Acquisition accounting

Definition

Acquisition accounting is a method used in business combinations where the acquiring company recognizes the assets and liabilities of the acquired company at their fair values as of the acquisition date. This approach is crucial for accurately representing the financial health of a company post-acquisition and provides insights into how the acquisition impacts earnings per share and overall financial performance.

5 Must Know Facts For Your Next Test

1. Acquisition accounting requires the acquiring company to assess the fair value of the acquired company's tangible and intangible assets, as well as its liabilities, at the acquisition date.
2. The difference between the purchase price and the fair value of net identifiable assets results in goodwill, which is tested for impairment annually.
3. This accounting method affects a company's balance sheet by increasing its total assets due to recognized goodwill and other fair value adjustments.
4. Acquisition accounting impacts earnings per share (EPS) calculations because it influences both net income through amortization of intangibles and changes in asset valuations.
5. Companies often need to provide detailed disclosures in financial statements about their acquisition accounting practices, including how they determined fair values and allocated purchase prices.

Review Questions

• How does acquisition accounting impact the financial statements of the acquiring company after a business combination?
  • Acquisition accounting significantly alters the financial statements of the acquiring company by adjusting the recorded values of acquired assets and liabilities to their fair values. This change typically increases total assets on the balance sheet, particularly through goodwill and other intangible assets. Additionally, it affects net income through amortization and potential impairment charges, which can subsequently impact earnings per share calculations.
• Discuss the role of goodwill in acquisition accounting and how it is accounted for over time.
  • Goodwill plays a pivotal role in acquisition accounting as it represents the excess purchase price paid over the fair value of net identifiable assets. Under this method, goodwill is not amortized but is subject to annual impairment testing. If goodwill is deemed impaired, the company must recognize a loss that reflects this reduction in value, impacting its financial performance and requiring disclosure in financial statements.
• Evaluate the implications of purchase price allocation in acquisition accounting on strategic decision-making within a company.
  • The process of purchase price allocation (PPA) in acquisition accounting has profound implications for strategic decision-making within a company. By accurately assessing fair values, management can make informed choices regarding resource allocation, operational integration, and future investment strategies. A well-executed PPA can highlight valuable intangible assets, guide post-acquisition synergies, and enhance overall financial planning, thereby influencing long-term growth prospects and competitive positioning.

Related terms

Goodwill: An intangible asset that arises when an acquiring company purchases another company for more than the fair value of its net identifiable assets.

Purchase Price Allocation (PPA): The process of assigning the purchase price of an acquired company to its identifiable assets and liabilities based on their fair values.

Fair Value Measurement: A principle used in accounting to determine the estimated worth of an asset or liability based on market conditions and other relevant factors.