Purchase price allocation: Ensuring accuracy, transparency and compliance
Accounting requirements
Companies that report under UK GAAP can conduct PPA exercises in accordance with IFRS principles and may elect to do so if there are plans to transition to IFRS in the future, or for reasons of good governance, transparency, and increased disclosure within the financial statements. The choice of accounting standard can influence the recognition of intangible assets and various technical points relating to purchase consideration, asset valuation and accounting lives. Purchase consideration In simple transaction structures purchase consideration is simply the cash amount paid for the acquired business - though it is important to recognise the distinction between enterprise and equity value where acquisitions have not been completed on a debt-free, cash-free basis. Where transaction structures include deferred consideration, or elements that are contingent on future performance metrics, such components are required to be fair-valued and included in the purchase consideration as at the acquisition date. Cash Generating Units The selection of CGUs plays an important role in determining the overall shape of a purchase price allocation and dictates the extent of allocation and supporting analysis required. If multiple CGUs are recognised the purchase consideration must be split between them, requiring a valuation of each one. Furthermore, all assets and liabilities must then be valued and allocated at a CGU level. CGU selection is primarily driven by accounting definitions (a CGU being broadly defined as the smallest group of assets that generate cash inflows that are largely independent of the cash inflows from other assets or groups of assets), whilst other practical considerations may include:
Companies reporting under both International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Practice in the UK (UK GAAP) are required to capitalise the fair value of all acquired assets and liabilities following an acquisition. Acquired intangible assets must first be identified, then valued and capitalised if certain criteria are met. Purchase consideration requires inclusion of the fair value of any contingent or deferred elements, and the balance of purchase consideration less the fair value of acquired net assets (including intangible assets) is required to be capitalised as goodwill. IFRS stipulates that intangible assets must be recognised separately from goodwill if they are deemed to be separable or arise from contractual or legal rights. The recognition criteria differs under UK GAAP where intangible assets are required to be recognised if deemed to be both separable and arising from contractual or legal rights. This leads to differences in the practical assessment of intangible assets under different accounting standards. The allocation of purchase consideration is required at a cash-generating unit level, a ‘CGU’ being the smallest group of assets that generate cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Acquired assets with indefinite lives are required to be depreciated or amortised, and the carrying value of intangible assets and goodwill is required to be tested for impairment at future reporting dates.
Practical considerations
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 existing group reporting structure • Future impairment testing • Information availability
Prior to determining the value of acquired assets and goodwill, there are certain up-front considerations that influence the broader shape of a PPA exercise. Primary amongst these are: Accounting standards Purchase price allocations are typically conducted in line with the accounting standards that the consolidated acquiring entity reports under, however there may be other considerations.
These up-front considerations frame the shape of the exercise and can influence the structure of future reporting requirements such as impairment testing.
The Financial Reporting Council
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