Best Practices in Purchase Price Allocation to Stay One Step Ahead

 Purchase price allocation comes into play when a company acquires another and allocates a purchase price to its different assets and liabilities as per the accounting rules of the acquired company. It is a method to assess the fair market value of the assets (tangible and intangible) and liabilities. The fair market value refers to the value a market participant would be willing to pay for the identified assets.

The amount left after the allocation of a purchase price to different assets and liabilities is allocated to goodwill. To ensure that the process of purchase price allocation is done correctly, accounting standard guidelines are applied. ASC 805 standards are present for this.

ASC 805 valuation

GAAP rules govern business combination and acquisition and have undergone modification and are known by various names such as FAS 141, FAS 141r, and more recently, ASC 805. Earlier, accounting standard FAS 141 was applied for purchase price allocation. It has now been modified and is known as Accounting Standards Codification (ASC) 805. The treatment of contingencies differs in the new version. In ASC 805, contingencies are calculated and listed on the date of the acquisition. In FAS 141, they were listed after the agreement was finalized. Therefore, ASC 805 is a more user-friendly approach and makes information more accessible and understandable.

Overall, ASC 805 is a broad concept and there are various sections that give guidelines for different types of acquisitions.

Best practices

It is ideal to have purchase price allocation conducted by professionals who have the expertise, knowledge and skill set required for financial reporting valuation. The professionals can offer practical insights to acquirers, sellers, auditors, and regulators.  

There are certain complex valuation issues that must be addressed while applying valuation standards such as:

• The valuation agency must estimate the accretion/dilution impact on future earnings which is also known as pre-acquisition pricing analysis

• Structuring or valuation of contingent and estimating potential future earnings impact

• Conducting valuation of contingent assets and liabilities

• Fair value measurement of all considerations as well as equity or non-controlling interests being transferred on the acquisition date 

• Fair value measurement of acquired real estate, tangible assets such as machinery and equipment, and intangible assets such as brand, intellectual property, customer loyalty, etc. on the acquisition date

• Contract liabilities as well as other liabilities should also undergo fair value measurement which analyses their value after depreciation and amortization

• Buy/sell equity interests valuation

• Valuation of derivatives and other financial instruments

These are only some of the services that a valuation agency must undertake. Purchase price allocation can help companies and investors estimate what future earnings will look like and assist management to better understand the acquired business.