AICPA’s Accounting and Valuation Guide on acquired intangible assets used in R&D activities - Q&A 5.12: Question 1: How should an acquiring entity classify in its statement of cash flows an R&D charge associated with the costs of IPR&D projects acquired as part of an asset acquisition that have no alternative future use? This guide explains the principles of accounting and financial reporting for business combinations and noncontrolling interests (ASC 805) under U.S. GAAP and IFRS. Even seemingly straightforward M&A transactions and non-controlling investments can introduce complex issues under ASC 805. Company B should measure the acquired IPR&D at its acquisition date fair value and record it as an indefinite-lived IPR&D intangible asset. Two of the compounds are the predominant assets acquired. All rights reserved. Company A expenses the $3 million as incurred as in-process R&D costs. The IPR&D guide indicates that the enabling technology, in order to be separately identifiable, should exhibit the same characteristics between the various products in which it is used. Timely and technically accurate accounting is indispensable to a successful business combination. Strategic buyers often seek to expand an existing revenue stream, obtain a new revenue stream, or extend control of their supply chain. However, the specific facts and circumstances would need to be assessed to determine if the risk of further development, along with the associated costs would be different in the two jurisdictions. Incremental R&D costs subsequent to the acquisition would be expensed. Question: What is the appropriate presentation of the up-front licensing fee in the statement of cash flows? Thus, the useful lives of such intangible assets cannot exceed the length of their legal rights and may be shorter. The IPR&D activities related to the new technology to be included in Version 2.0 would be recognized as an indefinite-lived IPR&D asset. If an income approach is used to measure the fair value of an intangible asset, Company A should consider the period of expected cash flows used to measure fair value adjusted as appropriate for the entity-specific factors noted above. Company A owns the rights to several drug compound candidates that are currently in Phase I of development. The legal entity also holds an at-market clinical research organization contract and an at-market clinical manufacturing organization contract. Once the associated R&D efforts are completed, the carrying value of the acquired IPR&D is reclassified as a finite-lived asset and amortized over its useful life. The amendments in this Update make the guidance in Updates 2014-02, 2014-03, 2014-07, and 2014-18 effective immediately by removing their effective dates. Non-public business entities that have not yet adopted this guidance must make an assessment under the previous guidance. The overall objective of the guidance included within ASC 805 is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination … Factors to consider may include: the employees’ roles, whether the workforce is subject to contracts with employers or service organizations, as well as the nature and stage of the assets acquired. This is a very important determination as the accounting for a business combination and an asset acquisition differs! Even seemingly straightforward M&A transactions and non-controlling investments can introduce complex issues under ASC 805. Pursuant to ASC 805-20-55-2 through 55-4, an intangible asset that meets the contractual-legal criterion or separability criterion is considered identifiable and is recognized at fair value using the market participant framework contained in ASC 820, Fair Value Measurement. Some examples include accounting and financial reporting for common control (or "put-together") transactions, assessing the necessity for push-down accounting and distinguishing between equity and cost method investments. Highlights of the Update FASB Issues PCC Alternative for Identifiable Intangible Assets in a Business Combination 2 of 13 2. Set preferences for tailored content suggestions across the site, US GAAP - Issues and Solutions for Pharmaceutical and Life Sciences: Chapter 4, Chapter 1 - Capitalization and Impairment, Chapter 3 - Manufacturing & Supply Chain, Phase of development of the related IPR&D project, Nature of the activities and costs necessary to further develop the related IPR&D project. Company A pays Company B a $3 million non-refundable fee to license Company B’s know-how and technology related to a compound in the research stage. For example, Complex capital structures as well as puts, calls and other contingent provisions can require classification of ownership interests outside of equity. ASC 230-10-45-13C: All of the following are cash outflows from investing activities...Payments at the time of purchase or soon before or after purchase to acquire property, plant, and equipment and other productive assets... ASC Master Glossary: Operating activities include all transactions and other events that are not defined as investing or financing activities (see paragraphs 230-10-45-12 through 45-15). The phrase “the NCI Standards” is used to refer to ASC 810-10 and IFRS 10. The Roadmap reflects guidance issued through November 25, 2020, as well as several active FASB projects that may result in changes to … The As in determining the useful life of depreciable tangible assets, regular maintenance may be assumed but enhancements may not. All rights reserved. No employees, other assets, or other activities are transferred. Company A acquires Company B in a business combination accounted for under ASC 805. It depends. Consider the post-acquisition financial reporting implications of the transaction, including how the transaction will be communicated to stakeholders and whether the transaction will impact any debt covenants or other existing agreements. A reporting entity shall then classify each separately identifiable source or use within the cash receipts and payments on the basis of their nature in financing, investing, or operating activities. The following PwC people contributed to the contents or served as technical reviewers of this publication: Kassie Bauman Cathy Benjamin Nicole Berman Wayne Carnall Brett Cohen Larry Dodyk Donald Doran Company B would need to consider whether the scientists hired by Company B through the transaction would meet the definition of an organized workforce that can be combined with an input and process to convert or develop an output. The screen test states that if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not considered a business and no further analysis is required. As Version 3.0 is not yet under development, and, therefore, lacks any substance as IPR&D, there would not be an asset recognized for Version 3.0. The project has been scaled to allow for additional trials to meet the regulatory requirements in each future jurisdiction. In IFRS, the guidance related to accounting for business combinations is included in IFRS 3, Business Combinations. Question: How should Company B account for the acquisition of the patented intellectual property? Intangible assets are amortized over their estimated useful lives. Start adding content to your list by clicking on the star icon included in each card. This example assumes adoption of Accounting Standards Update 2017-01, Clarifying the Definition of a Business. © 2017 - Sat Dec 26 22:28:03 UTC 2020 PwC. Contingent consideration arrangements of an acquiree assumed by the acquirer in a business combination shall be measured subsequently in accordance with the guidance for contingent consideration arrangements in paragraph 805-30-35-1. 805-20-05-4 The Accounting Alternative Subsections of this Subtopic provide guidance for an entity within the scope of paragraph 805-20-15-2 that elects the accounting alternative for the recognition of identifiable intangible assets acquired in a business combination. This definition is broad and can result in many transactions qualifying as business combinations when they are actually only asset acquisitions. © 2017 - Sat Dec 26 22:15:47 UTC 2020 PwC. Company A’s activities only consist of R&D on these product candidates. US Pharmaceutical & Life Sciences Assurance Leader, PwC US. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Company B expects to continue to use the intellectual property in the sale of currently marketed products as well as in identified future R&D activities. Determine the appropriate commercial, legal, tax, financial reporting, valuation and regulatory skills needed to complete the transaction and involve the appropriate professionals early in the process. ASC 350-30-35-2: The useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity... ASC 350-30-35-3: The estimate of the useful life of an intangible asset to an entity shall be based on an analysis of all pertinent factors, in particular, all of the following factors with no one factor being more presumptive than the other: a. Company B is developing a drug compound that is expected to become a leading product for its therapeutic indication. Please see www.pwc.com/structure for further details. but the initial accounting for the business combination can be complicated and often requires extensive time and effort. ASC 230-10-45-22A: In situations in which cash receipts and payments have aspects of more than one class of cash flows and cannot be separated by source or use... the appropriate classification shall depend on the activity that is likely to be the predominant source or use of cash flows for the item. Company A is also using the intellectual property in certain ongoing R&D activities. Identifying a Business combination Under ASC 805, A business is defined as: An integrated set of activities and assets that is capable of being conducted and managed or the purpose of providing a return. The guidance related to accounting for business combinations in U.S. GAAP is included in the Financial Accounting Standards Board’s Accounting Standards Codification (ASC) Topic 805, Business Combinations. Our knowledge can help you develop strategies to withstand regulatory scrutiny, anticipate potential areas of focus in filings and meet constantly evolving expectations for clear and transparent financial reporting. To find the text in the Roadmap that corresponds to a former Q&A, select the “Business Combinations” tab at the bottom of the Q&A to Roadmap Quick Reference Guide and search for the Q&A’s number or title. As a result, the AICPA concluded that these assets should be accounted for in accordance with their nature (e.g., market-related, technology-based). Contact us to discuss your business combination challenges. Company A also has a product candidate that received FDA approval, but for which it has not yet started production. Start adding content to your list by clicking on the star icon included in each card, How strategically approaching ASC 805 can help improve deal evaluation, structuring and communication. The authoritative accounting and reporting guidance for business combinations under US GAAP is included in Topic 805, Business Combinations, of the FASB Accounting Standards Codification. This example assumes adoption of Accounting Standards Update 2017-01, Clarifying the Definition of a Business. None of the acquired drug compounds are similar. 4. Enjoy the videos and music you love, upload original content, and share it all with friends, family, and the world on YouTube. Answer: Best practices suggest that an acquiring entity should report its cash acquisition of assets to be used in R&D activities as an investing outflow in its statement of cash flows. Version 3.0 was not yet under development at the date of the acquisition. KPMG’s in-depth guidance on and interpretation of ASU 2017-01, which revised ASC 805 as part of the FASB’s definition of a business project.KPMG provides examples and analysis on the identification of a transaction as an acquisition of assets or a business combination. Amortization of intangible assets should begin on the date the asset is available for its intended use, which is generally the acquisition date. To do so, Company B may elect to perform a qualitative impairment assessment under ASC 350-30-35-18A. This distinction is important because the accounting for an asset acquisition significantly differs in certain respects from the accounting for a business combination. Company A should perform the screen test and consider whether substantially all of the purchase price is concentrated in a single identifiable asset. If the qualitative assessment either failed or was not used, Company B would perform a quantitative assessment comparing the fair value of the IPR&D asset to its carrying value. f. The level of maintenance expenditures required to obtain the expected future economic benefits from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a very limited useful life). Company A is the owner of patented intellectual property used in medical devices that it currently markets and sells to customers. Based on the fact that none of the acquired compounds are similar, and two of the compounds are the predominant assets acquired, the screen test is likely not met and a full assessment must be performed. Set preferences for tailored content suggestions across the site, {{contentList.dataService.numberHits}} {{contentList.dataService.numberHits == 1 ? If abandoned, the carrying value of the IPR&D asset is written off. It also includes an updated appendix on the accounting for asset acquisitions, which is based on our updated Technical Line publication, A closer look at the accounting for asset acquisitions. A company uses the definition of a business under ASC 805, Business Combinations, to determine whether a transaction is a business combination (accounted for under ASC 805) or an asset acquisition. Question: How should Company A account for the various versions of the technology? Once the IPR&D asset becomes available for use, it should be amortized over its estimated useful life. Under ASC 805, acquired IPR&D continues to be measured at its acquisition date fair value but is accounted for initially as an indefinite-lived intangible asset (i.e., not subject to amortization). The late stage of development combined with the plan to scale trials to meet regulatory requirements in each future jurisdiction may suggest that disaggregation by jurisdiction of the intellectual property being developed is warranted. This determination for acquired IPR&D can be complex when an approved drug may ultimately benefit various jurisdictions. Only intangible assets that are incomplete and used in R&D activities should be accounted for in accordance with ASC 350-30-35-17A (that is, assigned an indefinite useful life upon acquisition). Established businesses often have many different types of inputs, processes, and outputs, whereas new businesses often have few inputs and processes and Company A’s activities primarily consist of research and development (R&D) on these compounds. Accounting Standards Update No. This two-day seminar covers accounting for acquisitions (ASC 805), non-controlling interests (ASC 810), intangible assets (ASC 360), goodwill (ASC 350), and the related deferred tax effects. acquired in a business combination. As described in section 8.2.4.1 in PwC’s Business Combinations guide, “[The IPR&D Guide] also eliminated the concept of core technology and introduces the concept of enabling technology which is intended to have a narrower definition. PwC is a trusted resource for helping companies navigate the accounting and financial reporting challenges of business combinations. Although acquired IPR&D may lack an alternative future use and, therefore, would be expensed immediately, it is still an asset for cash flow statement purposes. When making the unit of account determination, companies may consider, among other things, the following factors: Company A acquired Company B, which is accounted for as an acquisition of a business under ASC 805. If the patent was solely used in ongoing R&D, the AICPA concluded that it may be appropriate to aggregate the patent with other intangible assets used in the R&D activities and capitalize it as an indefinite lived IPR&D asset. Completed intangible assets acquired in a business combination to be used in R&D activities lack the necessary characteristic of being incomplete to be recorded as IPR&D. In general, Company A should classify the cash outflow based on what is likely to be the predominant use of cash. The production, testing and developing equipment would generally be separately recognized as tangible assets, measured at fair value, and depreciated over their estimated useful lives. 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