Yesterday, we wrote about the FAR (Federal Acquisition Regulation) prohibition against expensing goodwill against Government contracts (see FAR 31.205-49). Today we address a related matter - how to value assets resulting from business combinations. Or rather, how to value assets for Government cost accounting purposes, which may or may not be the same as for financial reporting purposes. As you recall, under the purchasing method of accounting for business combinations, assets of the acquired company are recorded at their fair value by the acquiring company. Usually, but not always, this results in a write-up of assets. Assets may have been fully depreciated but there is still economic life to those assets. Land, which is not depreciated, is carried on the books at its acquisition cost when typically, the value increases with time.
FAR 31.205-52 addresses asset valuation from business combinations. FAR distinguishes between tangible and intangible assets and states:
- (a) For tangible capital assets, when the purchase method of accounting for a business combination is used, whether or not the contract or subcontract is subject to CAS, the allowable depreciation and cost of money shall be based on the capitalized asset values measured and assigned in accordance with CAS 404, if allocable, reasonable, and not otherwise unallowable.
- (b) For intangible capital assets, when the purchase method of accounting for a business combination is used, allowable amortization and cost of money shall be limited to the total of the amounts that would have been allowed had the combination not taken place.
To figure out what the foregoing really means, one must refer to CAS 404.50(d). CAS 404 states, concerning capitalized values of tangible capital assets acquired in a business combination:
- (1) All the tangible capital assets of the acquired company that during the most recent cost accounting period prior to a business combination generated either depreciation expense or cost of money charges that were allocated to Federal government contracts or subcontracts negotiated on the basis of cost, shall be capitalized by the buyer at the net book value(s) of the asset(s) as reported by the seller at the time of the transaction.
- (2) All the tangible capital asset(s) of the acquired company that during the most recent cost accounting period prior to a business combination did not generate either depreciation expense or cost of money charges that were allocated to Federal government contracts or subcontracts negotiated on the basis of cost, shall be assigned a portion of the cost of the acquired company not to exceed their fair value(s) at the date of acquisition. When the fair value of identifiable acquired assets less liabilities assumed exceeds the purchase price of the acquired company ... the value otherwise assignable to tangible capital assets shall be reduced by a proportionate part of the excess.
So, to simplify things, Government contractors cannot write-up the value of tangible capital assets that have already been charged to the Government through depreciation - the Government doesn't want to buy the assets twice.
Intangible capital assets other than goodwill (e.g. intellectual property such as patents and trademarks) bear no such distinction. Amortization is limited to the amount that would have been allowed had the combination not taken place. It doesn't matter whether the Government was previously charged for the amortization. There can be no write-up of values.