Acquisition Cost – Principles and Formula

What Is an Acquisition Cost?

An acquisition cost is a single figure representing all of a company’s money for goods or services. Sometimes companies will provide different types of acquisition costs based on the type of goods or services purchased.

An acquisition cost is an upfront cost of acquiring a new customer. This typically includes cash down payment, procurement of goods or services, management, technical support, testing and evaluation, and other necessary elements to successfully launch a new product or service.

Understanding Acquisition Costs

Acquisition cost accounting is an important financial concept used to calculate the true cost of acquiring a company. In contrast, most financial statements include estimated costs for acquisition operations and later decline to disclose those costs.

Acquisition cost accounting is potentially more useful to investors than GAAP because it recognizes how much companies spend acquiring products and services instead of writing off the value of those acquisitions as marketing expenses.

For example, suppose the purchase price of a major piece of equipment is less than its original book value but is delivered late and requires extensive maintenance after delivery. In that case, the acquisition cost of the equipment will be higher than its original book value.

Acquisition Costs for Fixed Assets

In any business acquisition, some fixed costs cannot be passed on to customers. These costs should be factored into the price paid for the asset and included in the above calculation of acquisition costs. Fixed costs include salaries, benefits, salaries for others who work on the acquisition project, legal fees, and costs directly associated with establishing and maintaining a business presence.  

In manufacturing, acquisition costs typically include materials, equipment, backend support, operating & maintenance expenses, and other costs associated with manufacturing or producing goods.

The cost of acquisition may vary significantly for each property type and industry. For manufacturing, it can include upfront capital expenditures (equipment purchases or plant build-outs) and ongoing operating expenses, along with rare but damaging situations where equipment may need to be removed from service temporarily for repair or replacement, such as damaged components.

Acquisition Costs for Customers

It’s the upfront costs that a company must cover to acquire a new customer. There can be many reasons why a company decides to acquire a customer. Sometimes it’s because the company believes the customer will be a good fit for their business. Other times, it’s because the company needs the money and believes acquiring a customer is worthwhile. And sometimes, it’s simply because a competitor offered more money.

Understanding your customer acquisition costs is incredibly useful in planning future business strategies. These costs are traditionally associated with advertising and promotion, incentives and subsidies, the people who manage them, and other sales staff or contracts with external advertising firms.

To capture more customer data, wireless companies have been increasing data plans, extending their coverage areas, and offering more attractive incentives for new customers. And this is where behavioral economics comes in. Behavioral economics is an effective way of looking at marketing and advertising because it helps businesses understand how to capture customers at all costs.

Promotional forums, for example, offer customers the opportunity to influence others’ purchases by offering inducements. In one such example, Lightspeed Technology was advertising a $500 discount code on their site if customers contented themselves by purchasing a new product or service from them within 60 days of their original order.

Typical business acquisitions

  1. Horizontal acquisition is when an organization acquires a competitor within its same industry. It is a symbiotic and financially beneficial relationship.
  2. Vertical acquisition can be made either from the perspective of a distributor or supplier or from that company’s perspective as a retailer. It all comes down to the role played by each party involved – distributor or supplier acting as retailer or retailer acting as distributor or supplier. A distributor or supplier will generally look at overall growth potential in a market and may make a series of aggressive offers to any company interested in acquiring their product.
  3. Conglomerate acquisition, or conglomerate buyout, is a strategic corporate action where a large firm acquires another company in a different industry, the field of business, or niche market than itself. Conglomerates can diversify and add new strengths to their portfolios by operating in industries unrelated to their core competencies. The goal here is not to diversify but to purchase a company that has already established itself.
  4. Equipment or machinery acquisition is the act of any company or business purchasing new or used equipment and machinery to be used in production.
  5. Land acquisition is a transaction made by a business that involves the purchase of the real property.

Acquisition cost principles

Acquisition has several accounting principles that are used to account for fixed assets appropriately. Below listed are the common principles used-

  1. An asset’s acquisition cost is the total of all the expenditures made to purchase the asset. An acquisition cost can be tangible or intangible and include fees (e.g., commissions) paid on behalf of the company.
  2. The acquisition cost of a fixed asset generally consists of the purchase price and any additional expenses directly related to transferring an asset from the seller to the buyer. For example, if a transportation business delivers a piece of equipment to a business’s location on your behalf, they will charge you for that service. These charges would be included in the acquisition cost of the equipment
  3. All costs incurred in checking the functionality of equipment and machinery must be included in the total cost of acquisition.
  4. All costs related to installation or repair are capital expenditures and should be accounted for in the acquisition cost.
  5. The convention of conservatism requires that acquisition costs are calculated by deducting any fees paid from the initial purchase price. These fees may include cash payment, financing costs, and any intangible assets.
  6. In the case of a fixed asset, the acquisition cost does not include sales tax or other form of tax paid to acquire it.
  7. When purchasing fixed assets, be sure to take into account the costs associated with financing.

Acquisition cost formula

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

For example, A company purchases a machine for $50,000. During the acquisition of the machinery, the company also paid an additional $10,000 to repair.

Transportation costs associated were $5,000. Thus, the acquisition cost for the machine would be $55,000 ($50,000 + $10,000 – $5,000 = $55,000).

Mergers and acquisitions

Mergers and acquisitions, or M&A, are an integral part of business life. It is a process that occurs when one company takes over another. Companies use M&A for several reasons, including gaining new markets, increasing their profit margins, or diversifying their product offerings. A mixture of securities and cash is used for paying for an M&A.

 A merger is a cash investment in the business itself and is typically made to improve its financial performance. For example, a company may acquire a smaller company to increase its market share or improve profitability. Or it may acquire a company to increase its control over a market segment or respond to changing market conditions.

In either case, when you’re reading about M&A in the news, it’s usually a combination of both debt financing and equity financing (and sometimes other terms and conditions) that’s being used to close the deal on a particular business asset or entity.

The formula for making an all-securities acquisition is as follows

Acquisition cost = (number of shares outstanding) * ( the exchange ratio)

How Investors Use Cost of Acquisition?

Most reputable investors will take a great interest in the cost of acquisition for a company’s shares, especially if that number is unusually high or low.

Telecom companies typically have high costs of acquisition due to expensive marketing. These costs may exceed the revenue generated by a new customer.

Promotions like contract buyouts from competing cable companies and family plans for wireless customers are used by companies in this industry to attract new customers. These are expensive examples of costs of acquisition.