Corporate finance IFRS Valuations Purchase Price Allocation
Purchase Price Allocation
Under IFRS 3 (Business Combinations) (listed) companies have to attribute the purchase price of acquisitions in the consolidated financial statements to all identifiable assets and liabilities. This is also called a purchase price allocation. Identifiable means that the assets and liabilities are not necessarily on the balance sheet of the acquired company. These usually consist of brand names, intellectual property, contracts, customer lists, etc.
All identifiable assets and liabilities should be valued at fair value. For a building that is not so difficult, there is usually a known market value. For less current assets such as machinery it is more difficult. Replacement value would be one approach. Even more difficult is the valuation of intangible assets (brands, intellectual property, contracts, etc). The preferred methods of valuation based on reference is to look at a liquid market where such assets are traded. These markets are usually not available. The fair value should then be approached based on a DCF valuation. The complexity lies in the allocation of financial flows to individual assets. Liabilities must also be valued at fair value. Think of pensions and loans. For loans, the nominal value should not be used but the market value which may differ from the nominal value when the loan conditions differ from the conditions at the time the loan was provided.
After all assets and liabilities are identified and measured at fair value, the purchase price of the acquired company has to be allocated to these assets and liabilities. If part of the purchase price can not be attributed to these assets and liabilities it is goodwill. Goodwill is therefore nothing other than the portion of the purchase price that cannot be attributed to identifiable assets or liabilities. This final item on the consolidated balance sheet should be capitalized. Then there should not be amortized under IFRS. The reason is that the economic life of goodwill is not reliable to determine.