Acquisition Accounting

Publication Date :

26 Dec, 2023

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Table Of Contents

Acquisition Accounting Definition

Acquisition Accounting refers to the type of accounting method used when acquiring any new business or another company. Its primary purpose is to follow a systematic procedure for recording all financial transactions related to acquisition deals. Such transactions also include acquired assets, shares, and goodwill.

It allows firms to follow a specific method of accounting when purchasing another company. In this process, the firm may acquire (or buy) assets and shares of the other company. As a result, it is necessary to record these financial transactions properly. Therefore, companies deploy business acquisition accounting for this purpose.

Acquisition Accounting Definition

Acquisition accounting refers to the method of recording transactions relating to acquisitions. It occurs when one firm acquires another business or company.
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) first pioneered this concept in 2008 by replacing purchase accounting.
In accounting, International Financial Reporting Standards (IFRS) 3 and Accounting Standards Codification (ASC) 805 are primarily concerned with this acquisition. The purchase method and non-controllable interests (NCI) are methods of this accounting.
It differs from purchase accounting as it was used before. However, it was later replaced by this acquisition accounting.

Acquisition Accounting Explained

Acquisition accounting is a vital component of the accounting procedures focusing mainly on acquisitions. The origin of merger and acquisition accounting was first introduced by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) in 2008. It aimed to replace the purchase accounting method. Since then, business acquisition accounting journal entries have been popular among major businesses. However, the method followed does involve various steps.

The process of asset acquisition involves a major shift of two businesses. In this process, there is equal transfer of assets from one firm to another. It includes the assets, equity, and goodwill of the target company.

For instance, Company A (buyer) may have a large business model, and Company B (target company) might be comparatively smaller. As a result, the assets owned by them will also differ. If companies apply the standard accounting rule, it may be tough to decide its true value. Thus, while transferring these assets, estimating fair value is crucial. It helps businesses calculate the fair value of the assets for easy valuation.

The International Financial Reporting Standards (IFRS) and Accounting Standards Codification (ASC) have defined the asset acquisition accounting method. Also, both have mentioned the accounting standards for such deals. Let us look at them:

The IFRS 3 provides enough recognition for the assets acquired during business mergers and combinations. It further involves the purchase method and pooling of interests method.
Likewise, ASC 805 refers to the transactions where a business acquires assets and control over other businesses. Here, there is a certain amount of consideration involved during purchase. It can be in cash, equity, control, or similar methods.

Steps

Businesses can follow any standard for merger and acquisition accounting. However, the majority of them believe in IFRS 3. But it does involve various steps such as

#1 - Deciding On The Target Company

The foremost step for this accounting is the acquisition itself. Unless a company decides on acquisition, it is impossible to start with this method. Hence, when a business acquires another firm, a transaction deal occurs. It is then recorded in the financial books for accounting purposes.

This step also brings the identification of the acquirer and acquired. The firm that intends to buy (or acquire) is an acquirer. In contrast, the seller is referred to as acquired. It defines the control of the business.

#2 - Identification Of Acquisition Date

The next step is to identify the date on which the acquisition took place. This date is usually found in business contracts or legal documents. It also mentions the date on which the acquirer can have full control over the assets.

#3 - Measuring The Consideration

In business terms, consideration refers to the payment due in a financial transaction like acquisition or merger. It is a future payment of shares or profits to the acquired. So, if the company has any deferred payments, this consideration is visible in the books.

#4 - Calculating The Fair Value Of The Assets

It is the main step in the entire asset acquisition accounting process. Once acquisition occurs, the company may calculate the fair value of the assets. It helps to decide on the right purchase price allocation for the company.

There are primarily two methods for asset calculation. It includes the purchase method and non-controllable interests (NCI). At times, when the acquisition occurs, the acquirer may not have 100% control over the company. As a result, the entire equity cannot be directed to a single-parent company. In such cases, the NCI is applicable.

#5 - Recognizing The Goodwill

The last step is to calculate the goodwill of the acquirer. It includes the sum of consideration paid, non-controlling interest, fair value of any existing equity in the acquired, and less fair value of the acquired company's net assets. So, if the figure is negative, it means the company is undervalued, and it is a gain for the acquirer (buyer) and vice versa.

Examples

Let us look at some examples of asset acquisition accounting to understand the concept better:

Example #1

Suppose James is the owner of the firm Jameys Ltd operating in the soft toys industry. It has been more than seven years for this company in this industry. They have also witnessed immense returns in this time. However, James wants to expand his business in similar sectors. Currently, Jameys Ltd has a share of 30% in the market, and they wish to pursue more. And it is only possible if they acquire Honson Toys Ltd, which was under bankruptcy. Therefore, Jameys Ltd approached the latter, and after a quiet discussion, Honson Toys agreed to the acquisition.

Following are the details of this acquisition deal. Let us look at them:

Jamseys Ltd acquired 90% of the equity in the Honson Toys for $3000 million. The net value of Honson Toys's assets was recorded at $1000 million. The remaining equity (10%) belonged to the other shareholders. As a result, the NCI of the rest equity was $600 million. Let us calculate the goodwill and NCI of individual shares in the acquired assets.

Non-controllable interests (NCI) = Consideration ⨉ partial share (100% - 90%)

= 3000 * 10% = $300

Aspects	Full goodwill	Partial goodwill
Consideration	$3000	$3000
NCI	600	300
Fair value of the existing equity of acquiree Fair value of net assets less liabilities	(1000)	(1000)
Goodwill	$2600	$2300

The rest of the shareholders, having their stake in the Honson Toys, will have an NCI of $300 million. At the same time, the goodwill for Jamseys Ltd will be $2600.

Example #2

According to the recent news update as of October 2023, the multinational conglomerate Berkshire Hathaway was sued by Pilot Travel Centers for changing its acquisition accounting rules post-acquisition. The latter lodged a complaint in the Delaware Chancery Court stating that the acquirer (Berkshire Hathaway) had violated the terms by acquiring more than $10 billion. As a result, Buffett's lieutenants changed the business value, unfairly hurting Pilot and benefiting Berkshire. And in this process, the acquirer purchased 80% of the largest truck-top business.

Acquisition Accounting vs Merger Accounting

Although acquisition and merger accounting sound synonymous, they have differences. Let us look at some points:

Aspect	Acquisition Accounting	Merger Accounting
Meaning	It refers to the accounting method followed during acquisitions (acquiring stakes in other businesses).	Merger accounting is an accounting procedure of recording financial statements at times of mergers (a combination of two businesses).
Nature of transaction	Here, there is one firm involved that acquires another firm.	In this case, two businesses combine their businesses and synergies.
Recognition of assets and liabilities	The assets of the target company are combined with the acquirer (or buyer).	Here, the financial statements and associated assets and liabilities are merged into one.
Business structure	The acquirer is the owner in this case.	When merger occurs, a new entity is formed.

Acquisition Accounting vs Purchase Accounting

Acquisition accounting journal entries and purchase accounting seem similar, but they have distinct features. Let us look at them:

Aspect	Acquisition Accounting	Purchase Accounting
Meaning	It refers to the record of financial transactions and deals regarding acquisitions.	Purchase accounting is concerned with the accounting done while purchasing another company.
Purpose	It only aims at acquiring other businesses.	It is a broad concept that occurs during company purchases or mergers.
Occurrence	It occurs at the acquisition stage.	This accounting is usually performed after a company purchases another firm.

Frequently Asked Questions (FAQs)

1. What is acquisition cost in accounting?

Acquisition cost refers to the expenses incurred while acquiring another business or company. It majorly occurs when the acquirer purchases the assets of the target company. However, before calculating this cost, it is necessary to line up the current available assets. Once estimated, the cost is adjusted with the discounts, closing costs, and other expenses but before taxes.

2. How is acquisition shown in the balance sheet?

Since assets are the major point of concern, acquisition accounting usually occurs on the asset side. It allows them to record transactions under the fixed assets section. However, before that, it is necessary to calculate the fair value of the assets (tangible and intangible).

3. What are the limitations of acquisition accounting?

Although this accounting benefits financial records, some precautions are involved. While recording such transactions, it is important to distinguish between the acquisition of assets and the acquisition of business. Likewise, even consideration of assets also behaves the same.