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5.4 Merger accounting model
Publication date: 27 May 2020
us NFP guide
For accounting purposes, a merger occurs when two or more NFPs join together in their entirety to create a new organization. The governing bodies of the combining entities cede control of their respective entities to a new entity with a newly-formed governing body.
The requirements for merger accounting are set forth in the Merger of Not-for-Profit Entities subsections of ASC 958-805. Merger accounting has no business entity counterpart in ASC 805; it is unique to NFPs.
NP 5.3 discusses the FASB’s considerations for distinguishing between a merger and an acquisition. According to ASC 958-805-55-1, the ceding of control by all parties to a new entity is the sole definitive criterion for identifying a merger. In establishing a merger framework within the model, the FASB indicated their expectation that there would be a relatively high hurdle for qualifying to use merger accounting. The evaluation of whether all parties have ceded control must be based on a preponderance of the evidence.
Question NP 5-3 addresses the composition of the new entity’s governing board after a merger.
Question NP 5-3
In order for a combination of two NFPs to be considered a merger, must the governing board of the new entity have exactly equal representation from each entity?
In order for a combination of two NFPs to be considered a merger, must the governing board of the new entity have exactly equal representation from each entity?
PwC response
No. In fact, the FASB provides an example illustrating a combination that is accounted for as a merger in which the initial board of the combined entity has 15 members, with 9 appointed by one entity and 6 appointed by the other (see ASC 958-805-55-9 through ASC 958-805-55-16). The example analyzes the characteristics of the process leading to the combination, the participants in the combination, and the combined entity. Based on the preponderance of the evidence, it concludes that both entities have ceded control to a new entity in a transaction that would be accounted for as a merger.
The guidance for determining whether a combination is a merger is principles based and all relevant facts and circumstances of a particular transaction should be considered. For example, if the bylaws of the combined entity indicate that major decisions require a simple majority vote, and one of the combining organizations has one more board member than the other, then the entity with the additional board member would always be able to dictate the board’s decisions. However, if major decisions require a supermajority vote, an imbalance of board members might be less of a concern. It is important to bear in mind that no single indicator is by itself determinative, and that decisions should be made based on the preponderance of the evidence, using professional judgment.
Question NP 5-4 addresses whether cash consideration impacts the ability to qualify as a merger.
Question NP 5-4
Would a transfer of cash consideration preclude the use of merger accounting?
Would a transfer of cash consideration preclude the use of merger accounting?
PwC response
No. Although a merger typically is accomplished without a transfer of cash or other assets to any of the participating entities or any of their owners, members, sponsors, or other designated beneficiaries, we believe the presence or absence of consideration is not a determinative factor in distinguishing a merger from an acquisition.
Question NP 5-5 addresses qualification as a merger when one entity is a subsidiary.
Question NP 5-5
A freestanding hospital is combining with an entity that is a subsidiary of a hospital system. Can merger accounting be applied if one of the combining NFPs is a subsidiary of a larger organization?
A freestanding hospital is combining with an entity that is a subsidiary of a hospital system. Can merger accounting be applied if one of the combining NFPs is a subsidiary of a larger organization?
PwC response
No. If one of the combining entities continues to be operated as the subsidiary of another entity, then the entities have not come together in their entirety, and a new entity has not been created. In substance, this is an acquisition of the freestanding hospital by the system, using one of its subsidiaries to effect the acquisition.
5.4.1 Accounting requirements under merger model
Mergers are accounted for using the framework described in Figure NP 5-6, known informally as the “carryover method.” The assets and liabilities of the combining entities as of the merger date (the date the combination becomes effective) are combined using their historical amounts, adjusted as necessary to conform the combined entities’ respective accounting policies. Operations of the new entity are reported from the merger date forward, consistent with the FASB’s view that in a merger, a new entity (with no historical operations) emerges from the formerly separate organizations.
Figure NP 5-6
Merger model – accounting framework
Merger model – accounting framework
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If the merging entities used different accounting policies, those differences must be conformed so that the new entity will have a consistent accounting policy. For example, as discussed at NP 6.7.2.3, GAAP allows NFPs to elect an accounting policy of reporting donor-restricted contributions as unrestricted revenues if the restrictions are satisfied in the same reporting period that the contributions were received. One of the combining entities might have elected this accounting policy, while the other did not. If conforming the accounting policies results in an adjustment to financial statement amounts, those adjustments are reflected in the opening balances (which are the balances carried forward from the financial statements of the merging entities), with disclosure made of the nature and amount of any significant adjustments.
The new NFP must disclose information that enables its financial statement users to evaluate the nature and financial effect of the formation transaction. ASC 958-805-50-1 through ASC 958-805-50-6 identify the required disclosures, including certain required supplemental information (see NP 5.4.2). ASC 958-805-55-32 through ASC 958-805-55-37 illustrate disclosures that describe the merger, significant unrecognized assets (for example, conditional contributions receivable), any significant adjustments necessary to conform accounting policies, and identify the major classes of assets, liabilities, and net assets combined. AAG-NFP chapter 3 and AAG-HCO chapter 12 provide additional discussion.
Question NP 5-6 addresses one of the differences between acquisition and merger accounting.
Question NP 5-6
In a merger, should the opening balance sheet of the new entity recognize assets and liabilities that were not included in the predecessor entities’ historical financial statements because they did not meet the GAAP requirements for recognition (for example, internally generated intangible assets)?
In a merger, should the opening balance sheet of the new entity recognize assets and liabilities that were not included in the predecessor entities’ historical financial statements because they did not meet the GAAP requirements for recognition (for example, internally generated intangible assets)?
PwC response
No. ASC 958-805-25-7 states that the new entity should not recognize additional assets and liabilities that GAAP did not require or permit the combining entities to recognize in their historical financial statements.
Question NP 5-7 addresses whether the merged entity can change the predecessor entities’ decisions regarding election of the ASC 825-10 fair value option.
Question NP 5-7
Can the newly merged entity elect or reverse the instrument-by-instrument elections made under the fair value option subsections of ASC 825-10 by the predecessor entities’?
Can the newly merged entity elect or reverse the instrument-by-instrument elections made under the fair value option subsections of ASC 825-10 by the predecessor entities’?
PwC response
No. According to ASC 958-805-30-3, because the carryover method does not reflect a fresh-start measurement, a merger is not an event that permits the election of accounting options that are restricted to the entity’s initial acquisition or recognition of an item (or the reversal of a previous election), as is the case with the ASC 825-10 fair value option. Therefore, decisions made by the predecessor entities regarding election of the ASC 825-10 fair value option for particular assets or liabilities carry forward into the financial statements of the new entity. For example, assume that NFP A and NFP B each have an equity method investment. NFP A elected the ASC 825-10 fair value option for subsequent measurement of its investment but NFP B did not. If NFP A and NFP B merge, the new entity cannot reverse NFP A’s prior election of the fair value option for its investment that is carried over to the new entity, nor can it elect the fair value option for Hospital B’s investment. If NFP A had instead acquired NFP B, NFP A would be permitted to elect the fair value option for the investments obtained from NFP B in connection with its initial recognition of the acquired assets.
5.4.2 Required supplemental information for mergers
ASC 958-805-50-3 through ASC 958-805-50-5 describe pro forma disclosures that must be provided for certain mergers involving a conduit bond obligor with publicly-traded debt. ASC 958-805-55-3 identifies these disclosures as required supplemental information (RSI). Standard setters require the reporting of certain information outside the financial statements as RSI when they believe the information is essential to placing the financial statements in their proper context. RSI differs from other types of supplementary information that might accompany financial statements (for example, consolidating schedules that may be voluntarily provided) in that it is mandated by the FASB, and the FASB has established requirements for how it should be presented. ASC 958-805-55-3 specifies that the pro forma information should not be disclosed in the notes to the financial statements, but should instead be provided in a separate schedule that accompanies the financial statements and notes.
The pro forma disclosures are required only when the merger date does not coincide with the beginning of the first annual reporting period (and thus, the initial statement of activities or income statement covers a period of less than twelve months). In those situations, the new NFP must disclose what its revenue, change in net assets without donor restrictions, change in net assets with donor restrictions, and (for HCOs only) performance indicator would have been if the merger had occurred at the beginning of the annual reporting period. If the subsequent year’s financial statements are comparative, the pro forma disclosure for the year of merger must continue to be reported. If disclosure of the pro forma information is impracticable, the entity must disclose that fact and explain why the disclosure is impracticable.
ASC 958-805-55-38 illustrates this disclosure for an entity that does not report a performance indicator.
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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