Question

1. Identify and explain the reasons why total purchase price paid in acquiring a subsidiary company is rarely equal to its total net assets/equity as reported in its audited financial statements.

You may include the following in your discussion:

• Financial statement line items of assets/liabilities that would/would not usually give rise to the difference and the reasons thereon.

• Any other reasons.

Answer 1

Solution:

In acquisition accounting, purchase price allocation is a practice in which an acquirer allocates the purchase price into the assets and liabilities of the target company acquired in the transaction. Purchase price allocation is an important step in accounting reporting after the completion of a merger or acquisition. The currently accepted accounting standards, such as the International Financial Reporting Standards (IFRS), require employing the purchase price allocation method for any type of business combination deal, including both mergers and acquisitions. Note that past accounting standards required purchase price allocation only in acquisition deals.

Components of Purchase Price Allocation

Purchase price allocation primarily consists of the following components:

1. Net identifiable assets : Net identifiable assets refers to the total value of assets of an acquired company, less the total amount of its liabilities. Note that the “identifiable assets” are those with a certain value at a given point in time, and whose benefits can be recognized and reasonably quantified. Essentially, the net identifiable assets represent the book value of assets on the balance sheet of the acquired company. It is important to understand that identifiable assets may include both tangible and intangible assets.

2. Write-up : A write-up is an adjusting increase to the book value of an asset that is made if the asset’s carrying value is less than its fair market value. The write-up amount is determined when an independent business valuation specialist completes the assessment of the fair market value of assets of a target company.

3. Goodwill : Essentially, goodwill is the amount paid in excess of the target company’s net value of its assets minus its liabilities. Goodwill is calculated as a difference between the purchase price and the total value of assets and liabilities of an acquired company.

From an acquirer’s perspective, goodwill is critical in its accounting reporting because both US GAAP and IFRS require a company to re-evaluate all recorded goodwill at least once a year and record impairment adjustments if necessary. Goodwill is not depreciated but is sometimes amortized over time.

4.Note that acquisition-related costs – including, but not limited to, various legal, advisory, or consulting fees – are not considered in purchase price allocation. According to accounting standards, an acquirer must expense the costs whenever they have been charged while the corresponding services have been provided.

So it is quite clear from the discussion as above that there is many uncertian, estimation, valaution etc are taken into consideration while the  aquirer  pay off for aquiring a subsidiary company which may leads to difference in purhase price and net assets physically aquired.