How does purchase price allocation (PPA) work?

Answer

Mechanics

For every business combination (M&A), IFRS 3 requires the purchase price to be allocated across the target's identifiable assets and liabilities, each measured at fair value. Steps:

Calculate total consideration: cash + equity component + contingent consideration + assumed liabilities.
Measure net assets at fair value: PP&E to market, inventory at selling price less remaining costs to complete, customer relationships via DCF, technology via the relief-from-royalty method.
Goodwill = total consideration − net assets (FV) — the premium over the identifiable net assets.

Deep diveShow more details

Example — MidCap Software Inc acquires a software target

Inputs:

Total consideration: $200m
Book value of net assets: $80m
PPA step-ups to fair value:

```
Asset Step-up Useful life Amort p.a.
PP&E +$20m — —
Customer relationships +$30m 5y $6.0m
Technology +$15m 10y $1.5m
Order backlog +$5m 2y $2.5m
Total step-ups +$70m $10.0m
```

Calculation:
```
Net assets (FV): $80 + $70 = $150m
Goodwill: $200 − $150 = $50m
Additional D&A p.a.: = $10m
EBIT drag, later years: $10m p.a.
```

Practice

The PPA is prepared as of the closing date by Big Four valuation teams (KPMG, EY, PwC, Deloitte) and must be finalized within 12 months (the IFRS 3 measurement period).

Pitch tip

'PPA expectation in our pitch: 60% goodwill, 30% identifiable intangibles, 10% PP&E step-up — typical for middle-market machinery acquisitions'.

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