Purchase Price Allocation
Executive Summary
Key Takeaways
- ✓ Purchase price allocation splits the price paid for an acquired business between identifiable net assets at fair value and goodwill, the residual value the acquirer paid beyond those identifiable assets.
- ✓ Identifiable intangible assets separately recognized in the allocation — customer relationships, technology, brand — carry their own amortization schedule, distinct from goodwill.
- ✓ Goodwill is not amortized under IFRS or US GAAP but is instead tested periodically for impairment, which can result in a sudden write-down if the acquired business underperforms its acquisition-date expectations.
- ✓ The incremental depreciation and amortization arising from purchase price allocation reduces the combined entity's post-transaction net income, and must be reflected in a merger model's accretion/dilution calculation, not omitted as if the target's assets simply carried over at their pre-deal book value.
Definition¶
Purchase price allocation (PPA) is the process, required under acquisition accounting standards (IFRS 3 and ASC 805), of allocating the price paid for an acquired business between its identifiable net assets, recorded at fair value as of the acquisition date, and goodwill.
Goodwill = Purchase Price − Fair Value of Identifiable Net Assets Acquired
Identifiable net assets include both the target's existing tangible assets (revalued to fair value, which frequently differs from their book value on the target's pre-deal balance sheet) and any intangible assets separately identified and valued as part of the allocation exercise — customer relationships, proprietary technology, trademarks, and similar assets that meet the recognition criteria for separate identification.
Goodwill vs. Identifiable Intangible Assets¶
Goodwill is the residual figure — value the acquirer paid for that cannot be attributed to any specific identifiable asset, commonly attributed in substance to factors like the acquired workforce, expected synergies, and reputation. Under both IFRS and US GAAP, goodwill is not amortized on a scheduled basis; instead, it is tested at least annually for impairment and written down if the acquired business's value falls below its carrying amount, which can produce a large, sudden charge well after the original transaction closed.
Identifiable intangible assets separately recognized in the allocation are treated differently: they carry their own amortization schedule over an estimated useful life, and that amortization flows through the combined entity's income statement as an ongoing charge, distinct from goodwill's periodic-impairment treatment.
Why It Matters in a Merger Model¶
The incremental depreciation and amortization arising from purchase price allocation — from both revalued tangible assets and newly recognized intangible assets — reduces the combined entity's post-transaction net income relative to simply adding the acquirer's and target's pre-deal net income together. A merger model that omits this incremental D&A, effectively assuming the target's assets carry over unchanged at their pre-deal book value, overstates the combined entity's pro-forma earnings and therefore overstates the deal's apparent accretion to the acquirer's earnings per share.
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Frequently Asked Questions
What is purchase price allocation?
The process, required under acquisition accounting standards, of allocating the price paid for an acquired business between its identifiable net assets, revalued to fair value as of the acquisition date, and goodwill — the residual value representing what the acquirer paid beyond those identifiable assets.
What is goodwill in the context of purchase price allocation?
The residual amount by which the purchase price exceeds the fair value of the target's identifiable net assets acquired. It represents value the acquirer is paying for that cannot be attributed to a specific identifiable asset — reputation, assembled workforce, expected synergies, and similar unquantifiable factors are commonly cited as its economic substance.
Is goodwill amortized?
No, under both IFRS and US GAAP, goodwill arising from an acquisition is not amortized on a scheduled basis. Instead, it is tested at least annually for impairment, and written down if the acquired business's value is assessed to have fallen below its carrying amount — a treatment that can produce a sudden, large charge in a period well after the original transaction.
What happens to identifiable intangible assets recognized in a purchase price allocation?
Unlike goodwill, identifiable intangible assets separately recognized in the allocation — such as customer relationships, acquired technology, or brand value — do carry their own amortization schedule over their estimated useful life, and this amortization flows through the combined entity's income statement going forward.
Why does purchase price allocation matter for a merger model's accretion/dilution result?
Because the incremental depreciation and amortization arising from revalued tangible assets and newly recognized intangible assets reduces the combined entity's post-transaction net income. Omitting this incremental D&A and assuming the target's assets simply carry over at their pre-deal book value overstates the combined entity's pro-forma earnings and therefore overstates the deal's apparent accretion.
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Corporate Financial Modelling
Corporate financial modelling is the discipline of building financial models for operating companies — as distinct from a single asset, project, or development. Nearly every corporate model type is built on the same foundation, a fully integrated three-statement structure, and then specializes that foundation toward a specific purpose: a budget model constrains it to a fixed annual period, a driver-based model rebuilds it from operational units rather than percentage growth, a consolidation model extends it across multiple legal entities and currencies, a management reporting model extracts and re-presents its outputs as KPIs, and a transaction model (a merger model, an LBO) repurposes it to answer a specific capital-structure or ownership-change question. This page is the hub for the Knowledge Centre's corporate financial modelling content: the shared three-statement foundation, how each model type specializes it, and where each mechanic is covered in full technical depth elsewhere on this platform.
Merger Model and Accretion/Dilution Structure
A merger model tests whether a proposed acquisition increases or decreases the acquirer's earnings per share — the accretion/dilution result — by combining standalone projections for the acquirer and target with the mechanics specific to the transaction itself: purchase price allocation and the resulting goodwill, the financing structure (cash, new debt, or newly issued stock, in any combination), and any synergies expected from the combination. This guide covers the build sequence in full: standalone projections first, then purchase price allocation, then the financing structure and its effect on pro-forma shares and interest expense, then synergies traced to specific line items rather than a single aggregate assumption, and finally the accretion/dilution calculation itself, with the structural checks that catch the errors most specific to this model type.
Synergies
Synergies are the cost savings or revenue benefits a combined entity is expected to achieve that neither the acquirer nor the target could achieve standalone — eliminating a duplicated corporate function, negotiating better procurement terms at greater combined scale, or cross-selling one company's products through the other's customer base. In a merger model, synergies should be traced to specific, named drivers and phased in over a stated, realistic timeline rather than entered as a single aggregate addition to combined EBITDA, since an untraceable synergy figure is one of the most common ways a deal's headline accretion is overstated.
Accretion/Dilution
Accretion/dilution analysis compares an acquirer's pro-forma (post-transaction, combined) earnings per share against its standalone (pre-transaction) earnings per share to determine whether a proposed acquisition would increase (accretive) or decrease (dilutive) the acquirer's EPS. It is the headline output of a merger model, and depends on the combined entity's pro-forma net income (driven by both companies' standalone earnings, synergies, and incremental depreciation and interest from the deal itself) and the pro-forma diluted share count (driven by the financing mix).
Depreciation Schedule
A depreciation schedule in a financial model is a systematic calculation of the periodic reduction in the carrying value of a fixed asset over its useful economic life. The depreciation charge is expensed through the income statement each period, reducing EBITDA to operating profit (EBIT) and creating a non-cash charge that reduces taxable income. Two principal methods are used in financial models: straight-line depreciation (equal charge in each period) and reducing balance (declining charge in each period). The depreciation schedule feeds into three key statements: the income statement (depreciation charge), the balance sheet (net book value of assets), and the cash flow statement (depreciation added back as a non-cash item).
Enterprise Value (EV)
Enterprise value (EV) is the total value of a company's core operating business, independent of its capital structure — it represents what the business as a whole is worth to all capital providers combined, before distinguishing between debt and equity claims. Enterprise value is the direct output of discounting unlevered free cash flow (FCFF) at WACC. To move from enterprise value to the value attributable to equity holders specifically, net debt, minority interests, and other non-operating adjustments must be deducted — the enterprise-to-equity bridge.