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Acquisition premiums impact on companies' financial statements


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Pricing an acquisition target is generally a combination of art, science and intent. Acquirers are typically willing to pay an acquisition premium, the magnitude of which is most likely influenced by the perceived ability of the acquirer to increase the target's cash flows and reduce the required rate of return (i.e., the discount rate).

Sometimes paying a premium turns into an acquirer overpaying for a target, which has cascading accounting consequences, as illustrated in this article using the government services industry as an example to underscore the point. Until recently, there were a number of transactions across a variety of industry sectors consummated at relatively healthy multiples. In this environment, financial and strategic acquirers were often willing to pay a substantial premium to close an acquisition. Acquiring companies can test the potential accounting consequences of their intended purchase price for a target by performing a preliminary identification and valuation of the target's tangible and intangible assets during the due diligence phase.

By allocating the proposed purchase price to the identified assets, an acquirer will gain an early estimate of the level of residual goodwill that will need to be recorded on the balance sheet and the potential amortization expense related to the identifiable intangible assets. This will provide a good indication as to the accretive or dilutive impact of the transaction. Asset identification, valuation and purchase price allocation require a sophisticated understanding of accounting, finance, economics and industry dynamics that should be addressed early on in the transaction life cycle to prevent an acquirer from possibly overpaying for a target, which in turn could result in the recording of an impairment charge.

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