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Given that the transaction market is on the incline, it's timely to remember the importance of properly recognizing assets acquired in an acquisition. Properly accounting for assets acquired in a merger or acquisition can have significant monetary implications for a company. Improper valuation of goodwill and identifiable intangible assets can result in:
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). Unlike the hypothetical premise behind fair market value, fair value considers what a potential competitor would pay for the asset or pay to transfer a liability. This concept accounts for synergies arising from the transaction that would be recognized by a market participant.
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:
Each of these errors can have a significant impact in subsequent accounting periods. Undervaluing the assets typically results in an overvaluation of goodwill. This can result in a write-down of goodwill due to impairment in subsequent periods.
Goodwill impairments not only result in a write of equity (the corresponding entry to the goodwill write-down is a write-down of equity), but also lead to the additional cost of doing a full purchase price allocation to determine the goodwill impairment. While the actual impairment may be an accounting function, the time, money, and effort required to complete the analysis are real.
Chris Perret, CBV, AACI, Steven Hacker, CA, CBV, and Jason Lampi, MBA, are with MNP’s Valuations and Appraisal practice. Working closely with MNP’s extensive network of industry specialists, they deliver independent, concise valuation assessments in a wide range of areas.
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