Purchase Price Allocation and Goodwill in M&A
After a deal closes, the target's balance sheet gets rebuilt: assets marked to fair value, new intangibles identified, and whatever's left over booked as goodwill. Here is the full process, worked through with numbers.
What is purchase price allocation, and how is goodwill calculated?
Purchase price allocation restates an acquired company's assets and liabilities at fair value, and books the leftover purchase price as goodwill. Goodwill equals the purchase price less the fair value of identifiable net assets acquired. Under US GAAP, goodwill at a public company is not amortized; it is tested for impairment at least annually and written down if the acquired business underperforms.
Key takeaways
- Goodwill = purchase price − fair value of identifiable net assets acquired.
- Identifiable assets are written up or down to fair value, which creates new future D&A that did not exist pre-deal.
- Newly identified intangibles (customer relationships, trademarks, technology) are recognized and amortized over their useful lives.
- Public-company goodwill under US GAAP is impairment-tested, not amortized on a schedule.
- A goodwill impairment signals that a past acquisition is now worth less than what was paid for it.
What is purchase price allocation?
- Purchase price allocation (PPA)
- The acquisition accounting process that assigns the price paid for a target across the fair value of its identifiable assets and liabilities, recording any unallocated remainder as goodwill.
Once an acquisition closes, the acquirer can't just add the target's old balance sheet onto its own. Accounting rules require the purchase price to be allocated across the fair value of everything acquired: identifiable assets and liabilities are marked to their current fair value, not the value they were carried at on the target's own books, and whatever's left over is recorded as goodwill.
“Purchase price” here is the equity value paid for the target (see the enterprise value guide for the bridge between enterprise and equity value), and “identifiable net assets” means everything that can actually be identified and separately valued, tangible assets, identifiable intangibles, minus liabilities assumed.
What are the steps in a purchase price allocation?
- Determine the purchase price actually paid for the target's equity.
- Write the target's identifiable assets and liabilities up (or down) to fair value; this most often affects PP&E and any intangible assets already on the books, and creates new future depreciation and amortization going forward that wasn't there before the deal.
- Recognize any newly identified intangible assets that weren't previously on the target's own balance sheet at all, things like customer relationships, trademarks, or acquired technology, each independently valued and then amortized over its useful life.
- Goodwill plugs whatever remains: purchase price minus the fair value of everything identified and valued in the steps above.
Is goodwill amortized, and what triggers an impairment?
Under US GAAP, goodwill at a public company is not amortized on a schedule the way most other intangible assets are. Instead, it's tested for impairment at least annually, and written down if the acquired business is later determined to be worth less than what was originally paid for it. A goodwill impairment is a signal, sometimes a very public one, that a past acquisition didn't work out as expected.
Worked example: an acquirer pays $800mm for a target whose identifiable net assets have a fair value of $550mm.
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Common purchase price allocation interview questions
What is goodwill, and how is it calculated?
Goodwill is the excess of the purchase price paid over the fair value of the identifiable net assets acquired in a deal. It represents everything the acquirer paid for that isn't attributable to a specific, separately identified and valued asset, brand strength, synergies, workforce, and similar unquantifiable value.
Why do assets often get written up to fair value in a purchase price allocation?
The target's own balance sheet reflects historical accounting values, which can be well below what those assets are actually worth today. Purchase accounting requires restating identifiable assets and liabilities at their fair value as of the acquisition date, which often means writing up items like property, equipment, and intangibles.
Is goodwill amortized?
Under US GAAP, goodwill at a public company is not amortized on a schedule; instead it's tested for impairment at least annually. Private companies have the option to elect a simplified alternative that does amortize goodwill over a set period.
What triggers a goodwill impairment?
An impairment is recorded when the fair value of the acquired business (or the reporting unit it sits within) falls below its carrying value on the balance sheet, meaning the business is now worth less than what the acquirer originally paid and booked for it.
Why does a stock deal often create a deferred tax liability?
In many stock acquisitions, the target's assets get written up to fair value for book (accounting) purposes as part of purchase price allocation, but the tax basis of those assets doesn't step up the same way, it generally stays at its pre-deal historical cost, unless the deal is structured with an election that treats it as an asset purchase for tax purposes. That book-tax basis gap means future book depreciation and amortization will exceed what's deductible for tax, so a deferred tax liability is recorded to reflect that mismatch.