If and when your business acquires another company, it's not just purchasing the brand. It's also acquiring the company’s assets and liabilities, both current and non-current.
These assets and liabilities need to be accurately identified and recorded in your financial records, directing aspects of financial management like tax returns and depreciation structures.
The method for doing this is called purchase price allocation (PPA), and it's the topic of today’s lesson.
In this article, we’ll explore what purchase price allocation is, why it needs to be performed, and some of the common challenges finance leaders encounter when applying it.
What is purchase price allocation?
Purchase price allocation (PPA) is an accounting procedure that divides the total acquisition cost of a company into the fair value of its identifiable assets and liabilities, both tangible and intangible.
Required under accounting frameworks such as GAAP and IFRS, PPA ensures the acquisition is reflected accurately in financial statements. It also influences tax outcomes through depreciation and amortization and provides valuable insights for post-acquisition integration and strategic management.
Why purchase price allocation is important?
Purchase price allocation is a critical step in ensuring that an acquisition is represented accurately across financial, tax, and management reporting.
When a company is acquired, the purchase price needs to be divided among assets and liabilities. The way in which this is applied directly impacts how that transaction appears in key financial statements, how taxes are calculated, and how the new entity will be managed moving forward.
PPA and financial reporting
From a financial reporting perspective, PPA ensures compliance with standards such as GAAP and IFRS by assigning fair values to tangible and intangible assets. This impacts future depreciation, amortization, and impairment testing, shaping how profits and asset values are presented over time.
PPA and tax planning
When it comes to tax planning, accurate allocation of assets and liabilities influences the timing and amount of deductible expenses.
For instance, proper valuation of intangible assets like customer relationships or proprietary technology can create amortization benefits that reduce taxable income and make the acquisition more financially favorable.
PPA and management strategy
From a management strategy standpoint, PPA helps decision-makers understand what portion of the purchase price is tied to tangible versus intangible value. This clarity supports integration planning, performance tracking, and future investment decisions.
PPA and mergers
In the case of a merger, precise and well-documented purchase price allocation provides transparency to all stakeholders involved, reducing the risk of post-deal disputes and helping ensure that the new combined entity’s financials reflect its real economic value.
Key considerations in PPA
There are several key factors involved that influence the accuracy and effectiveness of purchase price allocation.
These include:
- Identifiable assets and liabilities: Only assets and liabilities that can be separately identified and measured are included in the allocation. This can include tangible assets like property as well as intangible assets like trademarks.
- Determining fair value: Each asset and liability must be valued at its fair market value as of the acquisition date. Independent valuations or market-based methods are often used to ensure objectivity and compliance with GAAP or IFRS requirements.
- Assessment of intangible assets: Intangible assets can often represent a large portion of the value of a modern business, but their nature makes them hard to calculate with certainty. Properly identifying and valuing these assets (especially those related to intellectual property or brand equity) is essential for accurate financial reporting and future amortization schedules.
- Calculating goodwill: Goodwill represents the residual amount after the fair value of identifiable net assets is subtracted from the purchase price. It captures elements such as brand reputation, workforce expertise, and expected synergies, and must later be tested for impairment rather than amortized.
- Tax implications: How the purchase price is allocated directly impacts tax deductions and deferred tax liabilities. As such, businesses need to align accounting and tax treatments carefully to avoid discrepancies.
- Regulatory compliance and disclosure: PPA must adhere to relevant accounting standards and include clear disclosures in financial statements.
How is purchase price allocation calculated? PPA formula
Purchase price allocation is calculated by determining the fair value of all identifiable assets and liabilities of the acquired company, then assigning the remaining balance to goodwill. The goal is to ensure the total allocated value equals the total purchase price paid in the acquisition.
Here’s the basic formula for purchase price allocation:
To understand how PPA works in practice, let’s work through an example.
Example of purchase price allocation
Suppose Company A acquires Company B for $10 million. On the acquisition date, Company B’s identifiable assets and liabilities are assessed at fair value as follows:
- Tangible assets: $4 million
- Intangible assets: $3 million
- Liabilities: $2 million
After having accounted for these items, finance identifies the total fair value of identifiable net assets to be:
$4M tangible + $3M intangible – $2M liabilities = $5M net assets
Given that the purchase price was $10 million, and net assets total only $5 million, the remaining $5 million is recorded as goodwill.
This amount represents the premium paid for expected synergies, brand reputation, or workforce expertise, all of which may be expected to bring future value but cannot be accurately identified as either tangible or intangible assets.
How to perform purchase price allocation
Performing purchase price allocation involves several structured steps to ensure accuracy, compliance, and clarity across financial reporting, tax planning, and management analysis.
Here’s a quick play-by-play:
- Determine the total purchase price, including any cash, stock, and contingent payments
- Identify and measure all identifiable assets and liabilities, tangible and intangible
- Use market-based or valuation techniques to establish the fair value of each item
- Allocate the purchase price by assigning values to each asset and liability, recording any excess of purchase price above net asset value as goodwill
- Assess how the allocation affects depreciation, amortization, and deferred tax positions
- Include transparent disclosures about the assumptions and valuation methods in upcoming financial statements
Key methodologies and approaches for determining fair value
When valuation professionals determine fair value, they typically use one or more of the following strategies:
- Income approach: Estimates value based on expected future cash flows discounted to present value
- Market approach: Uses comparable transactions or market data to assess what similar assets are worth
- Cost approach: Calculates what it would cost to replace or reproduce the asset, less depreciation
Selecting the right method depends on the nature of each asset. For example, trademarks and customer relationships often rely on the income approach, while equipment and property are commonly valued using the cost or market approach.
Tools and software that simplify the process
Purchase price allocation no longer needs to be the challenging and cumbersome process it used to be.
Modern valuation and accounting software can streamline the process by automating aspects of PPA, such as:
- Fair value calculations
- Scenario modeling
- Compliance reporting
Tools like ValuSource, BizEquity, and Oracle NetSuite provide frameworks for consistent valuation, while integrated financial operations platforms like BILL can help manage post-acquisition accounting and reporting.
Common challenges in purchase price allocation
While purchase price allocation is essential for accurate financial reporting and compliance, it can also be complex and subjective. Several challenges often arise during the process that can affect accuracy, consistency, and transparency.
Here are six of the most common.
1. Identifying and valuing intangible assets
Tangible assets are listed on the balance sheet, so they are easy to assign values to.
But determining the fair value of intangible assets like customer relationships, trademarks, or proprietary software is a lot more challenging.
That’s because intangible assets lack observable market pricing, meaning valuation relies on estimates of future cash flows, discount rates, and useful lives, and all of this can vary significantly between different analysts.
2. Estimating fair value accurately
Even tangible assets can be difficult to value if they are specialized, outdated, or held in volatile markets. Independent valuations and standardized methodologies are often required to ensure objectivity and compliance with GAAP or IFRS.
3. Determining useful lives and amortization periods
When considering the value of intangible assets, assigning an appropriate useful life has a direct impact on amortization schedules and, as a result, profitability.
Overestimating or underestimating these periods can distort future earnings and impair comparability between reporting periods.
4. Goodwill assessment and impairment
Goodwill must be treated differently from assets. It must be tested annually for impairment, not amortized.
In order to estimate goodwill’s recoverable value, analysts must forecast future cash flows for cash-generating units, and this too can be highly judgmental, sensitive to market shifts, and differ between analysts.
5. Tax and accounting alignment
Tax regulations often differ from financial reporting standards. Aligning purchase price allocation for both purposes can be difficult, potentially creating deferred tax assets or liabilities if timing differences arise.
6. Data quality and integration
When one company acquires another, it's not unusual to encounter incomplete or inconsistent financial data from the target company.
Poor data quality can lead to inaccurate valuations or delayed financial reporting.
Avoiding pitfalls and ensuring accuracy
As you prepare to engage in purchase price allocation post-acquisition, consider these best practices to help you maximize accuracy and avoid some of the common pitfalls we just discussed:
- Engage qualified valuation specialists familiar with both accounting and tax regulations
- Use consistent, well-documented valuation methodologies
- Validate assumptions with market data where possible
- Maintain transparent documentation and disclosures to satisfy audit and regulatory requirements
What are the accounting implications of purchase price allocation?
From an accounting perspective, purchase price allocation has several important implications:
- Balance sheet impact: Assets and liabilities are restated at fair value, and goodwill is added as the residual, changing total assets and equity
- Income statement impact: New depreciation and amortization schedules affect reported earnings
- Goodwill impairment: Goodwill is not amortized but tested annually for impairment, which can reduce net income if written down
- Deferred taxes: Differences between book and tax values create deferred tax assets or liabilities
- Financial ratios: Adjusted asset values and amortization influence metrics like ROA, debt-to-equity, and EBITDA
- Disclosure requirements: GAAP and IFRS mandate transparent reporting of valuation methods, assumptions, and allocation results
Managing purchase price allocation with BILL
Purchase price allocation is essential for accurate financial reporting, tax planning, and post-acquisition strategy.
By assigning fair values to acquired assets and liabilities and recording goodwill, businesses can ensure compliance, support clearer decision-making, and provide transparency to stakeholders.
BILL helps simplify the accounting and documentation that support PPA by providing:
- Centralized documentation and audit trails
- Clean, synced transaction data that reduces manual errors
- Automated workflows and controls for compliance
- Easy management of recurring and post-acquisition payments
