Answered: Explain how purchase accounting is…

Auditing: A Risk Based-Approach to Conducting a Quality Audit

10th Edition

ISBN:9781305080577

Author:Karla M Johnstone, Audrey A. Gramling, Larry E. Rittenberg

Publisher:Karla M Johnstone, Audrey A. Gramling, Larry E. Rittenberg

Chapter16: Advanced Topics Concerning Complex Auditing Judgments

Section: Chapter Questions

Problem 21MCQ

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Question

Explain how purchase accounting is implemented
in a merger. Does the accounting profession now
require this method? How is any premium that the
acquiring firm paid over the acquired firm’s book
value treated subsequent to a merger?

Expert Solution

Step 1

Purchase accounting can be defined as the practice of revising the assets and liabilities of the acquired business to their fair values at the acquisition time. This is treated under both the accounting framework that are IFRS and US GAAP.

Step 2

Ways in which the purchase accounting is implemented in a merger:

Identify a business combination: Firstly, the purchase accounting has a purpose of a business combination that is to achieve some form of synergy. The acquirer hopes to assume control of the acquiree.
Identify the acquirer: Next step is to identify the acquirer who is the party that retains control of the combined entity.
Measuring the cost of the transaction: The cost of the business combination is computed by taking the sum of the fair values at the acquisition date with any costs that is directly attributable to the business combination.
Allocate the cost of business combination: The acquirer should allocate the cost of a business combination at the acquisition date by recognizing the identifiable assets, liabilities, and contingent liabilities of the acquiree.
Purchase accounting for goodwill: On the acquisition date, the goodwill would arise from the business combination should be recognized in the balance sheet of the acquirer as an intangible asset.

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