On October 30, 2024, FASB issued an exposure draft clarifying the determination of the accounting acquirer in a business combination when the legal acquiree is a variable interest entity (VIE). The proposal would require an entity to consider the same factors currently used to determine the accounting acquirer in other acquisition transactions. If approved, application would be on a prospective basis and early adoption would be permitted. Comments are requested by December 16, 2024.
Background
Guidance in Accounting Standards Codification (ASC) 805, Business Combinations, and ASC 810, Consolidation, can be difficult to navigate. Conclusions for business combinations may differ when the legal acquiree is a VIE compared to when the legal acquiree is a voting interest entity, particularly if a transaction involves the exchange of equity interests. Under existing guidance, the accounting acquirer determination can significantly affect the carrying amounts of the combined entity’s assets and liabilities and post-combination net income. The accounting acquiree’s assets and liabilities are generally required to be initially measured at fair value, subject to specific exceptions in ASC 805. Under business combination guidance, the accounting acquirer’s existing assets and liabilities are not remeasured. The agenda request noted that if the legal acquiree is a VIE, the transaction cannot be accounted for as a reverse acquisition.
Current Guidance
ASC 805 currently states that in a business combination in which a VIE is acquired, the primary beneficiary of the legal acquiree is always the accounting acquirer.
For business combinations in which the acquired entity is not a VIE, and the application of ASC 810-10 (the voting interest entity model) does not clearly indicate which entity is the acquirer, an entity must consider the following factors (as detailed in 805-10-55-11 through 55-15) to determine the legal entity accounting acquirer:
- In a business combination effected primarily by transferring cash or other assets or by incurring liabilities, the acquirer usually is the entity that transfers the cash or other assets or incurs the liabilities.
- In a business combination effected primarily by exchanging equity interests, the acquirer usually is the entity that issues its equity interests. However, in some business combinations, commonly called reverse acquisitions, the issuing entity is the acquiree. Subtopic 805-40 provides guidance on accounting for reverse acquisitions. Other pertinent facts and circumstances also shall be considered in identifying the acquirer in a business combination effected by exchanging equity interests, including the following:
- The relative voting rights in the combined entity after the business combination. The acquirer usually is the combining entity whose owners as a group retain or receive the largest portion of the voting rights in the combined entity. In determining which group of owners retains or receives the largest portion of the voting rights, an entity shall consider the existence of any unusual or special voting arrangements and options, warrants, or convertible securities.
- The existence of a large minority voting interest in the combined entity if no other owner or organized group of owners has a significant voting interest. The acquirer usually is the combining entity whose single owner or organized group of owners holds the largest minority voting interest in the combined entity.
- The composition of the governing body of the combined entity. The acquirer usually is the combining entity whose owners have the ability to elect or appoint or to remove a majority of the members of the governing body of the combined entity.
- The composition of the senior management of the combined entity. The acquirer usually is the combining entity whose former management dominates the management of the combined entity.
- The terms of the exchange of equity interests. The acquirer usually is the combining entity that pays a premium over the precombination fair value of the equity interests of the other combining entity or entities.
- The acquirer usually is the combining entity whose relative size (measured in, for example, assets, revenues, or earnings) is significantly larger than that of the other combining entity or entities.
- In a business combination involving more than two entities, determining the acquirer shall include a consideration of—among other things—which of the combining entities initiated the combination, as well as the relative size of the combining entities, as noted in the preceding paragraph.
- A new entity formed to effect a business combination is not necessarily the acquirer. If a new entity is formed to issue equity interests to effect a business combination, one of the combining entities that existed before the business combination shall be identified as the acquirer by applying the guidance above. In contrast, a new entity that transfers cash or other assets or incurs liabilities as consideration may be the acquirer.
Current guidance specifically prohibits consideration of these factors if the legal acquiree is a VIE.
Staff research indicated that decision-making process was most challenging for the following business combinations:
- Umbrella partnership C corporation (Up-C) transactions in which a special purpose acquisition company (SPAC) acquires an operating company that is a limited liability company (LLC) or partnership. Often, the SPAC obtains controlling financial interest in the operating company as a general partner or managing member. In general, in Up-C transactions, the managing member of an LLC or the general partner of a partnership cannot be removed or blocked by the other non-managing members or limited partners. In this case, the operating company is generally a VIE. The SPAC is the primary beneficiary of the operating company and, consequently, the accounting acquirer.
- Certain business combinations where Up-C transactions are utilized to facilitate a business combination where the legal acquirer is a public corporation other than a SPAC.
- Merger of two corporations when the legal acquiree is a VIE due to insufficient equity at risk. This may occur when a SPAC acquires an operating company that is a VIE or in other business combinations in which the legal acquiree is a VIE due to insufficient equity at risk.
Proposed Changes
An entity would be required to consider the factors in 805-10-55-12 through 55-15, noted above, in determining which entity is the accounting acquirer when a VIE is acquired in a business combination effected primarily by exchanging equity interests, rather than following the requirement that the primary beneficiary of the VIE is always the accounting acquirer.
FASB intended these changes to be narrowly focused. For a transaction that is determined to be a reverse acquisition, the required accounting would not be changed. The accounting required for a transaction in which the legal acquirer is not a business and is determined to be the accounting acquiree also would not be changed.
For acquisition transactions in which the legal acquiree is a VIE, FASB anticipates these changes would result in the same accounting outcomes as economically similar transactions in which the legal acquiree is a voting interest entity.
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