What is Acquisition Accounting?
Let me explain acquisition accounting to you directly: it's a set of formal guidelines that dictate how you, as the buyer, must report the assets, liabilities, non-controlling interest (NCI), and goodwill of a company you've purchased on your consolidated statement of financial position.
You allocate the fair market value (FMV) of the acquired company between the net tangible and intangible assets on your balance sheet, and any difference that results is treated as goodwill. I should note that acquisition accounting is also commonly called business combination accounting.
Key Takeaways
To keep it straightforward, acquisition accounting provides the rules for how you report the assets, liabilities, non-controlling interest, and goodwill of the acquired company as the purchaser.
You distribute the fair market value of the acquired company across the net tangible and intangible assets on your balance sheet, with any leftover amount becoming goodwill.
Remember, all business combinations have to be handled as acquisitions for accounting purposes.
How Acquisition Accounting Works
Under International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS), you must treat all business combinations as acquisitions, which means identifying one company as the acquirer and the other as the acquiree, even if the deal forms a new entity.
The approach demands that everything is measured at FMV—the price a third party would pay in the open market—at the acquisition date when you take control of the target.
What Gets Measured at FMV
- Tangible assets and liabilities: These are physical items like machinery, buildings, and land.
- Intangible assets and liabilities: Nonphysical ones such as patents, trademarks, copyrights, goodwill, and brand recognition.
- Non-controlling interest: This is minority interest, where a shareholder owns less than 50% of shares and has no control; its fair value can often come from the acquiree's share price.
- Consideration paid to the seller: This could be cash, stock, or contingent earnouts, and you need calculations for any future obligations.
- Goodwill: After all that, you calculate goodwill if the purchase price exceeds the fair value sum of identifiable tangible and intangible assets acquired.
Important Note
Fair value analysis is typically done by a third-party valuation specialist, which ensures accuracy in these measurements.
History of Acquisition Accounting
Acquisition accounting came into effect in 2008, introduced by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), to replace the old purchase accounting method.
It was chosen because it bolsters the fair value concept, focusing on current market values in transactions and accounting for contingencies and non-controlling interests that purchase accounting ignored.
A key difference is in handling bargain acquisitions: under purchase accounting, the difference between fair value and purchase price was negative goodwill amortized over time on the balance sheet, but with acquisition accounting, it's immediately recognized as a gain on the income statement.
Complexities of Acquisition Accounting
While acquisition accounting has boosted transparency in mergers and acquisitions (M&A), it hasn't simplified combining financial records.
You have to adjust each component of the acquired entity's assets and liabilities to fair value, covering everything from inventory and contracts to hedging instruments and contingencies.
This extensive work is a primary reason why there's often a long gap between when boards agree on a deal and when it actually closes.
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