It is exactly two days before Christmas and everybody is in a rush to buy gifts. The Christmas season gives each of us a reason to spend more than usual for our family, friends and ourselves. When buying gifts, we normally have an idea of what to give and to whom it will be given. There is also reason why we choose to buy the gift for that specific person.
A person planning to buy a gift is very similar to a company who seeks to buy another company. There are very specific reasons why one would buy or take over a company and why a specific target company is chosen. More and more companies, big or small, are seeing acquisition as the easiest way to expand their business. Acquiring an existing business offers the benefit of having assets already in place, as well as personnel, customer base, and for some, an established brand.
Buying an existing business might, indeed, be the fastest and easiest way for a company to achieve its goals. However, it is definitely not the simplest transaction to account for, as it can also be very tricky in a lot of ways. A long list of questions and issues will have to be addressed, such as, the valuation of the business that’s being bought. Is the company acquiring only the business’s tangible assets (e.g. inventory, property, and equipment)? More importantly, when the company pays more than the value of the net assets acquired, how does the company account for the difference?
Similarly, when we buy gifts especially for our loved ones, we want to choose the best, and the best usually comes with a hefty price tag. Sometimes we doubt whether the item is really worth its price. In a business acquisition, the buying company pays an agreed amount or consideration in exchange for the assets acquired and liabilities assumed. In most cases, that amount or consideration is larger than the individual fair value of each of the he assets acquired and liabilities assumed, and this is where it becomes very challenging.
In the olden days, the difference would automatically be treated as goodwill. It is very convenient to attribute any excess payment as goodwill based on the simple logic that the buying company is paying for any future benefit that it will have from the current business’s good relationships.
However, nowadays, such accounting treatment is no longer acceptable. In any business acquisition, the buying company might also be buying something without physical substance—intangible assets—which may, or may not be, recognized in the selling company’s financial statements. Any excess payment in a business acquisition might also be attributable to these intangible assets.
That is why it is important to identify intangible assets, which may either be:
(a) separated and divided from the business acquired (i.e. it can be sold, transferred, licensed, rented, or exchanged, either individually or together with another related contract, identifiable asset or liability, regardless of whether the buying company does not intend to sell, license, or otherwise exchange it; for example, a customer or subscriber list); or
(b) an existing contractual-legal relationship even if not transferable or separable from the selling company (for example, an existing non-transferable lease agreement that has favorable terms relative to market or a technology patent owned by the seller that has been licensed to third parties).
Since it’s the season of shopping, let me illustrate further with Coach, Inc.’s recent acquisition of Kate Spade & Company. The acquisition is expected to boost Coach’s revenues and expand its market as Kate Spade has great reach across millennial customers, unlike Coach. If the total acquisition of Kate Spade’s business is in excess of the fair value of its assets and liabilities, Coach should assess if the premium is due to other intangibles acquired, such as Kate Spade’s brand name and any existing distribution agreements worldwide. Such intangibles should be recognized as a separate asset at fair value on the date of acquisition, even if not previously valued in Kate Spade’s books. So in the process of recognizing and measuring the identifiable assets acquired, the buying company might end up recognizing assets acquired and liabilities assumed that the selling company had not previously recognized in its financial statements, such as brand name, patents, or a customer relationship.
All of these identifiable intangible assets, apart from goodwill, should also be valued before you can say that the remaining excess payment pertains to goodwill.
In the end, in any business acquisition, we should always keep in mind that, although existing good relationships and reputation mean a lot, those are not the only things that matter and have value.
This is also similar to gift-giving this season: the brand and cost of our gifts are not the only things that matter. The thoughtfulness and the love that come with it matter, too.
Jocelyn J. De Chavez is an Assurance director, and an Accounting and Consulting Services director, of Isla Lipana & Co., the Philippine member firm of the PwC network. For more information, please email firstname.lastname@example.org. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.