Refer to the ASC to answer the following questions. Quote ASC in the answers. Ca
ID: 2564917 • Letter: R
Question
Refer to the ASC to answer the following questions. Quote ASC in the answers.
Case 16-9 Commitment to Share
BuyCo is a privately held technology developer and manufacturer in the transportation industry. On October 31, 20X1, BuyCo entered into an agreement with SellCo to purchase certain assets and assume certain liabilities of SellCo (the “Transaction”). BuyCo intends to incorporate the processes, economic resources, and technology acquired in the Transaction into its existing business to serve the transportation industry with energy-efficient solutions and provide a return to its shareholders. The assets and liabilities acquired meet the definition of a business as defined in ASC 805-10, Business Combinations: Overall. Pursuant to the agreement, BuyCo will transfer to the owners of SellCo cash of $2 million and 10 million shares of BuyCo common stock. BuyCo will also assume liabilities of $4.5 million. The terms of the agreement define the “liquidity event period” as the period beginning at the closing of the Transaction and ending on December 31, 20X2. If BuyCo undergoes an IPO during the liquidity event period, and the 10 million shares received by SellCo in the Transaction have a fair value of less than $20 million, BuyCo would be required to issue up to 2 million additional shares of common stock such that the total fair value of shares held by SellCo equals $20 million (the “Share Value Commitment”). BuyCo would have sufficient authorized and unissued shares to settle the Share Value Commitment, and BuyCo would be permitted to settle in unregistered shares. The agreement requires the Share Value Commitment to be settled in shares and under no conditions will BuyCo be required to settle the Share Value Commitment in cash. BuyCo has concluded that it is more likely than not that the number of shares required to settle the Share Value Commitment will be less than 2 million. The Transaction closed on December 31, 20X1, at which time BuyCo obtained control over the purchased assets and assumed liabilities of SellCo. The fair value of BuyCo common stock was $1.85 per share on October 31, 20X1, $1.95 per share on December 31, 20X1, and $1.90 per share on June 30, 20X2. BuyCo hired Entity E, a third-party valuation specialist, to determine the fair value of the Share Value Commitment. On the basis of the current fair value of BuyCo common stock, the guaranteed value of $20 million, the probability of an IPO occurring during the liquidity event period, and other relevant valuation assumptions, Entity E estimated the fair value of the Share Value Commitment to be $1.4 million, $450,000, and $1.2 million on October 31, 20X1, December 31, 20X1, and June 30, 20X2, respectively.
1. What is the total consideration transferred by BuyCo in the Transaction, and how should that consideration be measured?
2. How should the Share Value Commitment be reflected on the December 31, 20X1, balance sheet of BuyCo?
3. What journal entries, if any, are required to record the change in fair value for the Share Value Commitment between December 31, 20X1, and June 30, 20X2?
Explanation / Answer
BuyCo is a privately held technology developer and manufacturer in the transportation industry. BuyCo entered into a business combination with SellCo on October 31, 20X1 to purchase certain assets and assume certain liabilities of SellCo. The assets and liabilities acquired meet the definition of a business as defined by ASC 805-10-20, which means that it can be accounted for as a business combination. According to ASC 805-10-25-1, an entity should account for each business combination by applying the acquisition method. The total consideration transferred is equal to the acquisition date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the equity interest issued by the acquirer (ASC 805-30-30-7).
The agreement includes BuyCo transferring to the owners of SellCo $2 million in cash, assuming SellCo’s liabilities of $4.5 million, and transferring 10 million shares of BuyCo’s common stock to SellCo. The fair value of BuyCo’s common stock was $1.95 per share on December 31, 20X1, the date the transaction closed, for a total value of $19.5 million. The acquirer must also recognize the acquisition date fair value of any contingent consideration (ASC 805-30-25-5). A third party valuation specialist estimated the fair value of the the contingent consideration, which is the Share Value Commitment, to be $450,000 on December 31, 20X1.
The contingent consideration states that if BuyCo undergoes an IPO from December 31, 20X1 to December 31, 20X1, the liquidity event period, and the 10 million shares received by SellCo have a fair value of less than $20 Million, BuyCo would be required to issue up to 2 million additional shares of common stock so that the fair value of shares held by SellCo equals $20 million. BuyCo has concluded that it is more likely than not that the number of shares required to settle will be less than 2 million.
BuyCo’s Share Value Commitment should be accounted as a liability on the balance sheet on December 31, 20X1 as defined by ASC 480-10-25-14. As part of the agreement, BuyCo is required to settle the Share Value Commitment in shares. BuyCo’s equity shares shall be classified as liability because at the time of the inception the monetary value of the obligation was a known fixed monetary amount.
ASC 805-30-35-1 states that a contingent payment involving a liability will be re-measured at each subsequent reporting date until the contingent event has been settled, with changes being reported in net income. The measurement period is defined by ASC 805-10-25 as the time after the initial acquisition date during which the acquirer may adjust the provisional amounts recognized at the acquisition date. The measurement period ends as soon as the acquirer has the needed information about the facts and circumstances and does not exceed one year from the acquisition date. BuyCo signed a agreement with SellCo which defined the liquidity event period beginning at the closing of the Transaction (December 31, 20X1) and the ending on December 31, 20X2. During the measurement period, Buyco should retrospectively adjust the provisional amounts recognized. BuyCo would record the journal entry to adjust for the Share Value Commitment by debiting a loss in net income for $750,00 and crediting contingent consideration liability for $750,000.