Chapter 4 — Recognizing and Measuring the Identifiable Assets Acquired and Liabilities Assumed

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
Account relationships Broker relationships Fund manager contracts Investment management contracts	Brokerage relationships Core deposit intangibles Distribution channels Mortgage servicing rights
Credit Card Issuers	Consumer Products
Agent bank agreements Cardholder relationships Merchant relationships Recourse rights Servicing rights	Distribution agreements Employee contracts (sales representatives) Exclusivity agreements Internet domain names
Energy	Entertainment and Media
Easements Contracts; favorable/unfavorable contractual terms Contractual relationships Licenses and permits Rights of way; rights of use	Advertiser relationships/contracts Broadcast (FCC) licenses Carriage agreements Franchise rights Network affiliation agreements Programming rights
Insurance	Pharmaceuticals
Distribution channels (agents/agencies) Insurance in-force; renewal rights; value of business acquired Insurance licenses; registrations Reinsurance contracts Service contracts; provider contracts	IPR&D Partnering arrangements Patents, product rights Supplier contracts
Real Estate	Technology
Agency agreements In-place lease value Licenses Listing agreements Tenant relationships	Computer software Databases IPR&D Internet domain names
Telecommunications
Easements FCC licenses Licenses; rights of use

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:
1. Pilot plants (see [h] in the preceding paragraph)
2. 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 (the “guide”) 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.

4.10.4.7.1 Unit of Account for R&D Assets

Under ASC 805, an acquiring entity recognizes acquired IPR&D in a business combination at fair value as of the acquisition date. However, because ASC 805 does not provide any specific guidance on identifying the unit of account for identifiable assets, the acquiring entity must use judgment to determine whether separately identifiable IPR&D assets that share similar characteristics may be aggregated into a single unit of account.

When determining the unit of account for identifiable IPR&D assets, an entity should consider all the relevant facts and circumstances of an acquisition. Paragraph 2.20 of the guide lists the following factors (not inclusive) that an entity may consider when making this determination:

The phase of development of the related IPR&D project . . .
The nature of the activities and costs necessary to further develop the related IPR&D project
The risks associated with the further development of the related IPR&D project
The amount and timing of benefits expected to be derived in the future from the developed asset(s)
The expected economic life of the developed asset(s)
Whether there is an intent to manage costs for the developed asset(s) separately or on a combined basis in areas such as strategy, manufacturing, advertising, selling, and so on.
Whether the asset, whether an incomplete IPR&D project or when ultimately completed, would be transferred by itself or with other separately identifiable assets

The example below illustrates the application of these factors.

Example 4-7

On September 30, 20X8, Company X acquires Company Y in a transaction accounted for as a business combination. Company Y has been pursuing a new therapy designed to help patients suffering from Crohn’s disease. In the European Union, all clinical trials have been completed and the appropriate applications have been filed, but the product is awaiting regulatory approval. In the United States, the same product is under development, and not as far advanced; the product has only just commenced phase III clinical trials. In addition, if the product is approved in both the European Union and the United States, patent protection is expected to expire significantly later in the United States.

Given the above factors, X determines that two IPR&D assets should be recognized: one for the European Union and another for the United States. In reaching this determination, X considered that (1) the IPR&D project is in different stages of development in the two jurisdictions, (2) remaining costs are expected to be significantly higher in the United States as a result of the additional studies that remain to be completed, and (3) the useful life of the asset is expected to be greater in the United States as a result of the patent protection period.

See the guide for additional examples.

4.10.4.7.2 Intangible Assets Subject to Outlicensing Arrangements Associated With R&D Activities

Companies may acquire intangible assets associated with R&D activities that have been, or will be, outlicensed to other entities. The guide specifically addresses outlicensing arrangements. Paragraph 2.10 states, in part:

If the reporting entity intends to outlicense an acquired intangible asset (or acquires an already outlicensed intangible asset) but plans to play an active role [footnote omitted] in the development of the outlicensed asset (for example, under a collaborative arrangement with another party), the task force believes that such asset would be considered “used in R&D activities.” This is because the reporting entity will use the acquired asset in its R&D activities jointly with another party.

However, the task force believes that if the reporting entity intends to outlicense an acquired intangible asset and does not plan to be actively involved in its development, then such asset would not be considered “used in R&D activities.” If such outlicensing arrangement was in place at the time of [the] business combination, the outlicensed asset would not be considered “used in R&D activities;” [rather,] it would be considered a contract-based intangible asset, provided it meets the recognition criteria described in the “Asset Recognition Criteria” section in paragraphs 2.06–.07.

In light of the above, we expect that there will be circumstances in which an outlicensed R&D project that is being acquired should be accounted for as a contract-based intangible asset (as defined in ASC 805-20-55-31) rather than an IPR&D asset. Such a determination would be important because an R&D activity that constitutes IPR&D is accounted for as an indefinite-lived intangible asset (until completion or abandonment of the R&D efforts) in connection with a business combination. In contrast, a contract-based intangible would typically be accounted for as a finite-lived intangible asset (subject to amortization).

For example, assume that upon acquisition, an intangible asset associated with an R&D project has been fully outlicensed to a third party that is responsible for planning and executing the remaining R&D activities, achieving the R&D advances, and directly incurring the related R&D costs. The acquirer’s (and the combined enterprise’s) interest in the intangible asset is passive since the acquirer stands only to receive contractually obligated milestones and royalties on the basis of the success of the third party’s R&D efforts. In this example, the acquirer will not have any input into the R&D activities, R&D protocols, regulatory approval process, or any aspects of commercialization (e.g., manufacturing, sales, marketing, pricing) being performed by the third party. Further, the acquirer will not incur any costs related to the outlicensed property that meet the definition of R&D under ASC 730. In these circumstances, it would therefore be appropriate to account for the R&D project as a contract-based intangible asset; accordingly, the acquirer would determine the useful life of the asset and the method of amortization.

To reach such accounting conclusions, the licensor must carefully analyze the nature and extent of its ongoing involvement with the R&D project. In certain outlicensing arrangements, the licensor retains some level of continuing involvement with the intangible asset. For example, the licensor may have some obligation to reimburse R&D costs incurred by the third party or may continue to have input into the ongoing R&D activities. In such cases, it may be appropriate to account for the R&D activities as IPR&D (provided that all other facts and circumstances have been considered).

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.

Pending Content (Transition Guidance: ASC 805-60-65-1)

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, acquired in an acquisition by a not-for-profit entity, or recognized by a joint venture upon formation 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.

Defensive Intangible Assets

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 December 2023, the FASB issued ASU 2023-08, which addresses the accounting and disclosure requirements for certain crypto assets. The new guidance requires entities to subsequently measure certain crypto assets at fair value, with changes in fair value recorded in net income in each reporting period. In addition, entities are required to provide additional disclosures about the holdings of certain crypto assets. Before the adoption of ASU 2023-08, entities (other than those within the scope of the investment-company guidance in ASC 946 or certain types of broker-dealers) accounted for crypto assets as indefinite-lived intangible assets in accordance with ASC 350 (i.e., the assets were measured at historical cost less impairment). The FASB anticipates that the guidance in the ASU will better reflect the economics of certain crypto assets held by entities as well as reduce the complexity and cost of complying with a historical-cost-less-impairment model under the existing requirements in ASC 350. The amendments in ASU 2023-08 are effective for all entities for fiscal years beginning after December 15, 2024, including interim periods within those years. Early adoption is permitted.

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.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.