Post-Deal: Five Key Actions for Avoiding Audit and Valuation Surprises

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Purchase accounting is where M&A deals go from strategic close to Day 1 accounting readiness. In a recent BDO Talks Transactions webcast, BDO professionals walked through where transaction accounting work can break down and what proactive steps can be taken to avoid unwelcome surprises. Finance leaders can take the following actions before, during, and after close to reduce post-deal friction and strengthen post-deal stability: 

1. Determine the Accounting First

Leaders should treat the acquisition-date accounting as the baseline for subsequent financial reporting because it affects future audit procedures, reconciliations, amortization and depreciation, impairment testing, and other balance-sheet activity.

Every downstream accounting determination — including whether goodwill is recognized, how transaction costs are treated, and how acquired assets and liabilities are measured — depends in part on one question: Does the acquired set meet the definition of a business under Accounting Standards Codification (ASC) 805, Business Combinations? An entity must first apply the screen test. The screen is met when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; ASC 805 does not prescribe a bright-line percentage.  If the screen is not met, the entity evaluates whether the acquired set includes an input and a substantive process that together contribute to the ability to create outputs. The acquired set does not necessarily need to include outputs at the acquisition date to qualify as a business.

In contrast, an asset acquisition does not give rise to goodwill. Instead, if it is not a variable interest entity,  the cost of the acquisition, including qualifying transaction costs, is generally allocated to the acquired assets based on their relative fair values, subject to applicable exceptions. As a result, the amounts assigned to individual assets may differ from their standalone fair values.

An inaccurate or delayed determination of whether a transaction is accounted for as a business combination can cause audit delays, unexpected changes in reported earnings, and significant rework. The distinction affects, among other matters, whether goodwill is recognized, whether transaction costs are expensed or capitalized, how contingent consideration is initially accounted for, whether deferred taxes are recognized, and whether a measurement period is available.

2. Avoid the Pitfalls 

While each transaction is unique, a relatively small number of accounting issues contribute to post-close accounting friction, including: 

Contingent consideration (earn-outs): The accounting depends on the transaction type, and the terms and substance of the arrangement. In a business combination, contingent consideration is generally recognized at acquisition-date fair value as part of the consideration transferred and classified as a liability or equity under applicable U.S. GAAP. Liability-classified amounts are generally remeasured through earnings after the acquisition date, whereas equity-classified amounts generally are not remeasured. Payments to selling shareholders that are automatically forfeited upon termination of employment are compensation for post-combination services rather than consideration transferred; other arrangements require an evaluation of the relevant indicators in ASC 805.

If an earn-out initially included in consideration transferred is determined to represent post-combination compensation, excluding it from consideration reduces the calculated purchase price and post-acquisition earnings. 

Rollover equity: Equity retained or received by selling shareholders may represent consideration transferred, a continuing ownership interest, or compensation for post-combination services. The analysis depends on the arrangement’s terms and substance, including vesting and forfeiture provisions, linkage to continued employment, relative ownership rights, and whether the terms are available to employee and non-employee sellers on comparable bases. Different economic rights may affect valuation and classification, but they do not by themselves determine that a portion of the rollover is compensation.

Example: Company A acquires Company B in a business combination for total consideration that includes $80 million of cash and $20 million of rollover equity. If the rollover is fully vested (not forfeited upon termination of employment), and is provided to employee and non-employee shareholders on comparable terms, those facts may support treating the $20 million as consideration transferred or as a continuing ownership interest rather than post-combination compensation. The conclusion depends on the terms and substance of the arrangement.

Stay and success bonuses: The accounting depends on the facts and circumstances, including which party is obligated to make the payment, when the obligation was incurred, whether payment requires continued employment or future service, and whether the arrangement benefits the buyer or the seller. An obligation assumed from the acquiree is recognized in the acquisition accounting if it is an identifiable liability at the acquisition date. Payments for post-combination service are generally recognized as compensation expense over the requisite service period.

Working capital true-ups: Purchase agreements often provide a contractual post-closing process to finalize working capital or other specified purchase-price components, typically within 60 to 90 days after closing. Items such as omitted liabilities, revenue-related adjustments, and unapplied cash receipts may affect the contractual settlement and may be funded through escrow. The accounting depends on whether the item is an ASC 805 measurement-period adjustment or the correction of an error.

Excluded assets: The accounting reflects the assets and rights actually transferred under the executed transaction documents. If cash, real estate, intellectual property, vehicles, or other assets intended to be excluded are nevertheless included in the final agreement and legally transferred, the acquirer may need to recognize them. If an item was not transferred, an omission from an exhibit does not by itself establish that the acquirer obtained control of the asset; the complete contractual and legal facts must be evaluated.

Example: A corporate jet owned by the seller was intended to be excluded from a transaction but was omitted from the final excluded-assets exhibit. The parties would need to determine, based on the executed agreement and applicable law and U.S. GAAP, whether control of the jet transferred to the buyer from an accounting perspective. If control was transferred as part of the business combination, the buyer would recognize it at acquisition-date fair value; if it did not transfer, it would not be included in the opening balance sheet.

Previously unrecognized intangible assets: Often, internally generated trademarks, technology, customer relationships, and similar items are not recognized in the acquiree’s historical financial statements. In a business combination, however, the acquirer recognizes goodwill separately from identifiable intangible assets that meet the contractual-legal or separability criteria and measures them at their acquisition-date fair values. The assessment is not limited to business combinations in the technology and life sciences industries and must also consider whether an item is an asset under U.S. GAAP.

The common thread in avoiding these pitfalls is that the earlier a deal’s accounting treatment is determined, the less likely an issue is to resurface as a dispute or a surprise after close. 

While each issue is isolated, together they illustrate a broader reality: Many accounting surprises originate not from complex accounting rules but from assumptions that were never fully vetted during the transaction process.

3. Bring In Professionals Early

Engaging technical specialists early helps finance leaders avoid surprises down the road. Start with determining whether the transaction is a business combination and identifying the accounting acquirer with the technical specialists. 

In a merger, merger of equals, or de-SPAC transaction, identifying the accounting is a prerequisite because the accounting may differ from its legal form. In a business combination that is a forward acquisition, the accounting acquirer carries forward its historical basis while the accounting acquiree’s identifiable assets and liabilities are recognized under the acquisition method. Reverse acquisitions and transactions involving entities under common control (as determined under U.S. GAAP) require different analyses. If a valuation firm begins work before the accounting acquirer and applicable model are determined, the team risks valuing the wrong entity or applying the wrong measurement basis.

Finance leaders often focus on speed during a transaction, but speed without alignment can create costly rework. The most effective deal teams recognize that certain accounting determinations are foundational decisions that influence every downstream valuation, accounting, and reporting activity.

See more examples in our on-demand webcast: BDO Talks Transactions – Day 1 Readiness: Avoiding Audit and Valuation Surprises 

4. Build the Discipline That Prevents Audit Surprises

Using a post-deal stabilization checklist for closing and opening balance sheet readiness helps create a clear process to help organizations avoid costly rework and maintain confidence in their financial reporting. Consider the following post-deal practices:

Get the closing trial balance right first: Confirm accounts are fully and correctly identified. Watch for assets that are fully amortized or were never recognized under the seller’s historical accounting. 

Build bridge schedules: Reconcile the historical books to the closing balance sheet and then to the Day 1 opening balance sheet; these bridges become the source data for future amortization, depreciation, and impairment testing. 

Confirm the target’s audit posture: Tailor diligence and integration procedures to the reliability of the target’s financial information, the basis of accounting used, the quality of internal controls, and the availability of supporting records. An unaudited or cash-basis target may require substantial validation or conversion work before its information can be used to support acquisition accounting.

Use the measurement-period window appropriately: Record provisional amounts when acquisition accounting is incomplete at the reporting date and update them retrospectively when new information is obtained about facts and circumstances that existed as of the acquisition date. The measurement period ends when the necessary information is obtained or is no longer obtainable and cannot exceed one year from the acquisition date. Changes caused by post-acquisition events or errors are not measurement-period adjustments.

5. Right-Size Resources for the Transaction Window

There is often a mismatch between post-deal accounting complexity and the time available to handle these additional demands. Plan for both the increased workload, while still maintaining core finance functions such as close, reporting, financial planning and analysis (FP&A), and management requirements. 

Finance functions, particularly at middle-market and private equity-backed companies, are lean by design. The people who close the books are often the same people who own FP&A, treasury, and daily operations — generalists managing a technical, deadline-driven process that many only handle occasionally. 

Successful Day 1 readiness is about building the right processes and preparing teams for the uncertainties and details that naturally arise with deals. Early stakeholder alignment, clear ownership, thorough documentation, collaboration with experienced professionals, and disciplined reconciliation practices help companies manage a deal’s technical demands without derailing the core finance functions that keep the rest of the business running. 

 ¹While there is no bright line threshold, “substantially” all is generally interpreted to be approximately 90% or greater.  

 ²An asset acquisition of a variable interest entity is accounted for using the acquisition method in ASC 805, but a gain or loss is recognized instead of goodwill.