Royal Financial

⏱ Estimated reading time: 8 min read

When a M&A transaction occurs, it typically triggers reporting requirements, such as purchase price allocations. Working in both Finance and Tax, you realize allocations can vary based on if they are reported to stakeholders (financial/GAAP reporting) or taxing authorities (tax reporting).

In this post, we will discuss the purpose of, and key differences between, GAAP vs Tax financial reporting, what PPAs are and when you need to complete one, and elections for private companies intended to make all this recordkeeping easier. 

Purpose of Financial Reporting

Financial reporting is focused on informing investors and stakeholders. Reporting standards (e.g. US GAAP) generally utilize the accrual method of accounting which records income and expenses as they are earned or incurred.

Financial reporting should include ALL transactions, whether taxable or not (e.g. tax penalties). As such, financial reporting serves as the baseline for all other reporting, including tax.

Purpose of Tax Reporting

Tax reporting is driven by the Internal Revenue Code which is amended from time-to-time due to changes in fiscal policy. Financial reporting is still the back-bone and, as a result, tax reporting requires the tracking of Financial and Tax reporting differences, commonly referred to as “temporary” and “permanent” differences described in further detail below:

1. Temporary differences: Differences in GAAP and tax income that will eventually reverse. One example would be depreciation & amortization (D&A). D&A is included in both GAAP and tax accounting, however often utilizing different rates which eventually reconcile when the asset is sold or disposed of. 
2. Permanent difference: Differences in GAAP and tax income that will never reverse. Common examples of permanent differences include fines and penalties paid to governments for law violations, meals & entertainment expense, and settlement costs for corporate reorganizations.

Now that we have the basics down between GAAP and tax reporting, we can dive into what purchase price allocations are and the key differences we see between GAAP and Tax purchase price allocations (PPAs).  

What are Purchase Price Allocations (PPAs) and when do you need one?

A purchase price allocation is the allocation of the purchase price paid to the respective assets and liabilities included in a transaction. The requirement to complete a PPA will be based on the agency you are reporting to, as depicted below.

Remember, financial reporting is the back-bone for tax reporting. As such, we always start with financial reporting (which is why audits are so important).

GAAP PPA	Tax PPA
Subsequent to all transactions that involve a change-in-control, companies are required to complete a PPA (regardless if the transaction is structured as an asset or stock deal) for financial reporting purposes. In the U.S. guidance pertaining to completing a PPA is contained in FASB ASC Topic 805 Business Combinations and Topic 350, Intangibles – Goodwill and Other.	PPA is required for transactions that meet the definition of an applicable asset acquisition. §1060 and §338 of the Internal Revenue Code detail procedures for completing PPA’s for U.S. tax reporting purposes. §755 provides similar guidance for companies structured as LLCs or partnerships.

The allocations, for the most part, are similar for financial and tax reporting, however there are specific differences that impact (A) purchase price calculation and (B) valuation, which are discussed further in sections below.

Purchase Price & Valuation

As previously discussed, some of the differences between GAAP and tax reporting is the calculation of purchase price and the determination / definition of valuation.

With respect to calculating purchase price, the differences between GAAP and Tax reporting are highlighted below.  

Topic	GAAP	Tax
Transaction costs	Not included in purchase price (i.e. expensed as incurred)	Include certain costs in purchase price (i.e. capitalization)
Deferred Taxes	Included	Not included since tax books will already have tax liabilities or assets reported.
Accrued Liabilities	Includes all	Includes some
Contingent Consideration and Liabilities	Included and measured at FV if contractual and in certain cases if not contractual	Not included
Debt Measurement	Measured at fair value	Measured at face value

The second way GAAP and tax PPA reporting vary, is in how the standard of value is defined plus other differences as depicted in the table below.

Topic	GAAP	Tax
Defined term	GAAP utilizes the term “fair value” which is defined as the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants at the measurement date.	Tax utilizes the term “fair market value” which is defined as the price at which property would exchange between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both having reasonable knowledge of the relevant facts.
Bargain purchases	Gain recognized	Sequential allocation under the residual method
Ownership of assets	At the reporting unit level	At the reporting unit level
Goodwill allocation	Can allocate to the buyer’s pre-existing reporting units	Only allocated to acquired entities.
Goodwill Valuation and Impairment testing	Tested at the reporting unit level and assigned at a jurisdictional level.	Assigned at the jurisdictional level and no impairment testing requirements.
Tax amortization for intangible assets	Always included	Included only to the extent amortization is tax deductible

Elections for Privately Held Companies

FASB ASC 805 and 350 were amended in order to provide privately held companies with accounting alternatives aimed at simplifying the accounting and reporting process of PPAs.

Under Accounting Standards Updates (ASUs) 2014-18 and ASU 2014-02, privately held companies have the option to elect certain accounting alternatives related to the recognition and measurement of certain intangible assets and the amortization and impairment testing of goodwill (the “Goodwill Accounting Alternative”). 

Topic	General	Accounting Alternatives
Identifiable intangible assets	Recognize all assets that meet either the (a) contractual/legal criterion or (b) separable criterion.	Recognize the same intangible assets under the general guidance except (1) customer-related intangible assets unless they are capable of being sold or licensed independently from other assets of the business and (2) non-competition agreements.
Customer-based intangibles	n/a	Customer-related intangible assets that are capable of being sold or licensed independently from the other assets of the business, customer contracts, favorable/unfavorable leases.
Effect on pre-existing customer-based intangible or non-compete agreements	n/a	None
Subsequent measurement	No amortization; impairment model	Amortize over 10 years or less than 10 years in certain circumstances
Unit of Account	Reporting unit level	Either entity level or reporting unit level
Frequency and Nature of Impairment Test	Test at least annually. May perform qualitative assessment prior to quantitative assessment.	Impairment testing required only upon triggering events. May perform qualitative assessment prior to quantitative assessment.
Scope of Quantitative Test, if necessary	Two-step process. 1. Is FV or reporting unit > carrying value 2. Determine goodwill using hypothetical application of purchase accounting.	One-step process.
Effect on pre-existing goodwill	N/A	Amortize over 10 years from the beginning of the period of adoption or less than 10 years in certain circumstances.

Conclusion

Even though there are numerous similarities between GAAP and tax PPA accounting, there is still room for errors if you have two separate teams not coordinating with one another. A coordinated effort between each group (financial and tax) will help keep costs down and improve consistency across the organization. 

Disclaimer: The information provided herein is intended solely for informational purposes and no person(s) or other third-party may rely upon it as financial, tax, or legal advice or use it for any other purposes. As a result, Royal Financial, and any affiliates, assume no responsibility whatsoever to readers, or any other persons for that matter, as a result of the information contained herein.