Purchase Price Allocation Basics for Finance and Valutaion Professionals

Purchase Price Allocation (PPA) is an essential process in mergers, acquisitions and business combinations. It is used to allocate consideration transferred on an acquired business to identifiable assets acquired, liabilities assumed, and goodwill. For finance and valuation, the allocation is critical since it may have a significant impact on financial reports, valuation results, amortisation, impairment evaluation, and the interpretation of acquisition results.

The key elements of PPA are a combination of commercial analysis, accounting principles and valuation techniques and require the skills of professionals. Intangible assets identification, selection of valuation methods, the formulation of defensible assumptions and conclusion of the valuations are all essential. Professionals with a solid grasp of PPA fundamentals can serve as valuable resources for reporting and communication with other stakeholders and reporting to facilitate transaction and post-acquisition decision making.

The basics of purchase price allocation.

What is Purchase Price Allocation?

Purchase Price Allocation is the allocation of the consideration transferred in a business combination to the identifiable assets acquired and liabilities assumed, typically in accordance with the acquisition-date fair value of the acquired assets and assumed liabilities. Goodwill may be recognised under the appropriate accounting framework for any asset or liability not yet recognised or measured that results in an overall impact on the entity that is not attributable to a particular asset or liability.

Purchase price allocation basics can provide a foundation for professionals to grasp the linkage between acquisition consideration, fair value, identifiable assets and goodwill. The value of PPA is especially relevant because financial statements of the target company can be prepared in such a way that internally generated intangible assets with economic value may not be separately recognized.

Tangible and Intangible Assets: Identification

The first step in creating a comprehensive PPA is to determine all assets and liabilities that are part of the transaction. Examples of tangible assets would be property, equipment, inventory, and other physical assets. Customer relationships, trademarks, patents, proprietary technology, software, licenses, contractual rights and non-compete arrangements could be considered intangible assets, depending on the facts and the recognition criteria.

Intangible assets are less obvious to identify than tangible assets as they may not be apparent in the target's historical accounts. Experts must study documents that are involved in a transaction, legal contracts, customer data, IP records, management projections, and operations. Identification process is thorough to avoid valuable identifiable assets from being misidentified and placed in goodwill.

Knowing the role of goodwill.

In most cases, Goodwill is the difference between the value of the identifiable assets and identifiable liabilities, after the accounting adjustment for the acquisition, and the consideration given in the acquisition.Goodwill is typically the amount at which the acquired business's identifiable assets and identifiable liabilities exceed the consideration associated with the acquisition, after accounting for the acquisition in accordance with the accounting principles. It could be an expected benefit to synergies, growth opportunities, a team of people assembled, access to the market, or other benefits which are not separately recognized.

So the quality of the PPA can have a significant impact on the amount of goodwill that arises. Goodwill could be overstated if identifiable intangible assets are either not considered or under valued. On the other hand, however, there is the need for stakeholders to be able to understand the economic resources acquired in the transaction, where this can be achieved by the appropriate identification and valuation of the acquired assets.

Creating professional PPA skills.

This course provides an overview of the subject of PPA for all professionals.

PPA can be utilized at various points of an acquisition and may be met by professionals in finance, accounting, valuation, audit and transaction. Allocation and valuation experts might have to determine the fair values, auditors might have to review the supporting documentation, and corporate finance departments might have to review the transaction based on the results.

Having a practical knowledge of purchase price allocation for professionals will enable various stakeholders to know how their responsibilities relate to each other. Those who grasp the full PPA lifecycle can share more effectively with other professionals, and can also detect inconsistencies which may impact on the final financial reporting.

Enhancing documentation and audit preparedness

Documentation is a key component of a good PPA. A full reporting file provides explanation about the transaction, consideration transferred, the asset identification process, how the assets were valued, what assumptions were used, the useful lives, calculations performed, and how assets were finally allocated. All judgments should be substantiated with appropriate evidence.

A clear audit trail should also be provided by professionals between the data that is provided and the final valuation conclusion. Forecasts, contracts, market evidence, valuation models, and representations by management should be organized to assist the reviewers in determining how the conclusion is reached. When an audit occurs, documentation can minimize unnecessary questions and present evidence to back up the reasonableness of important valuation assumptions.

The challenge of linking PPA with Post-Acquisition Reporting

PPA is not a process that stops once it has been completed based on the valuation date. The resulting values may have consequences for future financial reporting, including amortisation, impairment, deferred tax accounting and others. It is therefore important for professionals to be aware of how the initial allocation is passed on to subsequent reporting periods.

The experience of following up on post-acquisition performance can also give an insight into the assumptions used in the original valuation. Real life customer retention, revenue growth, margins, technology adoption, and other measures of customer performance can be measured against customer expectations. This assists management in determining if the acquisition is producing the desired results and can enhance the quality of assumptions that are used in future acquisitions.

Conclusion

Purchase Price Allocation is an essential area for those working in the acquisition, financial reporting, valuation and audit fields. Through understanding the allocation of consideration, identification of intangible assets, determination of goodwill, and calculation of fair values, professionals can better assist in providing accurate and transparent reporting of transactions.

A robust PPA process includes technical accounting knowledge, valuation expertise, reliable assumptions and extensive documentation. Constantly using these components can generate defensible acquisition valuations, and provide organizations with a better understanding of the assets and economic benefits they receive in an acquisition. The training in PPA for finance and valuation professionals is thus a valuable skill in facilitating successful M&A deals and quality financial reporting.