No consideration is transferred

As discussed in Section 3.1.2, business combinations achieved without the transfer of consideration are

accounted for using the acquisition method (see Section 2.2). Examples of these types of business combinations include those in which:

y The buyer obtains control of the target through contract alone;

y The buyer is an existing investor in the target and obtains control as a result of the target acquiring its own shares; and

y The buyer is the existing majority (but noncontrolling) owner and obtains control of the target as a result of minority veto rights lapsing.

This is not an exhaustive list of situations in which a business combination can be effected without the transfer of consideration.

An example of a transaction in which a buyer obtains control of the target through contract alone involves a situation in which a PPM entity obtains control of a physician practice solely through the execution of a management agreement with the physician practice. Additional information about these types of arrangements is provided in various sections of Topic 810-10.

When the buyer gains control of the target without transferring any consideration, the question that arises is how to calculate the amount of goodwill or gain from a bargain purchase that should be recognized in connection with the business combination. As discussed in Section 12.1, the four elements potentially involved in determining the amount of goodwill or gain from a bargain purchase recognized in a business combination in which consideration is transferred include the amount of:

1. Consideration transferred (measured predominantly at fair value);

2. The acquisition-date fair value of any noncontrolling interest in the target;

3. The acquisition-date fair value of the buyer’s previously held equity interest in the target (if any); and 4. Net assets acquired by the buyer (which is 100% of the target’s net assets measured predominantly at fair

value).

When the buyer obtains control of a target in which it had a previously held equity interest and it does so without transferring consideration, we believe that the previously held equity interest (Element 3 of the goodwill calculation) should be valued at the acquisition-date fair value of the buyer’s interest in the target after it

obtains control. As such, the control premium would be included in the acquisition-date fair value of the buyer’s previously held equity interest. As discussed in Section 12.6, any difference between the acquisition-date fair value and the carrying amount of the buyer’s previously held equity interest should be recognized as a gain or loss in the income statement. While on the surface including the control premium in the acquisition-date fair value of the buyer’s previously held equity interest seems inconsistent with the discussion in Section 12.6.2, one of the fundamental principles of a business combination is that the calculation of goodwill (or a gain from a bargain purchase) should be based on the residual difference between the fair value of the target as a whole (which includes any control premium) and the net assets acquired (measured predominantly at fair value). To adhere to that principle in a business combination in which the buyer had a previously held equity interest in the target and obtains control of the target without transferring consideration, we believe the acquisition-date fair value of the buyer’s previously held equity interest should include the control premium.

Because of the unique circumstances often involved in business combinations that occur without the transfer of consideration, the buyer may need to use one or more valuation techniques to determine the acquisition-date fair value of its interest in the target as well as the acquisition-date fair value of any noncontrolling interest in the target (see Section 10.20.3). In determining these fair values, the guidance in Topic 820 on valuation techniques, and on determining fair value in general, should be consulted. These unique circumstances may also result in all of the equity interests in the target being attributed to the noncontrolling interest in the case of a business combination that occurs through contract alone.

As discussed in more detail in Section 3.1.2, concluding that business combinations can occur without the transfer of consideration introduces the possibility of an entity being the buyer in a business combination through no direct action of its own. Business combinations occurring through no direct action of the buyer present a risk that an entity could be the buyer in a business combination without knowing it. To prevent this situation from occurring, an entity should have procedures in place to monitor its current ownership percentage in investees at each reporting date.

Example 12-3: Buyer obtains control as a result of target’s acquisition of its own shares

Assume the following facts for a business combination in which Buyer obtains control of Target as a result of Target acquiring 25,000 of the 150,000 shares it has outstanding:

y Buyer transfers no consideration to Target or Target’s other owners.

y Prior to Target’s acquisition of 25,000 of its own shares, Buyer owned 67,500 shares in Target (a 45%

ownership interest) and accounted for its investment in Target using the equity method.

y The carrying value of Buyer’s investment in Target prior to gaining control of Target was $6,500,000.

y After Target’s acquisition of 25,000 of its own shares, Buyer’s ownership interest in Target is 54% (Buyer’s 67,500 shares of Target divided by 125,000 shares [150,000 of Target’s outstanding shares before Target’s acquisition of 25,000 of its own shares less the 25,000 shares acquired by Target]).

y The fair value of Buyer’s interest in Target on the acquisition date after it gains control is $9,600,000.

y The acquisition-date fair value of the noncontrolling interest’s 46% equity interest in Target is $6,900,000.

y Target’s net assets acquired by Buyer are $15,200,000, which consists of $25,800,000 of identifiable assets acquired and $10,600,000 of liabilities assumed.

The amount of goodwill to be recorded by Buyer due to its obtaining control of Target as a result of Target acquiring 25,000 of its own shares is determined as follows:

-$6,900,000 9,600,000 16,500,000 15,200,000

$1,300,000 Element 1: Consideration transferred

Element 2: Acquisition-date fair value of noncontrolling interest in Target Element 3: Acquisition-date fair value of Buyer’s previously held equity interest Total

Element 4: Net assets acquired

Goodwill: Excess of Elements 1 through 3 over Element 4

A summary journal entry representing the overall effects of the business combination on Buyer’s consolidated financial statements at the acquisition date is as follows:

Example 12-4: Buyer obtains control through contract alone

Assume the following facts for a business combination in which Buyer obtains control of Target through contract alone:

y Buyer transfers no consideration to Target or Target’s owners.

y The contract between Buyer and Target’s owners results in Buyer obtaining control.

y Buyer did not previously hold any equity interest in Target and the contract does not result in Buyer receiving any equity interest in Target.

y The fair value of the noncontrolling interest’s 100% equity interest in Target is $2,500,000.

y Target’s net assets acquired by Buyer are $2,400,000, which consists of $5,200,000 of identifiable assets acquired and $2,800,000 of liabilities assumed.

The amount of goodwill to be recorded by Buyer as a result of obtaining control of Target through contract alone is determined as follows:

Previously held equity interest in Target (Note) Gain

Identifiable assets Goodwill

Liabilities

Noncontrolling interest

Previously held equity interest in Target

Debit

$3,100,000

$25,800,000 1,300,000

Credit

$3,100,000

$10,600,000 6,900,000 9,600,000

Note: This journal entry is necessary given that the business combination involves a step acquisition (see discussion earlier in this section and Section 12.6). The amount of the gain is calculated as the excess of the acquisition-date fair value of Buyer’s previously held equity interest in Target over the carrying value of the related investment on Buyer’s books.

-$2,500,000 -2,500,000 2,400,000

$100,000 Element 1: Consideration transferred

Element 2: Acquisition-date fair value of noncontrolling interest’s 100% interest in Target Element 3: Acquisition-date fair value of previously held equity interest in Target

Total

Element 4: Net assets acquired

Goodwill: Excess of Elements 1 through 3 over Element 4

A summary journal entry representing the overall effects of the business combination on Buyer’s consolidated financial statements at the acquisition date is as follows: