Transaction accounting and reporting - ey.com · Global respondents have caught up with US...

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Transaction accounting and reporting Getting ahead of issues that matter

Transcript of Transaction accounting and reporting - ey.com · Global respondents have caught up with US...

Transaction accounting andreportingGetting ahead of issues that matter

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Con

tent

s

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Current trends and findings

Acquisitions

Divestitures

EY’s transaction accounting and reporting services

About EY

Current trends and findings

Page 4 Transaction accounting and reporting

EY’s Capital Confidence BarometerAbout the Barometer

► 1,600 executives► In 53 countries► Across 19 industry sectors► Involving 863 C-suite executives

EY’s CapitalConfidenceBarometer

EY’s Capital Confidence Barometer is a regular survey of senior executives from large companies around the worldconducted by the Economist Intelligence Unit (EIU).

The respondent community comprises of an independent EIU panel of senior executives and select EY clients andcontacts.

Our 13th Barometer provides a snapshot of our findings, gauges corporate confidence in the economic outlook, andidentifies boardroom trends and practices in the way companies manage their capital agenda.

Page 5 Transaction accounting and reporting

Sentiment on global deal market is increasinglypositive among both US and global respondents

What is your expectation for the M&A market in the next 12 months?

83%

15%

2%

60%

39%

1%

69%

26%

5%

Improving

Stable

Declining

88%

12%

0%

81%

19%

0%

75%

20%

5%

Improving

Stable

Declining Oct-15Oct-14Oct-13

Global respondents US respondents

► The vast majority of executives see the global M&A market remaining strong in 2015–16, with increased positivedealmaking sentiment supported by 2015’s heightened M&A activity.

► Global respondents have caught up with US executives, who were already upbeat about the global M&A picturesix months ago and are even more positive in this survey.

Page 6 Transaction accounting and reporting

Deal intentions continue to grow — especially inthe US — driven by improving deal fundamentals

Do you expect your company to actively pursue acquisitions in the next 12 months?

57%

69%

76%

37%

46%

69%

44%

51%

58%

Likelihood ofclosing

acquisitions

Quality ofacquisition

opportunities

Number ofacquisition

opportunities

% of positive attitude

45%

60%

65%

18%

31%

55%

32%

49%

55%Oct-15Apr-15Oct-14

US respondentsGlobal respondents

35%

31%40%

56%

59%

41%

29%

33%

61%74%

Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Expectations to pursue an acquisitionGlobal respondentsUS respondents

► Nearly three in four US executives plan a deal in the next year — the highest result the Barometer has recorded.► US executives who see the economy or deal markets as stable but not growing may feel urgency to complete deals

in the near term, ahead of any moderation in confidence; next year’s presidential election is likely also a factor.► Deal fundamentals are up across the board, with particularly strong increases in likelihood of closing deals and

quality of opportunities.

Page 7 Transaction accounting and reporting

US company pipelines, after a drop six monthsago, are gradually rebounding in size

How many deals of all sizes do you have inyour pipeline today?

How do you expect your deal pipeline to changeover the next 12 months?

44%

4%

6%

43%

6%

94%

13%

90%

Oct-14

Apr-15

Oct-15

Increase No change Decrease

US respondents

12%

11%

18%

18%

41%

61%

29%

6%

0%

4%

4%

39%

41%

14%

2%

1

2

3

4

>=5

Oct-15Apr-15Oct-14

► Two-, three- and four-deal pipelines show the strongest growth among US companies.► In April, US companies largely emphasized one-to-two-deal pipelines as smaller dealmakers came off the sidelines;

now, these companies are evaluating a slightly greater number of deals.► As shown in the chart (right), US companies expect to maintain this pace of deal evaluation — very few expect an

increase in pipeline size, but no one expects a decrease.

5 ormore

Page 8 Transaction accounting and reporting

Convergence and blurring of sectors spurringcompanies to consider cross-sector M&A

If you are planning an acquisition in a sector other than your own, please indicate which sector?

48%

52%

93%

7%

I am planning anacquisition

outside of myown sector

I am notplanning anacquisition

outside of myown sector

Global US

I am not planning anacquisition outside ofmy own sector, 7%

I am planning to do anacquisition outside ofmy own sector, 93%

► Companies considering an acquisition outside of their sector may also be evaluating deals within their sector.► Disruptive megatrends are blurring traditional boundaries between sectors, particularly around technology and

industrial processes.

US respondents

n Retail and wholesale, 13%n Government and public sector, 11%n Logistics and distribution, 10%n Manufacturing, 10%n Technology, 8%n Other transportation (incl. rail & truck), 6%n IT hardware and software, 5%n Real estate, 5%n Construction, 4%n Health care/provider care, 4%n Planning acquisition in other sectors, 17%

Acquisitions Note: Please customize deck for yourclient discussion to focus on acquisitions(slides 9-18) or divestitures (slides 19-25)

Page 10 Transaction accounting and reporting

Why complexity arises with acquisitions

The accounting and financial reporting considerations for acquisitions are oftencompounded by several factors, including:

► Differing accounting standards (e.g., USGAAP vs. IFRS) and policies used byeach of the respective entities involved

► Challenges associated with appropriatepurchase price allocation among theacquired assets and liabilities

► Complex technical accounting mattersincluding, but not limited to,consolidation, derivatives and hedging,debt modification, stock-basedcompensation, and foreign currencymatters

► Extent of day-one and day-twoaccounting adjustments, includingpush-down accounting

► Challenges with pro forma financialinformation

► Challenges surrounding a mid-monthclose

► Availability and experience of personnelthroughout the organization to addresscompeting demands such as managingnew accounting standards, installingnew systems or other strategicpriorities.

Page 11 Transaction accounting and reporting

Potential acquisition accounting surprises and pitfallsAssets acquired and liabilities assumed

Focus areas Acquisition date issue and consideration Potential implication

Inventoryadjustments

► Fair value of inventory (e.g., finished goods,work in progress, and raw materials) generallytends to be higher than the book value recordedby the acquiree at the acquisition date.

► Pace of inventory turns could compoundthis problem.

Expected profit margin

Budgeting andforecasting accuracy

Executorycontracts marketassessment

► Executory contracts (e.g., supply contracts oroperating leases) often contain terms that arenot equivalent to market terms.

► If the contracts are off-market, there ispossible asset or liability recognition withsubsequent noncash amortization.

Income or expense fromamortization until the contract iscompleted

Defensive assetdetermination

► Measures acquired defensive assets at fairvalue based on their highest and best use,regardless of intended use.

► Assigns fair values to defensive assets based onmarket participant assumptions, even thoughacquirer-specific assumptions may indicate theasset has little or no value.

Earnings, as a result of potentiallyhigher amortization expense

In-processresearch anddevelopment(IPR&D)consideration

► Recognize IPR&D as indefinite-lived intangibleassets at fair value subject to impairmenttesting.

► Often requires complex evaluations usingmarket participant assumptions.

► Tracking of the capitalized R&D costs isnecessary for impairment testing.

Earnings stability

Page 12 Transaction accounting and reporting

Focus areas Acquisition date issue and consideration Potential implication

Acquiree’sequity-methodinvestment basisdifferences

► Valuing equity-method investments, particularlyfor private companies, can be complex.

► Embedded basis differences (i.e., representingthe acquisition date fair value less the cost of theinvesteees underlying net assets) need to beidentified and accounted for.

Earnings, dependent onidentification and tracking

Earnings stability

Deferred revenuedifferences

► Fair value recognized by the acquirer is differentfrom the deferred revenue recorded on theacquiree’s historical balance sheet, in manycases.

Revenue and earnings

Hedgingdesignation andbreakage

► Hedge designations and documentation needsto be refreshed following a businesscombination to qualify for hedge accounting.

► Mark-to-market accounting could be required,unless done correctly.

Earnings stability, if there isbreakagein hedge accounting

Underestimatingthe effect ofaccounting policyelection choices

► Accounting policy choices could haveimplications on necessary disclosurerequirements, in many cases.

► Policy choices could have implications oninvestor communication.

Earnings stability, depending onpolicy elections made

Valuation matters ► Purchase price allocations could affect keyfuture performance metrics. Budgeting and forecasting accuracy

Lack of attentionto disclosureeffectiveness

► Disclosures that are opaque and do noteffectively tell your story could negatively affectmarket valuation and cost of capital.

Investor and other stakeholderconfidence

Potential acquisition accounting surprises and pitfallsAssets acquired and liabilities assumed (contd)

Page 13 Transaction accounting and reporting

Potential acquisition accounting surprises and pitfallsConsideration transferred matters

Focus areas Consideration matters Potential implication

Settlement ofpre-existingrelationships

► Part of the consideration transferred might relateto an acquirer’s settlement of pre-existingrelationship with an acquiree, even though it’snot specified separately in the transactiondocuments.

► This could potentially lead to earnings impact.

Earnings (post-combination), basedonwhether settlement is favorable orunfavorable.

Replacementawardsaccounting

► Replacement awards may relate to pre- or post-combination services.

► Fair value of the new awards may be greater,which could have an impact on earnings.

► Accelerated vesting with no future servicerequirement leads to earnings impact.

Earnings (post-combination)

Restructuringcharges

► Charges restructuring costs initiated orrequested by the acquirer, even though incurredby the acquiree, to post-acquisition earnings.

Earnings (post-combination)

Transaction costs► Charges transaction costs paid by the acquiree

that would otherwise be incurred by the acquirerto earnings.

Earnings (post-combination)

Page 14 Transaction accounting and reporting

Focus areas Consideration matters Potential implication

Contingentconsideration

► Earn-out provisions require careful analysis ofterms as they might be classified on the balancesheet as an equity arrangement or a liability.

► Treats earn-out provisions based on continuingemployment as employee compensationexpense instead of contingent consideration.

Earnings (post-combination),if liability classification

Earnings stability

Options andderivativesassociated withnon-controllinginterest

► These can be highly technical and theaccounting outcome is affected by certainfeatures that require careful analysis. Earnings stability

Financialinstruments usedto hedge risksassociated withtransactions

► Sometimes, instruments are used as economichedges of various risks related to a transaction.

► Generally, treated as freestanding instrumentson acquirer’s books but complexities exist.

► Costs and proceeds from entering into theseinstruments (including subsequent gains/loss)are generally not part of considerationtransferred.

Earnings stability

Noncash assetstransferred

► Consideration might include the transfer ofassets that the acquirer previously recognized inits financial statements at historical or amortizedcost.

► Acquirer may need to recognize gains/losses tothe extent acquisition date fair value differs.

Earnings

Potential acquisition accounting surprises and pitfallsConsideration transferred matters (contd)

Page 15 Transaction accounting and reporting

Potential acquisition accounting surprises and pitfallsConsideration transferred matters (contd)

Focus areas Consideration matters Potential implication

Reimbursementarrangements

► Sometimes, consideration transferred by theacquirer could include amounts to reimbursethe acquiree or its former owners for paymentsmade on the acquirer’s behalf.

► These are accounted for separately from thebusiness combination.

Earnings stability

Compensationarrangements

► Compensation arrangements could relate to pre-combination services, post-combination service,or a combination of the two.

► These are not always straightforward andrequire significant judgment.

Earnings (post-combination), ifamount attributed to post-combination services

Page 16 Transaction accounting and reporting

Reporting units Segment reporting► Acquisitions, particularly those that are large scale,

sometimes lead to a reassessment of reporting unitsfor purposes of reporting and impairment testing.

► New reporting units may be identified.

► New reporting units could impact future impairmentanalysis and SOX 404 testing.

► Acquisitions could change the financial informationused by the acquirer’s chief operating decision-maker(CODM) to make decisions about the company.

► The impact on the determination of operating andreportable segments may potentially affect investorcommunication and scrutiny.

Measurement period Financial reporting and disclosures► Adjustments to business combination accounting may

need to be recognized in the income statement ifdisclosures failed to indicate that the acquirer waswaiting on information.

► The 12-month measurement adjustment rule period isnot firm.

► New Accounting Standards Update (2015–16) –eliminates requirement to account for measurement-period adjustments retrospectively and instead,recognizes the adjustment during the period theamount is determined.

► The number of years (one, two or three) for whichaudited financials must be present generally dependson the significance of the acquired business.

► Measurement of significance can be challenging, asit depends on particular facts and circumstances.

► Consideration should be given to the availability ofinformation, if reporting is necessary.

► Pro forma, including various adjustments may beneeded.

Other key considerationsDisclosure matters

Page 17 Transaction accounting and reporting

Other key considerationsGAAP conversion matters

Number and nature of conversion issues Historical data gaps► Corporate structure, number of legal entities,

complexity of transactions, and nature of businessand industry can dictate issues.

► Current reporting, policy elections and judgmentsmade also play a role.

► IFRS provides exemptions in many areas for entitiesapplying IFRS for the first time, which can alleviatesome of the work to restate historical balances.

► US GAAP contains no similar exemptions, effectivelyrequiring entities to apply US GAAP as if it hadalways been applied. Entities may find it challengingto obtain historical data.

Reporting deadlines Policy alignment► After a transaction closes, the time before the next

filing deadline is often very short, requiring thatmultiple work streams work in tandem.

► Adjustments may be necessary to align financialreporting with the appropriate basis of accounting.

► Estimation methodologies and judgment may differ,potentially leading to further adjustments (e.g.,provisions).

Page 18 Transaction accounting and reporting

Other key considerationsFact-specific matters

Step-acquisitions Incomplete valuation scoping► Complex area of accounting could lead to gain or loss

recognition on the effective settlement of acquirer’spreviously held interest.

► Additional areas requiring fair value measurementmay be discovered later in the process.

► Incomplete valuation scoping (e.g., such as off-balance sheet contracts or equity methodinvestments in private companies) may delay thecompletion of business combination accounting andlead to additional measurement-period adjustments.

► Incomplete valuation scoping could lead to post-closeearnings adjustments if the ‘allocation window” hasclosed.

Disputes with sellers Internal controls over financial reporting► Disputes often arise due to disagreements over

contingent consideration, working capital adjustments,and the availability and accuracy of financialstatements.

► Disputes could lead to a negative impact onpost-combination earnings.

► Acquirers should act early in the integration processto confirm that controls of the acquired business aredesigned and operating at a level that will preventand detect material misstatement in the consolidatedfinancial statements.

Divestitures Note: Please customize deck for yourclient discussion to focus on acquisitions(slides 9-18) or divestitures (slides 19-25)

Page 20 Transaction accounting and reporting

Why complexity arises with divestitures

► The number of countries or legal entities involved, including the accountingframework applied

► Complexities involved with establishing and estimating corporate cost allocations► Evaluating the balance sheet for the carve-out financial statements, including the

pushdown of acquisition adjustments, debt, goodwill and intangible assets,employee benefits, income taxes, contingencies as well as considering impairmenttesting for the historical periods

► Challenges involved with preparing carve-out financial statements anddisclosures on the basis of the reliability and consistency of historical financialreporting systems and processes, and the use of smaller materiality thresholds

► Potential changes in the carve-out business resulting from acquisitions,divestitures, restructurings or reorganizations

► Segment reporting if required

► Accounting policy and other judgment assessments pre- and post-transaction

The accounting and financial reporting requirements for divestitures are oftencompounded by:

Page 21 Transaction accounting and reporting

Potential divestiture accounting surprises andpitfalls

Focus areas Transaction date issue and consideration Potential implication/value

Basis ofpresentation

► Presentation reflects the track record ofmanagement and the evolution of the businessas if it were a stand-alone entity.

► Must include all relevant activity that has beenand can be expected to be repeated.

► Inclusion/exclusion in the deal may not alwayscorrelate to inclusion/exclusion in carve-outfinancial statements.

► Mitigate potential SEC challenge relatedto the presentation and acceptability ofthe carve-out financial statements andsave time

Accounting policyassessment pre-and post-transaction

► Assessment of whether existing RemainCoaccounting policy is appropriate at the CarveColevel (if material to carved-out financialstatements).

► More appropriate policy may triggerhistorical accounting implications andchanges in the carve-out financialstatements

Corporate costallocations

► Costs historically allocated requirereassessment to determine all “costs of doingbusiness” are captured.

► Consider treatment of intercompany balancesand potential imputed interest.

► Mitigate potential SEC challenge ofallocation methods

► Required disclosures

Employee benefitplans

► Existing benefit plans require analysis of plansponsor and regulatory requirements of planretention (in certain municipalities).

► Consider determination of costs associated with“spinnor”.

► Determine impact of including/excludingin the carve-out financial statements andthe level of disclosure required

Page 22 Transaction accounting and reporting

Potential divestiture accounting surprises andpitfalls

Focus areas Transaction date issue and consideration Potential implication/value

Capital structureconsiderations(intercompany,equity and debt)

► Consider parent company equity related to cashand noncash settlement of balances isconsidered.

► Need full assessment of all accumulated othercomprehensive income (AOCI) forhistorical appropriateness.

► Has been a recent focus of SEC so cleardocumentation and disclosuresurrounding the activity and relationshipis required

Segment andreporting unitanalyses

► Need analysis of segment reporting (post-spin)as well as reporting unit identification forimpairment testing for all historical periods

► May yield a historical impairment chargenot previously required under the parentsimpairment testing (i.e., differingreporting units, etc.)

Long-lived assetimpairment

► Consider legal ownership of long-lived assets.► Lower materiality threshold could give rise to

long-lived asset impairment.

► May yield a historical impairment chargenot previously identified

Page 23 Transaction accounting and reporting

Potential divestiture accounting surprises andpitfalls

Focus areas Transaction date issue and consideration Potential implication/value

Carve-outtax provision

► Consider historical separate tax provisions forCarveCo – three-years audited and five-years intable (if applicable)

► Consider reassessment of:► Effective tax rate► Deferred tax assets and liabilities► Valuation allowances► Reserves for tax contingencies

► Understanding the requirements (andavailability of information (if applicable)upfront at the CarveCo level will helpestablish a timeline for the carve-outfinancial statements

Stock-basedcompensation

► Determine how plan allows for adjustments tooutstanding options (anti-dilution clauses, etc.)is reviewed.

• Modifications could cause incrementalcompensation costs

Accumulatedothercomprehensiveincome (AOCI)

► Identify AOCI balances specific to the carve outoperations (foreign currency, derivatives,pension, etc.).

► Challenges in transaction timeline due tothe accumulation of balances

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Segment reporting Goodwill► Segment disclosure based on RemainCo’s

management’s new structure

► Allocation methodology to be assessed

► Identified reporting units to be reassessed

► Allocation of goodwill to DiscOps

► Assessment of goodwill impairment

Income taxes Stock-based compensation► Tax treatment of transaction

► Tax basis

► Deferred tax assets (DTAs) and deferred tax liabilities(DTLs)

► Foreign earnings consideration

► Spun out employees entitled to Remainco shares?

► Change in control provisions

► Adjustment to existing grants

► Accelerated vesting terms

RemainCo considerations

Page 25

Discontinued operations Held-for-sale criteria► Timing of discontinued operations “DiscOps”

disclosure

► Disposal by distribution – Spinco held for use untildistribution

► Disposal by sale – If Spinco meets “held for sale”criteria can be recorded as discontinuedoperations prior to disposal

► Management commits to sale

► Available for immediate sale

► Active program to locate buyer

► Sale is probable

► Sale price resembles fair value

► No significant changes to plan anticipated

RemainCo considerations

EY’s transaction accounting and reportingservices

Page 27 Transaction accounting and reporting

How EY can helpFAAS in the transaction life cycle

Transactionlifecycle

► Technical accounting consultations anddiligence assistance

► Accounting implications of alternativeconsiderations

► GAAP comparisons (e.g., USGAAP vs. IFRS forinternational acquisitions)

► Policy differences► Assistance with regulatory

filing requirements

► Determining acquisitionimpact (“day one”)

► Managing requiredadjustments (“day two”)

► Accounting for legal entity andgroup reconstruction

► Financial processimprovement, e.g., accountingpolicy manual and alignment

► Conversions assistance► Ad hoc accounting support due to

regulatory change or complextransactions

► Treasury management(including derivatives portfolio)

► Management of reserves► Disclosure effectiveness

► Financial reporting assistancerelevant to:► Capital raising► Vendor due diligence► Pre-exit structuring assistance

► Post-exit structuringassistance (financialreporting)

► Financial statement closeprocess

Page 28 Transaction accounting and reporting

Transaction accounting and reportingCustomized to your transaction needs

Some of our services for audit clients and their affiliates may be more limited in order to comply with applicableindependence standards. Please reach out to your EY contact for further information.

Page 29 Transaction accounting and reporting

What benefits can you expect?

Pre-dealphase

► Detailed knowledge of transaction accounting risks and ways to manage those risks, plusinformation to bridge any gaps

► Documentation of a transaction structure that meets your tax and accounting purposes, plusunderstanding of the effects of accounting harmonization

Contractingphase

► Understanding of impacts of the transaction under various alternative scenarios► Understanding of the accounting effects of various contract terms► Clear guidance to help decision-makers

Implementingphase

► Appropriate accounting for the transaction in the financial statements► Greater understanding of the effects of accounting issues on covenants

Post-dealphase

► More efficient project execution► More effective conversion of acquiree's accounting to IFRS or US GAAP (as relevant)

Overall

► Confidence that you have properly considered the accounting and reporting requirementsand related deal points in all phases of the transaction

► Reduced risk of delays that could impact transaction execution► Reduced stress on your organization during the deal and in post-deal integration

EY will work with you as you make decisions during all phases of the project. Working in collaboration, we can help youdevelop:

About EY

Page 31 Transaction accounting and reporting

Why EY?

Experience andtechnicalknowledge

► Consistent and dedicated transaction accounting teams with in-depth experience, serve bothprivate equity and corporate companies in transactions.

► Specialists who combine technical accounting knowledge and practical experience withbusiness combination and divestiture transactions help you manage the process ofaccounting and financial reporting for a transformational event.

Multidisciplinaryteams

► Strong teaming with our transaction advisory, transaction tax and other service lines allowsus to quickly bring you the most relevant and experienced resources, with the insight andindustry expertise to address your needs.

Tools andsupports

► Proven tools and enablers help to create efficiencies that may translate into fasterperformance and lower cost, while maintaining high quality.

► Powerful technology-enabled services can help you address your unique accounting andfinancial reporting requirements.

Globalteams andframework

► Multinational clients are served by international transaction accounting teams located in allmajor countries.

► A globally consistent approach to deliver transaction accounting and reporting services.

Overall► Dedicated teams with extensive transaction accounting know-how, can quickly respond to

your needs.► Powerful tools and enablers supporting the efficient and effective implementation of

transactions.

Page 32 Transaction accounting and reporting

Michael CapiloutoTransactionAccounting and Reporting Leader, Americas

[email protected]+1 212 773 2248

Fred CliffordFAAS Leader, Canada

[email protected]+1 416 943 248

Saul GarciaFAAS Leader, MeCAR

[email protected]+525552838612

Alexandre HoeppersFAAS Leader, South America Region

[email protected]+55 11 2573 3658

Noam CanettiFAAS Leader, Israel

[email protected]+972 3 6232588

Financial Accounting Advisory ServicesContacts

EY | Assurance | Tax | Transactions | Advisory

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