In a previous article, the purposes for which an assessment may be requested during the preparation of companies' financial statements were listed. One of these purposes is to substantiate the allocation of the purchase price of a real estate or business.
Most often, when a company buys a real estate property, the total price of it is specified in the sale-purchase contract. The price is generated through the contribution of the components of the property, the most important being the land and the constructions, but sometimes movable assets detachable from the real estate component can also be involved, but also intangible elements, such as, for example, a building permit issued for the extension of the existing building, the rights and obligations related to that authorization being transferred to the acquiring company.
Each component of the property must be allocated a fair value to be recorded in the related accounting accounts – land, buildings, equipment, furniture or intangible assets. Thus, in addition to complying with accounting regulations, the allocation of the purchase price of a real estate property on its components is beneficial for the owner of the business because the real value of the land, respectively constructions, will be recorded, and the company's profit will not be vitiated by an oversized depreciation.
The price allocation process becomes more complex when we talk about the acquisition of an entire company by another following an M&A process. If in the case of real estate the allocation is made on some well-defined components, the price of one company is influenced by many more factors that should be highlighted separately in the accounting records, most of the time the intangible elements being very valuable.
The allotment process in this case involves estimating the fair value of the intangible, tangible and financial assets that have been transferred from the acquired company, as well as for any liabilities associated with those assets. While tangible and financial assets are identified and measured individually, the fair value of which is then recorded in the accounting accounts for each category, not all transferred intangible assets can be analysed and recorded separately.
For an intangible asset transferred in a business combination to be recognised in the accounts of the acquiring company it must meet one of two conditions: it must be separable, i.e. it may be separated or detached from the entity and sold, or arising from contractual or other legal rights.
From the category of separable or arising from contractual rights we can mention trademarks, brands, customer lists, licensing and royalty contracts, authorizations, broadcasting rights, non-compete agreements, rights over natural resources, databases, computer programs.
Inseparable intangible assets, such as trained labour, are usually recorded as goodwill in English. This is the difference between the purchase price paid for the transfer of the enterprise and the fair value of the net identifiable assets acquired.
Allocating the purchase price to components is a complex task, sometimes more difficult than the actual evaluation of a company. This process can be carried out by an authorized appraiser specializing in the valuation of real estate, movable property and enterprises, who in addition to experience and competence in the field of valuation of different types of assets, must also have financial and accounting knowledge, in order to understand the mechanism and logic of recording fair values in the accounting records of the company.
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