Purchase price allocation: Ensuring accuracy, transparency and compliance
Article
Introduction
With an increasingly diverse range of intangible assets driving the value of UK businesses and continuing economic uncertainty, there is a growing level of audit scrutiny regarding the valuation of intangible assets and goodwill in purchase price accounting. The UK’s audit regulation body, the Financial Reporting Council (FRC), acknowledges the increasing prevalence of intangible assets noting a “wide recognition of the growing importance of intangibles as we move towards a knowledge-based economy”, whilst also recognising the complexities this brings, due to “an accounting system that’s designed for a relatively stable world where companies were characterised by their physical assets, not the world we live in today that’s relatively uncertain, fluid and unknown and where intangible assets dominate” 1 . The incremental value generated by intangible assets and goodwill is notoriously difficult to quantify. Their valuation, and the wider purchase price allocation (PPA) process, are underpinned by complex techniques and often dependent on highly subjective assumptions. As such - and given that purchase price accounting typically requires such assets to be capitalised on balance sheet - PPA exercises are heavily scrutinised by auditors. The FRC states that “for many intangibles, the measurement uncertainty of fair value is so great as to call into question whether it could provide a representationally faithful depiction”. The complexities have been exacerbated in recent years due to the COVID-19 pandemic and a range of other economic challenges, leading to an increase in regulatory focus. A covid response paper from the Institute of Chartered Accountants in England and Wales (ICAEW) stated that “Assessing the valuation and impairment of clients’ assets has always demanded accountants’ toughest scrutiny and clearest judgment. Those skills and insights have never been more critical.” 2 The UK Government intervened with a 2021 policy paper published by the Department for Business reminding auditors of their “specific responsibility”, in particular “when reaching an overall judgement of whether the financial statements constitute a true and fair view of the entity’s financial position, but also for example judgements about line items in accounts such as revenue, goodwill and other intangible assets” 3 . In the current climate more than ever, astutely navigating the complexities of PPA is crucial to ensuring an informative and transparent set of accounts and a smooth audit process, whilst making well informed decisions leads to a better understanding of the impact on earnings and impairment testing in future periods. The esoteric nature of intangible asset valuation can lead to a complex and involved PPA process, which starts with establishing the reporting requirements.
In the current climate more than ever, astutely navigating the complexities of PPA is crucial to ensuring an informative and transparent set of accounts and a smooth audit process. Jim Davies Financial Advisory
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