How does financial liability function in an acquisition?

Apr 05, 2024

Liabilities, whether short or long-term, are inevitable in financial accounting. They arise due to loan obligations, payments to creditors, bad debts, bank overdrafts, or other means where the economic benefits are transferred to another party. 

Identification and settlement of financial liability is an essential function of the accounting department. 

What are the acquired financial liabilities?

In a business acquisition, a company buys a target company’s more than fifty percent assets and stocks to be its rightful owner.

Both the parties involved in the acquisition stand an equal chance of financial gains. The acquiring company increases its market capitalization and assets, whereas the target company diversifies its operations and overcomes entry barriers. 

Acquired financial liabilities are when an acquired company’s current and non-current liabilities are transferred to the company acquiring it.

The latter is responsible for running its business operations, making decisions regarding financial matters, using the assets to generate revenue, and handling all liabilities irrespective of whether or not they were disclosed. 

General obligations by an acquiring company

An acquiring company has some obligations towards the target company’s management and operations. 

1. Assets and liabilities

The acquired company’s assets and liabilities are now under the control of acquiring company. They can utilize the assets to churn out profits and increase production levels.

The financial liabilities are also to be paid off by the company. 

2. Shareholding pattern

The existing shares of the acquired company are either liquidated or converted into shares of the new company. However, in a majority of the situations, the stakes are sold for cash.

3. Company expenses

The larger company that acquired the smaller one is responsible for handling its income as well as expenses. It can change the way costs are treated and make it similar to their accounting practices. 

4. Employees

In an acquisition, employees can either be retained or changed. This decision solely depends on the acquiring company’s board of directors.

The retained employees might continue with their existing job responsibilities or can be given new duties. 

5. Board of directors

The acquired company’s board of directors will have a say in significant decisions, but the acquiring company’s directors will make the final decision.

6. Company culture

With the takeover of the smaller company, new rules and regulations apply to everything, including corporate culture. The existing employees might find a changed way of functioning and interacting with other colleagues. 

7. Relearn specific processes

An acquisition might lead the employees to develop new ways of working and understanding the requirements of the new job environment. 

How does financial liability function?

The acquiring company is not answerable for how they utilize the assets and liabilities. However, they must report it to their board of directors and keep them informed about its happenings.

As for the assets, the acquirer may or may not use them for their use. The company can use fixed assets like machinery for the same purpose or upgrade them to make them more efficient.

Similarly, if the asset has become obsolete or is currently not required by the company, they can sell it out and use the money to purchase new equipment.

The assets that the company intends to use must be recognized and calculated at their fair value. The accumulated depreciation is not to be carried forward by the acquirer. 

Intangible assets like trademarks and copyrights should not be immediately written off since they can assist the entity during the transition period. 

The acquiring entity is liable to clear out the debt and other liabilities of the acquiree. All the values must be recognized at fair value and be paid before the due date. The system of expense payout can or cannot be changed — depending on the acquirer’s management decision. 

To reduce the debt burden on both the business entities, the small company can help by paying off some liabilities. But this depends on their ability to pay and the availability of funds.

However, reducing the small business liabilities is the prime responsibility of the acquiring entity. They cannot force the counterparty to pay off the debt unless agreed otherwise. 

Business acquisitions are demanding in terms of resources, time, and cost. Companies that agree to be acquired by a larger company need to take considerable steps to ensure this collaboration will not backfire.

Once the agreement is completed, the acquired company loses a majority stake of its share and say in internal matters. 

Related read: How does financial liability function in a multinational company

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