BUSINESS COMBINATIONS 1
A businesscombination refers to a transaction where one party acquires controlof another’s business. Combinations increase the size of a businessdue to the consolidation of financial statements and accounts. Aprincipal-agent relationship entails a scenario where one personappoints another to act on his behalf. The agent is usually atliberty to make decisions without necessarily acquiring permissionfrom the principal. The principal has the mandate to dictate thelevel of performance and deliverables expected from the agent.However, a conflict usually arises in the principal-agentrelationship where the agent fails in his duties. The agent may notact in the best interests of the principal. The agency problemrequires the principal to offer incentives to the agent to motivatehim to act on his behalf (FASB, 2015). Performance contracts couldalso help the agent become more responsible in his obligation.
Various issueshave emerged in the principal-agent relationship needing expertanalysis. Financial statements require implementation by the personlegally contracted to transact the business. In the legal records,the principal is usually marked as the contact person. However, theagent can also claim this role since he has been legally contractedby the principal. Moreover, the agent conducts day-to-day business onbehalf of the principal. Therefore, he is best suited to implementfinancial statements. The resultant situation has left preparers offinancial statements in a quandary. Given this, the FinancialAccounting Standards Board (FASB) sought to make amendments providingadditional guidance to financial statement preparers. TheInternational Accounting Standards Board (IASB) also contributed tothe decision-making discussions.
Reportingentities needed criteria to apply when ascertaining whether adecision-maker acted as an agent or principal. There were also plentyof inconsistencies in the evaluation of kick-outs and rights ofparticipation. General partners had always been granted the right tocontrol limited partnerships. However, it became necessary toevaluate the requirements under which such an occurrence would befeasible. Each of the raised issues would be deliberated under anumbrella of subtopics. For example, the principal versus agentanalysis would focus on three fundamental areas. The rights held byother parties would first be considered before making anydeterminations. A provision was created to allow the rights ofparticipation to be held by a third party separate from theprincipal. Rights of participation held by multiple parties could beused to determine that the decision-maker was not a principal.Reporting entities could, therefore, evaluate the number of partiesneeded so as to invoke the rights (FASB, 2015). This would helpreporting entities to consider whether the rights suffice for anagency relationship.
The fees of adecision-maker would be evaluated to assess his capacity andauthority as a decision-maker. Nevertheless, the proposed amendmentsstill left room for a decision-maker to be rendered an agent. Thiswould occur in the situation where the decision maker`s fees droppedbelow a certain threshold. The stipulated level would be dictated bythe operating liabilities of the particular business. Other economicinterests could also be used in the principal versus agent analysis.Some economic interests would customarily expose a decision-maker toprofits while others would lead to losses. Guarantees and equityinterest result in negative returns while performance-based feesconstitute profits. Interests solely linked to positive returns arerarely indicative of a principal relationship. On the other hand, aprincipal relationship could be implied from either negative orpositive returns. It would also be viable for a reporting entity toevaluate whether the decision-maker is exposed to unique variablereturns. Such returns would result from other inputs such assubordinated economic interests (FASB, 2015). This wouldautomatically designate the decision-maker as a principal.
FASB and IASBboards have made various amendments that were passed in February2015. However, the recommendations would not be implementedimmediately. It was necessary to allow for time so that financialstatements preparers become familiar with the proposed changes. Theevaluation of fees and other economic interests would be used as amajor factor in the principal versus agent analysis (FASB, 2015). Therights held by other parties could also be used as a guidingprinciple.
Financial Accounting Standards Board. (2015). Retrieved from:http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176159223847&acceptedDisclaimer=true