4.10 Intangible Assets
ASC 805-20
25-10 The acquirer shall recognize separately from goodwill the identifiable intangible assets acquired in
a business combination. An intangible asset is identifiable if it meets either the separability criterion or the
contractual-legal criterion described in the definition of identifiable. Additional guidance on applying that
definition is provided in paragraphs 805-20-25-14 through 25-15, 805-20-55-2 through 55-45, and Example 1
(see paragraph 805-20-55-52). For guidance on the recognition and subsequent measurement of a defensive
intangible asset, see Subtopic 350-30.
The ASC master glossary defines intangible assets as “[a]ssets (not including financial assets) that lack
physical substance. (The term intangible assets is used to refer to intangible assets other than goodwill).”
An acquirer must recognize, separately from goodwill, the identifiable intangible assets acquired in a
business combination. An intangible asset is identifiable if it meets either the separability criterion or the
contractual-legal criterion.
Changing Lanes
The FASB had a project to improve the accounting for asset acquisitions and
business combinations by narrowing the differences
between the two accounting models. However, at its
June 15, 2022, meeting, the FASB decided to remove
this project from its agenda.
4.10.1 Initial Recognition of Intangible Assets
An intangible asset is identifiable and therefore recognized separately from goodwill if it meets either of
the following criteria:
- The intangible asset arises from contractual or other legal rights (i.e., the “contractual-legal criterion”), regardless of whether those rights are transferable or separable from the acquiree or from other rights and obligations.
- The intangible asset is separable (i.e., the “separability criterion”). According to ASC 805-20-55-3, an asset that meets this criterion “is capable of being separated or divided from the acquiree and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability.” An intangible asset is separable regardless of whether the acquirer intends to transfer it.
Both of these criteria are explained in more detail in the following
sections.
4.10.1.1 The Contractual-Legal Criterion
ASC 805-20
55-2 Paragraph 805-20-25-10 establishes that an intangible asset is identifiable if it meets either the
separability criterion or the contractual-legal criterion described in the definition of identifiable. An intangible
asset that meets the contractual-legal criterion is identifiable even if the asset is not transferable or separable
from the acquiree or from other rights and obligations. . . .
Many intangible assets arise from rights conveyed by contract, statute, or similar means. As stated in paragraph B156 of the Background Information and Basis for Conclusions of FASB Statement 141, “franchises are granted to
automobile dealers, fast-food outlets, and
professional sports teams. Trademarks and service
marks may be registered with the government.
Contracts are often negotiated with customers or
suppliers. Technological innovations are often
protected by patent.” Therefore, the fact that an
intangible asset arises from contractual or other
legal rights distinguishes it from goodwill. Such
an intangible asset must be recognized separately
from goodwill even if the acquirer is legally or
contractually restricted from selling,
transferring, or otherwise exchanging it.
Restrictions on selling or otherwise transferring
an intangible asset arising from contractual
rights do not affect its recognition; however,
such restrictions may affect its fair value
measurement.
ASC 805-20-55-2 provides the following examples of intangible assets arising
from contractual or other legal rights:
ASC 805-20
55-2 . . .
-
An acquiree leases a manufacturing facility to a lessee under an operating lease that has terms that are favorable relative to market terms. The lease terms explicitly prohibit transfer of the lease (through either sale or sublease). The amount by which the lease terms are favorable compared with the pricing of current market transactions for the same or similar items is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even though the acquirer cannot sell or otherwise transfer the lease contract. See also paragraph 805-20-25-12.
-
An acquiree owns and operates a nuclear power plant. The license to operate that power plant is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even if the acquirer cannot sell or transfer it separately from the acquired power plant. An acquirer may recognize the fair value of the operating license and the fair value of the power plant as a single asset for financial reporting purposes if the useful lives of those assets are similar.
-
An acquiree owns a technology patent. It has licensed that patent to others for their exclusive use outside the domestic market, receiving a specified percentage of future foreign revenue in exchange. Both the technology patent and the related license agreement meet the contractual-legal criterion for recognition separately from goodwill even if selling or exchanging the patent and the related license agreement separately from one another would not be practical.
Some intangible assets that meet the contractual-legal criterion may also meet the separability criterion,
but only one criterion must be met for an intangible asset to be identifiable. Similarly, an intangible
asset that meets the separability criterion is identifiable even if it does not arise from a contractual or
legal right.
4.10.1.2 The Separability Criterion
ASC 805-20
55-3 The separability criterion means that an acquired intangible asset is capable of being separated or divided
from the acquiree and sold, transferred, licensed, rented, or exchanged, either individually or together with a
related contract, identifiable asset, or liability. An intangible asset that the acquirer would be able to sell, license,
or otherwise exchange for something else of value meets the separability criterion even if the acquirer does not
intend to sell, license, or otherwise exchange it.
55-4 An acquired intangible asset meets the separability criterion if there is evidence of exchange transactions
for that type of asset or an asset of a similar type, even if those transactions are infrequent and regardless of
whether the acquirer is involved in them. For example, customer and subscriber lists are frequently licensed
and thus meet the separability criterion. Even if an acquiree believes its customer lists have characteristics
different from other customer lists, the fact that customer lists are frequently licensed generally means that
the acquired customer list meets the separability criterion. However, a customer list acquired in a business
combination would not meet the separability criterion if the terms of confidentiality or other agreements
prohibit an entity from selling, leasing, or otherwise exchanging information about its customers.
In contrast to goodwill, which cannot be separated from an entity, some intangible assets do not
arise from contractual or other legal rights but are capable of being separated from the acquiree and
exchanged for something else of value. Therefore, identifiable assets can also be distinguished from
goodwill on the basis of separability.
An acquired intangible asset meets the separability criterion if there is
evidence of exchange transactions for the asset or
similar assets, even if such exchanges occur
infrequently and the acquirer has not participated
and does not intend to participate in such
exchanges. It is the acquirer’s ability to
separate the asset from the combined entity that
makes an intangible asset separable. ASC
805-20-55-4 provides the following example of
customer-related intangible assets that meet the
separability criterion:
[C]ustomer and subscriber lists are frequently
licensed and thus meet the separability criterion.
Even if an acquiree believes its customer lists
have characteristics different from other customer
lists, the fact that customer lists are frequently
licensed generally means that the acquired
customer list meets the separability criterion.
However, a customer list acquired in a business
combination would not meet the separability
criterion if the terms of confidentiality or other
agreements prohibit an entity from selling,
leasing, or otherwise exchanging information about
its customers.
Therefore, even if an intangible asset that is related to a contract,
identifiable asset, or liability cannot be
separated individually from that contract,
identifiable asset, or liability, it will still
meet the separability criterion if it can be
transferred together with that related contract,
identifiable asset, or liability. ASC 805-20-55-5
provides examples of intangible assets that, while
not individually separable, are separable when
combined with other assets or liabilities.
ASC 805-20
55-5 An intangible asset that is not individually separable from the acquiree or combined entity meets the
separability criterion if it is separable in combination with a related contract, identifiable asset, or liability. For
example:
- Market participants exchange deposit liabilities and related depositor relationship intangible assets in observable exchange transactions. Therefore, the acquirer should recognize the depositor relationship intangible asset separately from goodwill.
- An acquiree owns a registered trademark and documented but unpatented technical expertise used to manufacture the trademarked product. To transfer ownership of a trademark, the owner is also required to transfer everything else necessary for the new owner to produce a product or service indistinguishable from that produced by the former owner. Because the unpatented technical expertise must be separated from the acquiree or combined entity and sold if the related trademark is sold, it meets the separability criterion.
Unlike the contractual-legal criterion, restrictions on the sale, transfer, or exchange of an intangible
asset may preclude the asset from meeting the separability criterion. If agreements, laws, or statutes
prohibit the sale, transfer, license, rent, or exchange of an intangible asset, that asset does not meet the
separability criterion, although it could still meet the contractual-legal criterion.
4.10.1.3 Intangible Assets That Are Not Identifiable as of the Acquisition Date
ASC 805-20
55-7 The acquirer also subsumes into goodwill any value attributed to items that do not qualify as assets at
the acquisition date. For example, the acquirer might attribute value to potential contracts the acquiree is
negotiating with prospective new customers at the acquisition date. Because those potential contracts are
not themselves assets at the acquisition date, the acquirer does not recognize them separately from goodwill.
The acquirer should not subsequently reclassify the value of those contracts from goodwill for events that
occur after the acquisition date. However, the acquirer should assess the facts and circumstances surrounding
events occurring shortly after the acquisition to determine whether a separately recognizable intangible asset
existed at the acquisition date.
An acquirer might identify certain intangible assets acquired in a business combination that may
have value but do not meet either the separability or contractual-legal criterion. Thus, such assets are
subsumed into goodwill.
FASB Statement 141 includes the following examples of intangible assets that are
not identifiable (while ASC 805 did not carry
forward all of these examples, they continue to be
relevant):
-
Potential contracts that an acquiree is negotiating with prospective new customers as of the acquisition date, which is specifically addressed in ASC 805-20-55-7.
-
Customer base or unidentifiable customers — a group of customers that are not known or identifiable to the entity (e.g., customers of a fast-food franchise).
-
Assembled workforce, which is specifically addressed in ASC 805-20-55-6.
-
Customer service capacity.
-
A presence in geographic markets or in certain locations.
-
Status as a nonunion, or strong labor relations.
-
Training that is ongoing.
-
Recruitment programs.
-
Outstanding credit ratings.
-
Access to capital markets.
-
Favorable governmental relationships.
ASC 805-20-55-7 acknowledges that while potential contracts do not meet the criteria for separate
recognition as of the acquisition date and cannot be subsequently reclassified from goodwill for
events that occur after the acquisition date, the acquirer should “assess the facts and circumstances
surrounding events occurring shortly after the acquisition to determine whether a separately
recognizable intangible asset existed at the acquisition date.”
In a business combination, an intangible asset must be identifiable according to the specific criteria in ASC 805 to be recognized, but in an asset acquisition, it must only meet the asset recognition criteria in FASB Concepts Statement 5 to be recognized in accordance with
ASC 350-30-25-4. (See Section C.3.4
for more information.)
4.10.1.3.1 Assembled Workforce
ASC 805-20
Assembled Workforce and Other Items That Are Not Identifiable
55-6 The acquirer subsumes into goodwill the value of an acquired intangible asset that is not identifiable as of
the acquisition date. For example, an acquirer may attribute value to the existence of an assembled workforce,
which is an existing collection of employees that permits the acquirer to continue to operate an acquired
business from the acquisition date. An assembled workforce does not represent the intellectual capital of the
skilled workforce ― the (often specialized) knowledge and experience that employees of an acquiree bring
to their jobs. Because the assembled workforce is not an identifiable asset to be recognized separately from
goodwill, any value attributed to it is subsumed into goodwill.
An assembled workforce is an example of an intangible asset that is not identifiable and therefore not separately recognizable in a business combination. In paragraph B178 of the Basis for Conclusions of Statement 141(R), the FASB explains why an assembled workforce is not an identifiable intangible asset to be recognized separately from goodwill in a business combination:
Because an assembled workforce is a collection of employees rather than an individual employee, it does not
arise from contractual or legal rights. Although individual employees might have employment contracts with the
employer, the collection of employees, as a whole, does not have such a contract. In addition, an assembled
workforce is not separable, either as individual employees or together with a related contract, identifiable asset,
or liability. An assembled workforce cannot be sold, transferred, licensed, rented, or otherwise exchanged
without causing disruption to the acquirer’s business. In contrast, an entity could continue to operate after
transferring an identifiable asset.
By contrast, an assembled workforce meets the recognition criteria if it is
acquired in an asset acquisition, as discussed in
Section C.3.4.1.
4.10.2 Initial Measurement of Intangible Assets
ASC 805-20
55-9 The identifiability criteria determine whether an intangible asset is recognized separately from goodwill.
However, the criteria neither provide guidance for measuring the fair value of an intangible asset nor restrict
the assumptions used in measuring the fair value of an intangible asset. For example, the acquirer would
take into account the assumptions that market participants would use when pricing the intangible asset,
such as expectations of future contract renewals, in measuring fair value. It is not necessary for the renewals
themselves to meet the identifiability criteria. (However, see paragraph 805-20-30-20, which establishes an
exception to the fair value measurement principle for reacquired rights recognized in a business combination.)
Intangible assets acquired in a business combination are measured at their acquisition-date fair values
in accordance with the guidance in ASC 820 unless the intangible asset qualifies for an exception to
ASC 805’s fair value measurement principle (e.g., a reacquired right).
SEC Considerations
The SEC staff frequently asks registrants how they have assigned amounts to assets acquired
and liabilities assumed in business combinations. In particular, the staff asks registrants that
have recorded a significant amount of goodwill why they have not attributed value to identifiable
intangible assets. The staff also compares the disclosures provided in press releases, the
business section, and MD&A to the disclosures in the financial statements. For example, the
SEC staff may ask why a registrant did not recognize a customer-related intangible asset if its
MD&A discloses that it acquired customers in a business combination. In addition, the SEC staff
may ask detailed questions about (1) how a registrant determined that intangible assets would
have finite or indefinite useful lives, (2) the useful lives of identified intangible assets determined
to have finite useful lives, and (3) material revisions to the initial accounting for a business
combination, including what significant assumptions have changed to support a revision to the
value of intangible assets.
4.10.2.1 Use of the Residual Method to Value Intangible Assets
In the past, some entities used what was called the “residual method” for assigning fair value to certain intangible assets that, it was believed, could not be separately and directly valued. However, in EITF Topic D-108, the SEC staff indicated that this method is not acceptable. Topic D-108 states, in part:
The SEC staff is aware of instances in which registrants have asserted that certain intangible assets that arise
from legal or contractual rights cannot be separately and directly valued (hereinafter referred to as a “direct
value method”) because the nature of the particular asset makes it fundamentally indistinguishable from
goodwill in a business combination (for example, cellular/spectrum licenses, cable franchise agreements, and
so forth). . . .
The SEC staff notes that a fundamental distinction between other recognized intangible assets and goodwill is
that goodwill is both defined and measured as an excess or residual asset, while other recognized intangible
assets are required to be measured at fair value. The SEC staff does not believe that the application of the
residual method to the valuation of intangible assets can be assumed to produce amounts representing the
fair values of those assets. . . . Furthermore, the SEC staff notes that the same types of assets being valued
using the residual method by some entities are being valued using a direct value method by other entities.
Accordingly, the SEC staff believes the residual method should no longer be used to value intangible assets
other than goodwill.
4.10.3 Combining Intangible Assets Into a Single Unit of Account
ASC 805 does not provide any specific guidance on identifying the unit of account for tangible or
intangible assets, but it offers the following three examples of acquired assets that may be combined for
financial reporting:
- “[A] group of complementary assets such as a trademark (or service mark) and its related trade name, formulas, recipes, and technological expertise.” (See ASC 805-20-55-18.)
- A license to operate a nuclear power plant and a power plant. (See ASC 805-20-55-2(b).)
- An artistic-related copyright “and any related assignments or license agreements.” (See ASC 805-20-55-30.)
In each example, the individual assets cited have similar useful lives — a factor that supports combining
them for financial reporting. In addition, we believe that to ensure that their effect on financial reporting
is similar, only assets that have similar methods of amortization should be combined. Likewise, ASC
805-20-55-24 states that “[a] customer contract and the related customer relationship may represent
two distinct intangible assets” because “[b]oth the useful lives and the pattern in which the economic
benefits of the two assets are consumed may differ.” Determining whether it is appropriate to combine
intangible assets into a single unit of account requires considerable judgment. See Section 4.10.4.2.8 for
more information about the unit of account for customer-related intangible assets.
4.10.4 Examples of Identifiable Intangible Assets
The implementation guidance in ASC 805-20-55 lists intangible assets that are frequently recognized
in business combinations. In correspondence to the FASB staff dated August 16, 2001, then SEC Chief
Accountant Lynn Turner notes the following:
Appendix A of SFAS No. 141 indicates that the list of identifiable intangible assets is illustrative. The SEC staff
believes there is a rebuttable presumption that any intangible asset identified in the listing will be valued in
a purchase business combination. In its review of filings, the staff may look to such documentation as the
sales agreement, memorandums, presentations by the target to the buyer, minutes of the Board of Directors
Meetings, etc. for discussions and evidence of assets, including intangibles, being purchased.
While the SEC staff’s comments referred to FASB Statement 141, the list of
intangible assets it describes was carried forward
to ASC 805, and therefore the views expressed
remain applicable.
The list of examples in ASC 805-20 is not all-inclusive. Entities should also
consider the following when searching for the
presence of acquired intangible assets:
-
Other acquisitions by the acquirer in the same line of business.
-
Other acquisitions by companies in the same industry.
-
Historical financial statements of the acquired entity for disclosure, discussion, or both, of any previously recognized or unrecognized intangibles.
ASC 805-20-55-12 indicates that the identifiable intangible assets discussed in
ASC 805-20 are divided into two groups that are
designated as follows (emphasis added):
-
“Intangible assets designated with the symbol # are those that arise from contractual or other legal rights.”
-
“Those designated with the symbol * do not arise from contractual or other legal rights but are separable.”
The guidance also notes that “[i]ntangible assets designated with the symbol # might also be separable,
but separability is not a necessary condition for an asset to meet the contractual-legal criterion.”
The sections below discuss both types of identifiable intangible assets.
4.10.4.1 Marketing-Related Intangible Assets
Marketing-related intangible assets are “primarily used in the marketing or promotion of products or
services.” They are typically registered or protected through legal rights and, therefore, generally meet
the contractual-legal criterion for recognition separately as intangible assets. ASC 805-20-55-14 provides
the following examples of marketing-related intangible assets:
- Trademarks, trade names, service marks, collective marks, certification marks #
- Trade dress (unique color, shape, package design) #
- Newspaper mastheads #
- Internet domain names #
- Noncompetition agreements. #
4.10.4.1.1 Trademarks, Trade Names, Service Marks, Collective Marks, and Certification Marks
ASC 805-20
Trademarks, Trade Names, Service Marks, Collective Marks, Certification Marks
#
55-16 Trademarks are words, names, symbols, or other devices used in trade to indicate the source of a
product and to distinguish it from the products of others. A service mark identifies and distinguishes the source
of a service rather than a product. Collective marks identify the goods or services of members of a group.
Certification marks certify the geographical origin or other characteristics of a good or service.
55-17 Trademarks, trade names, service marks, collective marks, and certification marks may be protected
legally through registration with governmental agencies, continuous use in commerce, or by other means. If
it is protected legally through registration or other means, a trademark or other mark acquired in a business
combination is an intangible asset that meets the contractual-legal criterion. Otherwise, a trademark or other
mark acquired in a business combination can be recognized separately from goodwill if the separability
criterion is met, which normally it would be.
55-18 The terms brand and brand name, often used as synonyms for trademarks and other marks, are general
marketing terms that typically refer to a group of complementary assets such as a trademark (or service mark)
and its related trade name, formulas, recipes, and technological expertise. This Subtopic does not preclude an
entity from recognizing, as a single asset separately from goodwill, a group of complementary intangible assets
commonly referred to as a brand if the assets that make up that group have similar useful lives.
4.10.4.1.2 Internet Domain Names
ASC 805-20
Internet Domain Names #
55-19 An Internet domain name is a unique alphanumeric name that is used to identify a particular numeric
Internet address. Registration of a domain name creates an association between that name and a designated
computer on the Internet for the period of the registration. Those registrations are renewable. A registered
domain name acquired in a business combination meets the contractual-legal criterion.
4.10.4.1.3 Noncompetition Agreements
Noncompetition or “noncompete” agreements are legal agreements that prohibit or restrict one party
from competing against another party, typically in a defined market for a specified period. Noncompete
agreements of the acquiree that were in place before the business combination would meet the
contractual-legal criterion because such agreements arise from legal or contractual rights. The terms,
conditions, and enforceability of noncompete agreements affect the fair value of such agreements (e.g.,
in certain jurisdictions, noncompete agreements may be unenforceable as a matter of law and therefore
have little value) but not their recognition. Amounts assigned to noncompete agreements are generally
subject to amortization; however, determining the period of amortization is a matter of judgment, and all
terms of the agreement, including restrictions on its enforceability, should be considered.
The acquirer and the acquiree may also enter into noncompete agreements at the
time of the business combination. There are
differing views regarding whether such agreements
should be accounted for as part of the business
combination or whether they represent transactions
that are separate from the acquisition (see
Section 6.2). These differing views
are discussed in paragraph BC19 of ASU 2014-18,
which is based on a consensus of the PCC. It
states, in part:
[W]hile many
reporting entities and public accountants consider
noncompetition agreements to be part of most
business combinations, to other reporting entities
and public accountants, most noncompetition
agreements represent transactions separate from a
business combination. Noncompetition agreements
are not specifically discussed in the guidance on
determining what is part of a business combination
transaction. To date, however, the diversity in
practice has not resulted in significantly
different financial reporting outcomes. As a
result, the PCC and the Board decided not to
provide additional guidance to clarify whether
noncompetition agreements are part of a business
combination.
Connecting the Dots
If the acquirer is a private company or not-for-profit entity, it may elect to apply the accounting alternative for the
recognition of noncompetition agreements acquired in a business combination, which is
discussed in Chapter 8.
4.10.4.2 Customer-Related Intangible Assets
Customer-related intangible assets include, but are not limited to, customer contracts and related
customer relationships, noncontractual customer relationships, customer lists, order and production
backlogs, and customer loyalty programs. Entities may find it challenging to recognize and measure
these assets because in many cases, an acquiree’s relationship with a customer can encompass various
types of intangible assets (e.g., a customer contract and related relationship, a customer list, and a
backlog), which may be interrelated. The values assigned to other intangible assets, such as brand
names and trademarks, may also affect the valuation of customer-related intangible assets. Further, as
noted in ASC 805-25-55-24, because the useful lives and pattern in which the assets’ economic benefits
are consumed may differ, entities may need to recognize separately the intangible assets related to a single customer relationship. ASC 805-20-55-20 provides the following examples of customer-related
intangible assets:
- Customer lists *
- Order or production backlog #
- Customer contracts and related customer relationships #
- Noncontractual customer relationships. *
4.10.4.2.1 Valuation Techniques and Assumptions Used in Measuring Customer- Related Intangible Assets
Because of the absence of market transactions involving identical or comparable assets, it is often
difficult to use the market approach to measure the fair value of a customer-relationship intangible
asset. Likewise, the cost approach may not be appropriate. Therefore, in most cases, customer-related
intangible assets are measured by using an income approach.
At the 2003 AICPA Conference on Current SEC Developments, then SEC OCA
Professional Accounting Fellow Chad Kokenge stated
the following in prepared
remarks:
[T]he [cost] approach only focuses on the
entity’s specific costs that are necessary to
“establish” the relationship. Such an approach
would not be sensitive to the volume of business
that might be generated by the customer, other
relationship aspects, such as referral capability,
or other factors that may be important to how a
marketplace participant might assess the asset. If
these factors are significant, we believe the use
of such an approach would generally be
inconsistent with the . . . definition of fair
value.
In addition, in a statement at the 2006 AICPA Conference on Current SEC and
PCAOB Developments, then SEC OCA Professional
Accounting Fellow Joseph Ucuzoglu also
addressed
the valuation of customer-relationship intangible
assets in a business combination:
Some have suggested that the SEC
staff always requires the use of an income
approach to value customer relationship intangible
assets. The staff has even heard some suggest
that, as long as a registrant characterizes its
valuation method as an income approach, the
specific assumptions used or results obtained will
not be challenged by the staff, because one has
complied with a perceived bright line requirement
to use an income approach. Let me assure you,
these statements are simply false. While an income
approach often provides the most appropriate
valuation of acquired customer relationship
intangible assets, circumstances may certainly
indicate that a different method provides a better
estimate of fair value. On the flipside, even when
a registrant concludes that an income approach is
the most appropriate valuation methodology, the
staff may nevertheless question the result
obtained when the underlying assumptions, such as
contributory asset charges, do not appear
reasonable in light of the circumstances.
When determining the appropriate
valuation of a customer relationship intangible
asset, I believe that the first step in the
process should be to obtain a thorough
understanding of the value drivers in the acquired
entity. That is, why is it that customers
continually return to purchase products or
services from the acquired entity? In some cases,
the nature of the relationship may be such that
customers are naturally “sticky,” and tend to stay
with the same vendor over time without frequently
reconsidering their purchasing decisions. In that
circumstance, it would appear that a significant
portion of the ongoing cash flows that the
acquired entity will generate can be attributed to
the strength of its customer relationships.
At the other end of the
spectrum, relationships may be a less significant
value driver in an environment where customers
frequently reassess their purchasing decisions and
can easily switch to another vendor with a lower
price or a superior product. In that environment,
if customers continually return to buy products
from the acquired entity, perhaps they do so in
large part due to factors other than the
relationship, such as a well-know[n] tradename,
strong brands, and proprietary technologies. As a
result, the value of the customer relationship
intangible asset may be less than would be the
case in a circumstance where the relationship is
stronger. However, the staff would generally
expect that the amount attributed to other
intangible assets would be commensurately higher,
reflecting the increasingly important role of
those assets in generating cash flows.
4.10.4.2.2 Customer Lists
ASC 805-20
Customer Lists *
55-21 A customer list consists of information about customers, such as their names and contact information. A
customer list also may be in the form of a database that includes other information about the customers, such
as their order histories and demographic information. A customer list generally does not arise from contractual
or other legal rights. However, customer lists are frequently leased or exchanged. Therefore, a customer list
acquired in a business combination normally meets the separability criterion.
There is often an active market for customer information, referred to as customer lists, which an entity
may receive regarding the acquiree’s customers. Such information is generally deemed to be separable
if there are no terms of confidentiality or restrictions on selling, leasing, or otherwise exchanging it, even
if the entity has no intention of doing so.
However, if the terms of confidentiality or restrictions on the sale or transfer
of customer lists prohibit a company from selling,
leasing, or otherwise exchanging a noncontractual
customer list, the separability criterion would
not be met and an intangible asset would not be
recognized apart from goodwill. While most
entities will possess some information about their
customers, thereby establishing the presence of a
customer-list intangible asset, the specific
information possessed and the resulting value of
this asset will vary.
The decision tree below is intended to help an
entity evaluate the criteria related to the
recognition apart from goodwill of a customer-list
intangible asset.
4.10.4.2.3 Order or Production Backlog
ASC 805-20
Order or Production Backlog #
55-22 An order or production backlog arises from contracts such as purchase or sales orders. An order or
production backlog acquired in a business combination meets the contractual-legal criterion even if the
purchase or sales orders are cancelable.
An order or production backlog acquired in a business combination meets the contractual-legal criterion
even if the purchase or sales orders are cancelable. However, the fact that a contract is cancelable may
affect the fair value measurement of the associated intangible asset.
4.10.4.2.4 Customer Contracts and Customer Relationships
ASC 805-20
Customer Contracts and the Related Customer Relationships #
55-23 If an entity establishes relationships with its customers through contracts, those customer relationships
arise from contractual rights. Therefore, customer contracts and the related customer relationships acquired
in a business combination meet the contractual-legal criterion, even if confidentiality or other contractual terms
prohibit the sale or transfer of a contract separately from the acquiree.
55-24 A customer contract and the related customer relationship may represent two distinct intangible assets.
Both the useful lives and the pattern in which the economic benefits of the two assets are consumed may
differ.
55-25 A customer relationship exists between an entity and its customer if the entity has information about
the customer and has regular contact with the customer, and the customer has the ability to make direct
contact with the entity. Customer relationships meet the contractual-legal criterion if an entity has a practice
of establishing contracts with its customers, regardless of whether a contract exists at the acquisition date.
Customer relationships also may arise through means other than contracts, such as through regular contact by
sales or service representatives. As noted in paragraph 805-20-55-22, an order or a production backlog arises
from contracts such as purchase or sales orders and therefore is considered a contractual right. Consequently,
if an entity has relationships with its customers through these types of contracts, the customer relationships
also arise from contractual rights and therefore meet the contractual-legal criterion.
Noncontractual Customer Relationships *
55-27 A customer relationship acquired in a business combination that does not arise from a contract may
nevertheless be identifiable because the relationship is separable. Exchange transactions for the same asset
or a similar asset that indicate that other entities have sold or otherwise transferred a particular type of
noncontractual customer relationship would provide evidence that the noncontractual customer relationship is
separable. For example, relationships with depositors are frequently exchanged with the related deposits and
therefore meet the criteria for recognition as an intangible asset separately from goodwill.
Customer relationships (both contractual and noncontractual) are recognized separately from goodwill
only if they exist as of the acquisition date. If the acquiree routinely signs contracts with its customers
(e.g., sales and purchase orders), the acquirer would recognize separate intangible assets for the
following:
- Customer contracts that exist as of the acquisition date.
- Customer relationships that exist as of the acquisition date, regardless of whether a contract exists on that date.
Although ASC 805 does not define the term “contractual,” it indicates that both of the above items would
satisfy the contractual-legal criterion. Therefore, the absence of enforceable rights by the parties to a
particular arrangement does not preclude recognition. The SEC staff has historically agreed with this
view.
In addition, while a noncontractual customer relationship may not be separable
by itself, it may be separable along with another
identifiable asset, liability, or contract — such
as a sales representative’s contract or a brand,
trademark, or product line — even if management
has no intention of separating it. In that case,
the customer relationship would meet the
separability criterion. ASC 805-20-55-25 provides
the following three criteria that may indicate
that a relationship exists between an entity and
its customer:
-
The acquired entity maintains current customer information.
-
The acquired entity contacts its customers regularly.
-
Customers can directly contact the acquired entity.
ASC 805 nullified EITF Issue 02-17 but carried forward the EITF’s prior decisions about customer contracts and related customer relationships. Issue 02-17 offered the
following illustration, which is still considered
relevant under the guidance in ASC 805:
Company X acquires Company Y in a
business combination on December 31, 20X2. Company
Y does business with its customers solely through
purchase and sales orders. At December 31, 20X2,
Company Y has a backlog of customer purchase
orders in-house from 60 percent of its customers,
all of whom are recurring customers. The other 40
percent of Company Y’s customers are also
recurring customers; however, as of December 31,
20X2, Company Y does not have any open purchase
orders, or other contracts, with those
customers.
Evaluation: The purchase orders from 60
percent of Company Y’s customers (whether
cancelable or not) meet the contractual-legal
criterion and, therefore, must be recorded at fair
value apart from goodwill. Additionally, since
Company Y has established its relationship with 60
percent of its customers through a contract, those
customer relationships meet the contractual-legal
criterion and must also be recorded at fair value
apart from goodwill.
Because Company Y has a practice of establishing
contracts with the remaining 40 percent of its
customers, those customer relationships also arise
through contractual rights and, therefore, meet
the contractual-legal criterion. Company X must
record the customer relationship for the remaining
40 percent of Company Y’s customers at fair value
apart from goodwill, even though Company Y does
not have contracts with those customers at
December 31, 20X2.
Connecting the Dots
If the acquirer is a private company or not-for-profit entity, it may elect to apply the accounting alternative for the
recognition of certain customer-related intangible assets acquired in a business combination,
which are discussed in Chapter 8.
The following cases from ASC 805-20-55-53 through 55-57 illustrate the
recognition of customer-contract and customer-relationship intangible
assets acquired in a business combination:
ASC 805-20
55-53 In each of the Cases, the Acquirer acquires Target in a business combination on December 31, 20X5.
Case A: Five-Year Supply Agreement
55-54 Target has a five-year agreement to supply goods to Customer. Both Target and Acquirer believe that
Customer will renew the agreement at the end of the current contract. The agreement is not separable. The
agreement, whether cancelable or not, meets the contractual-legal criterion. Additionally, because Target
establishes its relationship with Customer through a contract, not only the agreement itself but also Target’s
customer relationship with Customer meet the contractual-legal criterion.
Case B: One Customer, Contract in One of Two Lines of Business
55-55 Target manufactures goods in two distinct lines of business: sporting goods and electronics. Customer
purchases both sporting goods and electronics from Target. Target has a contract with Customer to be its
exclusive provider of sporting goods but has no contract for the supply of electronics to Customer. Both
Target and Acquirer believe that only one overall customer relationship exists between Target and Customer.
The contract to be Customer’s exclusive supplier of sporting goods, whether cancelable or not, meets the
contractual-legal criterion. Additionally, because Target establishes its relationship with Customer through a
contract, the customer relationship with Customer meets the contractual-legal criterion. Because Target has
only one customer relationship with Customer, the fair value of that relationship incorporates assumptions
about Target’s relationship with Customer related to both sporting goods and electronics. However, if
Acquirer determines that the customer relationships with Customer for sporting goods and for electronics are
separate from each other, Acquirer would assess whether the customer relationship for electronics meets the
separability criterion for identification as an intangible asset.
Case C: Purchase and Sales Orders
55-56 Target does business with its customers solely through purchase and sales orders. At December 31,
20X5, Target has a backlog of customer purchase orders from 60 percent of its customers, all of whom are
recurring customers. The other 40 percent of Target’s customers also are recurring customers. However, as of
December 31, 20X5, Target has no open purchase orders or other contracts with those customers. Regardless
of whether they are cancelable or not, the purchase orders from 60 percent of Target’s customers meet the
contractual-legal criterion. Additionally, because Target has established its relationship with 60 percent of its
customers through contracts, not only the purchase orders but also Target’s customer relationships meet
the contractual-legal criterion. Because Target has a practice of establishing contracts with the remaining
40 percent of its customers, its relationship with those customers also arises through contractual rights
and therefore meets the contractual-legal criterion even though Target does not have contracts with those
customers at December 31, 20X5.
Case D: Cancelable Contracts
55-57 Target has a portfolio of one-year motor insurance contracts that are cancelable by policyholders.
Because Target establishes its relationships with policyholders through insurance contracts, the customer
relationship with policyholders meets the contractual-legal criterion. The guidance in Subtopic 350-30 applies
to the customer relationship intangible asset.
4.10.4.2.5 Customer Loyalty Programs
Customer loyalty programs generally allow customers to earn current or future discounts, free products
or services, or other benefits on the basis of cumulative purchases from the operator of the program.
Many airlines, casinos, hotels, and retailers offer such programs. Typically, a program’s enrollment
process is designed to be easy for customers to complete, with the participants agreeing to the terms
and conditions of the program at the time of enrollment. Participants in such programs usually have no obligation to complete future purchases of products or services, and operators of such programs
generally reserve the right to modify or cancel the program at any time.
Despite the absence of enforceable rights between the parties regarding future
purchases or the fulfillment of accrued benefits,
such loyalty program arrangements are deemed to
meet the contractual-legal criterion because the
parties have agreed to certain terms and
conditions or had a previous contractual
relationship, or both. Any liability accruals, or
revenue deferrals, by the operator would also
indicate that the arrangement is “contractual.” In
addition to evaluating the recognition and
measurement of an acquired customer-related
intangible asset, an acquirer must separately
evaluate the recognition and measurement of
assumed liabilities related to the acquiree’s
customer loyalty program as of the acquisition
date.
4.10.4.2.6 Overlapping Customers
An acquirer and acquiree may have relationships with the same customers, sometimes referred to
as overlapping customers. If the acquired customer relationship is identifiable, the acquirer should
recognize an intangible asset. When estimating the fair value of the acquired relationship, the acquirer
must use assumptions that market participants would make about their ability to generate incremental
cash flows from these relationships.
In prepared remarks at the 2005 AICPA
Conference on SEC and PCAOB Developments, then SEC
OCA Professional Accounting Fellow Pamela
Schlosser offered the following example, which
discussed a scenario in which overlapping
customers would provide value to the acquirer:
Company A, which sells apparel
products to retail customers, acquires Company B,
which sells toy products to those same retail
customers. The question is: at what amount the
customer relationships of Company B should be
recognized, considering the fact that Company A
already had relationships with those very same
customers, albeit for different product sales?
Some have argued that in
this situation, no value should be attributed to
these intangible assets since Company A already
sold its products to Company B’s customer base,
and thus already had pre-established relationships
with them. However, we have found this argument
difficult to accept. Because of the acquisition,
Company A now has the ability to sell new products
(that is, toy products) to its retail customers
that it was unable to sell prior to the
acquisition of Company B. And even if the two
companies sold competing products to the same
retail customers, for instance both sold toy
products, the fact that Company A has increased
its “shelf space” at each of its customers’ retail
locations would be indicative of value to those
relationships.
In the SEC staff’s view, an acquired customer relationship that overlaps an
existing customer relationship has value because
it gives the acquirer the ability to generate
incremental cash flows; for example, an acquirer
can sell new products to the customer or increase
its “shelf space” with the customer. That value
may also be reflected in the recognition of other
intangible assets, such as trade names, that drive
customer loyalty. The SEC staff also indicated
that the most appropriate approach to valuing the
intangible asset would generally be an income
approach based on the benefits of incremental
sales to those customers.
4.10.4.2.7 Customer Base
A customer base is a group of customers, also referred to as walk-up customers,
that are not known or identifiable to the company.
For example, customers who make purchases from
newsstands or fast food restaurants may be loyal,
repeat customers, but often specific demographic
data on those customers is not maintained in such
a way that the separability criterion would be
met. However, if information about the customers
is obtained, a customer base may give rise to a
customer list or customer loyalty program. For
example, even just basic contact information about
a customer, such as name and address or telephone
number, may constitute a customer list.
4.10.4.2.8 Unit of Account for Customer-Related Intangible Assets
Customer-related intangible assets can pose challenging unit of account issues that require the use of
judgment. One issue is that if an acquiree’s relationship with a single customer gives rise to multiple
customer-related intangible assets (e.g., customer relationships, customer contracts, customer lists, or
backlog), questions may arise about whether different customer-related intangible assets pertaining
to the same customer should be recognized separately or as a single unit of account. As noted in
Section 4.10.3, we believe that to be combined for financial reporting, assets should have similar useful
lives and methods of amortization.
Another unit of account issue can occur if numerous customer-related intangible
assets with different customers are acquired. In
practice, customer-related intangible assets with
different customers but with similar
characteristics are frequently aggregated into
pools for recognition and measurement. Entities
must apply judgment in determining which
characteristics make the customers similar.
Subsequent useful life determinations and methods of amortization might differ
among pools. ASC 350-30 provides additional
guidance on subsequently measuring and accounting
for assets acquired in a business combination (see
Section 4.10.5).
4.10.4.3 Artistic-Related Intangible Assets
ASC 805-20
55-30 Artistic-related assets acquired in a business combination are identifiable if they arise from contractual
or legal rights such as those provided by copyright. The holder can transfer a copyright, either in whole through
an assignment or in part through a licensing agreement. An acquirer is not precluded from recognizing a
copyright intangible asset and any related assignments or license agreements as a single asset, provided they
have similar useful lives.
ASC 805-20-55-29 provides the following examples of artistic-related intangible assets:
- Plays, operas, ballets #
- Books, magazines, newspapers, other literary works #
- Musical works such as compositions, song lyrics, advertising jingles #
- Pictures, photographs #
- Video and audiovisual material, including motion pictures or films, music videos, television programs. #
4.10.4.4 Contract-Based Intangible Assets
ASC 805-20
55-31 Contract-based
intangible assets represent the value of rights
that arise from contractual arrangements. Customer
contracts are one type of contract-based
intangible asset. If the terms of a contract give
rise to a liability (for example, if the terms of
an operating lease or customer contract are
unfavorable relative to market terms), the
acquirer recognizes it as a liability assumed in
the business combination. . . .
As stated in ASC 805-20-55-31, “[c]ontract-based intangible assets represent the value of rights that
arise from contractual arrangements.” Contracts with terms that are favorable relative to market terms
give rise to contract-based intangible assets, and contracts with terms that are unfavorable relative to
market terms give rise to a liability assumed in the business combination (see additional discussion in
Section 4.10.4.4.5).
ASC 805-20-55-31 also provides the following examples of contract-based
intangible assets:
-
Licensing, royalty, standstill agreements #
-
Advertising, construction, management, service or supply contracts #
-
Operating lease agreements of a lessor #
-
Construction permits #
-
Franchise agreements #
-
Operating and broadcast rights #
-
Servicing contracts such as mortgage servicing contracts #
-
Employment contracts #
-
Use rights such as drilling, water, air, timber cutting, and route authorities. #
4.10.4.4.1 Franchise Agreements
A franchise agreement is a contractual arrangement through which a franchisor grants a franchisee the
right to operate a franchised outlet for a specified period. The purpose of the agreement is to distribute
a product or service, or an entire business concept, within a particular market area. A franchise
agreement of the acquiree that has terms that are favorable relative to market terms gives rise to
contract-based intangible assets, whereas an agreement that has terms that are unfavorable relative
to market terms gives rise to a liability assumed in the business combination. In addition, there may be
other intangible assets that an acquirer should recognize (e.g., customer lists or customer contracts and
related customer-relationship intangible assets).
4.10.4.4.2 Servicing Contracts Such as Mortgage Servicing Contracts
ASC 805-20
Servicing Contracts Such as Mortgage Servicing Contracts #
55-33 Contracts to service financial assets are one type of contract-based intangible asset. Although servicing is
inherent in all financial assets, it becomes a distinct asset or liability by either of the following:
- If the transfer of the servicer’s financial assets met the requirements for sale accounting
- Through the separate acquisition or assumption of a servicing obligation that does not relate to financial assets of the combined entity.
55-34 Topic 860 provides guidance on accounting for servicing contracts.
55-35 If mortgage loans, credit card receivables, or other financial assets are acquired in a business
combination with the servicing obligation, the inherent servicing rights are not a separate intangible asset
because the fair value of those servicing rights is included in the measurement of the fair value of the acquired
financial asset.
The ASC master glossary defines a servicing asset as “[a] contract to service financial assets under which
the benefits of servicing are expected to more than adequately compensate the servicer for performing
the servicing. A servicing contract is either: [(a)] [u]ndertaken in conjunction with selling or securitizing the
financial assets being serviced [or (b)] [p]urchased or assumed separately.” Further, ASC 860-50-05-3
states that contracts to service financial assets may include the following:
- Collecting principal, interest, and escrow payments from borrowers
- Paying taxes and insurance from escrowed funds
- Monitoring delinquencies
- Executing foreclosure if necessary
- Temporarily investing funds pending distribution
- Remitting fees to guarantors, trustees, and others providing services
- Accounting for and remitting principal and interest payments to the holders of beneficial interests or participating interests in the financial assets.
Although servicing is inherent in all financial assets, it is not recognized as
a separate intangible asset unless (1) the
underlying financial assets (e.g., receivables)
are sold or securitized and the servicing contract
is retained by the seller or (2) the servicing
contract is separately purchased or assumed.
4.10.4.4.3 Employment Contracts
ASC 805-20
Employment Contracts #
55-36 Employment contracts that are beneficial contracts from the perspective of the employer because the
pricing of those contracts is favorable relative to market terms are one type of contract-based intangible asset.
Employment contracts, including collective bargaining agreements, meet the contractual-legal criterion
for recognition apart from goodwill as intangible assets (or, in some circumstances, liabilities). When
valuing an employment contract, an entity should consider whether there are any favorable or
unfavorable contract elements and any inherent fair value related to the price that a market participant
would pay for an at-market employment contract. In practice, little value is often attributed to at-market
employment contracts because employees often give relatively short notice of their intention to leave
their job and the employment contracts are often not enforced. In addition, while an employment
contract may be perceived to be above or below market from the employer’s perspective (i.e., the pricing
of the contract is favorable or unfavorable relative to market terms), an entity may find it challenging
to measure such an asset or liability because of the difficulty of substantiating market compensation
for specific employees. Therefore, it is unusual for an acquirer to recognize an asset or liability for an
off-market employment contract. The value of an employment contract should be recognized separately
from the value of a noncompete agreement (see Section 4.10.4.1.3).
4.10.4.4.4 Use Rights
ASC 805-20
Use Rights #
55-37 Use rights such as drilling, water, air, timber cutting, and route authorities are contract-based intangible
assets to be accounted for separately from goodwill. Particular use rights may have characteristics of tangible,
rather than intangible, assets. For example, mineral rights are tangible assets. An acquirer should account for
use rights based on their nature.
Use rights are contract-based intangible assets. Certain use rights are
tangible, rather than intangible, assets. An acquirer should account for use rights on the basis of their
nature. For example, mineral rights, which are legal rights to explore, extract, and retain all or a portion
of mineral deposits, are tangible assets (see Section 4.8.2).
4.10.4.4.5 Executory Contracts
An executory contract is a contract that remains wholly unperformed or for which there remains
something to be done by either or both parties to the contract. Examples of executory contracts include
purchase and supply contracts, franchise agreements, service contracts, and licensing arrangements.
Because executory contracts arise from contractual rights, they are identifiable intangible assets. While
an executory contract acquired or assumed in a business combination is required to be recognized at its
fair value unless it is subject to an exception (e.g., a reacquired right), most executory contracts do not
have significant fair value unless they are favorable (or unfavorable) compared with the market terms for
the same or similar items as of the acquisition date or they have inherent fair value related to the price
that a market participant would to pay for an in-place, at-market contract.
4.10.4.5 Technology-Based Intangible Assets
Technology-based intangible assets generally represent innovations on products or services but can
also include collections of information held electronically. Many innovations and technological advances
are protected by contractual or other legal rights, such as patents and copyrights, and therefore meet
the contractual-legal criterion. ASC 805-20-55-38 provides the following examples of technology-based
intangible assets:
- Patented technology #
- Computer software and mask works #
- Unpatented technology *
- Databases, including title plants *
- Trade secrets, such as secret formulas, processes, recipes. #
4.10.4.5.1 Patented Technology, Unpatented Technology, and Trade Secrets
Patented technology is protected legally and, therefore, meets the contractual-legal criterion for
separate recognition as an intangible asset. Unpatented technology is typically not protected by legal or
contractual means and therefore does not meet the contractual-legal criterion. Unpatented technology,
however, is often sold in conjunction with other intangible assets, such as trade names or secret
formulas. If it can be sold with a related asset, the unpatented technology would meet the separability
criterion. However, the fact that the technology is unpatented may affect its fair value measurement.
4.10.4.5.2 Computer Software and Mask Works
ASC 805-20
Computer Software and Mask Works #
55-40 Computer software and program formats acquired in a business combination that are protected legally,
such as by patent or copyright, meet the contractual-legal criterion for identification as intangible assets.
55-41 Mask works are software permanently stored on a read-only memory chip as a series of stencils or
integrated circuitry. Mask works may have legal protection. Mask works with legal protection that are acquired
in a business combination meet the contractual-legal criterion for identification as intangible assets.
ASC 805-20-55-40 states that “[c]omputer software and program formats acquired in a business
combination that are protected legally, such as by patent or copyright, meet the contractual-legal
criterion for identification as intangible assets.” However, even software and program formats not
protected by patent or copyright may meet the separability criterion if they can be separated or divided from the acquiree (individually or combined with a related identifiable asset, liability, or contract) and
sold, transferred, licensed, rented, or exchanged.
4.10.4.5.3 Databases, Including Title Plants
ASC 805-20
Databases, Including Title Plants
55-42 Databases are collections of information, often stored in electronic form, such as on computer disks or
files. A database that includes original works of authorship may be entitled to copyright protection. A database
acquired in a business combination that is protected by copyright meets the contractual-legal criterion.
However, a database typically includes information created as a consequence of an entity’s normal operations,
such as customer lists, or specialized information, such as scientific data or credit information. Databases that
are not protected by copyright can be, and often are, exchanged, licensed, or leased to others in their entirety
or in part. Therefore, even if the future economic benefits from a database do not arise from legal rights, a
database acquired in a business combination meets the separability criterion.
55-43 Title plants constitute a historical record of all matters affecting title to parcels of land in a particular
geographical area. Title plant assets are bought and sold, either in whole or in part, in exchange transactions or
are licensed. Therefore, title plant assets acquired in a business combination meet the separability criterion.
While a database acquired in a business combination that is protected by copyright would meet
the contractual-legal criterion, databases that are not protected by copyright can be, and often are,
exchanged, licensed, or leased to others in their entirety or in part. Such databases acquired in a
business combination meet the separability criterion even if they do not arise from contractual rights
unless there is a restriction on their transfer or exchange.
ASC 805-20-55-43 defines title plant as “[a] historical record of all matters
affecting title to parcels of land in a particular
geographical area.” The number of years covered by
a title plant varies depending on regulatory
requirements and the minimum information period
considered necessary to issue title insurance
policies efficiently. Because title plant assets
are bought and sold (either in whole or in part)
in exchange transactions or are licensed, they
meet the separability criterion unless there is a
restriction on their transfer or exchange.
4.10.4.5.4 Trade Secrets Such as Secret Formulas, Processes, and Recipes
ASC 805-20
Trade Secrets Such as Secret Formulas, Processes, Recipes #
55-44 A trade secret is
“information, including a formula, pattern,
recipe, compilation, program, device, method,
technique, or process that (1) derives independent
economic value, actual or potential, from not
being generally known and (2) is the subject of
efforts that are reasonable under the
circumstances to maintain its secrecy,” according
to The New Role of Intellectual Property in
Commercial Transactions (Simensky and Breyer
1998).
55-45 If the future economic benefits from a trade secret acquired in a business combination are legally
protected, that asset meets the contractual-legal criterion. Otherwise, trade secrets acquired in a business
combination are identifiable only if the separability criterion is met, which is likely to be the case.
Antipiracy laws or regulations frequently exist to protect trade secrets and other intellectual property.
Even a trade secret that is not protected by laws or regulations would generally be recognized as an
intangible asset apart from goodwill if the separability criterion was met, which is likely to be the case.
However, the value of such a trade secret might be adversely affected by the lack of legal or regulatory
protection.
4.10.4.6 Examples of Intangible Assets by Industry
While some intangible assets, such as customer
relationships and trade names, are common in
various industries, others are specific to
particular industries. The table below provides
examples of intangible assets that may exist in
certain industries. Intangible assets should be
identified on the basis of the facts and
circumstances of each transaction.
Intangible Assets Associated With Certain Industries | |
---|---|
Asset
Management
|
Banking
|
|
|
Credit
Card Issuers
|
Consumer
Products
|
|
|
Energy
|
Entertainment and Media
|
|
|
Insurance
|
Pharmaceuticals
|
|
|
Real
Estate
|
Technology
|
|
|
Telecommunications
|
|
|
4.10.4.7 R&D Assets
Under ASC 805 and ASC 350, an acquirer recognizes all tangible and intangible
R&D assets acquired in a business combination
(e.g., IPR&D) at fair value as of the
acquisition date and subsequently accounts for
them as indefinite-lived intangible assets until
completion or abandonment of the associated
R&D efforts. An acquirer recognizes and
measures such assets independently of (1) whether
the acquiree had previously capitalized any
amounts related to its R&D activities or (2)
the amounts previously expended by the acquiree in
connection with those activities.
An acquirer recognizes tangible and intangible assets that result from, or are
to be used in, R&D activities as assets
regardless of whether the acquired assets have an
alternative future use. Acquired IPR&D assets
must be measured at their acquisition-date fair
values. Uncertainty about the outcome of an
individual project does not affect the recognition
of IPR&D but does affect its fair value
measurement. Even though the guidance describes
R&D as a single asset, ASC 730 defines the
terms “research” and “development” separately, as
follows:
Research is planned
search or critical investigation aimed at
discovery of new knowledge with the hope that such
knowledge will be useful in developing a new
product or service (referred to as product) or a
new process or technique (referred to as process)
or in bringing about a significant improvement to
an existing product or process.
Development is the
translation of research findings or other
knowledge into a plan or design for a new product
or process or for a significant improvement to an
existing product or process whether intended for
sale or use. It includes the conceptual
formulation, design, and testing of product
alternatives, construction of prototypes, and
operation of pilot plants.
ASC 730-10-55-1 lists examples of activities that are within the scope of ASC
730, and ASC 730-10-55-2 notes those that are
not.
ASC 730-10
Examples of Activities Typically Included in Research and Development
55-1 The following activities typically would be considered research and development within the scope of this
Topic (unless conducted for others under a contractual arrangement — see paragraph 730-10-15-4[a]):
- Laboratory research aimed at discovery of new knowledge
- Searching for applications of new research findings or other knowledge
- Conceptual formulation and design of possible product or process alternatives
- Testing in search for or evaluation of product or process alternatives
- Modification of the formulation or design of a product or process
- Design, construction, and testing of preproduction prototypes and models
- Design of tools, jigs, molds, and dies involving new technology
- Design, construction, and operation of a pilot plant that is not of a scale economically feasible to the entity for commercial production
- Engineering activity required to advance the design of a product to the point that it meets specific functional and economic requirements and is ready for manufacture
- Design and development of tools used to facilitate research and development or components of a product or process that are undergoing research and development activities.
Examples of Activities Typically Excluded From Research and Development
55-2 The following activities typically would not be considered research and development within the scope of
this Topic:
- Engineering follow-through in an early phase of commercial production
- Quality control during commercial production including routine testing of products
- Trouble-shooting in connection with break-downs during commercial production
- Routine, ongoing efforts to refine, enrich, or otherwise improve upon the qualities of an existing product
- Adaptation of an existing capability to a particular requirement or customer’s need as part of a continuing commercial activity
- Seasonal or other periodic design changes to existing products
- Routine design of tools, jigs, molds, and dies
- Activity, including design and construction engineering, related to the construction, relocation, rearrangement, or start-up of facilities or equipment other than the following:
- Pilot plants (see [h] in the preceding paragraph)
- Facilities or equipment whose sole use is for a particular research and development project (see paragraph 730-10-25-2[a]).
- Legal work in connection with patent applications or litigation, and the sale or licensing of patents.
R&D activities are only considered to be within the scope of ASC 730 if they are not “conducted for
others under a contractual arrangement.” If R&D activities are conducted for others under a contractual
arrangement, the costs should not be recognized as part of the acquired IPR&D.
If an entity acquires IPR&D in a business combination that it intends to use
in a manner other than its highest and best use
(e.g., it has plans to discontinue the R&D
project after the acquisition even though a
marketplace participant would continue the R&D
efforts), it would still be required to recognize
an intangible asset at fair value for the
IPR&D (see Section
4.9).
The guidance in ASC 805 does not affect the accounting for R&D expenditures
incurred outside of a business combination.
Therefore, if R&D costs related to an acquired
IPR&D project are incurred after the
acquisition date, an acquirer would expense them
in accordance with ASC 730, unless they have an
alternative future use.
Also, see Section
C.3.4.2 for information about
accounting for IPR&D acquired in an asset
acquisition.
Once complete, R&D projects may become other identifiable assets such as
patents, formulas, trade secrets, or
blueprints.
The AICPA Accounting & Valuation Guide Assets Acquired to Be Used in
Research and Development Activities outlines
best practices for the recognition and measurement
of IPR&D assets acquired in a business
combination or an asset acquisition. While the
guide focuses primarily on the software,
electronic devices, and pharmaceutical industries,
it is a useful reference for recognizing and
measuring acquired IPR&D assets in all
industries. The guide indicates that both of the
following conditions must be met for an IPR&D
asset to be recognized in a business combination:
-
The acquired asset (whether tangible or intangible) meets the definition of an asset on the acquisition date and is part of what the acquirer and acquiree exchanged in the business combination.
-
There is persuasive evidence that the specific IPR&D project has substance and is incomplete.
If the acquired IPR&D asset does not meet both of those criteria, it does not qualify for recognition.
However, even if the acquired asset does not qualify as IPR&D, it may still be recognized in the business
combination. For example, if a project has substance but is complete, the IPR&D may represent another
identifiable intangible asset such as a patent, formula, trade secret, or blueprint.
4.10.4.8 Defensive Intangible Assets
ASC 350-30
Defensive Intangible Assets
55-1 This implementation guidance addresses the determination of whether or not an intangible asset meets
the definition of a defensive intangible asset. A defensive intangible asset could include any of the following:
- An asset that the entity will never actively use
- An asset that will be used by the entity during a transition period when the intention of the entity is to discontinue the use of that asset.
55-1B The determination of whether an intangible asset is a defensive intangible asset is based on the
intentions of the reporting entity and that determination may change as the reporting entity’s intentions
change. For example, an intangible asset that was accounted for as a defensive intangible asset on the date
of acquisition will cease to be a defensive asset if the entity subsequently decides to actively use the asset).
Examples 9C and 9D (see paragraphs 350-30-55-28G through 55-28L) illustrate the determination of whether
an acquired intangible asset is a defensive intangible asset.
Sometimes, an entity may acquire an asset that it either does not intend to use or intends to use in a
manner other than its highest and best use. Such an asset is commonly called a defensive intangible
asset, which the ASC master glossary defines as “[a]n acquired intangible asset in a situation in which an
entity does not intend to actively use the asset but intends to hold (lock up) the asset to prevent others
from obtaining access to the asset.” For example, an entity may decide not to use the acquired trade
name of a competitor but intend to keep the name (rather than sell it) solely to prevent others from
using it. In this case, the asset is determined to have value to the acquirer albeit in a defensive manner
(i.e., by denying others access to its use). When measuring the fair value of a defensive intangible asset
in accordance with ASC 820, an acquirer should assume its highest and best use by market participants.
The implementation guidance in ASC 350-30-55 provides examples of defensive
intangible assets:
ASC 350-30
Example 9C: Trade Name
55-28H Entity A, a consumer products manufacturer, acquires an entity that sells a product that competes
with one of Entity A’s existing products. Entity A plans to discontinue the sale of the competing product within
the next six months, but will maintain the rights to the trade name, at minimal expected cost, to prevent a
competitor from using the trade name. As a result, Entity A’s existing product is expected to experience an
increase in market share. Entity A does not have any current plans to reintroduce the acquired trade name in
the future.
55-28I Because Entity A does not intend to actively use the acquired trade name, but intends to hold the rights
to the trade name to prevent others from using it, the trade name meets the definition of a defensive intangible
asset.
Example 9D: Internally Developed Software
55-28K Entity A acquires a group of assets, one of which is billing software developed by the selling entity for its
own use. After a six month transition period, Entity A plans to discontinue use of the internally developed billing
software. In valuing the billing software in connection with the acquisition, Entity A determines that a market
participant would use the billing software, along with other assets in the asset group, for its full remaining
economic life — that is, Entity A does not intend to use the asset in a way that is at its highest and best use.
Due to the specialized nature of the software, Entity A does not believe the software could be sold to a third
party without the other assets acquired.
55-28L Although Entity A does not intend to actively use the internally developed billing software after a six
month transition period, Entity A is not holding the internally developed software to prevent others from using
it. Therefore, the internally developed software asset does not meet the definition of a defensive intangible
asset.
4.10.4.8.1 Subsequent Accounting for Defensive Intangible Assets
ASC 350-30
Defensive Intangible Assets
25-5 A defensive intangible asset, other than an intangible asset that is used in research and development
activities, shall be accounted for as a separate unit of accounting. Such a defensive intangible asset shall
not be included as part of the cost of an entity’s existing intangible asset(s). For implementation guidance
on determining whether an intangible asset is a defensive intangible asset, see paragraph 350-30-55-1. For
guidance on intangible assets acquired in a business combination or in an acquisition by a not-for-profit
entity that are used in research and development activities (regardless of whether they have an alternative
future use), see paragraph 350-30-35-17A. For guidance on intangibles that are purchased from others for a
particular research and development project and that have no alternative future uses (in other research and
development projects or otherwise), see Subtopic 730-10.
35-5A This guidance addresses
the application of paragraphs 350-30-35-1 through
35-4 to a defensive intangible asset other than an
intangible asset that is used in research and
development activities. A defensive intangible
asset shall be assigned a useful life that
reflects the entity’s consumption of the expected
benefits related to that asset. The benefit a
reporting entity receives from holding a defensive
intangible asset is the direct and indirect cash
flows resulting from the entity preventing others
from realizing any value from the intangible asset
(defensively or otherwise). An entity shall
determine a defensive intangible asset’s useful
life, that is, the period over which an entity
consumes the expected benefits of the asset, by
estimating the period over which the defensive
intangible asset will diminish in fair value. The
period over which a defensive intangible asset
diminishes in fair value is a proxy for the period
over which the reporting entity expects a
defensive intangible asset to contribute directly
or indirectly to the future cash flows of the
entity.
35-5B
It would be rare for a defensive intangible asset to have an indefinite life because the fair value of the defensive intangible asset will generally diminish over time as a result of a lack of market exposure or as a result of competitive or other factors. Additionally, if an acquired intangible asset meets the definition of a defensive intangible asset, it shall not be considered immediately abandoned.
The guidance on the subsequent accounting for defensive intangible assets was developed in EITF Issue 08-7, which was codified in ASC 350-30. In Issue 08-7, the EITF concluded that intangible assets that an acquirer intends to use as defensive assets are a unit of account that is separate from any of the acquirer’s existing assets. The EITF also indicated that an acquirer should assign a useful life to a defensive intangible asset that reflects the period over which the entity consumes the asset’s expected benefits — that is, the direct and indirect cash flows resulting from the entity’s preventing others from realizing any value from the asset (defensively or otherwise). An acquirer should determine a defensive intangible asset’s useful life by estimating the period over which the asset will diminish in value, which is a proxy for the period over which the acquirer expects a defensive intangible asset to contribute directly or indirectly to its future cash flows.
While that Issue did not preclude an acquirer from assigning an indefinite life
to a defensive intangible asset, the EITF
concluded that it would be rare for an acquirer to
do so. The fair value of a defensive intangible
asset is generally expected to diminish over time
as a result of a lack of market exposure,
investment, competitive, and other factors. In
addition, the EITF indicated that if an acquired
intangible asset meets the definition of a
defensive intangible asset, it cannot be
considered immediately abandoned and written
off.
4.10.4.9 Digital Assets
Some digital assets may meet
the definition of an intangible asset and,
therefore, be accounted for in accordance with ASC
350. In a business combination, acquired digital
assets classified as identifiable intangible
assets, as well as digital assets that meet the
definition of a financial asset, are typically
recognized and measured at fair value as of the
acquisition date.
Changing Lanes
In September 2023, the FASB
discussed feedback on its proposed
ASU on the accounting for and
disclosure of certain crypto assets. On the basis
of comments received on the proposal, the Board
directed its staff to draft a final standard.
Currently, an entity must
account for crypto assets as indefinite-lived
intangible assets in accordance with ASC 350
(i.e., the assets must be measured at historical
cost less impairment) unless the entity is within
the scope of the investment-company guidance in
ASC 946 or is a certain type of broker-dealer.
Stakeholders have raised concerns that, among
other factors, this traditional intangible asset
model (1) does not faithfully represent the
economics of crypto assets and (2) makes the
recognition of impairments needlessly complex by
requiring entities to use a crypto asset’s lowest
observable fair value within a reporting period.
Accordingly, the proposed guidance would require
an entity, after initial recognition, to
subsequently measure certain crypto assets at fair
value, with changes in fair value included in net
income in each reporting period. The proposed
amendments are intended to better reflect the
economics of crypto assets held by entities as
well as to reduce the complexity and cost of
complying with a historical-cost-less-impairment
model under the existing requirements in ASC 350.
Practitioners should monitor the status of the
project for any developments that might change the
current accounting.
4.10.5 Subsequent Accounting for Intangible Assets
ASC 805-20
35-5 Additional guidance on subsequently measuring and accounting for assets acquired in a business
combination is addressed in Subtopic 350-30, which prescribes the accounting for identifiable intangible
assets acquired in a business combination, including recognition of intangible assets used in research
and development activities, regardless of whether those assets have an alternative future use, and their
classification as indefinite-lived until the completion or abandonment of the associated research and
development efforts.
ASC 805 clarifies that except for reacquired rights, an acquirer should apply the guidance in ASC 350-30
on the subsequent accounting for intangible assets acquired in a business combination.