How Acquisition Adjustment Works

In a merger and acquisition (M&A) deal, it's normal for the purchasing company to pay a premium. This merger and acquisition deal implies that it bids more than the target company's actual worth according to its market value as well as book value: total assets plus intangible assets and liabilities. A business can prefer an acquisition adjustment if its brand and other difficult-to-value intangible assets, such as patents and strong customer relations, provide value. Although you can't touch or see these properties, they are often the crown jewels of companies and a significant source of sales as well as income.

The concept of an acquisition adjustment works on several levels. The purchase change refers to the premium that an acquirer pays for a target company during a sale. More importantly, how you handle the purchase change affects how assets are capitalized and depreciated. In turn, the assets impact net income (NI), a primary indicator of corporate profitability, and corporate income taxes. Over time, deferring taxes with depreciation tax shields can add up to a substantial net present value.

Following the generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), companies must assess the market value of goodwill on their financial statements at least once a year and record any impairments. This statement entails the portion of the purchase price that exceeds the amount of the net fair market value of all identified assets acquired in the acquisition and the liabilities incurred in the process.

Real World Example of Acquisition Adjustment

Many modern businesses place higher importance on their intangible assets than on their tangible assets. Tangible assets can distort the business's financial and operational image. Intangible assets are frequently the secret to profitability these days. It means that businesses are willing to spend a lot of money to protect and extract more profit from them.

At the same time, many companies consider investments in their brand, research and development (R&D), or information technology to be expenditures when, in fact, they offer long-term value. These companies ought to treat this long-term value as a conventional fixed asset. For example, Kite Pharmaceutical, a cutting-edge biotech firm, posted annual losses of hundreds of millions of dollars because it expensed its research and development activities rather than capitalizing and depreciating them. Gilead Sciences purchased Kite Pharmaceutical in the second half of 2017 for a whopping $12 billion. Not bad for a company with little revenue but a lot of potential.

Ultimately, it is crucial to note that goodwill is difficult to value, vulnerable to manipulation, and can be classified as unfavorable when an acquirer pays less than the fair market value for a business.