The acquisition method is a crucial accounting approach for business combinations. It involves identifying the acquirer, determining the acquisition date, and recognizing assets, liabilities, and any noncontrolling interests. This method aims to provide a clear picture of the resources acquired and obligations assumed in a merger or acquisition.

The process includes several key steps, from identifying the acquirer to recognizing goodwill or gain. It also covers contingent consideration, acquisition-related costs, reverse acquisitions, and measurement period adjustments. Understanding these elements is essential for accurate financial reporting in business combinations.

Overview of acquisition method

• The acquisition method is the primary method used to account for business combinations under US GAAP and IFRS
• It involves identifying the acquirer, determining the acquisition date, recognizing and measuring identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree, and recognizing and measuring goodwill or a gain from a bargain purchase
• The acquisition method aims to reflect the perspective of the acquirer and provide relevant information to investors and other users of financial statements about the resources acquired and obligations assumed in a business combination

Steps in acquisition method

Identifying acquirer

• The acquirer is the entity that obtains control of the acquiree
• Control is the power to govern the financial and operating policies of an entity to obtain benefits from its activities
• Factors to consider in identifying the acquirer include the relative voting rights in the combined entity, the composition of the governing body and senior management of the combined entity, and the terms of the exchange of equity interests

Determining acquisition date

• The acquisition date is the date on which the acquirer obtains control of the acquiree
• This is typically the closing date of the transaction when the consideration is transferred and the assets and liabilities of the acquiree are acquired
• The acquisition date is important as it determines the fair value measurements of the assets acquired, liabilities assumed, and consideration transferred

Recognizing and measuring identifiable assets

• The acquirer recognizes the identifiable assets acquired in the business combination separately from goodwill
• Identifiable assets are those that meet either the separability criterion or the contractual-legal criterion
• Examples of identifiable assets include tangible assets (property, plant, and equipment), intangible assets (patents, trademarks, customer relationships), and financial assets (accounts receivable, investments)
• The identifiable assets are measured at their acquisition-date fair values

Recognizing and measuring liabilities assumed

• The acquirer recognizes the liabilities assumed in the business combination, including contingent liabilities, separately from goodwill
• Liabilities assumed are measured at their acquisition-date fair values
• Examples of liabilities assumed include accounts payable, loans, deferred tax liabilities, and employee benefit obligations
• Contingent liabilities are recognized if they are present obligations that arise from past events and their fair value can be measured reliably

Measuring consideration transferred

• Consideration transferred is the sum of the acquisition-date fair values of the assets transferred, liabilities incurred, and equity interests issued by the acquirer in exchange for control of the acquiree
• Consideration transferred can include cash, other assets, contingent consideration, equity interests, and share-based payment awards
• If the consideration transferred exceeds the net of the acquisition-date fair values of the identifiable assets acquired and liabilities assumed, the excess is recognized as goodwill

Recognizing and measuring noncontrolling interest

• Noncontrolling interest (NCI) is the equity in a subsidiary not attributable, directly or indirectly, to the parent
• The acquirer has the option to measure NCI at either fair value or the proportionate share of the acquiree's identifiable net assets
• The choice of measurement basis for NCI affects the amount of goodwill recognized and the subsequent accounting for changes in ownership interests

Recognizing and measuring goodwill or gain

• Goodwill is recognized as an asset and is measured as the excess of the consideration transferred plus the fair value of any noncontrolling interest over the net of the acquisition-date fair values of the identifiable assets acquired and liabilities assumed
• If the net of the acquisition-date fair values of the identifiable assets acquired and liabilities assumed exceeds the sum of the consideration transferred and the fair value of any noncontrolling interest, the excess is recognized as a gain (bargain purchase)

Accounting for contingent consideration

Types of contingent consideration

• Contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests to the former owners of the acquiree if specified future events occur or conditions are met
• Contingent consideration can be in the form of cash, other assets, equity interests, or a combination thereof
• Examples of contingent consideration include earn-out arrangements based on the future performance of the acquiree or the achievement of certain milestones

Initial recognition and measurement

• Contingent consideration is recognized as a liability or equity at the acquisition date, depending on its nature
• If the contingent consideration is classified as a liability, it is measured at fair value at the acquisition date and included in the consideration transferred
• If the contingent consideration is classified as equity, it is measured at fair value at the acquisition date and included in the equity of the combined entity

Subsequent accounting treatment

• Subsequent changes in the fair value of contingent consideration classified as a liability are recognized in profit or loss
• Subsequent changes in the fair value of contingent consideration classified as equity are not recognized
• If the contingent consideration is settled in cash or other assets, the settlement is accounted for as a financing transaction
• If the contingent consideration is settled by issuing equity instruments, the settlement is accounted for as an equity transaction

Acquisition-related costs

Types of acquisition-related costs

• Acquisition-related costs are costs the acquirer incurs to effect a business combination
• Examples of acquisition-related costs include finder's fees, advisory, legal, accounting, valuation, and other professional or consulting fees, and general administrative costs, including the costs of maintaining an internal acquisitions department

Accounting treatment of acquisition-related costs

• Acquisition-related costs are expensed in the periods in which the costs are incurred and the services are received
• Acquisition-related costs are not included in the consideration transferred and do not affect the measurement of goodwill or gain from a bargain purchase
• The only exception is for costs related to the issuance of debt or equity securities, which are recognized in accordance with the applicable standards (e.g., as a reduction of the proceeds from the issuance)

Reverse acquisitions

Definition of reverse acquisition

• A reverse acquisition occurs when the entity that issues securities (the legal acquirer) is identified as the acquiree for accounting purposes
• The entity whose equity interests are acquired (the legal acquiree) must be the acquirer for accounting purposes for the transaction to be considered a reverse acquisition
• Reverse acquisitions often occur when a private operating entity seeks to become a public entity through a combination with a public shell company

Accounting for reverse acquisitions

• In a reverse acquisition, the accounting acquirer (legal acquiree) is deemed to have issued shares to obtain control of the accounting acquiree (legal acquirer)
• The acquisition-date fair value of the consideration transferred by the accounting acquirer is based on the number of equity interests the legal subsidiary would have had to issue to give the owners of the legal parent the same percentage equity interest in the combined entity
• The assets and liabilities of the accounting acquiree (legal acquirer) are measured and recognized in the consolidated financial statements at their pre-combination carrying amounts
• The retained earnings and other equity balances of the accounting acquirer (legal acquiree) before the business combination are carried forward after the reverse acquisition

Measurement period adjustments

Definition of measurement period

• The measurement period is the period after the acquisition date during which the acquirer may adjust the provisional amounts recognized for a business combination
• The measurement period provides the acquirer with a reasonable time to obtain the information necessary to identify and measure the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree
• The measurement period ends as soon as the acquirer receives the information it was seeking or learns that more information is not obtainable, but it cannot exceed one year from the acquisition date

Accounting for measurement period adjustments

• During the measurement period, the acquirer retrospectively adjusts the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date
• Measurement period adjustments are made as if the accounting for the business combination had been completed at the acquisition date
• The acquirer recognizes an increase (decrease) in the provisional amount recognized for an identifiable asset (liability) by means of a decrease (increase) in goodwill
• The acquirer records the offset to the adjustment to goodwill in profit or loss in the period the adjustment is identified

Bargain purchases

Definition of bargain purchase

• A bargain purchase occurs when the net of the acquisition-date fair values of the identifiable assets acquired and liabilities assumed exceeds the sum of the consideration transferred and the fair value of any noncontrolling interest in the acquiree
• Bargain purchases are rare in practice, as sellers are generally unwilling to sell a business for less than its fair value

Accounting for bargain purchases

• Before recognizing a gain on a bargain purchase, the acquirer reassesses whether it has correctly identified all of the assets acquired and all of the liabilities assumed and recognizes any additional assets or liabilities identified in that review
• The acquirer also reviews the procedures used to measure the fair values of the identifiable assets acquired, liabilities assumed, noncontrolling interest (if any), and consideration transferred to ensure the measurements appropriately reflect all available information as of the acquisition date
• If a bargain purchase is still indicated after the reassessment, the acquirer recognizes the resulting gain in profit or loss on the acquisition date
• The gain is attributed to the acquirer and is not considered part of the net income of the combined entity

Disclosures related to acquisitions

Required disclosures for acquisitions

• The acquirer discloses information that enables users of its financial statements to evaluate the nature and financial effect of a business combination that occurs either during the current reporting period or after the reporting period but before the financial statements are issued
• The required disclosures include the name and description of the acquiree, the acquisition date, the percentage of voting equity interests acquired, the primary reasons for the acquisition, and a qualitative description of the factors that make up the goodwill recognized (e.g., expected synergies, intangible assets that do not qualify for separate recognition)
• The acquirer also discloses the acquisition-date fair values of the consideration transferred, assets acquired, and liabilities assumed, as well as the amount of any noncontrolling interest in the acquiree and the valuation techniques and key model inputs used for determining their fair values

Supplementary pro forma information

• If the business combination occurs during the reporting period, the acquirer discloses the revenue and profit or loss of the combined entity for the current reporting period as though the acquisition date had been as of the beginning of the annual reporting period
• If comparative financial statements are presented, the pro forma revenue and profit or loss for the comparative prior reporting period are also disclosed as though the acquisition date had occurred as of the beginning of the comparative prior annual reporting period
• The supplementary pro forma information is based on the historical financial information of the acquirer and acquiree, adjusted to give effect to pro forma events that are directly attributable to the business combination, factually supportable, and expected to have a continuing impact on the combined entity

Post-acquisition accounting issues

Contingent liabilities and indemnification assets

• If the acquirer recognizes a contingent liability assumed in a business combination, it measures the liability at the higher of its acquisition-date fair value or the amount that would be recognized in accordance with the standard on provisions, contingent liabilities, and contingent assets
• If the acquirer is indemnified by the seller for the outcome of a contingency or uncertainty related to an asset or liability, it recognizes an indemnification asset at the same time and on the same basis as the indemnified item, subject to the contractual limitations on its amount and an assessment of the collectibility of the indemnification asset

Reacquired rights

• A reacquired right is an identifiable intangible asset that the acquirer had previously granted to the acquiree to use, such as a right to use the acquirer's trade name under a franchise agreement
• The acquirer recognizes a reacquired right as an identifiable intangible asset separate from goodwill and measures it at its acquisition-date fair value based on the remaining contractual term of the related contract, regardless of whether market participants would consider potential contractual renewals when measuring its fair value

Assembled workforce

• An assembled workforce is an existing collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date
• The acquirer subsumes any value attributable to the assembled workforce in the amount recognized as goodwill and does not recognize it as a separate identifiable intangible asset

Acquisition of partial interest

• If the acquirer obtains control of an acquiree in which it held an equity interest immediately before the acquisition date (a step acquisition), it remeasures its previously held equity interest at its acquisition-date fair value and recognizes the resulting gain or loss, if any, in profit or loss
• The amount of any gain or loss recognized depends on whether the previously held equity interest was accounted for as an investment in an associate, a joint venture, or a financial asset

Examples of acquisition method application

• Company A acquires 100% of the voting shares of Company B for $500 million in cash. The fair values of Company B's identifiable assets and liabilities assumed are $400 million and $100 million, respectively. The excess of the consideration transferred over the net identifiable assets acquired ($500 million - ($400 million - $100 million) = $200 million) is recognized as goodwill.
• Company X acquires 80% of the voting shares of Company Y for $800 million in cash. The fair value of the noncontrolling interest in Company Y is $200 million. The fair values of Company Y's identifiable assets and liabilities assumed are $750 million and $250 million, respectively. The excess of the consideration transferred plus the fair value of the noncontrolling interest over the net identifiable assets acquired ($800 million + $200 million - ($750 million - $250 million) = $500 million) is recognized as goodwill.
• Company P acquires 100% of the voting shares of Company Q by issuing 1 million shares of its common stock with a fair value of $10 per share. The fair values of Company Q's identifiable assets and liabilities assumed are $12 million and $4 million, respectively. The excess of the net identifiable assets acquired over the consideration transferred (($12 million - $4 million) - $10 million = $2 million) is recognized as a gain from a bargain purchase in Company P's profit or loss.