Question

Case 18-1 Coffee Co. Coffee Co. (the “Company”) is a global distributor of organic coffee beans and teas that is registered with the SEC in the United States. The Company’s operations are primarily located in the United States, Canada, and South America. In March 20X8, Coffee Co., looking to refocus efforts to only produce coffee products, entered into an agreement (the “Agreement”) with Nature’s Beverage, a food distributor in the United States looking to expand its international footprint (the “Transaction”). Nature’s Beverage is registered with the SEC in the United States. Pursuant to the Agreement, Coffee Co. provided a sublicense to Nature’s Beverage for the distribution rights of Coffee Co.’s South American local tea brand, Herbal T, whereby Nature’s Beverage will distribute Herbal T in South America. Under the Agreement, Coffee Co. transferred the existing customer contracts in South America to Nature’s Beverage and an at-market supply contract with the producer of Herbal T. Coffee Co. retained all of its employees and distribution capabilities. The Transaction closed on March 1, 20X8 (the “Closing”). Additional Facts: • Nature’s Beverage incurred certain costs to acquire the sublicense of the distribution rights and a license to use the Herbal T brand. The costs included legal, accounting, and other professional or consulting fees totaling $50,000. • Nature’s Beverage agreed to transfer to Coffee Co. $3 million for the sublicense of the distribution rights of Herbal T. • Assume both companies have adopted FASB Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business.

Required:

1. Does the acquisition of the sublicense by Nature’s Beverage to distribute Herbal T meet the definition of a business?

2. How should Nature’s Beverage account for the acquisition, including the treatment of the transaction costs? (Note that the response will be dependent on the response to Question 1.)

Answer 1

1.

ACQUISITION OF SUBLICENSE MEETS THE DEFINITION OF BUSINESS

Nature’s Beverage is a company in the line of distributing food products in united states of America. The company was registered in the United States. The company entered into an agreement with Coffee company to supply the South American local tea brand in united states named Herbal T whereby the company will distribute Herbal T in South America. In the meantime, the coffee company supplied its existing contracts to nature’s beverage since the resultant company would thereby look after the distributing contracts of Herbal T. The above acquisition of sublicense is a valid contract and is undertaken in terms of expanding the business by nature’s beverage. As per the definition of business, it includes an agreement undertaken by a company in order to commence a trading, distribution, service provider, or any other form of activity in order to commence selling of a product or a service. Therefore, the agreement entered amongst the two entity constitutes business agreement allowing Nature's Beverage to sell the Herbal T product in different states of South America.

Further, the investment in the acquisition of distribution rights is done in order to expand the revenues of the company that itself constitutes establishment and acquisition of business right. This concludes that the acquisition made by the company meets the definition of business.

2.

ACCOUNT FOR OF THE ACQUISITION OF DISTRIBUTION RIGHTS OF HERBAL T BY NATURE’S BEVERAGE

Further in order enter into an agreement with coffee company, Nature’s beverage had to incur some amount in form of license fees, legal, accounting and consultancy expenses, fees against distribution rights paid to Coffee Co. Such costs incurred by Nature’s beverage were in the form of investment that will give returns to the company over the number of upcoming years (Shizhong, 2004). The company shall not charge such expenses incurred in the statement of profit and loss, either, the company shall capitalize all the expenses in the form of acquisition of distribution rights of Coffee company in its books of accounts.

All the transaction expenses are thereby called as expenses incurred in order to acquire the distribution rights and therefore all the costs shall not be capitalized in the distribution license only irrespective of the nature of other expenses.

As per the financial accounting standards board, the transactions costs are not considered to be in exchange of fair value of assets acquired and therefore shall be expensed. The tax treatment of such expenditures are not straightforward and the nature and timing of the expenditure have its impact over the tax treatment.

Costs incurred by the company in order to acquire the sublicense were not to be expensed as they were in form of investments (Financial Accounting Standards Board, 2000). These costs are also not amortized in the upcoming years as they are not in terms of real expenditure and no tax treatment would be there on such expenses.