The closing date is here, you sign on the dotted line and wire the funds to the seller. All the hard work, months of due diligence and time have finally paid off. You purchased your first business. All of a sudden, you realize it is less than a month from the end of the year, and three months away from the due date of your annual investor report. How am I going to complete the accounting and valuation procedures before then?
This scenario is all too common, and the accounting work that has to occur after an acquisition has taken place is one of the last things most managers consider. Don’t worry, Generally Accepted Accounting Principles (GAAP) does provide some relief. According to GAAP, if the accounting for the acquisition (identification and valuation of the acquired assets and liabilities) is not complete by the end of a reporting period, i.e. quarter end or year end, the acquiring entity can record provisional amounts in the financial statements and is provided additional time to properly identify, record, and measure the assets acquired and liabilities assumed. This extra time is referred to as the measurement period and is defined as the shorter of one year from the acquisition date or the date the acquiring entity receives the information it was seeking about facts and circumstances that existed as of the acquisition date, or learns that more information is not obtainable. The measurement period does not extend or delay the requirements to file financial statements, but provides an acquiring entity flexibility in reporting balances accurately and not rushing to a final conclusion on complex valuation and accounting matters.
During the measurement period, an acquiring entity should work to identify all assets and liabilities that were acquired or assumed, identify the full consideration paid in the transaction, and determine the final goodwill balance (if any) or bargain purchase gain. The assets and liabilities and subsequent adjustments to provisional amounts should be based on information that existed at the acquisition date. Events and circumstances that occurred after the acquisition date can be considered, but if these were not present at the acquisition date, they should not be considered in the measurement period analysis.
The application of the measurement period is commonly applied in situations where real estate, intangible assets, and significant contingencies exist at the acquisition date, and for acquisitions close to the end of a reporting period. At that point in time, the acquiring entity is likely waiting for the finalization of appraisals, may be gathering information to properly measure and record contingent liabilities, such as earn-outs and lawsuits, or may be waiting for the completion of a final working capital calculation.
Once the measurement period has ended, the acquiring entity would adjust the acquired assets and assumed liabilities to fair value, record additional assets or liabilities, or adjust the consideration paid if calculated on a contingent basis. Currently, the acquiring entity would retrospectively adjust any previous financial statement periods presented in the financial statements to state the balances as if these were recorded on the date of acquisition. In September 2015 (effective for fiscal years beginning after December 15, 2015, with early application permitted), the Financial Accounting Standards Board issued Accounting Standards Update 2015-16, which amended and simplified GAAP to record changes to these provisional amounts in the period they were identified, no longer requiring the retrospective adjustments in the financial statements.
The concept of the measurement period is best demonstrated in an example. Company A acquired Company B on December 15, 2014. Company A’s fiscal year ends on December 31, with audited financial statements due to the bank and investors on March 31. Company B’s fiscal year ends on November 30 and there is no requirement to have audited financial statements presented to a bank or investor. The purchase price was a cash payment of $10,000,000 and a contingent earn-out based on future EBITDA of Company B over a base amount for a five year period. Per the terms of the purchase agreement, Company A acquires all the working capital, the land and building, the equipment, a trade name, customer relationships and contracts, and assumes the debt, and related contingencies of Company B. The purchase agreement requires a final working capital schedule to be audited by Company A’s independent CPA firm and Company B must present audited financial statements to Company A to establish a base EBITDA for use in the earn-out calculation. After the acquisition, on January 5, 2015, a fire destroyed the building and equipment of Company B.
At the acquisition date, Company A ordered appraisals of the land, building, equipment, and intangible assets and began calculating the final working capital balance. It is anticipated these appraisals and the working capital calculation will be completed by April 15, 2015 and the audit of Company B is expected to be completed at the end of April 2015. Due to the expected completion dates of these key items, Company A would apply the measurement period guidance for their 2014 financial statements and record provisional amounts and disclose this in the financial statements. The measurement period in this situation would likely be from the date of acquisition to the end of May 2015 or June 2015, to allow Company A the necessary time to properly record, measure, and calculate the necessary balances. In the following year (2015 financial statements), Company A would either retrospectively adjust the financial statements for 2014 to the finalized fair values as if the final values were known at day one of the acquisition or early adopt Accounting Standards Update 2015-16 and recognize the changes in the 2015 financial statements. In regards to the fire, this event occurred during the measurement period, but the circumstances leading up to the event were not present at the acquisition date. Company A should not consider this event in the determination of the fair values for the 2014 financial statements, but should disclose this as a subsequent event in the 2014 financial statements. Any financial impact of this fire would then be recorded in the 2015 financial statements.
As you can see, the measurement period allows an acquiring entity time to properly record the transaction in their financial statements while remaining compliant with reporting deadlines. The acquiring entity should exercise caution in applying this standard though, and should not abuse the measurement period granted under GAAP to improperly adjust calculations and fair value assessments for subsequent events. The measurement period concept should not be used as an excuse to take your time to account for this transaction. Accurate financial information is key to investors and management and a good faith effort to complete the accounting for the acquisition timely should be made a top priority.
To learn more about the measurement period in business combinations, contact Michael Schaefer at 952.841.3052 or mschaefer@boulaygroup.com.