Purchase method

The purchase method of accounting in current standards is similar to the "acquisition accounting" method used in previous accounting standards. Its use provides some useful safeguards.

Previous accounting standards allowed two methods of accounting for mergers and acquisitions; merger accounting and acquisition accounting. The former was generally a more favourable treatment in its impact on the P & L. The purchase method of accounting is now compulsory in the US, the EU and wherever IFRSs have been adopted.

The purchase method of accounting must identify the acquirer (the entity that obtains control over the other entity). Under IFRSs the acquisition must be valued at fair value. The difference between the purchase price and the fair value should be recognised as goodwill.

A company cannot create a restructuring provision to provide for future losses or restructuring costs as a result of an acquisition. Such costs must be treated as post acquisition costs. This makes the impact of restructuring costs on profits more visible, and prevents the abuse of provisions to take an exaggerated hit to profits on acquisition and thereafter boost reported profits in subsequent years.

The use of the purchase method improves accounts, but investors are likely to disregard the impact of goodwill, which is the largest change. The elimination of provisions is more useful because of the extra visibility and the prevention of abuses.