Acquisition Method of Accounting vs. Purchase

Attribute	Acquisition Method of Accounting	Purchase
Definition	Accounting method used to record the acquisition of a company or assets	The act of acquiring ownership or control of goods or services in exchange for money or other consideration
Recognition	Recognizes the fair value of the acquired assets and liabilities	Recognizes the cost of the purchased goods or services
Measurement	Based on the fair value of the acquired assets and liabilities	Based on the cost of the purchased goods or services
Accounting Treatment	Requires the use of the acquisition method and consolidation of financial statements	May require recording the purchase as an expense or an asset
Applicability	Primarily used in business combinations and mergers	Applies to any type of purchase transaction

Introduction

When it comes to accounting for business combinations, two commonly used methods are the Acquisition Method of Accounting and Purchase. Both methods have their own attributes and implications, which can significantly impact financial reporting and decision-making. In this article, we will explore and compare the key characteristics of these two methods.

Acquisition Method of Accounting

The Acquisition Method of Accounting is a comprehensive approach used to account for business combinations. It is primarily governed by the International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP) in the United States. Under this method, the acquiring company recognizes and measures the assets, liabilities, and non-controlling interests of the acquired entity at their fair values at the acquisition date.

One of the key attributes of the Acquisition Method is the requirement to identify and recognize intangible assets separately from goodwill. This means that intangible assets such as patents, trademarks, customer relationships, and technology are valued and recorded individually, providing a more detailed and transparent view of the acquired entity's assets.

Furthermore, the Acquisition Method also requires the recognition of contingent liabilities, which are potential obligations that may arise from past events but their existence is uncertain. This ensures that potential risks and obligations are adequately reflected in the financial statements, providing a more accurate representation of the acquired entity's financial position.

Another important aspect of the Acquisition Method is the allocation of the purchase price. The acquiring company needs to allocate the purchase price to the identifiable assets and liabilities acquired based on their fair values. This allocation process helps in determining the amount of goodwill, which represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is then subject to periodic impairment tests to assess its value and potential write-downs.

Overall, the Acquisition Method of Accounting provides a more comprehensive and detailed approach to account for business combinations, ensuring transparency, accuracy, and comparability in financial reporting.

Purchase Method

The Purchase Method, also known as the Historical Cost Method, is an alternative approach to account for business combinations. Unlike the Acquisition Method, the Purchase Method does not require the recognition and valuation of assets and liabilities at their fair values. Instead, it records the acquired assets and liabilities at their historical cost, which is the amount paid to acquire them.

Under the Purchase Method, the acquiring company recognizes the acquired entity's assets and liabilities at their book values, which are typically based on historical cost. This means that the financial statements may not reflect the current fair values of the acquired entity's assets and liabilities, potentially leading to a less accurate representation of its financial position.

Additionally, the Purchase Method does not recognize intangible assets separately from goodwill. Instead, all the acquired assets are combined into a single category of goodwill. This can make it challenging to assess the value and nature of the intangible assets acquired, as they are not individually identified and valued.

Furthermore, the Purchase Method does not require the recognition of contingent liabilities. This means that potential risks and obligations may not be adequately reflected in the financial statements, potentially leading to an incomplete picture of the acquired entity's financial position.

Despite these limitations, the Purchase Method is still used in certain situations, especially when the fair value of the acquired entity's assets and liabilities cannot be reliably determined. It provides a simpler and less costly approach to account for business combinations, although it may result in less transparency and comparability in financial reporting.

Comparison

Now that we have explored the attributes of both the Acquisition Method of Accounting and the Purchase Method, let's compare them in terms of key aspects:

Recognition and Valuation of Assets and Liabilities

Under the Acquisition Method, assets and liabilities are recognized and valued at their fair values, providing a more accurate and up-to-date representation of the acquired entity's financial position. On the other hand, the Purchase Method records assets and liabilities at their historical cost, potentially leading to a less accurate reflection of their current values.

Separate Recognition of Intangible Assets

The Acquisition Method requires the separate recognition and valuation of intangible assets, allowing for a more detailed understanding of the acquired entity's intangible resources. In contrast, the Purchase Method combines all acquired assets into a single category of goodwill, making it challenging to assess the value and nature of individual intangible assets.

Recognition of Contingent Liabilities

The Acquisition Method mandates the recognition of contingent liabilities, ensuring potential risks and obligations are adequately reflected in the financial statements. Conversely, the Purchase Method does not require the recognition of contingent liabilities, potentially leading to an incomplete picture of the acquired entity's financial position.

Purchase Price Allocation

Under the Acquisition Method, the purchase price is allocated to identifiable assets and liabilities based on their fair values. This helps in determining the amount of goodwill, which is subject to periodic impairment tests. In contrast, the Purchase Method does not involve a detailed purchase price allocation process, as all acquired assets are combined into a single category of goodwill.

Transparency and Comparability

The Acquisition Method provides a more comprehensive and transparent approach to account for business combinations, ensuring accuracy and comparability in financial reporting. On the other hand, the Purchase Method may result in less transparency and comparability, as it relies on historical cost and does not provide detailed information on intangible assets and contingent liabilities.

Conclusion

In conclusion, the Acquisition Method of Accounting and the Purchase Method are two distinct approaches used to account for business combinations. While the Acquisition Method offers a more comprehensive and detailed approach, recognizing and valuing assets and liabilities at their fair values, the Purchase Method provides a simpler alternative based on historical cost. The choice between these methods depends on various factors, including the availability of reliable fair value measurements, the nature of the acquired entity's assets, and the desired level of transparency and comparability in financial reporting. Ultimately, both methods aim to provide a fair and accurate representation of business combinations, albeit with different attributes and implications.