Allocation of Purchase Price (Goodwill Impairment Tests)
When acquiring a company it is important to determine the allocation of the purchase price for tax purposes. For larger corporations, this goodwill must be valued annually for impairment, according to the Financial Accounting Standards Board (FASB), in order to maintain appropriate financial reporting. A valuation is often necessary to appropriately allocate the purchase price primarily between fixed assets and goodwill.
Hypothetical scenarios that require an expert in business valuation:
A business owner seeking to diversify his operations acquires a smaller business in a related industry. The buyer wants the purchase price mostly allocated to fixed assets so he can write them off quickly. The seller of the business wants the purchase price mostly allocated to goodwill, which is taxed at a lower rate. To determine a fair purchase price allocation, it may be necessary to obtain an independent business appraiser.
A large company has three different divisions, two of which were developed from businesses acquired in the past few years. The company is starting to prepare its annual financial reports and needs to determine if it has suffered goodwill impairment from its acquisition of the two businesses. In order to determine if goodwill has been impaired, the company needs an independent business appraiser to determine the fair market value of the two businesses it acquired.
Special considerations for purchase price allocation valuations (goodwill impairment):
When conducting a valuation to determine a fair allocation of the purchase price for a business, the fair market value of the underlying assets of the business is what is being valued, not the fair market value of the business itself. This is because the fair market value of the business is already known, it is the purchase price. To value the underlying assets it may be necessary to obtain an asset appraiser for the fixed assets of the business and a business appraiser for the remaining underlying assets, including intangible assets other than goodwill.
For larger corporations that have acquired a business, a goodwill impairment test must be completed on an annual basis. This test determines if the goodwill obtained through the acquisition of another business is worth less now than it is stated on the company’s books. In order to perform such a test, for non-publicly traded companies, an independent business appraiser would be needed to determine the fair market value of the business that was acquired.
For allocation of purchase price and goodwill impairment valuations it is important for the business appraiser to be knowledgeable of Financial Accounting Standard (FAS) No: 141, Business Combinations and FAS No: 142, Goodwill and other Intangible Assets. These accounting standards provide a framework for the valuation methodology and analysis that should be used in a valuation for the allocation of purchase price and goodwill impairment.
