If your company has just recently completed a business acquisition, the difference between the purchase price of the business and the net book value of the tangible assets acquired is just goodwill, right? Well, perhaps not. This is a common misconception when a business is acquired through the purchase of assets or shares.
When a business acquisition occurs, the acquiring company is required to allocate the purchase price amongst the assets and liabilities acquired. This process is known as Purchase Price Allocation (“PPA”) and is required for financial reporting and taxation purposes.
Why is a PPA Required?
Accounting Standards for Private Enterprises (“ASPE”) and International Financial Reporting Standards (“IFRS”) provide guidelines and principles for the treatment of a business combination, particularly when a company acquires a controlling interest of another business.
Under both ASPE and IFRS, there is a requirement that acquired tangible assets, intangible assets and liabilities be measured at their fair values. Any excess of the purchase price greater than the identified net tangible and intangible assets is then allocated to goodwill.
From a taxation point of view, the PPA process can have an impact on how tangible and intangible assets are amortized under the capital cost allowance (“CCA”) system, primarily with regard to the initial value and cost base ascribed to each asset class.
Commonly Acquired Assets
Tangible assets refer to assets that have a physical substance, a finite monetary value, and are usually depreciated over the lifespan of the asset. Intangible assets refer to assets that are not physical in nature, and typically do not appear on the balance sheet unless acquired.
Examples of common tangible and intangible assets acquired in a business combination that require measurement at fair value include the following:
Tangible Assets:
- Fixed Assets: Including land, building, and equipment.
- Working Capital: Capital required to meet current, short-term obligations (e.g. accounts receivable, inventory and prepaid expenses, etc.).
Intangible Assets:
- Customer Relationships: Arising from contractual and/or non-contractual relationships including: customer lists, work-in-progress and order backlogs.
- Brand: A company name or related products with a recognizable trademark or trade name.
- Non-compete Agreement: A legal arrangement that prohibits a person or business from competing with a company in a certain market for a specified time period.
- Permits and Licenses: Approval granted by an authorized public official or agency to allow a business to perform certain protected acts or services.
- Patents: Intellectual property that provides its owner an exclusive, legal right to use a process or create and sell a product.
- Technology: Proprietary knowledge and processes either developed or purchased by the operator of a business.
- Assembled Workforce: Existing employees that allow an acquirer to continue to operate from the date of the acquisition. The fair value of a company’s workforce is separately identified and treated as an extension of goodwill.
The fair value of acquired fixed assets can be obtained through professional appraisers, however the fair value of intangible assets requires the expertise of a Chartered Business Valuator (“CBV”) with experience and knowledge in the applicable valuation methodologies used in valuing intangible assets.
Example of a Price Purchase Allocation
Company A acquires Company B for $10 million.
The fair value of the net tangible assets (i.e. assets less liabilities) acquired is $6 million. A CBV is engaged to assist with the allocation of the $4 million excess with respect to intangible assets and goodwill.
The CBV determined the following intangible assets values as follows:
- Customer List: $1.8 million
- Brand and Tradenames: $175,000
- Non-compete agreement with Seller: $125,000
- Patents: $500,000; and
- Permits: $400,000
Based on the information above, the intangible assets are collectively valued at $3 million. Considering the fair value of the tangible assets at $6 million, the remaining $1 million of the purchase price is allocated to goodwill.
Goodwill is commonly referred to as an “unidentifiable” intangible asset the represents the contributing aspects of the value of a business that are not measurable. This can include intangible aspects including locational goodwill, the value of workforce, quality of supplier relationships, and other items that are particularly difficult to quantify separately.
GG Observations
From both a financial reporting and tax perspective, a PPA can be a useful tool.
As CBVs, we have the background and experience to assist you throughout the PPA process, and we have provided these opinions under a variety of frameworks, including ASPE, IFRS, and US GAAP. We will work with your team to assist in calculating the fair values of the acquired assets, as well as determining the purchase price breakdown. As well, we provide full audit support and cooperation to assist year-end auditors in reviewing and understanding the finer elements of the PPA.
