Mergers, acquisitions, and business combinations are terms describing the combining of two or more entities. They occur frequently in the business world including among Government contractors. Once an agreement has been reached on the "selling price", the acquiring party has to figure out how to account for the purchase. Government contractors need to realize that some of the purchase price may not be recoverable under its Government contracts.
There are two methods of accounting for business combinations; the purchase method and the pooling of interests method. Under the purchase method, the acquiring company accounts for the business combination as if it were acquiring the assets of the acquired company. The acquiring company records the transaction as the fair value of the assets acquired less the liabilities assumed. This results of this transaction can result in either a step up or write down of the assets recorded values. The difference between the acquiring company's cost and the sum of the fair values of tangible and identifiable intangible assets, less liabilities is recorded as goodwill (usually an asset).
The pooling of interests method on the other hand accounts for a business combination as the uniting of ownership interests of two companies. The recorded assets and liabilities of the constituent companies are carried forward to the combined corporation at their recorded amounts without any revaluation. Generally Accepted Accounting Principles (GAAP) however severely limit the circumstances whereby the pooling method may be used. Therefore, the pooling method of accounting is not commonly used when companies merge.
Goodwill is an unidentifiable intangible asset. It originates under the purchase method of accounting for a business combination when the price paid by the acquiring company exceeds the sum of the identifiable individual assets acquired less liabilities assumed, based upon their fair values. The excess is commonly referred to as goodwill. Goodwill may arise from the acquisition of a company as a whole or a portion thereof. The GAAP rules for writing off or writing down goodwill have changed over the years. Under current GAAP (SFAS No. 142) goodwill is written down or written off upon impairment (impairment is an accounting term used to describe a situation where the recorded value is no longer reasonable).
Now comes the difficult realization for contractors that need to write down or write off the goodwill recorded on their books. According to FAR 31.205-49, any costs for amortization, expensing, write-off, or write-down of goodwill, however represented, are unallowable.
Knowing this, many acquiring companies will attempt to minimize the goodwill recognized in their accounting records. The easiest way to do this is to step up the value of the assets acquired in the transaction. Contract auditors are aware of this however and will probably ask to see an appraisal or other support for the values placed on the acquired assets.
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