Purchase Price Allocation (PPA)

The buyer writes the acquired assets and liabilities up or down to fair value, identifies intangibles that the seller never had on its own balance sheet, and books the remainder of the price as goodwill. The common identifiable intangibles are customer relationships, brands and trade names, technology and patents, and order backlog. Each is given a useful life and amortised, except for indefinite-lived brands and goodwill itself, which are tested for impairment instead.

A worked case. A buyer pays £500m for a business with £120m of net identifiable assets at book value. Fair value work adds £40m to property, identifies £90m of customer relationships with a ten-year life and £30m of technology with a five-year life, and writes off £10m of the target’s existing capitalised costs. Net identifiable assets at fair value are 120 + 40 + 90 + 30 − 10 = £270m, so goodwill is 500 − 270 = £230m. Amortisation rises by 90/10 + 30/5 = £15m a year, which reduces reported operating profit by £15m before any synergy arrives.

That £15m is why accretion and dilution has to be tested on the right earnings measure. Cash EPS adds the intangible amortisation back and is the figure a buyer will quote; statutory EPS does not and is the figure a shareholder reads. Both are defensible and they can point in opposite directions in the first two years, so the answer in an interview names which one is being used.

Two mechanical consequences catch people. Writing inventory up to fair value means the step-up flows through cost of sales as that inventory is sold, usually within a couple of quarters, so gross margin is depressed once and then recovers. And a write-up of depreciable assets creates a deferred tax liability where the tax base has not been stepped up, which is itself part of the allocation and makes goodwill larger.

Whether the deal is a stock purchase or an asset purchase changes the tax position rather than the accounting one. In an asset deal the tax base is usually stepped up too, so the amortisation is deductible and the buyer gets a real cash benefit. In a stock deal it commonly is not, which is why the same price can be worth measurably more to a buyer in one structure than the other.