The Importance of Assessing LSP Liability in PPA

When companies engage in mergers and acquisitions (M&A), accurate financial due diligence is essential for a seamless transaction. One critical yet often overlooked aspect in this process is the assessment of long service payment liability (LSP liability) when performing purchase price allocation (PPA). Understanding and properly accounting for this liability is crucial to accurately determine the fair value of acquired entities and ensure compliance with financial reporting standards.

What is Long Service Payment Liability?

In Asia including Hong Kong and Mainland China, employees are entitled to severance payments or long service payments (LSPs) upon termination of employment after a specified period of service, provided certain conditions are met. These liabilities, governed by labor laws, represent a significant deferred compensation obligation for employers.

LSP liabilities are typically tied to an employee’s years of service and salary, making them long-term obligations that can fluctuate due to factors such as wage inflation, employee turnover, and changes in legal requirements.

Why Include LSP Liability in Purchase Price Allocation?

PPA is a critical step in any M&A process. It involves allocating the purchase price paid for an acquisition among the identifiable assets and liabilities of the acquired company at their fair values. Here’s why LSP liability assessment plays a pivotal role in this process:

  • 1

    Accurate Financial Representation

    Neglecting LSP liabilities can lead to an overstatement of net assets or goodwill. By recognizing this liability, buyers can paint an accurate financial picture of the acquired company and avoid surprises in future financial statements.

  • 2

    Compliance with Accounting Standards

    Under standards such as Business Combinations or IFRS 3, companies must allocate the purchase price to all identifiable liabilities, including long service obligations. Failure to account for LSP liabilities could lead to non-compliance with these standards, risking financial restatements or audit issues.

  • 3

    Strategic Planning and Cost Forecasting

    Understanding the extent of LSP obligations allows acquirers to anticipate future cash outflows. This insight is crucial for post-acquisition integration planning, workforce restructuring, and ensuring the acquired entity’s financial stability.

  • 4

    Impact on Valuation and Negotiations

    Assessing LSP liabilities provides a more realistic valuation of the target company. Armed with this knowledge, buyers can negotiate better terms and avoid overpaying for the acquisition.

  • 5

    Risk Management

    Unrecognized LSP liabilities can become hidden risks. By identifying and measuring them during the PPA process, acquirers can mitigate potential financial and legal exposure.

How to Assess LSP Liability?

Evaluating LSP liabilities during PPA involves actuarial analysis, as the calculation depends on various factors such as employee demographics, historical turnover rates, and projected salary growth. Collaborating with experienced valuation professionals ensures these obligations are measured accurately and incorporated into the PPA.

Case Example: The Impact of Proper LSP Assessment

Consider an acquisition where the target company employs a large, long-serving workforce while the company may not be required to record LSP liabilities under IAS 19 (usually apply to private companies). A post-acquisition review revealed unaccounted LSP liabilities amounting to millions, drastically reducing the value of the net assets acquired. By contrast, acquirers who proactively assessed LSP liabilities during PPA avoided this pitfall, allowing for smoother financial integration and strategic planning.

Conclusion

In the competitive and fast-paced world of M&A, the devil is in the details. The assessment of long service payment liability is more than a compliance exercise—it is a strategic step in achieving an accurate valuation, managing risks, and setting the foundation for post-acquisition success. Companies undertaking acquisitions must prioritize this evaluation to enhance transparency and safeguard their financial interests.

For a comprehensive approach to LSP liability assessment and purchase price allocation, connect with Valtech team today!

About Valtech Valuation

Valtech Valuation is a professional valuation firm accredited with ISO-9001 in valuation advisory services. The firm is renowned for its expertise in advanced valuation techniques, customized valuation models, data-driven insights, and adherence to compliance and reporting standards. The firm has a solid track record in valuation advisory for listed companies, private equity, fund managers, and financial institutions. Valtech’s qualified team comprises members with PhDs, CPA (HKICPA), CFA, Chartered Valuation Surveyors of the Royal Institution of Chartered Surveyors, and valuers accredited with Business Valuation (ABV) by AICPA and CVA qualifications in Singapore. Valtech continues to expand into more markets by leveraging its valuation platform and recruiting local experts.

Valtech Valuation

Beyond Numbers, Beyond Borders

Connect with us today