Acquisition Accounting

What is Acquisition Accounting?

Acquisition accounting is a set of formal guidelines describing how assets, liabilities, non-controlling interest (NCI) and goodwill of a purchased company must be reported by the buyer on its consolidated statement of financial position.

The fair market value (FMV) of the acquired company is allocated between the net tangible and intangible assets portion of the balance sheet of the buyer. Any resulting difference is regarded as goodwill. Acquisition accounting is also referred to as business combination accounting.

How Acquisition Accounting Works

International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) require all business combinations to be treated as acquisitions for accounting purposes, meaning that one company must be identified as an acquirer and one company must be identified as an acquiree even if the transaction creates a new company.

The acquisition accounting approach requires everything to be measured at FMV, the amount a third-party would pay on the open market, at the time of acquisition — the date that the acquirer took control of the target company. That includes the following:

Important

Fair value analysis is often conducted by a third-party valuation specialist.

History of Acquisition Accounting

Acquisition accounting was introduced in 2008 by the major accounting authorities, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), to replace the previous method, known as purchase accounting.

Acquisition accounting was preferred because it strengthened the concept of fair value. It focuses on prevailing market values in a transaction and includes contingencies and non-controlling interests, which were not accounted for under the purchase method.

Another difference between the two techniques is how bargain acquisitions are treated. Under the purchase method, the difference between the acquired company's fair value and its purchase price was recorded as negative goodwill (NGW) on the balance sheet that was to be amortized over time. In contrast, with acquisition accounting, NGW is immediately treated as a gain on the income statement.

Complexities of Acquisition Accounting

Acquisition accounting improved the transparency of mergers and acquisitions (M&A) but did not make the process of combining financial records easier. Each component of assets and liabilities of the acquired entity has to be adjusted for fair value in items ranging from inventory and contracts to hedging instruments and contingencies, to name just a few.

The amount of work needed to adjust and integrate the books of the two companies is one main reason for the long period between agreement on a deal by the respective boards of directors and the actual deal closing.