When Can an Asset Sale Become a “Merger”?

Strangely enough, when new accounting rules say it is.

As companies move to boost liquidity by selling off assets, some executives will be surprised to find that the transactions may be subject to a new merger rule. The reason: The relatively new accounting rule known as FAS 141(R) expands the definition of a business.

As a result, more asset sales will be considered a sale of a business for accounting purposes, and therefore will require an allocation of goodwill to the business sold, affecting the gain or loss on the sale. Goodwill is an intangible asset that represents the premium over book value that a buyer pays for a target company.

For example, all things being equal, if an asset group is carried on a company’s books at $600,000, and is then sold for $1 million, the company would record a pretax gain of $400,000. However, if the same assets now constitute a business under the new definition, their sell-off would require an allocation of goodwill to be added to their carrying value. Say that that the goodwill allocated is $100,000. Then the pretax gain on the sale would be reduced to $300,000. Further, the sell-off of assets may require a company to test its remaining goodwill for impairment.

What’s more, in certain situations, “there can be an significant amount of judgment” required by management and auditors to determine what is — and is not — a business for accounting purposes, says John Formica, a partner in the national technical office of PricewaterhouseCoopers.

Another area to watch, notes Formica, is how the income statement is affected by reductions in valuation allowances linked to deferred tax assets, as well as adjustments to tax reserves. Deferred tax assets stem from future tax deductions, like net operating losses. If a corporation with losses is uncertain about its ability to generate future taxable income, it is required to establish a valuation allowance, which is a current charge for a possible future tax benefit.

With regard to FAS 141(R), companies can take up to one year to make the final accounting adjustments for the transaction. Under the new rule, adjustments made outside of the one-year measurement period flow through the income statement and into earnings. That’s a departure from the old rules in that adjustments made to tax reserves and reductions in value allowances from acquisitions were generally recorded as a change to goodwill on the balance sheet, regardless if the adjustment was made outside of the one-year period.

This is the only provision within FAS 141(R) that applies to old deals, according to Formica. All other provisions relate to deals that close after Jan. 1, 2009.

The expanded definition of a business in FAS 141(R) may also increase the number of reporting units that are tested for goodwill impairment. Consider this, for example: When a company closes an acquisition, it must allocate goodwill to its reporting units — goodwill that is a segment or one level below, known as a component, says a PwC advisory. A component is considered a reporting unit if, among other things, it meets the definition of a business. The new broadened definition of a business may have the affect of classifying more components as reporting units to which goodwill must be ascribed and tested.

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