Question

When acquiring a business, typically all of the assets and liabilities will be acquired, even those off-balance sheets. Consider operating leases. This is a legal liability that currently is not reflected on a balance sheet. How is this accounted for upon acquisition and for consolidation? Consider ASC Codification 805-20 through 25 in your response. Use citations as appropriate.

Answer 1

As per FASB ASC 805-20-25-6, an acquirer should classify or designate the identifiable assets that are acquired and liabilities assumed as necessary so that appropriate GAAP can be applied at the acquisition date .

Below are the basis for the classification as on the acquistion date

1. Contractual terms
2. Economic conditions
3. Operating or accounting policies
4. Other pertinent conditions that exist at the acquisition date

As per (ASC 805-20-25-8), The classification of a lease contract as either an operating lease or a capital lease is made on the basis of the contractual terms and other facts at the inception of the contract

With respect to the contractual-legal criterion, this criteria can actually be met even if the asset is not transferable or separable from the acquiree or from other rights and obligations (ASC 805-20-55-2).

In order to provide additional understanding to entities of the contractual-legal criterion, the FASB included additional examples within the respective implementation guidance. Refer to Exhibit 1 below which provides three examples in which the contractual-legal criterion is met.

Exhibit 1: Contractual-Legal Criterion Examples (ASC 805-20-55-2) An acquiree leases a manufacturing facility under an operating lease that has terms that are favorable relative to market terms. The lease terms explicitly prohibit transfer of the lease (through either sale or sublease). The amount by which the lease terms are favorable compared with the pricing of current market transactions for the same or similar items is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even though the acquirer cannot sell or otherwise transfer the lease contract. An acquiree owns and operates a nuclear power plant. The license to operate that power plant is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even if the acquirer cannot sell or transfer it separately from the acquired power plant. An acquirer may recognize the fair value of the operating license and the fair value of the power plant as a single asset for financial reporting purposes if the useful lives of those assets are similar. An acquiree owns a technology patent. It has licensed that patent to others for their exclusive use outside the domestic market, receiving a specified percentage of future foreign revenue in exchange. Both the technology patent and the related license agreement meet the contractual-legal criterion for recognition separately from goodwill even if selling or exchanging the patent and the related license agreement separately from one another would not be practical.