When a company (acquirer) purchases another entity (target), the purchase price of different assets and liabilities of the target are allocated as per accounting rules. This is known as purchase price allocation and helps assess the fair market value of the assets (tangible and intangible) and liabilities of the acquired company. The fair market value can be defined as the value a market participant would be willing to pay for the identified assets. Following purchase price allocation , the residual amount is kept under the heading of goodwill.
To ensure purchase price allocation is correct, the accounting standard guidelines states certain requirements and guidelines to be followed. This is where ASC 805 standards can be helpful.
Accounting Standards Codification (ASC) 805 is an accounting rule of Financial Accounting Standard Board (FASB) and has been modified from the previous existing standard known as FAS 141. ASC 805 dictates the accounting rules for M&A and specifies how tangible and intangible assets should appear in the balance sheet. As per the modified version, under ASC 805, contingencies are calculated and recorded as on the date of the acquisition. ASC 805 gives investors more transparency and is a user-friendly approach.
Earlier, intangible assets were considered goodwill, which made accounting difficult. As the rules became more stringent, ASC 805 provided more clarity to investors as various crises raised concerns around values recorded in M&A transactions. Goodwill is the synergistic value of a business combination, while the rest is identifiable and booked on the balance sheet.
ASC 805 also undertakes the accounting of asset acquisition, which is the purchase of a group of assets or an asset that cannot be defined as a business. The accounting for these transactions is outlined under subsection ASC 805-50: Acquisition of assets rather than a business is carried out as per the cost accumulation model. Therefore, the complete cost of the acquisition, including transaction costs, is allocated to the assets acquired based on relative fair values, with some exceptions. This differs from accounting of a business combination, where a fair value model is used. As per ASC 805-50, the assets and liabilities are recorded at their fair values, and goodwill is the difference between the consideration paid and any transaction costs. In unusual circumstances, this amount can also be defined as bargain purchase gain. Therefore, the accounting for asset acquisition and that for a business combination differ due to the guidelines specified by accounting standards.
Therefore, ASC 805 gives investors an accurate picture of the value of assets purchased in an M&A transaction. Investors also get a clear view of the current fair market value of business acquisitions.