A purchase acquisition is a way of recording a company merger for accounting purposes when the companies involved do not pool their assets. Under this accounting method, the target company is treated by the acquiring company as an asset it is purchasing. The balance sheet is updated accordingly with the purchase acquisition to reflect the change in the value of the acquiring company. When companies merge, it is important to know what accounting method they are using to record the transaction, as this will have an impact on financial statements.
In a purchase acquisition, all of the assets of the target company are recorded on the parent company's balance sheet just like its own assets. In addition, its liabilities are recorded with the company liabilities. Both are recorded at fair market value. This may require the services of an appraiser to accurately determine their value, especially in the case of assets, like real estate, that may have been held by the company for an extended period of time, making it difficult to determine their current market value.
In a merger, it is not uncommon for an acquiring company to pay a premium above market value for the acquisition. This is also recorded in a purchase acquisition in the form of goodwill. Goodwill is treated as an intangible asset. Although the company is not physically getting anything as a result of the expenditure, it is receiving benefits such as the market share that goes with a good brand name or the target company's reputation for customer service. Companies hope to recoup this expense with future earnings.
As a general rule, if a merger occurs and the companies involved are not pooling their interests, it will be recorded as a purchase acquisition in the accounts of the acquiring company. This will be most obviously visible on the company's balance sheets. Balance sheets from prior periods should look markedly different, as they will not contain the assets and liabilities of the acquired company. The balance sheet may disclose the sources of new assets and liabilities as well, flagging the disclosures related to the merger transaction.
Accounting is only one aspect of the mergers and acquisitions process, but it is an important step. Failing to record transactions properly may lead to an audit by government agencies concerned about taxes, and it can also damage the shareholders by resulting in an inaccurate valuation of a business. If mergers are deliberately recorded improperly, it is treated as fraud and the people responsible can face criminal charges.