purchase accounting the acquisition of a company is no different than the acquisition
of any other asset at its fair value. It is the application of cost accounting to the pur-
chase of assets and the assumption of liabilities. In a purchase, the revenues and ex-
penses of the acquired company from its business operations accrue to the acquiring
company from the date of acquisition.
The purchase price of the acquisition must be allocated among the various assets
that are acquired, net of any liabilities assumed in the transaction in accordance with
the fair values of those assets. Fair values must be allocated to all identifiable assets
and liabilities whether they were or were not recorded on the books of the acquired
company. If the fair value of the net assets equals the acquisition price, the allocation
is straightforward. However, in most acquisitions, the fair value of the net assets and
the acquisition price are not equal. If the acquisition price exceeds the fair value of
the identifiable net assets, that excess must be allocated to goodwill. Likewise, if the
fair value of the acquired identifiable net assets exceeds the purchase price, that ex-
cess must be allocated to negative goodwill.
The acquisition should be accounted for as the cost paid or incurred. Cost is the
amount of cash paid or the fair value of other consideration given to the stockhold-
ers of the acquired company. Cost also includes transaction costs such as legal fees,
accounting fees, investment banking charges, and so on. Depending on the terms of
the acquisition agreement cost may also include some contingent considerations. Ex-
hibit 18.2 illustrates the accounting for a business combination under the purchase
method.
(c) Pooling of Interest. In a pooling of interest, unlike a purchase, an acquisition of
an another entity has not been deemed to have taken place. Instead, a pooling ac-
counts for the business combination as a uniting of the ownership interest of two
companies. For a business combination to be accounted for as a pooling, it must be
effected by the exchange of common stock, which would keep the resources of the
combined entities undistributed. A business combination may not be accounted for as
a pooling of interest if the consideration paid is cash. Since an acquisition has not
been deemed to have occurred, no new basis of accounting for the assets and liabili-
ties has been established. The assets and liabilities are carried over to the new com-
bined company at their book values.
Since an acquisition has not taken place, theoretically there is no purchase price.
Since there is no purchase price, no “excess” of purchase price arises in the transac-
tion so there is no goodwill. The treatment of the revenues and expenses of the com-
bined companies also differs from the treatment in a purchase. In a pooling, the rev-
enues and expenses of the combined companies for the year includes the revenue and
expenses of both of the constituents for the entire period being reported. Exhibit 18.3
illustrates the accounting for a business combination under the pooling-of-interest
method.
(d) Required Accounting for Business Combinations. This section discusses the re-
quired accounting standards in various jurisdictions.
(i) United States. On June 21, 2001, the FASB issued Statement No. 141, “Business
Combinations,” and FASB Statement No. 142, “Goodwill and Other Intangible As-
sets.” These statements drastically change the accounting for business combinations,
goodwill, and intangible assets. Statement No. 141 supercedes APB Opinion No. 16,
18.6 BUSINESS COMBINATIONS 18 • 15