Assets Acquired in a Business Combination to Be Used in Research and Development Activities: A Focus on Software, Electronic Devices, and Pharmaceutical Industries

INTRODUCTION

At the acquisition date of a business combination, Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 141, Business Combinations, requires that an entity allocate the cost of the acquired company (that is, the purchase price) to tangible and intangible assets acquired and liabilities assumed based on fair value.¹ Paragraph 35 of FASB Statement No. 141 states that an acquiring company should assign a portion of the purchase price to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. That allocation includes any assets resulting from research and development (R&D) activities of the acquired company or to be used in R&D activities of the combined enterprise. Independent appraisals may be used as an aid in determining the fair values of assets and liabilities.

FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method, clarifies the accounting treatment for assets to be used in R&D activities acquired in a purchase business combination. FASB Interpretation No. 4 specifies that ''the accounting for the cost of an item to be used in research and development activities is the same under paragraphs 11  and 12 of Statement No. 2, whether the item is purchased singly, or as part of a group of assets, or as part of an entire enterprise in a business combination accounted for by the purchase method."²

FASB Interpretation No. 4 requires that at the acquisition date, the acquiring company should charge to income costs allocated to assets acquired to be used in R&D activities, unless the assets have an alternative future use. Costs allocated to assets to be used in R&D activities that have an alternative future use and assets resulting from R&D activities are capitalized. After initial recognition, those assets acquired are accounted for in accordance with the provisions of FASB Statement No. 142, Goodwill and Other Intangible Assets.

The allocation of purchase price of an acquired business can significantly affect the financial reporting of current and future operating results of the combined enterprise. In the past, the amount of goodwill the combined enterprise amortized to income in future periods was directly affected by the immediate charge to income of amounts allocated to assets acquired to be used in R&D activities that have no alternative future use.³