In the gaming industry, casino mergers and acquisitions are more than a simple exchange of assets and liabilities. Such transactions include a confluence of complex financial, legal, regulatory, and operational considerations. They also require navigating through complex standards to comply with U.S. GAAP. These deals often involve millions of dollars and are too important to leave to chance.
Below, we analyze the application of accounting standards to one common scenario in the gaming industry.
The Scenario
A gaming company with seven locations (Company A) plans to acquire a smaller but strategically located establishment (Company B) primarily for cash. This transaction presents several accounting challenges and complexities. While working out the details of the deal, the parties must carefully consider all elements of the transaction including:
- Real property,1
- Furniture, fixtures, and equipment (FF&E),
- Equipment leases,
- Gaming licenses,
- Customer relationships (e.g., player databases),
- Trade names and trademarks, and
- Contingent consideration.
How should companies apply U.S. GAAP to this type of transaction, particularly considering nuances specific to the gaming industry?
The Early Stages of the Deal
Business Combination vs. Asset Acquisition
ASC 805, Business Combinations, provides the framework for business combinations and asset acquisitions. In this scenario, Company A must determine whether the acquisition of Company B is a business combination or an asset acquisition by assessing whether Company B meets the definition of a business. If Company B does not meet this definition, the transaction will be accounted for as an asset acquisition.
The assessment has two steps:
1. Determine 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. (The term “substantially all” is intended to be applied consistently with its use in other areas of U.S. GAAP and aligned with the acquirer’s existing accounting policies.)
For example, if the fair value of Company B’s gaming license constitutes 95% of the total fair value of the gross assets being acquired (excluding cash and cash equivalents, deferred tax assets and goodwill resulting from the effects of deferred tax liabilities), Company A is deemed to be effectively acquiring assets, including the regulatory license, rather than a full business. Therefore, the threshold is met, and the transaction would be accounted for as an asset acquisition.
If this condition is not met, continue to the second step:
2. Does Company B meet the definition of business?
A business is described in ASC 805 as “an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.” At a minimum, a business consists of inputs and processes applied to those inputs that have the ability to contribute to the creation of outputs.
If Company B is determined to meet the definition of a business, the transaction would be accounted for as a business combination.
Note – The rest of this article is written for a transaction that meets the definition of a business combination.
Consideration Transferred in a Business Combination
Consideration being transferred in a business combination generally is measured at fair value. This generally is the sum of the acquisition-date fair values of the assets transferred by Company A, liabilities incurred by Company A (including contingent liabilities), and equity interests issued by Company A. Examples of potential forms of consideration include, but are not limited to:
- Cash
- Other assets
- A business or subsidiary of the acquirer
- Contingent consideration (see below)
- Equity instruments (e.g., common stock, preferred stock, member interests)
- Stock options or warrants (however, share-based payment awards included in consideration transferred are measured in accordance with ASC 718, Compensation — Stock Compensation).
Fair Value Determinations
In a business combination, many elements of the transaction must be accounted for at fair value, for example:
- Tangible and Intangible Assets: In a business combination, the acquirer must recognize and measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at fair value (with limited exceptions). Here, Company B’s assets can include tangible assets such as real property or leasehold interests, FF&E, and intangible assets, such as the gaming license, customer databases, and intellectual property, including trade names and trademarks. A valuation professional typically estimates the fair values of the acquired assets when accounting for the business combination.
- Contingent Consideration: Many transactions include consideration that is triggered upon the occurrence of specific events (i.e., contingencies). Each contingent payment must be evaluated to determine whether it must be accounted for as contingent consideration or as a transaction separate from the business combination. Contingent payment arrangements that are determined to be separate from the business combination must be accounted for in accordance with other U.S. GAAP (for example, ASC 710, Compensation — General, or ASC 718). Companies must recognize contingent consideration in the scope of ASC 805 at fair value as of the acquisition date. Contingent consideration that is classified as a liability is remeasured every reporting period.
Information gained during the first stages of the transaction, as well as from the final closing documents, is typically evaluated by valuation specialists and delivered in the form of a narrative report detailing key assumptions, methodologies, and conclusions.
Financial Reporting for a Business Combination
Other considerations for a business combination include:
- Goodwill Recognition: Goodwill is recognized if the consideration transferred (plus the fair value of any noncontrolling interest in the acquiree and the fair value of previously held equity interests, if applicable) exceeds the acquired net assets. In our scenario, assume Company A will be acquiring Company B for $50 million in cash, with net assets acquired totaling $35 million. This simple example would result in goodwill of $15 million. This goodwill represents the future economic benefits that are not directly attributable to other identifiable assets, including synergies expected to be achieved in the business combination, which can include improved operational efficiencies, access to shared services, and marketing opportunities.
- Disclosures: ASC 805 requires comprehensive disclosures to help financial statement users understand the business combination and its impact on the new combined organization.
Information from the valuation reports, in conjunction with the closing deal documents and the accounting records from the acquired company, is considered and documented by management (or their specialists) in a technical whitepaper that walks through the ASC 805 guidance and provides conclusions and draft disclosures. Audit teams typically review this whitepaper as part of the financial statement audit process. Careful application of ASC 805 is crucial, particularly in the gaming and leisure industry, which is marked by frequent M&A activity, complex valuations, and regulatory compliance concerns.
Ongoing Impairment Testing
As part of its financial reporting, the combined entity must consider the acquired assets are impaired in accordance with ASC 350 and ASC 360.
Intangible Assets with Indefinite Lives
For some intangible assets, no factors limit their useful life and, thus, these intangible assets are considered indefinite lived and not amortized. Common examples of intangible assets with indefinite lives include trade names, trademarks, and (in the context of gaming industry deals) gaming licenses.
ASC 350 requires that these assets be evaluated at least annually for impairment, and more frequently if there are triggering events. Companies are allowed to perform an optional qualitative assessment to determine whether any triggering events created a situation in which it is more likely than not that the intangible asset is impaired. For example, if the jurisdiction in which Company B operates suddenly doubles the number of gaming licenses it is awarding, this may be an indicator that the gaming license intangible asset is impaired (because an increase in competition will likely follow), and Company A would need to perform further impairment testing.
If a company bypasses this qualitative assessment or determines that the intangible asset is more likely than not impaired, the company must determine the fair value of the asset and compare it to the asset’s carrying value. If the carrying value is more than the fair value, the intangible asset is considered impaired, and the difference between the fair value and the carrying value is recognized as an impairment.
Long-Lived Assets
ASC 360 covers the impairment testing for long-lived assets, which are tangible assets or intangible assets that have finite lives (that is, those that are subject to depreciation or amortization).
If there is a triggering event for a definite-lived asset that will be held and used, impairment testing conducted under ASC 360 aims to first compare the carrying amount of the asset group to its recoverable amount (its expected pre-tax undiscounted cash flows). If the carrying amount exceeds the sum of the undiscounted cash flows, the asset group is not recoverable, and the company recognizes an impairment and reduces the asset group’s carrying amount to its fair value.
Examples of definite-lived assets include:
- Buildings, machinery, FF&E, and leasehold improvements
- Internally developed software
- Leased assets (i.e., right-of-use assets)
- Customer relationships
In our example, Company A will monitor the asset groups that include the assets acquired from Company B following the acquisition close — as well as market factors and the potential for other triggering events — to determine if or when its finite-lived assets should be tested for impairment under ASC 360. For example, the real property acquired from Company B may decrease in value due to market changes or a natural disaster. If so, Company A would need to perform impairment testing.
Goodwill
For goodwill, impairment testing is conducted annually or more often if indicators or triggers are identified. Private companies have the option to assess triggering events at the end of the reporting period and the option to amortize goodwill, in which case there is no annual impairment test.
A company has an option to perform the same qualitative assessment as that for intangible assets with indefinite lives. If the company chooses to bypass the qualitative assessment or if the results of the qualitative assessment indicate that it is more likely than not that the reporting unit is impaired, the company compares the carrying value of the reporting unit inclusive of goodwill to its fair value. This assessment is typically referred to as the “step 1 test.” If the carrying value exceeds the fair value, a company will recognize a goodwill impairment for the amount by which the reporting unit’s carrying amount exceeds its fair value, limited to the goodwill allocated to that reporting unit.
Applying the Appropriate Accounting Standard Can be Challenging.
Managing asset acquisitions and business combinations within the gaming and leisure industry requires an understanding of nuanced situations, the ability to work with auditors and audit committees, and a meticulous adherence to accounting standards. Correct application of U.S. GAAP is required for accuracy, transparency, and compliance in financial reporting. Our professionals understand the intricacies involved in such transactions, from determining fair values as of the transaction date, to handling post-acquisition impairment testing.
Please contact our Gaming and Leisure team for more information. Additional guidance on these topics can also be found in BDO’s publications, Business Combinations Under ASC 805, and Goodwill and Impairment.
References
1 If Company A does not acquire the real property from Company B, it would need to determine the appropriate accounting for the lease, and whether that transaction is separate from (for accounting purposes) the business combination.