Acquisition Method

You got it! If the offsetting entry is recorded in shareholders' equity, the balance sheet wouldn't balance.

Suppose Meta was interested in buying a new startup called SunRay to access its patented VR technology. Clearly, investors would want to know the value of the patent on the financial statements to assess the transaction's value and potential.

What about the pooling-of-interests method would make this difficult?

Well, no. The pooling-of-interests method would capture the historical value, but probably not the full value to Facebook of SunRay's patents.

Not quite. The pooling-of-interests method does recognize patents as assets.

So, in the case of Facebook's purchase, if the transaction did go through, upon its closing, the acquisition method records the initial value of Facebook's investment at fair value. Any fees (legal, valuation, consultancy, etc.) associated with the transaction and any restructuring charges are expensed as incurred. Any contingent consideration is valued on the acquisition date and reported at fair value within the acquisition price. For liabilities, Facebook must recognize any contingent liabilities if the debt arises from past events and it can be reliably accounted for. But there's one specific difference between IFRS and US GAAP: IFRS only includes contingent liabilities if they can be reasonably measured, while US GAAP includes contingent liabilities that are _probable_ and can be reasonably measured.

Another key issue addressed by the acquisition method involves the indemnification of liabilities. Say, for instance, that SunRay has pending litigation resulting from a malfunctioning product, and the liability is recorded on SunRay's balance sheet, while Facebook requests that SunRay indemnify 50% of the liability risk. However, if SunRay agrees to the 50% indemnification, Facebook is still required to record 100% of the fair value of the liability on its balance sheet. How do you think Facebook should offset the liability?

The smart thing for Facebook to do is recognize both an asset and a liability at fair value regarding the pending litigation. The fair value asset would offset the portion of indemnity that Facebook received from SunRay, so the net amount is the 50% liability.

Incorrect. If the offsetting entry is recorded in shareholders' equity, the balance sheet wouldn't balance.

In addition to adjusting for contingent liabilities, Facebook may also have to adjust for any excess purchase price paid for SunRay. Under the acquisition method, IFRS allows Facebook a couple of options on how to account for goodwill, while US GAAP only allows one. Either way, since goodwill has an indefinite life, Facebook can only reduce goodwill through an impairment charge. It's not amortized.

But what would happen if Facebook bought SunRay at a discount? Well, under both IFRS and US GAAP, the acquisition method requires Facebook to recognize an immediate gain on the profit and loss statement for the difference between the purchase price and net assets. If the transaction included any contingent consideration, it must be accounted for at fair value, and any changes to the contingent consideration are recognized in profit and loss thereafter.

In summary: [[summary]]

Exactly! The pooling-of-interest method wouldn't capture off-balance-sheet values or potential synergies. But if Facebook were purchasing SunRay for a patent, that value _should_ be reflected on the financial statements at fair value so investors can understand the purpose behind the transaction. In such cases, the new accounting treatment required under both IFRS and US GAAP is the __acquisition method__, which reports all assets and liabilities at fair value, including those off the balance sheet of the acquired company.

It records assets at historical values

It doesn't recognize patents as assets

It doesn't recognize off-balance-sheet value

With a 50% indemnity asset

With a 50% equity gain in shareholders' equity

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