The primary goal for most companies is to expand their operations. One of the most reliable ways to do so is to grow operations organically. With this option, companies enter a market through their operations and work their way up the ranks. This way, they can gain experience in the market while getting more customers. However, organic growth may not always be available.
Sometimes, companies may enter already established markets. In those circumstances, growing organically may not be feasible as it requires time.
On top of that, the existing market participants may not allow new companies to operate without restrictions. Several other limitations may also exist which hinder new entrants from succeeding in a market.
However, these limitations do not prevent companies from exploring new markets and ventures. Apart from organic growth, companies also have other choices.
These may come in the form of colluding with existing market participants. Companies can use several options to do so. Among these, acquisitions are feasible, although they come with an acquisition cost. Before discussing this cost, it is crucial to understand what this process involves.
What is an Acquisition?
An acquisition is a financial process in which one company purchases most or all of another company’s shares. The company that acquires these shares becomes the acquirer, while the other is known as the target. In most circumstances, both companies form a parent-subsidiary relationship. However, the target company may also suffer other fates.
An acquisition allows a company to expand its operations without entering the market itself. Through the target company, the acquirer gets the opportunity to explore new ventures.
However, it comes at a cost, which involves acquiring shares. Usually, acquirers purchase all or enough stock to provide control over the target company. By doing so, they receive the right to control their operations.
For most acquirers, acquisitions bring more experience in the existing or new market. Through this process, they can build on the target company’s strengths while also capturing synergies.
Apart from acquisitions, companies can also achieve these through mergers. However, that process involves both companies merging into a new company.
Traditionally, acquisitions have been one of the most prominent ways for companies to grow their operations. Most companies also use this process to integrate vertically or horizontally within the supply chain.
However, it can also provide a way to explore new ventures without requiring expertise. On top of that, it also removes the restrictions imposed by the market when entering new areas.
Overall, acquisitions involve one company acquiring another company’s shares. However, not every share purchase constitutes an acquisition.
This process only occurs when the acquirer purchases enough stock to give it control over the target company. During acquisitions, both companies co-exist while forming a parent-subsidiary bond. The parent or acquirer gets control over the latter’s operations.
What is Acquisition Cost in accounting?
Acquisition cost refers to the total expenses a company occurs when taking over another company. Similarly, it may also include any charges paid for acquiring a business unit from another company. Acquisition cost usually involves costs incurred by a company resulting from a strategy to expand operations. However, acquisition costs in accounting may also refer to other expenses.
The alternative usage for this term involves the costs incurred by companies on property or equipment. However, the acquisition cost, in this case, will be the residual amount after adjusting for discounts, closing costs, incentives, and other essential expenditures.
However, these adjustments will not include sales taxes. In this scenario, acquisition cost includes expenses incurred for property or equipment after the necessary modifications.
Therefore, acquisition costs in accounting may refer to two separate expenses. The first involves any amount associated with acquiring a target company’s shares. In this context, acquisition costs will relate to the acquisition process.
The second, in contrast, involves expenses incurred on property and equipment. However, this cost will include any necessary adjustments under the accounting standards.
In some cases, the term acquisition cost may also have another usage. This cost can also describe any expenses incurred by a company in the efforts to acquire new customers.
However, this usage also includes the above two meanings. Expanding operations and buying property and equipment involve growing operations. Therefore, these processes may also fall under a similar definition.
Overall, acquisition cost in accounting can have three separate meanings. Firstly, it involves any expenses incurred in the mergers and acquisitions process.
In the second context, it includes the costs of acquiring fixed assets. Lastly, it may also include any expenses incurred on attracting or acquiring new customers.
How does Acquisition Cost work?
As mentioned, there are three contexts in which acquisitions costs apply. In all of these contexts, the acquirer will spend on expanding its business.
However, these may differ from each other due to the processes involved. Therefore, it is crucial to look at all contexts separately to understand how acquisition costs work.
Acquisition cost for Mergers and Acquisitions
Mergers and acquisitions (M&A) is a process in which two companies operate together. However, the former process involves both companies joining together into a single company. The latter, in contrast, includes one company acquiring the other’s shares to gain control. In both cases, the acquirer will incur some costs related to the process.
When it comes to mergers and acquisitions, the acquisition costs are straightforward. These costs include any expenses incurred on acquiring the target company’s shares.
In most circumstances, this transaction will occur through cash or bank. However, it may also involve the exchange of securities between both companies. Either way, the acquisition cost will be the market value of the compensation paid.
Acquisition cost for Fixed Assets
In the second context, acquisition cost refers to an expense incurred to acquire an asset. Usually, this amount includes the price of the underlying fixed asset itself. However, it may also require some adjustments due to accounting standards.
In those circumstances, the deductions may include transaction fees, legal fees, discounts, etc. After adjusting for these figures, the residual amount will represent the acquisition cost for fixed assets. However, companies cannot deduct any sales tax from the amount.
In some cases, companies may also manufacture or produce fixed assets. Therefore, the above definition for acquisition cost may not be suitable.
In those cases, any costs incurred on bringing the fixed asset to a working condition will constitute its acquisition cost. These may also include expenses, such as shipping, installation, mounting, calibration, etc.
Acquisition cost for Customers
In the last context, acquisition cost includes any expenses incurred on acquiring customers. However, this definition may not be suitable as companies cannot purchase customers.
Instead, the acquisition cost for customers involves expenses incurred for introducing customers to a company’s products or services. These usually include marketing and advertising, incentives, discounts, and similar expense.
Acquisition costs for customers can significantly improve a company’s profitability. Usually, new customers bring new business. However, they may also remain with the company for a long period.
For most companies, this cost represents an investment for the future. On top of that, it can also improve the return on investments for the company.
Conclusion
Acquisition costs involve three different contexts. The first involves any expenses incurred in the mergers and acquisitions process. Usually, this is the context with which most people associated these costs. However, it may also cover other areas.
Acquisitions costs for fixed assets involve the expenses incurred on acquiring fixed assets after making adjustments. Lastly, customer acquisition costs include the costs of introducing new customers to a company’s products.
