Balancing Perspectives During Deal Structuring
From a business standpoint, the primary focus in an M&A transaction is strategic alignment and value creation. In simpler terms, balancing profit maximization with risk minimization. However, accounting for an acquisition should never be overlooked as it is critical for the year-end financial reporting process.
Structuring any type of deal can be complex and requires a blend of legal, financial and operational expertise. Then there are the tax implications and the valuing of tangible as well as intangible assets.
Navigating the hurdles of heightened geopolitical and economic uncertainties, alongside increased financing expenses, may have dampened M&A acquisition activities in the market. But there is now renewed vigor and eagerness to get deals done.
With inflation easing and deal appetites rising, a modest increase in APAC M&A activity is anticipated in 2025 (see table below). Although not yet on a par with historical levels, analysts are also expecting deals to rally globally, particularly in North America and Europe. Having a robust risk strategy is critical and prudent executives are advised to adopt strong due diligence programs across all key risk areas.
Given that greater activity is now likely and with dealmakers narrowing their focus on core sectors and geographies, Ms. Grace Lui, Co-advisory Leader at CLA Global TS Advisory Pte., member firm of CLA Global in Singapore examines the importance of Purchase Price Allocation (PPA) in M&A transactions, and how this increased level of scrutiny can help dealmakers globally to better comprehend the value of assets they are buying. It can also help to make the entire process, including the persuasive synergies, growth prospects and competitive advantages, more transparent for all parties, notes Ms. Lui.
“When closing a transaction there are multiple operational logistics to navigate. It can often mean that accounting for the acquisition – the PPA - is an afterthought of the entire due diligence process. However, dealmakers should never underestimate the level of in-depth knowledge and experience required in the application of various fair value methodologies,” advises Ms. Lui.
The purpose of a PPA
After a deal is agreed, a Purchase Price Allocation (PPA) exercise is generally required to determine the fair value of the purchase consideration and net assets at the date of acquisition. Most geographies require this to comply with accounting regulations, for example IFRS 3, or the localized equivalent. For instance, in Singapore the PPA must be carried out in accordance with Singapore Financial Reporting Standard (International) SFRS(I) 3 – Business Combination. The International Accounting Standard (IAS) 28 also prescribes the application of PPA for investments in associates as well as investments in joint ventures.
The application of goodwill accounting is an important element. This is the difference between the purchase price and the net value of the assets, minus any liabilities. Due to the subjective nature of intangible assets, this can be more challenging to determine if there are limited market comparables. For this reason, it is advisable to seek out the expertise of professionals with extensive knowledge of fair value methodologies.
Follow the 5 step PPA process
The PPA is a necessary step in accounting regulations, to determine the fair market value of the company post-M&A transaction. Within the PPA process, there is an increased focus on areas such as purchase considerations and contingent considerations, as these areas directly impact the financial and operational outcomes of the acquisition.
To prepare a PPA, the following five steps should be considered:
Common pitfalls to look for
As many would expect, PPAs are typically more robust and contain fewer surprises when some of the valuation details are addressed prior to the transaction. To help bridge some of the potential differences, it can be good business practice when drafting the Share Purchase Agreement (SPA) to:
- Ascertain whether the acquisition constitutes a business or an acquisition of assets to ensure compliance with the correct accounting standards
Upon executing the letter of intent and completion of due diligence work, both seller and buyer should proceed to draft the SPA for acquiring the target business/entity or assets. The buyer may discuss with auditors and consider applying the simplified assessment process for the acquisition - the optional ‘concentration test’. This test can ascertain whether the transaction meets the business combination definition before undertaking the rigorous valuation process.
A concentration test is an assessment and a shorter way to determine if a newly acquired set of activities and assets constitutes a business or an acquisition of assets. The concentration test is considered met if a substantial portion of the fair value of the acquired assets is concentrated in a single identifiable asset, or a group of similar assets. If this is the case, no further evaluation is required. - Determine acquisition date
PPA accounting standards specify that the valuation should be performed on the date that control of the acquisition is obtained. This is typically the date the acquirer legally transfers the business consideration, assets and liabilities. However, the acquirer might obtain control on an earlier or later date. This must be stipulated in the SPA. - Purchase consideration needs to be fair valued
The fair value of purchase consideration is the total agreed value paid by an acquirer to an acquiree on the date control passes. It includes the fair value of all interests the acquirer may have held in the acquired business, as well as the fair value of any contingent consideration.
The common components of a purchase consideration include cash payments, equity instruments, stock options and most importantly, contingent considerations (earn-outs or milestone payments).
If a purchase consideration comprises listed company shares with inactive trading, this is valued by analyzing the income projections rather than relying on the stock price of the acquirer.
3.1 Contingent consideration/earnouts
Contingent consideration is often applied to bridge different perspectives. It usually takes the form of cash or shares and is based upon specified conditions or targets being met.
Usually reliant on achieving certain project milestone or financial goals after the sale, this type of purchase agreement can reduce the risk for buyers by avoiding payment for future performance or events if they do not materialize. Equally, it can be used to facilitate a more successful transition, as it can present an attractive financing strategy by allowing part of the acquisition to be underwritten by the target’s future profits.
These earnouts can be challenging to structure, value, and account for. One of the main complexities in estimating the fair value is assigning probabilities to different profit outcomes.
The fair value of the contingent consideration is accounted for at the time of the transaction. A contingent consideration can be structured for months or years and may include one milestone or many. The total consideration, including the present value of the earnout, is used to calculate goodwill.
Subsequent accounting measurement depends on the classification of the contingent consideration. If it is equity-classified, it does not need to be remeasured. If it is liability-classified, it should be remeasured at fair value at each reporting date.
3.2 Call/put options and forward contracts
Some SPAs may consider inserting call or put options or forward contracts to acquire the remaining interests of the entity from the non-controlling interests (NCI). This provides a buyer with more time to gain a better understanding of the financial effects of the acquisition.
The accounting treatment of the respective contracts to purchase additional shares is dependent on whether ownership benefits are transferred to the acquirer on the transactional date. If transferred this is considered part of the business combination included within the controlling interests. If it is not transferred to acquirer, it will be accounted for as a separate transaction and classified and measured in accordance with IAS 32 Financial Instruments: Presentation. - Goodwill impairment risks
Post-acquisition, the new owner (acquirer) is responsible for conducting an annual goodwill impairment test. This involves comparing the asset to its fair market value to see if the fair market value has declined below the reported value.
It requires a thorough analysis of the acquired performance of the business consideration, as well as future cashflow projections. If an impairment is identified, the acquirer must adjust the carrying amount of goodwill on the balance sheet. This depreciation (amortization) can have a significant impact on financial statements.
The maximum impairment loss cannot exceed the carrying amount. This means that the asset’s value cannot be reduced below zero or recorded as a negative number. - Cross border acquisitions
If acquiring a foreign operation, this must be accounted for in the functional currency of the foreign operation, not the currency stipulated in the SPA. As a result, currency volatility may affect the subsequent re-measurement of the currency. This may in turn affect financial statement operating results.
“Getting M&A transactions finalized in the current market given the longstanding macroeconomic volatility, challenging financial conditions, and increased regulatory scrutiny can be tough. However, PPAs shouldn’t just be regarded as post-transactional accounting compliance exercise. PPAs can help to identify commercial synergies, determine fair market value and can be a critical step in ensuring proper tax and reporting treatment of assets and liabilities,” ends Ms. Lui.
For further information
Ms. Grace Lui
Co-advisory leader, Director, Valuation, Transaction Services & Outsourcing
CLA Global TS
https://www.cla-ts.com/team/ms-grace-lui
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