To comply with generally accepted accounting principles (GAAP), companies know there are a lot of rules to follow for financial reporting purposes. Are you planning to acquire or merge with another business? Business combinations and acquisitions is an area where adhering to GAAP requirements necessitates special attention.
These rules have evolved through a variety of names (the current being ASC 805), but these standards are more commonly known as purchase price allocations, where a company looking to acquire another company allocates the purchase price into liabilities and assets from the transaction. An acquirer must report the fair values of the acquired tangible and intangible assets, which must be reflected on the opening post-acquisition balance sheet. Tangible assets typically include equipment, property and inventory. Understanding what constitutes an intangible asset, however, is more mystifying to many business owners. Here is a framework to better categorize identifiable intangible assets:
- Marketing-related (trademarks, trade names, domain names, noncompete agreements)
- Customer-related (customer relationships, customer lists, production backlogs)
- Artistic-related (patents, literature, photographs)
- Contract-based (permits, franchise agreements, leases, employment contracts)
- Technology-based (copyrights, trade secrets, software)
These values are regularly adjusted to accurately reflect depreciation and amortization charges. Intangible assets that are not amortized, such as goodwill and in-process research and development, must be tested for impairment on at least an annual basis.
Why is accuracy so critical?
A purchase price allocation impacts the tax balance sheet, which is used as a basis for annual tax depreciation and amortization changes, but a PPA also impacts profits that determine the taxes paid and returned to investors and owners.
Depreciation and amortization can either be overstated or understated, which has a direct impact on whether net income is higher or lower. If a PPA is not entirely accurate, it can also result in a future impairment of intangible assets, which would be a loss on financial statements. Of these inaccuracies, some of the consequences can happen immediately, but others could happen years down the road. The company’s bottom line, an investor’s perception of the business, and future profit are all areas that stand to be affected by an inaccurate purchase price allocation. PPAs provide far greater transparency for investors, as well as a more detailed look into each component of a company’s value.
At Appraisal Economics, we have a deep understanding of the reporting requirements that will withstand SEC and audit scrutiny. If you want to make sure your purchase price allocation is accurate, choose the experienced professionals who have the requisite experience to provide accurate documentation.