There are a number of items that should be recognized in income under ASC 805, including transaction costs, restructuring charges, revaluations of contingent consideration, adjustments to acquired contingencies, gain or loss on previously held equity interests, credit loss expense for purchased financial assets that are not credit impaired (applicable after the adoption of ASU 2016-13) and bargain purchase gains.
Reporting entities will need to exercise judgment in determining the appropriate income statement classification for these items based on their nature. Generally, the income statement recognition of items in a business combination should mirror their recognition outside of a business combination, and most items recognized in income should be classified as part of operations. For example, transaction costs should typically be recorded in operations, particularly if the acquiring reporting entity has a history of making acquisitions or expects to make more acquisitions in the future. Additionally, items that may occur as part of the business combination, but that are recognized separate from the business combination, such as employee compensation arrangements for postcombination services and the settlement of certain preexisting relationships, should generally be recorded in the income statement based on their nature.
Adjustments to an indemnification asset for an income tax liability should be recorded in pretax income, not as a part of income tax expense. This is because ASC 740 narrowly defines the term “income taxes” as domestic and foreign taxes based on income. Recoveries under an indemnification agreement do not fall within the scope of this definition. Therefore, although dollar-for-dollar changes in the income tax liability and the related indemnification asset (subject to the limitations of the indemnity and collectability) will be neutral on an after-tax basis, pretax income and tax expense will change when the amount of the income tax liability and related indemnification asset change.
Changes in fair value measurements of items such as contingent consideration may contain elements of changes in assumptions used in the determination of fair value and changes due to the passage of time (the time value of money). Generally, we would not expect reporting entities to separate a change in fair value into its components; we would expect the reporting entities to record the entire change as a component of operating income.
On the balance sheet, an acquirer's obligation to pay contingent consideration or contingent right to receive a return of some consideration paid (i.e., contingently returnable consideration) is recognized as an asset, a liability, or in shareholders' equity. See BCG 2.6.4 for further details on the classification.
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