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5.3 Overview of not-for-profit combinations
Publication date: 27 May 2020
us NFP guide
Like business entities, NFPs may engage in business combinations. The NFP combination accounting model (described in ASC 958-805, Not-for-Profit Entities – Business Combinations) differs from the model applied by business entities in that it distinguishes a merger of two or more NFPs from an acquisition of another entity. That difference, as well as differences in measurement associated with the acquisition model, are justified by characteristics unique to NFP combination transactions, which are described in NP 5.3.1.
The ASC 958-805 model applies to (a) combinations of two or more NFPs and (b) combinations in which an NFP acquires a for-profit entity. It excludes transactions that are not considered business combinations (e.g., asset acquisitions, transactions involving entities under common control). It also excludes acquisitions by for-profit entities (for example, if an NFP parent makes an acquisition using a for-profit subsidiary), which are accounted for using ASC 805. Figure NP 5-3 summarizes the scope of ASC 958-805.
Figure NP 5-3
Scope of ASC 958-805
Scope of ASC 958-805
In scope
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Outside of scope
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If a transaction is a combination, it must be classified as either a “merger of not-for-profit entities” or an “acquisition by a not-for-profit entity.” These terms are defined in the ASC Master Glossary.
Merger of NFP entities: A transaction or other event in which the governing bodies of two or more NFPs cede control to those entities to create a new NFP.
Acquisition by an NFP entity: A transaction or other event in which an NFP acquirer obtains control of one or more nonprofit activities or businesses and initially recognizes their assets and liabilities in the acquirer’s financial statements. When applicable guidance in Topic 805 is applied by an NFP entity, the term business combination has the same meaning as this term has for a for-profit entity. Likewise, a reference to business combinations in guidance that links to Topic 805 has the same meaning as a reference to acquisitions by NFP entities.
Ceding of control by all parties to a new entity is the sole definitive criterion for identifying a merger of NFPs. Similarly, one entity obtaining control over another entity is the sole definitive criterion for identifying an acquisition. When making these evaluations, the NFP-specific definition of “control” is used: the direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise. See NP 5.2.1.
In some cases, it is clear that a transaction is an acquisition, and the identities of the acquirer and acquiree are evident. In others, it is necessary to go through an evaluation process to determine whether a particular transaction is a merger, an acquisition, or another form of transaction (such as formation of a joint venture). ASC 958-805-55-3 through ASC 958-805-55-8 provide indicators, summarized in Figure NP 5-4, to use in evaluating transaction-specific characteristics, such as the process leading to the combination and the characteristics of the combining and combined entities related to governance, control powers, and financial capacity.
Figure NP 5-4
Distinguishing mergers from acquisitions
Distinguishing mergers from acquisitions
Indicators of a merger
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Indicators of an acquisition
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As several of the factors used for identifying an acquirer in the acquisition model (ASC 958-805-55-42 through ASC 958-805-55-46) are similar, that guidance may add helpful perspective on distinguishing mergers from acquisitions.
The determination should consider all the facts and circumstances surrounding the transaction, using professional judgment based on the preponderance of evidence. The guidance is built around principles and indicators, rather than “bright line” prescriptive criteria, due to the complex nature of the determinations in some cases. ASC 958-805-55 includes illustrations that demonstrate how the control criteria (that is, ceding control versus obtaining control) and the indicators would be applied in evaluating the nature of various transactions. Example 1 compares the factors that would lead to a merger conclusion (ASC 958-805-55-15 through ASC 958-805-55-16) to those that would lead to a joint venture conclusion (ASC 958-805-55-17 through ASC 958-805-55-19), using assumptions described in ASC 958-805-55-10 through ASC 958-805-55-14. Example 2 (ASC 958-805-55-20 through ASC 958-805-55-31) analyzes a fact pattern that is determined to be an acquisition.
See AAG-NFP chapter 3 and AAG-HCO chapter 12 for additional discussion.
Question NP 5-2 addresses whether there is a rebuttable presumption that a transaction is an acquisition.
Question NP 5-2
Is there a rebuttable presumption that a transaction is an acquisition that must be overcome in order to use merger accounting?
Is there a rebuttable presumption that a transaction is an acquisition that must be overcome in order to use merger accounting?
PwC response
No. In the Basis for Conclusions of FAS 164 (the standard that underlies this section of the codification), the Board acknowledged that they considered but ultimately decided not to incorporate a rebuttable presumption in the model. The Board concluded that applying the guidance for distinguishing mergers from acquisitions in a neutral manner would generally produce a better result.
5.3.1 Conceptual differences between NFP and business entity combinations guidance
The motivation for NFPs to enter into business combinations can differ significantly from those of business entities. Combinations of business entities are presumed to involve a bargained exchange—a transaction in which each party sacrifices and receives commensurate value—whereas NFP combinations can be motivated by considerations related to their mission as well as financial considerations. Because NFPs lack the types of ownership interests that business entities have, negotiations generally focus on governance and furthering the mission and programs of the entities for the benefit of the public, not maximizing returns for equity holders.
The focus on mission means that many NFP combinations do not involve an exchange of consideration other than the assumption of an acquiree’s liabilities. If cash consideration is paid, it may be unrelated to the fair value of the acquiree, or it may be transferred to an unrelated third party (for example, to establish a charitable foundation). Thus, unlike combinations of businesses, consideration exchanged does not provide evidence of the acquired NFP’s fair value. As a result, market data on NFP combinations is limited, and to the extent available, may not accurately reflect fair value of the underlying transactions.
In many NFP combinations, a significant portion of the economics may be akin to a contribution. For example, an NFP’s governing board might voluntarily surrender control in order to align itself with a larger or stronger NFP (in essence “contributing” the NFP to the larger or stronger entity). Or, an NFP parent might transfer a subsidiary to another NFP in exchange for an amount of consideration that bears no relationship to the subsidiary’s fair value (for example, an amount needed by the parent to fund a retirement obligation).
Despite the differences, the guidance developed for combinations of NFPs (ASC 958-805) is largely based on the guidance applied by business entities (ASC 805) except when departures are justified by characteristics unique to NFP transactions. The principal differences between the accounting models used by NFPs and business entities are highlighted in Figure NP 5-5.
Business entity (ASC 805)
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NFP (ASC 958-805)
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An acquirer must be designated in every combination.
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“True mergers” or “mergers of equals” occur in which none of the combining entities obtain control of the others. Thus, mergers are distinguished from acquisitions and accounted for differently. See NP 5.4.
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Transactions involving business entities are deemed to be bargained exchanges.
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NFP acquisitions typically do not involve a bargained exchange of equal fair value, although those sometimes occur.
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An acquisition is measured using the fair value of the consideration exchanged for control of the acquiree and requires the acquirer to recognize 100% of the fair value of the net assets (“enterprise value”) acquired, which often includes goodwill.
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An acquisition is measured using the fair value of individual assets acquired compared to liabilities assumed and consideration, if any (a “net assets” approach), with the residual recognized as either an inherent contribution received or, in a net deficit acquisition, as goodwill. Goodwill is recognized less frequently than in business entity combinations. See NP 5.5.2.
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Goodwill represents the excess of the amount paid over the fair value of the acquirer. It is recognized as an asset.
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The nature of goodwill recognized by an NFP may differ significantly from goodwill recognized in business entity acquisitions. In certain circumstances, it represents an excess of liabilities assumed over assets acquired; in others, it may be immediately expensed. See NP 5.5.3.2.
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5.3.2 Asset acquisition versus acquisition of a business or nonprofit activity
As noted in NP 5.3 some transactions involve the acquisition of a portion of an entity, rather than a complete entity. The term business or nonprofit activity is used to differentiate such acquisitions that should be accounted for as a business combination from acquisitions of an asset (or a group of assets) that do not qualify as a business combination (and therefore, are accounted for as asset acquisitions under ASC 805-50).
Note about recent standard setting
This section reflects ASU 2017-01, Business Combinations: Clarifying the Definition of a Business, which changes the boundary distinguishing acquisitions of a business or nonprofit activity from acquisitions of assets. For NFPs, ASU 2017-01 is effective for annual periods beginning after December 15, 2018 (that is, calendar 2019 and fiscal 2020), and interim periods within the following year. The guidance is applied prospectively as of the beginning of the period of adoption.
The accounting used for an asset acquisition differs significantly from the accounting for a business combination. For example, in a business combination, each asset and liability acquired is measured at fair value and either goodwill or an inherent contribution is recognized, as discussed at NP 5.5. In an asset acquisition, however, the cost of the acquisition is allocated among the assets acquired on a relative fair value basis, and no goodwill or inherent contribution is recognized. Another difference is that transaction costs are capitalized in an asset acquisition but are expensed in a business combination. See PPE 2 for more information on accounting for asset acquisitions.
ASC 805-10-55-3A through ASC 805-10-55-9 provide guidance on how an entity should evaluate whether it has acquired a business or instead, acquired an asset or group of assets that is akin to an asset acquisition. ASC 958-805-55-40 extends that guidance to include nonprofit activities.
Excerpt from ASC 958-805-55-40
In applying the guidance in paragraphs 805-10-55-3A through 55-9, references to a business or businesses also refer to a not-for-profit activity or not-for-profit activities, and references to the three elements of input, process, and output also include outputs that provide or have the ability to provide goods or services to beneficiaries, customers, or members that fulfill the purpose or mission for which an NFP exists.
First, the acquiring entity should evaluate whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset (or group of similar identifiable assets), using a screening test described in ASC 805-10-55-5A. ASC 805-10-55-5B provides guidance on what qualifies as a single identifiable asset.
Excerpt from ASC 805-10-55-5A
If substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not considered a business.
A single identifiable asset includes any individual asset or group of assets that could be recognized and measured as a single identifiable asset in a business combination. However, for purposes of this evaluation, the following should be considered a single asset:
- A tangible asset that is attached to and cannot be physically removed and used separately from another tangible asset (or an intangible asset representing the right to use a tangible asset) without incurring significant cost or significant diminution in utility or fair value to either asset (for example, land and building)
- In-place lease intangibles, including favorable and unfavorable intangible assets or liabilities, and the related leased assets.
If a transaction qualifies as a single asset (or group of similar assets) under this test, it is not considered a business or nonprofit activity, and is accounted for under the “asset acquisition” subsections of ASC 805-50. Example NP 5-2 illustrates application of the screen.
If the screen does not classify the transaction as an acquisition of a single asset (or group of similar assets), the acquirer would need to analyze the relationships among the inputs, processes, and outputs acquired to determine whether the transaction meets the definition of a business or nonprofit activity, which can be judgmental and complex.
For more information on this analysis, see BCG 1.2.
EXAMPLE NP 5-2
Business combination vs asset acquisition
Business combination vs asset acquisition
NFP Health System (“System”) purchases a medical office building. At the acquisition date, the building is fully leased out to tenants, and System becomes a party to all of the existing leases at closing. System also hires the current leasing and other personnel involved with the operations of the property.
Would this transaction be accounted for as a purchase of property (an asset acquisition) or an acquisition of a business or nonprofit activity (a business combination)?
Analysis
To answer this question, System would need to perform a screen test to determine if substantially all of the fair value of the gross assets acquired (the land, building, property improvements, and in-place leases) is concentrated in a single asset or group of similar assets. According to ASC 805-10-55-5B, the building and property improvements are attached to the land and cannot be removed without incurring significant cost, and the in-place lease intangible is combined with the related real estate. Because substantially all of the fair value of the gross assets acquired is concentrated in a single asset (the combined land, building, and lease intangible), the acquisition would not be considered a business or nonprofit activity. Thus, System would account for the acquisition using the “asset acquisition” subsections of ASC 805-50.
If System instead had acquired dissimilar assets in the transaction (for example, a medical office building and a retail facility), the “acquired set” would pass through the screen and further analysis of the inputs, processes, and outputs would be required.
5.3.2.1 Definition of nonprofit activity
The term nonprofit activity is used in many areas of GAAP (for example, business combinations, discontinued operations, and asset disposals) and is defined in the ASC master glossary.
Nonprofit activity: An integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing benefits, other than goods or services at a profit or profit equivalent, as a fulfillment of an entity’s purpose or mission (for example, goods or services to beneficiaries, customers, or members). As with a not-for-profit entity, a nonprofit activity possesses characteristics that distinguish it from a business or a for-profit business entity.
According to ASC 958-805-55-40, nonprofit activity is the not-for-profit counterpart of the definition of a business.
Excerpt from ASC 958-805-55-40
In addition to the term business, this Subtopic also uses the term nonprofit activity to differentiate an acquisition of an integrated set of activities and assets that is within its scope from an acquisition of a group of assets that is outside its scope. It builds on the definition of a business in defining a nonprofit activity; each is defined as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing benefits.
The nature of the benefits provided distinguishes a business activity from a nonprofit activity. For a business activity, the primary focus is on economic benefits, such as revenues, while for a nonprofit activity, benefits are identified in terms of achieving a purpose or mission (which may or may not generate revenues).
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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