19.01 Business combinations, as defined in the FASB Accounting Standards Codification (ASC) glossary, are transactions or other events in which an acquirer obtains control of one or more businesses. A business, as defined in the FASB ASC glossary, is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. In accordance with FASB ASC 805-10-55-3, a business combination may be structured in a variety of ways for legal, taxation, or other reasons, which include but are not limited to, the following:
• One or more businesses become subsidiaries of an acquirer or the net assets of one or more businesses are legally merged into the acquirer
• One combining entity transfers its nets assets or its owners transfer their equity interests to another combining entity or its owners
• All of the combining entities transfer their net assets or the owners of those entities transfer their equity interests to a newly formed entity (sometimes referred to as a roll-up or put-together transaction)
• A group of former owners of one of the combining entities obtains control of the combined entity
Business combinations may involve one entity acquiring the equity interests or net assets of another entity or both entities transferring their equity interests or net assets to a newly formed entity. Business combinations involving depository institutions are common and result from voluntary decisions as well as regulatory mandates. Most business combination issues are the same for depository institutions as for other business entities. This chapter addresses only significant issues that are unique to depository institutions.
19.02 Staff Accounting Bulletin (SAB) No. 112, which was issued by the SEC in June 2009, amends or rescinds portions of the SEC’s interpretative guidance regarding business combinations (codified in the SEC Codification of Staff Accounting Bulletins, topic 2, “Business Combinations”). This guidance was amended to make the SEC’s interpretative guidance consistent with accounting guidance in FASB ASC 805, Business Combinations, and FASB ASC 810, Consolidations. Among other changes, SEC Codification of Staff Accounting Bulletins topic 2(A)(5), which provided guidance on assigning acquisition costs to loans receivable acquired in a business combination, was removed. FASB ASC 805 provides new guidance that requires acquired receivables, including loans, to be measured at their acquisition date fair value and precludes the acquirer from recognizing a separate valuation allowance at the acquisition date for assets acquired in a business combination. In addition, SAB No. 112 amended SEC Codification of Staff Accounting Bulletins topic 2(A)(6), “Debt Issue Costs,” to conform to the requirement in FASB ASC 805-10-25-23 that acquisition-related costs be accounted for as expenses in the period in which the costs are incurred and services are received, except for costs incurred to issue debt or equity securities which are recognized in accordance with other applicable U.S. generally accepted accounting principles (GAAP). The full text of SAB No. 112 is located on the SEC website.
19.03 In certain circumstances, an acquired bank or savings institution uses the acquiring institution's basis of accounting in preparing the acquired institution's financial statements. GAAP provides that an acquired entity may elect to apply pushdown accounting in its separate financial statements upon a change-in-control event in which an acquirer obtains control of the acquired entity. FASB ASC 805-50 addresses the specific guidance on pushdown accounting for all entities.
19.04 As addressed in the entry business combinations in the “Glossary” section of the Federal Financial Institutions Examination Council’s Instructions for Preparation of Consolidated Reports of Condition and Income, the federal bank supervisory agencies note that the pushdown accounting election available under GAAP can be used to produce a particular result in the Consolidated Reports of Condition and Income (Call Report) that may not be reflective of the economic substance of the underlying business combination. Therefore, an institution’s primary federal regulator reserves the right to require or prohibit the institution’s use of pushdown accounting for Call Report purposes based on the regulator’s evaluation of whether the election best reflects the facts and circumstances of the business combination.
19.05 The Office of the Comptroller of the Currency’s (OCC’s) Bank Accounting Advisory Series (BAAS) is updated periodically to express the Office of the Chief Accountant’s current views on accounting topics of interest to national banks and federal savings associations. See further discussion of the BAAS in paragraph 7.82 of this guide. Topic 10, “Acquisitions, Corporate Reorganizations, and Consolidations,” of the BAAS includes interpretations and responses on (a) acquisitions, (b) intangible assets, (c) push-down accounting, (d) corporate reorganizations, and (e) related party transactions. Readers are encouraged to view this publication under the “Publications—Bank Management” page at www.occ.gov.
19.06 SEC Codification of Staff Accounting Bulletins topic 11(N), “Disclosures of The Impact of Assistance From Federal Financial Institution Regulatory Agencies,” discusses accounting for transfers of nonperforming assets by financial institutions and disclosure of the impact of financial assistance from regulators. SEC Codification of Staff Accounting Bulletins topic 11(N) states the SEC staff's belief that users of financial statements must be able to assess the impact of credit and other risks on a company following a regulatory assisted acquisition, transfer, or other reorganization on a basis comparable with that disclosed by other institutions, that is, as if the assistance did not exist. In that regard, the SEC staff believes that the amount of regulatory assistance should be separately disclosed and should be separately identified in the statistical information furnished pursuant to Industry Guide 3, Statistical Disclosures by Bank Holding Companies, to the extent that it affects such information. Further, the nature, extent, and impact of such assistance should be fully disclosed in management's discussion and analysis.
19.07 On June 7, 2010, the OCC, the Board of Governors of the Federal Reserve System (Federal Reserve), the FDIC, the National Credit Union Administration (NCUA), and the Office of Thrift Supervision (prior to its transfer of powers to the OCC, the Federal Reserve, and the FDIC)2 issued Interagency Supervisory Guidance on Bargain Purchases and FDIC- and NCUA-Assisted Acquisitions to address supervisory considerations related to bargain purchase gains and the impact such gains have on the application (licensing) approval process. This guidance also highlights the accounting and reporting requirements unique to business combinations resulting in bargain purchase gains and FDIC- and NCUA-assisted acquisitions of failed institutions. Although this guidance principally focuses on bargain purchase gains, it is also relevant to business combinations in general. Readers can access the full text of this guidance from the OCC, the Federal Reserve, the FDIC, or the NCUA websites.
19.08 Accounting for business combinations involving financial institutions is similar to that for entities in other industries. According to paragraphs 2–3 of FASB ASC 805-10-15, the guidance in FASB ASC 805 applies to all entities and to all transactions that meet the definition of a business combination. Certain specific qualifications and exceptions are listed in FASB ASC 805-10-15-4.
19.09 Per FASB ASC 805-10-25-1, an entity should determine whether a transaction or other event is a business combination which requires that the assets acquired and liabilities assumed constitute a business, and each business combination should be accounted for by applying the acquisition method. If the assets acquired are not a business, the reporting entity should account for the transaction or other event as an asset acquisition. An entity should account for each business combination by applying the acquisition method.
19.10 FASB ASC 805-10-05-4 explains that the acquisition method requires all of the following steps:
a. Identifying the acquirer (see FASB ASC 805-10)
b. Determining the acquisition date (see FASB ASC 805-10)
c. Recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree (see FASB ASC 805-20)
d. Recognizing and measuring goodwill or a gain from a bargain purchase (see FASB ASC 805-30)
19.11 Regarding paragraph 19.10a–b, paragraphs 4 and 6 of FASB ASC 805-10-25 state that for each business combination, one of the combining entities should be identified as the acquirer. The acquirer should identify the acquisition date, which is the date on which it obtains control of the acquiree.
19.12 Regarding paragraph 19.10c, recognition of identifiable assets acquired and liabilities assumed is subject to the conditions specified in paragraphs 2–3 of FASB ASC 805-20-25. However, an entity (the acquirer) within the scope of FASB ASC 805-20-15-2 may elect to apply the accounting alternative for the recognition of identifiable assets acquired in a business combination as described in paragraphs 29–32 of FASB ASC 805-20-25. Under the acquisition method, the acquirer should measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at their acquisition-date fair values, as explained in paragraphs 1–2 of FASB ASC 805-20-30, with exceptions to the measurement principle identified and their accounting treatment addressed in paragraphs 10–23 of FASB ASC 805-20-30.
Considerations for Private Companies that Elect to use Standards as Issued by the Private Company Council
FASB ASU No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination (a consensus of the Private Company Council), denotes that a private company that elects the accounting alternative to recognize or otherwise consider the fair value of intangible assets as a result of any in-scope transactions should no longer recognize separately from goodwill (1) customer-related intangible assets unless they are capable of being sold or licensed independently from the other assets of the business and (2) noncompetition agreements. An entity that elects the accounting alternative in FASB ASU No. 2014-18 must adopt the private company alternative to amortize goodwill as described in FASB ASU No. 2014-02, Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill. However, an entity that elects the accounting alternative in FASB ASU No. 2014-02 is not required to adopt the amendments in FASB ASU No. 2014-18. Readers of this guide are encouraged to consult the full text of FASB ASU No. 2014-18, available at www.fasb.org.
19.13 FASB ASC 805-20-30-4 states that the acquirer should not recognize a separate valuation allowance as of the acquisition date for assets acquired in a business combination that are measured at their acquisition-date fair values because the effects of uncertainty about future cash flows are included in the fair value measure. For example, because FASB ASC 805-20 requires the acquirer to measure acquired receivables, including loans, at their acquisition date fair values, the acquirer does not recognize a separate valuation allowance for the contractual cash flows that are deemed to be uncollectible at that date.
19.14 Regarding paragraph 19.10d and as stated in FASB ASC 805-30-30-1, the acquirer should recognize goodwill as of the acquisition date, measured as the excess of items (a) over (b):
a. The aggregate of the following:
i. The consideration transferred measured in accordance with FASB ASC 805-30-30, which generally requires acquisition-date fair value (see FASB ASC 805-30-30-7)
ii. The fair value of any noncontrolling interest in the acquiree
iii. In a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree
b. The net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with FASB ASC 805
19.15 FASB ASC 350, Intangibles—Goodwill and Other, provides guidance on financial accounting and reporting related to goodwill and other intangibles, other than the accounting at acquisition for goodwill and other intangibles acquired in a business combination. Acquisition guidance for intangible assets acquired in a business combination is provided in FASB ASC 805-20 and guidance on recognition and initial measurement of goodwill acquired in a business combination is provided in FASB ASC 805-30. See chapter 12, “Other Assets, Other Liabilities, and Other Investments,” of this guide for a discussion of the requirements of FASB ASC 350.
19.16 The consideration transferred in a business combination should be measured at fair value, which should be calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the equity interests issued by the acquirer, as stated in FASB ASC 805-30-30-7.
19.17 For certain assets and liabilities acquired, such as loans and deposits, for which there is not an active market, determining fair values usually involves estimating cash flows and discounting those cash flows at prevailing risk adjusted market rates of interest. However, other valuation techniques may be used to determine fair value as defined in FASB ASC 820, Fair Value Measurement. Core deposit intangibles represent a separate asset, and, therefore, transaction deposits are generally valued at their face amount plus any accrued interest.
Purchase of a Loan or Group of Loans
19.18 FASB ASC 310-20-30-5 explains that the initial investment in a loan or group of loans acquired in other than a business combination should include the amount paid to the seller plus any fees paid or less any fees received. FASB ASC 310-20-25-22 explains that the initial investment frequently differs from the related loan's principal amount at the date of purchase. This difference should be recognized as an adjustment of yield over the life of the loan, in accordance with FASB ASC 310-20-35-15 except for loans acquired with deteriorated credit quality, which are discussed in more detail beginning in paragraph 19.21.
19.19 FASB ASC 310-20-30-5 further explains that, in applying the provisions of FASB ASC 310-20 to loans purchased as a group, the purchaser may allocate the initial investment to the individual loans or may account for the initial investment in the aggregate. In accordance with FASB ASC 310-20-35-16, the cash flows provided by the underlying loan contracts should be used to apply the interest method, except as set forth in FASB ASC 310-20-35-26. If prepayments are not anticipated pursuant to that paragraph and prepayments occur or a portion of the purchased loans is sold, a proportionate amount of the related deferred fees and purchase premium or discount should be recognized in income so that the effective interest rate on the remaining portion of loans continues unchanged.
19.20 Loan receivables may be acquired with a fair value (if acquired through a business combination) or relative fair value (if acquired through an asset purchase) lower than the contractual amounts due (principal amount) that are not required to be accounted for in accordance with the guidance in FASB ASC 310-30, which is addressed in the subsequent paragraphs. The discount relating to such acquired loan receivables must be accounted for subsequently through accretion. In a letter to the SEC on December 18, 2009, the AICPA addressed accounting in subsequent periods for discount accretion associated with such loan receivables. The letter confirmed the understanding that the SEC Staff would not object to an accounting policy based on contractual cash flows or an accounting policy based on expected cash flows. Readers may access this letter on the AICPA website at aicpa.org.
Loans and Debt Securities Acquired With Deteriorated Credit Quality
19.21 FASB ASC 310-30 provides recognition, measurement, and disclosure guidance regarding loans acquired with evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. The application of FASB ASC 310-30 requires that each loan should be evaluated individually to determine whether the loan meets the scope criteria of FASB ASC 310-30-15-2. A loan may be acquired at a discount because of a change in credit quality or rate or both, according to FASB ASC 310-30-30-2. When a loan is acquired at a discount that relates, at least in part, to the loan's credit quality, the effective interest rate is the discount rate that equates the present value of the investor's estimate of the loan's future cash flows to the purchase price of the loan. There is further discussion on accounting for loans and debt securities acquired with deteriorated credit quality in chapter 8, “Loans,” of this guide beginning with paragraph 8.110.
Special Considerations in Applying the Acquisition Method to Combinations of Mutual Entities
19.22 Although similar in many ways to other businesses, mutual entities have distinct characteristics that arise primarily because their members are both customers and owners, according to FASB ASC 805-30-55-4. Members of mutual entities generally expect to receive benefits for their membership, often in the form of reduced fees charged for goods and services or patronage dividends. The portion of patronage dividends allocated to each member is often based on the amount of business the member did with the mutual entity during the year.
19.23 As stated in FASB ASC 805-30-55-3, when two mutual entities combine, the fair value of the equity or member interests in the acquiree (or the fair value of the acquiree) may be more reliably measurable than the fair value of the member interests transferred by the acquirer. In that situation, paragraphs 2–3 of FASB ASC 805-30-30 require the acquirer to determine the amount of goodwill by using the acquisition-date fair value of the acquiree’s equity interests instead of the acquisition-date fair value of the acquirer’s equity interests transferred as consideration.
19.24 FASB ASC 805-30-55-5 states that a fair value measurement of a mutual entity should include the assumptions that market participants would make about future member benefits as well as any other relevant assumptions market participants would make about the mutual entity. For example, an estimated cash flow model may be used to determine the fair value of a mutual entity. The cash flows used as inputs to the model should be based on the expected cash flows of the mutual entity, which are likely to reflect reductions for member benefits, such as reduced fees charged for goods and services.
19.25 The acquirer in a combination of mutual entities should recognize the acquiree’s net assets as a direct addition to capital or equity in its statement of financial position, not as an addition to retained earnings, which is consistent with the way in which other types of entities apply the acquisition method.
Impairment and Disposal Accounting for Certain Acquired Long Term Customer Relationship Intangible Assets
19.26 The impairment and disposal provisions of FASB ASC 360-10 apply to long term customer relationship intangible assets, except for servicing assets, recognized in the acquisition of a financial institution. Examples of long term customer relationship intangible assets may include depositor and borrower relationship intangible assets, and credit cardholder intangible assets.3 See chapter 11, “Real Estate Investments, Real Estate Owned, and Other Foreclosed Assets,” of this guide for impairment guidance on intangibles addressed in FASB ASC 360-10.
19.27 Servicing assets are tested for impairment under paragraphs 9–14 of FASB ASC 860-50-35 (unless held at fair value in accordance with FASB ASC 860-50-35-1b). See chapter 10, “Transfers and Servicing and Variable Interest Entities,” of this guide for further discussion over servicing assets and the related requirements set forth in FASB ASC 860, Transfers and Servicing.
19.28 Depository institutions may acquire branch office locations. Such transactions typically involve the assumption of deposit liabilities by the acquiring institution in exchange for the receipt of a lesser amount of cash, or other assets, such as loans.
19.29 In accordance with FASB ASC 805, an entity should determine whether a transaction or other event is a business combination by applying the definition of a business combination. If the assets acquired are not a business, the reporting entity should account for the transaction or the other event as an asset acquisition, as stated in FASB ASC 805-10-25-1. As discussed in FASB ASC 350-30-25-2 and consistent with FASB ASC 805-50-30-3, the cost of a group of assets acquired in a transaction other than a business combination should be allocated to the individual assets acquired based on their relative fair values and should not give rise to goodwill.
19.30 The “Acquisition of Assets Rather than a Business” subsections of FASB ASC 805-50 address a transaction in which the assets acquired and liabilities assumed do not constitute a business, such a transaction is accounted for as an asset acquisition.
19.31 Business combinations may take many forms and generally involve complex transactions that have a pervasive effect on the financial statements impacting numerous financial statement line items and assertions. The primary objective of audit procedures for business combinations is to obtain reasonable assurance that the transaction is properly recorded in accordance with GAAP. Supervisory management personnel need to review and adequately support accounting entries made to record the transaction initially including the recognition and measurement of the assets and liabilities of the acquired entity and those required in subsequent years. Supervisory management personnel also need to evaluate the disclosures made with respect to the business combinations. Moreover, subsequent to the acquisition date management should review assumptions used in assigning values to assets and liabilities for continuing validity.
19.32 AU-C section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement,5 addresses the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements through understanding the entity and its environment, including the entity’s internal control. Paragraphs .13–.14 of AU-C section 315 state that the auditor should obtain an understanding of internal control relevant to the audit and, in doing so, should evaluate the design of those controls and determine whether they have been implemented by performing procedures in addition to inquiry of the entity’s personnel. See chapter 5, “Audit Considerations and Certain Financial Reporting Matters,” of this guide for further discussion of the components of internal control. To provide a basis for designing and performing further audit procedures, paragraph .26 of AU-C section 315 states that the auditor should identify and assess the risks of material misstatement at the financial statement level and the relevant assertion level for classes of transactions, account balances, and disclosures.
19.33 Paragraph .06 of AU-C section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained, states that the auditor should design and perform further audit procedures whose nature, timing, and extent are based on, and responsive to, the assessed risks of material misstatement at the relevant assertion level. Irrespective of the assessed risks of material misstatement, paragraph .18 of AU-C section 330 states that the auditor should design and perform substantive procedures for all relevant assertions related to each material class of transactions, account balance, and disclosure. Paragraph .A45 of AU-C section 330 further states that this requirement reflects the facts that (a) the auditor’s assessment of risk is judgmental and may not be sufficiently precise to identify all risks of material misstatement, and (b) inherent limitations to internal control exist, including management override.
19.34 AU-C section 501, Audit Evidence—Specific Considerations for Selected Items, addresses specific considerations by the auditor in obtaining sufficient appropriate audit evidence, in accordance with AU-C section 330; AU-C section 500, Audit Evidence; and other relevant AU-C sections, regarding certain aspects of (a) investments in securities and derivative instruments; (b) inventory; (c) litigation, claims, and assessments involving the entity; and (d) segment information in an audit of financial statements. In addition, AU-C section 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, addresses the auditor’s responsibilities relating to accounting estimates, including fair value accounting estimates and related disclosures, in an audit of financial statements.6 Specifically, it expands on how AU-C section 315, AU-C section 330, and other relevant AU-C sections are to be applied with regard to accounting estimates. It also includes requirements and guidance related to misstatements of individual accounting estimates and indicators of possible management bias. The companion AICPA Audit Guide Special Considerations in Auditing Financial Instruments provides background information about financial instruments and discussion of audit considerations relating to financial instruments.
19.35 Many fair values assigned to an acquired depository institution’s assets and liabilities will be based on valuations by independent third-party appraisals. In applying audit procedures over these fair values, the auditor often relies on representations of independent experts. AU-C section 500 addresses the auditor’s use of the work of an individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements (defined in the auditing standards as a management’s specialist). AU-C section 620, Using the Work of an Auditor’s Specialist, addresses the auditor’s responsibilities relating to the work of an individual or organization possessing expertise in a field other than accounting or auditing when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence (defined in the auditing standards as an auditor’s specialist). See paragraph .A1 of AU-C section 620 for further examples of expertise in a field other than accounting or auditing.
19.36 Using the work of a management’s specialist. If information to be used as audit evidence has been prepared using the work of a management’s specialist, paragraph .08 of AU-C section 500 states that the auditor should, to the extent necessary, taking into account the significance of that specialist’s work for the auditor’s purposes,
a. evaluate the competence, capabilities, and objectivity of that specialist;
b. obtain an understanding of the work of that specialist; and
c. evaluate the appropriateness of that specialist’s work as audit evidence for the relevant assertion.
19.37 Information regarding the competence, capabilities, and objectivity of a management’s specialist may come from a variety of sources, such as knowledge of that specialist’s qualifications, membership in a professional body or industry association, license to practice, or other forms of external recognition (a listing of additional sources is addressed in paragraph .A39 of AU-C section 500). Further application and explanatory material regarding the reliability of information produced by a management’s specialist is addressed in paragraphs .A35–.A49 of AU-C section 500.
19.38 Using the work of an auditor’s specialist. In accordance with paragraph .09 of AU-C section 620, the auditor should evaluate whether the auditor’s specialist has the necessary competence, capabilities, and objectivity for the auditor’s purposes. In the case of an auditor’s external specialist, the evaluation of objectivity should include inquiry regarding interests and relationships that may create a threat to the objectivity of the auditor’s specialist.
19.39 Paragraphs .12–.13 of AU-C section 620 state that the auditor should evaluate the adequacy of the work of the auditor’s specialist for the auditor’s purposes, including
a. the relevance and reasonableness of the findings and conclusions of the auditor’s specialist and their consistency with other audit evidence.
b. if the work of the auditor’s specialist involves the use of significant assumptions and methods,7
i. obtaining an understanding of those assumptions and methods and
ii. evaluating the relevance and reasonableness of those assumptions and methods in the circumstances, giving consideration to the rationale and support provided by the specialist, and in relation to the auditor’s other findings and conclusions.
c. if the work of the auditor’s specialist involves the use of source data that is significant to the work of the auditor’s specialist, the relevance, completeness, and accuracy of that source data.
19.40 If the auditor determines that the work of the auditor’s specialist is not adequate for the auditor’s purposes, the auditor should
a. agree with the auditor’s specialist on the nature and extent of further work to be performed by the auditor’s specialist or
b. perform additional audit procedures appropriate to the circumstances.
19.41 The audit objectives and procedures applied to an acquisition of assets and assumption of liabilities (for example a branch acquisition) will generally be substantially the same as the objectives and procedures applied to a business combination, as described more fully in the preceding paragraphs.