If your company completed an acquisition in 2019, it’s time to look at how the transaction will affect year-end financial reporting. Acquisitions that meet the definition of a change in control business combination will come with certain accounting requirements of which you should be aware.
Accounting guidance (the so-called measurement principle requirements) in Accounting Standards Codification Topic 805, Business Combinations require an acquiring company with a change in control business combination to complete a purchase price allocation by the end of a measurement period, not to exceed one year from the date of the acquisition.
As discussed in our previous article, The Important Role Purchase Price Allocation Plays in M&A, the work involved in a purchase price allocation-related valuation may put some additional strain on your company’s internal financial department. Valuation providers can alleviate that burden by performing the valuation related to the purchase price allocation. (For that matter, accounting providers may also be able to help by generating the proper accounting entries.)
Financial executives and their management teams can maximize the benefit of bringing on additional resources to perform the purchase price allocation by being proactive in collecting the information needed to scope and prepare the analysis. The following provides a closer look at what you can do to make their purchase price allocation easier.
What You Need to Get Started
The valuation provider may assist your efforts to meet the recognition and measurement principles in ASC Topic 805. First, a valuation provider will need to understand the mechanics of the transaction and the operations of the acquired entity. This understanding is accomplished through an information request.
Third-party provider information requests will generally ask the acquiring company to produce transaction documents including the purchase agreement and disclosure schedules, Confidential Information Memorandum (CIM), and Quality of Earnings (QOE) statements.
Information requests will also include the acquired company’s historical and projected financial information, and any detail about the acquired assets. This may include a detailed schedule of personal property, inventory, and leases (or the locations of owned real estate).
If your company is privately held, you should also decide at this point in the process if your company will take any accounting elections that would affect the scope of the purchase price allocation. It is important to note that while making certain accounting elections may appear to simplify the purchase price allocation process, there are certain circumstances that would make the valuation of assets that are typically eliminated under these accounting elections (mainly customer relationships) necessary. Financial executives and management teams should consult with their financial statement preparation team, accounting advisory consultants, and audit team at the onset of the engagement to understand how making accounting elections will affect the purchase price allocation-related valuation scope.
Evaluating Your Information
Once you have the requested information compiled, have your internal team review it. You will need to have a preliminary sense of what assets and liabilities may require valuation. Valuation providers may ask the magnitude of certain assets, like fixed assets and inventory, relative to the total assets on the balance sheet. Valuation providers will also ask which assets were the primary drivers of the acquisition. For instance, was the acquiring company seeking to acquire a brand, a proprietary technology, or to broaden its customer base?
Auditors, valuation specialists and other accounting advisory folks fully expect the process of meeting the recognition requirements will be a joint effort to some extent. The valuation professional can provide some insight, but will primarily focused on supporting measurement requirements.
How Detailed is the Information You Have Compiled?
You may also consider the amount of the valuation work involved in order to have a sense of whether the scope proposed by the valuation provider appears reasonable. Does the acquired company have multiple product or service lines that could require the valuation provider to value more than one category of inventory, customers or technology? Is there contingent consideration or other components of the purchase price that could require fair value analysis? Each additional layer of complication will result in additional time and expense required to meet the purchase price allocation-related valuation objectives.
Keep in mind that there may be additional information requested as the engagement gets underway; the initial request from the provider is just meant to be a jumping off point.
What to Expect from the Purchase Price Allocation Process
Congratulations, you have the materials gathered and selected your valuation provider. Nevertheless, the process of gathering, providing, interpreting and assuming information around the transaction will continue throughout the process. You and your management team will likely need to remain an active participant throughout the purchase price allocation process. Your provider will likely need additional information and may have follow-up questions throughout the process. Because of this, most valuation providers will follow an engagement timeline that is centered on milestones rather than concrete timelines or fixed dates. These milestones upon the commencement of the engagement generally include:
- Submission of the Information Request
- Information transfer
- Follow-up questions for CFO/Controller
- Preliminary discussion of initial findings (i.e., reasonableness check)
- Draft exhibits sent to CFO/Controller
- Full draft report and exhibits sent to CFO/Controller
- Completion of the Audit Review Process
- Management representation letter sent to valuation provider
- Final report sent to CFO/Controller
The time to achieve these milestones is dependent upon the level of stakeholder participation, availability of information and resources and the level of transaction complexity.
The Key to Purchase Price Allocation Success
You and your management team’s proactive understanding and organization of documents related to your transaction will help the valuation provider provide an accurate scope at the onset of the engagement. That forethought can help limit requests for additional information and follow-up discussions. Good planning, document retention and thorough communication allows for a smoother valuation process and hopefully a bigger bang for your buck when engaging a third party provider.
For more information about purchase price allocations, please contact the author, Bianca Cuniglio at firstname.lastname@example.org.