Under the guidelines of International Financial Reporting Standard 3 – Business Combinations (IFRS 3), a company acquiring control over another entity is required to disclose in its financial statements the fair value of net assets of the acquired entity, including both tangible and intangible items.

The difference between the purchase price and the net fair value of assets and liabilities should be recognized as goodwill.

For this purpose, a Purchase Price Allocation (PPA) process is carried out, the purpose of which is to identify, measure to fair value the acquired net assets (both tangible and intangible), and then disclose them in the balance sheet of the acquiring company.

Purchase price allocation should be performed at the level of individual CGUs, in accordance with the guidelines of IFRS 3 and International Accounting Standard 36 - Impairment of Assets (IAS 36).

The PPA process should therefore begin with determining the number of cash generating units (CGUs) existing within the acquired business.

The next phase in the analysis is to perform four steps for each of the identified CGUs:

  1. Identification – which aims to identify assets and liabilities not included in the balance sheet of the target company at the date of acquisition. During this step, intangible assets may be disclosed, including (but not limited to):
  • Marketing-related assets, e.g., trademarks and brands, Internet domains;
  • Customer-related assets, e.g., customer lists/databases, business contacts, customer relationships;
  • Contract-related assets: licenses, royalty agreements, advertising, construction, management, service or supply contracts, franchise agreements, usage rights (mining, drilling, emission rights, etc.);
  • Technology-related assets, e.g., patented and unpatented technologies, software, databases;
  • Assets related to artistic activities, e.g., plays, operas and ballets, musical works, song lyrics, photographs or paintings.
  1. Recognition – whereby identified assets and liabilities are tested to relevant asset recognition criteria, in accordance with IFRS 3.
  2. Valuation – which is designed to restate the assets and liabilities to their fair value – this relates to items both existing on the balance sheet of the acquired company as of the date of the acquisition and those newly identified (and meeting the recognition criteria). The fair value of each asset and liability is estimated separately based on the market, income or cost approach.
  3. Allocation – whereby the total cost of acquisition is allocated to the sum of the net fair value of assets and liabilities attributable to the buyer. The excess (if any) of the consideration paid over the buyer's share of the total fair value of assets less liabilities is known as goodwill.

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