Understanding Goodwill and Business Combinations Under ASC 805

What Is a Business Combination?

A business combination occurs when one entity obtains control of one or more businesses. Under ASC 805, virtually all business combinations must use the acquisition method — the acquirer recognises all identifiable assets and liabilities at their acquisition-date fair values, with the excess of consideration paid over net fair value recognised as goodwill.

The Acquisition Method Step by Step

Step one identifies the acquirer. Step two determines the acquisition date. Step three recognises all identifiable assets and liabilities at fair value — including intangible assets the acquiree may never have previously recognised, such as customer relationships, trade names, and developed technology. Step four calculates goodwill as the excess of consideration transferred plus non-controlling interest, minus the net identifiable assets at fair value.

Goodwill Impairment Testing

Goodwill is not amortised under US GAAP. It is tested for impairment at least annually by comparing the fair value of a reporting unit to its carrying value. If carrying value exceeds fair value, an impairment charge is recognised up to the amount of goodwill allocated to that unit.

Contingent Consideration

Many business combinations include earnout provisions. These must be recognised at acquisition-date fair value and included in the consideration transferred when calculating goodwill. If classified as a liability, contingent consideration is remeasured to fair value at each reporting date, with changes in earnings.