What is Deal Accounting?
Acquisition accounting has always been a challenge for analysts and associates. I think it’s partly because the presentation of purchase accounting (the method prescribed under US GAAP and IFRS for handling acquisitions) in financial models conflates several accounting adjustments, so when newbie modelers are thrown into the thick of it, it becomes challenging to really understand all the moving parts.
Similar to the previous article where we covered LBO analysis, the goal of this article is to provide a clear, step-by-step explanation of the basics of acquisition accounting in the simplest way possible. If you understand this, all the complexities of acquisition accounting become much easier to grasp. As with most things finance, really understanding the basic building blocks is hugely important for mastery of more complex topics.
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Deal Accounting: 2-Step Process Example
Bigco wants to buy Littleco, which has a book value (assets, net of liabilities) of $50 million. Bigco is willing to pay $100 million.
Why would acquirer be willing to pay $100 million for a company whose balance sheet tells us it’s only worth $50 million? Good question – maybe because the balance sheet carrying values of the assets don’t really reflect their true value; maybe the acquirer company is overpaying; or maybe it’s something else entirely. Either way, we’ll discuss that in a little while, but in the meantime, let’s get back to the task at hand.