What Is Purchase Price Allocation?
When one company buys another, US GAAP (ASC 805) requires the buyer to restate the target's balance sheet at fair value as of the closing date rather than carrying over old book values. PPA is that process: every acquired asset and assumed liability gets a fresh valuation, and the purchase price is spread across them. Whatever portion of the price cannot be pinned to an identifiable item becomes goodwill.
The identifiable intangibles are usually the most consequential step. Valuation specialists put numbers on customer relationships, developed technology, trade names, backlog, and non-compete agreements — assets the target never showed on its own balance sheet because it built them internally. These newly recognized intangibles are then amortized against earnings over useful lives that commonly range from 3 to 15 years.
How a PPA Is Built
Consider a buyer paying $1 billion for a target with $400 million of net tangible assets at fair value after write-ups. Specialists might attribute $250 million to identifiable intangibles, leaving $350 million of goodwill as the residual. If the deal is a stock purchase, the write-ups are book-only, so the buyer also records a deferred tax liability equal to the intangible write-up multiplied by the tax rate, which increases goodwill further.
Each allocation choice has earnings consequences. Amounts assigned to inventory step-ups flow through cost of goods sold within months, PP&E write-ups raise depreciation, and finite-lived intangibles create a steady amortization drag. Goodwill, by contrast, is never amortized under current US GAAP for public companies — it simply sits on the balance sheet until an impairment test says otherwise.
Why PPA Matters in Deals and Models
PPA is a core mechanic of every merger model. Incremental intangible amortization reduces the combined company's GAAP earnings, which is why many deals that are accretive on a cash EPS basis look dilutive on a GAAP basis. Bankers therefore present accretion and dilution both ways, and buyers often guide investors to earnings metrics that exclude deal amortization entirely.
The allocation also sets up future risk. A deal that overpays leaves a large goodwill balance vulnerable to impairment if performance disappoints — write-downs like AOL Time Warner's roughly $99 billion charge in 2002 remain cautionary tales. In interviews, expect questions on why goodwill is created, how asset write-ups generate deferred tax liabilities, and how intangible amortization flows through an accretion-dilution analysis.
