The Hindu Business Line : Role of purchase price allocation in M&A

PPA involves apportionment of deal price, that is, assets acquired and liabilities assumed, into various tangible assets, intangible assets and goodwill.

Amit Jain
Sowmya Madhavan

These are the days of the big ticket mergers and acquisitions (M&A), and India Inc. is no longer a fringe player in the game. The Indian business space is brimming with activity which is increasingly becoming two-way, that is, deals by Indian companies abroad — Tata Steel’s acquisition of Corus, HINDALCO of Novelis, Essar Global of Algoma Steel Canada, etc. — and deals by global majors in India — Vodafone’s acquisition of Hutch Essar, Dubai Financial of Thomas Cook India, Hershey of Godrej Beverages, Cummins of Tata Holset, etc. The deal list is becoming longer by the day.

Increasing use

Given this deal dynamism, one term which is increasingly being used and becoming important from the perspective of financial statements preparation is purchase price allocation (PPA). The term itself is not new to global accounting parlance with US GAAP introducing it in 2001 ( FAS 141) and International Financial Reporting Standard in 2004 (IFRS 3). As more Indian companies go for overseas listings, wherein they may have to follow IFRS/US GAAP accounting standards, the concept of PPA is expected to get more attention. The guidelines prescribe financial reporting by an entity based on purchase method of accounting, when it undertakes a business combination. A business combination is the bringing together of separate entities or businesses into one reporting entity. PPA essentially involves, for a business combination, apportionment of deal price, that is, assets acquired and liabilities assumed, into various tangible assets, intangible assets (based on their estimated fair values at date of acquisition) and goodwill.

In addition to the fair valuation, the PPA process also requires determining the expected depreciation/amortisation of fair valued assets in the coming years. Assets having specific life are depreciated/amortised over their expected lives. Other assets, including goodwill, are subject to impairment reviews periodically. This could directly impact the EPS (and hence market price) of the acquirer as some assets require accelerated depreciation compared to others. Hence, it becomes very important for the acquiring company to analyse beforehand how the deal will be accounted for.

Intangible assets

The PPA process also highlights the importance of understanding the intangible assets of the acquiree during the M&A process. Going through this process is crucial to ensure accurate representation to avoid market misinterpretation and ensure congruence with company strategy.

For example, a transaction motivated by acquisition of key brands but limited value allocated to the brands in the PPA could be seen as an anomaly. Further the valuation of various assets in the PPA exercise excludes buyer-specific synergies. These synergies are included in goodwill. For example, in the case of a deal where significant premium has been paid based on synergies, the goodwill amount will be on the higher side as all the buyer-specific synergies will become a part of the goodwill. This helps in explicitly emphasising the realisation of synergies (and thereby management execution) as a key factor in the success of the transaction.

Indian scene

Let us now look at Indian accounting standards on this? Is there some catching up to do? Indian standards — AS 14 (Accounting for Amalgamations), for instance — with the usage of one of the two methods (pooling-of-interests and purchase) of accounting for business combinations is okay, but US GAAP and IFRS have made the transition to the application of only the purchase method.

The purchase method recognises and measures assets and liabilities in the same way regardless of the nature of the consideration that is exchanged for them. Whether the acquirer issues its shares in exchange or pays cash for the acquisition, the net assets of one entity that are transferred are accounted for on the same basis, that is, on a fair-value basis.

Fair values reflect the expected cash flows associated with acquired assets and assumed liabilities. As the pooling method records the net assets acquired at their carrying amounts rather than at their fair values, the information that the pooling method provides about the cash-generating abilities of those net assets is much less useful compared to the purchase method.

Consequently, users of financial statements which are prepared based on purchase method are better able to assess the initial costs of the investments made and the subsequent performance of those investments and compare them with the performance of other entities.

However, given the investor friendliness of the PPA, it may not be too long before these guidelines are appreciated by Indian standard-setters and implemented for the benefit of the investor community.

(The authors are with Ernst & Young.)

More Stories on : Mergers & Acquisitions | Accounting Standards

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Sticklish Issues

Building blocks of computing taxable house property income

Money supply versus prices

Taking hedging forward

Engineering grads urged to acquire additional skills

Exploring prospects for a marine biologist

Role of purchase price allocation in M&A

Just Do It

Number Crunch

Can I get rebate on two housing loans?

There is no substitute for hard work

Your defence against cold

Simplicity on the far side of complexity