Acquisition Accounting

When an acquirer buys another company, the acquirer must record the event under 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 . Measure the amount of any noncontrolling interest in the acquired business !. Measure the amount of consideration paid to the seller ". Measure any goodwill or gain on the transaction We will deal with each of these steps below.

Measure tangible assets and liabilities. Measure tangible assets and liabilities at their fair mar#et values as of the acquisition date, which is the date when the acquirer gains control over the acquiree. There are a few e$ceptions, such as lease and insurance contracts, which are measured as of their inception dates. %owever, 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. Measure intangible assets and liabilities. Measure intangible assets and liabilities at their fair mar#et 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 tas# 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. 'nce measured and recorded as part of the acquisition transaction, intangible assets must be amorti(ed over their useful economic lives. )f the life span of an intangible asset is considered to be indefinite, do not amorti(e it until such time as a useful economic life can be determined. 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 mar#et price of the stoc# of the
1

acquiree, if an active mar#et for it e$ists. This amount is li#ely 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.

Measure consideration paid. There are many types of consideration that may be paid to the seller, including cash, debt, stoc#, a contingent earnout, and other types of assets. *o matter what type of consideration is paid, it is measured at its fair value as of the acquisition date. The following calculation is used to ascertain the total amount of consideration paid: + ,air value of assets paid to seller + ,air value of acquirer equity awards that replace e$isting acquiree awards & ,air value of liabilities incurred by the seller - Total consideration paid The acquirer should include in this consideration calculation the amount of any future payment obligations, such as earnouts. )f events occur after the acquisition date, such as the completion of a target under an earnout arrangement, its accounting recognition varies depending on the type of consideration paid. )f the contingent payment is in equity, there is no remeasurement of the consideration paid, and any change in the amount of equity issued is noted within the equity section of the balance sheet. )f the contingent payment involves an asset or liability, it is remeasured at each subsequent reporting date until the contingent event has been settled, with changes being reported in net income.

Measure goodwill or bargain purchase gain. .fter all of the preceding steps have been completed, the acquirer must bac# into the amount of any goodwill or gain on a bargain purchase by using the following calculation: /onsideration paid + *oncontrolling interest 0 )dentifiable assets acquired + )dentifiable liabilities acquired Acquisition Method When one company controls another company the controlling company is called the parent and the controlled company is called the subsidiary. 1ince the parent controls the operating and financing decisions of the subsidiary, it is worthwhile to loo# at both the companies2 financial performance and financial position together. /onsolidated financial statements are prepared to

achieve this ob3ective. 41 5..6 and ),71 require the consolidated financial statements to be prepared under the acquisition method. )n the acquisition method, the parent includes all the assets of the subsidiary on its consolidated balance sheet and includes all the subsidiary2s revenues and e$penses in its consolidated revenues and e$penses. )t creates a component called 2non&controlling interest2 or 2minority interest2 in its equity section which represents the claim of others on the subsidiary2s net assets. . line item also appears on the consolidated income statement below net income which represents net income attributable to the non&controlling interest. 8$ample /ompany 6 currently holds 9": of the outstanding share capitals of /ompany 1. /ompany 62s assets are ; < million, its liabilities are ;2< million and its shareholders2 equity is ;1< million. /ompany 12s assets are ;1< million, its liabilities are ;9 million and its equity is ; million. /ompany 6 will include the assets of /ompany 1 on its balance sheet so its total assets will be ;!< million =; < million + ;1< million>, its total liabilities will be ;29 million =;2< million + ;9 million>. )ts equity will be ;1 million =;!< million minus ;29 million> but it will have two components: first component would result to the interest of the /ompany 6 in /ompany 12s net assets while the other component is called the non&controlling interest and it represents the interest of other /ompany 1 shareholders who hold the remaining 2": of the outstanding shares. *on&controlling interest on /ompany 62s balance sheet would equal 2": of /ompany 12s net assets =;1< million minus ;9 million> which equals ;<.9" million. The equity component that represents /ompany 62s interest is hence ;12.2" million =total equity of ;1 million minus non&controlling interest of ;<.9" million>.

un <, 2<<" The IASB and the US Financial Accounting Standards Board (FASB) have each published for public comment e posure drafts containing !oint proposals to improve and align the accounting for business combinations" The proposals include a draft standard that the boards have developed in their first ma3or 3oint pro3ect. The proposed standard would replace the e$isting requirements of the ).1?2s ),71 Business Combinations and the ,.1?2s 1tatement 1!1 Business Combinations. The proposals retain the fundamental requirement of ),71 and 1,.1 1!1 to account for all business combinations using the purchase method of accounting, by which one party is always identified as acquiring the other.

#rincipal changes being proposed to IF$S %& o The acquirer would measure the business acquired at its total fair value and, consequently, recognise the goodwill attributable to any non& controlling interests =previously referred to as minority interests> rather than 3ust the portion attributable to the acquirer. This is sometimes called the 2full goodwill method2. The current version of ),71 requires a business combination to be measured and recognised on the basis of the accumulated cost of the combination.
o

6ayments to third parties for consulting, legal, audit, and similar services associated with an acquisition would be recognised generally as e$penses when incurred rather than capitalised as part of the business combination. The current version of ),71 requires direct costs of the business combination to be included in the cost of the acquiree.

The acquirer would measure and recognise the acquisition&date fair value of the assets acquired and liabilities assumed as part of the business combination, with limited e$ceptions. Those e$ceptions are goodwill, non&current assets =or disposal group> classified as held for sale, deferred ta$ assets or liabilities, and assets or liabilities related to the acquiree2s employee benefit plans. Thus there will be fewer e$ceptions to the principle of measuring assets acquired and liabilities assumed in a business combination at fair value.

The acquirer would recognise separately from goodwill an acquiree2s intangible assets that meet the definition of an intangible asset in ).1 @ Intangible Assets and are identifiable =that is, they arise from contractual&legal rights or are separable>. The current version of ),71 requires the recognition of intangible assets separately from goodwill only if they meet the ).1 @ definition and are reliably measurable. The acquirer would account for a bargain purchase by reducing goodwill until the goodwill related to that business combination is reduced to (ero and then by recognising any remaining e$cess in profit or loss. The current version of ),71 requires the e$cess of the acquirer2s interest in the net fair values of the acquiree2s assets and liabilities over cost to be recognised immediately in profit or loss.

.cquisitions of additional non&controlling equity interests after the business combination will no longer be accounted for using the acquisition method. )nstead, they will be accounted for as transactions with owners.

The scope of ),71

would be broadened to include business

combinations involving only mutual entities and those achieved by contract alone. T'o additional e posure drafts& o The ).1? and the ,.1? also published e$posure drafts proposing that non&controlling interests should be classified as equity within the consolidated financial statements and that the acquisition of non& controlling interests should be accounted for as an equity transaction. The ).1?2s proposals are presented as amendments to ).1 29 Consolidated and Separate Financial Statements. The ).1? also has proposed to amend ).1 9 Provisions, Contingent Liabilities and Contingent Assets, to treat items previously described as 2contingent liabilities2 more consistently in and outside a business combination.

"