What Is an Acquisition Adjustment?

An acquisition adjustment describes the difference between the price an acquirer pays to purchase another company and the net original cost of the target’s assets. Also known as "goodwill", it is a premium paid for acquiring a company for more than its tangible assets or book value.

Key Takeaways

  • An acquisition adjustment describes the difference between the price an acquirer pays to purchase another company and the net original cost of the target’s assets.
  • A company may prefer an acquisition adjustment if the brand and other intangible assets, including patents and customer relations, provide it with value.
  • How the acquisition adjustment is treated affects how assets are depreciated, which, in turn, impacts net income (NI) and corporate income taxes.

Understanding an Acquisition Adjustment

In a merger and acquisition (M&A) transaction, it's common for the acquiring company to pay a premium, meaning it bids more than the target company is currently deemed to be worth according to its market and book value: total assets plus intangible assets and liabilities.

Usually, a company may prefer an acquisition adjustment if the brand and other hard to appraise intangible assets, such as patents and good customer relations, provide it with value. Even though these types of assets cannot be seen or touched, they are regularly the crown jewels of businesses and a key driver of their revenue and profits.

The idea behind an acquisition adjustment takes place on a couple of levels. First, and most basic, the acquisition adjustment speaks to the premium an acquirer pays for a target business during a transaction. Second, and on a deeper level, how the acquisition adjustment is treated ultimately affects how assets are capitalized and depreciated, which, in turn, impacts net income (NI), a key gauge of corporate profitability, and corporate income taxes. Delaying taxes with depreciation tax shields can add up to significant net present value over longer time periods.

Generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) require companies to assess the value of goodwill, the portion of the purchase price exceeding the sum of the net fair value of all recognizable assets bought in the acquisition and the liabilities assumed in the process, on their financial statements at least once a year and record any impairments: a permanent reduction in the value of assets.

Important

Goodwill is difficult to price, prone to manipulation, and can also be categorized as negative when an acquirer purchases a company for less than its fair market value.

Special Considerations

Many modern companies derive more value from their intangible assets than their tangible assets carried on their balance sheet, which can distort their financial and operational picture. These days intangible assets regularly hold the key to success, meaning that companies are often willing to fork out lots of money to preserve and extract more value from them.

At the same time, many businesses treat investments in their brand, research and development (R&D) or information technology as expenses, when in fact, they provide long-term value and, hence, should be accounted for similarly to a traditional fixed asset.

Kite Pharmaceutical, a cutting-edge biotech company, reported hundreds of millions of dollars in losses every year because they expensed their R&D efforts, rather than capitalizing and depreciating them. In the second half of 2017, it was acquired by Gilead Sciences for no less than $12 billion. Not bad for a business showing little income but a lot of value.