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The Differences Between the Acquisition Method & the Purchase Method in Accounting

Original post by Matt Petryni of Demand Media

Accounting for mergers and acquisitions -- the practice of combining one business with another -- is often complex and subject to strict accounting principles. The purchase method and the acquisition method are both accounting practices intended to help provide an accurate record of this process. Understanding the differences is important for businesses and investors reviewing a business combination.

History

Prior to 2008, the purchase method was the widely accepted standard of practice used to account for the merger or acquisition of two different business entities. This method was first adopted in 2001 and required use of a concept called the fair-value principle in accounting for all business combinations. In late 2008, the major accounting authorities, the Financial Accounting Standards Board and the International Accounting Standards Board, updated their rules to adopt a slightly revised form of the purchase method in merger and acquisition accounting, called the acquisition method. At that point, the purchase method of accounting for mergers and acquisitions was no longer to be used for these kinds of transactions.

Fair Value Principle

Both the purchase method and the acquisition method apply the fair-value principle, though how they actually do so differs. The fair-value principle is important to understanding these differences. The principle simply states that the assets and liabilities should be accounted for at their fair value, even if their purchase price exceeds that value. The difference between the fair value and the actual cost is accounted for as goodwill. This approach is intended to provide greater accuracy in reporting the merger or acquisition's effect on equity to investors.

Fair Value in the Purchase Method

In the purchase method, the costs to either business arising from their combination are generally accounted for as a part of those businesses' fair value. Effectively, these transaction-related costs are factored into the purchase price of the acquiree company. Restructuring costs are also included in fair value, even if they are not fully in place by the acquisition date. Under the purchase method, fair value could only include contingencies -- assets and liabilities that have not yet been realized -- that had a high probability of settlement.

The Acquisition Method

According to Peter Aghimien of Indiana University, South Bend, "the acquisition method is designed to improve the recognition and measurement of the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree." To this end, many of the restructuring costs and transaction-related costs factored into fair value under the purchase method are recorded separately, as business expenses. In addition, the acquisition method requires the acquirer "to measure the fair value of the acquiree, as a whole, as of the acquisition date," rather than over the time period between the acquisition's announcement and its actual occurrence, according to the Canadian Accounting Standards Board. Finally, any contingencies that are "more likely than not" to see settlement are recognized at their fair value, according to FASB.

                   

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About the Author

Matt Petryni has been writing since 2007. He was the environmental issues columnist at the "Oregon Daily Emerald" and has experience in environmental and land-use planning. Petryni holds a Bachelor of Science of planning, public policy and management from the University of Oregon.

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