Have you heard of pushdown accounting? This can be a tricky, and maybe painful, process in a business acquisition transaction. In this episode of PKF Texas – The Entrepreneur’s Playbook®, Audit and Transaction Advisory Services Director, Chris Hatten, CPA, CVA, CM&AA, explains in detail what this looks like and what you should consider.
Jen: This is the PKF Texas – Entrepreneur’s Playbook®. I’m Jen Lemanski, and I’m back again with Chris Hatten, a Transaction Advisory Director and one of our Approachable Advisors™ here at PKF Texas. Chris, welcome back to the Playbook.
Chris: Appreciate it, Jen.
Jen: So, I know you work on transactions on the M&A side, so that’s transaction, but then you’re also an Audit Director here, so you handle audits.
Chris: Yes.
What is Pushdown Accounting
Jen: So, for a company that’s being acquired, what’s one challenge that they may face on the audit side?
Chris: Well, the one that we probably see most frequently – particularly because of the transactional work that we do with a lot of private equity groups, as well as our larger private companies – is something that’s called pushdown accounting. And what that is, is basically… say private equity group comes in and buys XYZ company for a hundred million dollars, but their balance sheet was originally twenty million dollars. And so, it’s the process of pushing the acquisition fair value down to the acquired company.
And so, you know, one, it’s not mandatory. And so that’s something they have to think about doing. But more times than not, we do see them to make that election. And it’s actually more of a time-consuming process than you would think about. So, as an example, let’s say you’re looking at fixed assets, which are your vehicles, your machinery and equipment and all that, and needing to get those reflected at fair value. Well, a lot of those items have been depreciated over, let’s say, the past four or five years. And so, what could have been a $500,000 balance being depreciated down to $250,000 now needs to get fair valued. And a lot of times those numbers actually end up going up.
Jen: Interesting.
Chris: Yeah. So, your balance sheet has a tendency to get blown up a little bit. Where we see a lot of the larger increases is probably in land and then buildings and those kinds of things. So, it can be a very time-consuming process. It’s one we encourage our clients not to put off because there’s also a lot of things that go into it that, I would say, weren’t recorded before.
And so, as they’re going through this process one account that, you know, everybody’s familiar with is Goodwill. And so, that would not have been on the historical company’s books unless they had gone through a previous transaction. And so, now you’ve got potential intangible assets, patents, that kind of stuff, that they have to go ahead and record.
And there’s even some liabilities, you could have contingent consideration that’s going to the seller. And a lot of these items have to get valued, which can be a tricky process. Sometimes companies will bring in an evaluation firm to do the work. It’s not mandatory, but the larger the engagement, larger the transaction, I should say, the more likely that you’re going to need some kind of third-party help. You know, for a lower middle market company to go through and do those type of evaluations it might be a stretch. And so, that’s where the value can come in from a firm like that because that’s what they do. That’s their so-called wheelhouse. And so, they’ll be able to go through and value some of those hard to determine assets, whether it’s Goodwill and other intangibles writing up property and equipment and that kind of stuff.
Thinking Ahead
Jen: Is that something that they should do if they think, “Okay, I’m looking at selling my business.” They don’t have any interested parties or anything like that – is that something that they should, kind of, do ahead of time, even like to get themselves ready for, to be a good target for sale?
Chris: This would actually be something that is done after the fact. And so, sometimes if you’re the selling entity, and let’s say the owner is not going to have a continued interest in the company, they might say that’s y’all’s issue. They do have an interest in it for tax ramifications, but from a financial reporting issue, that’s kind of something that they’re able to push off to a certain extent.
Jen: So, pretty much as soon as you know, you’re selling and you have a buyer, you’re like, “Okay, let’s go ahead and get this process started.”
Chris: Yeah. If you’re coming over as part of the transaction, it’s something that you want to jump on sooner than later. And so, my main takeaway in all this is that don’t park it. It needs to kind of be part of your closing process checklist, to-do list. Because a lot of times we see these deals that get done, let’s say, they’re done third, fourth quarters, sometimes we see them second quarter, and they’re still working on getting the valuation done as we’re going into their year-end audit. And so, here they are having to try and readjust the books up to fair value, as well as get some of these other accounts closed out. And it can be a very painful process for all those involved, including the auditors, as well as our clients in their accounting team.
Jen: Nice. Well, perfect. Well, we’ll get you back to talk about some more transaction-related topics. Sound good?
Chris: That’d be great.
Jen: Perfect. This has been another thought leadership production brought to you by PKF Texas – The Entrepreneur’s Playbook®. For more information about pushdown accounting and other topics, visit www.PKFTexas.com.