Purchase price allocation, explained simply
Tangible assets such as inventory and equipment are valued first, then identifiable intangibles such as customer relationships, trade names and technology. Goodwill reflects what cannot be assigned to a specific asset.
Book PPA, under ASC 805, determines reported earnings, since identified intangibles are amortized. A separate tax allocation, using IRS Form 8594 in asset deals, drives tax deductions. Private companies have simplifying options, such as amortizing goodwill.
Allocation of the purchase price
IllustrativeAlder Creek Manufacturing, $36.8 million, $ millions
Goodwill of $13.8 million is the excess of price over identified net assets.
Steps
- Determine the total purchase price, including earn-outs at fair value
- Identify the assets acquired and liabilities assumed
- Value tangible assets, such as inventory and equipment
- Identify and value intangible assets
- Record the remainder as goodwill
Worked example
| Alder Creek, $ millions | Fair value |
|---|---|
| Net working capital | 7.0 |
| Property, plant and equipment | 6.0 |
| Customer relationships | 8.0 |
| Trade name | 2.0 |
| Identified net assets | 23.0 |
| Goodwill (36.8 − 23.0) | 13.8 |
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Why it matters in a deal
PPA shapes reported earnings, tax deductions and the balance sheet. Diligence findings, such as customer retention and asset condition, feed the valuation of intangibles.
Red flags
- Large goodwill with few identified intangibles
- Earn-outs left out of the purchase price
- Book and tax allocations that differ without explanation