1.5 Pushdown accounting
6 min read•august 19, 2024
is a method used in where the acquiring company's accounting basis is applied to the acquired company's financial statements. This approach adjusts the acquired company's assets and liabilities to fair value, creating a new basis of accounting as if it were a new entity.
The provides guidance on pushdown accounting, including change in control thresholds and optional application. This method can significantly impact the acquired company's financial statements, affecting debt covenants, tax considerations, and comparability of pre- and post-acquisition financial reports.
Definition of pushdown accounting
- Pushdown accounting is a method of accounting for a business combination where the acquiring company's accounting basis is "pushed down" to the acquired company's financial statements
- Involves adjusting the acquired company's assets and liabilities to fair value as of the acquisition date, similar to the acquiring company's accounting for the business combination
- Pushdown accounting effectively creates a new basis of accounting for the acquired company, as if it were a new entity as of the acquisition date
Applicability for new basis of accounting
- Pushdown accounting is applicable when there is a change in control of the acquired company, typically through an acquisition by another entity
- The new basis of accounting reflects the acquiring company's cost basis in the acquired company, rather than the historical cost basis of the acquired company
- Pushdown accounting is not required in all cases, but can be elected by the acquired company if certain criteria are met, providing flexibility in financial reporting
FASB ASC requirements for pushdown accounting
Change in control threshold
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- FASB ASC 805-50-25-4 provides guidance on the change in control threshold for pushdown accounting
- An acquirer obtains control of the acquiree when it holds more than 50% of the voting shares, which is the most common threshold for a change in control
- Other indicators of control may include the ability to appoint a majority of the board of directors or make key operating decisions
Substantial change in ownership threshold
- FASB ASC 805-50-25-6 outlines the substantial change in ownership threshold for pushdown accounting
- A substantial change in ownership occurs when an acquirer obtains at least an 80% interest in the acquiree, which is a higher threshold than the change in control threshold
- This threshold is based on the presumption that an 80% or greater ownership interest allows the acquirer to control the acquiree's financial and operating policies
Mandatory vs optional application
- Pushdown accounting is not mandatory for all business combinations, even if the change in control or substantial change in ownership thresholds are met
- FASB ASC 805-50-25-8 allows the acquiree to elect to apply pushdown accounting in its separate financial statements when an acquirer obtains control
- If elected, pushdown accounting must be applied as of the acquisition date and cannot be reversed later
Pushdown accounting entries
Adjusting assets to fair value
- Under pushdown accounting, the acquired company's assets are adjusted to their fair values as of the acquisition date
- This may result in a step-up or step-down in the carrying value of assets such as inventory, property, plant, and equipment, and intangible assets
- The fair value adjustments are based on market participant assumptions and may differ from the acquired company's historical carrying values
Adjusting liabilities to fair value
- Similar to assets, the acquired company's liabilities are also adjusted to their fair values as of the acquisition date under pushdown accounting
- This may include adjustments to debt, contingent liabilities, and other obligations
- The fair value adjustments to liabilities may impact the acquired company's post-acquisition interest expense and debt covenants
Goodwill recognition or bargain purchase gain
- If the acquisition price exceeds the fair value of the acquired company's net assets, the excess is recognized as in the acquired company's financial statements
- Conversely, if the fair value of the acquired company's net assets exceeds the acquisition price, a bargain purchase gain is recognized in the acquired company's income statement
- The recognition of goodwill or a bargain purchase gain under pushdown accounting may differ from the acquiring company's
Impact on retained earnings
- Pushdown accounting can have a significant impact on the acquired company's retained earnings balance
- The cumulative effect of the fair value adjustments to assets and liabilities, as well as the recognition of goodwill or a bargain purchase gain, is recorded in the acquired company's retained earnings
- This can result in a substantial change in the acquired company's equity structure and may impact debt covenants or other financial ratios
Pushdown accounting implications
Impact on debt covenants
- The application of pushdown accounting can have a significant impact on the acquired company's debt covenants
- Fair value adjustments to assets and liabilities, as well as changes in the equity structure, may affect financial ratios and covenant compliance
- It is important to review debt agreements and communicate with lenders to understand the potential implications of pushdown accounting
Tax considerations and deferred taxes
- Pushdown accounting can create temporary differences between the book and tax basis of assets and liabilities
- These temporary differences may result in the recognition of or liabilities in the acquired company's financial statements
- It is important to consider the tax implications of pushdown accounting and consult with tax professionals to ensure proper treatment
Post-acquisition financial statements
- The acquired company's post-acquisition financial statements will reflect the new basis of accounting established through pushdown accounting
- This may result in changes to the company's reported financial position, results of operations, and cash flows compared to its pre-acquisition financial statements
- It is important to clearly communicate the impact of pushdown accounting to stakeholders and provide transparent disclosures in the financial statements
Comparability of financial statements pre- vs post-acquisition
- Pushdown accounting can create challenges in comparing the acquired company's financial statements before and after the acquisition
- The new basis of accounting may result in significant changes to the company's financial metrics and ratios
- It is important to provide clear disclosures and explanations of the impact of pushdown accounting to help users understand the comparability of the financial statements
SEC reporting considerations
Regulation S-X Rule 3-05 requirements
- If the acquired company is significant to the acquiring company under SEC Regulation S-X Rule 3-05, certain financial statements and pro forma information may be required
- The significance tests under Rule 3-05 are based on the acquired company's assets, income, and investment test compared to the acquiring company
- If the acquired company is significant, audited financial statements for the most recent fiscal year and unaudited financial statements for any interim periods may be required
Pro forma financial information
- In addition to historical financial statements, pro forma financial information may be required under SEC rules
- Pro forma financial information presents the combined company's results as if the acquisition had occurred at the beginning of the fiscal year
- This information helps investors understand the impact of the acquisition on the combined company's financial performance
Significance tests for acquired businesses
- The SEC's significance tests determine whether an acquired business is significant to the acquiring company
- The three significance tests are the investment test, the asset test, and the income test
- If an acquired business exceeds certain thresholds under these tests, additional financial statements and pro forma information may be required in the acquiring company's SEC filings
Alternatives to pushdown accounting
Maintaining acquired company's historical basis
- As an alternative to pushdown accounting, the acquired company may choose to maintain its historical basis of accounting
- Under this approach, the acquired company's assets and liabilities are not adjusted to fair value, and no goodwill or bargain purchase gain is recognized
- This may be appropriate if the acquired company will continue to operate as a separate entity and its financial statements will be used for standalone reporting purposes
Parent company accounting for acquisition
- Another alternative is for the parent company (acquiring company) to account for the acquisition in its consolidated financial statements without pushing down the new basis of accounting to the acquired company
- Under this approach, the parent company would recognize the acquired assets and liabilities at fair value and record goodwill or a bargain purchase gain in its consolidated financial statements
- The acquired company's separate financial statements would continue to reflect its historical basis of accounting
Key Terms to Review (18)
Acquisition Accounting: Acquisition accounting is the method used to account for the purchase of another company, where the acquiring company recognizes the assets and liabilities of the acquired company at their fair values on the acquisition date. This process involves determining the total consideration transferred, which may include cash, stock, or other forms of payment, and recognizing any resulting goodwill or bargain purchase gains. This method is essential for understanding how mergers and acquisitions impact the financial statements and can affect pushdown accounting, goodwill impairment testing, and the recognition of bargain purchase gains.
Business combinations: Business combinations refer to the merging of two or more companies into a single entity, aimed at achieving synergies, enhancing market share, and increasing operational efficiencies. This process includes different forms of mergers and acquisitions, which often result in changes to financial reporting and accounting practices. Understanding how business combinations affect financial statements is crucial for assessing the overall impact on the organizations involved.
Consolidated Financial Statements: Consolidated financial statements present the financial position and results of operations of a parent company and its subsidiaries as a single entity. This approach provides a comprehensive view of the entire corporate group, reflecting total assets, liabilities, equity, revenues, and expenses, while eliminating intercompany transactions and balances.
Deferred Tax Assets: Deferred tax assets are financial accounting items that represent amounts a company can deduct from its taxable income in the future. They arise due to temporary differences between the accounting treatment of certain transactions and their treatment for tax purposes, often leading to tax benefits that can be utilized in later periods. Understanding deferred tax assets is crucial when analyzing various accounting practices related to acquisitions, asset purchases, and intercompany transactions as they affect the overall tax strategy and financial health of a business.
Deferred Tax Liabilities: Deferred tax liabilities are tax obligations that a company has incurred but has not yet paid, often due to timing differences between accounting income and taxable income. These arise when income is recognized on the financial statements before it is taxable under tax law, creating a future tax payment obligation. Understanding these liabilities is essential for analyzing financial health and assessing potential tax impacts related to various accounting strategies.
Fair Value Measurement: Fair value measurement is the process of determining the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This concept plays a critical role in financial reporting and valuation, providing a consistent framework for valuing assets and liabilities across various accounting standards and situations.
FASB: The Financial Accounting Standards Board (FASB) is a private-sector organization responsible for establishing and improving financial accounting and reporting standards in the United States. Its guidelines shape how companies prepare their financial statements, impacting various areas such as the treatment of pushdown accounting, the assessment of goodwill impairment, and the reporting of intercompany transactions. FASB standards also play a crucial role in determining the primary beneficiary in consolidation scenarios and defining classifications for held-for-sale assets, as well as segment disclosures within financial statements.
GAAP: Generally Accepted Accounting Principles (GAAP) are a set of accounting standards, principles, and procedures used in financial reporting. They ensure consistency, reliability, and transparency in the financial statements, enabling stakeholders to make informed decisions based on comparable financial information.
Goodwill: Goodwill is an intangible asset that arises when a company acquires another company for a price greater than the fair value of its net identifiable assets. This excess payment reflects the acquired company's reputation, customer relationships, and brand value, which contribute to its earning potential beyond just physical assets.
IASB: The International Accounting Standards Board (IASB) is an independent body that develops and establishes International Financial Reporting Standards (IFRS), which aim to bring transparency, accountability, and efficiency to financial markets around the world. It plays a crucial role in shaping the accounting principles that govern financial reporting, which directly impacts pushdown accounting, goodwill impairment testing, intercompany transactions, primary beneficiary determination, held-for-sale classification, and segment disclosures.
IFRS: International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) that provide a common framework for financial reporting globally. These standards are designed to ensure transparency, accountability, and comparability in financial statements, which is essential for investors and other stakeholders making informed economic decisions.
Minority Interest Allocation: Minority interest allocation refers to the accounting practice of recognizing the portion of a subsidiary’s equity that is not owned by the parent company. This concept is crucial in consolidated financial statements, as it reflects the claim of minority shareholders on the assets and income of the subsidiary, ensuring transparency and accuracy in financial reporting. It becomes particularly relevant when applying pushdown accounting, where the financial statements of the subsidiary reflect the fair value of its assets and liabilities at the time of acquisition.
Non-controlling interest: Non-controlling interest refers to the portion of equity ownership in a subsidiary not attributable to the parent company. This concept is crucial in accounting for consolidations, as it reflects the ownership stake held by minority shareholders in a subsidiary, and impacts how financial statements are prepared and presented.
Parent Company Financial Statements: Parent company financial statements are the consolidated financial reports that reflect the financial position and performance of a parent company and its subsidiaries as a single entity. These statements are crucial for understanding the overall financial health of the parent company and provide insights into how it manages its investments in subsidiaries, including revenue from these subsidiaries, liabilities, and equity positions.
Pushdown accounting: Pushdown accounting is a financial reporting method that allows an acquired company to record the effects of a business combination directly in its own financial statements. This practice aligns the financial statements of the acquired company with the fair value of its assets and liabilities as determined during the acquisition, effectively reflecting the new ownership structure and values in its balance sheet. It simplifies the consolidation process for the parent company and provides clearer financial information to investors and stakeholders.
Pushdown implications for reporting: Pushdown implications for reporting refer to the effects that arise when a subsidiary's financial statements reflect the fair value of its assets and liabilities as determined during an acquisition. This practice allows the acquirer to push down the acquisition accounting effects into the financial statements of the acquired entity, thus aligning the subsidiary's reporting with the consolidated financial reporting of the parent company. By adopting pushdown accounting, financial results become more transparent and provide a clearer picture of the subsidiary’s financial position post-acquisition.
Pushdown vs. Traditional Accounting: Pushdown accounting refers to a method where the financial statements of an acquired company reflect the acquisition date fair value of its assets and liabilities, while traditional accounting maintains the historical cost basis of the acquired entity. This difference in approach significantly affects how assets and goodwill are reported on the financial statements, leading to variations in financial reporting and implications for taxation and valuation.
Stock Acquisitions: Stock acquisitions refer to the process where one company purchases a controlling interest in another company by acquiring its shares. This method allows the acquiring company to gain ownership and control over the target company's assets and operations, often leading to significant strategic advantages. Stock acquisitions can be executed through public offerings or private negotiations, impacting financial reporting and tax considerations.