by Accounting for Acquisitions involves the process of recording transactions that occur when one company (the acquirer) gains control over another company (the target) through the purchase of its shares, assets, or both. There are generally two accounting methods for acquisitions:
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Purchase Method
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Pooling of Interests Method (now obsolete under IFRS and some local GAAPs but still used in certain jurisdictions)
1. Purchase Method (or Acquisition Method)
Under the purchase method, the acquirer recognizes the fair value of the assets acquired and liabilities assumed at the acquisition date. This method results in goodwill (if the purchase price exceeds the fair value of the net assets acquired) or a gain from a bargain purchase (if the fair value of the net assets exceeds the purchase price).
Key Steps in the Purchase Method:
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Identify the Acquirer: The entity obtaining control.
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Determine the Acquisition Date: The date when control is transferred.
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Measure Assets and Liabilities: Fair values at the acquisition date.
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Record Goodwill: The excess of the cost of the acquired company over the fair value of its identifiable net assets.
2. Pooling of Interests Method (Obsolete)
Under the pooling of interests method (now obsolete in many accounting standards like IFRS), assets and liabilities of the combining entities were combined at their carrying amounts without any fair value adjustments. No goodwill or purchase price allocations were required, and the combined entity’s equity was adjusted accordingly.
Accounting Entries for Acquisition Under Purchase Method
The following are the general steps involved in making accounting entries for acquisitions under the purchase method:
| Transaction | Accounting Entry |
|---|---|
| 1. Recognition of Purchase Price Paid | Debit: Investment in Subsidiary (Acquired Company) |
| – | Credit: Bank (or Payables for the purchase amount) |
| 2. Acquisition of Assets | Debit: Assets Acquired (e.g., Property, Equipment, Intangibles, Inventory, etc.) |
| – | Credit: Liability Assumed (e.g., Long-term Debt, Short-term Liabilities) |
| 3. Recognition of Liabilities | Debit: Liabilities (e.g., Accounts Payable, Debt, Provisions) |
| – | Credit: Acquisition-related Payable (Acquirer liability to settle) |
| 4. Calculation of Goodwill | Debit: Goodwill (if purchase price > fair value of net assets acquired) |
| – | Credit: Purchase Price (or excess of fair value of net assets over purchase price) |
| 5. Amortization of Intangible Assets | Debit: Amortization Expense (over the useful life) |
| – | Credit: Accumulated Amortization (on acquired intangible assets) |
| 6. Fair Value Adjustments on Assets | Debit: Assets (to adjust to fair value if applicable) |
| – | Credit: Liabilities (if fair value adjustment results in a liability) |
| 7. Elimination of the Target’s Equity | Debit: Share Capital (Target company’s equity) |
| – | Debit: Reserves (Target company’s reserves) |
| – | Credit: Investment in Subsidiary (initially recorded) |
Key Considerations in the Accounting for Acquisitions:
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Fair Value of Assets and Liabilities: At the acquisition date, the acquirer needs to record the fair value of the identifiable assets and liabilities.
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Goodwill or Bargain Purchase:
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Goodwill is recorded if the acquisition cost exceeds the fair value of the net assets acquired.
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If the acquirer buys the target company for less than its net asset value, the acquirer records a bargain purchase gain (negative goodwill).
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Adjustments for Contingent Liabilities and Assets: If there are contingent assets or liabilities associated with the acquired company, these need to be measured at fair value and accounted for accordingly.
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Elimination of Intercompany Transactions: After the acquisition, intercompany transactions between the acquirer and the target must be eliminated during consolidation (if applicable).
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Amortization of Intangibles and Goodwill: Intangible assets acquired in the acquisition are amortized over their useful life, and goodwill is tested for impairment annually (as per most accounting standards like IFRS or US GAAP).
Example of Acquisition Accounting Entries:
Assume Company A acquires Company B for $1,000,000. The fair value of Company B’s identifiable assets and liabilities is as follows:
| Asset / Liability | Fair Value |
|---|---|
| Cash | $100,000 |
| Property and Equipment | $500,000 |
| Intangible Assets | $300,000 |
| Liabilities (Payables) | $200,000 |
| Shareholders’ Equity | $700,000 |
The purchase price of $1,000,000 exceeds the net asset value of Company B ($100,000 + $500,000 + $300,000 – $200,000 = $700,000), so Company A recognizes goodwill of $300,000 ($1,000,000 – $700,000).
Accounting Journal Entries Example:
| Transaction | Debit | Credit |
|---|---|---|
|
1. Record Purchase Price |
Investment in B ($1,000,000) |
Bank ($1,000,000) |
|
2. Record Assets Acquired |
Cash ($100,000) | Assets Acquired |
| – | Property ($500,000) | – |
| – |
Intangible Assets ($300,000) |
– |
|
3. Record Liabilities Assumed |
Liabilities ($200,000) | Liabilities Assumed |
|
4. Record Goodwill |
Goodwill ($300,000) |
Investment in B ($300,000) |
