I NEED A PURCHASE PRICE ALLOCATION
My Auditor Says I Need a Purchase Price Allocation
GAAP (ASC 805), IFRS (IFRS 3), and UK GAAP accounting rules indicate that when a company purchases another, the purchasing company should state the fair value of the acquired goodwill on the balance sheet. This is accomplished by a valuation process called a “purchase price allocation”, so called because it involves the allocation of the purchase price among the fair values of the target's tangible assets and identifiable intangible assets. When these asset values are subtracted from the purchase price, the difference is the indicated fair value of goodwill. The following formula clarifies this concept:
Goodwill = Purchase price - Value of Tangible Assets - Value of Intangible Assets (other than Goodwill).
Purchase price allocation projects can become very complex. Further, nearly half of the audit deficiencies identified by the PCAOB (Public Company Accounting Oversight Board) are connected to a fair value element of the audit. Thus, purchase price allocations often pose the greatest risk of causing an audit deficiency.
Generally, audit rules require that an independent professional perform the purchase price allocation. As the company being audited is not independent, they are generally prohibited from furnishing the purchase price valuation to the auditor. Similarly, the auditor is not independent because, were they to provide the valuation for the audit, they would be placed in a position of auditing their own work.
Performing the value allocation procedures has two primary steps, the first of which is determining the purchase price. While the notion that the purchase price of an acquisition is unknown may sound strange, the reality of modern acquisition practices is such that acquirers rarely pay 100% cash for their acquisitions. The price (or “consideration”) often takes forms other than or in addition to cash, including seller financing, stock or options in the acquiring company, post-employment agreements, assumed liabilities, acquisition costs (sometimes), and contingent consideration, known commonly as “earn-outs.” When these noncash payment terms are contained in the purchase price, they must be explicitly addressed. If the buyer’s stock is used as payment, it’s possible that a second valuation will be required - that of the buyer.
The second step is to allocate value among to tangible and intangible assets. Typically, each intangible asset will require a valuation. Sometimes, particularly for capital asset-heavy companies, tangible assets will require an independent valuation. Intangible assets almost always require a valuation. Such assets might include:
Trade names/marks
Patents
Internally-developed Software
Data
Vendor/supplier relationships
Customer contracts
Trade secrets
Customer relationships
Non-competition agreements
Which assets will require a valuation depends on the nature of the acquired company and often will be identified by your financial statement auditor.
Because of the high risk of an audit deficiency arising from a fair value assessment, your financial statement auditor will pay close attention to the valuation that you submit for the audit work file. The auditor is within their rights to ask as many questions as they wish, require corrections, or even reject the valuation altogether and force you to retain another firm. To manage this risk, you must select a provider that understands the proper procedures to facilitate auditor acceptance of the purchase price allocation and marginalize the potential for an audit deficiency.
If you have been directed to provide a purchase price allocation for your financial statement audit and are interested in managing your financial statement audit risk, contact High Score Strategies for a consultation.
CONTACT US
We will respond to you as quickly as possible. Thank you so much for reaching out.