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Purchase Price Allocation: Definition, Examples, and Methodology

Purchase Price Allocation, or PPA, refers to the acquisition accounting necessary when a company merges with or acquires another company. The purchase price allocation is the price paid for all the assets and liabilities included in the transaction. A PPA is necessary in order to comply with the financial or tax reporting requirements existing in the Financial Accounting Standards Board. However, there are several differences between filling in a financial report and a federal tax report. In the article below, we will go through all the main points pertaining to a PPA.

Purchase Price Allocation – Identify Assets and Establish Value

In order to comply with the accounting standards, the acquirer has to report the type and the associated fair value of the acquired assets, both tangible and intangible. These values have to suffer periodical adjustments in order to reflect depreciation and amortization changes. An intangible asset that is not amortized must be tested for impairment.

In a PPA, the acquirer has to determine the total purchase price of both cash and non-cash transactions. Liabilities are also part of the calculation of the price. Next, the acquirer has to identify the types of tangible or intangible assets acquired through the transaction. And finally, the acquirer has to value the identified assets using cost, market or income approaches as appropriate.

Guidelines

The Financial Accounting Standards Board issued the Accounting Standards Codification as a source of accounting principles in order to help non-governmental businesses allocate the right purchase price. The ASC Topic 805, Business Combination is the source providing accounting guidance for acquired assets. For tax reporting purposes, the Internal Revenue Code, Section 1060 has all the necessary information.

The Standard of Value

For financial reporting, the standard of value is fair value. According to the FASB, the definition of the fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

For tax reporting, the standard of value is fair market value. According to Investopedia, the fair market value is “the price that a person reasonably interested in buying a given asset would pay to a person reasonably interested in selling it for the purchase of the asset or asset would fetch in the marketplace.”

Differences

There are specific differences between financial reporting and tax reports:

  • For financial reporting, the acquirer must value and include contingent consideration in the PPA. This will not appear in tax reporting.
  • Tax amortization benefits will be included in financial reporting. In case of tax reporting, the acquirer will only include the value of tax amortization if the deal was a direct purchase of assets or stock acquisition.
  • The acquirer must include deferred income taxes in financial reporting but not in tax reporting.
  • For financial reporting, the acquirer can add goodwill assets to their existing reporting units. Tax reporting does not permit the commingling of assets.
  • For financial reporting, the acquirer can include gains from the exceeding of the fair value but not for tax reporting.

Comprehensive examples are provided by the World Bank Group website.

Final Words

We hope this guide on purchase price allocation has been helpful in your financial endeavors.

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