Purchase Price Allocation

Overview

When one business acquires control of another, the acquirer's accounts must recognise what it has actually bought. Under the acquisition method in IFRS 3 and in ASC 805 for US GAAP, the consideration transferred is allocated to the identifiable assets acquired and liabilities assumed, measured at fair value at the acquisition date. Any excess of the consideration over the net fair value of those items is recognised as goodwill.

The allocation often brings onto the balance sheet intangible assets that the target never recorded, such as customer relationships, brands and technology. Their values and useful lives determine future amortisation and the deferred tax position, so the work has a lasting effect on reported results and on later impairment testing.

What the service covers

A purchase price allocation engagement typically covers:

• Identification of the assets and liabilities acquired, including intangible assets that meet the recognition criteria and were not previously on the balance sheet.
• Fair value of identifiable intangibles such as customer relationships, trade names, technology, order backlog, licences and non-compete agreements.
• Fair value adjustments to tangible assets, including property, plant and equipment and inventory.
• Fair value of contingent consideration and other forms of deferred or conditional payment.
• Deferred tax effects arising from the difference between fair values and tax bases.
• Calculation of goodwill and, where relevant, any bargain purchase.
• Estimated useful lives and the resulting amortisation, and the link to subsequent impairment testing.

Key activities and deliverables

Key activities

• Review the purchase agreement, consideration, closing date and the financial information of the target.
• Hold discussions with management about the acquired business, customers, brands, technology and the rationale for the deal.
• Identify the assets and liabilities to be recognised, and agree the approach with you and your auditors.
• Value the identified intangible assets using methods that suit each asset.
• Test the overall result by reconciling the sum of the fair values with the transaction price and the implied return.
• Prepare the report and respond to auditor queries during their review.

Deliverables

• A purchase price allocation report suitable for presentation to your auditors.
• A schedule of assets and liabilities at fair value, with goodwill derived.
• Valuation models for each material intangible asset, with useful life assessments.
• Deferred tax and amortisation schedules for the accounting team.
• Support for the measurement period, in which provisional amounts may be adjusted for up to twelve months from the acquisition date under IFRS 3.

Our approach and methodology

We measure fair value as defined in IFRS 13 and ASC 820, from the perspective of a market participant, and we select the method for each asset according to the way it generates value. Typical methods include the multi-period excess earnings method for the principal customer-related or technology asset, the relief-from-royalty method for brands and technology, the with-and-without method for non-compete arrangements and cost-based approaches where suitable.

The individual valuations are then cross-checked against the transaction price and the buyer's expected returns, so that the discount rates used for different assets are consistent with the overall return on the deal. We aim to deliver documentation that stands up to audit review, and we plan the timetable around your reporting dates so that provisional accounting can be completed on time.

Benefits for clients

• Financial statements that comply with the applicable acquisition accounting standard.
• Documented, supportable fair values that facilitate the audit process.
• Clear visibility of the future amortisation charge and the deferred tax position.
• A better understanding of what drove the price paid, including the value attributed to customers, brands and technology.
• A sound starting point for the later impairment testing of goodwill and intangibles.

Who needs this service

A purchase price allocation is required whenever an acquisition is accounted for as a business combination, so it is relevant to:

• Listed and unlisted groups preparing consolidated accounts under IFRS or US GAAP.
• Corporate acquirers completing a bolt-on or transformational acquisition.
• Private equity-backed groups and their portfolio companies reporting to lenders and investors.
• Finance teams working to a reporting timetable and facing audit review.
• Businesses that must reassess provisional values within the measurement period.