Purchase Price Allocation: Why It Matters After an Acquisition

When a company acquires another business, the deal is usually agreed as a single price. The accounting does not stop there. Under MFRS 3, Business Combinations, the buyer must allocate that price to the individual assets acquired and liabilities assumed, measured at their fair values at the acquisition date. Whatever cannot be allocated becomes goodwill.

This exercise is known as purchase price allocation (PPA). It is often treated as a year-end technicality, but it shapes the acquirer’s balance sheet for years and affects reported profit from the first year after the deal.

When is a PPA required?

A PPA is required whenever an entity obtains control of a business, whether by buying shares in a company or by acquiring a business directly. The first question is therefore whether the acquisition is a business combination at all.

MFRS 3 defines a business as an integrated set of activities and assets that includes, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. If what is acquired does not meet this definition, for example a single property or a group of similar assets, the transaction is an asset acquisition. The cost is then allocated to the assets based on their relative fair values, and no goodwill arises.

How the allocation works

In simplified terms, goodwill is calculated as:

• the consideration transferred, including the fair value of any contingent consideration;
• plus the amount of any non-controlling interest in the acquiree;
• plus the fair value of any interest the acquirer held before obtaining control;
• less the fair value of the identifiable assets acquired and liabilities assumed.

The key word is identifiable. Goodwill is not measured directly. It is the residual left after everything that can be separately identified has been recognised at fair value. The more thoroughly the acquired assets are identified, the smaller and better supported the goodwill figure becomes.

The assets that are easy to miss: intangibles

Many of the most valuable assets in an acquisition never appear in the target’s own financial statements, because they were built internally rather than purchased. In a business combination, an intangible asset is recognised separately from goodwill if it is separable or arises from contractual or other legal rights.

Common examples include:

• Customer relationships and contracts: recurring customers, long-term supply contracts and order backlogs.
• Brands and trade names: registered trademarks and well-known product or company names.
• Technology: software, patents, formulas and proprietary processes.
• Licences and permits: operating licences, franchise rights and concessions.
• Non-compete agreements: commitments by the sellers not to compete with the business.

These assets are typically valued using income-based methods, such as the multi-period excess earnings method for customer relationships or the relief-from-royalty method for brands and technology, in line with the fair value principles of MFRS 13, Fair Value Measurement. By contrast, an assembled workforce is not recognised as a separate intangible asset. Its value forms part of goodwill.

Tangible assets need attention too. Property, plant and equipment, inventories and receivables are remeasured to fair value, which can differ significantly from their carrying amounts in the target’s books. Contingent liabilities that are present obligations are recognised if their fair value can be measured reliably, even when an outflow is not probable.

Why the PPA matters

1. It changes future profit

Under MFRS, goodwill is not amortised. Intangible assets with finite useful lives, however, are amortised, and fair value increases in property, plant and equipment lead to higher depreciation. An inventory fair value uplift is expensed through cost of sales as the inventory is sold, which reduces gross margin in the first months after the acquisition.

The allocation therefore decides how much of the purchase price will be charged against profit in future years, and how much will sit in goodwill.

2. It sets up future impairment tests

Under MFRS 136, Impairment of Assets, goodwill must be allocated to cash-generating units and tested for impairment at least annually. An impairment loss on goodwill cannot be reversed. If goodwill is overstated because intangible assets were not identified, or if the deal assumptions were optimistic, the risk of a future write-down increases.

3. It creates deferred tax

Fair value adjustments usually do not change the tax base of the acquired assets, particularly when shares are acquired. The resulting temporary differences give rise to deferred tax liabilities under MFRS 112, Income Taxes, which in turn increase goodwill. This step is frequently overlooked in deal models.

4. It affects ratios, covenants and earn-outs

Higher amortisation and depreciation reduce reported earnings, which can affect loan covenants, earnings-based bonuses and earn-out calculations. Contingent consideration itself must be measured at fair value at the acquisition date. Later changes in the fair value of contingent consideration classified as a liability, other than measurement period adjustments, are generally recognised in profit or loss.

5. It will be scrutinised

PPAs are an area of audit focus because they rely on significant judgement and forecasts. For groups preparing for a listing, past acquisitions and their accounting will also be reviewed as part of the reporting accountants’ work.

A simplified example

A company acquires 100% of a target for RM50 million. The target’s net assets in its own books are RM20 million. The PPA identifies the following fair value adjustments:

• Property, plant and equipment: increase of RM3 million.
• Customer relationships: RM8 million, with an estimated useful life of 8 years.
• Brand: RM4 million, with an estimated useful life of 10 years.
• Deferred tax liability on the RM15 million of adjustments at 24%: RM3.6 million.

Net identifiable assets at fair value are therefore RM31.4 million (RM20 million plus RM15 million less RM3.6 million), and goodwill is RM18.6 million. Without the PPA, goodwill would have been presented as RM30 million.

From the following year, the customer relationships and brand alone create amortisation of RM1.4 million a year before tax, in addition to higher depreciation on the property, plant and equipment. Goodwill of RM18.6 million is tested for impairment every year.

The figures are illustrative. Actual values depend on the business, the valuation methods used and the assumptions applied.

Timing: the 12-month measurement period

If the PPA is not complete by the end of the reporting period in which the acquisition occurs, the acquirer reports provisional amounts. MFRS 3 allows a measurement period of up to 12 months from the acquisition date to finalise them, based on information about facts and circumstances that existed at that date. Adjustments made during this period are recognised retrospectively, as if they had been made at the acquisition date.

The measurement period is not a reason to delay. Information is easiest to obtain while the deal team, the sellers and the due diligence findings are still close at hand.

Other points to keep in mind

• Acquisition-related costs: legal, due diligence and advisory fees are expensed when incurred, not added to goodwill.
• Non-controlling interests: for each acquisition, the acquirer may measure the non-controlling interest either at fair value or at its proportionate share of the identifiable net assets. The choice affects the amount of goodwill recognised.
• Bargain purchases: if the identifiable net assets exceed the consideration, the acquirer must first reassess the identification and measurement of all items. Any remaining excess is recognised as a gain in profit or loss.
• Companies reporting under MPERS: a PPA is also required under Section 19, Business Combinations and Goodwill. The key difference is that goodwill is amortised under MPERS rather than tested only for impairment. MPERS (2025), which applies from 1 January 2027, also requires acquisition-related costs to be expensed and contingent consideration to be measured at fair value.

Common pitfalls

• Recognising the whole excess of price over book value as goodwill, without identifying intangible assets.
• Using assumptions in the PPA that do not match those in the deal model or the valuation used to agree the price.
• Forgetting deferred tax on fair value adjustments.
• Overlooking the inventory uplift and its effect on early post-acquisition margins.
• Involving valuers only at year-end, when key people and information are harder to reach.
• Keeping insufficient documentation of methods, assumptions and useful lives for audit review.

Conclusion

A purchase price allocation turns a single deal price into the balance sheet the acquirer will live with for years. It determines how much of the price becomes amortisation and depreciation, how much sits in goodwill subject to annual impairment testing, and how much deferred tax is recognised.

The best results come from starting early, ideally during due diligence, and aligning the PPA with the assumptions used to price the deal. At WS Group, our valuation team supports acquirers with purchase price allocations, fair value measurements and goodwill impairment testing.