Pushdown accounting is a method used in business combinations 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 FASB 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
- 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 goodwill 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 consolidated financial statements
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 deferred tax assets 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
- 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