Purchase Price Allocation Study: Intangible asset recognition to add value

Almost a third of business consideration is allocated to intangible assets and goodwill.

In brief

• Ind AS 103: Business Combinations influences how companies strategize and execute their acquisition plans.
• Purchase Price Allocation is significant for income-tax purposes; treatment of different intangibles and goodwill varies and requires measurement at fair value.

Ind AS 103 accounting impacts the way companies plan and execute their acquisition strategies. It requires identifying key intangibles and estimating their relative contribution to overall deal value in business combinations in India. While comprehensive valuation guidelines exist and specialists are involved, the subjective nature of assumptions and workings necessitates independent benchmarking with other acquirers’ financial reporting for acquisitions. This study provides additional reference points for various stakeholders and can act as a broad guide while evaluating the possible impact of mergers and acquisitions accounting on amortization expenses and overall impact of PPA on financial statements.

The application of Ind AS 103 necessitates that assets/liabilities (including intangible assets and contingent liabilities, which did not exist on the balance sheet of target entities/businesses) acquired in a transaction be measured at fair value, using appropriate intangible asset valuation methods. Any residual value thereafter gets allocated to goodwill or capital reserve. PPA not only affects the future earnings and balance sheet of a company but may also have tax implications. It also serves as an indicator of a deal’s strategic rationale and value drivers to shareholders. In the era of increased auditor and regulatory scrutiny, this matter warrants careful attention. Depending on the transaction structure, Purchase Price Allocation in India could also hold significance due to various tax implications of business combinations, as tax treatment for different intangibles and goodwill may differ.

EY has undertaken a study of business combination accounting for transactions that were disclosed in annual reports of the top 500+ listed companies in India by market capitalization and 120+ private companies (covering over 750 transactions) since implementation of Ind AS till 31 March 2024. This study presents the results of assets (primarily intangible assets) that are typically recognized and reported by a company during an acquisition. However, the results of this study should not be viewed in isolation, since each deal would have specific nuances.

Key findings of PPA Study

• The study found that 28% of enterprise value was allocated to identified intangible assets and 35% to goodwill, with allocation varying significantly across industries. Goodwill allocation in India followed a pattern similar to global transactions, such as those in the US.
• In sectors such as telecommunications, life sciences, retail consumer products, and technology (IT/ITES), a relatively higher proportion of enterprise value allocation in acquisitions is to the intangible assets. This is reflected by the underlying products, brands, intellectual property, license and rights and customer relationships, etc.
• Capital-intensive sectors, such as real estate and hospitality, energy and metals, allocate more than two-third of the target’s enterprise value to tangible assets.
• Marketing-related intangibles were the key acquisition driver in the consumer products, life sciences and retail sector. Customer-related intangibles seem to be the acquisition driver in the IT/ITeS sector.

The purchase price allocation study also revealed some interesting results as follows:

• Generally, a non-compete agreement is a part of most acquisitions as a safeguard to the buyer. However, allocation of value to non-compete agreement is on the lower side - possibly indicating either a shorter life or probability/ impact of competition is perceived to be minimal.
• Depending on the transaction structure, purchase price allocation in India (PPA) will also have relevance from an income-tax perspective, as tax treatment for different intangibles and goodwill would be different and have to be measured at fair value applying appropriate valuation methods and residual value allocated to goodwill/capital reserve.

The sector-wise allocation trends of purchase consideration among Goodwill, intangible assets and tangible assets are as follows: