When one company is acquired by another, there are some formal guidelines that must be followed to record this transaction. These guidelines are all set out in the acquisition method of accounting. Find out more about what is acquisition in accounting below.
Acquisition accounting explained
When your business acquires another company, it’s required to report certain aspects of the sale on a consolidated statement. Factors that must be reported include things like goodwill, non-controlling interest, assets, and liabilities. The specific rules around reporting each of these areas is covered by acquisition accounting.
As part of acquisition accounting, you must report the acquired company’s fair market value between the net tangible and intangible assets recorded on your balance sheet. If there’s any difference between the two types of assets, this is recorded as goodwill.
How acquisition analysis accounting works
Any combination of businesses should be treated as an acquisition in accounting, according to International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS). This means that even if the merger between two businesses creates an entirely new company, you must still treat one of the businesses as an acquirer and the other as an acquiree.
Following acquisition analysis accounting, financials need to be recorded at fair market value, or what a third-party buyer would pay on an open market at the time of acquisition. Here’s what should be accounted for in an acquisition analysis:
Tangible assets and liabilities: These include things like property, land, and machinery.
Intangible assets and liabilities: This category includes trademarks, patents, and branding.
Non-controlling interest: This refers to any shareholders owning a small percentage of outstanding shares, thus having no decision-making ability.
Consideration paid to seller: This refers to the way the buyer pays, including any reference to future payments like cash or stocks.
Goodwill: Goodwill is what remains after the purchaser has calculated the other components of the transaction. When the purchase price is higher than the sum value of all these other assets, it’s recorded as goodwill.
Acquisition vs purchase accounting
Prior to 2008, purchase accounting was the method used to calculate and record acquisitions in business. However, this was replaced by the FASB and IASB in 2008 with acquisition accounting. The two methods vary slightly, with acquisition accounting focusing more heavily on fair market value. It also includes non-controlling interests, which wasn’t accounted for under the purchase method.
Acquisition method of accounting example
Imagine that your business has just purchased another in this acquisition method of accounting example. You would need to follow these steps to record the transaction:
Step 1: Measure the tangible assets and liabilities
You would gather all the business’s tangible assets, including factories and machinery, and record them.
Step 2: Measure the intangible assets and liabilities
You would then take all the intangible assets, which can be harder to find as they won’t necessarily be on the acquired company’s balance sheet.
Step 3: Measure the noncontrolling interest
Take the market price of the acquiree’s stock to determine its fair value. Measure and record this from the date of acquisition.
Step 4: Measure the seller consideration
In this example, imagine that you’ve agreed to pay out cash and stock as part of the transaction, including future earnouts on the shares. You should tally these up and record the consideration.
Step 5: Measure the goodwill
Finally, you must work out the goodwill of this acquisition. Use the following formula:
Consideration Paid + Noncontrolling Interest – Identifiable Assets + Identifiable Liabilities
Now, imagine that the calculation results in a negative value. This means that you’ve paid less than the fair value for the company’s assets and liabilities. As a result, you’ll need to recognize this purchase as a gain in your financial statements.
As you can see from the example above, using the acquisition method of accounting can be a lengthy process. At times, it can’t be completed in time to be recorded in the same accounting period as the transaction. In this case, you can use estimates for the relevant period and then adjust these later with exact calculations.
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