Disadvantages of Not Doing a Purchase Price Allocation

Subsequent to an acquisition, the purchase price is allocated to the assets and liabilities of a company in what is known as purchase price allocation. The primary objective of this exercise is to ensure financial statements are updated, especially with regard to an asset (tangible/intangible) in order to establish its accurate value. The process is required for complying with financial reporting standards (GAAP/IFRS) as per set guidelines and, if not done accurately, can create serious accounting issues for the company. It is essential to carry out the correct valuation of acquired assets and liabilities and allocate the residual value to intangible assets such as goodwill and intellectual property. 
Having an inaccurate purchase price allocation or not conducting it can create issues for the company in later stages. They are:
  • Inaccurate purchase price allocation analysis can lead to gross over/understatement of acquired intangibles, which could result in red flags during your annual audit.
  • The implied goodwill assessment (residual transaction value net of identified intangible) can be a complex process. Intangibles can be valued using a variety of approaches such as multi-period, excess-earnings method (MPEEM), relief-from-royalty (RFR) method or cost approach. If material assumptions are ignored/unsubstantiated by corroborative analysis, it could lead to future impairments and losses in the company’s financials.
  • Over or understated liabilities in books can create financial reporting issues later.
However, the most important reason to perform a purchase price allocation analysis is to have accurate, updated and detailed financial records. It is an essential financial reporting exercise under the guidelines set by IFRS/GAAP.
Without a proper purchase price allocation, your financial statements will remain incomplete. Valuation of intangibles will be ambiguous, and you would have not adhered to a critical rule set by financial reporting agencies (SEC, AICPA, FASB).  
Purchase price allocation has a significant effect on the balance sheet, income statement (depreciation and amortization) and finally profits, which impact taxes paid and returns to owners/ investors. The incorrect calculation could affect your future transactions, earnings, and prospects. Such errors will create a negative perception in the mind of stakeholders as well. 
Therefore, ignoring the process of purchase price allocation is not an option at all. Since it is a complicated procedure that requires knowledge of financial models and expertise, it is always recommended to get the process done by an experienced third-party advisor.

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