In bref, a busness acquston, from the accountng standpont, s a

transacton n whch both the acqurng and acqured company are st eft
standng as separate enttes at the end of the transacton. If the acqurng
company spreads the acquston prce over the assets beng bought at ther
far market vaue, wth any remanng porton of the acquston prce beng
recorded n a goodw account, the purchase method s used to account
the transacton. So, how do you account transacton of a busness acquston
usng purchase method?
Ths post provdes you wth step-by-step gude on how to account transacton
of busness acquston usng purchase method.
There are three prmary steps nvoved on the accountng for busness
acquston usng purchase method.

Step-1. Determne the Purchase Prce
How do you determne the purchase prce? You woud determne purchase
vaue based on far market vaue. For exampe:
If the purchase s made wth stock, the stock must be vaued at ts far
market vaue.
If treasury stock s used as part of the consderaton, then ths must
aso be vaued at ts far market vaue.
If the buyers stock s thny traded or cosey hed, then t may be
necessary to obtan the servces of an nvestment banker or appraser,
who can use varous vauaton modes and ndustry surveys to derve a
prce per share.

Step-2. Aocate Prce Among the Varous Assets of the Company
Beng Purchased
The second step n the purchase method s to aocate the purchase prce
among the acqured companys assets and abtes, whch are then
recorded n the buyers accountng records.
The man ssue on the second step s that the method of vauaton vares by
ne tem on the acqured companys baance sheet. Here are the key
vauaton rues:
1. Accounts Receivable - Record A/R at ts present vaue, ess the
aowance for bad debts. For exampe, f present vaue of the A/R s $250,000
wth $5000 bad debt aowance sttng underneath, then the vaue of the A/R
s 245,000. Gven the exceedngy short tme frame over whch the A/R s
outstandng, there s generay no need to dscount ths vauaton, uness
there are recevabes wth very ong coecton terms. Aso, snce the
acquston transacton s generay not competed unt severa months after
the acquston date (gven the effort requred to make the accountng entry),
the amount of the aowance for bad debts can be very precsey determned
as of the acquston date.
2. Marketable Securities - You woud record marketabe securtes at ther
FAIR MARKET VALUE. If you are under the U.S |ursdcton, ths coud be an
opportunty for the buyer to mark up a securty to ts far market vaue (f
such s the case)-snce the GAAP normay ony aows for the recognton of
reductons n market vaue. For ths reason, ths s an area n whch there s
some opportunty to aocate an addtona porton of the purchase prce
beyond the orgna cost of the asset. However, snce most companes ony
nvest n short-term, hghy qud securtes, t s unkey that there w be a
arge amount of potenta apprecaton n the securtes.
3. InventoryRaw Materials - You woud record raw matera nventores
at ther REPLACEMENT COST. Though, ths can be a probem f the acquree
s n an ndustry, such as computer hardware, where nventory costs drop at
a rapd pace as new products rapdy come nto the marketpace.
Consequenty, the buyer may fnd tsef wth a sgnfcanty ower nventory
vauaton as a resut of the purchase transacton than orgnay appeared on
the accountng records of the acquree.
. Inventory!inished "oods - You woud record FG nventores at ther
SELLING PRICE, ess ther AVERAGE PROFIT MARGIN + DISPOSITION COSTS.
Ths can be a dffcut cacuaton to make, though, f the fnshed goods have
varabe prces dependng upon where or n what quanttes they are sod-n
such cases, the determnaton of seng prce shoud be based on a hstory of
the most common saes transactons. For exampe, f 80% of a unts sod
are n purchase quanttes that resut n a per-unt prce of $1.50, then ths s
the most approprate prce to use.
#ote: The above rue can be avoded f the acquree has frm saes contracts
as of the date of the acquston wth specfc customers that can be used to
ceary determne the prces at whch the fnshed goods w actuay be sod.
$. Inventory%ork&In&'rocess - You woud record WIP nventores by
usng the same vauaton treatment as fnshed goods, except that the cost
of converson nto fnshed goods must aso be subtracted from ther
eventua sae prce.
(. 'roperty) 'lant) and *+uipment ,''-*. - You woud record PP&Es at
ther REPLACEMENT COST. Ths can be a dffcut task that engthens the
nterva before the acquston |ourna entry s competed, because some
assets may be so od that there s no equvaent product currenty on the
market, or equpment may be so specazed that t s dffcut to fnd a
reasonabe aternatve on the market. Ths vauaton step frequenty cas for
the servces of an appraser.
/. ''-* to be Sold - If buyer ntends to se off assets as of the acquston
date, then these assets shoud be recorded at ther FAIR MARKET VALUE.
Ths most accuratey refects ther dsposa vaue as of the acquston date.
0. 1apital 2eases - If the acquree possesses assets that were purchased
wth capta eases, then you woud vaue the asset at ts FAIR MARKET
VALUE, whe vaung the assocated ease at ts NET PRESENT VALUE.
3. Research and 4evelopment Assets ,R-4. - If any assets assocated
wth specfc R&D pro|ects are part of the acquree, you woud then charge
the R&D assets off to expense f there s no expectaton that they w have
an aternatve future use once the current R&D pro|ect has been competed.
The precse aocaton of assets to expense or asset accounts can be dffcut,
though, snce the exstng pro|ects may be expected to ast we nto the
future, or the future use of the assets may not be easy to determne.
Consequenty, one shoud carefuy document the reasons for the treatment
of R&D assets.
15. Intan6ible Assets - You woud record ntangbe assets at ther
APPRAISED VALUES. If the buyer cannot reasonaby assgn a cost to them or
dentfy them, you woud then assgn no cost.
11. Accounts and #otes 'ayable - You can typcay record A/P at ther
CURRENT AMOUNTS as sted on the books of the acquree. However, f the
A/Ps are not to be pad for some tme, you woud then record them at ther
DISCOUNTED PRESENT VALUES. The same ogc appes to notes payabe;
snce a-but the shortest-ved notes-w have a sgnfcanty dfferent
present vaue, they shoud be dscounted and recorded as such. Note,
however, that ths treatment s used on the assumpton that the buyer woud
otherwse be purchasng these abtes on the date of the acquston, not
on a varety of dates stretchng out nto the future, and so must be
dscounted to show ther vaue on the acquston date.
12. Accruals - Accruas are fa under the short-term (or current) abtes.
These abtes are typcay very short-term ones that w be reversed
shorty after the current accountng perod. Accordngy, they are to be
vaued at ther PRESENT VALUE (dscountng s rarey necessary).
13. 'ension 2iability - If there s an unfunded penson abty, even f not
recognzed on the books of the acquree, t must be recognzed by the buyer
as part of the purchase transacton.
1. Stock 7ption 'lan ,S7'. - If the buyer decdes to take over an
exstng stock opton pan of the acquree, then t must aocate part of the
purchase prce to the ncrementa dfference between the prce at whch
shares may be purchased under the pan and the market prce for the stock
as of the date of the acquston. However, f the buyer forced the acquree to
sette a cams under the opton pan pror to the acquston, then ths
becomes a compensaton expense that s recorded on the books of the
acquree.
The company beng purchased can be bought wth any form of consderaton,
such as stock, cash, or property.
2et8s construct a case e9ample:
Le Dharma Corporaton acqures Robnson Ma Corporaton by spreadng the
acquston prce over the assets beng bought at ther far market vaue-
wth any remanng porton of the acquston prce beng recorded n a
goodw account, so we use purchase method for the case.
I: the ac+uirin6 company (Le Dharma Corporaton) buys the
ac+uiree8s (Robnson Ma Corporaton) stock with ;$55)555 o: cash, the
entry on Le Dharmas books woud be:
|Debt|. Investment n Robnson Ma Corporaton = $500,000
|Credt|. Cash = $500,000
Aternatvey, f 2ie 4harma were to make the purchase usin6 a mi9 o:
25< cash and 05< :or a note, the entry woud be:
|Debt|. Investment n Robnson Ma Corporaton = $500,000
|Credt|. Cash = $100,000
|Credt|. Note payabe = $400,000
Another approach woud be to e9chan6e $)555 shares o: 2ie 4harma8s
;1 par value stock :or that o: Robinson Ma as a :orm o: payment.
Under ths method, the entry woud be:
|Debt|. Investment n Robnson Ma Corporaton = $500,000
|Credt|. Common stock-par vaue = $ 5,000
|Credt|. Common stock-addtona pad-n capta = $495,000
The resut of a the precedng vauaton rues s shown beow-where I show
the cacuaton that woud be requred to ad|ust the books of an acquree n
order to then consodate t wth the resuts of the acqurng company:
The above tabe shows the nta book cost of each account on the
acqurees baance sheet, foowed by a stng of the requred vauaton of
each account under the purchase method, the ad|ustment requred, and the
new account vauaton. The new account vauaton on the rght sde of the
tabe can then be combned drecty nto the records of the acqurng
company.
Note, under the 'urchase Method =aluation coumn, that:
a desgnaton of NPV means that the net present vaue of the ne
tem s shown,
a desgnaton of FMV means that the far market vaue s shown (ess
any costs requred to se the tem, f appcabe)
RC desgnates the use of repacement cost
SLM desgnates the use of sae prce ess the gross margn
AV desgnates an assets apprased vaue.
In the above tabe, debts and credts are specfed for each ad|ustng entry
sted n the Re+uired Ad>ustment coumn.
The amount of goodw shown n the Re+uired Ad>ustment coumn s
derved by subtractng the purchase prce of $15,000 from the tota of a far
market and other vauatons shown n the Purchase Method Vauaton
coumn. In ths case, we have a far market vauaton of $18,398 for a
assets, ess a far market vauaton of $8,075 for a abtes, whch yeds a
net far market vaue for the acquree of $10,323. When ths far market
vaue s subtracted from the purchase prce of $15,000, we end up wth a
resdua of $4,677, whch s sted n the goodw account.
Pease note that the Ad>usted Ac+uiree Records coumn on the rght
sde of the tabe st must be added to the acqurers records to arrve at a
consodated fnanca statement for the combned enttes.

Step-3. Account for the Frst Year Parta Resuts of the Purchased
Entty
The thrd step n the acquston process s to account for the frst year parta
resuts of the acqured company on the buyers fnanca statements. Here
the rues of thumb:
Ony the ncome of the acquree that fas wthn ts current fsca year,
but after the date of the acquston, shoud be added to the buyers
accountng records.
The buyer must charge a costs assocated wth the acquston to
current expense-they cannot be captazed. These acquston costs
shoud be amost entrey for outsde servces, snce any nterna costs
charged to the acquston woud key have been ncurred anyway,
even n the absence of the acquston.
The ony varaton from ths rue s the costs assocated wth ssung
equty to pay for the acquston; these costs can be recorded as an
offset to the addtona pad-n capta account.
An addtona tem s that a abty shoud be recognzed at the tme of
the acquston for any pant cosngs or osses on the dspostons of
assets that are panned as of that date; ths s not an expense that s
recognzed at a ater date, snce we assume that the buyer was aware
at the purchase date that some asset dspostons woud be requred.
If the acqurer chooses to report ts fnanca resuts for mutpe years
pror to the acquston, t does not report the combned resuts of the
two enttes for years pror to the acquston.
A reverse ac+uisition s one n whch the company ssung ts shares or
other payment s actuay the acquree, because the acqurng companys
sharehoders do not own a ma|orty of the stock after the acquston s
competed. Though rare, ths approach s sometmes used when a she
company wth avaabe fundng buys an operatng company, or when a
pubcy hed she company s used to buy a non-pubc company, thereby
avodng the need to go through an nta pubc offerng (IPO) by the non-
pubc company. In ths case, the assets and abtes of the she corporaton
are revaued to ther far market vaue and then recorded on the books of the
company beng bought.
If you are an accountant, your man nterest n your companys merger and
acquston actvtes s how to account for the transactons. The man
approach you woud use probaby s the purchase method, whch has been
descrbed on ths post. An aternatve s the poong of nterests method,
however, the FASB s contnuay revewng the need for ths method, and
was cose to emnatng t as of I made ths post. The IASB has prohbted the
use of poong of nterest method, competey.
?here are also many situations in which a company merely makes a
small investment in another company) rather than makin6 a bi6 and
outri6ht purchase. Ths requres three possbe types of accountng-
dependng upon the sze of the nvestment and the degree of contro
attaned over the sub|ect company-whch are: the cost method, equty
method, and consodaton method, I woud pan to dscuss on the comng
post, one-by-one.
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About Putra
Putra s a CPA. Hs ast poston, n the corporate word, was a controer for a
corporaton n Costa Mesa, CA. After spendng 15 years as a nne-to-fve empoyee, he
decded to serve more compan