Contrary to common belief, consideration paid less net tangible assets acquired does not necessarily equate to goodwill. Goodwill is only one of the many intangible assets that may have been acquired as part of a transaction. Australian accounting standards require buyers to allocate the consideration paid in a business acquisition to all assets acquired and liabilities assumed, including both tangible and intangible assets, for financial reporting purposes. The valuation of intangibles can be complex, and whilst the purchase price allocation (PPA) is necessary for accounting purposes, it can have material tax implications.
Understanding when and what intangible assets can be recognised
AASB 3 Business Combinations sets out criteria in determining what constitutes a separately identifiable intangible asset. Examples can include brand names, trademarks, patents, software and technology, customer contracts and arrangement. Key to identifying and assessing the ability to attribute value requires deep understanding of the core operations and key drivers of performance of the target business.
Applying technical valuation concepts correctly
Intangibles are generally valued based on the cash flows they generate on a standalone basis and determining these cash flows is often not straight forward. Technical valuation concepts such as contributory asset charges and tax amortisation benefits are more often than not applied incorrectly, which could mean that the subsequent valuation is materially over or understated.
Inadvertently including strategic value
The valuation of intangibles should be consistent with the concept of fair value for accounting purposes. This definition requires consideration of the concept of most likely hypothetical buyer and the income stream applicable to them. Generally, strategic value would only be considered to the extent that multiple hypothetical buyers could access strategic benefits.
Tax & accounting implications
We touched on the accounting implications and impacts on EPS in the previous Part 1 blog, however, tax considerations such as the ability for an acquirer to claim tax deductions on depreciation for certain intangible assets acquired (e.g. software and patents) and understanding tax effect accounting implications are also important considerations for any PPA exercise.
Navigating the PPA process
Management, auditors and tax advisors are all key stakeholders in the PPA process. Obtaining buy in early from each party as to the intangible assets recognised as part of the process, and working collaboratively is critical to ensure an efficient process and sound conclusion.