What Are Acquisition Related Costs?
Acquisition related costs are expenses incurred by an acquirer to effect a business combination. These costs fall under the broad category of financial accounting and are governed by specific accounting standards, primarily those related to business combinations. Unlike some other transaction costs, acquisition related costs are generally expensed as incurred, meaning they immediately reduce a company's profit on the income statement. They include a variety of outlays, such as fees paid to third-party advisors like investment banking firms, lawyers, accountants, and valuation specialists. Costs associated with registering and issuing debt securities or equity securities to finance the acquisition are also considered acquisition related costs.
History and Origin
The accounting treatment of acquisition related costs has evolved significantly. Prior to 2001, under Accounting Principles Board (APB) Opinion No. 16, companies could sometimes capitalize certain costs associated with a business combination, particularly when using the "purchase method" of accounting. This meant these costs could be added to the cost of the acquired assets on the balance sheet rather than immediately expensed. However, the Financial Accounting Standards Board (FASB) introduced Statement of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, in 2001, which aimed to simplify business combination accounting by requiring virtually all such transactions to be accounted for using the acquisition method.11
A key change came with SFAS 141R (a revision of SFAS 141) in 2007, which was later codified into ASC 805, Business Combinations. Under ASC 805, the general rule became that acquisition related costs, with the exception of costs to issue debt or equity securities, must be expensed as incurred.10,9 This shift reflects the view that these costs are services consumed by the acquirer to facilitate the transaction, rather than assets that provide future economic benefit. The Securities and Exchange Commission (SEC) has also provided guidance, clarifying that internal costs associated with an acquisition, such as salaries for an internal acquisitions department, should be expensed rather than capitalized.8
Key Takeaways
- Acquisition related costs are expenses incurred by an acquiring company during a business combination.
- These costs include fees for legal, accounting, advisory, and valuation services, as well as costs of issuing debt or equity to finance the deal.
- Under U.S. GAAP (specifically ASC 805), most acquisition related costs must be expensed as incurred, rather than capitalized.
- Expensing these costs directly impacts the acquirer's income statement, reducing reported net income in the period they are incurred.
- The treatment ensures transparency by showing the full cost of completing a merger or acquisition immediately.
Interpreting Acquisition Related Costs
Understanding acquisition related costs is crucial for assessing the true financial impact of a merger or acquisition (M&A) on an acquiring company. Since these costs are generally expensing and hit the income statement immediately, they can significantly reduce reported earnings in the period the acquisition closes. For investors and analysts, higher acquisition related costs, especially relative to the size of the deal, can signal complexities or intense competition surrounding the transaction. It is important to distinguish these operational expenses from the actual purchase price paid for the acquired business, which typically impacts the balance sheet and may give rise to items like goodwill.
Hypothetical Example
Consider TechCorp, a publicly traded company, which decides to acquire InnovateCo for $100 million. To complete this mergers and acquisitions transaction, TechCorp incurs the following acquisition related costs:
- Investment banking advisory fees: $2.5 million
- Legal fees for drafting contracts and regulatory filings: $1.2 million
- Due diligence and valuation fees (accounting and consulting): $800,000
- Costs to issue new equity securities to fund the acquisition: $500,000
Under ASC 805, TechCorp would generally expense the investment banking fees, legal fees, and due diligence/valuation fees as they are incurred. This means a total of $4.5 million ($2.5M + $1.2M + $0.8M) would be recognized as an expense on TechCorp's income statement in the period the services are received. The $500,000 cost to issue equity securities, however, would typically be recorded as a reduction of the proceeds from the equity issuance, impacting the balance sheet directly rather than being expensed on the income statement. This distinction is vital for accurate financial statements.
Practical Applications
Acquisition related costs are an inherent part of most significant mergers and acquisitions activity. They are prominently disclosed in the footnotes to the financial statements of acquiring companies, providing transparency on the resources expended to complete a deal. Financial analysts pay close attention to these costs when evaluating a company's profitability and the efficiency of its M&A strategy. For instance, high advisory fees paid to investment banking firms are a common component of these costs. Firms like Firmex, a provider of virtual data rooms, regularly publish data and trends on M&A advisory fees, offering insights into industry norms and fee structures.7 Regulatory bodies, such as the SEC, also scrutinize the reporting of these costs to ensure compliance with financial accounting standards and to protect investors.
Limitations and Criticisms
While expensing acquisition related costs provides a clear, immediate picture of transaction expenses, it does not fully capture the strategic long-term impact or potential for value destruction in mergers and acquisitions. A primary criticism is that these costs are often substantial, and despite the investment, a significant percentage of M&A deals fail to achieve their intended objectives or create shareholder value. Research indicates that failure rates for M&A can range from 40% to as high as 80%, meaning many companies incur substantial acquisition related costs without realizing the anticipated benefits or synergies.6,5
This high failure rate highlights a limitation: the expensing of acquisition related costs only reflects the immediate outlay, not the success or failure of the underlying business combination. Companies may spend millions on legal, advisory, and due diligence fees, only to find that the combined entity struggles with integration, cultural clashes, or unmet financial targets. The expensing treatment doesn't allow for the capitalization of these costs as an asset, even if the intent was to generate future value, reinforcing that these are costs of doing business rather than an investment in a tangible or identifiable intangible asset.
Acquisition related costs vs. Asset Acquisition Costs
While both terms involve the purchase of something by a company, the accounting treatment for acquisition related costs and asset acquisition costs differs significantly based on the nature of what is being acquired.
Feature | Acquisition Related Costs | Asset Acquisition Costs |
---|---|---|
What is acquired? | A business (a "business combination") | An individual asset or a group of assets that do not constitute a business |
Accounting Standard | Primarily ASC 805, Business Combinations | ASC 805-50, Asset Acquisitions, and other applicable GAAP for specific assets |
Treatment of Costs | Generally expensing as incurred on the income statement. | Generally capitalization as part of the cost of the acquired asset(s) on the balance sheet.4 |
Rationale | Costs are for services consumed to effect the transaction. | Costs are necessary to acquire and prepare the asset for its intended use. |
Goodwill Recognition | Can lead to the recognition of goodwill. | Does not result in the recognition of goodwill.3 |
The key distinction lies in whether the acquired entity constitutes a "business" as defined by accounting standards. If it is a business, then the costs incurred to effect that acquisition are generally expensed as acquisition related costs. If the transaction involves only a single asset or a group of assets that do not meet the definition of a business, then the related costs are typically capitalized into the cost basis of those assets. This difference directly impacts a company's reported profitability and asset values.
FAQs
What types of expenses are included in acquisition related costs?
Acquisition related costs typically include fees paid to external parties such as investment banking advisors, legal counsel, accountants, and valuation experts. They also encompass general administrative costs incurred by the acquirer's internal acquisitions department. Costs associated with registering and issuing debt or equity securities to finance the acquisition are also part of these costs, though their specific accounting treatment may differ slightly.2
How do acquisition related costs impact a company's financial statements?
For the most part, acquisition related costs are immediately expensed on the acquirer's income statement in the period they are incurred. This reduces the company's reported profit (net income) for that period. Costs related to issuing debt or equity, however, are typically treated as a reduction of the related debt or equity proceeds on the balance sheet, rather than being expensed.
Are acquisition related costs the same as the purchase price of an acquisition?
No. Acquisition related costs are distinct from the actual purchase price (also known as "consideration transferred") of the acquired business. The purchase price is the amount paid to the former owners of the acquired business, which is used to determine the fair value of the assets acquired and liabilities assumed, and any resulting goodwill. Acquisition related costs are additional expenses incurred by the acquirer to complete the transaction itself, separate from the payment for the business.1
Why are these costs expensed rather than capitalized?
Accounting standards, particularly ASC 805 under U.S. GAAP, generally require acquisition related costs to be expensed because they are viewed as services consumed by the acquirer to facilitate the business combination. They do not represent an asset that provides future economic benefits in the same way that the acquired business itself does. This expensing approach aims to provide a more transparent view of the costs incurred to complete a transaction in the period they occur.