Purchase price allocation and impairment testing in Australian corporate transactions

Purchase price allocation and impairment testing in Australian corporate transactions

When the post deal dust settles and the bankers and lawyers have left the room, it’s time for business integration and to record the transaction in the acquirer’s financial statements. The accounting for an acquisition may seem straightforward however there’s more to consider than merely consolidating the acquired and the acquirers balance sheets.

Financial reporting standards, specifically AASB 3 – Business Combinations, require the acquisition consideration to be allocated to the assets acquired and liabilities assumed, in a process referred to as purchase price allocation or PPA.

The premise behind a PPA is that the fair value of consideration is allocated to the fair value of acquired tangible and intangible assets and liabilities with any residual allocated to goodwill.

Why is a PPA needed?

Importantly, a PPA is a requirement under Australian accounting standards, however a comprehensive PPA also ensures the purchasers financial statements accurately reflect the acquired assets and liabilities, including any intangible assets such as brands, technology and customer relationships and goodwill – most of which are unlikely to be reflected in the targets stand-alone balance sheet. The values allocated to the intangible assets are the basis for future amortisation and impairment testing.

Today, impairment testing is a critical safeguard against overstated asset values and unexpected write-downs which can affect investor confidence and market performance.

Whilst it is a requirement for compliance a PPA has significant value beyond and the transparency the process affords is important for stakeholders such as investors, creditors and regulatory bodies who rely on financial statements to make informed decisions.

Key steps for effective PPA and impairment testing

To achieve accuracy and credibility in the PPA process, a structured approach is essential. Each step plays a critical role in ensuring compliance with accounting standards and delivering meaningful insights for stakeholders.

1. Confirm the transaction meets the definition of a business combination

The first step is to determine whether the transaction meets the definition of a business combination.

AASB 3: Business Combinations defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses.

AASB 10: Consolidated Financial Statements states that an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.

2. Identify the acquirer

For each business combination, one party needs to be identified as the acquirer.

3. Determine the acquisition date

The acquirer must identify the acquisition date being the date control is obtained.

4. Identify acquired assets and liabilities

The acquirer must recognise, separately from goodwill, the identifiable assets acquired and liabilities assumed as at the acquisition date. This includes both the tangible and intangible assets acquired.

The separately identifiable intangible assets must be identified and often include:

• Intellectual property such as patents, trademarks, and proprietary technology.
• Customer-related assets like contracts, customer lists, and relationships.
• Brand value and trade names, which can significantly influence market positioning.
• Non-compete agreements and other contractual rights.

This process requires a thorough review of the acquisition agreement, operational data, and legal documentation. It’s important to distinguish between assets that meet the recognition criteria under AASB 138: Intangible Assets and those that do not. For example, internally generated goodwill cannot be recognised separately, while identifiable intangible assets must be valued individually.

5. Select appropriate valuation methods

Once assets are identified, the next step is to apply the correct valuation methodology which is dependent on the nature of the asset and industry norms:

• Income approach: Common for customer relationships and technology. It estimates the present value of future economic benefits using discounted cash flow models.
• Market approach: Suitable for assets like trademarks or brands where comparable market transactions exist.
• Cost approach: Often used for software or internally developed technology, based on the cost to recreate or replace the asset.

Selecting the right method requires judgment and experience. For example, valuing a brand may involve analysing royalty rates in similar industries, while customer relationships requires churn analysis and revenue projections.

6. Determine useful life

The final step is to establish the useful life of each intangible asset for amortisation and impairment testing purposes which involves assessing:

• Legal or contractual terms (e.g., patent expiry dates or contract durations).
• Economic factors, such as expected market demand or technological obsolescence.
• Historical performance and industry trends, which can influence longevity.

Assets with indefinite useful lives, such as certain brands, are not amortised but must undergo annual impairment testing under AASB 136 Impairment of Assets. Goodwill also requires annual impairment testing, regardless of performance indicators.

Build trust through transparency

In an environment where intangible assets dominate corporate balance sheets, PPA and impairment testing are essential components of an acquisition strategy. For Australian businesses, these processes not only ensure compliance but also enhance transparency and investor trust. By approaching PPA and impairment testing with precision and expertise, businesses can transform complex valuation requirements into strategic advantages.

Frequently asked questions, answered by our corporate finance team at PKF Australia