February 15, 2017
The Financial Accounting Standards Board’s guidance on the definition of a business could be of special benefit to the real estate, pharmaceutical, biotech and financial services industries, but doesn’t go as far as some had hoped.
FASB issued the accounting standards update last month (see FASB clarifies business definition). The update clarifies whether transactions should be treated as asset acquisitions or business combinations.
Julie Valpey and Brandon Landas, partners in BDO’s National Securities and Exchange Commission Department, see more of an impact for public companies in the real estate industry.
“Acquisitions of real estate, which previously were accounted for the most part under ASC 805, Business Combinations, will now not be considered a business under the new standard and now will be accounted for as an asset acquisition,” said Valpey. “It doesn’t change the accounting a whole lot. There will still be purchase price allocations to the various real estate assets acquired. There will still be intangibles related to leases. I think probably the biggest difference in the accounting would be that acquisition costs will now be capitalized, as opposed to being expensed under the business combination guidance.”
Landas anticipates most real estate will be considered an asset acquisition under the new guidance because land, buildings and related intangibles will be counted as a single asset. “They still have to go through the same procedures,” he said. “It’s just allocated differently so the purchase price will be the total of what gets allocated now on a relative fair value basis, and then you capitalize the acquisition costs.”
He sees some impact in the health care real estate space, which are treated slightly differently for asset acquisitions. “But that same asset acquisition literature that we’ve been operating under doesn’t change,” he said. “It’s really just, ‘What is an asset?’”
Beyond real estate, the new guidance could affect other types of industries. “It will impact any company that is doing an acquisition,” said Valpey. “They will have to evaluate under this new guidance, and where it meets the definition of a business, it will be a business combination. But they will have to go through the steps that are in this new guidance where you look at whether it’s a single asset, or the purchase price is predominantly related to a single asset. If it is, then it would be an asset purchase. If it’s not, then you would go to business combination accounting. So it does apply to all industries, all companies.”
Along with real estate, Landas sees an impact on the pharmaceutical, biotech and financial services industries.
“There are a lot of times when you can acquire a license agreement,” he said. “Under the previous literature that in itself could make it a business combination, so things like that will now be asset acquisitions as well. I think there’s also some application to some of the financial industries. So real estate, pharma, biotech, and the financial industry are probably where it would show up. It’s classification of an asset versus a business.”
However, even for the real estate industry, the new guidance won’t have as far-reaching an impact as some had anticipated.
“I do think a lot of the executives at real estate companies are thinking it will have a bigger impact, but they realize that’s not the case once you dig into it,” said Landas. “From my understanding, for pharma, it could have a much bigger impact with license agreements.”
Some real estate executives had expected the Securities and Exchange Commission to make changes in its rules, but that hasn’t happened yet.
“I know a lot of the public real estate companies were hoping that this would cross over to the SEC’s rule where real estate acquisitions require that financial statements be filed, and if it was a business combination under FASB, it certainly met the rules under the SEC’s guidance,” said Valpey. “I think a lot of public companies were thinking that this would change the SEC’s requirements to where if it was not a business under the FASB rules, they would not have to file those financial statements. But we have not heard that the SEC is changing its guidance to where those would not be required.”
The issue may become a topic for discussion for the SEC, but Landas and Valpey don’t expect the SEC rules to change.
“I think public real estate companies were thinking it would be a big source of relief, but so far it doesn’t seem like that’s going to happen anytime soon,” said Valpey.
Landas pointed out there are two different types of definitions. “The SEC rule for significant acquisitions under Rule 305 for regular businesses, or 314 for real estate, requires financials of the target to be filed by the public company,” he explained. “And the definition of a business for those is generally based on continuity of revenues. Under real estate if you had a lease in place and there’s a leasing history and leasing revenues, then that would meet the definition of a business for SEC reporting purposes, but now that’s different under GAAP. So the FASB changed it, but it still doesn’t necessarily adjust the SEC rules.”
Neither Landas nor Valpey anticipate the new guidance will have much of an impact on accounting firms that are doing mergers and acquisitions with each other.
“The new guidance is focused on if you’re acquiring substantially all of something,” said Landas. “I think if you’re acquiring an accounting firm, there would be a lot of different pieces. You would be buying their real estate and their property. You would buying their assembled workforce. You would be buying a bunch of different things, so I think it would probably not get to that point in that scenario.”
Many companies may decide to adopt the new guidance early, as of the beginning of this year, rather than waiting until the end of the year.
“I think most real estate companies are probably going to adopt it Jan. 1, 2017, which would be a year early, just to have a clean cutoff,” said Landas. “My guess is that most of them would want to adopt it early to give them a little bit of the benefit of not having to immediately expense the acquisition costs. But I don’t know that there’s necessarily going to be that many that are actually going to push it back to Q4, which they technically could.”
For publicly traded companies, the update takes effect for annual periods beginning after Dec. 15, 2017, including interim periods within those annual periods. For all other companies and organizations, the update is effective for annual periods beginning after Dec. 15, 2018, and interim periods within annual periods beginning after Dec. 15, 2019.
“For acquisitions in Q4 of 2016 it could be adopted because those acquisitions have not been in financial statements presented to the public yet,” said Landas. “Then it has to be adopted January 1 of 2018. My feeling is that most are going to adopt it for any transactions after Jan. 1, 2017, so they would essentially be adopting it one year early for any acquisitions they do in 2017.”