What Is Intangible Asset PPA and Why Is It Important in Business Combinations?

Mergers and acquisitions are more than just the transfer of ownership of a company. If an acquisition is made, the buyer should identify the assets and liabilities acquired and allocate the purchase consideration among the acquired assets and liabilities. Intangible assets can be much more complex than tangible assets like property, equipment and inventory, which can be relatively easy to identify.

Intangible assets can be a significant part of the economic value of the company acquired. While non-physical in nature, the value of customer relationships, brands, patents, technology, software, licences and contractual rights can create significant future value. The Purchase Price Allocation process mitigates this risk by structuring the process to enable acquirers to identify and value these assets appropriately, allowing them to have a better understanding of the resources they acquire with the purchase.

Learning about Intangible Assets in Purchase Price Allocation

What is Intangible Asset PPA?

Intangible Asset PPA — It is the process of determining and measuring the value of identifiable intangible assets acquired in a business combination. The analysis is part of the exercise called Purchase Price Allocation, in which the consideration transferred is recognised as an identifiable asset acquired and a liability assumed at the acquisition date with any amount remaining after this recognition being generally recognised as goodwill, in accordance with the relevant accounting framework.

The significance of intangible asset PPA is that economic value of internally developed or acquired intangible resources may not be fully reflected in historical financial statements. A company could have a big customer base, proprietary technology or a recognised brand name that has been built up over many years but not valued at their full economic value on its balance sheet. These assets may require an additional identification and valuation upon the acquisition to the extent required by the recognition criteria.

Why Are Intangible Assets Important?

intangible assets are important assets that can support future revenues and profits. Relationships with customers can become repetitive sales, technology can help to differentiate products, and brands can shape customer demand and pricing power. The protection of intellectual property can also give a business a legal or competitive edge, which can help to produce additional economic value in the future.

It can help stakeholders understand what they have purchased when identifying these assets during PPA. It can also impact future financial reporting as identifiable intangible assets with finite useful live may be amortised over their useful lives. The allocation can thus impact reported earnings, asset balances and future impairment considerations.

Correctly identifying Intangible Assets

The first step in an intangible asset PPA is to identify intangible assets that could be relevant. An understanding of the acquired business, transaction documents, the IP portfolio, customer contracts, technology, licensing, brands, etc. is required.

Intangible assets are assets that do not manifest themselves physically or in the form of cash. Professionals must identify intangible assets and not double count any economic benefits. For instance, customer relationships, technology, workforce capabilities and more can combine to generate projected revenue. A thoughtfully analysis is needed to ascertain benefits that can be assigned to each of the identifiable assets and which constitute a more comprehensive asset level benefit that may be part of goodwill.

Appropriate methods for valuing intangible assets.

To understand the concept of PPA for Intangible Assets.

Valuation methods will be required to be different for intangible assets, depending on the nature of the asset, and this is the point at which PPA comes into play. Depending on the nature of the intangible asset and the reliability of the information, the income approach, the market approach or the cost approach may be relevant.

When future economic benefits are measurable then the income approach will be helpful. Market-based approaches may be used if similar transactions or market evidence is available and cost-based approaches may be suitable for certain technology or software assets. Selected method should be based on proper justification and consistent with the expected economic contributions from the asset.

Assessing Customer Relationship and Brands

Customer-related items are often important intangible assets in a business combination. They might be determined by factors such as future customer retention, revenue increases, profitability, customer churn, and the investment needed to preserve the customer relationships. For some assets with customer relationships, a multi-period excess earnings method may be used, where the future cash flows of those customer relationships are estimated, after deducting cash flows from other related assets.

Brands and trademarks can also yield tremendous economic gains. For some brands, the relief from the royalty method is often adopted because it attempts to measure the value of the brand on the assumption that the company would be obliged to pay the royalties if it did not own the brand. Key assumptions may include expected revenues, royalty rates, tax effects and an appropriate discount rate.

What is the value of technology or intellectual property?

Technology and intellectual property may be more difficult as its value for the future could rely on competition, development costs, market adoption, innovation, and technological obsolescence. The remaining useful life of the technology may need to be assessed, along with estimates of the economic benefits of the asset remaining in the future.

An income based or cost based approach may be appropriate depending on the circumstances. If the technology has been developed in-house, costs to reproduce or replace the asset could be taken into account with consideration for functional and economic obsolescence. Where the technology creates recognizable future cash flows, an income approach may be a more suitable measure of economic value.

Conclusion

Intangible assets can make up a large portion of the value of the business that is acquired in a merger or an acquisition. A comprehensive intangible asset PPA aids companies in identifying these resources, estimating the economic worth of these resources and separating them from goodwill. Depending on the transaction, customer relationships, brand, technology, intellectual property, software and contractual rights may all be of concern.

The key elements of a well-documented PPA process are the use of the right assets, valuation methods, financial modelling, defensible assumptions, and the use of the appropriate process. The systematic approach to intangible asset valuation can help acquiring companies increase transparency, enhance financial reporting, meet audit standards and develop greater understanding of the economic resources acquired as a result of a business combination.