What is Purchase Price in M&A Transactions?
In this article, we will discuss purchase price allocation for M&A transactions in detail.
Did you know, you must carry out purchase price allocation if you’re thinking any kind of business combination transaction. For example, during M&A transactions reporting in accordance with IFRS, the purchase price allocation must be carried out. The term purchase price allocation refers to the process by which a buyer divides the price they paid for purchase into the acquired firm’s assets and liabilities. Knowing the fair market value of the acquired firm is crucial for purchase price allocation purposes. Issues may arise for the purchasing entity if the purchase price allocation was not performed appropriately.
In this article, we will discuss purchase price allocation for M&A transactions in detail. The article touches on components of purchase price allocation, benefits of purchase price in m&a, what influences purchase price, and more.
Purchase price allocation in M&A transactions
Due diligence, discussions, and closing processes are all part of the merger and acquisition process for a functional firm. As the acquirer works to finalize the purchase and negotiate the operational restrictions of merging the two firms, accounting for the M&A transactions may be the last thing on their mind.
Accounting for mergers and acquisitions is a complex procedure that most accountants and financiers seldom encounter. Lack of familiarity with M&A transactions accounting might make completing the year-end financial report a challenging task. For this reason, it’s crucial to have a correct purchase price allocation valuation carried out. Let’s understand purchase price allocation in detail to avoid such mishaps in reporting M&A transactions.
What is purchase price allocation?
As part of the M&A transactions accounting process, a buyer will execute an exercise known as a purchase price allocation. It is the practice of dividing the amount paid for an acquired business into its respective shares of tangible and intangible assets, as the name indicates.
Purchase price allocation is needed by the existing accounting laws, like the International Financial Reporting Standards (IFRS), for any kind of transaction arrangement, including M&A transactions. This requirement applies to both domestic and international transactions. It is important to note that previously, purchase price allocation was just necessary in the event that talks pertaining to a takeover were taking place.
The change of ownership of a company necessitates the use of M&A tansactions accounting for tax and financial reporting purposes. Users of financial statements may have a better understanding of the value of the acquired company’s components by referring to the purchase price allocation.
Components of purchase price
The accountants are able to identify the fundamental valuation process and arrive at a conclusion about the net worth owing to the purchase price allocation, which is comprised of three elements as noted below –
- Write up – An asset’s book value is said to be written up when it has been determined that its carrying value is lower than its fair market value. The write-up amount is determined after a third-party business valuation expert has determined the true market worth of the company’s assets which has been bought in a transaction.
- Net identifiable assets – Net identifiable assets is used to describe the difference between the total value of a purchased company’s assets and liabilities. Assets that can be valued precisely at a particular moment and whose advantages can be precisely recognized and specified are referred to as identifiable assets. The balance sheet amount of the purchased company’s assets is the essence of net identifiable assets. Note that both physical and intangible assets may be identified.
- Goodwill – Goodwill refers to the overpayment for a firm over its net asset worth less its liabilities. Goodwill is the difference between the purchase price of a company and the fair market value of its assets and liabilities. Companies must conduct an annual goodwill impairment test and report any necessary modifications to goodwill balances. Because goodwill does not depreciate but is instead occasionally amortized, this is the case.
What influences purchase price?
For purchase price allocation, you need to know certain aspects involved in M&A transactions that may affect the purchase price. Here’s a list of these influencing aspects and when they can fluctuate the purchase price.
- Debt – For most of the times when a business is acquired, the debt is be refinanced through a change of control, which may raise or lower the purchase price based on the seller’s and purchaser’s preferences. The price a buyer truly pays for a seller should not be affected by whatever debt is assumed. However, if the buyer repays the Debt in the transaction, the Purchase Price will go up. A buyer kind of raises the amount paid if the previous debt is replaced with a new loan, however he or she isn’t really spending more money.
- Cash – Because of the need of maintaining a stable cash flow to keep the lights on and the bills paid, cash is a vital asset for every company. When determining the total worth of a company, it is customary to exclude any cash reserves and instead deduct the whole amount of cash available. So if you’re wondering if the company cash can result in a price reduction, according to the enterprise value concept, the purchaser cannot just pocket it. A buyer would not be able to just stroll in and keep all the cash the seller had on hand for the company.
- Transaction fees – All M&A transactions come with a transaction fees. The transaction fee will always result in an increase in the purchase price paid by the buyer. These fees include the fees of the layers, accountants, bankers, and more.
- Unfunded pension – An unfunded pension program is a kind of employer-managed retirement plan in which pension payments are made out of the company’s present operating funds when they become due. That’s in contrast to a pension plan that’s “advance funded” where the company saves up for retirement benefits in advance and never touches the money. The purchase price may not be affected if these programs aren’t required to be paid or repaid following a change of control.
- Capital lease – For financial reporting purposes, a capital lease is the same as if the business had purchased the leased asset outright. Just like unfunded pensions, the purchase price may not be affected if it isn’t required to be paid or repaid following a change of control.
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