Acquisition Method of Accounting
The acquisition method of accounting is an approach used to record and report financial information when one company acquires another company. Under this method, the acquiring company combines the financial statements of the acquired company with its own financial statements. The acquisition method follows specific accounting principles and guidelines, as outlined by the Generally Accepted Accounting Principles (GAAP) in the United States and the International Financial Reporting Standards (IFRS) internationally.
The main steps involved in the acquisition method of accounting are:
- Identifying the acquirer: The first step is to determine which company is the acquirer (the company that obtains control over the acquired company).
- Determining the acquisition date: The acquisition date is the date when the acquirer gains control over the acquired company. This is typically when the acquisition transaction is closed and the acquirer starts consolidating the acquired company’s financial statements.
- Measuring the fair value of the acquired company: The acquirer must determine the fair value of the acquired company, which includes measuring the fair value of the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquired company.
- Recognizing and measuring goodwill or gain from a bargain purchase: Goodwill arises when the purchase price paid by the acquirer exceeds the fair value of the net identifiable assets acquired. If the fair value of the net identifiable assets exceeds the purchase price, it results in a gain from a bargain purchase.
- Consolidating financial statements: After measuring the fair values and recognizing goodwill or gain from a bargain purchase, the acquirer consolidates the acquired company’s financial statements with its own, combining the assets, liabilities, revenues, and expenses of both companies into a single set of financial statements.
By following the acquisition method of accounting, companies can accurately reflect the financial impact of an acquisition and provide a clearer picture of the combined entity’s financial position and performance to investors, regulators, and other stakeholders.
Example of Acquisition Method of Accounting
Let’s consider a hypothetical example of the acquisition method of accounting. Suppose Company A acquires Company B for $1 million. Here’s how the acquisition would be accounted for using the acquisition method:
- Identifying the acquirer: Company A is the acquirer, as it is obtaining control over Company B.
- Determining the acquisition date: Let’s say the acquisition transaction closes on June 1, 2023. This is the date when Company A gains control over Company B, and it will be considered the acquisition date.
- Measuring the fair value of the acquired company:
- Company B’s identifiable assets at fair value: $800,000
- Company B’s liabilities at fair value: $200,000
- Net identifiable assets: $800,000 (assets) – $200,000 (liabilities) = $600,000
- Recognizing and measuring goodwill or gain from a bargain purchase:
- Purchase price: $1,000,000
- Fair value of net identifiable assets: $600,000
- Goodwill: $1,000,000 (purchase price) – $600,000 (fair value of net identifiable assets) = $400,000
- Consolidating financial statements: Company A will consolidate Company B’s financial statements with its own by adding the fair values of Company B’s assets and liabilities to its balance sheet. Company A will also recognize the goodwill of $400,000 as an intangible asset on its balance sheet.
In summary, Company A acquired Company B for $1 million, resulting in $400,000 of goodwill. Company A will consolidate the financial statements of both companies, reflecting the combined assets, liabilities, revenues, and expenses in its financial reporting.