Purchase Price Allocation
Purchase price allocation (PPA) is the process required under ASC 805 (Business Combinations) whereby an acquirer assigns the total consideration paid in an acquisition to the identifiable assets acquired and liabilities assumed at their fair values on the acquisition date, with any residual amount recorded as goodwill.
Purchase price allocation is a critical post-closing accounting exercise that determines how an acquisition is reflected on the acquirer's balance sheet and what impacts will flow through future income statements. Under ASC 805, the acquirer has a measurement period of up to one year after the acquisition date to complete the PPA, though preliminary estimates must be reflected in financial statements filed before the final allocation is complete.
The PPA process begins with identifying and measuring all tangible and intangible assets acquired. Tangible assets (real estate, equipment, inventory) are measured at fair value, which may differ significantly from book value. Inventory is stepped up to net realizable value, creating a one-time cost of goods sold charge as the stepped-up inventory is sold post-acquisition.
Identifiable intangible assets are a major component of most PPAs. The acquirer must separately recognize any intangible asset that meets either the separability criterion (can be sold or transferred independently) or the contractual-legal criterion (arises from contractual or legal rights). Common identified intangibles include customer relationships, trade names and trademarks, developed technology, backlog, non-compete agreements, and favorable/unfavorable leases. Each is assigned a fair value (typically using discounted cash flow, relief-from-royalty, or multi-period excess earnings methods) and a useful life for amortization.
The amortization of acquired intangibles — which flows through operating expenses post-acquisition — is a significant non-cash charge that depresses GAAP earnings. This is why acquirers frequently present adjusted earnings excluding amortization of acquisition-related intangibles (often labeled as adjusted EBITDA or adjusted EPS).
Any excess of purchase price over the fair value of net identifiable assets is recorded as goodwill. Goodwill is not amortized under US GAAP but is tested for impairment annually (or more frequently if impairment indicators arise) under ASC 350.