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Business Combination vs. Asset Acquisition : How to define a business - YouTube
Channel: Accounting Academy
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hi and welcome to accounting academy聽
i'm Fitz and this is my dog FiFo聽聽
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we love to help people learn more about聽
accounting so join us on our adventures聽聽
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as we dive into accounting topics. On today's聽
adventure we are going to be helping our friend聽聽
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Laine. She's considering buying into a new line聽
of business. She has some questions about how聽聽
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to determine if this is an asset acquisition or聽
a business combination; and what is a business.聽聽
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Hey Laine. Hey Fitz hey FIFO. We heard you're聽
expanding your business. That's right we're聽聽
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expanding from just callers into leashes as well.聽
We're acquiring a small leash manufacturer. While聽聽
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they're a business that doesn't really feel聽
like we're buying a full business since what聽聽
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I really want is their lease making machinery.聽
Okay so how can we help. There's a lot of new聽聽
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guidance and I'm having trouble determining聽
if this would be an asset acquisition or a聽聽
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business combination. It would also be helpful聽
just to refresh me on the accounting for both.聽聽
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Sure well let's start with the basics and then聽
we can run through your scenario. So to start I'd聽聽
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like to note that the guidance has been updated as聽
of January 2017 when the FASB issued ASU 2017-01聽聽
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titled 'clarifying the definition of a business.'聽
The easiest way to think of this is that if you聽聽
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meet the definition of a business then it's聽
probably a business combination. And if it聽聽
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doesn't then it would be an asset acquisition.聽
Yeah that's mostly true. A lot of times it will聽聽
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be fairly obvious. Such as buying a machine to聽
produce leashes is probably an asset acquisition,聽聽
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but if you're buying a well-developed聽
business who already makes leases聽聽
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it's probably a business combination. Okay but聽
should I go through the guidance to make sure it's聽聽
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not a business. Yeah it's good to go through聽
the guidance at ASC 805 10 55 5a through 5c.聽聽
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This guidance gives certain screeners for when聽
a purchase might not be a business combination.聽聽
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But let's go through the basics of how the聽
guidance defines a business first. Okay I think I聽聽
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remember there are three items. Inputs, a process,聽
and outputs, right? Yep those are the three,聽聽
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but I will note that the new guidance does state聽
that the outputs are not necessarily required聽聽
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to be considered a business. For example an聽
early stage company with no revenue. Could聽聽
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we go through what each of those really are. Sure聽
let's start with the inputs. The guidance defines聽聽
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inputs as any economic resource that creates, or聽
has the ability to contribute to the creation of,聽聽
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outputs. When one or more processes are applied to聽
it. So in my situation this would be the machinery聽聽
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that I'm purchasing. Yeah that would qualify.聽
Okay so the next is a process. This is defined聽聽
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as any system, standard, protocol, convention, or聽
rule that would be applied to an input, or inputs,聽聽
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that creates an output. Okay so in this case the聽
process would be the company that we are acquiring聽聽
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business process they have steps to convert聽
inventory through the manufacturing process聽聽
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to create leashes. Yep. Okay and the outputs are聽
the final leash in this case. Yeah that's correct.聽聽
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Okay and how does the accounting differ for both聽
an asset acquisition and a business combination.聽聽
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So if it's an asset acquisition the purchase聽
price, or cost, would be allocated across the聽聽
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assets paid for, based on their respective聽
fair value. If it's a business combination聽聽
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all assets and liabilities acquired would be聽
fair valued and recorded at their new valuation.聽聽
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This could result in goodwill being聽
recognized or even a bargain purchase gain.聽聽
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Oh that sounds complicated. Yes it can be. I would聽
recommend the expertise of a fair valuation expert聽聽
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to assist. Okay well thanks Fitz. I think in my聽
situation it feels like I'm acquiring a business.聽聽
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I'm acquiring inventory and cash with the purchase聽
of a large machine. Yeah it definitely has inputs,聽聽
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i.e the machine and inventory, processes i.e聽
the manufacturing process already set up,聽聽
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and outputs, the leashes. Yeah it does feel a聽
little odd still, because most of the value is聽聽
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just that one machine. Well there is one聽
bit of other guidance that may be useful.聽聽
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This is substantially all screener that is part of聽
805 10-55-5a. This guidance basically says that,聽聽
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excluding cash, if substantially all assets聽
fair value is within one asset then it does聽聽
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not meet the definition of a business. Okay but聽
what is the threshold for substantially all?聽聽
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Good question this is a bit of a gray area. Some聽
firms have said 90% constitutes substantially all,聽聽
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but judgment will need to be applied. Oh聽
then I think I qualify for this exception,聽聽
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and we would be an asset acquisition. Great.聽
Okay but can we quickly go through my entries.聽聽
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Sure what are the details of your deal. So we聽
purchased everything for $100,000. The machinery聽聽
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is on his books for $70,000 but it's worth more聽
than $95,000. We're also getting $1,000 in cash聽聽
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and $9,000 of inventory. Okay well cash and聽
inventory cannot be booked at an allocation costs聽聽
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exceeding fair value, because they are financial聽
assets. So those will come on the books at $1,000聽聽
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and $9,000 respectively. Okay but what about the聽
machine. Well in this case you will allocate the聽聽
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remainder of the cost to this single asset. So聽
$90,000? Yep. Easy enough. Yeah not too hard聽聽
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of an example. Thank you so much Fitz I really聽
appreciate you walking me through all the basics,聽聽
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and of course you too FIFO. Alright folks聽
thanks so much for watching. Please like,聽聽
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share, comment, and subscribe. And if聽
you can donate a patreon. Anything you聽聽
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can give helps to keep the lights on, and聽
ensures we can continue to create content.聽聽
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And of course helps feed FIFO. If you want to聽
contact us about anything you saw in this video聽聽
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accounting advice or ideas for future videos聽
contact us at patreon.com accounting academy.聽聽
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this video is designed to be illustrated and is聽
not represented in official positions we make聽聽
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no representations warranties or guarantees and聽
assume no responsibility for the application of聽聽
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this material please seek advice from a competent聽
professional expert assistant is required
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