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4.2 Intangible assets: identifiable criteria (business combinations)
Publication date: 15 Jun 2023
us Business combinations guide
Intangible assets are assets, excluding financial assets, that lack physical substance. In determining whether an identifiable intangible asset should be recognized separately from goodwill, the acquirer should evaluate whether the asset meets either of the following criteria:
- Contractual-legal criterion: The intangible asset arises from contractual or other legal rights (regardless of whether those rights are transferable or separable from the acquired business or from other rights and obligations) in accordance with ASC 805-20-55-2.
- Separability criterion: The intangible asset is capable of being separated or divided from the acquired business and sold, transferred, licensed, rented, or exchanged. An intangible asset that the acquirer would be able to sell, license, or otherwise exchange for something of value meets the separability criterion, even if the acquirer does not intend to sell, license, or otherwise exchange it. If an intangible asset cannot be sold, transferred, licensed, rented, or exchanged individually, it is still considered separable if it can be sold, transferred, licensed, rented, or exchanged in combination with a related contract, asset, or liability (ASC 805-20-55-5). However, there cannot be restrictions on the transfer, sale, or exchange of the asset in accordance with ASC 805-20-55-3 through ASC 805-20-55-4.
Intangible assets that meet either of these criteria are considered identifiable and are separately recognized at fair value on the acquisition date. Certain intangible assets, however, do not typically meet either of the identifiable criteria and, therefore, are not recognized as separate intangible assets. Examples include:
- Customer base or unidentifiable “walk-up” customers
- Noncontractual customer relationships that are not separable
- Customer service capability
- Presence in geographic locations or markets
- Specially trained employees
In a business combination an assembled workforce is not recognized as a separate intangible asset in accordance with ASC 805-20-55-6. See BCG 4.3.3.2 for further information on an assembled workforce.
The flowchart in Figure BCG 4-1 outlines a process that may be used to determine whether an intangible asset meets the identifiable criteria for separate recognition.
Figure BCG 4-1
Does an intangible asset meet the identifiable criteria?
Does an intangible asset meet the identifiable criteria?
______________
1 Consider whether the intangible asset arises from contractual or other legal rights, even if the asset is not transferable or separable from the acquiree in accordance with ASC 805-20-55-2.
1 Consider whether the intangible asset arises from contractual or other legal rights, even if the asset is not transferable or separable from the acquiree in accordance with ASC 805-20-55-2.
2 Consider whether the intangible asset is capable of being separated; whether there are sales of similar types of assets in the market; or whether it is separable in conjunction with a related contract, asset, or liability in accordance with ASC 805-20-55-3 through ASC 805-20-55-4.
3 Consider whether the terms of confidentiality or other agreements prohibit an entity from selling, leasing, or otherwise exchanging the underlying information in accordance with ASC 805-20-55-4.
4.2.1 Contractual-legal criterion (intangible assets)
Intangible assets that arise from contractual or other legal rights are recognized separately from goodwill, even if the asset is not transferable or separable from the acquiree or from other rights and obligations. Intangible assets may arise from licenses, contracts, lease agreements, or other types of arrangements that the acquired business has entered into with other parties.
ASC 805 does not define the term “contractual or other legal rights,” but the list of contractual-legal intangible assets included in ASC 805 makes it clear that the definition is intended to be broad. For instance, a purchase order, even if cancellable, meets the contractual-legal criterion, although it may not be considered a contract from a legal perspective in certain jurisdictions. In accordance with ASC 805-20-55-25, customer relationships meet the contractual-legal criterion if an entity has a practice of establishing contracts with its customers, regardless of whether there is an outstanding contract or purchase order at the acquisition date. In addition, the use of the contractual-legal criterion to recognize intangible assets under ASC 805 may be broader than that used in other accounting literature in US GAAP. For example, a signed contract is not necessary at the acquisition date to recognize a customer-related intangible asset. However, in applying other accounting literature in US GAAP, an entity may be precluded from recognizing revenue without a signed contract because it may not be able to support existence of a contract.
Contracts or agreements may also contain clauses that explicitly prohibit the transfer or sale of a specified item separately from the acquiree (e.g., transfer restrictions related to a government contract). These types of prohibitions should not affect an acquirer from recognizing the contractual rights as an intangible asset. However, such restrictions may affect the fair value of the intangible asset. For example, a restriction to sell an asset may impact its fair value if such restrictions would transfer to market-participants.
Contracts may also be cancellable at the option of either party. The ability to cancel a contract does not affect its recognition as a separate intangible asset acquired in a business combination, although it may affect its fair value.
Sometimes a contract of the acquired entity states that the right to an asset (such as a license or permit) does not survive a change in control, but reverts back to the issuer. The new owner of the business must execute a new arrangement to acquire the asset from the issuer. In such circumstances, the contractual asset is not an asset of the acquiree to be recognized in the acquisition accounting.
4.2.2 Separability criterion (intangible assets)
The determination of whether an intangible asset meets the separability criterion can be challenging. An acquirer should determine whether the asset is capable of being separated from the acquired business, regardless of the intent of the acquirer with respect to that particular asset. For example, a brand is generally capable of being separated from the acquired business and, therefore, would meet the separability criterion, even if the acquirer does not intend to sell it.
In determining whether an intangible asset is capable of separation, a company could observe sales or exchanges in the market for the same or similar types of assets. Sales of the same or similar types of assets indicate that the asset is able to be sold separately, regardless of the acquirer’s involvement in such sales or the frequency of such transactions. Intangible assets may be closely related to a contract, identifiable asset, or liability, and cannot be separated individually from the contract, asset, or liability. An intangible asset will still meet the separability criterion as long as it is transferable in combination with a related contract, identifiable asset, or liability.
However, to meet the separability criterion, there cannot be restrictions on the transfer, sale, or exchange of the asset. For example, customer information is often protected by a confidentiality agreement (e.g., patient relationships at a healthcare facility). A customer list that cannot be leased or sold due to a confidentiality agreement would not be considered capable of being separated from the rest of the acquired business and would not meet the separability criterion found in ASC 805-20-55-4.
4.2.3 Examples of applying the identifiable criteria (intangibles)
Example BCG 4-1, Example BCG 4-2, and Example BCG 4-3 demonstrate the application of the identifiable criteria when determining whether an intangible asset should be recognized in a business combination.
EXAMPLE BCG 4-1
Sales to customers through contracts
Sales to customers through contracts
Company X acquires Company Y in a business combination on December 31, 20X1. Company Y conducts business with its customers solely through purchase orders. At the acquisition date, Company Y has customer purchase orders in place from 60% of its customers, all of whom are recurring customers. The other 40% of Company Y’s customers are also recurring customers. However, as of December 31, 20X1, Company Y does not have any open purchase orders with those customers.
Which portion of Company Y's customer relationships would be recognized and measured at the acquisition date?
Analysis
Company X needs to determine whether any of the acquired customer relationships are identifiable intangible assets that should be recognized. The purchase orders (whether cancellable or not) in place at the acquisition date from 60% of Company Y’s customers meet the contractual-legal criterion. Further, Company X needs to determine if a production backlog arises from the acquired purchase orders as this may meet the contractual-legal criterion for recognition. Consequently, the relationships with customers through these types of contracts also arise from contractual rights and, therefore, meet the contractual-legal criterion. The fair value of these customer relationships are recognized as an intangible asset apart from goodwill. Additionally, since Company Y has established relationships with the remaining 40% of its customers through its past practice of establishing contracts, those customer relationships would also meet the contractual-legal criterion and be recognized at fair value. Therefore, even though Company Y does not have contracts in place at the acquisition date with a portion of its customers, Company X would consider the value associated with all of its customers for purposes of recognizing and measuring Company Y’s customer relationships.
EXAMPLE BCG 4-2
Deposit liabilities and related depositor relationships
Deposit liabilities and related depositor relationships
A financial institution that holds deposits on behalf of its customers is acquired. There are no restrictions on sales of deposit liabilities and the related depositor relationships.
Should deposit liabilities and related depositor relationships be accounted for at the acquisition date?
Analysis
Yes. Deposit liabilities and the related depositor relationship intangible assets may be exchanged in observable exchange transactions. As a result, the depositor relationship intangible asset would be considered identifiable and meet the separability criterion since the depositor relationship intangible asset can be sold in conjunction with the deposit liability.
EXAMPLE BCG 4-3
Unpatented process closely related to a trademark
Unpatented process closely related to a trademark
An acquiree, a food and beverage manufacturer, sells hot sauce using a secret recipe. The acquiree owns a registered trademark, a secret recipe formula, and unpatented process used to prepare its famous hot sauce. If the trademark is sold, the seller would also transfer all knowledge associated with the trademark, which would include the secret recipe formula and the unpatented process used to prepare its hot sauce.
How should the trademark and complementary assets be accounted for at the acquisition date?
Analysis
The acquirer would recognize an intangible asset for the registered trademark based on the contractual-legal criterion. Separate intangible assets would also be recognized for the accompanying secret recipe formula and the unpatented process based on the separability criterion. The separability criterion is met because the secret recipe formula and unpatented process would be transferred with the trademark. As discussed in BCG 4.4, the acquirer may group complementary intangible assets (registered trademark, related secret recipe formula, and unpatented process) as a single intangible asset if their useful lives are similar.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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