What is Acquisition Accounting and How does it Work?

Posted In | Finance | Accounting Software

Acquisition accounting is a method of accounting for the consolidation of two or more companies into a single entity. This method is used when one company, known as the acquirer, purchases another company, known as the acquirer.

 

 

 

Process of Acquisition Accounting

The process of acquisition accounting involves several steps. 

 

1. First, the acquirer must determine the fair market value of the assets and liabilities of the acquiree. This includes identifying and valuing all of the assets and liabilities of the acquiree, including intangible assets such as trademarks and patents.
    
2. Once the fair market value of the assets and liabilities has been determined, the acquirer must then allocate the purchase price to these assets and liabilities. This allocation is based on the relative fair market value of each asset and liability.
    
3. After the purchase price has been allocated, the acquirer must then adjust the carrying value of the assets and liabilities of the acquiree to their fair market value. This adjustment is known as goodwill and is the difference between the fair market value of the assets and liabilities and their carrying value.
    
4. Once the assets and liabilities have been adjusted to their fair market value, the acquirer must then consolidate the financial statements of the acquirer and the acquiree. This involves combining the assets, liabilities, and equity of both companies into a single set of financial statements.

 

Example of Acquisition Accounting

To illustrate the process of acquisition accounting, let's consider the following example.

 

Company A acquires Company B for $100 million. Company B has assets worth $80 million and liabilities worth $20 million.

 

1. Determine the fair market value of the assets and liabilities of Company B:

• Fair market value of assets: $80 million
• Fair market value of liabilities: $20 million

 

2. Allocate the purchase price to the assets and liabilities of Company B:

• Purchase price allocated to assets: $80 million
• Purchase price allocated to liabilities: $20 million

 

3. Adjust the carrying value of the assets and liabilities of Company B to their fair market value:

• Goodwill: $20 million (difference between fair market value of assets and liabilities and their carrying value)

 

4. Consolidate the financial statements of Company A and Company B:

• Combine the assets, liabilities, and equity of both companies into a single set of financial statements.

 

In this example, acquisition accounting involves determining the fair market value of the assets and liabilities of Company B, allocating the purchase price to these assets and liabilities, adjusting the carrying value of the assets and liabilities to their fair market value, and consolidating the financial statements of Company A and Company B.

 

Conclusion

Acquisition accounting is a complex process that requires careful consideration and analysis. It is important for companies to carefully consider the potential impact of an acquisition on their financial statements and to consult with financial professionals to ensure that the acquisition is accounted for correctly.

 

Frequently Asked Questions: 

1. How are acquisitions shown on the balance sheet?

Acquisitions are shown on the balance sheet as part of the consolidated financial statements of the acquirer and the acquiree. When a company acquires another company, the assets and liabilities of the acquiree are added to the assets and liabilities of the acquirer on the consolidated balance sheet. The purchase price is recorded as an asset, typically in the "goodwill" category. 

 

2. Are acquisition costs expensed or capitalized?

Acquisition costs, also known as "deal costs," are typically expensed rather than capitalized. These costs include fees and expenses associated with the acquisition, such as legal fees, advisory fees, and due diligence costs. According to generally accepted accounting principles (GAAP), acquisition costs should be expensed as incurred. This means that they should be recognized as an expense on the income statement in the period in which they are incurred.

 

3. What journal is used to record acquisitions?

In general, acquisitions may involve a variety of journal entries, including entries to record the purchase price, the allocation of the purchase price to the assets and liabilities of the acquiree, and the adjustment of the carrying value of the assets and liabilities to their fair market value. The specific journal entries used to record an acquisition will depend on the details of the transaction and should be carefully reviewed by a qualified accountant to ensure accuracy and compliance with relevant accounting standards.