Common Issues in Purchase Price Allocation and How to Address Them

If you’re reading this article, chances are you have a general understanding of Purchase Price Allocation and its related accounting for business acquisitions. If not, check out our introductory article here.

Accounting for business combinations can be one of the most complex areas of US GAAP, and a leading cause for costly overruns and fees by auditors if not done correctly. Through this article, I hope to help you see the Top 3 issues for a company in their business combination accounting under ASC 805, and the steps that you can take now to save yourself the headaches and back-and-forth with auditors down the road.

Issue #1: Complex Valuation

Purchase Price Allocation requires a company to record the acquired company’s balance sheet as of its acquisition date. Not only do you have to record every asset and liability on the balance sheet at its fair value, which may be different from its current balance, but you must also identify and estimate new intangible assets and purchase price components that are not clearly noted in a company’s accounting.

If you’re not a valuation expert yourself, it’s likely that you have no idea where to start with these valuations and unfortunately it’s not as easy as the click of a button.

And any back-of-the-napkin calculation that you may try to put together will almost certainly be ripped apart by an auditor and their own valuation specialists when they review. This can lead to significant audit adjustments and internal control deficiencies, and you end up having to re-do the entire exercise anyway.

Unless it is a small acquisition that will fly under the radar of an audit, do yourself a favor and hire a valuation expert to help with your acquisitions. They bring the expertise to easily discuss the types of intangible assets and other areas of an acquisition that require valuation and know the accepted valuation techniques that will pass muster in an audit.

Also note that it takes time for a valuation expert to perform their work, and the tighter turnaround needed results in higher fees to get the job done. Engaging them early on, and well before audit fieldwork begins, can save you both time and money.

Ideally, your company already has a go-to valuation expert that has prior experience in knowing your business. If not, we partner with multiple valuation firms that have an excellent track record; reach out to our team for valuation firm recommendations.

Issue #2: Missing Acquisition Considerations

Acquisitions tend to be complex in their structures, and their terms vary on a deal-by-deal basis. Missing certain parts of an acquisition in your accounting review can result in a major adjustment or overhaul of the evaluation further down the road. Here are a few items to remember:

• Purchase Price Consideration: The amount paid for an acquisition includes more than just cash paid. It can include liabilities to the sellers (e.g., loans/notes or deferred payments) or company stock issued. It also includes contingent consideration, potential future payments that may or may not be paid based on future events or formulas; a common example of this is earnouts that may be paid if the acquired company meets certain revenue or EBITDA thresholds post-acquisition.

• Employment Agreements: Sometimes certain sellers will enter employment contracts as an employee or contractor of the buyer upon acquisition. These should be reviewed for key sellers/employees to determine if any parts of the contract may be considered part of the acquisition accounting.

• Other Agreements: Similar to above, sellers may enter into various agreements with the buyer as part of the acquisition. This can include lease agreements, as well as transition service agreements (or TSA’s). Any such agreements must be reviewed to see if they represent separate transactions, or if they should be accounted for as part of the acquisition accounting.

Reviewing a purchase agreement alone will often not uncover everything that should be considered; you need to do a thorough evaluation of all agreements, exhibits, and schedules included in the acquisition documents. Engaging a technical accounting expert can help save you time and effort in this review.

Issue #3: Closing Balance Sheet

All the accounting for an acquisition, and especially the Purchase Price Allocation, revolves around having a complete and accurate Closing Balance Sheet as of the acquisition date. Unfortunately, what is often provided by the sellers on the closing date is an estimated balance sheet. As a result, you are often left with a high-level document that is not accurate or supportable, and you are often pressed with a tight timeline to determine the right numbers as of the acquisition date for post-acquisition adjustments to the purchase price.

To prepare for this, have the following steps in mind as soon as the acquisition closes:

• Identify the acquired company’s accounting and reporting capabilities. Ideally, you should be able to log into their ERP and pull a Balance Sheet as of the specific acquisition date. However, many systems are limited in their reporting, and you may need to do your own manual rollforward (or rollback) procedures to get from whatever is provided to the actual acquisition date.

• Reconcile key account balances. Even if you can easily pull a Balance Sheet out of the acquired company’s ERP, that doesn’t mean the numbers are right. Many accounting entries are only performed as part of the close process at month-end or quarter-end, and so you may need to make mid-period adjustments for the correct acquisition-date balance.

All the above can take significant time and effort to reach an accurate Closing Balance Sheet as of the acquisition date. Make sure you plan to have the right time and resources to devote to this exercise.

Conclusion

Accounting for a business combination can be extremely confusing and costly, and it doesn’t help when every acquisition brings its own set of terms and circumstances. By becoming aware of the above issues and arming yourself with enough time and the right resources to perform a thorough accounting evaluation, you can avoid major audit overruns and headaches when it comes time for the audit.

Not sure where to start? See our other articles, including an overall introduction to business combination accounting here.

Or, schedule a discovery call with our team of technical accounting experts to help you navigate every step of the process.