20. Acquisition Method
The acquisition method is a method of accounting for business combinations, in which the acquirer records the assets and liabilities of the acquired company at their fair values as of the acquisition date. The acquisition method is also known as the purchase method, as it is used when the acquirer purchases the assets and liabilities of the acquired company.
Under the acquisition method, the acquirer recognizes the excess purchase price (the difference between the acquisition cost and the fair value of the identifiable assets and liabilities) as goodwill. Goodwill is an intangible asset that reflects the inherent value of the business combination, such as the value of the acquired company’s brand, customer relationships, and other intangible assets that are not separately identifiable and cannot be reliably measured.
Here is an example of how the acquisition method would be applied:
Suppose Company A acquires Company B for a total cost of $10 million. The fair value of Company B’s identifiable assets is determined to be $6 million, and the fair value of its liabilities is determined to be $2 million. The excess purchase price in this case is $2 million ($10 million – $6 million – $2 million), and the acquirer must determine how much of this excess purchase price should be recognized as goodwill.
Under the acquisition method, the acquirer would recognize the entire excess purchase price as goodwill, as it reflects the inherent value of the business combination. The fair values of the assets and liabilities of Company B would be recorded on the acquirer’s balance sheet as of the acquisition date, and any differences between the acquisition cost and the fair values of the assets and liabilities would be recognized in the income statement as part of the business combination.
Overall, the acquisition method is a widely used method of accounting for business combinations, as it allows the acquirer to accurately reflect the nature of the transaction and the fair values of the assets and liabilities acquired. It is important to carefully consider the fair value estimates used in the acquisition method in order to ensure that the financial statements accurately reflect the nature of the business combination.