What Is Purchase Acquisition Accounting?
Purchase acquisition accounting is a method of reporting the purchase of a company on the balance sheet of the company that acquires it. It treats the target firm as an investment. There is no pooling of assets. Rather, the assets of the target firm are added to the balance sheet of the acquirer at a price that reflects their fair market value. This, in turn, increases the acquirer's fair market value. Liabilities of the target are subtracted from the fair value of the assets.
The amount paid by the acquirer over the net value of the target's assets and liabilities is considered goodwill, which is kept on the balance sheet and amortized yearly.
This method has become the accepted standard for purchase accounting. The acquisition accounting method is sometimes referred to as business combination accounting.
- Purchase acquisition accounting is now the standard way to record the purchase of a company on the balance sheet of the acquiring company.
- The assets of the acquired company are recorded as assets of the acquirer at fair market value.
- This method of accounting increases the fair market value of the acquiring company.
Understanding Purchase Acquisition Accounting
Purchase acquisition accounting is a set of guidelines for recording the purchase of a company on the consolidated statements of financial position of the company that buys it.
This is the standard documentation for recording the assets and liabilities of a company with subsidiaries. It is most relevant to public companies since privately-held firms have fewer reporting requirements.
Purchase acquisition accounting strengthens the concept of fair market value at the time of a merger or acquisition.
The purchase acquisition accounting approach requires that all assets and liabilities, tangible and intangible, be measured at fair market value. That is, it is valued at the amount that a third party would have paid on the open market on the date that the company acquired it.
Other Accounting Methods
If the business combination is not a strict takeover of one company by another, then other methods of accounting are allowed. Pooling of interest or merger accounting may be allowed by FASB or the IASB.
For instance, if the companies are under common control and interests are pooled between the acquirer and the target, all assets and liabilities of the acquirer and target are netted using their book value. No goodwill results from the purchase transaction. Since there is no goodwill to write off, this can result in higher future earnings for the newly formed entity.
When the acquirer uses the acquisition accounting method, the target is treated as an investment. The target's assets and liabilities are netted using current fair market value and if the amount paid for the target is greater than that netted value, the difference is considered as goodwill.
Because goodwill must be written off against future earnings, this can reduce the future earnings of the entity.
The concept of purchase acquisition accounting was introduced in 2007 and 2008 by the major accounting authorities, the Financial Accounting Standards Board (FASB), and the International Accounting Standards Board (IASB). It replaces the previous method, known as purchase accounting.
Acquisition accounting was preferred because it strengthened the concept of fair market value at the time of a transaction. It also adds accounting for contingencies and non-controlling interests, which were not considered under the previous method.
It treats the target firm as an investment. There is no pooling of assets.