Mergers and acquisitions (M&A) require deep analysis and review of objectives to ensure all parties find the deal terms agreeable. M&A also takes multidisciplinary support from both in-house and external resources. Transaction teams generally include representatives from legal, accounting and tax departments, among others, and oftentimes third-party consultative services are sought to assist with vetting a target entity in the form of due diligence.

Buy-side companies in particular need to consider how the transaction will impact their financial statements post-transaction. A valuation professional can be included in the mix as the close of the deal approaches to assist with valuation services related to accounting for the acquisition of an operating business or a business combination — namely the purchase price allocation — that will need to be completed before you can prepare your financial statements.

Accounting for a business combination can be a complex process not regularly encountered by in-house accounting and finance professionals. A valuation professional can provide valuable support to assigning value to acquired tangible and intangible assets. Having the right professional can also increase process efficiency by taking some of the complex valuation work off of the shoulders of your company’s CFO or Controller. Here’s a closer look at why retaining a valuation professional to assist with purchase price allocations may be beneficial to your company.

What is a Purchase Price Allocation?

Valuing the acquired company’s assets will be a vital part of accounting for the transaction under the Financial Accounting Standards Board (FASB) ASC Topic 805, Business Combinations. This is generally accomplished through a purchase price allocation.

A purchase price allocation is an exercise performed as part of a buyer’s acquisition accounting. As the name suggests, it is the process of allocating the purchase price paid for an acquired company to the acquired company’s tangible and intangible assets. Acquisition accounting is a financial reporting and tax requirement triggered by the change-in-control transaction. ASC Topic 805, provides guidance for completing a purchase price allocation for financial reporting.

Purchase price allocations help to accurately reflect value drivers for an acquired business and help financial statement users understand what each part of the purchased business is worth.

It is important to highlight that not all acquired targets are subject to being recorded as a business combination. In January 2017, the FASB issued Accounting Standards Update (ASU) 2017-01 to provide clarity to the definition of a business combination. The guidance simplifies the parameters necessary for a transaction to be classified as an asset acquisition.

What Is Valued in a Purchase Price Allocation?

Components of the purchase consideration as well as the underlying assets your company acquires and the liabilities it assumes can all be subject to valuation. Company management will need to be able to identify which elements may be relevant for your specific transaction.

The best place to start is by reviewing available transaction information to understand the components of the purchase consideration. Purchase consideration that includes the issuance of a note or the potential for future contingent payments, or ownership interest that will remain with the selling party may require valuation.

Management should also understand the primary assets of the operating business. Is the business asset heavy (real estate/personal property)? Was the target acquired for its customer base, a unique technology, or brand awareness? Similarly, understanding any liabilities assumed is also helpful in defining the scope of the purchase price allocation assignment. Does the target operate with a significant amount of deferred revenue or other liabilities?

Accounting Elections

In 2014, ASC Topic 805 and ASC Topic 350, Intangibles, Goodwill, and Other (ASC Topic 350) were amended to simplify the accounting process for purchase price allocations. Under ASU 2014-18,  (ASU 2014-18) and 2014-02 (ASU 2014-02), privately-held companies have the option to elect certain accounting alternatives related to the recognition of certain intangible assets and the amortization and impairment testing of goodwill.

Under ASU 2014-02, private companies can elect to amortize goodwill on a straight-line basis over a 10-year period, or in some cases a shorter period of time. Under ASU 2014-18, private companies can choose to not separately recognize intangible assets arising from non-competition agreements or certain customer-related intangible assets. If your company chooses to elect these alternatives, a purchase price allocation is still required, however the exercise is more limited in scope.

Despite electing ASU 2014-02 and ASU 2014-18, in certain circumstances, your audit team may request you perform a valuation of acquired customer relationships to ensure that the concluded level of goodwill is sufficient to support the inclusion of the customer relationship and other assets. The valuation of customer relationships is also sometimes required as an input for the valuation of other items such as inventory or other assets being valued using certain valuation approaches (such as a multi-period excess earnings approach).

The Upside to Engaging a Valuation Professional to Assist with Your Purchase Price Allocation

Despite recent accounting alternatives to simplify the purchase accounting process, purchase price allocations in certain circumstances can still present complexities that may be burdensome for in-house accounting professionals. Enlisting a valuation professional can help to add efficiencies to the purchase accounting process.

Next Up

We will continue to visit more on the role of valuation in a continuation of our M&A Series. Next, we’ll take a closer look at what management teams can expect from the purchase price valuation process.

For more information, please contact us.