Prospectively planning the cash and noncash earnings impact enables explicit incorporation into bank covenant agreements.  We occasionally find clients who must make a non cash write down that then breaks a bank covenant.  While catching this non cash issue was not the original intent of the covenant, today the situation may be the first step to a forced bankruptcy or liquidation.  In years past such non cash covenant breaks were routinely administratively corrected.

 

For buyers, it might be helpful to understand just how much goodwill is being purchased before the deal closes.   Even if the economics of the deal are positive, the financial reporting aspects may appear to be dilutive to shareholders.  By prospectively managing the purchase structure, the transaction can be better aligned with financial benefits. 

 

Advance planning streamlines the purchase price allocation process and also expedites auditor and SEC review.  In the excitement of an acquisition, the economic benefits are frequently shared with investors.  When the accounting and tax treatment is less favorable than investors expected, managers surfer.  Compliance with these new accounting rules can be costly, by being proactive; the cost will yield a management planning benefit, better investor relations, and compliance without surprises. 

 

Not all purchase price allocations are equivalent.  Annual goodwill testing is required.  A well done purchase price allocation will simplify future impairment testing by establishing a financial model that anticipates future testing.  The model enables simplified annual measurement and testing as well as ongoing monitoring for management reporting purposes.  Management can now proactively evaluate business decisions with clarity as to the financial reporting impact of those decisions. 

 

There are also potential tax benefits for performing a purchase price allocation.  On acquisition, depreciated or self created assets are required by IRS rules to be marked to market.   Generally this new higher basis can then be used to offset current and future tax through expensing items and accelerating depreciation.  The cash flow benefit of this tax deferral can be significant and should be considered as part of the purchase decision.  Furthermore, there may be a requirement for the buyer and seller to agree to the tax allocation.  This agreement is easier to reach prior to deal consummation.

 

Before the deal, the transaction structure can be optimized so that the purchase price allocation process quantifies cash benefits and highlights reporting issues enabling management and investors to be well informed when making a buy decision.  After the deal, purchase price allocation becomes a compliance function with little flexibility and potentially significant financial reporting consequences.

 

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