In the past three years there has been an increase in mergers and acquisitions (“M&A”) activity compared to the prior few years. For example, in the mining sector we are seeing many of our clients opt for purchase of existing assets or companies versus green field exploration and the requisite costs and start up time to find new reserves of commodities.

As many of you are aware, Suncorp’s core services have long been valuations for insurance placement and that continues today. Additionally, we are recognized as industry experts in providing valuation services for Purchase Price Allocation (“PPA”) financial reporting requirements resulting from acquisitions. Accordingly, we felt it timely to offer this quick guide to Purchase Price Allocation Valuation.

Requirements for a Comprehensive PPA Valuation

So, what is required in a Purchase Price Allocation valuation? Essentially, the purchase price paid for the acquired company must be allocated to the tangible and intangible assets. Often, the requirement is driven by accounting standards such as International Financial Reporting Standard (“IFRS”) 3 or Financial Accounting Standard 141 (R) on Business Combinations. Purchase Price Allocation recognizes that most assets are recorded at Fair Value and limited life assets are amortized over their economic life. Accordingly, the tracking of this expense can have a profound impact on year to year reported earnings. Purchase Price Allocation determines Fair Value and allows investors to better assess the company’s worth in a transparent, objective manner.

A Case Study

We can best illustrate the concepts at hand with a recent case study, where we were called upon to assist a Chemical Manufacturing conglomerate as it purchased facilities in North and South America. We were called upon to report Fair Value in compliance with IFRS 3.

Tangible Assets involved in the operations and part of our scope of engagement were:

• Owned Land
• Owned Land Improvements
• Owned Buildings
• Machinery and Equipment
• Laboratory Equipment
• Office Furniture
• Office Machines
• Computer Hardware
• Unlicensed Mobile Equipment
• Licensed Vehicles
• Assets Under Rental or Lease
• Construction-in-Progress

As recommended by IFRS our reporting provided a level of detail/componentization that would facilitate reporting requirements relative to the purchased property. With consideration to the preceding, our service set out to:

• Componentize and report the major buildings by major components (i.e. structure, roof coverings, interior finishes ad building services)
• Segregate the Site Improvements by Type (i.e. paving, fencing, lighting, etc.)
• Itemize the Machinery and Equipment with a Replacement Cost of $100,000 or greater

The Fair Value of other property such as office furnishings and equipment, computer hardware & software and minor tooling, which represented a small component of the overall value, was reported in logical groupings by type and location.

In accordance with IFRS guidelines, we understood that our client would utilize the assets’ Fair Value developed as part of this undertaking, as the cost base to be amortized over the assets’ Remaining Useful Life (“RUL”). Suncorp therefore, also provided an estimate of the RUL for each asset entry.

As per our initial client meeting, we understood that facilities to be purchased varied in terms of profitability. Hence, some economic obsolescence may apply to the less profitable plants. In this instance a Business Enterprise Valuation (“BEV”) determined on a plant-by-plant basis was considered an appropriate approach that would take into account Economic Obsolescence. This ensured that the purchase price allocation reflected “Fair Value” in accordance with IFRS.

Finally, our valuation services included determining the Fair Value of the Identifiable Intangible Assets.

Our valuation developed a comprehensive, supportable conclusion of Fair Value for financial reporting purposes. The provision of our services involved many steps including site inspections and cataloging the tangible assets in order to reach our conclusions of value. We would be happy to meet with you and/or your clients to fully explain PPA services. As we have demonstrated in this short article, this can be a complex endeavor with significant impact on the balance sheet of the purchasing organization.

About Suncorp Valuations

Suncorp Valuations is a leading provider of independent valuation, appraisal, and advisory services. Suncorp’s valuations and appraisals have been relied upon by leading insurance companies, public and private companies, property owners and managers, tax authorities, accounting bodies, courts, municipalities and financial institutions from all over the world.

Our valuation and appraisal staff consist of professionals that are highly accredited in the fields of engineering, real estate and equipment appraisal, business valuation, risk management and loss control. Our multi-disciplinary, multi-regional and multilingual staff take an interactive team approach and have been involved in some of the most complex valuation assignments across the globe.

For questions or comments, or to be added or removed from this distribution list please Contact Us.

In a past newsletter we have examined the correlation between commodity prices and construction costs that during periods of escalating commodity prices property owners can find themselves underinsured as the cost to replace certain types of assets escalate. In periods such as these many property owners question why they should be insuring their buildings or equipment for a higher value when they are aware that the market value of their property may not have appreciated to the same degree or in some cases may have even declined.

While this is counter-intuitive, property owners need to be cognizant of the difference between market value and replacement or insurable value. Market value, as determined by an accredited appraiser, represents the probable price that would be realized for a specified property at a specific point in time, if offered for sale on the open market. Generally speaking, market value is arrived at through an analysis and reconciliation of the market environment, the investment characteristics of the property, and its depreciated replacement value of the improvements. Reconstruction costs are the basis for determining replacement or insurable values and include an analysis of the labor, materials, equipment and other costs required to reproduce a property (or piece of equipment) of like kind and quality in the same location.

While there has been little research on the relationship between market and replacement values, the graph below produced by Robert Shiller of Yale University charts U.S. home prices against construction costs, population growth and interest rates since 1880. What is evident from this research is that there is little relationship between building costs and housing prices and there have even been periods where the two are negatively correlated. In fact, despite the decline in U.S. housing prices over the past couple of years there continues to be a general escalation in building construction costs across the country.

With respect to other types of occupancies (commercial, industrial, multi-family) our experience suggests that there can be a minimal correlation between changes in the market value of a property and the costs associated with constructing that same property. The relationship between market and replacement or insurance value is even less evident when one considers that costs associated with reconstruction can be significantly higher than new (Greenfield) construction for a number of reasons which include:

• Demolition and Debris Removal – In the case of a total loss the remaining structure needs to be demolished and removed from the site which can be costly.
• Changes to Building Codes for Fire Protection, Handicap Access, and Parking – Changes to building codes may require costly upgrades to comply with current building codes.
• Regional Economic Factors –A variety of regional economic factors in an area can increase the demand for labor and building materials which can lead to an escalation in the costs associated with both new and reconstruction.
• Inefficiencies– When a new building is constructed materials can often be purchased in bulk while in a reconstruction materials must be purchased on a piecemeal basis which can be more expensive.

About Suncorp Valuations

Suncorp Valuations is a leading provider of independent valuation, appraisal, and advisory services. Suncorp’s valuations and appraisals have been relied upon by leading insurance companies, public and private companies, property owners and managers, tax authorities, accounting bodies, courts, municipalities and financial institutions from all over the world.

Our valuation and appraisal staff consist of professionals that are highly accredited in the fields of engineering, real estate and equipment appraisal, business valuation, risk management and loss control. Our multi-disciplinary, multi-regional and multilingual staff take an interactive team approach and have been involved in some of the most complex valuation assignments across the globe.

For questions or comments, or to be added or removed from this distribution list please Contact Us.