Looking to buy a business? Don’t forget the Purchase Price Allocation challenge

As M&A activity begins to increase, acquisitive finance teams will naturally focus on getting their deals done. But even after the champagne corks have been popped, some important work remains.

One key challenge concerns the accounting for the transaction, in particular the completion of the Purchase Price Allocation (PPA). Whether acquiring a local or overseas business, under accounting rules (specifically IFRS 3, Business Combinations), ‘fair values’ must be allocated to all the identifiable assets and liabilities of the acquired company.

“This may be relatively straightforward in relation to items such as fixed assets, debtors and creditors, but other items not necessarily included in the balance sheet may also need to be fair valued,” says Phil Cowan, Head of Corporate Finance at Moore Stephens. “These could include assets such as brands, licences, customer lists, software and other forms of intellectual property. Contingent liabilities, such as potential legal settlements, also need to be valued.” The calculations can be relatively complex if, for example, a discount rate is applied to take account of the time value of money in relation to a payout (or receipt) expected to occur in a few years’ time.

“Acquirers will need to appoint an independent third party to complete this work,” Phil says. “Their auditor cannot undertake this task, due to an inherent conflict of interest. So as the M&A market becomes more active, acquirers need to be prepared for this important post-acquisition task. The work needs to be tackled in a logical manner, with sound process behind it.”

In most instances, the difference between the price paid for the acquired business and the total fair value of its assets and liabilities will generate a positive goodwill figure. This isn’t always the case. “If fair value exceeds the consideration paid, it can lead to a negative goodwill figure,” Phil notes. “It’s an accounting quirk arising from applying the rules.”

Contacts

Phil Cowan

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Corporate Finance