A Definitive Guide to Acquisition Cost (With Formula)

Acquisition cost is a term used in business to describe how much money it requires to gain equipment or property after making adjustments to revenue and profits before taxes. This term also references how much it costs to take over another company or buy an existing unit from another business. This type of cost gives businesses an understanding of the correct amount paid for assets before you consider the cost of taxes.

In this article, we explore what acquisition cost is, list common business acquisitions, define the principles used when finding the acquisition cost and examine the relevant formula.

What is acquisition cost?

Acquisition cost, sometimes referred to as book value or asset book value, is a cost concept that applies to when a business gains a fixed asset like a building, equipment or land. The acquisition cost of the fixed asset is how much it cost the company to buy the asset minus any sales tax. Acquisition cost includes adjustments like incentives, discounts and closing costs. You can do this calculation to determine the true financial expense of an asset, including any expenses that may not have occurred in the purchase price.

You record acquisition costs on a company's balance sheet under the fixed assets section. The total cost included on the balance sheet includes all costs incurred to use the asset, including costs associated with getting the asset working and producing.

Related: What's the Difference Between an Acquisition vs. a Merger?

Typical business acquisitions

There are several different acquisitions a business may make. Common business acquisitions include:

• Horizontal acquisition: This is when a business gains another company in the same industry or sector that the purchasing business considers a competitor. This type of acquisition typically benefits both parties.

• Vertical acquisition: This type of acquisition is when a company gains a distributor or a supplier of products that directly relate to what the company sells to consumers. This form of acquisition typically gives the buying company more control over the supply chain.

• Conglomerate acquisition: A conglomerate acquisition is when a business purchases another company that is in a completely different industry or field. Companies do this to achieve diversification, and it allows the purchasing company to enter new industries.

• Equipment or machinery acquisition: This is when a company purchases new or used equipment or machinery to be used in the production process. For example, a company may purchase a steel press to create sheets of metal.

• Land: A land acquisition is when a company purchases land or a building. For example, a company may purchase land to expand the amount of production space it has.

There are several other types of acquisitions a company can make depending on the company's needs and industry.

Related: Everything You Need To Know About Tuck-In Acquisitions

Acquisition cost principles

Companies can use acquisition cost principles to follow proper accounting for fixed assets. The following are the most common principles associated with this cost:

• The acquisition cost includes any additional costs paid to get the title and legal ownership over of the asset. For example, if a company pays commissions during the acquisition process, it's part of the acquisition cost.

• The acquisition cost for a fixed asset includes additional expenses paid to get the asset to the right location. For example, if a company pays a transportation business to move an asset, this is part of the acquisition cost.

• Any cost spent to determine whether equipment or machinery is fully functional is in the total acquisition cost.

• It includes any cost spent installing or repairing equipment or machinery gained in the machinery's acquisition.

• Following the rules of the accounting convention of conservatism, the company deducts fictitious expenses from the purchase price to get the acquisition cost. Examples of fictitious expenses include amortization, depreciation, discounts and impairment costs.

• Sales tax and any other form of tax paid to gain a fixed asset aren't part of the acquisition cost.

• Other adjustments to consider include the amount of money it takes to finance the purchase of the fixed asset is part of the acquisition cost.

Related: Mergers and Acquisitions: Definition, Types and How They Work

Acquisition cost formula

The following is the acquisition cost formula most recognized by accountants and businesses:

Acquisition cost = (Expenses related to the acquisition + cost of acquisition) - (taxes + depreciation + amortization + impairment costs)

Example: A company purchases a piece of land for $50,000. During the acquisition of the land, the company also paid an additional $10,000 to gain the title of the land and to have the land fully inspected. Taxes associated with the acquisition of land were $5,000. This means that the acquisition cost for the land would be $55,000 ($50,000 + $10,000 - $5,000 = $55,000).

Related: What Is Strategic Acquisition? (Definition, Benefits and Tips)

What are mergers and acquisitions?

Mergers and acquisitions (M&A) is a common type of acquisition a company takes part in to gain acquisitions. This is when a business absorbs another company to gain that company and all of its holdings. The payment for an M&A is in securities, cash or a combination of the two. When the company makes the payment as a combination of securities and cash, it's a mixed offering.

Related: Pros and Cons of Business Mergers and Acquisitions

Acquisition cost in real estate

When using acquisition cost in real estate, the definition for this cost is the complete amount paid by a company or person in relation to purchasing a piece of property. The entire amount becomes part of tax records and in the books. When a person or business is filing corporate taxes, they can claim these expenses. This type of cost differs from the gross sales price, as acquisition cost is only what the buyer pays to gain a piece of property.