Common Purchase Price Allocation Mistakes and How to Avoid Them

Purchase Price Allocation (PPA) is a critical process in mergers and acquisitions (M&A), where the purchase price is allocated among the acquired assets and assumed liabilities based on their fair values.

It is important to get the purchase price allocation right for financial reporting and tax returns. However many companies do not perform this process correctly that may cause issues, which in turn can lead to considerable financial and compliance issues.

Here, we’ll cover what exactly this process is, common mistakes companies make, and solutions to address potential issues relating to the purchase price allocation in Singapore.

What Is Purchase Price Allocation?

Purchase Price Allocation (PPA) is the process of allocating the purchase price of a business acquisition amongst its tangible and intangible assets and liabilities. On many occasions, when company X acquires company Y, the purchase price exceeds the fair value of the identifiable net assets of the acquired company. This surplus is commonly recorded as goodwill.

A robust purchase price allocation valuation ensures that every asset, liability, and goodwill is appropriately reflected in the financial statements. It is important not only for meeting accounting requirements such as IFRS or US GAAP, but also for assisting a business in its ongoing decision-making after completing any acquisition.

Why Robust Purchase Price Allocation Matters?

There are many reasons why purchase price allocation is important, these include:

• Regulatory Compliance: Accounting standards require fair-value purchase price allocation (e.g., IFRS 3, ASC 805). Incorrect allocations may result in regulatory scrutiny or penalties.
• Tax Implications: Taxes on assets are calculated based on their respective allocations. The error could cause you to overpayment or underpayment of taxes.
• Misreporting of Finances: Erroneous figures can lead stakeholders to the wrong conclusions.
• Business Decisions: An appropriate and robust valuation of assets informs management when deciding on further investments or disposals.

Errors in purchase price allocation can have a drag on a company for a period of time, so it is important to avoid them.

Common Purchase Price Allocation Mistakes

Here are a few typical errors businesses commit in Purchase Price Allocation:

1. Ignoring Intangible Assets

Most companies focus on tangible assets, such as buildings, machinery, and inventory, and ignore or underplay the intangible assets. Intangible assets such as patents, trademarks, customer relationships, and software are to be identified and recognised. Goodwill is the residual intangible value.  

If these results are not properly considered or valued, goodwill can be understated, and reporting requirements can be violated.

How to Avoid:

• Conduct a thorough intangible asset identification process and review of all potential intangible assets.
• Engage professionals to perform purchase-price allocation valuation of intangible assets.
• Proper disclosure of intangibles in financial reports with remaining useful lives.

2. Using Incorrect Valuation Methods

Failing to select the appropriate valuation method is another common slip-up. There are different ways to value different assets. For example:

• Physical assets are typically valued at cost or market value.
• Refer to income using multi-period excess earnings method (MEEM) or relief from royalties (RFR) for intangible assets.

A one-size-fits-all approach can easily lead to erroneous purchase price allocation in Singapore or elsewhere.

How to Avoid:

• Use appropriate valuation techniques based on the type of asset.
• Seek (intangible asset or real property or other) specialists for unique assets.
• Adhere to accounting standards in the valuation of asset-specific.

3. Overlooking Deferred Taxes

Deferred taxes are attributable to differences between the book and tax values of assets and liabilities. Deferred taxes are often ignored during purchase price allocation and can lead to tax surprises down the road.

How to Avoid:

• Recognise temporary differences between the book and tax values.
• Calculate deferred tax assets liabilities appropriately.
• Financial statements must be fairly presented.

4. Misclassifying Liabilities

Companies sometimes misclassify liabilities as operating expenses or fail to recognise contingent liabilities. This can include items such as pending lawsuits, warranty liabilities, and environmental cleanup costs.

Misclassification of these could misrepresent the company’s net assets and affect the goodwill amount.

How to Avoid:

• Be mindful of any known or potential liabilities.
• Include contingent liabilities in the allocation if they are probable and reasonably estimable.
• If in doubt, consult lawyers and tax specialists to determine the classification of the liability.

5. Ignoring Market Conditions

Some market factors and economic conditions may significantly influence an asset’s value. Market conditions, interest rates, or sector risks can result in over- or under-valuing the asset.

How to Avoid:

• Take the market and the economy into account when valuing.
• List assets at fair value.
• Clearly document valuation assumptions when performing purchase price allocation.

6. Relying Solely on Book Values

A common mistake in PPA is to use book value instead of fair value. Book values are at historical costs and not the same as market or fair values.

For example, an old machine purchased 10 years ago might have had an original cost of $25,000 but a book value of only $10,000. The concept of fair value, if not accepted, would lead to distortions in accounts and depreciation and amortisation schedules.

How to Avoid:

• Apply fair value to all significant assets and liabilities.
• Update valuations regularly for more current figures.
• Ensure consistency with accounting standards.

7. Poor Documentation

Another common error is the lack of thorough documentation of the purchase price allocation, which may have occurred in Singapore or other jurisdictions. Without records, auditors could ask questions about how allocations are conducted, which could lead to compliance issues.

How to Avoid:

• Keep a clear record of all your valuations, assumptions, and their rationale.
• Continue to gather supporting evidence, such as contracts, appraisals, and market research.
• Create a sufficiently detailed PPA report for internal and external evaluation.

8. Ignoring Post-Acquisition Adjustments

Post-acquisition, certain working capital, inventory, or contingent liabilities may need to be adjusted. Failure to take these post-acquisition adjustments into account can lead to a misrepresentation of the final purchase price allocation.

How to Avoid:

• Keep a close eye on the acquisition for any changes that need to be made.
• Restate the financial statements to their appropriate post-acquisition figures.
• Communicate changes to stakeholders transparently.

Best Practices to Avoid Purchase Price Allocation Mistakes

To steer clear of the common mistakes companies have been known to make in respect of the PPA, this advice should not be overlooked:

• Leverage Experience: Employ experienced valuers to deliver a robust purchase price allocation valuation exercise.
• Full Asset Search: Account for each tangible and intangible asset. Nothing should go unaccounted for.
• Valuation Counts: Practice recognising the value of assets and complying with accounting principles.
• Review for Tax Effect: Verify that the correct deferred taxes and tax liabilities have been recognised.
• Document Everything: Record all assumptions, valuations, and methodologies adopted.
• Consideration of Market: Take into account market conditions and sector-specific risks to achieve realistic valuations.
• Monitor Post-Acquisition Adjustments: Reallocate for changes in liability, working capital, or other items.

With best practices, businesses can both get the allocation of the purchase price right in Singapore and remain compliant elsewhere.

Benefits of Proper Purchase Price Allocation

There are several benefits to appropriate Purchase Price Allocation:

• True and Fair Accounting: Reasonable values assigned to accounts.
• Tax Efficient: Proper allocation minimises tax liability and improves deductions.
• Regulatory compliance: Reduce fines and audit exposure.
• Better Decision-making: Helps management make complex strategic and tactical decisions.
• Stakeholder Transparency: Builds confidence among investors, auditors, and regulators.

Conclusion

PPA is not a checkbox exercise in compliance. It is an essential component of accurately reflecting your company’s financial position after the business combination. With thorough data and a complete understanding of the relevant details of purchase price allocation in Singapore, which governs how all intangible assets are recognised, you can make the transaction process to be less of a hassle.

Remember the objective of a purchase price allocation valuation: The transparent reporting of those allocated values. When done properly, it provides investors, auditors, and regulators with a very clear view of precisely what has been bought — and why it matters.

Don’t make the above-noted mistakes. Here’s how not to fall into the main traps: Don’t be reactionary. Think it through, and get help from professionals early in the process. That way, your PPA is more than just an auditor’s report. It becomes an important driver in determining how your future business strategy can be used to both grow and enhance its value.