Purchase Accounting

Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
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Purchase accounting is an accounting method that is used under certain circumstances in accounting for a business combination, such as a merger, consolidation, or stock acquisition.  Accounting for a business combination by the purchase method follows principles normally applicable under the historical-cost method for acquisitions of assets and issuances of stock.  The cost to the purchasing entity of acquiring another company in a business combination treated as a purchase is the amount of cash disbursed or the fair value of other assets distributed or securities issued. 

The cost of the assets recorded on the acquired company’s books is not recorded by the acquiring company as the cost of the purchased assets, as would be the case when the pooling-of-interests method is used.  Because the assets acquired are recorded at their fair market value, any excess of cost over these fair values of total identifiable net assets is assigned to intangibles, such as goodwill.  Goodwill is amortized over a period not to exceed 40 years.  The purchase method of accounting must be used for a business combination unless all conditions prescribed for a pooling of interests are met.

In purchase accounting, post-acquisition earnings of the acquired entity are combined with the surviving entity’s earnings.  Restatement of the financial statements of prior years is not required.

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