Read the Reference Materials and click the “Questions” tab to answer the questions, a CPD proof will be generated and sent to your email upon completion of this case study. If you fail on your first attempt, don’t worry. You will see the answers and you may attempt again.
This case study is provided for free for non-commercial use and mainly for supporting continuing professional development in Mainland China, Hong Kong SAR and the Asia Pacific Region.

Please read the 2 articles below.

Reading 1: https://www.roedl.com/insights/ma-dialog/2021-02/ma-vocabulary-understanding-experts-purchase-price-allocation

Reading 2: https://www2.deloitte.com/nl/nl/pages/technologie-media-telecom/articles/purchase-price-allocation.html

In addition, there are some other topics that are relevant to a typical PPA.

Full Goodwill Method & Partial Goodwill Method

If there is a positive difference between the purchase consideration and the fair value of net identifiable assets, the difference should be recorded as goodwill.

Goodwill can be recognized by using full goodwill method or partial goodwill method, depending on which accounting standards the company is following. IFRS allows both methods while US GAAP allows only full goodwill method. The difference between the two methods is the treatment of the non-controlling interests. Partial goodwill method only recognizes the acquired portion, while full goodwill method recognizes the whole acquiree’s goodwill.

For example, the fair value of Company A’s net assets is $30, and we pay $40 to acquire 80% stake of Company A. The fair value of Company A would then be $40 / 80% = $50. The full goodwill recorded would hence be $50 – $30 = $20. The goodwill under partial goodwill could be computed by multiplying full goodwill by acquired stake, which is: $20 * 80% = $16.

Unless full stake of the company is acquired, the partial goodwill should always be lower than the full goodwill, leading to a higher ROE and ROA. The balance sheet could have significant difference between two methods, so this issue must be considered early before the transaction settled.

Some Common Valuation Methods Used in PPA

  • Relief from Royalty method: For valuation of trademarks, patents or technologies by estimation of royalty rate and royalty relief from owning such intangible asset. This method is one specific form of income approach.
  • Multi Period Excess Earnings method: For valuation of licenses, customer relationships using the residual method after considering charges from contributory assets. This method is one specific form of income approach.

Summary

In view of technological advancement, intangible assets become more dominant than tangible assets in the valuation of companies. A properly performed PPA would incur higher complexity in the future, especially for the valuation of various internally generated intangible assets. Several variations of income approach based methods could be used, such as relief from royalty method and multi period excess earnings method.

Transaction team must be familiar in different issues of PPA, otherwise biased valuation is likely to occur, and the fair value of the acquired company could be misrepresented.