Business merger and acquisition (M&A) transactions have significant financial reporting implications. Notably, the company’s balance sheet will look markedly different than it did before the business combination. Here’s some guidance on reporting business combinations under U.S. Generally Accepted Accounting Principles (GAAP).

Allocating the purchase price

GAAP requires a buyer to allocate the purchase price to all acquired assets and liabilities based on their fair values. This process starts by estimating a cash equivalent purchase price.

If a buyer pays 100% cash up front, the purchase price is already at a cash equivalent value. But the cash equivalent price is less clear if a seller accepts noncash terms, such as an earnout that’s contingent on the acquired entity’s future performance or stock in the newly formed entity.

The next step is to identify all tangible and intangible assets and liabilities acquired in the business combination. The seller’s presale balance sheet will report most tangible assets and liabilities, including inventory, equipment, and payables. However, intangibles are reported only if they were previously purchased by the seller. Most intangibles are generated in-house, so they’re rarely included on the seller’s balance sheet.

Assigning fair value

Acquired assets and liabilities are then added to the buyer’s balance sheet, based on their fair values on the acquisition date. The difference between the sum of these fair values and the purchase price is reported as goodwill.

Goodwill and other indefinite-lived intangibles — such as brand names and in-process research and development — usually aren’t amortized for GAAP purposes. Instead, companies generally must test goodwill for impairment each year. Impairment testing also may be necessary when certain triggering events happen.

Examples of triggering events include the loss of a major customer or enactment of unfavorable government regulations. If a borrower reports an impairment loss, it could mean that the business combination has failed to achieve management’s expectations.

Rather than test for impairment, private companies may elect to amortize goodwill straight-line, generally over 10 years. However, companies that elect this alternate method must still test for impairment when certain triggering events occur.

In rare instances, a buyer negotiates a bargain purchase. Here, the fair value of the net assets exceeds the fair value of consideration transfer (the purchase price). Rather than book negative goodwill, the buyer reports a gain from the purchase on the income statement.

Get it right

Accurate purchase price allocations are essential to minimizing write-offs and restatements in subsequent periods. Contact us to get M&A accounting right from the start. We can help ensure your fair value estimates are supported by market data and reliable valuation techniques.

© 2023

Does your company struggle to close its books at the end of each month? The month-end close requires accounting personnel to round up data from across the organization. This process can strain internal resources, potentially leading to delayed financial reporting, errors and even fraud. Here are some simple ways to streamline your company’s monthly closing process.

Develop a standardized process

Gathering accounting data involves many moving parts throughout the organization. To reduce the stress, aim for a consistent approach that applies standard operating procedures and robust checklists.

This minimizes the use of ad-hoc processes. It also helps ensure consistency when reporting financial data month after month.

Provide ample time for data analysis

Too often, the accounting department dedicates most of the time allocated to closing the books to the mechanics of the process. But spending some time analyzing the data for integrity and accuracy is critical. Examples of review procedures include:

• Reconciling amounts in a ledger to source documents (such as invoices, contracts, or bank records),
• Testing a random sample of transactions for accuracy,
• Benchmarking monthly results against historical performance or industry standards, and
• Assigning multiple workers to perform the same tasks simultaneously.

Without adequate due diligence, the probability of errors (or fraud) in the financial statements increases. Failure to evaluate the data can result in more time being spent correcting errors that could have been caught with a simple review — before they were recorded in your financial records.

Encourage process improvements

Workers who are actively involved in closing out the books often may be best equipped to recognize trouble spots and bottlenecks. So, it’s important to adopt a continuous improvement mindset.

Consider brainstorming as a team. Then, assign responsibility for adopting changes to an employee with the follow-through capabilities and authority to drive change in your organization.

Be flexible with staffing

Often, accounting departments require certain specialized staff to be present during the month-end close. If an employee is unavailable, the department may be shorthanded and unable to complete critical tasks.

Implementing a cross-training program for key steps can help minimize frustration and delays. It may also help identify inefficiencies in the financial reporting process.

Consider automation

Your accounting department may rely on manual processes to extract, manipulate, and report data. However, these processes create opportunities for human errors and fraud.

Fortunately, modern accounting software can automate certain routine, repeatable tasks, such as invoicing, accounts payable management, and payroll administration. In some cases, you may need to upgrade your current accounting software to take full advantage of the power of automation.

Keep it simple

Closing the books doesn’t have to be a stressful, labor-intensive chore. We can help you simplify the process and give your accounting staff more time to focus on value-added tasks that take your company’s financial reporting to the next level.

© 2023

From time to time, owners of closely held businesses might need to advance their companies money to bridge a temporary downturn or provide funds for an expansion or another major purchase. How should those advances be classified under U.S. Generally Accepted Accounting Principles (GAAP)? Depending on the facts and circumstances of the transaction, an advance may be reported as debt or additional paid-in capital.

What are the deciding factors?

When classifying a shareholder advance, it’s important to consider the economic substance of the transaction over its form. The accounting rules lay out the following issues to evaluate when reporting these transactions:

Intent to repay. Open-ended understandings between related parties about repayment imply that an advance is a form of equity. For example, an advance may be classified as a capital contribution if it was extended to save the business from imminent failure and no attempts at repayment have ever been made.

Terms of the advance. An advance is more likely to be treated as bona fide debt if the parties have signed a written promissory note that bears reasonable interest, has a fixed maturity date and a history of periodic loan repayments, and includes some form of collateral. However, if an advance is subordinate to bank debt and other creditors, it’s more likely to qualify as equity.

Ability to repay. This includes the company’s historic and future debt service capacity, as well as its credit standing and ability to secure other forms of financing. The stronger these factors are, the more appropriate it may be to classify the advance as debt.

Third-party reporting. Consistently treating an advance as debt (or equity) on tax returns can provide additional insight into its proper classification.

With shareholder advances, disclosures are key. Under GAAP, you’re required to describe any related-party transactions, including the magnitude and specific line items in the financial statements that are affected. Numerous related-party transactions may necessitate the use of a tabular format to make the footnotes to the financial statements more reader-friendly.

Why does it matter?

The proper classification of shareholder advances is especially important when a company has unsecured bank loans or more than one shareholder. It’s also relevant for tax purposes because advances that are classified as debt typically require imputed interest charges. However, the tax rules don’t always align with GAAP.

To further complicate matters, shareholders sometimes forgive loans or convert them to equity. Reporting these types of transactions can become complex when the fair value of the equity differs from the carrying value of the debt.

Get it right

There isn’t a one-size-fits-all solution for classifying shareholder advances. We can help you address the challenges of reporting these transactions and adequately disclose the details in your financial statements.

© 2023

Every fall, CPAs are busy preparing for audit season, which generally runs from January to April each year. This includes meeting with clients, assigning staff and scheduling fieldwork.

Likewise, organizations with calendar year ends should prepare for audit fieldwork. A little prep work this fall can help facilitate the process, minimize adjustments and surprises, and add more value to the audit process. Here are four ways to gear up for your audit.

1. Disclose operational changes

Internal and external changes may bring opportunities and risks that could affect your auditor’s procedures. So it’s important to identify all recent developments of importance and discuss them with your auditor before fieldwork begins.

Examples of noteworthy internal events or transactions include:

• Major asset acquisitions or divestitures,
• New or expanded product lines,
• Relocation or a new lease for commercial space,
• Application for new debt (or refinanced debt),
• Addition (or retirement) of owners and other key employees,
• Losses and business interruptions from natural disasters, fraud, or cyberattacks,
• Acquisition (or loss) of a key customer or supplier, and
• A change in accounting software.

Your auditor will also want to hear about external changes, such as pending lawsuits and tax audits, new sources of competition, and new regulations. When in doubt, tell your auditor.

2. Ask questions about gray areas

All transactions for the year should be entered into your accounting system before the start of fieldwork. But your accounting personnel might not know exactly how to report certain items. There have been several major changes to the federal tax code and U.S. Generally Accepted Accounting Principles (GAAP) in recent years.

If your staff is uncertain how to account for a particular transaction or when a new rule goes into effect, it’s a good idea to ask for help before closing the books at year-end. Doing so will help minimize inquiries and the need to make adjusting journal entries during fieldwork.

3. Review last year’s audit

Start by looking at last year’s adjusting journal entries and management points. You should have taken steps to correct whatever problems were found last year. For example, if your controller forgot to record accrued payroll and vacation last year, double-check that accruals have been done for 2023. Likewise, if your auditor suggested that you needed stronger internal controls over purchasing, you could make last-minute changes before year end, such as segregating ordering and vendor payment duties between two employees or cross-checking vendor vs. employee addresses.

You should also anticipate requests for documentation and inquiries from auditors. Chances are you’ll create many of these schedules — such as accounts receivable aging reports and fixed asset listings — when you reconcile your general ledger. Consider compiling an audit binder before the start of fieldwork to expedite the process. It also helps to designate an internal liaison to field the audit team’s inquiries. Often, this is the company’s CFO or controller, but it can be anyone who’s knowledgeable about the company’s operations and accounting systems.

In addition, each account balance should have a schedule that supports its year-end balance. Amounts reported on these schedules should match the financial statements. Be ready to explain and defend any estimates that underlie account balances, such as allowances for uncollectible accounts, warranty reserves or percentage of completion.

4. Adopt a positive frame of mind

Some in-house accounting personnel see audit fieldwork as a painstaking disruption to their daily operations. They may begrudge having to explain their business operations and accounting procedures to outsiders who will highlight mistakes and weaknesses in financial reporting.

Although no one likes to be questioned or critiqued, audits shouldn’t be adversarial. Your external auditor is a resource that can provide assurance about your financial reporting to lenders and investors, offer fresh insights and accounting expertise, and recommend ways to strengthen internal controls and minimize risks. Financial statement audits should be seen as a learning opportunity and an investment in your organization’s future.

Preparing for your auditor’s arrival not only facilitates the process and promotes timeliness, but also engenders a partnership between in-house and external accounting resources.

 

Interested in learning more? Contact us to talk to one of our Audit professionals.

© 2023