What is Deal Accounting?
Acquisition accounting has always been a challenge for analysts and associates. I think it’s partly because the presentation of purchase accounting (the method prescribed under US GAAP and IFRS for handling acquisitions) in financial models conflates several accounting adjustments, so when newbie modelers are thrown into the thick of it, it becomes challenging to really understand all the moving parts.
Similar to the previous article where we covered LBO analysis, the goal of this article is to provide a clear, step-by-step explanation of the basics of acquisition accounting in the simplest way possible. If you understand this, all the complexities of acquisition accounting become much easier to grasp. As with most things finance, really understanding the basic building blocks is hugely important for mastery of more complex topics.
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Deal Accounting: 2-Step Process Example
Bigco wants to buy Littleco, which has a book value (assets, net of liabilities) of $50 million. Bigco is willing to pay $100 million.
Why would acquirer be willing to pay $100 million for a company whose balance sheet tells us it’s only worth $50 million? Good question – maybe because the balance sheet carrying values of the assets don’t really reflect their true value; maybe the acquirer company is overpaying; or maybe it’s something else entirely. Either way, we’ll discuss that in a little while, but in the meantime, let’s get back to the task at hand.
Thanks a lot for exemplying such a topic in this simple for me.
Thank you for sharing! Hope you could advise this: The franchisor will buy out their franchisee. They will offset receivables against purchase prices. They will succeed only assets(cash, inventory, fixed assets and deposits), and they will not succeed liabilities. Franchisees do not maintain book value for each outlet, and they… Read more »
Tiffany:
Could you please clarify if you are referring to a Franchisor-Franchisee relationship or an M&A deal.
Best,
Jeff
Thanks a lot ! you’re amazing !!
Hi Matan, Thanks for your article. I just want to check with you what will be the accounting treatment for this transaction. Our company will buy another company worth 780K. It has office unit worth 760K and remaining loan from the bank of 540K. The difference 240K is drawing from… Read more »
From what I can tell, the FMV of Net Assets would be 760k (760k – 0 in liabilities), which would mean 20k gets allocated to Goodwill. That covers the assets, then on the Liabilities and Equity side, I would include 540k in debt and 240k in equity. Hope this helps.