Acquisition method of accounting

When an acquiree buys another company and the acquirer uses GAAP, the acquirer must record the event using the acquisition method. This approach mandates a series of steps to record the acquisitions, which are:

  1. Measure any tangible assets and liabilities that were acquired
  2. Measure any intangible assets and liabilities that were acquired
  3. Measure the amount of any noncontrolling interest in the acquired business
  4. Measure the amount of consideration paid to the seller
  5. Measure any goodwill or gain on the transaction

We will deal with each of these steps below.

1. Measure Tangible Assets and Liabilities

Measure tangible assets and liabilities at their fair market values as of the acquisition date, which is the date when the acquirer gains control over the acquiree. There are a few exceptions, such as lease and insurance contracts, which are measured as of their inception dates. However, most assets and liabilities should be measured as of the acquisition date. This fair value analysis is frequently done by a third-party valuation firm.

2. Measure Intangible Assets and Liabilities

Measure intangible assets and liabilities at their fair market values as of the acquisition date, which is the date when the acquirer gains control over the acquiree. This tends to be a more difficult task for the acquirer than the measurement of tangible assets and liabilities, since the acquiree may not have recorded many of these items on its balance sheet. Under GAAP, some intangibles cannot be recognized as assets.

3. Measure Noncontrolling Interest

Measure and record the noncontrolling interest in the acquiree at its fair value on the acquisition date. The fair value can be derived from the market price of the stock of the acquiree, if an active market for it exists. This amount is likely to be less per share than the price the acquirer paid to buy the business, since there is no control premium associated with the noncontrolling interest.

4. Measure Consideration Paid

There are many types of consideration that may be paid to the seller, including cash, debt, stock, a contingent earnout, and other types of assets. No matter what type of consideration is paid, it is measured at its fair value as of the acquisition date. The acquirer should include in this consideration calculation the amount of any future payment obligations, such as earnouts. 

5. Measure Goodwill or Bargain Purchase Gain

After all of the preceding steps have been completed, the acquirer must back into the amount of any goodwill or gain on a bargain purchase by using the following calculation:

Consideration paid + Noncontrolling interest – Identifiable assets acquired
 + Identifiable liabilities acquired

If this calculation results in a bargain purchase (formerly known as negative goodwill), then the acquirer has paid less for the acquiree than the fair values of its assets and liabilities indicate that it is worth. A bargain purchase is recognized as a gain as of the acquisition date. 

Summary

The many steps noted here to record an acquisition cannot always be completed in time to be accurately recorded in the accounting period when an acquisition is completed. If it appears that the accounting will be delayed, the acquirer should report its best estimates in the relevant accounting period, and then adjust those figures later, based on facts and circumstances that existed as of the acquisition date. Information arising at a later date may result in subsequent changes to asset and liability values, but they should not be used to retroactively adjust the recordation of the original acquisition entry.

Related Courses

Business Combinations and Consolidations 
Mergers & Acquisitions