Application on “Valuation of Purchase Price Allocation”

02-December-2020 by Virtue Ventures

Have you recently purchased another business? Great! Did you understand that a merger or acquisition (“M&A”) often initiates additional tax and financial reporting requirements? One of the most widely recognized necessity is a Purchase Price Allocation ("PPA").


What is Purchase Price Allocation?

A PPA practice essentially involves circulation of the value of the purchase consideration among various tangible and intangible assets (and liabilities) acquired from the target following the transaction. Residual purchase consideration, if any, is recorded as goodwill in the acquiring company’s books.


Why purchase price allocation necessary? 

The primary explanation purchase accounting is essential is for financial reporting purposes. The objective for the transaction is to reflect the proper values of the assets and liabilities on the opening balance sheet. Investors also appreciate the performance of a purchase price allocation in order to understand the transaction and its implications in detail.


When do we need to do a Purchase Price Allocation?

The most basic explanations behind a PPA are to report the results of the transaction to investors in the form of financial reports, and to take depreciation and amortization into account when calculating taxes or cash flow statements. Therefore, a PPA is commonly prepared after the end of the transaction while the management of the Target Company and information related to the historical and prospective of the business are readily accessible.
Long wait after the end of the transaction can create the difficulty in acquiring the data such as personnel leave, management shifts, and records. However, there is also a strong argument for starting your Purchase Price Allocation even way before the completion of the transaction.

Why do investors demand a Purchase Price Allocation?

The simple answer is to comprehend the response to the question "What did we purchase?". With preparation of Purchase Price Allocation exercise, Investors will be having a clear understanding of where their money is being used. Key reason of the investor is to know the goodwill which is being left over after allocating the value of purchase price to various assets and based on that they can track back the allocation of the value for individual assets along with the part of the goodwill.


What steps do you take in performing a Purchase Price Allocation?

The acquisition of a business requires an allocation of the purchase price for tax and/or financial reporting purposes. This means that the process consists of three main steps:

  • Calculating the purchase price (total consideration paid). Total considerations could be cash, stock, or other legal obligation.
  • Identifying the correct assets acquired and liabilities for allocating the value to them.
  • Calculating the Fair Value with various methodologies including market, cash flow and asset based.

Assigning the right values to the rights assets is imperative to any purchase transaction. It’s absolutely true that management will have the best intuition as to why it wants to pursue a particular transaction, which is why we work very closely with the management team to understand the intricacies and outlook for the transaction. Given the complexity of such analyses, and the time required to prepare them, most management teams will work with an outside valuation consultant to prepare a PPA.