GR-1002 - SAP Group Reporting - Purchase Method - details

To learn more - please meet us at

www.budemy.com

------

The Purchase Method of Consolidation: A Comprehensive Guide

The Purchase Method, also known as the Acquisition Method, is the prevailing approach to accounting for business combinations. This method provides a clear and accurate picture of the acquirer's financial position by recognizing the acquired business at fair value.

Core Principles

• Fair Value Measurement: The foundation of the Purchase Method is the valuation of all identifiable assets acquired and liabilities assumed at their fair values as of the acquisition date. This ensures the consolidated financial statements reflect the true economic substance of the transaction.
• Goodwill Recognition: When the purchase price exceeds the fair value of identifiable net assets, the difference is recorded as goodwill, representing the value of intangible factors such as brand reputation, customer relationships, and skilled workforce. Conversely, if the purchase price is less than the fair value of net assets acquired, a gain on bargain purchase is recognized.
• Non-Controlling Interest: If the acquirer obtains less than 100% ownership, the fair value of the remaining interest held by other shareholders (non-controlling interest) is recognized separately in the consolidated financial statements.
• Consolidation: The acquirer consolidates the subsidiary's financial results into its own, combining like items of assets, liabilities, revenues, and expenses. This provides a unified view of the combined entity's performance.

Illustrative Examples

Scenario 1: Acquisition with Goodwill

Company X acquires 90% of Company Y for $1,000,000. The fair value of Company Y's net identifiable assets is $800,000, and the fair value of the non-controlling interest is $100,000.

• Total Acquisition Value: $1,000,000 (90% stake) + $100,000 (10% non-controlling interest) = $1,100,000
• Goodwill: $1,100,000 (Total Acquisition Value) - $800,000 (Fair Value of Net Assets) = $300,000

Journal Entries:

• Acquisition:
  • Debit: Assets (various) $800,000
  • Credit: Liabilities (various) $0 (assumed for simplicity)
• Non-Controlling Interest:
  • Debit: Non-controlling Interest $100,000
• Goodwill:
  • Debit: Goodwill $300,000
• Cash Payment:
  • Credit: Cash $1,000,000

Scenario 2: Bargain Purchase

Company A acquires 75% of Company B for $500,000. The fair value of Company B's net identifiable assets is $700,000, and the fair value of the non-controlling interest is $200,000.

• Total Acquisition Value: $500,000 (75% stake) + $200,000 (25% non-controlling interest) = $700,000
• Gain on Bargain Purchase: $700,000 (Fair Value of Net Assets) - $700,000 (Total Acquisition Value) = $0 (In this case, the purchase price equals the fair value, so no gain is recognized)

Journal Entries:

• Acquisition:
  • Debit: Assets (various) $700,000
  • Credit: Liabilities (various) $0 (assumed for simplicity)
• Non-Controlling Interest:
  • Debit: Non-controlling Interest $200,000
• Cash Payment:
  • Credit: Cash $500,000
• Gain on Bargain Purchase: (If applicable)
  • Credit: Gain on Bargain Purchase

Practical Applications

The Purchase Method is crucial for:

• Mergers and Acquisitions: Accurately reflects the cost of the acquisition and the value of the acquired business.
• Investment Analysis: Provides investors with a clear understanding of the financial health and performance of the combined entity.
• Financial Reporting: Ensures compliance with accounting standards (IFRS and US GAAP) for business combinations.

Post-Acquisition Considerations

• Goodwill Impairment: Goodwill is regularly tested for impairment to ensure its carrying value is not overstated.
• Accounting Policies: The acquirer aligns the subsidiary's accounting policies with its own for consistency in reporting.
• Intercompany Transactions: Transactions between the parent and subsidiary are eliminated to avoid double-counting in the consolidated financial statements.

By understanding and applying the Purchase Method, stakeholders can gain valuable insights into the financial impact of business combinations and make informed decisions.