1. Introduction
In the process of mergers and acquisitions, one crucial aspect is the determination of the purchase price or the consideration. The consideration can be in the form of cash, stock, or a combination of both. In cases where the consideration includes stock, it is essential to have a clear understanding of how the purchase price will be allocated among the shareholders of the acquired company. This process is known as the allocation of purchase price or the fair value allocation.
2. What is Fair Value Allocation?
Fair value allocation is the process of allocating the purchase price of an acquisition among the assets and liabilities of the acquired company. It involves determining the fair value of each asset and liability and then allocating the purchase price based on these values. The fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
3. How is Fair Value Allocation Done?
The fair value allocation process involves several steps, including identifying the assets and liabilities of the acquired company, determining their fair values, and allocating the purchase price based on these values. The allocation is usually done using a valuation model, such as the income approach, market approach, or cost approach.
4. Importance of Fair Value Allocation
Fair value allocation is essential because it determines how the purchase price will be allocated among the shareholders of the acquired company. If the allocation is not done correctly, it can result in incorrect financial reporting, which can lead to legal and regulatory issues. Additionally, it can also affect the tax implications of the acquisition for both the acquirer and the acquired company.
5. Conclusion
In conclusion, fair value allocation is a critical aspect of mergers and acquisitions involving stock as part of the consideration. It ensures that the purchase price is allocated correctly among the assets and liabilities of the acquired company, resulting in accurate financial reporting and proper tax implications. Therefore, it is essential to have a clear understanding of fair value allocation and to ensure that it is done correctly.