Purchase acquisition accounting is the commonly accepted method to document the acquisition of another business on the balance sheet of the acquiring company. The business’ assets that are being acquired are documented on the acquiring firm’s books at fair market value. The fair market value – defined as what assets would go for on the open market between a buyer and seller on the acquisition date – would increase the overall value of the acquiring company.  

The purchase accounting adjustment re-assesses the acquired business’ liabilities and assets to fair value. Required under GAAP and IFRS, re-assessed items include intangibles, inventories, and fixed assets. Adding intangible assets, like non-compete agreements or customer rosters, to the acquiring company’s books will impact how assets and liabilities are valued because these items were not originally accounted for by the acquired company.

Potential accounting outcomes from an acquisition include depreciation and inventory considerations. Depreciation strategies, such as going beyond straight-line depreciation, will need to be examined and strategically implemented because fixed assets with higher valuations will have accounting implications. For inventory that is re-assessed with higher valuations, the cost of goods sold will increase upon sales for the acquiring company.

Looking forward, the purchase accounting adjustments often affect the business taking ownership of recognizable non-cash expenses. The company buying the other company out can see major losses from these recognizable non-cash expenses prior to the business completing the amortization of the underlying intangible assets. Companies, chiefly publicly traded ones, are encouraged to discuss the losses in financial documents to illustrate their impact on forward guidance.

According to ASC 805 and GAAP, in order to be considered a business combination, certain criteria must be met. According to the CPA Journal, businesses must evaluate if the transaction in question meets the distinctions between acquiring another business versus acquiring assets only. It’s important to distinguish between the two because if an asset acquisition occurs, the transaction is processed via a cost accumulation standard. However, if the transaction in question qualifies as a business acquisition, meeting ASC 805 criteria, it uses a fair value standard.

The primary way to determine in which category a transaction may be classified is to see if it fits the business definition. Based upon FASB’s January 217 Accounting Standards Update (ASU) 2017-01, Clarifying the Definition of a Business, the following explanation is provided.

According to FASB, to be considered a business for this business acquisition accounting purpose, a company is defined as a group or collection of tasks that encompass “an input and a substantive process.” Though it’s important to note that the fair value of the collection is not centralized in one or multiple assets. The inputs and processes generally result in services and/or goods to buyers and repayment to stakeholders. It also may apply to companies that don’t presently produce outputs.

When it comes to a business acquisition, having accountants that understand the intricacies of navigating the process is essential for a business to emerge more streamlined after integrating assets.

According to the Federal Register, there were about 90,000 local and state government entities throughout the country in 2022. This number is comprised of towns, counties, cities, special districts, and independent school districts. One of the commonalities these organizations share is their use of modified accrual accounting.

Understanding the Differences Between Cash and Accrual Accounting

Cash basis accounting recognizes transactions upon the exchange of cash. Expenses are not recognized until they are paid, and revenue isn’t recognized until payment has been received. Neither future obligations nor anticipated revenues are recorded in financial statements until the cash transaction has happened.

Accrual accounting treats the recognition of expenses when they are incurred. When it comes to recognizing revenue, it occurs once a business is owed compensation for its contracted complete delivery of products or services. The act of exchanging cash or payment is less important with accrual accounting.

What is Modified Accrual Accounting

This method of accounting merges the directness of cash accounting and some attributes of the more complex but equally useful accrual accounting method to account for transaction differences. One can record modified accrual accounting as each transaction is analyzed and accounted for, hinging primarily on whether an asset is short- or long-term, be it how a business recognizes revenue or incurs a liability.

Short Term Versus Long Term

This method is highly dependent on the type of asset in question. When the cash balance has been impacted by a short-term occurrence, such as a sale to a customer or the purchase of raw materials from a vendor, it must be recorded using the cash basis. This is most often recorded on the income statement.

When it comes to events that impact more than one accounting timeframe, it is referred to as long-term. If the debt that is due beyond 12 months or fixed assets are in question, these are considered long-term and must be documented on the balance sheet.

For assets such as fixed long-term debt and fixed assets, which are considered longer-term, they are recorded on the balance sheet. Such assets are then depreciated or amortized over an asset’s lifetime.

Where Modified Accrual is Used

While public companies may use this for financial statements internally, it is not permitted for public financial reporting by generally accepted accounting principles (GAAP) or the International Financial Reporting Standards (IFRS). One important consideration for private or public companies is that when the modified cash basis method is used, there is an implicit consideration that transactions recorded on a cash basis will have to be adjusted to an accrual-based accounting to be accepted by third-party auditors.

Since the financial statements submitted to be evaluated by a third-party auditor would not have been 100 percent on an accrual basis, they would fail a third-party audit, creating a crisis of confidence among outside observers. The transition from a cash basis will require less translation to a full accrual basis accounting. However, for non-publicly traded, private businesses, for internally-only used financial statements and/or no financing required, it can be useful.

One important reason this standard is widely used throughout government agencies is because the Government Accounting Standards Board (GASB) created the standard, and it is recognized as an established metric.

The reason governmental agencies implement this standard is because local and state governments keep their attention on present year fiscal responsibilities. This works with their dual principal purposes. The first is to document in any event if present-year monetary inflows are satisfactory to fund present-year costs. It also satisfies that each government entity can substantiate if government funds are utilized in accordance with the law.

Depending on the type of entity and how they are functioning in the economy, private or public sectors can look at how modified accrual accounting impacts their operations.

Liquidity refers to a business’s ability to convert its short-term assets or securities into cash quickly to meet its short-term financial obligations or pay bills due within the next 12 months. Naturally, cash is the most liquid. This is different than solvency, which refers to the ability of a business to satisfy its long-term bills.

It’s important to distinguish between market liquidity and accounting liquidity. Market liquidity implies how a nation’s stock market or real estate market functions, specifically if there are enough buyers and sellers. The closer the bid and ask prices are, the greater the level of liquidity that exists. The greater the liquidity, the easier it is for participants to transact.

Determining the liquidity of a business helps investors see how a company balances its cash. This demonstrates how well a company manages its ability to pay bills versus being able to direct money for retained earnings, dividends, reinvesting in its business, or for acquisitions. When it comes to measuring liquidity, there are three ratios that estimate how liquid a business is: current, quick, and cash ratios.

Current Ratio

This compares current assets to current liabilities. It’s expressed as follows:

Current Ratio = Current Assets / Current Liabilities  = $20,000 / $5,000 = 4

This means for every $1 in outstanding bills, the company has $4 in cash available to satisfy those debts. While each industry has a unique target ratio, a range of 1.5 to 2.5 is seen as a healthy measure.

Quick Ratio (Acid-Test Ratio)

This calculation removes inventories and some short-term assets that are more illiquid than incoming payments expected to be paid within a reasonable short-term time frame, such as accounts receivable. It’s expressed as:

Quick Ratio = (Cash and Cash Equivalents + Short-Term Investments + Accounts Receivable) / Current Liabilities   

If the resulting number is less than 1, this could indicate the business is facing an inability to pay its short-term bills.

Cash Ratio

This looks at how well a company can pay off short-term debt with its cash and similar financial assets that can be converted to cash instantaneously. It’s expressed as follows:

Cash Ratio = Cash and Cash Equivalents / Current Liabilities = $10,000 / $3,000 = 3.33

With a 3.33 ratio, this example shows the company is in good shape liquidity-wise. A general reference of at least 0.5 (but higher shows better financial health) is recommended.

Interpreting Results

Once the results are calculated, businesses can analyze their findings and see the financial position of their company. For example, if they are looking for financing, lenders take into account these ratios to determine a level of confidence in debt repayment. If a company is looking for investors, savvy investors can determine how competitive the company is against its industry/sector competitors.

Internal Company Reflection

Depending on the company’s circumstances, changes might need to be implemented immediately and over the long term. A business may need to look at operating costs to cut costs. Cash flow projections are recommended to see how the company is doing on its restructuring and cost-cutting efforts.

When it comes to managing liquidity, using these ratios along with short- and long-term planning to improve a company’s financial and liquidity position can make a business more attractive to lenders and investors and more resistant to economic downturns.

Blockchain has the promise to revolutionize the way businesses and their accountants keep track of their financial records. When it comes to audit evidence, blockchain may be able to give organizations more efficient ways to bring financial data into universal conformity; help businesses present relevant financial data in an open manner; and interpret and select data effectively. Blockchain is a digitally distributed ledger that captures transactions conducted among parties within a network. It’s a peer-to-peer, internet-based archive that records all transactions since its creation and maintains proof of these transactions.

Each participant is a node on the mutual database connected to the blockchain, with every user maintaining an identical copy of the ledger. Each entry is a transaction that represents an exchange of value between participants. Along with featuring near real-time transaction settlement, which speeds up payment completion between parties, properly designed blockchains create unchangeable transaction records. This can help auditors investigate transactions as they occur in real-time.

And as blockchain is adopted more and more, auditors will be able to obtain data from the blockchain; however, it’s important to view it all with a skeptical eye. Transactions may be fraudulent or prone to error. Viewers must be even more skeptical if the blockchain is controlled by an entity other than the entity being audited.

Using Bitcoin as an example, the transfer of assets is recorded on the blockchain. Accountants can use blockchain to look at transactions one by one. However, instead of focusing on bookkeeping tasks, for example, accountants’ roles are expected to evolve into higher-level tasks requiring more judgment. As blockchain adoption increases, responsibilities like bookkeeping and reconciliation will require less of an accountant’s time, permitting them to work on more analytical tasks like transaction classification and valuations.

Determining depreciation and the resulting salvage value of an asset when its useful life is exhausted is one example of a transaction that might need some investigating by an auditor.

The Internal Revenue Service mandates businesses judge a fair salvage value, but it’s just that – an estimate. Based on the asset’s usage and expected service time frame, the equipment could have scrap value contingent on metal content or technology that might become obsolete, rendering it of little to no value. Since it’s so subjective, this can impact a company’s accounting and resulting profitability and income tax obligations, requiring careful judgment.

If the salvage value is determined to be too high, it will reduce the depreciation for the business. If it’s too low, depreciation would be factored in too much, and the company’s net earnings will be less than expected. As part of determining the salvage value, businesses and those who audit a business’ financial statements need to exercise judgment when looking into transactions, whether it’s on the blockchain or another type of ledger.

As blockchain evolves, businesses that take advantage of this technology can leverage its efficiencies to reduce the need for rote work and focus on the substance of accurately reporting transactions and not the rudimentary movement of data between parties.

With the world seeing inflation, the Internal Revenue Service (IRS) has issued guidance for tax filers. Based upon an October 2022 IRS News Release, there have been more than 60 adjustments in conjunction with its yearly inflation alterations. Highlights of inflation adjustments include increasing the married couples’ standard deduction for 2023 by $1,800 to $27,700. Another highlight of inflation adjustments includes raising the threshold for the highest tax rate of 37 percent for individual taxpayers to an income higher than $578,125 or $693,750 if two married individuals are filing jointly.

However, there are certain things that are not subject to indexing for inflation. This includes permitting unlimited itemized deductions and maintaining the personal exemption at zero for the 2023 tax year – codified into law by the Tax Cuts and Jobs Act. The modified adjusted gross income (MAGI) amount used by joint filers to determine the reduction in the Lifetime Learning Credit (§25A(d)(2)) is not inflation adjusted for the taxable year (post-Dec. 31, 2020).

When it comes to the topic of inflation, while the United States experienced monthly inflation as high as 9.1 percent in 2022, there are considerations for economies and businesses operating in foreign jurisdictions where the rate of inflation is much higher for sustained periods of time (multiple years).

The International Financial Reporting Standards (IFRS), via International Accounting Standard IAS 29, explains how companies navigate financial statements if their primary currency used for commerce is the same legal tender experiencing hyperinflation in a particular economy, generally within a specific country. It also may be referred to as functional currency. IFRS generally looks at wages, pricing, and interest correlated with a price index increasing by at least 100 percent in aggregate over 36 months when determining if a company’s financial statements must be amended for economies with hyperinflation.

With PWC considering Argentina a hyperinflationary economy to entities whose functional currency is the Argentine peso, it’s considered so due to IAS 29. Specifically, IAS 29.3 details criteria when evaluating if indeed, an economy and its currency is experiencing hyperinflation. Select criteria include:

• Residents of the subject jurisdiction attempting to preserve wealth via non-monetary assets or stable non-native currencies.
• Business is indexed and transacted in non-native currencies with far lower rates of inflation.
• When credit is the means of a transaction, it is priced at levels factoring in the expected debasement of the subject currency according to the time frame of the borrowing.

As of the 2019 publication, based on the 36-month lookback measuring inflation gauges and the IAS 29 evaluation criteria indicating hyperinflation, PWC determined the Argentina economy to be hyperinflationary. And according to IAS 29 standards, if a company’s primary legal tender it uses for commerce is the same as a country experiencing hyperinflation economic conditions, it must adhere to specific financial reporting standards.

Financial statements in hyperinflationary environments, according to IAS 29, that factor in relative details are required to be reported in the functional currency in up-to-date figures at the conclusion of the coverage time frame. When it comes to revising to current units of currency, businesses must use a general price index to account for inflationary changes. In addition to requiring a distinct declaration for a required business’ net monetary position, it must be reflected as proceeds or a decline in profits for the defined time frame.

The business must adhere to full disclosure, which includes transparency whereby financial statements have been restated, what price index the business relied upon to adjust for currency inflation considerations, and if the financial statements have been put together via historical or original costs versus current or fair value costs. The remaining requirement is that business results must assess its financial outcome and situation in its functional currency. Although according to IAS 21 guidelines, once financial results are restated, the restated functional currency can then be read in alternate forms of currency.

When it comes to inflation and the jurisdiction it occurs in, knowing the levels is important to help businesses account for times of normal and abnormally high levels.