The AICPA released a draft accounting and valuation guide for “Assets Acquired to Be Used in Research and Development Activities” in November 2011. The guide replaces the 2001 practice aid “Assets Acquired in a Business Combination to Be Used in Research and Development Activities: A Focus on Software, Electronic Devices & Pharmaceutical Products.” The draft guide focuses on the treatment of acquired intangible assets that will be used in research and development efforts subsequent to the transaction (“In-Process R&D” or “IPR&D” assets). IPR&D assets also include assets expected to be used defensively to protect assets related to ongoing R&D projects. Here are five takeaways from the draft guide:

  • Accounting Treatment – Initial Recognition. Acquired IPR&D projects generally satisfy the conditions necessary to be considered identifiable assets. Accordingly, current accounting guidance requires an acquirer to recognize (i.e. capitalize) IPR&D assets at their acquisition-date fair values following a business combination. In contrast, costs associated with intangible assets procured outside of a business combination (through an asset acquisition, for instance) to be used in R&D projects are capitalized only if they are deemed to have alternative future uses.
  • Accounting Treatment – Subsequent Measurement. Capitalized IPR&D assets are considered to be indefinite lived until the related R&D projects are complete or abandoned. Indefinite lived intangible assets are not amortized but tested for impairment on an annual basis, or more frequently if there are indications that the assets may be impaired. The Financial Accounting Standards Board recently issued a proposed Accounting Standards Update that would grant companies the option to assess qualitative factors before employing quantitative impairment tests. Assets that may arise from completed or abandoned R&D projects no longer constitute IPR&D assets.
  • Valuation Approach and Methods. Valuation methods generally fall into one of three approaches: cost, market or income. Determining replacement cost for an asset that builds on unique or proprietary technology with uncertain market prospects is typically unreliable, which renders methods under the cost approach unsuitable for measuring the fair value of IPR&D assets. The market approach is generally untenable because transactional data on sufficiently comparable assets are not likely to be available. By default, therefore, methods under the income approach are most appropriate in measuring the fair value of IPR&D assets. Such methods include the multi-period excess earnings method, relief from royalty method, decision tree analysis, with-and-without analysis, and various simulation methods.
  • Prospective Financial Information. Application of the income approach relies on prospective financial information (“PFI”) tailored to the IPR&D asset being valued. Asset-specific PFI is extracted from enterprise-level PFI after adjustments to remove items not related to the IPR&D asset. Valuation specialists develop PFI for companies after careful evaluation of available information including management perspectives, acquisition models, internal budgets and forecasts, marketing presentations, board presentations, or analyses prepared by third-parties. In the case of business combinations, PFI should reconcile with the corresponding final purchase price. Fair value measurement prescribes the development of appropriate PFI from a market participant perspective, which requires careful examination of potentially idiosyncratic elements specific to (parties involved in) the particular transaction.
  • Documentation and Disclosure. Valuation specialists help minimize the time, effort and costs associated with the fair value measurement and review process by carefully recording information sources, assumptions, adjustments and rationale for the techniques or methods underlying the valuation analyses. Such documentation also facilitates satisfaction of disclosures requirements prescribed by the relevant financial reporting standards.

Mercer Capital provides a range of fair value measurement services to financial managers. Please contact us to explore how we can help you measure and document the fair value of IPR&D assets.

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