In recent years a number of standards have been issued regarding the accounting for business combinations. Further clariﬁcation will be forthcoming to take account of principle-based concepts such as the accounting for variable interest entities.
One aspect of business combinations, in-process research and development (“IPR&D”), has resulted in SEC staff challenging registrants that have recognized signiﬁcant IPR&D charges as part of a purchase business combination.
Generally accepted accounting principles require that the purchase price allocation in a purchase business combination begin with an analysis to identify all of the tangible and intangible assets acquired. Intangible assets, such as rights to existing products, underlying technology, patents, copyrights, brand names, customer lists, marketing channels, and engineering work force, may be identiﬁed. The fair value of each asset must be estimated. The total purchase cost is allocated based on the relative fair values of the individual assets.
When determining the appropriateness of an IPR&D write-off, challenges have run to valuation methodologies and value assigned to both core technology (which is capitalized and amortized) versus IPR&D (which is expensed immediately). Underlying assumptions and data used to develop the valuations should be adequately tested or challenged by companies and their auditors. Companies should expect the SEC staff to question any signiﬁcant IPR&D charges included in historical ﬁnancial statements or disclosed as possible future transactions.
In response to issues noted in accounting for special purpose entities, guidance has been issued that changes the criteria to be evaluated when considering whether to consolidate an entity. The guidance sets out consolidation principles such as the risks and rewards of ownership that must be considered prior to traditional voting interest considerations.
Liability versus equity classiﬁcation
Scrutiny has been placed on the classiﬁcation of liabilities and equity in ﬁnancial statements. This has resulted in the issuance of a standard that clariﬁes this classiﬁcation. Certain ﬁnancial instruments that were previously classiﬁed as “mezzanine” in the balance sheet may now be required to be classiﬁed as
The SEC has recently questioned registrants on the determination of business segments and adequacy of segment reporting disclosure. They found that there was often an inappropriate aggregation of multiple segments or there was an inadequate explanation of the basis for aggregating information.