Definition
Acquisition accounting, also known as purchase accounting, is the process and set of accounting rules followed when one company acquires another. The principal aspect of acquisition accounting is that the fair value of the purchase consideration is allocated between the acquiring company’s underlying net tangible and intangible assets. Any excess of the purchase consideration over the fair values of the identifiable net assets (both tangible and intangible) of the acquired company is recognized as goodwill. The financial results of the acquired company are included in the consolidated financial statements of the acquiring company from the acquisition date.
Key Points:
- Purchase Consideration: The total value paid by the acquiring company to take over the acquired company.
- Fair Value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
- Intangible Assets: Non-monetary assets without physical substance such as patents, licenses, and trademarks.
- Goodwill: A residual value representing the excess of purchase consideration over the fair value of identifiable net assets.
- Consolidated Financial Statements: Financial statements that present the financial position and performance of a parent company and its subsidiaries as a single economic entity.
Examples
-
Tech Inc. Acquires StartUp Ltd.: Tech Inc. acquires all shares of StartUp Ltd., paying $10 million. At the acquisition date, StartUp Ltd.’s net tangible assets fair value is $7 million, and identifiable intangible assets are valued at $1 million. Therefore, the goodwill recorded on Tech Inc.’s financial statements is $2 million ($10 million - $8 million).
-
Manufact Corp. Buys Industrial Co.: Manufact Corp. acquires Industrial Co. for $15 million. The fair value of Industrial Co.’s net tangible assets is $9 million, and its identifiable intangible assets (patents and brand) are valued at $3 million. The goodwill recognized by Manufact Corp. is $3 million ($15 million - $12 million).
Frequently Asked Questions
What is the purpose of acquisition accounting?
Answer: The purpose of acquisition accounting is to provide a clear and standard approach for recognizing and measuring a business combination. It ensures that financial statements accurately reflect the fair value of the acquired company and any consequent goodwill.
How is goodwill accounted for under acquisition accounting?
Answer: Goodwill is recognized as an intangible asset on the acquirer’s balance sheet. It represents the amount paid over the fair value of the identifiable net assets (tangible and intangible) acquired. Goodwill is subject to annual impairment testing.
What standards govern acquisition accounting?
Answer: International Financial Reporting Standard (IFRS) 3 - Business Combinations, and Section 19 of the Financial Reporting Standard applicable in the UK and Republic of Ireland, govern acquisition accounting.
How are intangible assets identified in acquisition accounting?
Answer: Intangible assets are identified based on their separability from the acquired entity or their arising from contractual or other legal rights. These assets should be identifiable and their fair values should be measurable at the acquisition date.
Is acquisition accounting applicable after the acquisition date?
Answer: No, acquisition accounting is applied at the date of acquisition to value and record assets, liabilities, and goodwill. However, subsequent measurement and reporting of these items, including goodwill impairment, are ongoing post-acquisition responsibilities.
What happens to the acquired company’s financial results post-acquisition?
Answer: The financial results of the acquired company are included in the consolidated financial statements of the acquiring company from the acquisition date forward.
Can acquisition accounting result in negative goodwill?
Answer: Yes, if the purchase consideration is less than the fair value of the acquired net assets, negative goodwill, or a “bargain purchase gain,” occurs. This gain is recognized immediately in the acquirer’s profit and loss statement.
How are acquisition-related costs treated in acquisition accounting?
Answer: Acquisition-related costs, such as legal, accounting, and other professional fees, are expensed as incurred and not included in the purchase consideration.
What is the difference between acquisition accounting and merger accounting?
Answer: Acquisition accounting recognizes the purchase consideration and fair values allocated to acquired assets and liabilities, resulting in goodwill. Merger accounting (pooling of interests), used less commonly, combines the financial statements of merging entities as if they were always single entities, with no goodwill recognized.
Is it mandatory for all companies to follow acquisition accounting?
Answer: Yes, it is mandatory for companies engaged in acquisitions to follow acquisition accounting standards for accurate and fair reporting of business combinations.
Related Terms
- Fair Value: The estimated price for an asset in a transaction between knowledgeable and willing market participants.
- Goodwill: The excess of the purchase consideration over the fair value of identifiable net assets acquired in a business combination.
- Consolidated Financial Statements: Financial statements that combine the financial information of a parent company and its subsidiaries.
- Intangible Assets: Non-physical assets such as patents, trademarks, and goodwill.
- Business Combination: The unification of two or more companies into a single reporting entity.
Online References
- IFRS 3 Business Combinations
- Financial Reporting Standard Applicable in the UK and Republic of Ireland
Suggested Books for Further Studies
- “Business Combinations (International GAAP Accounting)” by Greg F. Burton, Richard J. G. Hammett, and David A. Schwermer: This comprehensive guide covers all aspects of IFRS 3 and detailed examples.
- “Financial Accounting: An International Introduction” by David Alexander and Christopher Nobes: This book covers fundamental accounting principles, including acquisition accounting.
- “Mergers, Acquisitions, and Corporate Restructuring” by Patrick A. Gaughan: Provides insights into the strategic, financial, and legal aspects of mergers and acquisitions.
Accounting Basics: “Acquisition Accounting” Fundamentals Quiz
Thank you for diving into this comprehensive guide to acquisition accounting. Keep pushing yourself toward mastery in the nuanced field of accounting!
