The purchase method is a popular accounting process for mergers and acquisitions that accounts for all expenses and allows for the inclusion of goodwill. It also prevents the creation of provisions related to restructuring costs and presents a more balanced view of the financial state of the new entity.
The purchase method is an accounting process used during an acquisition or merger. Similar in nature to the earlier acquisition accounting method that was once the standard for this type of financial accounting and record keeping, this approach also incorporates some elements of merger accounting, essentially creating a uniform mode of accounting for expenses associated with any type of purchase. . The purchase method has gained popularity in the United States and in most countries that are members of the European Union.
As with any accounting approach, the purchase method is intended to account for any and all expenses associated with the merger or acquisition. Unlike other approaches, this method requires that the two entities involved in the transaction be clearly identified. This is particularly important when the business deal involves a European entity, as the business being acquired must be valued at fair market value, as well as the purchase price. By setting the course of expenses associated with each step of the transaction, it is much easier to track depreciation and amortization and relate it to that fair market value.
A key difference to the purchase method is that it allows for the inclusion of what is known as goodwill. This is simply the difference between the actual purchase price and the fair market value of the entity that was merged or acquired. Some other record keeping approaches did not include a clear way to document this difference in a balance sheet or other accounting record. The inclusion of goodwill in the accounting is believed to improve the overall accuracy of record keeping.
One of the guarantees integrated in the purchase method is the prevention of the creation of some type of provision related to the restructuring of the two entities involved in the merger or acquisition. The method requires that there be no margin for restructuring costs at the front end; instead, expenses of that nature are considered after-the-fact expenses. Following this approach makes it very difficult to inflate the expenses associated with the pre-acquisition period, which would tend to present lower earnings up front. This in turn means that it is not possible to inflate earnings during the years immediately following the merger or acquisition. Therefore, the method helps to present a more balanced view of the actual financial state of the new unified entity.
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