By Matthew Redente, Matthew Rosenblatt, and P. Beau Schwegman
The Financial Accounting Standards Board (FASB) has clarified its definition of a “business” when determining whether an acquisition should be treated as a business combination or an asset purchase for accounting purposes. The guidance is significant for the life sciences industry.
Many life sciences companies acquire licenses and other intellectual property (IP) in various stages of development, but it is sometimes unclear whether such acquisitions should be treated as business combinations or asset acquisitions. This determination can have significant accounting implications.
The Business “Screen”
Accounting Standards Update (ASU) No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business,” provides a screening test (“screen”) which assists entities with evaluating when the transfer of an integrated set of assets and activities (“set”) constitutes a business or asset acquisition. Under the screen, if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business, no further analysis is required, and the transaction would be accounted for as an asset acquisition.
A single identifiable asset includes any individual asset or group of assets that could be recognized and measured as a single identifiable asset in a business combination (further defined within paragraph 805-10-55-5B of the ASU). A group of similar assets includes multiple assets identified in accordance with the single identifiable asset guidance. However, when evaluating whether assets are similar, an entity should consider the nature of each single identifiable asset and the risk associated with managing and creating outputs from these assets. (Assets that should not be considered similar are further defined within paragraph 805-10-55-5C of the ASU.) If the screen is not met, the ASU offers a framework for determining whether the set has indeed met the definition of a business.
The Post-Screen Assessment Framework
Under the ASU, a business must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output. The framework enumerates criteria for evaluating whether this standard is satisfied, based on whether a set has outputs.
When a set does not have outputs, it will have both an input and a substantive process that together significantly contribute to the ability to create outputs only if it includes an organized workforce and an input the workforce could develop or convert into output. Paragraph 805-10-55-5E of the ASU outlines the criteria of what constitutes a business when the set has outputs.
Life Sciences Example
The ASU provides an example involving life sciences companies in which a pharmaceutical company (Pharma) buys another company (Biotech) with several in-process R&D projects but no marketable product or revenue. The set includes senior management and scientists who perform R&D activities. Biotech also has long-lived tangible assets.
The in-process R&D projects are not similar assets because they have significantly different risks. In addition, fair value is associated with the workforce due to its proprietary knowledge of, and experience with, Biotech’s ongoing development projects and to its potential for new development projects. Because substantially all of the fair value of the gross assets acquired is not concentrated in a single identifiable asset or group of similar identifiable assets, further analysis is required.
Specifically, because the set does not have outputs, Pharma must determine whether the set has both an input and a substantive process that together significantly contribute to the ability to create outputs. The criteria are met because the scientists constitute an organized workforce that can perform processes that, when applied to the in-process R&D inputs, are critical to the ability to develop those inputs into a product. In addition, a more-than-insignificant amount of goodwill (including the workforce fair value) exists – another indicator that the workforce is performing a critical process. The set, therefore, includes both inputs and substantive processes and can be defined as a business, according to the ASU guidance.
Considerations Going Forward
ASU 2017-01 is effective for public business entities for annual periods beginning after Dec. 15, 2017, including interim periods within those periods. All other entities should apply these amendments to annual periods beginning after Dec. 15, 2018, including interim periods within annual periods beginning after Dec. 15, 2019. Early adoption is permitted if certain criteria are met. This ASU should be applied prospectively. Applying the guidance to determine the appropriate accounting treatment for acquisitions requires careful consideration, as transactions that historically have been accounted for as business acquisitions might now be considered asset acquisitions.
Matthew Redente, CPA; Matthew Rosenblatt, CPA; and P. Beau Schwegman, CPA all work for Crowe Horwath LLP, a public accounting, consulting, and technology firm with offices around the world.