141(R), these costs will be expensed for financial reporting purposes without a corresponding tax deduction until the acquired shares are subsequently sold, thus raising the company’s effective rate for that reporting period. The ability of management to more accurately estimate income tax effects at the acquisition date will decrease the potential for significant volatility in the company’s effective tax rate in periods following the acquisition.
  2. Timing of deals — The greater use of fair value measures and the new rules for reporting adjustments to acquisition-date estimates may influence the timing of deals closing. For example, closing a deal early in a quarter will provide more time for management to refine the acquisition accounting estimates and thus mitigate later revisions to prior-period financial statements.
  3. Enhanced tax due diligence procedures — Effective acquisition accounting and measurement comes down to the quality and availability of information. Companies will need to enhance their tax due diligence processes to thoroughly identify and accurately measure tax uncertainties and valuation allowances associated with acquired tax attributes. A heightened focus on tax due diligence and the quality of resulting documentation is necessary to reduce future tax rate implications that the company could experience in light of new information uncovered following the transaction’s close. Companies that fail to develop a robust process of assessing acquisition-date fair value could experience volatility in earnings subsequent to the transaction’s close or may be required to revise prior-period earnings. Buyers should impose elevated due diligence procedures — involving their tax team in the deal process — and request detailed documentation to allow them to construct supportable acquisition estimates. Correspondingly, prospective sellers should be prepared to provide such documentation and have their records in place prior to putting a business on the market.

Alvarez & Marsal Taxand Says: Tax departments need to develop an understanding of the new FAS 141(R), as many issues will be changing for calendar-year-end companies in the first quarter of 2009, affecting the calculation of the 2009 effective tax rate estimate. Tax directors and client advisors alike should be considering what previous acquisition activity will be affected by FAS 141(R). Review balances from before FAS 141(R) was adopted — is there any valuation allowance or unrecognized tax reserves that could relate back to an acquisition? Do existing tax accounting procedures and records have visibility to track tax attributes to distinguish acquisition-related items (and from which acquisition)? A&M suggests that companies proactively document tax balances of deferred items, valuation allowances and uncertain tax positions. Companies should also track future reversals of identified reserves to avoid errors in reporting, revise their accounting policies and procedures to differentiate between existing tax reserves and those acquired as part of a business combination, and allow enough time to evaluate and measure accounting for the transaction as of the acquisition date. For any current mergers and acquisitions activity, companies will need to carefully assess the accounting for acquisitions that are in process in late 2008. Disclaimer As provided in Treasury Department Circular 230, this e-newsletter is not intended or written by Alvarez & Marsal Taxand, LLC, to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer. Alvarez & Marsal Taxand, LLC distributes a complimentary electronic newsletter to subscribers on a weekly basis. A&M Tax Advisor Weekly provides comprehensive and timely insight on a wide range of taxation issues including international tax, state and local tax, incentives and current issues. Readers are reminded that they should not consider these documents to be a recommendation to undertake any tax position, nor consider the information contained therein to be complete. Before any item or treatment is reported, or excluded from reporting on tax returns, financial statements, or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in these releases may not continue to apply to a reader's situation due to changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances. Author Robert Filip Managing Director, Seattle 425-748-5100 Email | Profile Cheria Coram, Senior Associate, contributed to this article. For More Information on this Topic, Contact: James CarreonManaging Director, San Francisco415-490-2121Email | Profile James Eberle Managing Director, Washington, D.C. 703-852-5011 Email | Profile Jose LamelaManaging Director, Miami305-704-6710Email | Profile Other Related Issues: 11/04/08 Transaction Cost Analyses — A Kinder, Gentler IRS? 08/18/08 Update on Convergence of Income Tax Accounting Standards FAS 109 and IAS 12 12/20/07 Acquiring Loss Corporations — Commonly Encountered Rules, Pitfalls and Strategies Feedback: We would like to hear from you. Click here to provide your feedback. About Alvarez & Marsal Taxand Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M’s commitment to offering clients a choice in advisers who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the U.S., and serves the U.K. from its base in London, England. Alvarez & Marsal Taxand is a founding member of Taxand, the first global network of independent tax advisers that provides multinational companies with the premier alternative to Big Four audit firms. Formed in 2005 by a small group of highly respected tax firms, Taxand has grown to more than 2,000 tax professionals, including 300 international partners based in more than 40 countries. To learn more, visit www.alvarezandmarsal.com or www.taxand.com. © Copyright 2008 Alvarez & Marsal Holdings, LLC. All Rights Reserved.

Issue / Subtitle: 
Issue 52
Newsletter Date: 
Tuesday, December 23, 2008
Category: 
Mergers & Acquisitions
Tax Implications of the New Acquisition Accounting Standards under FAS 141(R)

December 23, 2008

Nearly every organization will be affected by the major changes in acquisition accounting introduced by new accounting standards under Financial Accounting Standards Board Statement No. 141 (revised 2007), Business Combinations. The changes introduced by FAS 141(R) — which are effective for transactions that occur in fiscal years beginning after December 15, 2008 — will affect how companies account for and report business acquisitions and will impact the financial statement reporting at the acquisition date and in subsequent periods.

In issuing FAS 141(R), the FASB’s goals were to improve the purchase method of accounting for business combinations (now called the acquisition method) and align the accounting for business combinations under US GAAP and international financial reporting standards, together with greater use of fair values in financial reporting and expanded disclosures. FAS 141(R) requires all business combinations (any event in which the acquirer obtains “control” of a “business”) to be accounted for using the acquisition method.

Highlighted Areas of Change for M&A Deals under the New Accounting Standards

Deal Costs
Transaction costs related to an acquisition will generally be expensed as incurred. Typical deal costs include fees paid to bankers, attorneys, accountants and valuation specialists. These deal costs will be expensed as the professional fees are incurred, affecting the income statement of such period. The FASB’s thinking for this change is that these costs are not part of the fair value of the target company but rather are costs of acquiring the business. Accounting for deal costs under the new standards will have an immediate impact on earnings, reducing reported earnings in the period prior to the transaction’s closing date.

Restructuring Costs
Costs related to the planned restructuring of the target’s operations will generally be recorded in the earnings in the post-acquisition period. Under the new standards, the restructuring costs can be recognized as a liability under acquisition accounting only if certain conditions are met as of the acquisition date. For example, before a liability can be recorded, the acquirer’s restructuring plan must be approved and brought into effect, and the facilities must be abandoned.

Acquired Contingencies
Contingencies are assets or liabilities with uncertainty as to their future outcome and costs. Examples of common contingencies include pending legal claims, tax disputes and environmental liabilities. The acquirer must determine the nature of the contingency and the likelihood of the outcome, and record acquired contingent assets and liabilities at fair value as of the acquisition date. FAS 141(R) requires assets or liabilities resulting from contractual contingencies to be recognized at fair value as of the acquisition date. Assets or liabilities resulting from all other contingencies (non-contractual in nature) must also be recognized on the acquisition date and measured at fair value as of the acquisition date, only if they meet the “more likely than not” standard of FASB Concepts Statement No. 6, Elements of Financial Statements. If new information becomes available after the acquisition, the acquirer will need to evaluate the new information. The acquirer must then measure a liability at the higher of its acquisition-date fair value or the amount determined under existing guidance for non-acquired contingencies (i.e., applying FAS 5), and measure the asset at the lower of its acquisition-date fair value or the best estimate of its realizable amount.

Acquired Tax Reserves and Unrecognized Tax Benefits
Adjustments to acquisition-related tax reserves (e.g., valuation allowance or uncertain tax position) will now be recorded in earnings when occurred, instead of adjusting goodwill as was done under the prior purchase accounting standards. While the application of FAS 141(R) is generally prospective (affecting periods after its effective date), the provision related to income tax accounting is retrospective, applying to acquisitions prior to the effective date of FAS 141(R).

Adjustments to Acquisition-Date Accounting Estimates
Companies will continue to have a period of time after the acquisition date to true-up acquisition accounting estimates, similar to the current standard. However, under FAS 141(R), the treatment of these adjustments will differ from prior standards, where they generally were reflected in the period of the change. Under FAS 141(R), companies will be required to revise prior-period financial statements to record material adjustments to acquisition-date accounting estimates.

Income Taxes — Significant Changes to Accounting for Income Taxes as Related to Business Acquisitions

Transition provisions for the adoption of FAS 141(R) are generally prospective in their application, with the exception of accounting for changes in the valuation allowance of acquired deferred tax assets and the resolution of uncertain tax positions under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FAS 141(R) requires retrospective application in accounting for adjustments to valuation allowances and tax uncertainties attributable to prior business combinations.

An acquirer will need to recognize and measure the tax effect of all the temporary differences (tax benefit), carryforwards (deferred tax assets and liabilities) and income tax uncertainties of an acquired company in a business combination in accordance with FAS 109, Accounting for Income Taxes, and FIN 48. While the basic concepts of FAS 109 remain, FAS 141(R) changes certain provisions, resulting in significant changes to the tax accounting of acquisitions.

Release of Valuation Allowance
FAS 141(R) amends the income tax accounting guidance of FAS 109 to require that post-acquisition adjustments of valuation allowances no longer reduce goodwill or non-current assets. Instead, a reversal of a valuation allowance relating to acquired deferred tax assets will be recognized in income tax expense. An acquisition may also trigger a change in the assessment of recoverability for the buyer’s pre-acquisition-date deferred tax assets. Under FAS 141(R), such changes will be recognized through the income statement and recorded in the income tax provision. As a result, they will directly affect a company’s effective tax rate.

Adjustments to Uncertain Tax Positions
FAS 141(R) nullifies EITF 93-7, Uncertainties Related to Income Taxes in a Purchase Business Combination. Prior to FAS 141(R), adjustments to acquired tax liabilities were recorded as an adjustment to goodwill, irrespective of the time between the adjustment and the acquisition date. Under FAS 141(R), adjustments to acquisition-related uncertain tax reserves (e.g., FAS 5 or FIN 48 liabilities) will be recorded in earnings as part of the provision for income taxes, directly affecting a company’s effective tax rate.

Exception for Qualified Measurement Period Adjustments
The measurement period gives the acquirer up to one year after the acquisition date to obtain information and adjust the initial amounts recognized for a business combination. During the measurement period, any changes to a valuation allowance or uncertain tax position that was recorded as part of the acquisition as a result of additional insight into the facts and circumstances that existed at the acquisition date are recorded as an adjustment to goodwill. Adjustments after the measurement period, or based on new information uncovered within the measurement period, will be recorded in earnings as part of the provision for income taxes.

Excess Tax-Deductible Goodwill
FAS 141(R) also calls for recognition of a deferred tax asset equaling the income tax benefit of tax-deductible goodwill in excess of book goodwill at the acquisition date. Under prior rules, such a tax benefit was only recognized in the reporting period during which the deduction was actually taken on the company’s tax return. Recording the deferred tax asset for the excess tax goodwill on the acquisition date correspondingly increases the fair value of acquired net assets and decreases goodwill recorded under acquisition accounting for financial reporting purposes.

What Your Tax Department Should Understand

  1. Effective tax rate volatility — Under FAS 141(R), except for certain qualified measurement period adjustments, changes to tax reserves will now be recorded in earnings, directly affecting a company’s income tax expense and effective tax rate. Additionally, nontaxable transactions and related costs, such as a tax-free stock acquisition, are often treated as part of the cost of the acquired entity for tax purposes and increase the tax basis of the acquired shares. Under FAS 141(R), these costs will be expensed for financial reporting purposes without a corresponding tax deduction until the acquired shares are subsequently sold, thus raising the company’s effective rate for that reporting period. The ability of management to more accurately estimate income tax effects at the acquisition date will decrease the potential for significant volatility in the company’s effective tax rate in periods following the acquisition.

  2. Timing of deals — The greater use of fair value measures and the new rules for reporting adjustments to acquisition-date estimates may influence the timing of deals closing. For example, closing a deal early in a quarter will provide more time for management to refine the acquisition accounting estimates and thus mitigate later revisions to prior-period financial statements.

  3. Enhanced tax due diligence procedures — Effective acquisition accounting and measurement comes down to the quality and availability of information. Companies will need to enhance their tax due diligence processes to thoroughly identify and accurately measure tax uncertainties and valuation allowances associated with acquired tax attributes. A heightened focus on tax due diligence and the quality of resulting documentation is necessary to reduce future tax rate implications that the company could experience in light of new information uncovered following the transaction’s close. Companies that fail to develop a robust process of assessing acquisition-date fair value could experience volatility in earnings subsequent to the transaction’s close or may be required to revise prior-period earnings. Buyers should impose elevated due diligence procedures — involving their tax team in the deal process — and request detailed documentation to allow them to construct supportable acquisition estimates. Correspondingly, prospective sellers should be prepared to provide such documentation and have their records in place prior to putting a business on the market.

Alvarez & Marsal Taxand Says:

Tax departments need to develop an understanding of the new FAS 141(R), as many issues will be changing for calendar-year-end companies in the first quarter of 2009, affecting the calculation of the 2009 effective tax rate estimate. Tax directors and client advisors alike should be considering what previous acquisition activity will be affected by FAS 141(R). Review balances from before FAS 141(R) was adopted — is there any valuation allowance or unrecognized tax reserves that could relate back to an acquisition? Do existing tax accounting procedures and records have visibility to track tax attributes to distinguish acquisition-related items (and from which acquisition)? A&M suggests that companies proactively document tax balances of deferred items, valuation allowances and uncertain tax positions. Companies should also track future reversals of identified reserves to avoid errors in reporting, revise their accounting policies and procedures to differentiate between existing tax reserves and those acquired as part of a business combination, and allow enough time to evaluate and measure accounting for the transaction as of the acquisition date. For any current mergers and acquisitions activity, companies will need to carefully assess the accounting for acquisitions that are in process in late 2008.

Disclaimer

As provided in Treasury Department Circular 230, this e-newsletter is not intended or written by Alvarez & Marsal Taxand, LLC, to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.

Alvarez & Marsal Taxand, LLC distributes a complimentary electronic newsletter to subscribers on a weekly basis. A&M Tax Advisor Weekly provides comprehensive and timely insight on a wide range of taxation issues including international tax, state and local tax, incentives and current issues. Readers are reminded that they should not consider these documents to be a recommendation to undertake any tax position, nor consider the information contained therein to be complete. Before any item or treatment is reported, or excluded from reporting on tax returns, financial statements, or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in these releases may not continue to apply to a reader's situation due to changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.

Author

Robert Filip
Managing Director, Seattle
425-748-5100
Email | Profile

Cheria Coram, Senior Associate, contributed to this article.

For More Information on this Topic, Contact:

James Carreon
Managing Director, San Francisco
415-490-2121
Email | Profile

James Eberle
Managing Director, Washington, D.C.
703-852-5011
Email | Profile

Jose Lamela
Managing Director, Miami
305-704-6710
Email | Profile

Other Related Issues:

11/04/08 Transaction Cost Analyses — A Kinder, Gentler IRS?
08/18/08 Update on Convergence of Income Tax Accounting Standards FAS 109 and IAS 12
12/20/07 Acquiring Loss Corporations — Commonly Encountered Rules, Pitfalls and Strategies

Feedback:

We would like to hear from you.
Click here to provide your feedback.

About Alvarez & Marsal Taxand

Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M’s commitment to offering clients a choice in advisers who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the U.S., and serves the U.K. from its base in London, England.

Alvarez & Marsal Taxand is a founding member of Taxand, the first global network of independent tax advisers that provides multinational companies with the premier alternative to Big Four audit firms. Formed in 2005 by a small group of highly respected tax firms, Taxand has grown to more than 2,000 tax professionals, including 300 international partners based in more than 40 countries.

To learn more, visit www.alvarezandmarsal.com or www.taxand.com.

© Copyright 2008 Alvarez & Marsal Holdings, LLC. All Rights Reserved.