[IMGCAP(1)]The AICPA recently issued an Accounting and Valuation Guide on assets acquired to be used in research and development activities, replacing a practice aid it issued in 2001 for in-process research and development.
Since the issuance of the 2001 practice aid, amounts allocated to IPR&D have continued to grow. Accounting guidance has also changed significantly with the issuance of SFAS 157 (now ASC 820) relating to fair value and SFAS 141(R) (now ASC 805) relating to business combinations.
Prior to SFAS 141(R), the acquirer was required to measure and immediately expense assets acquired to be used in R&D activities that had no alternative future use. The current accounting guidance requires assets acquired in a business combination to be used in R&D activities to be capitalized and treated as an indefinite-lived asset until completion or abandonment of R&D efforts.
During this time, the assets are subject to impairment testing requirements. The recently issued guide has been updated to reflect the latest accounting guidance through May 1, 2013. The key changes and additions are as follows:
Fair value measurement guidance contained in ASC 820;
Best practices and examples related to valuation methods used to measure the fair value of IPR&D with a focus on software, electronic devices, and pharmaceutical industries;
Discussion of the differential accounting treatment of assets to be used in R&D activities that are acquired in a business combination vs. an asset acquisition, and the accounting impact of any alternative future use for such assets;
The introduction of “enabling technology,” which replaces the previous concept of “core technology” and has a narrower definition;
Best practices for the initial and subsequent accounting and disclosures related to IPR&D; and,
Expansion of appropriate techniques to value IPR&D, including the relief from the royalty method and the cost approach.
Identification of IPR&D
The AICPA task force that worked on the updated guide identified the following categories of intangible assets as those that may involve R&D activities:
Active internal R&D project;
Outlicensed intangible assets with active involvement; and,
Temporarily idled assets.
In order for the R&D activity to be deemed an asset, the project must meet the ASC 805 asset recognition criteria. Additionally the R&D activity/project should exhibit persuasive evidence of having “substance” and being “incomplete” as of the valuation date.
Unit of Account
According to the AICPA guide, separately identifiable IPR&D assets that share similar characteristics (and are substantially the same) may be aggregated into a single unit of account.
Even with a full understanding of the acquisition rationale and related R&D activities, it is likely that determination of the appropriate unit of account will require significant judgment on the part of both management and valuation specialists. The task force has identified the following indicators to assist in determining whether intangible assets may be considered similar and combined (the list is not exhaustive):
Phase of development;
Nature of activities and costs necessary to further develop the related IPR&D project;
Risks associated with further development;
Amount and timing of benefits expected;
Expected economic life of the developed assets;
If there is an intent to manage costs for developed assets separately or on a combined basis; and,
Whether the asset would be transferred by itself or with other separately identifiable assets;
Valuation of IPR&D Assets
The guide discusses the application of various valuation techniques appropriate for IPR&D. While the task force mentioned the three primary methodologies (cost, market and income), the expectation is that the income approach will be the most widely used given the nature of IPR&D.
However, the task force indicated there might be certain situations in which the market and cost approaches are appropriate. The guide details the primary forms of the income approach used to value IPR&D: the multi-period excess earnings method, the relief from royalty method and the decision tree analysis method.
Core vs. Enabling Technology
The task force believes core technology represents “technical processes, intellectual property and institutional understanding,” each of which generally meets the ASC 805 criteria for separate recognition. Therefore, consistent with evolution of valuation, the task force believes that it is no longer appropriate to recognize core technology as a separate asset, apart from IPR&D.
Instead, the guide defines “enabling technology” as “underlying technology that has value through its continued use or reuse across many products or produce families.” The task force cites as examples of enabling technology a portfolio of patents or an underlying form of drug delivery.
If enabling technology meets the accounting criteria for recognition, it could be a separate unit of account if it does not share the useful life, growth risk and profitability of the products in which it is used. If deemed to be a separate unit of account, enabling technology would be separately valued and amortized based on its remaining useful life.
P.J. Patel is co-CEO and senior managing director of Valuation Research Corporation. He specializes in the valuation of businesses, assets and liabilities for financial reporting purposes. He is a frequent presenter on valuation issues such as valuing intangibles including customer relationships and intellectual property.