When a company is bought, its purchase price, debts and other long-term liabilities are fully absorbed by the acquirer’s balance sheet. However, only the income it earns for its acquirer is added to the income statement. This has the effect of depressing the acquirer’s invested capital by only partially recognising the profitability of the acquired firm while fully recognising the capital invested in it.
The thing to do is to adjust invested capital so that it reflects the impact of the acquisition for only the period in which it was acquired, to align it with the “acquired” income on the income statement. Supposing a firm made an acquisition right in the middle of the year, and that acquired firm had an invested capital of $50 billion, then, only 50% of that invested capital, or $25 billion, would impact the invested capital of the acquirer. By time-weighting the acquisitions’ invested capital, the acquirer’s stewardship of that capital is only judged for the portion of the fiscal year when the acquirer was in control.
This allows me to calculate the average invested capital as,
Beginning Invested Capital + (Ending Invested Capital – Acquired Invested Capital) / 2) + Time Weighted Acquired Invested Capital