post closing purchase price adjustment accounting

Introduction. The parties must determine who will prepare the initial draft of the net working capital statement (the “Closing Statement”) showing the calculation of the actual amount of net working capital as of the closing so it can be compared to the target amount. the effect that post-closing collections of receivables will have on the calculation of working capital, particularly collections that occur prior to the time that any post-closing adjustment is finalized. 1. Most post-close disputes arise when broad purchase price adjustment provisions assign working capital a high value without reference to existing accounting policies. Finally, post-closing adjustments to the purchase price are increases or reductions to the purchase price to account for changes in the company’s financial condition between signing and closing. Most (but not all) adjustments are “two-way” and adjust in the seller’s favor if actual NWC exceeds the NWC target. – Incentivize Seller to support business post-closing • Benefits for Seller – Leverage post-closing synergies and opportunities to increase ultimate purchase price – Defer taxes – but beware of employment-related contingencies • Same accounting ground rules for purchase price adjustments apply to … The definition of working capital is current assets less current liabilities. working capital, outstanding tax liabilities, tax shield) to actual amounts on Closing Date • Identity of vendor will affect feasibility and structure of adjustment provisions Here's how both sides to a business acquisition can protect the value of their deal against pre-closing working capital fluctuations. Understand your clients’ strategies and the most pressing issues they are facing. • If there is an “at-closing” adjustment, the estimated closing balance sheet is typically either "prepared in consultation with the buyer"or must be The closing day balance sheet often involves some guesswork, and the actual balances may not be available until a few weeks go by. Finally, since most (but not all) NWC adjustment formulas require payment to the seller if closing NWC exceeds the target, the NWC adjustment protects the seller from unusually positive NWC fluctuations that would otherwise give the buyer a windfall in the form of excess working capital. Setting the right NWC adjustment target is important for buyers and sellers, but reaching agreement on the target can be difficult. By: Scott Van Vooren This blog post is a part of Lane & Waterman’s M & A Blog Series. It is best to agree upon a detailed schedule of accounting policies and procedures for line items especially prone to disagreement, such as inventory, reserves for uncollected accounts, reserves for contingent liabilities, accruals for paid time off and bonuses, prorated expenses and other problematic items unique to the target company’s industry. Buyers will likely push to structure the purchase price with post-closing working capital adjustments and deferred consideration payments (collectively, “post-closing adjustments”) that are contingent on the performance of the business post-closing in line with agreed financial targets. The parties need to take into account, among other considerations, seasonal fluctuations, unusual or nonrecurring events and recent growth in the business requiring higher levels of “normal” working capital. • Assuming there are no logistical problems involved in … Post-closing adjustment provisions require close attention. Purchase price adjustments reflect changes in the agreed purchase price of the target company that typically occur between the signing of the letter of intent or acquisition agreement and the closing date. Preparation of Actual Net Working Capital Amount. It is critical for the parties’ counsel, management, accountants and financial advisers to work closely as a team to draft and negotiate these provisions, with careful attention being given to items that might be manipulated, misinterpreted or disputed in hindsight. Getting these matters right requires a team effort and careful attention to detail by all participants. Most post-close disputes arise when broad purchase price adjustment provisions assign working capital a high value without reference to existing accounting policies. However, if the actual net working capital as of the closing date is $1.2 million, the buyer would be required to pay the seller $200,000. To arrive at a final purchase price, that provision begins by stating a nominal purchase price of $57.384 million, which then is adjusted primarily through the so-called “Closing Adjustment” .… Another adjustment mechanism that has broad approval is the parties' agreement to have the target produce a preliminary estimate on closing. For example, if the target NWC is $1,000,000 but actual working capital at closing is just $700,000, the seller would pay or credit the buyer an additional $300,000 in adjusted purchase price. This article highlights some of the essential elements of a well-drafted Net Working Capital Adjustment. If that price variance is significant, it should be reclassified to the following: raw materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold. An important part of closing the accounting books for your business is posting to the General Ledger any corrections or adjustment entries you find as you close the journals. The high volume of M&A transactions makes post-closing price adjustment provisions and accounting arbitrations a critical part of doing business. A net working capital, or NWC, adjustment, for example, … Define the key terms carefully, and include a schedule of accounting policies and procedures, along with sample calculations. Attaching a list of the specific accounts or financial line items or a sample calculation as a schedule to the purchase agreement are ways to narrow the risk of a later misunderstanding. by Birdzell, Luther E., III. www.ballardspahr.com (No claim to original U.S. government material.) The two most common standards for calculating a Net Working Capital Adjustment are generally accepted accounting principles (GAAP) or GAAP applied consistently with historical financial statements of the target business. The next generation search tool for finding the right lawyer for you. Purchase price allocation is an important step in accounting reporting after the completion of a … The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have. A change in net working capital is a common basis for a purchase price adjustment and is the focus of this posting. In other cases, the post-closing purchase price finalization can lead to disputes between the buyer and the seller that can involve substantial amounts and potentially make or break the deal. In acquisition accounting, purchase price allocation is a practice in which an acquirer allocates the purchase price into the assets and liabilities of the target company acquired in the transaction. D. Buyer Preference for Pre-Closing Adjustment. Purchase accounting is the practice of revising the assets and liabilities of an acquired business to their fair values at the time of the acquisition.This treatment is required under the various accounting frameworks, such as GAAP and IFRS.Common revisions of asset and liability values include: A purchase price allocation (PPA) categorizes the purchase price into the various assets and liabilities acquired. On the other hand, if the seller submits objections, there is usually a period for the parties to negotiate and try to resolve the seller’s objections. It is customary that disputes related to Net Working Capital Adjustments be resolved by an independent accountant rather than a court, since these disputes relate to the proper interpretation of GAAP and its application to financial information. Post-closing purchase price adjustments are sometimes based on income, expense, asset and liability items in addition to, or instead of, the standard NWC components, such as net assets. A large component of the PPA is the identification and assignment of the fair market value of all tangible and intangible assets and liabilities assumed in a business acquisition as at the date of closing. Merger agreements typically include post-closing purchase price adjustment provisions. Abstract- The price paid for a business is usually adjusted after the closing date.Unfortunately, these post-closing purchase price adjustments tend to be quite expensive and unexpected by … Many sellers have been surprised at the magnitude of post-closing adjustments, so it’s a good idea to track “cash at close” before the deal is consummated, and prior to and after closing. Asset Purchase Agreement Post Closing Working Capital Adjustment To Purchase Price clause from Asset Purchase Agreement Agreement for GUNDERSON RAIL SERVICES LLC | AMERICAN ALLIED RAILWAY EQUIPMENT CO., INC., | AMERICAN ALLIED FREIGHT CAR CO., INC., Governing Law Illinois Browse our agreements, contract clauses and provisions for free. The NWC adjustment also reduces the seller’s incentive to manipulate working capital by accelerating collection of receivables, delaying payables and taking other actions to maximize cash distributable to the seller prior to closing. In an acquisition, a company purchases another company’s assets Types of Assets Common types of assets include current, non-current, physical, intangible, operating, and non-operating. Earnings or cash- flow adjustments are especially appealing in transactions in which the purchase price was based on a multiple of earnings or cash flow. It is quite common for there to be a post-closing purchase price adjustment. For instance, in the previous example, if closing NWC were $1,300,000, the buyer would pay the seller the $300,000 excess as an adjustment to the purchase price to account for this difference. Copyright © 2012 by Ballard Spahr LLP. The purchase agreement should (1) describe the process for appointing an independent accountant to resolve disputes, (2) define the scope of the independent accountant’s review, (3) allocate the independent accountant’s fees between the parties, and (4) state that the determination by the independent accountant shall be binding and conclusive on the parties absent manifest error or fraud. For example, post-closing purchase price adjustments may be based on the target business’s net working capital, net worth, net assets, or another financial measure agreed to by the parties. (a) Within ten Business Days after the Cut-Off Date, the Company shall deliver to Buyer and CBNA (i) the Schedule of Trust Student Loans and (ii) a statement of the aggregate Trust Certificate Purchase Price, each as of the Cut-Off Date (the “Estimated Trust Certificate Purchase Price”). Aside from the target amount and whether the Net Working Capital Adjustment will be a one-way or two-way adjustment, the most important aspects of a Net Working Capital Adjustment provision are (1) the definition of “net working capital,” (2) the standards of accounting to be used in calculating net working capital, (3) which party initially determines the actual amount of net working capital as of the closing date and the access to relevant books and records by the non-preparing party, and (4) the dispute resolution process. Typically, the fees of the arbitrating accountant are allocated in proportion to the amount of the disputed adjustment that is resolved for and against each party. For Disputes are common and mistakes can be very costly. Click here to sign up for Ballard Spahr e-communications in a variety of practice areas. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. If all objections are not resolved, most agreements provide for binding private arbitration, usually by a mutually agreed-upon public accounting firm. All rights reserved. If an arbitrating accounting firm is engaged, the parties should consider any potential conflicts of interest and whether the designated firm’s fees would be proportionate to the anticipated amount of any disputed adjustment. Post-closing purchase price adjustments can vary greatly from transaction to transaction. Asset Purchase When the acquirer structures the transaction as a purchase of assets, the assets will be added to its balance sheet at the prices paid for them. Furthermore, the purchase price may be paid in full at closing or partly at closing with the remainder being paid over a specified period of time following the closing, pursuant to a promissory note made payable to the seller by the buyer. Introducing PRO ComplianceThe essential resource for in-house professionals. Purchase Price Adjustments in Acquisition Agreements. In addition to mathematical mistakes, disputes related to purchase price adjustments may arise when the financial components of an adjustment are not properly defined, creating questions as to whether certain transactions should be included in the amount of net working capital at closing. Negotiating the Post-Closing Adjustment Provisions. I assume that the purchase price variance was recorded at the time that the raw materials were purchased. Disagreements can arise over how to apply GAAP to certain facts and circumstances. This is a critical step. Likewise, if the acquiree's NWC comes in above its target, then the acquiring company might pay the seller the amount in excess of the target as a price adjustment. The designated accounting firm’s authority should be limited only to the items in dispute and to resolving the disputed items within the range of values claimed by the parties. The adjustments to the cash purchase price consist of holdback funds (held in escrow to secure the post-closing obligations of Taxpayer) and of a purchase price adjustment (reflecting a dollar-for-dollar increase or decrease in the price based on certain balance sheet adjustments). Payment of the adjustment amount is due once the adjustment amount is agreed upon or is finally determined by the arbitrating accountant. Click here to sign up for Ballard Spahr e-communications in a variety of practice areas. The following discussion focuses mainly on NWC adjustments to the purchase price. Seller will want credit for post-closing collections, especially if those receivables were included in the reserve. Because purchase agreements normally provide that post- closing purchase price adjustments are to be calculated in accordance with GAAP, disputes over applicable accounting principles mainly concern whether the GAAP-compliance underlying the closing balance sheet calculation should be judged anew, or if it should be judged in the context of how the company applied GAAP … www.ballardspahr.com (No claim to original U.S. government material.) The seller and its counsel also need to review the language carefully to close off any opportunities for the buyer to “double dip.” Double-dipping might occur, for example, when the buyer claims the same items in both the post-closing adjustment and under the indemnity provisions of the agreement, or includes the same adjustment item in more than one adjustment category. Alternatives for the determination of the purchase price in share sale and purchase deals. Post-closing the buyer takes the position that the company’s inventory is outdated and that GAAP calls for a sizeable inventory allowance for excess and obsolete inventory. Make the closing estimate as accurate as possible to avoid big adjustment swings in the post-closing process. Keep a step ahead of your key competitors and benchmark against them. The timing of working capital adjustments varies from deal to deal. It can also be dollar-for-dollar or subject to a deductible or cap. Some adjustments reward the seller with additional payments contingent on future performance of the acquired business. Attaching a sample NWC calculation as a schedule to the purchase agreement can also be very helpful in minimizing disputes. Elements of a simple entry that summarizes any changes you found on NWC adjustments to the relevant information critical. 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