Understanding Acquisition Accounting

Updated: Oct 28



If you are a business owner or CFO who is looking to acquire another company or merge with another business, then this blog post is for you. This is meant to create an understanding of how acquisition accounting works and to provide a starting point for questions you may want to ask when going through the process. Acquisition accounting involves determining business combination, the fair value of the assets and liabilities that are transferred as part of the transaction, as well as identifying any goodwill, gain on purchase or other intangible assets that may have been created as a result. In some cases, it can be confusing whether the acquisition is simply an asset purchase versus a true business merger. This blog helps to sort out the differences and walk you through some of the accounting considerations involved in this process.


Key Terminology:


Business Combination

A transaction or other event which the buyer obtains control of one or more business. These transactions are considered to be true mergers.


Asset Purchase

A transaction in which the buyer acquires only some, or all of a target company's assets. These types of transactions are typically considered to be purchasing assets and are treated differently than a business acquisition.

Goodwill

An intangible asset that is created as a result of the business combination. This can arise in several different ways, including through the difference between the value placed on the target company's assets and liabilities in comparison to their market values, or from intangible assets such as brand recognition and customer base. In some cases, it could be an indicator of overpaying for the fair market value of the target company's assets.


Bargain Purchase

An acquisition in which the buyer purchases assets at a discount as opposed to overpaying for the value of the target company's assets. This type of acquisition ends in a one-time gain recorded on the net-income.

Step 1 Determine whether the acquisition is an Asset purchase or a Business Combination


ASC 805-10-55-3A defines “business” as follows:

A business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants.

In order to be considered a business, a set needs to have an input and a substantive process that together significantly contribute to the ability to create outputs.


Input

Financial resources including cash and cash equivalents, accounts receivables to provide for the liquidity to purchase materials, pay for labor, and lease equipment, to create goods or services.


Process

If provided with inputs, there are processes in place, such as systems, protocols and people with the intellectual capacity to execute and create outputs.


Outputs

Goods or services to be provided to the customers.


Step 2 Determine the fair value of the assets and liabilities


The fair value of the assets and liabilities is determined based on their market values. This can be assessed using a variety of valuation techniques, such as cost-to-replace analysis, discounted cash flow analysis, and comparable asset sales. The fair value may also be determined by reference to other valuations performed as part of the transaction process. Hiring a valuation consultant or business appraiser is highly recommended.


Step 3 Calculate goodwill or gain on bargain purchase


If the acquisition is deemed to be a business combination, then a goodwill or gain on bargain purchase will arise. Calculate the difference between the cash price versus the target company's net asset fair value, if the cash price is higher than the net asset fair value then you will have to record an intangible asset on the balance sheet, if the cash price is less than the net asset fair value then you will have to record a one-time gain on the income statement.


If the acquisition is deemed to be an asset purchase, the accounting treatment would be to group them into similar identifiable categories and record the cash price allocable to each category on the balance sheet. There is no goodwill or gain on bargain purchase.

Conclusion

If you are contemplating an acquisition or merger, it is important that you understand the accounting implications of your business combination. The first step in this process is to determine whether the transaction meets the definition of a business as per ASC 805 accounting standards. If so, then you will need to follow the steps outlined in these standards to accurately account for the assets and liabilities that are transferred as part of the business combination, as well as any intangible assets or goodwill that may be created in the process. You will also need to consider whether there are any tax implications for your business, such as potential capital gains taxes on the sale of the target company's assets, or the potential impact of new debt obligations.


GFT is an accounting outsource firm helping middle market companies navigate the complexities of accounting. We provide managed accounting services to increase our client's finance department's capacity in order to achieve the most difficult deadlines - such as a looming merger or acquisition.

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