"Walk me through a purchase price allocation" is a staple question in M&A and accounting interviews, and it's one where candidates who only memorize "goodwill = purchase price minus book value" get caught out. Here's the framework interviewers are actually listening for.
1. Start from fair value, not book value
The first thing to establish is that PPA restates the target's assets and liabilities to fair value as of the acquisition date — not their historical book value. Any difference between fair value and book value on an asset is a step-up, and step-ups typically show up on property, plant & equipment (PP&E) and on intangibles the target never carried on its own balance sheet, like customer relationships or technology.
2. Compute the fair value of net identifiable assets
Add the book value of net assets to every step-up you identify:
Fair Value of Net Identifiable Assets = Book Value of Net Assets + Sum of Step-Ups
This is the number interviewers want you to isolate before touching goodwill — jumping straight to "purchase price minus book value" skips a step and glosses over where the step-ups actually go.
3. Goodwill is the plug, not the target
Goodwill = Purchase Price - Fair Value of Net Identifiable Assets
Say explicitly that goodwill captures what the acquirer paid for beyond identifiable, fair-valued assets — synergies, workforce, brand, or plain overpayment — and that it is not amortized under current US GAAP or IFRS, just tested annually for impairment. Interviewers frequently probe this distinction because it's the single most common conceptual mix-up on this topic.
4. Don't stop at the balance sheet — quantify the earnings impact
A strong answer doesn't stop once goodwill is calculated. Each step-up amortizes over its own useful life, creating incremental D&A that reduces the combined company's EBIT and net income going forward:
Incremental Annual D&A = Sum of (Step-Up / Useful Life) across each stepped-up asset
Then tax-effect it — but only if the deal structure actually allows it:
After-Tax Earnings Impact = Incremental Annual D&A x (1 - Tax Rate)
5. The nuance that separates strong answers from average ones
The step-up amortization is only tax-deductible if the deal is structured as an asset purchase or a stock purchase with a Section 338(h)(10) election. In a plain stock deal, there's no tax basis step-up — the same book D&A hit reduces GAAP net income, but there's no offsetting cash tax benefit; instead a deferred tax liability gets recorded. Naming this distinction unprompted is a reliable way to signal you understand PPA beyond the formulas.
To see this entire framework applied to a full numerical example — a $650m acquisition with PP&E and intangible step-ups, working through fair value, goodwill, incremental D&A, and the after-tax earnings impact — practice with the Purchase Price Allocation (PPA) case study.
Once you're comfortable with PPA, the natural next step is seeing how the resulting incremental D&A feeds into a full accretion/dilution analysis — it's one of the standard adjustments interviewers expect you to layer in before concluding whether a deal is accretive or dilutive.