When one company buys another, the purchase price rarely matches the target's book value of net assets. Purchase price allocation (PPA) is the accounting exercise that explains the difference — and under IFRS 3 Business Combinations, getting it right shapes a company's balance sheet and future profit and loss for years after the deal closes.
What purchase price allocation actually does
PPA takes the total consideration paid for an acquisition and allocates it across the identifiable assets acquired and liabilities assumed, each restated to fair value at the acquisition date. Anything left over after that allocation is recognised as goodwill. In formula terms: Goodwill = Purchase consideration − Fair value of identifiable net assets acquired.
This isn't optional bookkeeping. IFRS 3 requires an acquirer to identify and separately value every acquired asset that meets the recognition criteria — including intangible assets the target never recognised on its own balance sheet, because internally generated intangibles (brands, customer relationships, proprietary technology) generally can't be capitalised under IAS 38 until they change hands in a business combination.
The identifiable assets that commonly surface in a PPA
- Customer relationships and contracts — often valued using a multi-period excess earnings method based on projected cash flows from the existing customer base.
- Brand and trademarks — typically valued with a relief-from-royalty approach, estimating the royalty a third party would pay to license the brand.
- Technology and IP — valued by cost, market or income approaches depending on how mature and transferable the asset is.
- Property, plant and equipment — restated to fair value even where the target's own carrying value was based on historical cost.
- Contingent liabilities — recognised at fair value if they meet IFRS 3's criteria, even when they wouldn't have met the recognition threshold under IAS 37 on a standalone basis.
Why goodwill is the residual, not the target
A common misconception is that goodwill is estimated first and the rest follows. It's the opposite: PPA values every identifiable asset and liability independently, and goodwill absorbs whatever value can't be attributed to a specific, separately identifiable item — synergies, assembled workforce, and other elements that don't meet IFRS 3's separate recognition criteria. A rigorous PPA that identifies more intangibles pushes more of the purchase price out of goodwill and into assets that, unlike goodwill, are usually amortised over a finite useful life.
Why this matters beyond the acquisition date
The allocation drives real P&L consequences long after the deal completes. Identifiable intangible assets with a finite life get amortised, creating a recurring non-cash charge; goodwill itself is not amortised under IFRS but is tested for impairment annually under IAS 36, which can produce a sudden, large write-down if the acquired business underperforms. Getting the PPA wrong — under-identifying intangibles and inflating goodwill — can mask the real economics of a deal from analysts and investors for years.
IFRS 3 gives acquirers a "measurement period" of up to twelve months from the acquisition date to finalise provisional PPA figures as new information about the acquisition-date facts comes to light, which is why many companies' first post-acquisition annual report includes a note describing the PPA as provisional.
A simplified example
Suppose an acquirer pays £50m for a target whose identifiable net assets, before any fair value adjustments, are carried at £20m. A PPA exercise identifies £8m of customer relationships and £4m of brand value not previously on the target's balance sheet, and revalues property upward by £3m. The identifiable net assets at fair value rise to £35m (£20m + £8m + £4m + £3m). Goodwill is then £50m − £35m = £15m, rather than the £30m that would have been recorded under a naive approach that skipped intangible identification. The £12m of newly recognised intangibles will now be amortised over their useful lives, spreading a P&L charge across future periods that would otherwise have sat inside an unamortised goodwill balance.
Frequently asked questions
Is purchase price allocation the same under IFRS and US GAAP?
The core mechanics are similar — both IFRS 3 and ASC 805 require identifiable assets and liabilities to be measured at fair value with any residual recognised as goodwill — but detailed recognition and measurement guidance differs in places, so a PPA prepared under one framework can't simply be relabelled for the other.
Who performs a PPA?
Larger or more complex acquisitions typically use independent valuation specialists, since intangible asset valuation requires specific methodologies (excess earnings, relief-from-royalty, cost approaches) that go beyond standard financial reporting skills.
Does PPA apply to asset purchases as well as share purchases?
IFRS 3 only applies where the transaction meets the definition of a business combination — broadly, the acquisition of a business rather than a standalone group of assets. A straightforward asset purchase is accounted for differently, without goodwill recognition.
PPA is a natural extension of the financial reporting knowledge tested throughout the ACCA Strategic Business Reporting syllabus and CIMA's strategic-level papers. For a deeper look at how acquisitions interact with consolidated accounts, see our guide to IAS 36 impairment of assets, and explore Learnsignal's course options if you're preparing for exams that cover business combinations.
This page was last updated:
Learnsignal Education Team
Expert Tutor at Learnsignal
Qualified professional with years of experience helping students advance their professional careers.
View all posts by Learnsignal Education Team
