What is a Purchase Method?

The purchase method is an accounting process that is utilized during an acquisition or merger. Similar in nature to the older acquisition accounting method that once was the standard for this type of financial posting and record keeping, this approach also incorporates some elements of merger accounting, essentially creating a uniform mode of accounting for the expenditures associated with either type of purchase. The purchase method has gained popularity in the United States and most of the countries that are members of the European Union.

As with any approach to accounting, the purchase method has the goal of accounting for each and every expense associated with the merger or acquisition. Unlike some other approaches, this method requires that the two entities involved in the transaction be clearly identified. This is particularly important when the business deal involves a European entity, since the business that is being acquired must be valued at fair market value as well as the purchase price. By establishing the course of expenditures that are associated with each step of the transaction, it is much easier to track depreciation and amortization and relate it back to that fair market value.

A key difference to the purchase method is that it allows for the inclusion of what is known as good will. This is simply the difference between the actual purchase price and the fair market value of the entity that is merged or acquired. Some other approaches to record keeping did not include a clear way to document this difference on a balance sheet or other accounting record. The inclusion of good will in the accounting is believed to enhance the overall accuracy of the record keeping.

One of the safeguards that is built into the purchase method is the prevention of the creation of some type of provision related to the restructuring of the two entities involved in the merger or acquisition. The method requires that there be no allowance for restructuring costs on the front end; instead, expenses of that nature are considered to be expenses after the fact. Following this approach makes it very hard to inflate the expenses associated with the pre-acquisition period, which would tend to present lower profits at the onset. This in turn means that it is not possible to inflate the profits for the years immediately following the merger or acquisition. Thus, the method helps to present a more balanced view of the actual financial status of the new unified entity.