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Are You Correctly Applying Fair Value Standards? Purchase Price Allocations and Goodwill Impairment Tests

February 18, 2011

Are You Correctly Applying Fair Value Standards? Purchase Price Allocations and Goodwill Impairment Tests

Synopsis
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Insight
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The transaction market in Canada has declined over the last few years, but the importance of properly recognizing assets acquired in an acquisition has not. Properly accounting for assets acquired in a merger or acquisition can have significant monetary implications.

An acquirer in an asset or share purchase should always take the time to have a proper purchase price allocation completed. A purchase price allocation divides the purchase price among the tangible and intangible assets and liabilities using fair value. Any residual amount of the purchase price after allocation is recorded as goodwill.

The key concept behind fair value is that the value of an asset or liability is based on what a market participant would pay to acquire the rights to the asset or transfer the liability. This applies whether you use the Canadian Institute of Chartered Accountants (CICA), the Financial Accounting Standards Board (FASB), or the International Financial Reporting Standards (IFRS). Most companies do not regularly engage in transaction accounting so management is often inexperienced with financial accounting rules and procedures when dealing with transactions.

Potential errors in purchase accounting include:

  • Failing to account for all identifiable intangible assets or improperly identifying intangible assets
  • Using incorrect or suspect methods to value the assets and liabilities
  • Valuing the assets from a buyer-specific perspective
  • Failing to properly determine market participant synergies or not eliminating acquirer-specific synergies
  • Determining the proper remaining useful life of the assets
  • Over/under allocation of goodwill

Each of these errors can have a significant impact in subsequent accounting periods.

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