Purchase Price Allocation (PPA) Under IFRS 3: Complete Guide

Purchase Price Allocation (PPA) is the process of allocating the purchase price in a business combination to the identifiable assets acquired and liabilities assumed. Under IFRS 3 Business Combinations, this allocation must be done at the acquisition date and involves identifying fair values of all assets and liabilities.

Why Purchase Price Allocation Matters

When acquiring a business, the purchase price rarely equals the book value of net assets. The difference represents:

• Identifiable intangible assets (customer relationships, patents, brand names)
• Goodwill (expected synergies not separately identifiable)
• Fair value adjustments to existing assets/liabilities

Proper PPA affects future earnings through depreciation, amortization, and impairment tests.

Steps in Purchase Price Allocation

Step 1: Identify the Acquiring Entity

Determine which entity obtained control of the other. This is usually clear but may involve complex structures.

Step 2: Determine Acquisition Date

The date when the acquirer obtains control. This is typically the closing date when consideration is transferred.

Step 3: Recognize Identifiable Assets Acquired

Recognize all identifiable assets that meet recognition criteria:

• Arise from contractual or legal rights
• Are separable (can be sold, transferred)
• Have measurable fair value

Step 4: Recognize Liabilities Assumed

Recognize liabilities that meet recognition criteria:

• Are present obligations
• Result from past events
• Have measurable fair value

Step 5: Measure Fair Values

Measure all recognized assets and liabilities at fair value:

• Market approach: Use quoted market prices
• Income approach: Present value of future cash flows
• Cost approach: Replacement cost

Step 6: Calculate Goodwill

Goodwill = Purchase consideration + Non-controlling interest - Fair value of net identifiable assets

Journal Entries for PPA

At acquisition date, record the business combination as follows:

Dr Property, Plant & Equipment     $3,000,000
Dr Customer Relationships           $800,000
Dr Brand Name                        $400,000
Dr Inventories                       $X
Dr Accounts Receivable               $X
Dr Goodwill                        $1,320,000
    Cr Common Stock (Target)         $6,000,000
    Cr Deferred Tax Liability         $720,000
    Cr Cash                          $10,000,000

Intangible Assets in PPA

Common identifiable intangible assets recognized in PPA:

1. Customer-Related Intangibles

• Customer relationships: Value of existing customer base
• Customer contracts: Value of contracts in place
• Order backlog: Value of unfilled orders

2. Marketing-Related Intangibles

• Brand names: Trademarks, trade names
• Trade dress: Product packaging, design
• Domain names

3. Technology-Based Intangibles

• Patents
• Copyrights
• Software
• Trade secrets

4. Contract-Based Intangibles

• Licensing agreements
• Franchise agreements
• Service contracts

Measuring Fair Value of Intangibles

Multi-Period Excess Earnings Method (MPEEM)

Used for customer relationships and other intangibles with identifiable cash flows:

• Project incremental cash flows
• Discount using appropriate rate
• Contribute returns to other assets

Relief from Royalty Method

Used for brand names and patents:

• Determine royalty rate
• Project future royalties
• Discount to present value

With-and-Without Method

Compare value of business with and without the intangible.

Goodwill vs. Bargain Purchase

Goodwill (Positive PPA)

When purchase price exceeds fair value of net assets:

• Recognize as asset
• Test annually for impairment
• No amortization

Bargain Purchase (Negative Goodwill)

When purchase price is less than fair value of net assets:

• Recognize gain in profit or loss immediately
• Reassess identification of all assets/liabilities
• Common in distressed acquisitions

Dr Net Assets                    $6,500,000
    Cr Cash                      $5,000,000
    Cr Gain on Bargain Purchase  $1,500,000

Subsequent Measurement & Amortization

• Goodwill: Tested annually for impairment, no amortization
• Intangibles with finite lives: Amortized over useful life, tested for impairment
• Intangibles with indefinite lives: Tested annually for impairment, no amortization

Deferred Tax in PPA

Fair value adjustments create temporary differences:

• Recognize deferred tax liability on taxable temporary differences
• Recognize deferred tax asset on deductible temporary differences
• Tax rate depends on expected manner of recovery

Key Takeaways

• PPA must be completed at acquisition date
• Identify all identifiable assets and liabilities
• Measure at fair value using appropriate methods
• Goodwill = Consideration - FV of net identifiable assets
• Deferred tax on fair value adjustments is critical
• Subsequent testing for impairment is required