The Acquisition Method illustrated

The Acquisition Method illustrated – a little history of acquisitions, mergers, purchase accounting, pooling of interests, goodwill, intangible assets acquired and the current end to this IFRS 3 Business Combinations. This is a developing story I will add stuff to end with a complete overview. The Acquisition Method illustrated

The short case: The Acquisition Method illustrated

The company A Corp is purchasing all shares in B Corp. Control is acquired by A Corp, B Corp disappears from the economic entity, and B or B’s shareholders receive either A Corp stock or other property. This will result in a business combination which means A Corp’s acquisition of control over the business of B Corp. The Acquisition Method illustrated

The acquisition will be accounted for as a ‘purchase’, this means that the acquired assets will be entered on the acquirer’s (A Corp’s) books at their current cost to it and liabilities will be credited at their current values; i.e., the total purchase price will be allocated among the individual assets and liabilities acquired to the extent of their fair market values.

This is one of the two most important consequences of accounting for the combination as a purchase, for it means that, in the usual case, where current cost is higher than the seller’s book carrying value, the buyer’s future income statements will be charged with greater expenses than the seller’s statements would have shown as these assets are depreciated or amortized. The result is that the increment in the buyer’s income’resulting from the acquisition usually will be less than the seller’s income would have been without the combination. The Acquisition Method illustrated The Acquisition Method illustrated

The Acquisition Method illustrated


In the past ‘pooling of interest’ was allowed, the accounting for such a pooling of interests is radically different from purchase accounting and rests on the notion that when two entities come together, with the interests in rights and rewards of the owners of each continuing, the old basis of accounting for each should continue.

This means that the book carrying values of the assets and liabilities of each entity are continued on the books of the new or surviving entity and the earned surpluses of the two were combined, with potentially significant differences in accounting policies chosen, valuations allowed and equity and earnings retained combined is like adding oranges and apples, it simply adds up but it does not add up to consistent useful information.

But that is the past!!

Once a reporting entity is satisfied that a transaction meets the definition of a business combination, it shall account for each business combination by applying the acquisition method: The Acquisition Method illustrated

The Acquisition Method illustrated

Step 3 Recognize and measure identifiable assets acquired, liabilities assumed and non-controlling Interests

Identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities at acquisition date.

The acquirer’s application of the recognition principle and conditions may result in some assets and liabilities being recognized that were not previously recognized in the acquiree’s financial statements, for example brand names or patents. The Acquisition Method illustrated

Identifiable assets acquired and liabilities assumed shall be recognized at their acquisition date fair values. The Acquisition Method illustrated

Any non-controlling interest in the acquiree shall be measured either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets.

Step 4 Recognizing and Measuring Goodwill or Gain From Bargain Purchase

Measured as the excess of (a) over (b) Measured as the excess of (b) over (a) The Acquisition Method illustrated

  1. the aggregate of: The Acquisition Method illustrated The Acquisition Method illustrated
    • the consideration transferred which generally requires acquisition–date fair value*; The Acquisition Method illustrated
    • the amount of any non-controlling interest in the acquiree; The Acquisition Method illustrated
    • in a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree; and
  2. the net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed.  The Acquisition Method illustrated

A gain from a bargain purchase is recognized in net income of the acquirer on the acquisition date only once the acquirer has reassessed whether it has correctly identified all of the assets acquired and all of the liabilities assumed. The Acquisition Method illustrated

* Calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree and the equity interests issued by the acquirer. Potential forms of consideration include but are not limited to cash, other assets, a business or subsidiary of the acquirer, contingent consideration, equity instruments and options. The Acquisition Method illustrated

Measurement Period

This is the period after the acquisition date (if the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs), during which the acquirer may adjust the provisional amounts recognized for a business combination. A summary of the measurement period timeline is shown below:

The Acquisition Method illustrated

After this period ends, the acquirer can revise the accounting for the business combination only to correct an error in line with IAS 8 Accounting policies, Changes in accounting estimates and errors. The Acquisition Method illustrated The Acquisition Method illustrated

During the measurement period, the acquirer shall retrospectively adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date and, if known, would have affected the measurement of the amounts recognized as of that date. This may include recognizing additional assets and liabilities. The Acquisition Method illustrated

As measurement period adjustments are applied retrospectively, the acquirer shall revise comparative information for prior periods presented in financial statements as needed, including making any change in depreciation, amortization or other income effects recognized in completing the initial accounting.

OVERVIEW

  • Business combinations are accounted for under the acquisition method, with limited exceptions.
  • A ‘business combination’ is a transaction or other event in which an acquirer obtains control of one or more businesses.
  • The acquirer in a business combination is the combining entity that obtains control of the other combining business or businesses.
  • In some cases, the legal acquiree is identified as the acquirer for accounting purposes (reverse acquisition).
  • The ‘date of acquisition’ is the date on which the acquirer obtains control of the acquiree.
  • Consideration transferred by the acquirer, which is generally measured at fair value at the date of acquisition, may include assets transferred, liabilities incurred by the acquirer to the previous owners of the acquiree and equity interests issued by the acquirer.
  • Contingent consideration transferred is initially recognised at fair value. Contingent consideration classified as a liability or an asset is remeasured to fair value each period until settlement, with changes recognised in profit or loss. Contingent consideration classified as equity is not remeasured.
  • Any items that are not part of the business combination transaction are accounted for outside the acquisition accounting.

See more details on the current IFRS 3 Business Combinations – Acquisition method.

The Acquisition Method illustrated

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