When to Make Opening Balance Sheet Adjustments at Acquisition
When an acquirer purchases the assets or all of the stock of a target company, the target may cease to exist as a separate entity and the parent’s balance sheet will be adjusted as of the acquisition date. In other cases, such as when the acquirer purchases just some of the stock of a target, the target will continue to exist as a separate entity. If this occurs, the acquirer must record the purchase, but it will forgo other accounting adjustments until the end of a post-acquisition financial reporting period.
When the acquirer structures the transaction as a purchase of assets, the assets will be added to its balance sheet at the prices paid for them. This typically requires allocating the total purchase price to a number of separate asset classes. If the total price paid exceeds the combined fair market values of all assets purchased, the acquirer classifies the remainder as goodwill, which is recorded on the balance sheet as an intangible asset.
Assume Company A acquires the assets of Company B for $500,000 cash. The fair market values – not the book values – of the assets acquired total $400,000. On the acquisition date, Company A adjusts its balance sheet by debiting various asset accounts for $400,000, debiting “Goodwill” for $100,000 and crediting “Cash” for $500,000.
Company A may purchase half of the stock of Company B for $250,000 cash. In this case, Company A’s entry on the acquisition date will be to debit “Investment in B” for $250,000 and credit “Cash” for $250,000. Company B will continue to maintain its own set of books without any changes on the acquisition date.
If A’s ownership of B is at least 20 percent and A exercises “substantial influence” over B, the parent company must prepare a consolidated set of financial statements for A and B combined at the end of each reporting period. This is normally accomplished through the use of detailed spreadsheets that restate the accounts of A and B to make the companies appear as a single entity.
The consolidated financial statements will show the subsidiary’s assets at fair market values as of the date of the acquisition, as well as the purchase goodwill. Journal entries will never be made for the adjusted values because they are spreadsheet calculations used for consolidation purposes and not part of A’s or B’s books.
If Company A purchases all of the stock of Company B, Company A could place the assets of Company B on its books, as described in the Asset Purchase section above, and cancel the stock of B. Alternatively, Company A could record an investment in Company B that would be similar to the accounting described in the Acquisition of Part of the Stock section, including the preparation of consolidated financial statements at the end of each financial reporting period.
In many cases the acquirer continues to operate the wholly owned subsidiary separately with its own set of books. The purpose may be to maintain financial flexibility by giving the subsidiary the ability to raise capital independently, to shield the parent from liability for the subsidiary, or to meet regulatory requirements when the subsidiary engages in activities that must be reported separately to government.