Purchase Price Allocation

When it is done

As soon as one company obtains control of another, it is not enough to record the amount paid as an investment. The purchase price has to be allocated to what was actually acquired: individual assets and liabilities, each at fair value at the acquisition date. Only the remainder that cannot be allocated stays as goodwill. In a buy-and-build strategy this exercise repeats with every add-on.

What is measured

The difficult part is the intangibles that never appeared on the acquired company's balance sheet, because internally generated intangibles may not be capitalised. Typically:

• Customer relationships – measured through the excess earnings expected from the existing base, discounted and adjusted for attrition.
• Brands and naming rights – usually through royalties saved.
• Technology, software, patents – through royalties saved or reproduction cost.
• Order backlog – the work contracted but not yet delivered.
• Non-compete undertakings from the purchase agreement.

On the other side sit hidden burdens: pension obligations, onerous contracts, litigation. Deferred taxes have to be recognised on the difference between fair values and tax base – a point regularly forgotten in practice that shifts the allocation noticeably.

Effect on reported earnings

This is the real reason purchase price allocation is not a purely technical matter. Whatever is allocated to intangibles is amortised over their useful life and burdens the earnings of the following years. Whatever lands in goodwill is not amortised under IFRS but tested annually for impairment; under German GAAP it is amortised, as a rule over ten years.

A wide allocation to customer relationships with a short useful life depresses reported earnings for several years. That is not a matter of taste – the measurement has to be defensible – but the ranges are real, and the consequences are carried by the next set of accounts. At the next sale those charges are added back in the EBITDA normalisation – cleanly only if they were recorded separately from the start.

German GAAP and IFRS

Both frameworks require the allocation but differ in the detail: which intangibles can be recognised separately, how goodwill is treated, and how contingent consideration such as an earn-out is handled, which under IFRS is recognised at fair value at the acquisition date. Anyone preparing both sets of accounts needs two calculations, not one – see also IFRS conversion.

In practice

The measurement is almost always performed by an external expert, because the auditor reviews it and the methodology has to be documented. What the finance function has to deliver is the data: revenue by customer over several years, attrition rates, contribution margins by product line, order backlog, contract terms. Where that data is not cleanly available, the first consolidated accounts after the acquisition slip – the most common reason purchase price allocation becomes the bottleneck. It is therefore part of post-merger integration, not an afterthought to it.

Who supports the first consolidation alongside the running business is set out under Finance as a Service for Private Equity.