Question

In: Accounting

What is your honest opinion? When one company purchases another company, should the accounting profession continue...

What is your honest opinion? When one company purchases another company, should the accounting profession continue to accept recognition of bargain purchase gains?

Solutions

Expert Solution

It's my personal opinion. There cannot be a right or wrong question that arises here.

Let me give you a brief about Mergers and Acquitions [ M & A ].

Businesses always look to expand constantly throuthout their existence. That's how they will be able to generate higher shareholder's wealth.

That's where Mergers and Acquitions [ M & A ] comes to picture.

Let's say a company wants to enter a new geographical market [ one of many reasons for M&A ]

Entity has to either conduct feasibity study and then enter the market, bear the risks of new business. This process is time-consuming. Time is money.

So people decided that they would buy this time by buying out a company that's already estabished in a market. That company would have build a viable and running business through it's strengths and obviously over a period of time.

This is the basic reason why business go for M&A.

Now let's see a few rationale behind M & A.

The Business houses look for synegetic operations. Combined Value of New Entity > [ Value of Purchaser Company + Satndalone Value of Acquiree ]

VA = $ 50 VB =$25 Say VAB = $90

When two companies come together or when a company is acquired by another company it leads to adds value by

  • achieving economies of scale
  • cost cutting
  • wider market reach
  • access to rich research and development resources
  • enter new markets and new ventures
  • tax benefits/incentives etc.

Generally non-hostile mergers/acquisitions occur with this as objective. But there can be cases of hostile take-overs as well.

Hostile take-overs is more often impulse and aimed at beating the threat/potential threat to the company. Example Instagram - Facebook Deal in 2012.

We record gain on bargain purchase when the fair value of assets acquired are more than what the consideration is transferred.

It's a gain enjoyed by the company for it's superior position and negotiation skills employed.

Gain on Bargain Purchase is a capital profit and it is usually transfered to Capital Reserve under Equity or shown as Negative Goodwill under Assets.


Accountants and Accounting Bodies recognise this fact and allow such a treatment as it's a not so often transaction. [ We don't come across M&A for a company regulary ] It's basically non-recurring. Even though it doesn't occur often the gain on the transaction of acquisition needs to quantified and reflected in Financial Position and Income Statements of Entity to show clearer picture of events that have happened.


So, if there's a premium paid for buying a company is recognised as Goodwill, it makes sense to record a gain [ Capital in Nature ] as well.

My Opinion

Yes, it should continue to be recognise bargain purchase gains.


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