Purchase price allocation
An important but often overlooked area of any acquisition is the purchase price allocation (PPA) clause in the sale and purchase agreement. The PPA reflects the agreement on how the consideration paid for the assets acquired (including intangible assets) and liabilities assumed will be allocated. In addition to providing a “day one” balance sheet for the acquirer setting out the individual assets/liabilities that have been acquired, the PPA has wider tax and accounting implications dependent on how the parties choose to allocate value. For example, where greater value is ascribed to the tangible assets acquired, there is a higher base for depreciation going forward, but this may conversely expose the seller to tax on depreciation recovered.
There are many elements involved in a successful transaction, but often consideration of the accounting and tax implications are pushed to the side. When most companies make an acquisition, they examine the impact of the acquisition on future earnings, earnings per share, and potential debt covenants. To do so adequately requires consideration as to which intangible assets will be recognised on acquisition, and then subsequently amortised. Few companies explicitly consider the acquisition accounting implications. Additionally, limited focus is given by companies to explicitly consider the potential impact of impairment of goodwill following an acquisition.
The PPA valuation process analyses individual assets and business processes in a level of detail that is often not explored. Fundamental to this analysis is a clear understanding of the target’s core operational drivers. A further potential benefit of a structured PPA is understanding the allocation of value to tax depreciable assets.
The multi-faceted impact of acquisition accounting (i.e. tax, accounting and valuation issues) makes this a complex area requiring considerable skills, experience and effort to ensure robust and satisfactory outcomes.
Broadly, to enhance value a PPA should:
confirm the acquisition date
confirm the cost of the acquisition (e.g. including both “deferred consideration” and “contingent consideration”)
identify all assets (both tangible and intangible) acquired and liabilities assumed (including contingent liabilities)
determine the fair market values of all assets (including identifiable intangible assets) and liabilities and any tax amortisation benefits
consider tax impacts and confirm deferred tax balances
determine goodwill or the discount.
While PPAs are often overlooked in the wider deal process, they can have material financial impacts.
Findex is here to assist you achieve robust, reasoned and defensible PPA outcomes. Please contact us if you would like further information.