Purchase Price Allocation

What is Purchase Price Allocation?

Purchase Price Allocation is a process in accounting in which the acquirer (often a bank that processes payments on behalf of a business) assigns the assets and liabilities of the company targeted.

Mergers and acquisitions (M&A) are business transactions and deals in which one business buys another.

Therefore, purchase price allocation is an important part of accounting. When the M&A transaction deal is closed, the acquirer calculates and reports the PPA on its financial statements with three main transaction components.

In PPA, certain standards are followed to perform it. Along with that, some formulas are needed to calculate and perform the steps of PPA.

International Financial Reporting Standard (IFRS) is a standard that governs financial reporting and accounting, requiring PPA for mergers and acquisitions.

It includes a set of international accounting standards, including how transactions should be reported in financial statements. Therefore, most businesses follow IFRP for PPA.

Components of Purchase Price Allocation

Purchase price allocation is appraising the assets and liabilities acquired in a business combination agreement. The fair value of the tangible and intangible assets and liabilities is the allocated purchase price.

PPA is a method of accounting that considers three key components of a transaction:

• Net Identifiable Assets
• Goodwill
• Write-Up

1. Net Identifiable assets

Net identifiable assets, also referred to as net book value, are the total value of the acquired company's assets minus the total value of its liabilities.

The net book value is found on the acquired company balance sheet and includes tangible and intangible assets.

1. What are Tangible Assets?
   Tangible assets are assets that are physical and hold value. Examples include property, plant & equipment, also known as (PP&E).
2. What are Intangible assets?
   Assets that lack physical substance are called intangible assets. These are further classified into:
   • Identifiable - Assets that can be separated from other assets, such as patents, trademarks, copyright, and intellectual property.)
   • Unidentifiable - Assets that cannot be separated from a company, such as goodwill.

Intangible Assets can be separated from the goodwill amount and be measured and considered as fair value if:

• The asset is related to legal rights. 
• The asset can be separated from the target acquisition and transferred or sold without restrictions.

2. Goodwill

Goodwill is the value that can give the acquiring company a competitive advantage. Therefore, it is the part of a purchase price that is higher than the total calculated fair value amount.

Goodwill is the excess amount paid over the target company's net value.

Fair value is the price set by a market, and a buyer is willing to pay to purchase an asset.

3. Fair Value Adjustments (Write-up)

A fair market value is assessed when there is a difference between an asset's fair value and the book value. An adjusting increase is added to the book value if the value of the assets is less than its fair market value.

Therefore, the fair value adjustment outcome is the difference between fair value and net identifiable assets.

Steps to perform purchase price allocation

A few steps need to be accomplished to perform Purchase Price Allocation.

Before going to the steps, there are formulas for each transaction that must be considered to perform PPA.

To Find PPA, you need to calculate Net Identifiable assets, Fair Value Adjustment (Write up), and Goodwill

Net identifiable assets = acquired assets – acquired liabilities

Fair Value Adjustment = fair market value – net identifiable assets

Goodwill = paid purchase price – fair market value

Purchase price allocation = net identifiable assets + write-up + goodwill

After learning those formulas, steps of PPA can be proceeded and calculated.

• Step 1 - Determine the target company’s assets.
• Step 2 - Determine the target company’s liabilities.
• Step 3 - Determine the company’s identifiable net asset value on its balance sheet.
• Step 4 - Assign a fair market value to the assets and liabilities of the target company for purchased identifiable tangible assets and identifiable intangible assets.
• Step 5 - If the market value of assets exceeds book value, record the book value of assets.
• Step 6 - The amount of Goodwill is obtained by calculating the difference between the fair market value of assets and the sum of net book value and fair value adjustments.
• Step 7 - Record the calculated balances.

Example of Purchase Price Allocation

To better understand how PPA is performed in the business field, here is an example:

1. Company A buys Company B for $13 million.
2. The book value of Company B’s assets is $7 million.
3. The book value of Company B’s liabilities is $3 Million.
4. Net Identifiable asset = Assets ($7 Million) - Liabilities ($3 Million) = $4 million.
5. Therefore, the net Identifiable assets are $4 Million.
6. A business valuation specialist assesses the fair value market of Company B and determines the value to be $10 million. 
7. The fair value adjustment (Write Up) = Fair market value ($10 Million) - Net Identifiable Asset ($4 Million) = $6 Million.
8. Since the purchase price of Company A to B is $13 Million, which is greater than the Fair Market Value ($10 million), Goodwill must be calculated.
9. Goodwill = Purchase price ($13 Million) - Fair Market Value ($10 Million) = $3 Million.
10. Purchase Price Allocation = Net Identifiable asset ($4 Million) + Write up ($6 Million) + Goodwill ($3 Million) = $13 Million.

Therefore, by finding the three main components of PPA, i.e., Net Identifiable asset, write-up, and Goodwill, PPA can be calculated.

Research and authored by Asma Constantini | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Acquisition Finance Structures
• Definitive Purchase Agreement
• Mergers & Acquisitions (M&A)
• Net Asset Liquidation
• Stock Acquisition