Purchase Price Allocation: 6 Things to Settle First

Purchase Price Allocation: 6 Things to Settle First

Purchase price allocation is the step that turns one number, what you paid, into many: so much for equipment, so much for inventory, so much for goodwill. Those splits flow into your tax return and into the opening books, and they are far easier to settle before closing than to untangle after. Most buyers hand it to the last page of the agreement and meet it again in tax season.

The six items below are a checklist, not a ranking. The one firm written up is System Six, a Seattle bookkeeping and fractional CFO firm that helps organizations modernize a finance function after an acquisition. System Six is a vetted Sam's List member and a paying member of our featured program; payment does not buy the language we use or its reviews. You can read how we picked this firm at the end.

1. Know Why Purchase Price Allocation Touches Both the Tax Return and the Opening Books

The allocation does two jobs. For tax, it generally decides how much of your price you can recover through depreciation and amortization, and how quickly. For the books, it sets the starting value of each asset your accountant records on day one, which drives every depreciation entry afterward.

Those two jobs are related but not identical. The tax side follows the Internal Revenue Code, and for many asset purchases that means section 1060. The book side follows accounting rules, usually ASC 805 for a business combination, which has its own way of measuring assets and goodwill.

The limitation: a favorable allocation on paper is not a favorable result in practice. The seller is usually on the other side of the same numbers, often with opposite tax interests, so expect a negotiation, not a free choice.

2. Find Out Who Proposes the Purchase Price Allocation and When It Is Fixed

Someone has to put the first draft on the table, and it is often the buyer's side or the deal advisor. The question is when. A common answer is a schedule attached to the purchase agreement, signed at closing. Another is a promise to agree later, which tends to be the version that causes fights.

Generally, an allocation the buyer and seller both agree to in writing is binding on them for tax purposes, with narrow exceptions your attorney can explain. That makes the agreement the place where the number lives. If your agreement leaves allocation open or says the parties will agree within some period after closing, put a name and a date next to that task.

The limitation: a written allocation binds the parties to each other. It does not bind the IRS, which can challenge an allocation it believes is not supported by the facts.

3. Learn the Seven Asset Classes Before You Argue About Order

In an applicable asset acquisition, section 1060 uses what is called the residual method. The price is assigned to assets in seven classes, in order, with each class limited to the fair market value of what is in it. Whatever is left after the first six classes lands in the seventh.

In plain terms, the classes run like this: cash and deposit accounts first, then actively traded personal property and similar items, then receivables, then inventory, then everything else such as equipment, buildings and land, then intangibles other than goodwill such as customer lists and non-competes, and last, goodwill and going concern value. Order matters because the last class absorbs the remainder, so a dollar given to equipment is a dollar taken from goodwill.

The limitation: a stock purchase is generally not an asset purchase, so these rules usually do not apply by default. Certain elections can treat a stock deal like an asset deal for tax, so ask your CPA which structure you have.

4. Match Book and Tax Treatment, and Know Where They Will Differ

Your opening books under ASC 805 generally record the assets and liabilities you acquired at fair value, with goodwill as the leftover. That sounds like the tax residual method, and the logic is similar, but the details are not the same. Some assets and liabilities are measured differently, and deferred taxes can appear on the book side when the two sets of numbers diverge.

This is also where goodwill and fixed asset valuation earns its keep. A valuation of equipment, buildings and intangibles gives both sides of the ledger something to start from. Many small deals use a valuation professional for the larger or harder-to-value items, and an appraisal or a documented method for the rest.

Keep a simple reconciliation: one column for the tax allocation, one for the book value, and a note on each difference. It will make your first year-end and any later audit calmer.

The limitation: a valuation is an informed estimate, not a measurement. Two qualified people can reach different values, and a buyer, a seller and a tax authority may each prefer a different one.

5. Plan for Form 8594 and Keep the Records Behind It

When section 1060 applies, buyer and seller each report the allocation to the IRS on Form 8594, the Asset Acquisition Statement, filed with their income tax returns for the year of the sale. The two forms should agree. A mismatch invites questions, which is one more reason to fix the allocation in the agreement.

If the allocation changes later, for example after a price adjustment, a supplemental Form 8594 may be needed for that later year. Check the current instructions for the filing details that apply to you.

Keep the paper trail: the agreement and its allocation schedule, any valuation report, the closing statement, a fixed asset register with each asset's starting cost and date placed in service, and a note of how each class was determined. Those are what you will want if anyone asks how a number was reached.

The limitation: Form 8594 reports an allocation; it does not make a weak one stronger. Support for each figure matters more than the form that carries it.

6. Know When to Bring In the Finance Lead

The usual mistake is waiting. Allocation is easiest while the price is still negotiable and the seller still cares. After closing, you are explaining numbers that other people already agreed to.

A finance lead, whether a controller, a CPA or a fractional CFO, can read the draft schedule, check that it fits the structure, set up the fixed asset register and plan how the opening entries will be booked. They can also tell you when the question is bigger than finance and belongs with a valuation professional or a tax attorney.

The limitation: bringing someone in does not move the work off your plate. You still need to supply the facts, the agreement and decisions on what you will accept.

Where System Six Fits

This is finance-function work, which is what System Six describes. It is a Seattle firm listed under fractional CFOs and serving clients nationwide. Its live profile lists Non-Profit Organizations, Professional Service Firms and Real Estate Investors as specialties, and lists bookkeeping and advisory services among its services. It says it serves small businesses generating between $1 million and $10 million of revenue, and that it helps organizations, including those looking to modernize their finance function after an acquisition.

System Six does not yet have enough reviews on Sam's List for us to cite a count, so we describe the firm by what its profile says instead. The profile has limited review history, so ask for client references from owners who bought a business.

The limitation, plainly: the profile does not name purchase price allocation, Form 8594 or valuation, so ask what is included and how the firm works with your CPA and attorney. It describes its clients as businesses with $1 million to $10 million in revenue, so a smaller business should ask whether it fits. A bookkeeping and fractional CFO firm does not replace tax or legal counsel or a valuation professional.

Frequently Asked Questions

What is purchase price allocation?

It is how the total price of an acquisition is divided among the assets acquired, such as equipment, inventory, intangibles and goodwill. The split affects tax deductions and the starting values on the buyer's books. In many asset deals, section 1060 sets the tax method.

What is Form 8594?

It is the IRS Asset Acquisition Statement. In an applicable asset acquisition, buyer and seller each file it with their income tax return for the year of the sale to report how the price was allocated. The two filings should be consistent.

Does purchase price allocation differ for book and tax purposes?

It can. Book purchase accounting under ASC 805 measures acquired assets and liabilities at fair value, while tax uses its own rules, such as the section 1060 classes. Differences are common, so reconcile them and ask your CPA how they will be tracked.

Who decides the allocation, the buyer or the seller?

Both, through the purchase agreement. Either side may propose a schedule, but the two are generally expected to report consistently, so it is usually negotiated and written into the agreement. Have your attorney and CPA review it before signing.

Before you sign, gather the draft agreement, the allocation schedule, any equipment lists or valuation work and the seller's fixed asset records. You can browse fractional CFOs on Sam's List, including the firm above, and ask each how it supports the opening books after a purchase.

How We Picked This Firm

You should be able to check our work, so here is how this post was built.

The pool. The pool is the firm written up here, a vetted Sam's List member in our featured program. This is not a survey of every firm that supports buyers after an acquisition, and many Sam's List members and other firms not written up here could fit.

How it is organized. The six items are things to settle, not a ranking. System Six is the only firm written up, so there is no order of firms.

What review counts mean here. System Six has too few verified reviews on Sam's List for us to cite a count, so we describe it by its profile and do not rely on reviews. A count shows how many clients wrote something down. It does not measure technical quality.

What payment does and does not buy. Listing on Sam's List is free, and so is being named in this article. The firm written up here is a paying member of our featured program, which is why it gets a write-up. What payment does not buy is the language we use about a firm, its review count, or a promise that it fits you.

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About the author: Kimberly Green is the cofounder of Sam's List, where business owners and high earners find vetted CPAs, financial advisors, and fractional CFOs. She's met one-on-one with 400+ financial professionals and writes from the real data behind thousands of client-advisor matches. Ask her anything about finding an accountant - she's heard it all, including the questions people are afraid to ask.