Purchase Price Allocations (“PPA’s”) are essential in mergers and acquisitions (“M&A”). PPA’s provide transparency into how the purchase price is distributed among its various assets and liabilities. This article explains why PPA’s are necessary, and how to conduct a PPA.
Why a PPA should be performed
International Financial Reporting Standard 3 (“IFRS 3”) specifically requires the allocation of the purchase price in an M&A transaction to be allocated to the assets acquired and liabilities assumed in the Business Combination. PPA’s therefore ensure compliance with IFRS 3, which further ensures that financial statements reflect the economic reality of the transaction.
Furthermore, by identifying and valuing acquired assets and liabilities separately, PPA’s improve the accuracy and reliability of financial statements – ensuring that the goodwill or gain on bargain purchase is properly calculated.
A well-conducted PPA provides stakeholders with a clear understanding of how the acquisition price was derived, and its impact on the company’s financial health.
The PPA Process
- Identify the acquirer
The acquirer is the entity that gains control over the target and is typically determined by:
- Its ability to direct significant activities of the acquiree.
- Its ownership of a majority of voting shares.
- The entity contributing towards most of the purchase price.
- The larger entity within the transaction.
- Determine the acquisition date
The acquisition date is the date when the acquirer obtains control of the target. This is often the closing date of the transaction – the date when the legal transfer of ownership occurs. This is the date on which the fair values of the assets and liabilities will be determined.
- Determine the implied purchase price
The purchase price consists of the total consideration paid for the acquisition, which includes cash payments, equity shares issued, contingent consideration, assets transferred, assumed liabilities, and any other components.
- Identify the assets acquired and liabilities assumed
The next step in the PPA process is to compile a detailed report of the target company’s assets and liabilities. This includes both tangible and intangible assets.
- Calculate the fair value of the assets acquired and liabilities assumed
Each identified asset and liability must be valued at its fair value as of the acquisition date. This involves valuing tangible assets using approaches such as market comparison, cost, or income methods, and intangible assets using techniques like the relief-from-royalty method for trademarks or the multi-period excess earnings method for customer relationships.
- Calculate goodwill or gain on bargain purchase
Goodwill is the excess of the purchase price over the fair value of the net identifiable assets. However, if the purchase price is less than the fair value of the net identifiable assets, it results in a gain on bargain purchase which will be recorded as a profit in the acquirer’s financial statements.
PPAs are essential in providing transparent and accurate financial reporting in M&A transactions. By engaging experienced valuation professionals, businesses can navigate this complex process effectively, thereby ensuring that stakeholders have a clear view of the acquisition’s financial impact.