Purchase price allocation is the process of assigning fair value to identifiable acquired assets and recognized liabilities when one entity acquires another entity in a business combination. It involves the acquisition of identifiable assets, recognition of liabilities, determination of goodwill or bargain purchase gain, and fair value measurement. Purchase price allocation is an essential step in business combinations, as it provides a basis for recognizing the acquired assets and liabilities and determining the fair value of the consideration paid.
Understanding Purchase Price Allocation
Purchase price allocation is a critical accounting procedure that involves allocating the total cost of an acquired asset to its individual components. This allocation helps businesses accurately account for the value of the acquired assets and depreciate them over their useful lives.
Components of Purchase Price
When acquiring an asset, the purchase price often includes several components:
- Tangible assets: Physical assets such as equipment, buildings, and inventory
- Intangible assets: Non-physical assets such as patents, trademarks, and goodwill
- Liabilities: Obligations assumed by the acquiring company as part of the acquisition
Purchase Price Allocation Process
The purchase price allocation process involves the following steps:
- Identify the Acquired Assets: Determine all the tangible and intangible assets included in the acquisition.
- Determine Fair Value: Estimate the fair value of each acquired asset. Fair value represents the current market value of the asset, typically determined through appraisal or market research.
- Allocate the Purchase Price: Assign the total purchase price among the acquired assets based on their respective fair values. This can be done using different allocation methods discussed below.
Allocation Methods
There are two primary methods for allocating the purchase price:
- Proportionate Fair Value Method: Allocates the purchase price to each asset in proportion to its fair value relative to the total fair value of all acquired assets.
- Specific Identification Method: Specifically identifies the assets that were acquired and assigns the purchase price based on their specific costs or fair values.
Table: Purchase Price Allocation Methods
| Method | Objective | Advantages | Disadvantages |
|---|---|---|---|
| Proportionate Fair Value | Apportion the purchase price based on relative fair values | Simple and straightforward | May not reflect actual cost of specific assets |
| Specific Identification | Identify and assign specific costs to each asset | Provides more precise allocation | Can be complex and time-consuming |
Example
Suppose Company A acquires Company B for a purchase price of $10 million. The fair values of the acquired assets are as follows:
- Inventory: $2 million
- Equipment: $3 million
- Patent: $2 million
- Goodwill: $3 million
Using the proportionate fair value method, the purchase price would be allocated as follows:
- Inventory: $10 million x (2 / 10) = $2 million
- Equipment: $10 million x (3 / 10) = $3 million
- Patent: $10 million x (2 / 10) = $2 million
- Goodwill: $10 million x (3 / 10) = $3 million
Question 1:
What is the concept of purchase price allocation?
Answer:
Purchase price allocation is the process of assigning the cost of an acquired business to the specific assets and liabilities acquired.
Question 2:
How is purchase price allocation determined?
Answer:
Purchase price allocation is determined by fair value of the individual assets and liabilities acquired, considering market prices or appraised values.
Question 3:
What is the purpose of purchase price allocation?
Answer:
Purchase price allocation enables accurate recording of the acquired assets and liabilities on the acquiring company’s financial statements, providing a clear representation of the acquired business’s financial position.
Well, there you have it, folks! Purchase price allocation may not be the most exciting topic, but it’s essential knowledge for anyone buying a business or investing in real estate. I hope this article has helped clear things up a bit. If you’re still curious, don’t hesitate to drop me a line or visit us again soon. We’re always happy to chat about accounting and finance topics. Thanks for reading!