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What is Purchase Price Allocation?

What is Purchase Price Allocation

Purchase price allocation, in acquisitions and mergers, is the value you allocate to the purchase of liabilities and assets of the target company. The process of assigning a value to the assets and liabilities acquired is a vital accounting step companies should consider when making a purchase.

Purpose 

When making an acquisition, a company pays a lump sum to get a pool of assets and liabilities from the target firm. Nevertheless, for purposes of tax, the purchasing company must establish the tax basis for each asset being purchased.

Once the acquiring company identifies the purchase price allocation for the assets, it will be able to compute things such as tax amortization deductions, depreciation, and other implications. The asset seller will also need to determine the capital losses and capital gains, it requires reporting.

International Financial Reporting Standards 

According to the IFRS, companies have to use the method of purchase price allocation to report on the assets and liabilities bought in the framework of an acquisition merger.

When Should You Carry Out a Purchase Price Allocation?

Purchase price allocations are typically carried out after acquisitions and merger deals are completed.

Nonetheless, it is quite practical to begin the purchase price allocation during the process acquisition, to enable the seller and buyer to have a better knowledge of the tax implications and what to expect from the transaction. Since the purchase price allocation has an impact on both the seller and buyer, it is ideal to sort out this aspect before finalizing the transaction.

Components of Purchase Price Allocation 

The main elements of purchase price allocation include:

  • Net identifiable assets
  • Total consideration paid 
  • Write-ups 
  • Goodwill 
  • Net identifiable assets: represents the entire value of assets bought (tangible or intangible) by a firm minus its liabilities. Essentially, you are considering the book value of your target organization’s assets on its balance sheet.
  • Total consideration paid: comprises anything valuable used in the purchase of assets or liabilities such as stock, cash, cryptocurrency, debit, or other payment forms in place of cash.
  • Write-up:  refers to an asset’s book value increase if the carrying value is below its reasonable market value.
  • Goodwill: refers to the money paid above the target company’s net asset value gotten by taking the difference between the liabilities and the total fair market value.

How Do You Allocate Purchase Price?

Any organization undergoing a merger or acquisition needs to carry out a purchase price allocation, to comply with the appropriate accounting guidelines. 

The following are the steps you need to follow to do your purchase price allocation:

  • Identify the target organization’s assets’ book value.
  • Identify the target business’s liabilities’ book value. 
  • Determine the firm’s net asset value on its financial statement
  • Allocate a reasonable market value to the liabilities and both tangible and intangible assets 
  • Write up the assets’ book value if their book value is less than the assets’ market value. 
  • Calculate the goodwill by taking the difference between the net book value of assets and the fair market value paid for the assets 

Example of Purchase Price Allocation 

Let us consider the purchase price allocation below for a better understanding. 

We are going to assume the acquisition parameters as follows:

  • Company X acquires Company Y for $70,000,000
  • Company Y’s book value of assets are $50,000,000 with $30,000,000 in liabilities 
  • Company Y’s net book value of its assets is $20,000,000
  • Company Y’s fair market value of its assets and liabilities is $50,000,000

In the example, Company X’s purchase price allocation is as follows:

  • There must be a write-up of $30m ($50M fair market value – $20M net book value), adjusting the organization’s net book value to the market value
  • There must be goodwill of $20M to be recorded, representing the amount paid exceeding the net book value of the assets and the write-up.
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