Purchase price allocation

Definition

Purchase price allocation refers to the process of assigning the total purchase price of an acquired company to its identifiable assets and liabilities at fair value. This is crucial for understanding the financial implications of a business acquisition and is key in determining the amount of goodwill and other intangible assets that may arise in the transaction.

5 Must Know Facts For Your Next Test

1. Purchase price allocation is critical for determining how much goodwill is recognized on the balance sheet after a business acquisition.
2. The process involves valuing all identifiable tangible and intangible assets, such as property, equipment, patents, and trademarks.
3. Any amount paid over the fair value of identifiable net assets is recorded as goodwill, which can impact future impairment testing.
4. Companies must adhere to specific accounting standards, like ASC 805 in the U.S., when conducting purchase price allocation.
5. Proper allocation can affect future financial statements, tax implications, and the overall financial position of the acquiring entity.

Review Questions

• How does purchase price allocation impact the recognition of goodwill in a business acquisition?
  • Purchase price allocation directly affects how much goodwill is recognized following a business acquisition. When a company acquires another, it allocates the purchase price to identifiable net assets at fair value. Any excess amount paid over these identifiable net assets is recorded as goodwill. This means that if more value is assigned to tangible and intangible assets, less will be left for goodwill, affecting both financial reporting and future impairment considerations.
• What are the key steps involved in the purchase price allocation process after a company completes an acquisition?
  • The purchase price allocation process involves several key steps. First, the total purchase price is determined. Next, all identifiable tangible and intangible assets are valued at fair market value. Liabilities assumed during the acquisition are also assessed at their fair value. The difference between the purchase price and the fair value of net identifiable assets acquired is then recognized as goodwill. Each step requires careful valuation to ensure compliance with accounting standards.
• Evaluate the consequences of incorrect purchase price allocation on a company's financial statements and overall valuation.
  • Incorrect purchase price allocation can have significant repercussions on a company's financial statements and overall valuation. If assets are undervalued or overvalued during allocation, it could lead to misreported earnings and balance sheet figures. This misrepresentation can affect investor perception and lead to inaccurate assessments of company performance. Additionally, improper allocation can result in challenges during impairment testing of goodwill or intangible assets, which may lead to unexpected write-downs and financial losses in future periods.

Related terms

Goodwill: Goodwill is an intangible asset that represents the excess purchase price over the fair value of identifiable net assets acquired in a business combination.

Fair Value:

Fair value is the estimated market value of an asset or liability, determined based on what a knowledgeable buyer would pay in an orderly transaction.

Acquisition Accounting: Acquisition accounting is the method used to account for business combinations, focusing on recognizing the assets acquired and liabilities assumed at their fair values.