Push-Down Accounting in Business Combinations

12.2 Push-Down Accounting

Push-down accounting is a financial reporting technique used in the context of business combinations, where the acquirer’s basis of accounting is “pushed down” to the acquired entity’s financial statements. This method provides a clear representation of the new ownership’s perspective by reflecting the fair value of the acquired assets and liabilities directly on the acquired company’s books. In this section, we will delve into the principles, application, and implications of push-down accounting, particularly within the framework of Canadian accounting standards.

Understanding Push-Down Accounting

Push-down accounting allows the acquired company to revalue its assets and liabilities to reflect the purchase price paid by the acquirer. This approach can simplify the consolidation process by aligning the acquired entity’s financial statements with the acquirer’s accounting basis. It is particularly relevant in scenarios where the acquired company will continue to operate as a standalone entity or when separate financial reporting is required.

Key Concepts

1. Revaluation of Assets and Liabilities: Under push-down accounting, the acquired company’s assets and liabilities are revalued to their fair values at the acquisition date. This revaluation aligns the acquired entity’s financial statements with the acquirer’s purchase price allocation.

2. Goodwill Recognition: Goodwill, representing the excess of the purchase price over the fair value of identifiable net assets, is recognized on the acquired company’s balance sheet. This treatment reflects the premium paid by the acquirer for expected future economic benefits.

3. Equity Adjustment: The equity section of the acquired company’s balance sheet is adjusted to reflect the new ownership structure. This adjustment may involve eliminating the pre-acquisition retained earnings and other equity components.

Regulatory Framework

In Canada, push-down accounting is not explicitly mandated by the International Financial Reporting Standards (IFRS) or the Accounting Standards for Private Enterprises (ASPE). However, it is permitted under certain conditions, particularly when the acquired company becomes wholly owned by the acquirer. The decision to apply push-down accounting should be based on the relevance and reliability of the financial information provided to users.

Application of Push-Down Accounting

The application of push-down accounting involves several steps, which we will explore in detail:

Step 1: Determine the Applicability

Before applying push-down accounting, it is crucial to determine whether it is appropriate for the specific business combination. Factors to consider include:

• Ownership Structure: Push-down accounting is typically applied when the acquired company becomes wholly owned by the acquirer.
• Financial Reporting Requirements: Consider whether separate financial statements for the acquired company are necessary and if push-down accounting would enhance the relevance and reliability of the information.

Step 2: Revalue Assets and Liabilities

Once the decision to apply push-down accounting is made, the next step is to revalue the acquired company’s assets and liabilities to their fair values at the acquisition date. This process involves:

• Identifying Identifiable Assets and Liabilities: Determine which assets and liabilities are subject to revaluation. This includes tangible assets, intangible assets, and liabilities.
• Fair Value Measurement: Use appropriate valuation techniques to measure the fair value of each identifiable asset and liability. This may involve market-based, income-based, or cost-based approaches.

Step 3: Recognize Goodwill

Goodwill is recognized on the acquired company’s balance sheet as the excess of the purchase price over the fair value of identifiable net assets. The calculation of goodwill involves:

• Purchase Price Allocation: Allocate the total purchase price to the identifiable assets and liabilities based on their fair values.
• Goodwill Calculation: Subtract the fair value of identifiable net assets from the total purchase price to determine the goodwill amount.

Step 4: Adjust Equity

The equity section of the acquired company’s balance sheet is adjusted to reflect the new ownership structure. This involves:

• Eliminating Pre-Acquisition Equity: Remove the pre-acquisition retained earnings and other equity components from the balance sheet.
• Recording New Equity: Record the new equity structure based on the acquirer’s investment and any additional adjustments resulting from the revaluation process.

Practical Examples and Case Studies

To illustrate the application of push-down accounting, let’s consider a practical example:

Example: Acquisition of TechCorp by Innovate Inc.

Innovate Inc. acquires 100% of TechCorp for a purchase price of $10 million. The fair value of TechCorp’s identifiable net assets is $8 million. Under push-down accounting, TechCorp’s financial statements would be adjusted as follows:

1. Revaluation of Assets and Liabilities: TechCorp’s assets and liabilities are revalued to their fair values, resulting in a $2 million increase in asset values.

2. Goodwill Recognition: Goodwill of $2 million ($10 million purchase price - $8 million fair value of net assets) is recognized on TechCorp’s balance sheet.

3. Equity Adjustment: TechCorp’s pre-acquisition retained earnings are eliminated, and the new equity structure reflects Innovate Inc.’s ownership.

Benefits and Challenges of Push-Down Accounting

Benefits

• Simplified Consolidation: Push-down accounting can simplify the consolidation process by aligning the acquired company’s financial statements with the acquirer’s accounting basis.
• Enhanced Transparency: By reflecting the fair value of assets and liabilities, push-down accounting provides a clearer picture of the acquired company’s financial position from the perspective of the new ownership.
• Improved Decision-Making: Users of financial statements, such as investors and creditors, benefit from more relevant and reliable information, aiding in decision-making processes.

Challenges

• Complex Valuation Process: Determining the fair value of identifiable assets and liabilities can be complex and may require the use of professional valuation experts.
• Potential for Earnings Volatility: The revaluation of assets and liabilities may lead to increased volatility in earnings, particularly if the fair values fluctuate significantly over time.
• Regulatory Considerations: The decision to apply push-down accounting should be carefully evaluated in light of applicable accounting standards and regulatory requirements.

Best Practices for Implementing Push-Down Accounting

To effectively implement push-down accounting, consider the following best practices:

1. Engage Professional Valuation Experts: Utilize the expertise of professional valuators to ensure accurate and reliable fair value measurements.

2. Document the Decision-Making Process: Maintain thorough documentation of the decision to apply push-down accounting, including the rationale and supporting evidence.

3. Communicate with Stakeholders: Clearly communicate the impact of push-down accounting on the acquired company’s financial statements to stakeholders, including investors, creditors, and regulators.

4. Monitor Changes in Fair Values: Regularly review and update the fair values of revalued assets and liabilities to ensure ongoing accuracy and compliance with accounting standards.

Regulatory and Compliance Considerations

In Canada, the application of push-down accounting should be guided by the principles of IFRS and ASPE, as well as any relevant guidance from CPA Canada. It is essential to ensure that the financial statements provide a true and fair view of the acquired company’s financial position and performance.

IFRS Considerations

While IFRS does not explicitly mandate push-down accounting, it allows for the revaluation of assets and liabilities in certain circumstances. The decision to apply push-down accounting should be based on the relevance and reliability of the financial information provided to users.

ASPE Considerations

Under ASPE, push-down accounting is not explicitly addressed. However, entities may choose to apply it if it results in more relevant and reliable financial information. The decision should be supported by appropriate documentation and rationale.

Conclusion

Push-down accounting is a valuable tool in the context of business combinations, providing a clear representation of the acquired company’s financial position from the perspective of the new ownership. By revaluing assets and liabilities to their fair values, push-down accounting enhances transparency and simplifies the consolidation process. However, its application requires careful consideration of regulatory requirements, valuation complexities, and stakeholder communication. By following best practices and engaging professional expertise, entities can effectively implement push-down accounting and provide users with relevant and reliable financial information.

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