Introduction

Absorption is a type of accounting process which occurs when two companies merge. It refers to the process of taking an asset into a business or an expense that belonged to another entity. This article will discuss how absorption works and how it affects your financial statements.

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Absorption Definition & Meaning

Absorption is a type of accounting process that occurs when two companies merge. In this scenario, an asset belonging to one company is taken into the other business or an expense belonging to one company becomes the responsibility of the other business.

It can also occur when a loan or credit card installment is transferred from one entity to another (for example, through refinancing).

Absorption involves two entities

Absorption is the process of taking an asset into a business or an expense that belonged to another entity. In this case, two entities are involved:

  • The entity that owns the asset or assumes the liability
  • The entity that absorbs it

Under absorption, the associated expenses will be debited to an expense account and the asset will be credited to an asset account.

During acquisition accounting, the costs of acquisition are allocated between tangible assets and goodwill

The difference between the cost of a company and its fair value is known as goodwill. Goodwill is not amortized, but it must be tested for impairment annually or more often if circumstances indicate that an impairment may have occurred.

Goodwill is considered a long-lived asset because it can’t be converted into cash readily like other assets (e.g., machinery). Goodwill does not qualify for tax-deferred treatment under Section 197 of the Internal Revenue Code unless it’s acquired in an asset purchase rather than through an exchange of stock or securities in which case it could qualify under Section 382 limitations (see below).

The total asset value minus cost is known as goodwill

If the acquisition price is higher than the fair value of net assets acquired, it is known as goodwill. For example, if you buy a company for $10 million and its net assets are worth $5 million, then your goodwill would be $5 million. Goodwill is not reported on the income statement; instead, it’s listed separately in the balance sheet (on an accounting basis).

Goodwill cannot be depreciated and amortized like other tangible assets because it doesn’t have any physical substance. It’s essentially an intangible asset that represents an intangible benefit to your business as a result of acquiring another company or product line.

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Absorption is a type of accounting process which occurs when two companies merge

The absorption method can also be referred to as the “purchase method.” In this case, the company that is receiving assets will use them as if they were purchased by them, using the cost of those assets at their original value.

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