What is a Purchase Acquisition
Purchase acquisition is an accounting method used in mergers and acquisitions where there is no pooling of interests and the purchasing company treats the target firm as an investment. The assets of the target are valued and added to the balance sheet of the acquirer at fair value, increasing 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.
BREAKING DOWN Purchase Acquisition
There are many ways an acquirer can pursue the purchase of a target. If interests are pooled between the acquirer and the target, all assets and liabilities of the acquirer and target are netted using their book value and 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 purchase acquisition method, it treats the target as an investment. The target's assets and liabilities are netted using current fair value and if the amount paid for the target is greater than that netted value, the difference is reflected as goodwill. Because goodwill must be written-off against future earnings, this can reduce the future earnings of the entity.