Question

Current practice requires that the assets acquired in a business combination be measured at fair value as defined by SFAS No. 157 (see FASB ASC 820-10).

Side 1: Argue that the acquiring company should measure the acquired company's plant assets that it plans to use in int operations in accordance with the requirements of SFAS No. 141 before its revisions.

Side 2: Argue that the acquiring company should measure the acquired company's plant assets that it plans to use in its operations in accordance with the SFAS No. 141 revision. Choose one side and present an argument.

Answer 1

ANSWER:

side1:

According to the guidance contained at FASB ASC 805, a company should measure the plant assets of an acquired company that it plans to use in its operations using replacement cost.  This makes sense because, replacement cost measures the amount that a company would have to pay to acquire the assets that it will use.  In other words, we believe that an entry value is appropriate to measure the current value of assets in use.

If the plant assets of an acquired company were measured in accordance with SFAS No. 157, the parent company would have to value assets acquired based on exit values.  These exit values would be the values that the parent company could get from selling the assets in an orderly sale.  If the parent company plans to use these assets, the value they could get from selling them is not relevant.  Instead, the only relevant cost is the cost that it would take to acquire them in their current condition.

side2:

Fair value under the guidance contained at FASB ASC 820 is based on exit value.  It is the amount that a company would receive from selling an asset in an orderly sale.  The company always makes a choice to sell and replace an asset or to keep it.  The exit value measures the opportunity to sell.  Once owned, the opportunity to sell is the only relevant current value.  Since the company already owns the asset, the opportunity to purchase another one just like it is not relevant.

Since companies are always making replace or keep decisions, they are reinvesting in the asset by keeping rather than selling it.  This is in effect a capital budgeting decision-making process. If you were trying to decide whether to sell or keep, you would compare the future cash flows for each alternative.  The future cash flows to sell would be what you would get by selling the assets combined with the cost of acquiring a new one along with financing decisions, tax effects and potential effects on cash flow resulting from increased efficiency of a replacement asset.  You would not be acquiring another asset in the same condition as the old one.  The future cash flows to keep would be similar, but would not include the cost of replacement, since keeping the asset would negate its replacement.