COMMENTARY · PPA & CPC 15/IFRS 3
Post-acquisition PPA: three recurring errors.
The auditor reviewing PPA every quarter develops a sense for the same flaws. Three of them appear with disproportionate frequency in mid-quality reports.
COMMENTARY · PPA & CPC 15/IFRS 3
The auditor reviewing PPA every quarter develops a sense for the same flaws. Three of them appear with disproportionate frequency in mid-quality reports.
PPA (Purchase Price Allocation) is the discipline of CPC 15 / IFRS 3: when a company acquires another, the acquisition price must be allocated to the acquired identifiable assets at fair value, with residual destined to goodwill. The exercise has clear technical structure, but conducted in haste produces results that the auditor catches on first reading.
Three errors recur:
CPC 15 requires identifying as separate assets every intangible that meets the criterion of separability or contractual origin: customer relationships, brands, contracts, licenses, technology. Not throwing all this in goodwill is the technical work.
The recurring shortcut: identify only brand and goodwill, ignoring customer relationships (when there is meaningful concentration), assets in the form of contracts (when there are long contracts) or technology (when product/process is differentiating asset). The auditor questions, and the company has to redo. Better to do right the first time.
Each identified intangible asset receives an estimated useful life. Customer relationships: usually 5-15 years (attrition rate determines). Brand: indefinite useful life when it is the main commercial asset, defined when secondary. Technology: 5-10 years. Contracts: residual contractual duration.
The recurring flaw is inconsistency between estimates. Brand with indefinite life coexisting with customer relationships of 5 years for the same business is signal of inadequate analysis. Either the brand also has defined life, or relationships justify longer life. Coherence between premises is what defends the report.
Goodwill, once recognized, must be tested for impairment at least annually under CPC 01 / IAS 36. The test compares carrying value of CGU (cash-generating unit) with recoverable value, defined as the higher of value in use and fair value less costs to sell.
Standard practice that frequently fails: maintaining the impairment test of years previous to the acquisition without updating discount rate, projection horizon, or assumed growth. The auditor compares the test of year N with that of year N-1 and identifies that the model is "frozen" in conditions of the past. Goodwill that has not absorbed any impact of subsequent economic deterioration is suspect.
"A PPA done in haste, with these three errors, is a PPA that will be redone. Doing it right the first time costs less than restating financial statements."
The PPA is not isolated technical work. It is the entry of an acquisition in the balance sheet, with consequence over five, ten, fifteen years of impairment tests. Each shortcut in the original report becomes a recurring problem until the asset is fully amortized or until the CGU is dissolved. The first PPA is the most expensive of all.