Purchase Price Allocation (PPA)
PPA is the accounting exercise that answers 'what exactly did we buy?' by allocating the purchase price across the target's assets, liabilities, and goodwill.
Definition
Purchase price allocation (PPA) is the accounting process under ASC 805 that assigns the total acquisition purchase price to the fair values of the target's identifiable tangible assets, intangible assets, liabilities, and any remainder as goodwill. It determines how the deal appears on the acquirer's balance sheet post-close.
Purchase Price Allocation
How a $500M purchase price is allocated to assets
Goodwill Calculation
The residual that can't be allocated to identifiable assets
Purchase Price
Total consideration paid to acquire target
$500M
Fair Value of Net Assets
Tangible + identifiable intangible assets, net of liabilities
$350M
Tangible Assets
$200M
Identifiable Intangibles
$150M
Goodwill
$500M - $350M = $150M
$150M
Represents synergies, assembled workforce, and going-concern value that can't be separately identified. Tested annually for impairment — never amortized.
Balance Sheet Impact
How PPA changes the acquirer's balance sheet
Total assets stay the same ($1,400M) — $500M cash was used to acquire $200M of tangible assets, $150M of identifiable intangibles, and $150M of goodwill.
How PPA Works
Step 1: Determine total purchase consideration (cash + stock + assumed liabilities). Step 2: Identify and fair-value all tangible assets (PP&E, inventory) and intangible assets (customer relationships, technology, brand, non-competes). Step 3: Fair-value all assumed liabilities. Step 4: The excess of purchase price over net identifiable assets = goodwill. Third-party valuation firms typically perform the fair value analysis.
Intangible Assets and Amortization
PPA often creates significant intangible assets (20–40% of purchase price for tech/healthcare companies) that must be amortized over their useful lives (typically 5–15 years). This amortization flows through the income statement, reducing reported earnings. It is a non-cash charge and is typically added back for adjusted earnings. Goodwill is not amortized but is tested annually for impairment.
Impact on the Merger Model
PPA directly affects pro forma earnings in the merger model through new amortization of intangible write-ups and potential step-ups in asset values. Higher intangible write-ups = more amortization = lower reported pro forma earnings = more dilution on a GAAP basis. However, since this amortization is non-cash, most bankers look at accretion/dilution on a cash EPS basis, which adds back the PPA amortization.
Worked Example — With Real Numbers
Acquirer pays $1B ([enterprise value](https://www.ibflash.com/concepts/enterprise-value)) for Target Co. Fair value of tangible assets = $300M, intangible assets (customer relationships $200M, technology $100M) = $300M, liabilities = $150M. Net identifiable assets = $300M + $300M - $150M = $450M. Goodwill = $1B - $450M = $550M. The $300M of intangibles amortize over 10 years, adding $30M/year in non-cash amortization expense.
Key Takeaways
Goodwill = purchase price minus the fair value of net identifiable assets
Intangible asset write-ups create amortization that reduces reported pro forma earnings
Goodwill is not amortized — it is tested for impairment annually
PPA amortization is non-cash, so analysts often look at cash EPS excluding it
Common Mistakes in Interviews
Confusing goodwill with intangible assets — goodwill is the residual, intangibles are specifically identified
Forgetting that PPA amortization affects GAAP accretion/dilution analysis
Not realizing that inventory step-ups create a one-time COGS hit when the marked-up inventory is sold
How Interviewers Test This
If asked 'what happens to goodwill in an acquisition?', explain that goodwill equals the premium over fair value of net assets, it sits on the balance sheet indefinitely, and it's tested for impairment annually — not amortized. Review with the IB Quiz.
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