Acquisition Accounting

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What is acquisition accounting?

Acquisition accounting is a set of official guidelines describing how the assets, liabilities, share of non-controlling shareholders (NCI) and goodwill of a purchased company must be reported by the buyer in its consolidated statement of financial situation.

Fair market value (JVM) of the acquired company is distributed among the net tangible fixed assets and the part of the intangible assets of the balance sheet of the buyer. Any resulting difference is considered goodwill. Acquisition accounting is also called accounting for business combinations.

Key points to remember

  • Acquisition accounting is a set of official directives describing how the assets, liabilities, share of non-controlling shareholders and goodwill of an acquired company must be declared by the buyer.
  • The fair market value of the acquired company is distributed among the tangible net assets and the part of the intangible assets of the balance sheet of the buyer. Any resulting difference is considered goodwill.
  • All business combinations should be treated as acquisitions for accounting purposes.

Operation of acquisition accounting

International financial reporting standards (IFRS) and international accounting standards (IAS) require that all business combinations be treated as acquisitions for accounting purposes, which means that a company must be identified as an acquirer and a company must be identified as acquired even if the transaction creates a new business.

The acquisition accounting approach requires that everything be measured at the FMV, the amount that a third party would pay in the open market, at the time of acquisition – the date on which the acquirer took control of the target company. This includes the following:

  • Tangible assets and liabilities: Assets that have physical form, including machinery, buildings and land.
  • Intangible assets and liabilities: Non-physical assets, such as patents, brands, copyrights, goodwill and brand recognition.
  • Non-controlling interest: Also called minority stake, it is a shareholder holding less than 50% of the outstanding shares and having no control over the decisions. If possible, the fair value of non-controlling shareholders can be derived from the share price of the acquired business.
  • Consideration paid to the seller: The buyer can pay in several ways, including cash, shares or conditional supplement. Calculations must be provided for any future payment obligation.
  • Good will: Once all these steps have been taken, the buyer must then calculate whether there is a goodwill. Goodwill is recorded in a situation where the purchase price is greater than the sum of the fair value of all identifiable tangible and intangible assets purchased during the acquisition.

Important

Fair value analysis is often performed by a third party valuation specialist.

History of acquisition accounting

Acquisition accounting was introduced in 2008 by the main accounting authorities, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), replace the previous method, known as purchase accounting.

Acquisition accounting was favored because it reinforced the concept of fair value. It focuses on the market values ​​in effect in a transaction and includes contingencies and non-controlling interests, which were not accounted for using the purchase method.

Another difference between the two techniques is the way good business acquisitions are handled. Under the purchase method, the difference between the fair value of the acquired company and its purchase price was recognized as negative goodwill (NGW) on the balance sheet which had to be amortized over time. However, with acquisition accounting, NGW is immediately treated as a gain on the income statement.

Complexity of acquisition accounting

Acquisition accounting improved the transparency of mergers and acquisitions (M&A) but did not facilitate the process of combining financial records. Each component of the assets and liabilities of the acquired entity must be adjusted to fair value in items ranging from inventories and contracts to hedging instruments and contingencies, to name a few.

The amount of work required to adjust and integrate the books of the two companies is one of the main reasons for the long period between the agreement on an agreement by the respective boards of directors and the actual termination of the agreement.

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