What is push-down accounting?
Advanced accounting is an accounting method used by businesses when they buy another business. The accounting base of the acquirer is used to prepare the financial statements of the purchased entity. In the process, the assets and the target company’s liabilities are updated to reflect the purchase cost rather than the historical cost.
This accounting method is required by United States generally accepted accounting principles (GAAP), but is not accepted by the International Financial Reporting Standards (IFRS).
Key points to remember
- Top-down accounting is an agreement consisting in accounting for the purchase of a subsidiary at the purchase cost, rather than at its historical cost.
- The assets and liabilities of the target company are amortized (or reduced) to reflect the purchase price.
- All gains and losses associated with the new book value are “pushed back” from the purchaser to the income statement and balance sheet of the acquired company.
How top-down accounting works
When one company buys another, questions arise about how to measure the assets and liabilities of the acquired company. In push down accounting, the assets and liabilities of the target company are amortized (or reduced) to reflect the purchase price.
According to the Financial Accounting Standards Board (FASB) of the United States, the total amount paid to buy the target becomes the new book value of the target in its financial statements. All gains and losses associated with the new book value are “pushed back” from the purchaser to the income statement and balance sheet of the acquired company. If the purchase price exceeds fair value, the excess is recognized in goodwill, an intangible asset.
In push down accounting, the costs incurred to acquire a company appear in the target’s individual financial statements, rather than the acquirer. It is sometimes useful to think of lowering the accounts like a new business created with borrowed funds. Both the debt and the assets acquired are recorded under the new subsidiary.
Example of top-down accounting
ABC decides to buy XYZ, which is valued at $ 9 million. ABC buys the business for $ 12 million, which translates into a bonus. To finance its acquisition, ABC is providing XYZ shareholders with $ 8 million in ABC shares and a $ 4 million cash payment, which it is raising through a debt offer.
Even if ABC borrows the money, the debt is recognized on XYZ’s balance sheet in the liability account. In addition, interest paid on the debt is recognized as an expense for the acquired company. In this case, XYZ’s net assets, i.e. assets minus liabilities, must be equal to $ 12 million, and goodwill will be recorded as $ 12 million – 9 millions of dollars = 3 millions of dollars.
Lower accounting requirements
The Securities and Exchange Commission (SEC) defines the rules to be observed when public enterprises must use push down accounting. Push-down accounting is generally compulsory when the parent company acquires at least 95% of the subsidiary. If the participation is between 80% and 95%, scrolling accounting can also be used. Nothing less and it is not allowed.
Private companies are not required to practice push-down accounting, but may choose to do so if it can help assess the performance of an acquired business.
Advantages and disadvantages of push-down accounting
From a managerial point of view, keeping the debt on the books of the subsidiary makes it possible to judge the profitability of the acquisition. From a tax and reporting perspective, the pros or cons of downward accounting will depend on the details of the acquisition, as well as the jurisdictions involved.