Integration of financial statements

The deal is done, the M&A advisors and lawyers have left the building, and the integration of the acquired business is underway. Just as the dust begins to settle, the external accountant comes knocking: the transaction must be recorded in the financial statements. This essential step ensures that the consolidated annual report accurately reflects the acquired company. This may appear straightforward - you only need the balance sheet of the acquired company, right? However, this process is often more complicated than anticipated.

Aligning accounting principles

The first step is aligning the acquired company’s financial statements with the acquirer’s accounting principles. If the acquired business is transitioning from Dutch GAAP (RJ) to IFRS, this can be a challenging exercise, involving intricate standards such as IFRS 15 (revenue recognition) and IFRS 16 (lease accounting).

Purchase Price Allocation (PPA)

Financial reporting standards require the price paid for the company to be allocated to the assets acquired and liabilities assumed, a procedure that is referred to as a purchase price allocation or PPA. This process can be complex. For instance, the purchase price may not be clear when it includes equity elements (e.g., share swap), or deferred or conditional payments (e.g., earn-outs), as opposed to a cash payment.

Fair value adjustments

An accurate and reliable estimate of the purchase price is essential for determining goodwill - the difference between the net asset value and the price paid. Through the PPA, fair value adjustments must be made to assets and liabilities, such as revaluing real estate, inventory, or machinery, investments in associates, and possibly also long-term loans. Beyond adjustments of existing balance sheet items, assets or liabilities that did not meet recognition criteria earlier (and therefore won't show on the balance sheet) must now be accounted for. For instance, an internally developed brand may not have appeared on the balance sheet pre-acquisition but will need valuation and recognition post-acquisition. Other examples include customer relationships, databases, intellectual property, favourable or unfavourable contracts, and contingent liabilities.

Goodwill in the TMT market

After allocating the purchase price as much as possible to all assets acquired and liabilities assumed, what remains is goodwill - the residual value that the company expects to monetise in the future from assets that do not exist today, such as growth from future customers or synergies effects. 

The residual goodwill is quite common in the TMT market with its start-ups and scale-ups. Reporting standards require annual goodwill impairment testing to ensure its recoverability. For businesses with multiple cash-generating units, goodwill must be allocated accordingly.

Cash generating units

The reporting standards require that this goodwill amount is tested annually to see if it can be recovered by the business. If goodwill is not recoverable (in whole or partly), this results in an impairment of goodwill. In order to properly monitor the recoverability over time, and in the case of multiple cash-generating units (i.e., the smallest group of assets that independently generates assets from the rest of the business, such as a business unit or product segment), the final goodwill amount needs to be allocated to the cash-generating units.

Challenges for the controller

The task of performing the PPA often falls to internal financial controllers who may not have participated in the M&A process. The professionals on the transaction team are now too busy working on a new deal. Also, a purchase price allocation is a rare event for many controllers. For most of them, there is no need to specialise in this type of accounting. With limited experience and minimal support from the transaction team, these controllers face the complex challenge of determining the purchase price, understanding financial assumptions, and valuing newly identified assets.

Uncovering unpleasant surprises

Post-transaction adjustments from the PPA can have unforeseen consequences. For instance, the amortisation of a newly recognised brand name will reduce the net profit and could therefore have a negative impact on the dividend capacity of the company. Also, (fair value) adjustments to inventory or the recognition of favourable contracts could have an impact on future EBITDAs. Conducting a pre-PPA analysis during the transaction phase will reveal these potential effects, avoiding surprises later.

Creating value through the M&A lifecycle

This is why it is so important to acknowledge that an M&A deal is in fact a cycle, where each step impacts the next ones. To streamline post-deal processes, here’s some advice. In an ideal M&A cycle, a pre-PPA analysis (that focuses on the early identification of acquired assets and synergies, and on what the (consolidated) post-deal financial statements would look like) is performed before closing the deal. Also, the financial controllers who are delegated to perform the purchase price allocation require proper guidance and accurate documentation to ensure efficient preparation and approval by external accountants. By focusing on these steps, companies can shift their attention to what truly adds value: delivering the promised returns.

The M&A cycle in a nutshell

Below we have embedded a picture of the M&A lifecycle and a short description of each phase. In a series of articles, we delve into each step of the M&A lifecycle, sharing stories and thoughts about each of these phases. 

How Deloitte helps TMT companies

Our M&A, Strategy & Business Design, Restructuring, Turnaround & Cost
Transformation, and Valuation & Modelling teams can help you to mitigaterisk and identify opportunities.

We offer comprehensive risk identification and assessment, leveraging our deep industry knowledge and robust methodologies, including due diligence and strategic analysis, to identify and mitigate potential risks. Additionally, we help you to identify and capitalise on synergies from Mergers & Acquisitions and other strategic initiatives, maximising value for your stakeholders.

Would you like to know more? Please contact us via the contact details below.