Look Before You Leap – Understanding Some Unique Accounting Rules

In the last couple of years, I have witnessed several of my private company clients reorganize their operations, through either a merger, an acquisition or a significant management member buyout. While such situations provide a great stage for all to display their accounting chops, they also present us an opportunity to consult with our clients and help them avoid an accounting faux pas or burdensome and unnecessary disclosures caused by an inadvertent accounting election. So, in no specific order, I thought I would summarize some of the unique accounting issues I’ve encountered in such situations and how to navigate them:

  • Acquisition costs incurred by the acquirer to effect a business combination: typically, these costs are expensed as period costs when incurred and as the related services are rendered. However, debt issuance costs or costs incurred to issue equity securities are required to be presented as a deduction from the corresponding debt liability or proceeds from issuing equity.
    • Debt issuance costs such as professional fees, registration or underwriting fees, that would ordinarily not have been incurred had the debt not been incurred, should be netted against debt borrowings. The accounting rules relating to debt issuance were explained by my colleague Kay Filler not so long ago: Debt Issuance Costs – Accounting Presentation Rules Demystified
    • Similar costs to issue equity shares are treated as a reduction of the proceeds from the equity issuance as laid out in ASC 505-10.
    • It is important to correctly identify such issuance related costs in order to apply the proper accounting treatment. For instance, requesting your attorneys and other professionals to provide a detailed breakdown on their invoices for debt or equity issuance related costs will help in this process.
  • Pushdown accounting: Under ASC 805-50, this is an election now available to privately held acquiree companies when an acquiring company obtains control of the acquiree. The acquiring company recognizes acquired assets and liabilities at fair value, which is typically a step-up from the historical cost basis and under pushdown accounting rules, the separate financials of the acquired company can reflect these assets and liabilities on a stepped-up basis. A thorough read of this standard is imperative to understand how your financial statements are impacted by applying this guidance. More so because once elected, this accounting policy is irrevocable. It is important to note that a company has until its financial statements are issued or available to be issued to make this accounting election. There are some obvious areas of impact on the financials once pushdown accounting is elected, such as increased value of assets and increase in the depreciation expense, recognition of goodwill and related amortization, etc. The not so obvious impact is what companies should think through before making this election.
    • If the acquired company is in a different jurisdiction than the acquirer, take a moment to investigate if pushdown accounting is permitted in all jurisdictions. For instance, IFRS does not permit pushdown accounting and will result in the reversal of all such accounting for local statutory filings.
    • Could the recording of assets and liabilities at the new stepped up basis with an impact on depreciation and amortization expense result in the violation of debt covenant ratios? Better to know that ahead of time rather than seek a subsequent waiver from the lender.

These are just a few examples of instances when it pays to research specific accounting guidance and speak to your accountant before expending your energies on complex accounting entries. They will be happy to walk you through the merits of an accounting election and the impact on your financials.