Company A acquires Company B in a business combination accounted for under ASC 805. In the absence of that experience, the entity shall consider the assumptions that market participants would use about renewal or extension, consistent with the highest and best use of the asset by market participants, adjusted for entity-specific factors in this paragraph. 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. It depends. Company A expenses the $3 million as incurred as in-process R&D costs. In this regard, an acquiring entity should treat assets acquired to be used in R&D activities similar to how it reports other acquired assets in the statement of cash flows. Timely and technically accurate accounting is indispensable to a successful business combination. Each member firm is a separate legal entity. As a result, the value of the Version 1.0 technology that is able to be reused in later versions would be included as part of the Version 1.0 intangible asset as it is not considered to be a separate enabling technology asset. A change in the estimated useful lives of intangible assets is considered a change in an accounting estimate and should be accounted for prospectively in the period of change and future periods. 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 fully developed and commercialized technology present in Version 1.0 would be recognized as a separate software technology asset and amortized over its useful life. For example, Complex capital structures as well as puts, calls and other contingent provisions can require classification of ownership interests outside of equity. Company A’s product candidate that has received FDA approval (it is no longer “in-process”) would be recognized as a finite-lived intangible asset at the date of acquisition, separate from the acquired IPR&D, and amortized over its estimated useful life. Two of the compounds are the predominant assets acquired. PwC is a trusted resource for helping companies navigate the accounting and financial reporting challenges of business combinations. Question: How should Company A account for the various versions of the technology? As part of the business combination, Company A acquires the intellectual property of Company B that meets the criteria for separate recognition of an intangible asset apart from goodwill. Company A should perform the screen test and consider whether substantially all of the purchase price is concentrated in a single identifiable asset. Company A is the owner of patented intellectual property used in medical devices that it currently markets and sells to customers. 'result' : 'results'}}. © 2017 - Sat Dec 26 22:28:03 UTC 2020 PwC. ASC 805-10-55-3A defines a business as an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. [Content moved from paragraph 805-20-35-4A] 3. Company A should consider the nature of the underlying cash flow in determining its classification. FASB ASC Topic 805, Business Combinations, is a specialized accounting area that has evolved over the years and continues to be the subject of simplification initiatives by FASB. Company A is in the pharmaceutical industry and owns the rights to several product (drug compound) candidates. Company A owns the rights to several drug compound candidates that are currently in Phase I of development. Question: How should Company B account for the acquired IPR&D? Companies may pursue mergers and acquisitions for a variety of reasons. Company A would likely not record a separate enabling technology as the design and technology of Version 1.0 is not used in the same form in the later versions (i.e., it is further enhanced and altered). ii PwC Acknowledgments The Business Combinations and Noncontrolling Interests, ... Business combinations and noncontrolling interests. As a result, the AICPA concluded that these assets should be accounted for in accordance with their nature (e.g., market-related, technology-based). Company A determines that this meets the definition of an asset acquisition and the license has no alternative future use. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. 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. The project reached market approval in Canada, the US, and Europe just prior to acquisition, and regulatory approval is currently being pursued in Japan and Brazil. 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. As such, Company A should account for the transaction as an asset acquisition. Even seemingly straightforward M&A transactions and non-controlling investments can introduce complex issues under ASC 805. When arriving at cash flows from operating activities under the indirect method of reporting cash flows, best practices suggest that an acquiring entity should add back to net income the costs of assets acquired to be used in R&D activities that are charged to expense. Detailed analysis can be necessary to determine the scope of the accounting guidance as well the entity that is subject to its requirements. Once the IPR&D asset becomes available for use, it should be amortized over its estimated useful life. Prospective application is required. "Unless you work for a company that is a serial acquirer, you are not applying acquisitio… Company B would likely conclude that there are no outputs acquired because the compounds are in early stage of development. This example assumes adoption of Accounting Standards Update 2017-01, Clarifying the Definition of a Business. Arrangements; or Update 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. 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 Set preferences for tailored content suggestions across the site, {{contentList.dataService.numberHits}} {{contentList.dataService.numberHits == 1 ? All rights reserved. Company A purchases a legal entity from Company B that contains the rights to a Phase 3 (in the clinical research phase) compound being developed to treat diabetes, or the in-process research and development (IPR&D) project. As in determining the useful life of depreciable tangible assets, regular maintenance may be assumed but enhancements may not. Given that the nature of this cash flow has aspects of more than one class of cash flows as well as the lack of authoritative guidance in this area, we believe that classification in either operating or investing is acceptable. 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. 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). The IPR&D Guide indicates that enabling technology will be recognized as a separate asset less frequently than core technology had previously been recognized, and that the introduction of enabling technology is not expected to significantly contribute to the amount of recognized goodwill. Company A’s activities only consist of R&D on these product candidates. Version 3.0 was not yet under development at the date of the acquisition. If the screen test is not met, then a company must perform further assessment. What Are the Main Provisions? Therefore, there is no fair value associated with these arrangements. Enjoy the videos and music you love, upload original content, and share it all with friends, family, and the world on YouTube. Supersede paragraphs 805-50-05-1 and 805-50-05-8 and its related heading, amend paragraphs 805-50-05-2 and 805-50-05-6 through 05-7 and the Subsection title and add the General Note, and add paragraph 805-50-05-9 and the new Subsection title, with a link to transition paragraph 805-50-65-1, as follows: Business Combinations—Related Issues 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. Each member firm is a separate legal entity. If the initial accounting for a business combination is incomplete at the end of the financial reporting period in which the combination occurs, paragraph 805-10-25-13 requires that the acquirer recognize in its financial statements provisional amounts for the items for which the accounting is incomplete. Question: Should Company A account for the transaction as a business combination or an asset acquisition? Develop a clear roadmap of the economic objectives that will drive the transaction and can be used to communicate goals, both internally and with advisors. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. No employees, other assets, or other activities are transferred. As part of the business combination, Company A acquires the intellectual property of Company B that meets the criteria for separate recognition of an intangible asset apart from goodwill. They may also introduce. Company B also hires all of the scientists formerly employed by Company A, who are integral to developing the acquired product candidates. Company B acquires Company A in a business combination. Company A should consistently apply their classification conclusion to similar transactions. Question: Should Company B account for the transaction as a business combination or an asset acquisition? Highlights of the Update FASB Issues PCC Alternative for Identifiable Intangible Assets in a Business Combination 2 of 13 2. If the enabling technology shares the same useful life, growth risk, and profitability of the products in which it is used, a separate asset would likely not be recognized. 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. ASU 2017-1 is effective for non-public business entities for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. To do so, Company B may elect to perform a qualitative impairment assessment under ASC 350-30-35-18A. 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. Financial buyers often aim to extract value from the target, frequently by transforming key aspects of the business. Accounting Standards Update No. 805-20-35-4C . In the full assessment, Company B will need to consider whether it has acquired inputs, substantive processes, and outputs. Examples of enabling technology provided in the IPR&D Guide include a portfolio of patents, a software object library, or an underlying form of drug delivery technology. Intangible assets are amortized over their estimated useful lives. The expected use of the asset by the entity. Throughout this guide, the phrase “the Standards” is used to refer to ASC 805 and IFRS 3. None of the acquired drug compounds are similar. This guide explains the principles of accounting and financial reporting for business combinations and noncontrolling interests (ASC 805) under U.S. GAAP and IFRS. Enabling technology is…underlying technology that has value through its combined use or reuse across many product or product families. 4. 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. It is complex and may require CPAs to face new issues and apply certain accounting principles for the first time (see the sidebar, "Accounting Quick Tips," below). This definition is broad and can result in many transactions qualifying as business combinations when they are actually only asset acquisitions. 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. 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. 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. 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). Our FRD publication on business combinations has been updated to reflect recent standard-setting activity and to further clarify and enhance our interpretive guidance in several areas. Rather than merely describing these standards, we endeavor to explain 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. The project has been scaled to allow for additional trials to meet the regulatory requirements in each future jurisdiction. As a result, all of the consideration will be allocated to the IPR&D project. 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. PwC Not-for-profit entities – mergers and acquisitions • Provides guidance for - Combinations of two or more NPOs - NPO acquisitions of for-profit organizations - Noncontrolling interests (minority interests) - Goodwill - Intangible assets • Codified in ASC 958-805 The intellectual property acquired by Company A does not represent IPR&D. The framework for this assessment is discussed in ASC 805-10-55-5D through 55-9. Risks associated with the further development of the related IPR&D project; Amount and timing of benefits expected to be derived from the developed asset, Expected economic life of the developed asset, Whether there is an intent to manage advertising and selling costs for the developed asset separately or on a combined basis, Once completed, whether the product would be transferred as a single asset or multiple assets. 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. An entity uses the definition of a business in ASC 805 in determining whether to account for a transaction as an asset acquisition or a business combination. 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. This determination for acquired IPR&D can be complex when an approved drug may ultimately benefit various jurisdictions. 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. 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. Another approach is to record a single global asset. Thus, the useful lives of such intangible assets cannot exceed the length of their legal rights and may be shorter. Please see www.pwc.com/structure for further details. assets or businesses. 5. This distinction is important because the accounting for an asset acquisition significantly differs in certain respects from the accounting for a business combination. Company B was also conducting R&D related to significant improvements to Version 1.0 (Version 1.0 was being modified and would be partly reused in Version 2.0) that Company B expects to sell in their new scanner. e.      The effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, known technical advances, legislative action that results in an uncertainty or changing regulatory environment, and expected changes in distribution channels). The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate. 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. The clinical research organization contract and the clinical manufacturing organization contract are at market rates and could be provided by multiple vendors in the marketplace. 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. Subsequent to the acquisition, the acquired IPR&D would be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Industry practice would suggest that Company A may recognize at least two, and potentially up to five, separate assets: one intangible asset representing the rights to the compound in all market-approved jurisdictions (or a separate asset for each of the three market approved jurisdictions) and one IPR&D asset for the portion still being developed (or two, if separated by jurisdiction). If the precise length is unknown, intangible assets should be amortized over a company’s best estimate of the assets’ useful life. The AICPA’s Accounting and Valuation Guide on acquired intangible assets used in R&D activities a makes a distinction between complete and incomplete intangible assets used in R&D. Non-public business entities that have not yet adopted this guidance must make an assessment under the previous guidance. Company A is also using the intellectual property in certain ongoing R&D activities. Other than the stage of development, the compounds have no other similarities and are designed to treat disparate conditions. Included in the IPR&D project is the historical know-how, formula protocols, designs, and procedures expected to be needed to complete Phase 3. 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. 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. All rights reserved. Overview. 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. 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. This example assumes adoption of Accounting Standards Update 2017-01, Clarifying the Definition of a Business. 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. Chapter 2 — Identifying a Business Combination 9 2.1 Definition of a Business Combination 9 2.2 Transactions Within the Scope of ASC 805-10, ASC 805-20, and ASC 805-30 11 2.2.1 Roll-Up or Put-Together Transactions 12 2.2.2 Combinations Between Two or More Mutual Entities 12 2.2.3 True Mergers or Mergers of Equals 13 ASC 350-30-35 provides factors to consider in determining the appropriate unit of accounting both for recognition and subsequent impairment assessments of intangible assets. Strategic buyers often seek to expand an existing revenue stream, obtain a new revenue stream, or extend control of their supply chain. c.      Any legal, regulatory, or contractual provisions that may limit the useful life. ASC 805-10-55-5A through 55-5C introduce a screen test to be performed prior to the full assessment. Company A would also consider whether a separate enabling technology asset should be recognized for Version 1.0. 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. To determine the useful life, in addition to the factors in ASC 350-30-35-3, Company A should consider industry-specific factors, such as the following: a. 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. Company B is developing a drug compound that is expected to become a leading product for its therapeutic indication. 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. 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. Stage of development, the useful life of another asset or a group of to. Development ( R & D project project has been scaled to allow for additional that! The statement of cash flows and useful lives time and effort the business combinations, frequently by transforming aspects... Other than the stage of development { { contentList.dataService.numberHits == 1 these product.. Expense should generally be determined based on legal rights this meets the definition of an intangible ’. Employees, other assets, or other activities are generally the acquisition of a business affects many of! 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