PURCHASE PRICE ALLOCATION (PPA) IN M&A TRANSACTIONS: ACCOUNTING REQUIREMENTS AND VALUATION PERSPECTIVES

Key contents in purchase price allocation

PPA is a requirement under IFRS 3 in M&A transactions

Under IFRS 3 Business Combinations, when a company obtains control over another business through a transaction identified as a business combination, the acquirer must allocate the purchase price to all assets and liabilities of the target company. This allocation must be performed as of the acquisition date and based on the fair value of each asset and liability.

The basic principle of PPA is to identify the fair value of all identifiable assets and liabilities acquired in the transaction. After determining the fair value of these assets and liabilities, the difference between the purchase price and the fair value of net assets is recognized as goodwill.

Requirements related to fair value, identifiable intangible assets, and goodwill

One of the key elements of PPA is determining the fair value of assets, especially identifiable intangible assets. Under IFRS 13 Fair Value Measurement, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

In the PPA process, a company does not only remeasure tangible assets such as real estate, machinery and equipment, or inventory, but also needs to identify and recognize intangible assets if they can be separately identified.

Under Vietnamese Valuation Standards, an intangible asset is considered identifiable if there is tangible evidence of its existence, it is capable of generating income, and its value can be quantified in monetary terms.

In practice, many intangible assets are commonly identified during PPA, such as brands, customer relationships, technology, software, or business operating rights. These assets may not have previously been recognized in the target company’s financial statements but may still generate future economic benefits. After identifiable intangible assets are recognized, the remaining value of the transaction is recognized as goodwill.

Key considerations in determining the fair value of intangible assets

Determining the fair value of intangible assets is often the most complex part of the PPA process. Unlike tangible assets that may be supported by market transactions, many intangible assets do not have a direct trading market. Therefore, valuation often relies on financial methods and economic models.

In valuation practice, the most commonly used approach is the Income Approach, where the value of an asset is determined based on the economic cash flows that the asset can generate in the future. For example, the Relief-from-Royalty method is often used to value brands.

Under this method, the value of a brand is determined based on the assumption that, if the company did not own the brand, it would have to pay royalties to use it. The brand value is then calculated as the present value of the hypothetical royalty payments that the company avoids by owning the brand.

Another method commonly used in PPA is the Multi-period Excess Earnings Method (MPEEM), which is often applied to assets such as customer relationships or customer contracts. This method determines the value of an asset based on the excess cash flows generated by that asset after deducting capital charges for other assets involved in generating revenue.

In addition to the Income Approach, the Market Approach may be applied in certain cases if comparable market transactions exist, while the Cost Approach may be applied to reproducible assets such as software or internal technology. However, selecting the appropriate valuation approach should depend on the economic nature of the asset, the availability of market data, and the purpose of the valuation.

Assumptions and financial projections at the acquisition date

A key point in valuing intangible assets for PPA is that the assumptions and financial projections used in the valuation model must reflect expectations as of the acquisition date. Under IFRS 13 Fair Value Measurement, fair value must reflect the assumptions that market participants would use at the measurement date.

This means that financial projections used in the valuation model must be based on information available as of the acquisition date, rather than information or business results that arise after that date.

In addition, these projections should reflect an unbiased and market-based view. Strategic plans or buyer-specific economic benefits, such as restructuring benefits, use of the acquirer’s distribution system, or post-transaction synergies, are generally not included in the financial projections used to value identifiable intangible assets. These benefits are typically reflected in goodwill rather than in the value of identifiable assets.

In practice, financial projections prepared by the management of the acquired company or the seller during the transaction preparation process are often used as an important reference for PPA purposes, as they reflect the expectations of the parties at the time of negotiation. However, valuation professionals still need to assess the reasonableness of these assumptions and ensure that the projections used are consistent with market participant assumptions and are not biased.

Practical application of PPA

In Vietnam, the application of PPA is still relatively new for many companies, especially those that have not yet adopted international accounting standards. Common challenges include limited market data for valuing intangible assets, difficulties in building asset-specific cash flow models, and differences between Vietnamese accounting standards and international standards.

However, for foreign-invested companies or companies belonging to multinational groups, PPA is often a mandatory requirement in the preparation of consolidated financial statements.

The role of valuation in PPA