Purchase Price Accounting: Understand the Value of an Acquisition

Bank officers, let’s say you’ve just made an acquisition. The union seems to position you well in terms of new business opportunities and growth potential. But what about the dollars and cents of the transaction? You’ve just purchased a bank, but what you’ve actually acquired is a set of assets and liabilities. Do you understand their value?

Financial institutions are uniquely challenged in trying to fully quantify their organizational value post-merger. It’s difficult to paint an accurate picture of worth when many of your assets are loan products. The value of every loan hinges on its expected cash flows, and those are heavily dependent on each individual borrower.

Say for instance that the bank you’ve just folded-in has two loans on the books, each for $50,000, several years old and with the same interest rate. They may look identical on the surface, but clearly, the future cash flow of these two assets could vary greatly, based on borrower behaviors and circumstances.

Assessing value

So what is each one worth, and how do you account for that? These are difficult questions, because assessing the loans that you’ve acquired through M&A is a complex undertaking. It’s certainly not feasible to personally and individually evaluate the potential repayment capacity of each loan.

And yet, understanding the “big picture” of your organization simply must include this information. It’s vital to your ability to lead your institution into the future, so don’t let the picture remain blurry. Financial clarity about today is required for you to make strategic forecasts about tomorrow.

And that’s certainly not the only issue. An accurate understanding of your recently acquired assets and assumed liabilities is necessary to determine how much of the total price you’ve paid for this institution is allocated to assets, tangible and intangible, and how much is goodwill.

The calculation method

A comprehensive understanding of all of the assets and liabilities brought over in your merger or acquisition can be gained by conducting a thorough analysis under purchase price accounting. Through this process, your institution can evaluate – and properly account for – what it really got in the deal.

Purchase price accounting involves converting the book values of these assets and liabilities into their fair market values as of the acquisition date. In other words, using a complex but standard accounting method, you can determine more accurately how to account for each of your acquired loans. Each of these assets is also subsequently measured for impairment, and amortization.

A critical endeavor

Purchase price accounting is more vital than some realize. It’s possible the banks who shortcut this step believe they already have an adequate understanding of what they’ve acquired. It’s likely they did their due diligence prior to moving forward with the union, and they feel well-armed with a good enough estimate of value, including fair market value.

If you fail to properly implement purchase price accounting, you risk making strategic decisions about your bank that are based on a less-than-exact understanding of its fiscal reality. Because as we’ve learned all too well in the past decade, a loan’s value is not a sure thing.

It is important to monitor the loans purchased after acquisition to determine if the cash flows from the purchased loans are performing better or worse than the original estimate. The accounting for these loans can become complex and sometimes “shadow” accounting is required, because the accounting software cannot handle the transaction in accordance with GAAP.

Guidance from experts

Your entire merger and acquisition process can be simplified with the assistance of expert advisors who will offer due diligence, transaction structure and support, and purchase price accounting. In fact, it’s smart to engage them early in your M&A process, even before you identify a target, since these professionals can guide you through every step of your union.

As you evaluate accounting firms for this type of support, look for one large enough to field a team of seasoned certified valuators. Determining fair value is a fundamentally important part of your transaction strategy, and this is best done by designated valuations professionals. It’s also recommended that you look for a team that specializes in the banking industry. M&A transactions in your arena face distinct challenges.

At Clark Schaefer Hackett we have exactly those credentials. We specialize in full-service community banks and regularly advise these institutions in all aspects of their M&A strategies, including purchase price accounting.

For more information contact Scott Deters at sdeters@cshco.com.

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