When a company acquires another, the acquisition price must be broken down into identifiable assets and liabilities in a consolidated balance sheet for accounting purposes.
For this, based on the currently accepted accounting standards, the purchase price allocation (PPA) method can be employed for all types of business combination deals, including mergers and acquisitions.
To understand the PPA method and how it works, let us first look at its main components listed as follows:
1) Net Identifiable Assets
Net identifiable assets are used to determine the book value of assets on the balance sheet of the acquired company; and they include both tangible and intangible assets. These assets are derived from the total value of assets minus the total amount of liabilities. Their value is usually ascertained at a given point in time, and their benefits are recognizable and reasonably quantifiable.
Goodwill is the difference between the purchase price and total value of the assets and liabilities of the acquired company. Hence it is usually seen as the extra amount paid, which does not depreciate but amortizes over time. Though an intangible asset, goodwill is still critical for accounting reports. Hence a company must at least once every year re-evaluate all its recorded goodwill, and when necessary record its damage adjustments.
3) Write- up
A write-up is the increment in the book value of an asset if its carrying value is lower than its fair market value, normally determined by an independent business valuation specialist who assesses the fair market value of the acquired company’s assets.
Having understood the components, we can now use the following example to understand the PPA model.
Scenario: Company X acquires company Y for $10 billion. To complete the deal, company X will have to perform a purchase price allocation.
So using the PPA model, firstly, Company Y’s assets have a book value of $7 billion and its liabilities are worth $4 billion. The value of its net identifiable assets is then $3 million.
Next, the independent business valuation specialist assessed the fair value of both assets and liabilities of Company Y to be $8 billion, so Company X has to now recognise a $5 billion write-up.
Since the acquisition price paid was $10 billion, which exceeds the net identifiable assets and write-up cost, Company X needs to record a goodwill of $2 million.
It is worthy to note that acquisition-related costs are not inclusive of the various legal, advisory and consultation fees as these payments are not part of the purchase price allocation.
The role of a business valuation service provider is to provide the acquiring company a detailed and comprehensible report of the valuations and effects on the non-tangible assets and goodwill of the acquired company. They offer user-friendly audit processes and supply the necessary information for meeting the extensive disclosure requirements related to PPA.
Speak with a PPA specialist today.