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Purchase Price Allocation (PPA) is the process of allocating the total purchase price of an acquired company to its identifiable assets and liabilities. Any residual amount that cannot be attributed to these identifiable items is recorded on the balance sheet as Goodwill.

In essence, Goodwill is the outcome of a well-executed Purchase Price Allocation. But Purchase Price Allocation is more than just calculating goodwill — it is a structured accounting and valuation exercise that serves several critical purposes. Click here for more information about our Purchase Price Allocation (PPA) services.

What Does the PPA Process Involve?

A typical PPA includes the following steps:

• Identifying the acquirer and target
• Determining the acquisition date
• Calculating the purchase consideration, including contingent or derivative elements
• Identifying and remeasuring assets and liabilities at fair value
• Recognizing any new assets or liabilities not previously recorded
• Accounting for deferred taxes
• Estimating amortization or depreciation of the acquired assets
• Preparing an opening balance sheet

How Are Assets and Liabilities Identified?

Only items that meet the definition of an asset or liability under relevant accounting standards (such as IFRS, US GAAP, or Dutch GAAP) may be separately recognized. Generally:

• An asset must be identifiable (legally separable or arising from contractual rights), controlled by the entity, and expected to bring future economic benefits.
• A liability involves a present obligation stemming from past events that will likely lead to an outflow of resources.

If an acquired element does not meet these definitions, its value is often subsumed into Goodwill. Some examples of Goodwill can include workforce, knowhow, future customers, future technologies, and certain contingent assets.

Do Synergies Affect the Valuation?

Yes, but with an important distinction:

• Market synergies (e.g. cost savings or pricing adjustments that most buyers could achieve) may support asset revaluations.
• Buyer-specific synergies (e.g. proprietary technology integration or unique cost savings, cross selling) must be excluded from the asset valuations but are included in the IRR calculation (see below) of the acquisition.

This distinction is crucial when complying with fair value (IFRS), fair market value (US GAAP), or reële waarde (Dutch GAAP) standards.

How Does PPA Inform Strategic and Financial Planning?

A thorough PPA can provide insights beyond accounting compliance:

• Internal Rate of Return (IRR): Helps assess the return profile of the acquisition, incorporating all expected benefits
• Cost of Capital (WACC): Used in impairment testing and to evaluate investment efficiency, also more broadly beyond just the acquired company
• Forecasting and Budgeting: Refined expectations and performance metrics can support more accurate and defendable financial projections
• Opening Balance Sheet: Serves both accounting and valuation functions, however it is not uncommon for this to be incomplete at the start of the Purchase Price Allocation process

What About PPA Reporting?

Purchase Price Allocation results should be documented in a clear, auditable format. A good Purchase Price Allocation report:

• Explains the methodologies, assumptions, and data sources
• Supports all key estimates with defensible arguments
• Includes sensitivity analyses where relevant
• Anticipates and answers likely auditor questions

In Summary

Purchase Price Allocation is a detailed process that allocates the acquisition price to assets and liabilities of an acquired company. Goodwill represents the portion of the price that cannot be allocated to identifiable elements. A proper Purchase Price Allocation provides critical insights for financial reporting, valuation, and strategic planning.

Frequently asked questions

Q: Is Goodwill the same as overpaying?

A: Not necessarily. Goodwill reflects intangible benefits such as future customers, future technologies, and/or special synergies that are not separately identifiable for accounting purposes. Goodwill is a typical outcome of an acquisition; negative goodwill (also known as “lucky buy” or “badwill” is relatively uncommon.

Q: Is PPA mandatory under IFRS or US GAAP?

A: No. While in most cases it is required for business combinations regardless of company size, Purchase Price Allocation might not be required if the acquiror does not have an obligation to consolidated subsidiaries or the acquiror did not obtain effective control of the acquired entity.

Q: Where can I find a PPA model?

A: There is no “one size fits all” in Purchase Price Allocations. Each transaction is different and, for this reason, the calculation model of one transaction is typically insufficient for other transactions. Even in the case of similar transactions, economic conditions may render a given valuation method inapplicable for a certain asset or liability.

Q: What kinds of valuation methods are used in a PPA?

A: There are many specialist valuation techniques applied in Purchase Price Allocations that are relatively uncommon in other types of valuations. Some examples are relief from royalty, incremental income, with and without, lost profit, multi-period excess earnings, distributor method, etc. Each of these techniques includes a number of inputs and assumptions, which can differ between transactions. Each of these methods values either the cash flows that the acquiror might realize from holding a given asset (or liability) or the cash flows avoided.

Q: How do I value an earnout?

A: After identifying the earnout conditions and payouts, some typical techniques include Monte Carlo simulation, binomial tree, trinomial tree, and probability-weighted payout methods, amongst others. Each of these methods has its own strengths and weakness. The Monte Carlo simulations is typically known for maximizing accuracy and customization of the inputs but is difficult to explain. Probability-weighted payout methods can be relatively easy to explain, but may be seen as relatively less accurate. Binomial and trinomial trees offer interesting visuals but have rigid cash flow boundaries and can be relatively difficult to build. In all cases, a model is only so good as its inputs. A high quality model with low quality inputs leads to a low quality valuation.

Click here for more information about our Purchase Price Allocation (PPA) services.