Mergers And Acquisitions, Vol 10 Pdf

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Information key to divestiture transactions

Information key to divestiture transactions

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  • 1. September 2010 Mergers & Acquisitions —A snapshot Change the way you think about tomorrow’s deals* Stay ahead of the new accounting and reporting standards for M&A Summary Carve-out Financial Statements: A  Purpose of Carve-out challenging process Financial Statements In many M&A transactions, companies looking to dispose of non-core  Treatment of Certain businesses or to generate cash may sell only a portion of their operations Assets, Liabilities & (e.g., a subsidiary or a business unit). As part of these transactions, a seller Expenses may need, or want, to prepare separate financial statements of the operations  Non-financial Asset being sold, commonly referred to as carve-out financial statements. Impairments The preparation of these financial statements can be challenging as there is  Other Reporting limited guidance covering their composition. This volume of Mergers & Considerations Acquisitions - A snapshot, focuses on some of the issues companies may face  Conclusion when preparing carve-out financial statements, how those statements may differ from their own financial statements, and how the M&A Standards 1 may impact the accounting for transactions that are reported in the carve-out financial statements. 1 Accounting Standards Codification Topic 805, Business Combinations, is the US Standard on M&A, and Accounting Standards Codification Topic 810, Consolidation, is the US Standard on consolidations (collectively the "M&A Standards"). *connectedthinking 
  • 2. Purpose of Carve-out Financial Statements Tangible and Intangible Assets Carve-out financial statements refer to the separate Carve-out Entity financial statements of a business that are derived or "carved-out" from the financial statements of a larger Depending on the circumstances, assets may be attributed entity. The purpose of the carve-out financial statements is to the carve-out entity based on legal ownership, usage, or to reflect the historical operations of the carve-out entity on through an intercompany sharing arrangement, such as an a stand-alone basis. The separate financial statements operating or lease agreement. It is not always easy to may be used to comply with a buyer's requirement for determine which assets should be included in the carve- audited financial statements of an acquired business, out financial statements. This could be the case when appear in an initial public offering of securities, or serve as numerous divisions within a consolidated entity share the the basis for final purchase price discussions in an M&A use of an asset. transaction. Applying the Guidance - Shared Intangible Assets Oftentimes, separate financial statements have never Facts: The carve-out entity and several other business been prepared for the results of a company's operations units utilized the selling company's brand name. The below the consolidated level, and those operations may brand name is legally owned by the selling company and not be fully burdened with the total cost of doing business. will not be sold to the buyer. Thus, preparing carve-out financial statements for the first time can be challenging. Adding to the challenges is the Analysis: It would not be appropriate to reflect a portion of fact that no accounting definition of a carve-out transaction the historical cost of the brand name as an asset on the exists, and there is limited accounting guidance related to carve-out entity's balance sheet since the brand will not be the preparation of carve-out financial statements. Further, sold to the buyer. The carve-out income statement should judgments may need to be made in many areas, including reflect an expense representative of the cost to use the impairment and valuation allowance assessments, and brand name, such as a hypothetical royalty that might be those judgments may differ from the judgments made in charged by the owner of the brand. On the other hand, if preparing the seller's financial statements. Any judgments the buyer were to acquire the brand name along with the and assessments that are needed will likely be needed for carve-out entity, it would generally be appropriate to all relevant periods presented. Moreover, the seller's include a brand name asset on the balance sheet of the financial statements and the carve-out financial statements carve-out entity. The income statement would then reflect may treat the same item differently. As a result, the the full cost of the amortization of the brand name, offset preparation of carve-out financial statements requires in part by intercompany credits reflecting any use of the special attention to ensure that all of the assets and brand name by the other business units. liabilities of the separate business have been properly identified, and that all relevant costs of doing business have been reflected in the carve-out financial statements. Selling Company Treatment of Certain Assets, Liabilities and Expenses The tangible and intangible assets included in the carve- out financial statements should be assessed by the selling The assets and liabilities that are assigned to the carve-out company for appropriate presentation. Most likely, these entity will reflect, for the most part, the same basis of assets will be reflected as assets held for sale in the accounting as that used by the selling company. This is the selling company's financial statements once the held-for- case even though an entity that acquires the carve-out sale criteria are met. At that time, depreciation or entity will record its assets and liabilities at fair value in amortization would cease in the seller's financial accordance with acquisition accounting requirements. Thus, statements, even though the assets would continue to be while the purpose of carve-out financial statements is to used and depreciated or amortized by the carve-out entity. reflect the historical operations of the carve-out entity, acquisition accounting reflects the investment made by the Debt acquiring entity. Carve-out Entity However, determining which asset, liability, or expense items should be included in the carve-out financial statements may be challenging. Some of the more Determining if debt arrangements should be reflected in challenging items are discussed below in the context of both the carve-out financial statements requires careful the carve-out entity and the selling company, as applicable. consideration. Third-party debt issued directly by the 2 Mergers & Acquisitions—A snapshot
  • 3. carve-out entity would be included in the carve-out curtailment accounting for the pension plan is required. financial statements. In addition, if the proceeds from the Such accounting could result in a charge/credit to the selling sale of the carve-out entity will be used to retire debt company's income statement, which would not be reflected issued by the selling company or the carve-out entity by the carve-out entity. In addition, if the carve-out entity's guarantees or pledges its assets as collateral, the debt operations were significant, a seller may decide to terminate and an allocation of interest expense may also need to be the pension plan. In this case, the seller's financial included in the carve-out financial statements. There may statements would reflect accounting for the termination of its be other arrangements in which the debt may need to be pension plan. reflected in the carve-out financial statements. In making these determinations, consideration should be given to the Income Taxes presentation that is most meaningful to users of the carve- out financial statements. Carve-out Entity Selling Company Income tax accounting is usually not straight forward, and the accounting for income taxes in carve-out financial The selling company will need to consider the appropriate statements is no exception. Generally, a carve-out entity presentation and disclosure of the debt in its financial must prepare a tax provision as if it was a separate stand- statements. For example, third-party debt issued directly alone entity. Appropriate consideration at the carve-out by the carve-out entity and that will be assumed by the entity level must be given to tax attributes such as tax- buyer would be reflected as part of the assets and sharing agreements, net operating losses and tax credits, liabilities held for sale by the selling company. However, uncertain tax positions, deferred tax asset valuation debt that is reflected in the carve-out financial statements allowances, and assertions that cash will be held and used because the proceeds of a debt or equity offering of the outside of the US. carve-out entity will be used to retire debt issued by the selling company may need to be reflected as a liability by For example, historically a consolidated entity may not the selling company. have recorded a valuation allowance as future projections of consolidated income or tax planning strategies allowed Pension (and other benefit arrangements) for realization of deferred tax assets. However, an assessment of operations at the carve-out entity level Carve-out Entity could result in the need for a valuation allowance in the carve-out financial statements. These assessments should On first glance, the assignment of pension balances and reflect the facts and circumstances as they existed at allocation of pension expense to the carve-out entity may historical dates and should not incorporate the benefits of seem straight forward - a liability for accrued contributions hindsight. or an asset for prepaid contributions, and a reasonable allocation of pension expense for each year presented. Selling Company However, depending on either the agreement in place between the seller and buyer, or statutory requirements, a A sale of the carve-out entity will affect the selling selling company may legally transfer a portion of its company's income taxes. A gain or loss recognized on the pension plan to the carve-out entity. In this scenario, a net sale of the carve-out entity will have direct tax effects. pension liability or asset taking into account the projected Appropriate consideration must also be given to other tax benefit obligation and plan assets for the transferred effects of the sale. For example, profit from the carve-out portion of the plan, not just accrued or prepaid entity may have supported the future use of the selling contributions, may need to be reflected in the carve-out company's net operating loss. No longer benefiting from financial statements. This may require a separate actuarial the carve-out entity profit may require the selling company valuation for the projected benefit obligation related to the to record an adjustment to its income tax valuation carve-out entity's employees and consideration of allowances. underlying assumptions. The asset transfer may also require approval by the regulator of the pension plan. Expenses Selling Company Carve-out Entity Pension items may also impact the seller's financial Similar to income tax accounting, expense allocation in statements. In situations where employees of the carve-out carve-out financial statements may not be straight forward. entity will no longer accrue benefits under the seller's Determining which expenses should be included in the pension plan, the seller would need to determine if carve-out entity financial statements and the appropriate Change the way you think about tomorrow's deals 3
  • 4. methodologies to allocate those expenses are critical and The reporting unit or asset group level at which impairment can be challenging. testing is performed is determined based on the structure and management of the carve-out entity's operations. Some companies may perform cost allocations as part of their internal management reporting. For example, the Goodwill selling company may have charged the carve-out entity a management fee for general management services (e.g., Carve-out Entity executive salaries or administrative processing, such as accounting and payroll). If the carve-out business was acquired by the selling company, goodwill is generally included in the financial When preparing the carve-out financial statements, it is statements of the carve-out entity. important to understand the components and methodology used in determining and allocating the management fee to The amount of goodwill included is the total amount of assess whether the costs reflect a reasonable allocation to goodwill recorded by the selling company related to the the carve-out financial statements. Some expenses carve-out entity when it was acquired. This amount of included within the management fee would generally be goodwill and level at which goodwill is tested by the carve- allocated to the carve-out entity based on time spent while out entity may differ from that of the selling company. others may be allocated based on sales levels, profitability, headcount, or other appropriate metrics. The Applying the Guidance - Goodwill Impairment carve-out entity will need to determine which expenses Facts: Company X has one reporting unit (level of included in the management fee should be included in its goodwill impairment testing) that consists of two financial statements and if the allocation methodology businesses (Business A and Business B). Company X utilized was appropriate. plans to sell Business A and to prepare carve-out financial statements for Business A. Other companies that do not perform cost allocations as part of their internal management reporting would typically Business A had been previously acquired by Company X need to assess the range of costs and services provided which resulted in the recognition of $100 of goodwill. by the selling company to the carve-out entity to identify a Business B was not acquired and no goodwill directly reasonable allocation of such costs in the carve-out related to Business B has been recorded by Company X. financial statements. Analysis: In Business A's carve-out financial statements, Selling Company $100 of goodwill would be assigned to Business A. This equals the total goodwill that relates to the acquisition of Expense allocation in the carve-out financial statements Business A by Company X. may not always follow how those same expenses are reflected in the selling company's financial statements. For example, a portion of the CEO's salary may be allocated to The carve-out entity will need to determine its reporting the carve-out entity in the carve-out financial statements. units to test goodwill included in the carve-out financial However, if the selling company reflects the carve-out entity statements for impairment at least annually. For example, as a discontinued operation, general corporate overhead, if the carve-out entity was an equipment rental company which includes the CEO's salary, is not reported as part of that is managed as two lines of business (in-store and discontinued operations in the selling company's financial online), this could result in two reporting units at the carve- statements. out entity level. Whereas, the selling company may manage the business as one operation, equipment rental, Non-financial Asset Impairments and determine that there is only one reporting unit. While from an overall perspective, the equipment rental Reflecting non-financial asset impairments in the carve-out operations may have supported the combined goodwill financial statements is not as simple as merely allocating balance, slumping operations in either the in-store or to the carve-out entity a portion of any impairment charge online operations may not support goodwill in the separate that may have been taken at the selling company level. reporting units from the carve-out entity's perspective. To appropriately reflect impairments in the carve-out entity's financial statements, long-lived asset impairments Selling Company must be evaluated based on the actual assets assigned to the carve-out entity. This includes goodwill (if the carve-out A portion of the goodwill of the reporting unit that included entity had been previously acquired by the seller), the carve-out entity (assuming it is a business) is included indefinite-lived intangibles, and other long-lived assets. in the calculation of any gain or loss on the sale of the 4 Mergers & Acquisitions—A snapshot
  • 5. carve-out entity in the selling company's financial Other Reporting Considerations statements. However, the amount of goodwill included in the gain or loss calculation may not be the same amount In a typical carve-out transaction, most reporting items of goodwill that was assigned to the carve-out entity in the carryover from the selling company. However, when the carve-out financial statements. This is because the carve-out entity will be involved in an initial public offering goodwill balance used by the selling company in (IPO), the carve-out entity will have a number of reporting determining any gain or loss on the sale of the carve-out decisions to make, including determination of its year-end entity is based on the relative fair value of the carve-out reporting date and selection of its accounting principles. In entity to the remaining businesses in the selling company's addition, the selling company must also consider the impact reporting unit. that the carve-out transaction may have on its reporting requirements. Applying the Guidance - Goodwill Impairment Facts: Same facts as above. Additionally, Business A has Gain or Loss a fair value of $1,000 and Business B has a fair value of $3,000. Carve-out Entity Analysis: In determining Company X's gain or loss on the sale of Business A, Company X would allocate the $100 of The carve-out entity will not report a gain or loss on its sale. goodwill between Business A and Business B based on This gain or loss is reflected in the selling company's financial statements. their relative fair values. Company X would allocate 25% ($1,000/$4,000), or $25, to Business A in calculating its Selling Company gain or loss on the sale of Business A. The M&A Standards require deconsolidation and a gain or loss to be recognized when an entity loses control of a business. In determining the amount of gain or loss to be Long-lived Assets Other than Goodwill recognized on the sale of the carve-out entity, taxes, the allocation of goodwill, amounts included in other Carve-out Entity comprehensive income, and continuing relationships need to be considered. Examples of continuing relationships Similar to determining its reporting units for goodwill include guarantees on contracts or lines of credit of the impairment testing, the carve-out entity will need to carve-out entity, or long-term contracts between the seller determine its asset groups for impairment testing of its other and the carve-out entity that will survive the sale. Any long-lived assets. The carve-out entity will need to proceeds that represent consideration for such separately assess if any events have occurred to its stand arrangements must be separately accounted for. As a alone operations that would trigger the need to perform a result, the net assets included in the calculation of the gain long-lived asset impairment test for each period covered by or loss by the seller may differ from the net asset balances included in the carve-out financial statements. the carve-out financial statements. Again, this assessment would be made without the benefit of hindsight. Materiality Selling Company Carve-out Entity Consideration of long-lived asset impairment is also important for the selling company. Similar to determining The carve-out entity will need to assess materiality for its reporting units for goodwill impairment testing, a selling separate financial statements. Consideration should be given to immaterial misstatements at the selling company company's asset groups may differ from the asset groups level that may be material to the carve-out entity, as well as of the carve-out entity. In addition, because the carve-out any misstatements noted at the carve-out entity level. entity's operations will be held by the selling company for only a short period of time prior to sale, the selling Selling Company company may need to recognize a long-lived asset impairment charge. This could be the case even if an Any misstatements found at the carve-out entity level also impairment charge is not recognized by the carve-out need to be assessed for materiality in the selling company entity in the carve-out financial statements. financial statements. Change the way you think about tomorrow's deals 5
  • 6. Cash flows those disclosed at a consolidated level in the selling company's financial statements. Carve-out Entity A carve-out entity that is undertaking an IPO and will be The presentation of the carve-out entity's statement of cash publicly traded will need to consider the disclosure of flows can be challenging. For example, intercompany historical earnings per share for all income statement transactions that would not have been reflected in the periods presented. consolidated statement of cash flows at the selling company level will need to be reflected in the cash flow statement at Additionally, in certain situations, the SEC requires that the carve-out financial statements include operations that will the carve-out entity level. These intercompany transactions not become part of the carve-out entity going forward, but need to be carefully scrutinized for proper classification. which will remain with the selling company. When these requirements are met, the carve-out financial statements Selling Company would generally reflect the operations that will remain with the selling company as discontinued operations. The selling company will also need to consider the cash flows of the carve-out entity. For example, if the carve-out Selling Company entity qualifies as a discontinued operation, the selling entity will need to consider how to reflect those cash flows in its A seller that is a public company must also change its cash flow statement. accounting principle, and obtain and file a preferability letter related to the change, if there is a change in accounting Disclosures principle at the carve-out entity level and the seller will continue to reflect the carve-out entity in consolidation or on Carve-out Entity the equity method after the sale. In addition to the required financial statement disclosures, Conclusion the carve-out financial statements should include comprehensive disclosure of the basis of presentation, As you can see, the preparation of carve-out financial accounting policies unique in attributing or allocating statements is far from straight-forward. We have balances (e.g., income taxes or pensions), expense discussed only some of the challenges that may arise in allocation methodologies and related party transactions. understanding differences between carve-out and selling company financial statements. Companies preparing Selling Company carve-out financial statements may find that a significant investment in time and resources will be necessary to Disclosure considerations for subsequent events or any meet these challenges. With the limited specific guidance continuing relationship with the carve-out entity should be covering carve-out financial statements, being aware of assessed for inclusion in the selling company's financial current practice will help you navigate through the statements. process. SEC considerations Carve-out Entity If there is a change in accounting principle at the carve-out entity level from what it was at the selling company level, the carve-out entity should disclose the nature of the change in accounting principle and justification for it in the carve-out financial statements. The carve-out entity should clearly explain why the newly adopted accounting principle is preferable. The carve-out entity will also need to include required segment disclosures in its financial statements. Most likely, the segments of the carve-out entity will differ from 6 Mergers & Acquisitions—A snapshot
  • 7. PwC has developed the following publications related to PwC clients who would like to obtain any of these business combinations and noncontrolling interests, publications should contact their engagement partner. covering topics relevant to a broad range of constituents. Prospective clients and friends should contact the managing partner of the PwC office nearest you, which can be found at  10 Minutes on Mergers and Acquisitions—for chief www.pwc.com. For more information on this publication executive officers and board members please contact one of the following individuals:  What You Need to Know about the New Accounting Martyn Curragh Standards Affecting M&A Deals—for senior executives U.S. Transaction Services Leader and deal makers (646) 471-2622 martyn.curragh@us.pwc.com  Mergers & Acquisitions—A snapshot—a series of publications for senior executives and deal makers on emerging M&A financial reporting issues Lawrence N. Dodyk U.S. Business Combinations Leader  Business Combinations and Consolidations…the new (973) 236-7213 accounting standards—an executive brochure on the lawrence.dodyk@us.pwc.com new accounting standards John R. Formica Jr.  A Global Guide to Accounting for Business National Professional Services Group Partner Combinations and Noncontrolling Interests: Application (973) 236-4152 of U.S. GAAP and IFRS Standards—for accounting john.r.formica@us.pwc.com professionals and deal makers Donna L. Coallier  DataLine 2008–01: FAS 141(R), Business Transaction Services Partner Combinations—for accounting professionals and deal (646) 471-8760 makers donna.coallier@us.pwc.com  DataLine 2008–02: FAS 160, Noncontrolling Interests Dimitri B. Drone in Consolidated Financial Statements—for accounting Transaction Services Valuation Partner professionals and deal makers (646) 471-3859 dimitri.b.drone@us.pwc.com  DataLine 2008–30: Key Considerations for Implementing FAS 141(R) and FAS 160—for accounting Jay B. Seliber professionals and deal makers Business Combinations Implementation Leader  DataLine 2008–35: Nonfinancial Asset Impairment (408) 817-5938 Considerations—for accounting professionals and deal jay.seliber@us.pwc.com makers  DataLine 2009–16: New Guidance for Acquired Contingencies —for accounting professionals and deal makers  DataLine 2009–34: Accounting for Contingent Consideration Issued in a Business Combination —for accounting professionals and deal makers 6 Mergers & Acquisitions—A snapshot
  • 8. pwc.com © 2010 PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. *connected thinking is a trademark of PricewaterhouseCoopers LLP (US). The information contained in this document is provided ‘as is’, for general guidance on matters of interest only. PricewaterhouseCoopers is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. Before making any decision or taking any action, you should consult a competent professional adviser. NY-09-0287-A