Mergers & acquisitions

a snapshot
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Did I buy a group of assets or a business?

December 14, 2011
Why should I care?

What's inside Determining whether an acquired group of assets is a business has proven to
be one of the more challenging aspects of applying the current M&A
Why does it matter? accounting guidance. For many transactions, the determination will be
straightforward. However, the current guidance will cause many transactions
What is a business? that are "on the edge," and previously would have been accounted for as asset
Industry-specific acquisitions, to be accounted for as business combinations. Why is this
considerations determination important? While the measurement of assets and liabilities in
Disposal transactions both types of transactions will yield similar results, several differences can
arise that can have a significant impact on a company's earnings, financial
Public company reporting ratios, and business metrics.
Conclusion
This edition of Mergers & acquisitions a snapshot, identifies relevant
considerations in determining whether a business has been acquired and why
it matters not only upon acquisition but also for disposals and public company
reporting.

1
Accounting Standards Codification 805 is the US standard on M&A, and Accounting Standards
Codification 810 is the US standard on noncontrolling interests.

M&A snapshot 1
Why does it matter? What is a business?
Determining whether a business has been acquired has far The M&A standards contain a definition of a business that
reaching business and accounting implications. To can result in a broad range of transactions qualifying as
illustrate, the table below outlines some of the key areas business acquisitions. A business is an integrated set of
where the accounting treatment can differ. assets and activities capable of being managed to provide a
return to its owners. Businesses consist of
Area Business Asset acquisition assets/resources, and systems, standards, or protocols
combination applied to those assets/resources, that have the ability to
Measurement of assets Fair value Allocate purchase create economic benefits, such as revenues or lower costs.
and liabilities consideration based
on relative fair values In many transactions, the asset or business determination
Transaction costs Expense Capitalize will be straightforward. For example, the acquisition of an
Contingent Generally record at fair Generally record when operating company active in the marketplace will qualify
consideration value; mark to market probable and as a business, whereas the purchase of a single machine
through P&L post- reasonably estimable
will be accounted for as an asset acquisition.
close if a liability
IPR&D Capitalize as an Expense assuming no However, in other instances, this assessment can become
indefinite lived asset alternative future use
until project completed more complex and judgmental. In making this
or abandoned determination, it is important to: 1) identify the elements
Goodwill Recognize as Cannot be recognized in the acquired group (i.e., the assets purchased and
standalone asset processes transferred); 2) assess the capability of those
Acquired Recognize at fair value Generally record when elements to generate economic benefits; and 3) assess the
contingencies if determinable; probable and impact of any missing elements on a market participant's
otherwise, when reasonably estimable ability to generate economic benefits. The table below
probable and
outlines some factors that may distinguish business
reasonably estimable
combinations from asset acquisitions.
Assembled workforce Subsumed within Recognize as
goodwill standalone asset
Business combination Asset acquisition
Key business processes acquired No processes acquired or only
administrative processes acquired
A market participant could A market participant could not
manage the assets to provide a manage the assets to provide a
return to its owners return to its owners without
combining them with other assets
Key elements are missing but can Key elements are missing and
be easily replicated or obtained cannot be easily replicated or
obtained
Key employees hired No employees hired
Able to produce "Day 1" outputs Not able to create economic
benefits
Presence of liabilities and/or No goodwill present
goodwill

M&A snapshot 2
Industry-specific considerations
Determining whether a business has been acquired can be
particularly challenging in certain industries.
Considerations relevant to some of these industries are
discussed below.
Oil and gas industry
In the oil and gas industry, properties acquired for
extractive activities vary significantly in terms of their
stage of development and viability. Properties may be
completely unexplored and undeveloped on one extreme,
and may be actively producing on the other. Due to the
differing stages of development and exploration, judgment
is required to determine whether many properties are
businesses or assets.
An example of a transaction in this industry is described
below.
Example 1 acquisition of oil and gas exploration
company
Facts: Company K is an oil and gas exploration company.
Company K owns a proven but undeveloped property.
Company K has performed enough exploration activities
to determine that the property is proven, but has not yet
begun to extract the mineral reserves from the property.
Additionally, Company K has constructed transportation
infrastructure that will be used to transport the mineral
reserves. However, this infrastructure has not yet been
placed into operation. Company L is an oil and gas
production company that operates a large portfolio of
producing properties. Company L acquires Company K.
Analysis: In the past, this transaction may have been
treated as the acquisition of property. However, under
the current guidance it is likely a business has been
acquired. The acquisition includes assets (property and
transportation infrastructure) and systems/protocols
(supporting exploration activities). While there are
missing elements (other infrastructure and developed
reserves), Company L determined that likely market
participants would have, or could easily obtain, the
necessary operational processes to manage the acquired
group in a way that would provide a return to investors.
Real estate industry
Acquired properties vary as to the level of business
processes that are needed to yield a return and the degree
to which those processes are present at acquisition. For
example, the nature of tenant solicitation, maintenance,
and property management can vary significantly in the
purchase of an empty building versus a building with
multiple tenants.
This concept is highlighted in the following example.
Example 2 acquisition of commercial properties
Facts: Company W, a real estate investment entity, owns
and manages a group of commercial properties across the
United States. Company W decides to purchase a
commercial office property in San Francisco. The existing
property is 90% occupied, and Company W will become a
party to the lease agreements upon acquisition. Company
W will replace existing security, cleaning, and
maintenance contracts with new contracts. However, the
existing property management agreement will be
terminated and Company W will undertake all property
management functions, such as collecting rent and
supervising maintenance work. In connection with the
transaction, Company W will also hire leasing managers
and other management personnel involved with the
operations of the property.
Analysis: In the past, this transaction may have been
treated as the acquisition of real estate. However, under
the current guidance, it is likely a business has been
acquired. Company W acquired assets (commercial
property, lease agreements, and other contracts) and
hired key leasing and management personnel. Further,
rental income is present immediately after the
acquisition. Company W concluded that other market
participants would have existing property management
expertise.
Technology industry
In the technology industry, IPR&D and contingent
consideration arrangements are prevalent, making the
stakes particularly high for determining what constitutes a
business. In making this determination, it is important to
consider the stage of development of IPR&D and the level
of expertise of any employees hired in connection with the
transaction.
M&A snapshot 3
Outsourcing arrangements are common in the technology
industry because they allow companies to lower their fixed
costs. An example illustrating the application of this
guidance to an outsourcing arrangement is presented
below.
Example 3 outsourcing arrangement
Facts: Company O is in the business of providing
information technology outsourcing services. It offers to
provide services to Firm P under a 20 year agreement. As
part of the agreement, Company O acquires a building,
computer equipment, and certain intellectual property
("IP") held by Firm P. While all employees of Firm P
working in this area have been hired by Company O in the
transaction, Company O plans to initiate a restructuring,
which will eliminate headcount and improve efficiency.
Analysis: In the past, this arrangement may have been
treated as an executory contract. Now, it is likely a
business has been acquired. Company O acquired assets
(building, computer equipment, IP) and
systems/protocols (computer systems, knowledge
resident in employees). Further, the acquired group is
capable of providing a return to its owners.
Pharmaceutical & life sciences industry
Similar to the technology sector, IPR&D and contingent
consideration arrangements can constitute a significant
portion of a transaction in the pharmaceutical and life
sciences industry. Some relevant factors to consider in
determining whether a business has been acquired include
the stage of development of any drug compounds acquired
and any processes attached to the acquired assets. In most
cases, there are likely to be more processes associated with
later stage drug compounds than those in earlier stages. In
addition, certain licensing arrangements, such as some
worldwide perpetual licenses in which employees,
processes, or other assets have been acquired, may be
business acquisitions.
The following example illustrates the application of this
guidance in the pharmaceutical industry.
Example 4 acquisition of research and
development company
Facts: Development Inc. owns the right to several
product (drug compound) candidates. Its only activities
consist of research and development that is being
performed on the product candidates. Development Inc.
employs management and administrative personnel as
well as scientists that are vital to performing the R&D.
Big Pharma Co. acquires the rights to certain of the
product candidates as well as testing and development
equipment from Development Inc. Big Pharma Co. also
hires the scientists formerly employed by Development
Inc. who are developing the acquired candidates.
Analysis: This transaction would likely have been
accounted for as an asset acquisition in the past
(acquisition of a pre-revenue development company).
However, under the current guidance, it is likely a
business has been acquired. Big Pharma acquired assets
(product candidates, testing, and development
equipment) and the operating protocols and procedures
established by the scientists. While Big Pharma Co. did
not acquire a manufacturing facility or a sales force, it
determined that the likely market participants are other
large pharmaceutical companies that already have these
items or could easily replicate them.
Disposal transactions
The business versus asset determination is also relevant
for disposal transactions. A key difference between an
asset sale and a business sale is that in the latter case
goodwill needs to be allocated to the business sold. This
allocation could have a significant impact on the gain or
loss recognized from the sale. Allocation of goodwill to the
business sold would also trigger the need for an
impairment assessment of the remaining goodwill in the
reporting unit.
The following example highlights these considerations for
a disposal transaction.
M&A snapshot 4
 In summary
Example 5 disposal of a plant
There are no "bright lines" that can be used in determining
Facts: Company V is a diversified manufacturing whether a business has been acquired. Often times, this
company that has a widget reporting unit. The widget determination is judgmental and can have a significant
reporting unit comprises two plants - one that sources impact on a buyer's financial reporting. Making these
US subsidiaries and one that sources European judgments will not be easy but buyers will want to avoid
subsidiaries. Company V decides to sell the plant in post-deal "surprises" by addressing this issue early in the
Europe for $2,000. Financial information for the widget deal process.
reporting unit and its two plants prior to the disposal is
provided in the table below.
For more information on this publication please contact
US Europe Total one of the following individuals:
Fair value $3,000 $2,000 $5,000
John Glynn
Net assets $1,500 $1,000 $2,500 Valuation Services Leader
(excluding (646) 471-8420
goodwill) john.p.glynn@us.pwc.com
Goodwill $500
Henri Leveque
Total book $3,000 Accounting Advisory Services Leader
value (678) 419-3100
h.a.leveque@us.pwc.com
Analysis: The plant in Europe likely qualifies as a
business because it has tangible and intangible assets
and processes, such as manufacturing protocols and Principal authors:
knowledgeable employees. The plant is also currently
producing widgets. Company V would allocate a portion Lawrence N. Dodyk
of the total widget reporting unit goodwill upon disposal US Business Combinations Leader
based on the relative fair values of the US and European (973) 236-7213
plants. This results in an allocation of 40% lawrence.dodyk@us.pwc.com
($2,000/$5,000) of the total widget reporting unit
goodwill to the European plant, or $200. As a result, the Kevin McManus
book value of the European plant is $1,200 and Assurance Senior Manager
Company V will record a gain of $800 based on a sales (704) 344-4320
price of $2,000. Absent the allocation of goodwill to the kevin.m.mcmanus@us.pwc.com
European plant, Company V would have recorded a gain
of $1,000. In addition, Company V will test the John Vanosdall
remaining amount of goodwill for impairment. National Professional Services Group Director
(973) 236-4030
john.p.vanosdall@us.pwc.com

Public company reporting

For public companies, the asset versus business
determination can also impact SEC reporting
requirements. While the SEC's rules are different from the
M&A rules, what constitutes a business will, for the most
part, be the same for both. Specifically, the SEC rules
require financial statements for acquired businesses that
are considered significant. In contrast, there is no such
requirement for asset acquisitions.

M&A snapshot 5
PwC has developed the following publications related to Dataline 2009-34: Accounting for Contingent
business combinations and noncontrolling interests, Consideration Issued in a Business Combinationfor
covering topics relevant to a broad range of constituents.
accounting professionals and deal makers

10Minutes on Mergers and Acquisitionsfor chief Dataline 2011-20: Goodwill ImpairmentFASB

executive officers and board members proposes changes to impairment testfor accounting
professionals and deal makers
What You Need to Know about the New Accounting
Standards Affecting M&A Dealsfor senior executives Dataline 2011-28: FASB issues guidance that simplifies
and deal makers goodwill impairment test and allows early adoptionfor
accounting professionals and deal makers
Mergers & acquisitionsa snapshota series of
publications for senior executives and deal makers on
emerging M&A financial reporting issues PwC clients who would like to obtain any of these
publications should contact their engagement partner.
Business Combinations and Consolidationsthe new Prospective clients and friends should contact the
accounting standardsan executive brochure on the managing partner of the nearest PwC office, which can be
new accounting standards found at www.pwc.com.
A Global Guide to Accounting for Business
Combinations and Noncontrolling Interests: Application
of U.S. GAAP and IFRS Standardsfor accounting
professionals and deal makers
Dataline 2008-01: FAS 141(R), Business
Combinationsfor accounting professionals and deal
makers
Dataline 2008-02: FAS 160, Noncontrolling Interests in
Consolidated Financial Statementsfor accounting
professionals and deal makers
Dataline 2008-30: Key Considerations for
Implementing FAS 141(R) and FAS 160for accounting
professionals and deal makers
Dataline 2008-35: Nonfinancial Asset Impairment
Considerationsfor accounting professionals and deal
makers
Dataline 2009-08: Revisions to EITF Topic D-98,
Classification and Measurement of Redeemable
Securitiesfor accounting professionals and deal
makers
Dataline 2009-16: New Guidance for Acquired
Contingenciesfor accounting professionals and deal
makers

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