Purchase price allocation
M&A / Merger ModelThe exercise of spreading the price paid for a business across its identifiable assets and liabilities at fair value, with the remainder becoming goodwill.
Also written: PPA
When one company buys another, the price is not simply added to the balance sheet. Each identifiable asset and liability acquired is written to fair value, including intangibles the target never recognised because it built them rather than bought them: brands, customer relationships, developed technology.
Whatever is left after that allocation is goodwill. Goodwill is therefore a residual, not a valuation of anything in particular, which is why it is tested for impairment rather than amortised.
The allocation drives real post deal earnings. Writing intangibles up creates amortisation that depresses reported profit for years without any change in cash. Writing inventory up to fair value depresses gross margin as that inventory is sold. Both effects are why acquirers guide to figures excluding purchase accounting effects.
It also creates deferred tax. Book values rise but tax bases usually do not, so the difference generates a deferred tax liability at completion that is purely an artefact of the transaction.
The price paid is 1,200, against 300 of net assets on the target's own balance sheet. The difference is not simply goodwill.