Expand
Resize
Add to favorites
Figure BCG 4-2 includes a list of intangible assets by major category and identifies whether the asset would typically meet the contractual-legal criterion or the separability criterion in accordance with ASC 805-20-55-11 through ASC 805-20-55-45. In certain cases, an intangible asset may meet both criteria. However, the table highlights the primary criterion under which the specific intangible asset would be recognized. The list is not intended to be all-inclusive; therefore, other acquired intangible assets might also meet the criteria for recognition apart from goodwill.
Figure BCG 4-2
Intangible assets that generally meet the criteria for separate recognition
Intangible asset
Contractual-legal criterion
Separability criterion
Marketing-related:
Trademarks, trade names
Service marks, collective marks, certification marks
Trade dress (unique color, shape, or package design)
Newspaper mastheads
Internet domain names
Noncompetition agreements
Artistic-related:
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, music videos, television programs
Contract-based:
Licensing, royalty, standstill agreements
Advertising, construction, management, service, or supply contracts1
Lease agreements2
Construction permits
Franchise agreements
Operating and broadcast rights
Use rights,3 such as drilling, water, air, mineral, timber cutting, and route authorities
Servicing contracts (e.g., mortgage servicing contracts)
Employment contracts4
Technology-based:
Patented technology
Research and development
Computer software and mask works
Unpatented technology
Databases, including title plants
Trade secrets, such as secret formulas, processes, recipes
Customer-related:
Customer lists
Order or production backlog
Customer contracts and related customer relationships
Noncontractual customer relationships

1 In most cases, such intangible assets would be favorable or unfavorable contracts. See BCG 4.3.3.5 for additional information.
2 After adoption of ASC 842, acquired lease contracts of a lessee that are favorable or unfavorable are no longer recorded as a separate intangible. See BCG 4.3.3.7 for further information on lease intangibles.
3 Only in certain circumstances. See BCG 4.3.3.3 for further information.
4 Only in certain circumstances. See BCG 4.3.3.2 for further information.

4.3.1 Marketing-related intangible assets

Marketing-related intangible assets are primarily used in the marketing or promotion of products or services. They are typically protected through legal means and, therefore, generally meet the contractual-legal criterion for recognition separately as an intangible asset.

4.3.1.1 Trademarks, trade names, and other marks (intangible assets)

Trademarks, trade names, and other marks are often registered with governmental agencies or are unregistered, but otherwise protected. Whether registered or unregistered, but otherwise protected, trademarks, trade names, and other marks have some legal protection and would meet the contractual-legal criterion. If trademarks or other marks are not protected legally, but there is evidence of similar sales or exchanges, the trademarks or other marks would meet the separability criterion.
A brand is the term often used for a group of assets associated with a trademark or trade name. An acquirer can recognize a group of complementary assets, such as a brand, as a single asset apart from goodwill if the assets have similar useful lives and either the contractual-legal or separable criterion is met. See BCG 4.4 for further information on complementary intangible assets and grouping of other intangible assets.

4.3.1.2 Trade dress, newspaper mastheads, and internet domains

Trade dress refers to the unique color, shape, or packaging of a product. If protected legally (as discussed above in relation to trademarks), then the trade dress meets the contractual-legal criterion. If the trade dress is not legally protected, but there is evidence of sales of the same or similar trade dress assets, or if the trade dress is sold in conjunction with a related asset, such as a trademark, then it would meet the separability criterion.
Newspaper mastheads are generally protected through legal rights, similar to a trademark and, therefore, would meet the contractual-legal criterion. If not protected legally, a company would look at whether exchanges or sales of mastheads occur to determine if the separability criterion is met.
Internet domain names are unique names used to identify a particular internet site or internet address. These domain names are usually registered and, therefore, would meet the contractual-legal criterion found in ASC 805-20-55-19.

4.3.1.3 Noncompetition agreements (intangible assets)

Noncompetition (“noncompete”) agreements are legal arrangements that generally prohibit a person or business from competing with a company in a certain market for a specified period of time. An acquiree may have preexisting noncompete agreements in place at the time of the acquisition. As those agreements arise from a legal or contractual right, they would meet the contractual-legal criterion and represent an acquired asset that would be recognized as part of the business combination. The terms, conditions, and enforceability of noncompete agreements may affect the fair value assigned to the intangible asset but would not affect their recognition.
Other payments made to former employees that may be described as noncompete payments might actually be compensation for services in the postcombination period. See BCG 3 for further information on accounting for compensation arrangements.
A noncompete agreement negotiated as part of a business combination generally prohibits former owners or key employees from competing with the combined entity. The agreement typically covers a set period of time that commences after the acquisition date or termination of employment with the combined entity. A noncompete agreement negotiated as part of a business combination will typically be initiated by the acquirer to protect the interests of the acquirer and the combined entity. Transactions are to be treated separately if they are entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer. As such, noncompete agreements negotiated as part of a business combination should generally be accounted for as transactions separate from the business combination. For example, if an entity pays $20 million to acquire a target, including a noncompete agreement with a fair value of $2 million, the noncompete agreement should be recognized separately at a fair value of $2 million. The remaining purchase price ($18 million) will be allocated to the net assets acquired, excluding the noncompete agreement.
A noncompete agreement will normally have a finite life requiring amortization of the asset. The amortization period should reflect the period over which the benefits from the noncompete agreement are derived. Determining the period is a matter of judgment in which all terms of the agreement, including restrictions on enforceability of the agreement, should be considered. See BCG 8 for further information on postacquisition accounting for finite-lived intangible assets.

4.3.2 Artistic-related intangible assets

Artistic-related intangible assets are creative assets that are typically protected by copyrights or other contractual and legal means. Artistic-related intangible assets are recognized separately in accordance with ASC 805-20-55-30 if they arise from contractual or legal rights, such as copyrights. Artistic-related intangible assets include (1) plays, operas, ballets; (2) books, magazines, newspapers, other literary works; (3) musical works, such as compositions, song lyrics, advertising jingles; (4) pictures and photographs; and (5) video and audiovisual material, including motion pictures or films, music videos, and television programs. Copyrights can be assigned or licensed, in whole or in part, to others. A copyright-protected intangible asset and related assignments or license agreements may be recognized as a single complementary asset as long as the component assets have similar useful lives. See BCG 4.4 for further information on grouping of complementary assets.

4.3.3 Contract-based intangible assets

Contract-based intangible assets represent the value of rights that arise from contractual arrangements. Customer contracts are one type of contract-based intangible assets. Contract-based intangible assets include (1) licensing, royalty, and standstill agreements; (2) advertising, construction, management, service, or supply contracts; (3) construction permits; (4) franchise agreements; (5) operating and broadcast rights; (6) contracts to service financial assets; (7) employment contracts; (8) use rights; and (9) lease agreements. Contracts whose terms are considered at-the-money, as well as contracts in which the terms are favorable relative to market may also give rise to contract-based intangible assets. If the terms of a contract are unfavorable relative to market, the acquirer recognizes a liability assumed in the business combination. See BCG 4.3.3.5 for further information on favorable and unfavorable contracts.

4.3.3.1 Contracts to service financial assets (intangible assets)

Contracts to service financial assets may include 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; and accounting for and remitting principal and interest payments to the holders of beneficial 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. ASC 860-50, Servicing Assets and Liabilities, provides guidance on the accounting for service contracts.
If mortgage loans, credit card receivables, or other financial assets are acquired in a business combination along with the contract to service those assets, then neither of the above criteria has been met and the servicing rights will not be recognized as a separate intangible asset. However, the fair value of the servicing rights should be considered in measuring the fair value of the underlying mortgage loans, credit card receivables, or other financial assets.

4.3.3.2 Employment contracts (intangible assets)

Employment contracts may result in contract-based intangible assets or liabilities according to ASC 805-20-55-36. An employment contract may be above or below market in the same way as a lease or a servicing contract. However, the recognition of employment contract intangible assets and liabilities is rare in practice. Employees can choose to leave employment with relatively short notice periods, and employment contracts are usually not enforced. In addition, the difficulty of substantiating market compensation for specific employees may present challenges in measuring such an asset or liability.
An exception might be when a professional sports team is acquired. The player contracts may well give rise to employment contract intangible assets and liabilities. The athletes often work under professional restrictions, such that they cannot leave their contracted teams at will and play with another team to maintain their professional standing. Player contracts may also be separable, in that they are often the subject of observable market transactions.
Preexisting employment contracts in the acquired business may also contain noncompetition clauses. These noncompetition clauses may have value and should be assessed separately as intangible assets. See BCG 4.3.1.3 for further information on noncompetition agreements.
Assembled workforce
An assembled workforce is defined in ASC 805-20-55-6 as an existing collection of employees that permits an acquirer to continue to operate from the date of the acquisition. Although individual employees may have employment agreements with the acquiree, which may, at least theoretically, be separately recognized and measured as discussed above, the entire assembled workforce does not have such a contract. Therefore, an assembled workforce does not meet the contractual-legal criterion. Furthermore, an assembled workforce is not considered separable because it cannot be sold or transferred without causing disruption to the acquiree’s business. An assembled workforce is not an identifiable intangible asset that is to be separately recognized and, as such, any value attributable to the assembled workforce is included in goodwill.
An intangible asset may be recognized for an assembled workforce acquired in an asset acquisition. However, an assembled workforce may be indicative that a business was acquired, as discussed in BCG 1. See PPE 2 for information on the accounting for an assembled workforce in an asset acquisition.
The intellectual capital that has been created by a skilled workforce may be embodied in the fair value of an entity’s other intangible assets that would be recognized at the acquisition date as the employer retains the rights associated with those intangible assets. For example, in measuring the fair value of proprietary technologies and processes, the intellectual capital of the employee groups embedded within the proprietary technologies or processes would be considered.
Collective bargaining agreements
A collective bargaining or union agreement typically dictates the terms of employment (e.g., wage rates, overtime rates, and holidays), but does not bind the employee or employer to a specified duration of employment. The employee is still an at-will employee and has the ability to leave or may be terminated. Therefore, similar to an assembled workforce, typically no intangible asset would be separately recognized related to the employees covered under the agreement. However, a collective bargaining agreement of an acquired entity may be recognized as a separate intangible asset or liability if the terms of the agreement are favorable or unfavorable when compared to market terms.

4.3.3.3 Use rights (intangible assets)

Use rights, such as drilling, water, air, mineral, timber cutting, and route authorities’ rights, are contract-based intangible assets. Use rights are unique in that they may have characteristics of both tangible and intangible assets. Use rights should be recognized based on their nature as either a tangible or intangible asset. For example, mineral rights, which are legal rights to explore, extract, and retain all or a portion of mineral deposits, are tangible assets in accordance with ASC 805-20-55-37.

4.3.3.4 Insurance and reinsurance contract intangible assets

An intangible asset (or a liability) may be recognized at the acquisition date for the difference between the fair value of all assets and liabilities arising from the rights and obligations of any acquired insurance and reinsurance contracts and their carrying amounts. See IG 12 for further information on the accounting for insurance and reinsurance contract intangible assets acquired in a business combination.

4.3.3.5 Favorable and unfavorable contracts (intangible assets)

This section addresses acquired contracts that are favorable or unfavorable, except for lease contracts, which are discussed in BCG 4.3.3.7. Intangible assets or liabilities may be recognized for certain off balance sheet contracts whose terms are favorable or unfavorable compared to current market terms. In making this assessment, the terms of a contract should be compared to market prices at the date of acquisition to determine whether an intangible asset or liability should be recognized. If the terms of an acquired contract are favorable relative to market prices, an intangible asset is recognized. On the other hand, if the terms of the acquired contract are unfavorable relative to market prices, then a liability is recognized. The FASB has characterized the differences in contract terms relative to market terms as assets and liabilities, but these adjustments in value are unlikely to meet the definitions of an asset and liability. Within this guide, these adjustments are referred to as assets and liabilities for consistency with the treatment by the FASB.
A significant area of judgment in measuring favorable and unfavorable contracts is whether contract renewal or extension terms should be considered. Generally, an unfavorable contract would not be recorded as a result of a contract renewal or extension. The following factors should be considered in determining whether to include renewals or extensions:
  • Whether renewals or extensions are discretionary without the need to renegotiate key terms or are within the control of the acquiree. Renewals or extensions that are within the control of the acquiree would likely be considered if the terms are favorable to the acquirer.
  • Whether the renewals or extensions provide economic benefit to the holder of the renewal right. The holder of a renewal right, either the acquiree or the counterparty, will likely act in their best interest.
  • Whether there are any other factors that would indicate a contract may or may not be renewed.
Each arrangement is recognized and measured separately. The resulting amounts for favorable and unfavorable contracts are not offset.
Example BCG 4-4 and Example BCG 4-5 demonstrate the recognition and measurement of favorable and unfavorable contracts, respectively.
EXAMPLE BCG 4-4
Favorable purchase contract
Company N acquires Company O in a business combination. Company O purchases electricity through a purchase contract, which is in year three of a five-year arrangement. At the end of the original term, Company O has the option at its sole discretion to extend the purchase contract for another five years. The annual cost of electricity per the original contract is $80 per year, and the annual cost for the five-year extension period is $110 per year. The current annual market price for electricity at the acquisition date is $200; and market rates are not expected to change during the original contract term or the extension period. For the purpose of this example, assume that Company N does not account for the contract as a derivative.
How should Company N account for the acquired favorable purchase contract?
Analysis
Company O’s purchase contract for electricity is favorable. Both the original contract and extension terms allow Company O to purchase electricity at amounts below the annual market price of $200. Because the contract terms are favorable based on the remaining two years of the original contractual term and the extension terms are favorable, Company N would likely consider the five-year extension term as well in measuring the favorable contract.
EXAMPLE BCG 4-5
Unfavorable purchase contract
Company N acquires Company O in a business combination. Company O purchases electricity through a purchase contract, which is in year three of a five-year arrangement. At the end of the original term, Company O has the option at its sole discretion to extend the purchase contract for another five years. The annual cost of electricity per the original contract is $80 per year, and the annual cost for the five-year extension period is $110 per year. The current annual market price for electricity at the acquisition date is $50 per year and market rates are not expected to change during the original contract term or the extension period.
How should Company N account for the acquired unfavorable purchase contract?
Analysis
Company O’s purchase contract is unfavorable. Both the original contract and extension term require it to pay amounts in excess of the current annual market price of $50. While Company N would recognize and measure a liability for the two years remaining under the original contract term, the extension term would not be considered in measuring the unfavorable contract because Company N can choose not to extend the unfavorable contract.

The fair value of an intangible asset or liability associated with favorable and unfavorable contract terms would generally be determined based on present-value techniques. For example, the difference between the contract price and the current market price for the remaining contractual term, including any expected renewals, would be calculated and then discounted to arrive at a net present-value amount. The fair value of the intangible asset or liability would then be amortized over the remaining contract term, including renewals, if applicable.

4.3.3.6 At-the-money contracts (intangible assets)

At-the-money contracts should be evaluated for any intangible assets that may need to be separately recognized. At-the-money contract terms reflect market terms at the date of acquisition. However, the contract may have value for which market participants would be willing to pay a premium because the contract provides future economic benefits.
In assessing whether a separate intangible asset exists for an at-the-money contract, an entity should consider other qualitative reasons or characteristics, such as (1) the uniqueness or scarcity of the contract or leased asset; (2) the unique characteristics of the contract; (3) the efforts to date that a seller has expended to obtain and fulfill the contract; (4) the potential for future contract renewals or extensions; or (5) exclusivity. The existence of these characteristics may make the contract more valuable, resulting in market participants being willing to pay a premium for the contract.

4.3.3.7 Acquisition accounting for lease agreements

A lease agreement represents an arrangement in which one party obtains the right to use an asset from another party for a period of time, in exchange for the payment of consideration. Lease arrangements that exist at the acquisition date may result in the recognition of various assets and liabilities, including separate intangible assets based on the contractual-legal criterion. The type of lease (e.g., operating lease) and whether the acquiree is the lessee or the lessor to the lease will impact the various assets and liabilities that may be recognized in a business combination. The lease accounting may also differ depending on whether the company has adopted ASC 842.
ASC 842, Leases, was effective for years beginning after December 15, 2018 for public business entities. Certain not-for-profit entities and employee benefit plans that file financial statements with the SEC are also subject to the transition date applicable to public business entities. All other entities are required to apply ASC 842 for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. The standard may be adopted early.
Under the revised guidance, a lessee will record right-of-use assets and lease liabilities on their balance sheet for all leases, unless the lessee makes an accounting policy election that exempts the measurement and recognition of short-term leases. A lessee will no longer record favorable or unfavorable terms of the lease as a separate intangible asset. Instead, the favorable or unfavorable terms of the lease will now be included in the right-of-use asset. A lessee will classify leases as operating or finance leases. Unlike the accounting guidance under ASC 840, operating leases will be reported on a lessee’s balance sheet. See LG 3 for further information on lease classification for lessees.
Lessor accounting has also been impacted by the revised guidance, although the changes are more limited. A lessor will classify leases as operating, sales-type, or direct financing. See LG 3 for further information on lease classification for lessors.
Acquiree is a lessee (under ASC 840)
Assets and liabilities that arise on the acquisition date from leases assumed in a business combination should be measured at their fair value on the acquisition date.
ASC 805-20-25-8(a) states that in a business combination, the acquiring entity retains the lease classification determined by the acquired entity (i.e., operating or capital). Lease classification should not be changed as a result of a business combination unless the provisions of the lease are modified.
Two approaches have developed to measure the fair value of the assets and liabilities on the acquisition date arising from a lease assumed in a business combination. Under the first approach, the acquirer follows ASC 840 for lease classification and assumes the same lease term that was used by the acquiree in establishing the original lease classification when determining the fair value of the lease assets and liabilities at the acquisition date. For example, if, at the inception of the lease contract, the acquiree determined that a renewal option was reasonably assured to be exercised at the end of the noncancellable term, the acquiree would have included the period covered by the renewal option in the lease term in classifying and accounting for the lease. In this case, the acquirer would assume the same lease term, including the period covered by the renewal option, for purposes of measuring the lease assets and liabilities. This would be true even if the rental payments that would be due during the period covered by the renewal option were unfavorable to market terms at the acquisition date and the acquirer had no intention of exercising the renewal option. Under the second approach, the acquirer applies ASC 840 only to the classification of the lease. Following this approach, the assumptions used by the acquirer in measuring the lease assets and liabilities at fair value on the acquisition date are not required to be consistent with the assumptions used by the acquiree at the inception of the lease.
An acquiree may be the lessee in an operating lease agreement containing rental rates that are favorable or unfavorable compared to the market terms of leases for similar items at the acquisition date. As the lease arrangement is not recorded on the lessee’s balance sheet, an intangible asset or liability should be recognized for such a favorable or unfavorable arrangement. There may also be value associated with an at-the-money lease contract depending on the nature of the leased asset. See BCG 4.3.3.6 for further information on at-the-money contracts. In addition, other assets may be identifiable if the terms of the lease contain purchase or renewal options. Lastly, leasehold improvements of the acquired entity would be recognized as tangible assets on the acquisition date at their fair value.
A separate intangible asset or liability would not typically be recognized for the lease contract terms if the acquiree is a lessee in a capital lease, since the leased asset and lease liability are already recognized on the lessee’s balance sheet. Any value inherent in the lease (i.e., fair value associated with favorable or unfavorable rental rates, renewal or purchase options, or “in-place” leases), is typically reflected in the amount assigned to the asset under capital lease and the capital lease obligation.
In measuring the amount to record for the property under capital lease, the acquirer should determine whether it is expected that the acquirer will obtain ownership of the leased property by the end of the lease term. Factors to consider when making this determination include contractual requirements (e.g., automatic transfer of title) or a bargain purchase option. If it is expected that the acquirer will obtain ownership of the leased property, then the acquirer should record the property under capital lease at the fair value of the underlying property. If it is not expected that the acquirer will obtain ownership of the leased property, then the acquirer should record the property under capital lease at an amount equal to the fair value of the leasehold interest (i.e., the fair value of the right to use the property until the end of the lease). In addition, any related leasehold improvements would be recognized and measured at fair value.
A liability for the remaining rent payments due under a capital lease would also be recognized and measured at fair value. The assumptions used in measuring the liability, such as the lease term, should be consistent with the assumptions used in measuring the asset.
Acquiree is a lessee (under ASC 842)
Leases are one of the limited exceptions to the recognition (ASC 805-20-25-17) and measurement (ASC 805-20-30-12) principles under ASC 805 and follow specific guidance for acquired leases under ASC 842 and ASC 805. Furthermore, paragraph BC416 in the Basis for Conclusions of ASU 2016-02 acknowledged that the acquiree’s right-of-use assets and lease liabilities would not be recorded at fair value, although the net carrying amount for the lease will approximate the fair value at the date of acquisition.
In a business combination, ASC 842-10-55-11 requires that the acquirer retain the acquiree’s previous lease classification, unless the lease is modified. If the lease is modified and the modification is not accounted for as a separate new lease, the modification is evaluated in accordance with the guidance on lessee lease modifications. See LG 5.2 for further information.
This means that even when the assumptions used to measure the lease liability indicate that the lease would be classified differently, the acquirer is required to retain the classification used by the acquiree. For example, for a new lease, a purchase option that is reasonably certain of exercise would result in the lease being classified as a finance lease. However, if the acquiree classified the lease as an operating lease because, prior to the acquisition date, the purchase option was not reasonably certain of exercise, the acquirer is required to retain the acquiree’s lease classification as an operating lease. The acquirer would include the exercise of the purchase option when measuring the lease liability and right-of-use asset. The acquirer would also consider the purchase option when determining the useful life of the right-of-use asset (i.e., the useful life of the underlying leased asset).
ASC 805-20-30-24 provides guidance on the recognition and measurement of leases acquired in a business combination in which the acquiree is the lessee. This guidance applies to operating and finance leases.

ASC 805-20-30-24

For leases in which the acquiree is a lessee, the acquirer shall measure the lease liability at the present value of the remaining lease payments, as if the acquired lease were a new lease of the acquirer at the acquisition date. The acquirer shall measure the right-of-use asset at the same amount as the lease liability as adjusted to reflect favorable or unfavorable terms of the lease when compared with market terms.

The acquired lease liability should be measured as if it were a new lease following the guidance under ASC 842 (e.g., reassessment of the lease term, discount rate, lease payments, purchase options), except when taking into account the lease classification requirements under ASC 842-10-55-11.
The right-of-use asset is measured at the amount of the lease liability and adjusted by any favorable or unfavorable terms of the lease as compared to market terms. When determining whether there are any favorable or unfavorable terms of a lease that require recognition, the acquirer should consider all of the terms of the lease (e.g., contractual rent payments, renewal or termination options, purchase options, lease incentives). For example, assume an acquired lease includes an option to purchase the underlying asset for $15 and the option has a fair value of $4 at the acquisition date. If the purchase option is reasonably certain of being exercised, the purchase option payment of $15 would be included in the lease payments used to measure the lease liability and right-of-use asset. Assume that after including the purchase option of $15, the acquirer determines that the lease liability is $20. Besides the purchase option, the terms of the lease are determined to be at market. As such, the favorable terms of the lease are equal to the value of the purchase option of $4. The favorable terms of the lease would be recorded as an adjustment to the right-of-use asset and the value of the right-of-use asset recorded in the acquisition would be $24. Refer to LG 3.4 and LG 4.2.1 for more information on the application of the reasonably certain threshold and the measurement of the lease liability, respectively.
If there is a renewal option that allows the lessee to renew with favorable lease terms (i.e., contractual rent payments are less than market rent), the renewal option should be considered in measuring the favorable terms of the lease. Renewal options should also be considered when determining the lease term. When renewal options are reasonably certain of being exercised, the lease term should include the additional term provided by the renewal option. The contractual rent payments made during the lease term will be included when measuring the lease liability and right-of-use asset.
If an option (e.g., renewal option, termination option, purchase option) is not reasonably certain of being exercised, the lease term used to determine the lease liability and right-of-use asset would not be impacted by the option. However, when the option is not reasonably certain of being exercised, there would still be value associated with the option; this value would be included when determining any adjustment to the right-of-use asset for favorable or unfavorable terms of the lease.
When recording the right-of-use asset for an acquired finance lease, the acquirer does not record the right-of-use asset at the fair value of the underlying asset, as was the case under ASC 840 for a capital lease when it was expected that the acquirer would obtain ownership of the leased asset. Under the guidance in ASC 805-20-30-24, the fair value of a purchase option that is reasonably certain of exercise would be included as an adjustment to the right-of-use asset when recording the favorable terms of the lease. When there is an automatic transfer of title at the end of the lease, the fair value of the underlying asset would be included when recording the favorable or unfavorable terms of the lease.
When calculating the adjustment to the right-of-use asset for favorable or unfavorable terms of the lease, market participant assumptions should be used following the fair value principles of ASC 820. In calculating the fair value of the favorable or unfavorable terms of the lease, the discount rate applied should be that of a market participant which, would not necessarily be the same as the lessee’s incremental borrowing rate that was used to measure the lease liability. When the terms of the lease are above market (i.e., unfavorable to the lessee), the acquirer should use a discount rate that takes into consideration credit risk given that the unfavorable terms are similar to an acquired uncollateralized financing liability.
As discussed in ASC 805-20-25-28B, an acquirer in a business combination can make an accounting policy election to not measure or recognize leases that have a remaining lease term of 12 months or less at the acquisition date. In addition, under this policy election, the acquirer would not recognize an intangible asset if the terms of an operating lease are favorable relative to market terms or a liability if the terms are unfavorable relative to market terms. The election is made by class of underlying asset and is applicable to all of the company’s acquisitions. See LG 2.2.1 for information on the short-term lease measurement and recognition exemption.
There may also be value associated with an at-the-money lease contract depending on the nature of the leased asset (e.g., a lease of gates at an airport for which a market participant might be willing to pay for the lease even when the lease is at market terms). See BCG 4.3.3.6 for further information on at-the-money contracts.
Leasehold improvements of the acquired entity would be recognized as tangible assets on the acquisition date at their fair value. ASC 805-20-35-6 provides guidance on the amortization of leasehold improvements acquired in a business combination.

ASC 805-20-35-6

Leasehold improvements acquired in a business combination shall be amortized over the shorter of the useful life of the assets and the remaining lease term at the date of acquisition. However, if the lease transfers ownership of the underlying asset to the lessee, or the lessee is reasonably certain to exercise an option to purchase the underlying asset, the lessee shall amortize the leasehold improvements to the end of their useful life.

Acquiree is a lessor (under ASC 840)
Assets and liabilities that arise on the acquisition date from leases assumed in a business combination should be measured at their fair value on the acquisition date.
ASC 805-20-25-8(a) states that in a business combination, the acquiring entity retains the lease classification used by the acquired entity (i.e., operating, sales-type, direct financing, or leveraged lease). Lease classification should not be changed as a result of a business combination unless the provisions of the lease are modified.
Two approaches have developed to measure the fair value of the assets and liabilities on the acquisition date arising from a lease assumed in a business combination. Under the first approach, the acquirer follows ASC 840 for lease classification and assumes the same lease term that was used by the acquiree in establishing the original lease classification when determining the fair value of the lease assets and liabilities at the acquisition date. For example, if, at the inception of the lease contract, the acquiree determined that a renewal option was reasonably assured to be exercised at the end of the noncancellable term, the acquiree would have included the period covered by the renewal option in the lease term in classifying and accounting for the lease. In this case, the acquirer would assume the same lease term, including the period covered by the renewal option, for purposes of measuring the lease assets and liabilities. This would be true even if the rental payments that would be due during the period covered by the renewal option were unfavorable to market terms at the acquisition date such that the lessee was not reasonably assured of exercising the renewal option. Under the second approach, the acquirer applies ASC 840 only to the classification of the lease. Following this approach, the assumptions used by the acquirer in measuring the lease assets and liabilities at fair value on the acquisition date are not required to be consistent with the assumptions used by the acquiree at the inception of the lease.
The asset subject to the lease would be recognized and measured at fair value unencumbered by the related lease if the acquiree is a lessor in an operating lease. In other words, the leased property (including any acquired tenant improvements) is measured at the same amount, regardless of whether an operating lease is in place. An intangible asset or liability may also be recognized if the lease contract terms are favorable or unfavorable as compared to market terms. In addition, in certain circumstances, an intangible asset may be recognized at the acquisition date in accordance with ASC 805-20-30-5 for the value associated with the existing lease (referred to as an “in-place” lease, as further discussed in this section) and for any value associated with the relationship the lessor has with the lessee. Further, a liability may be recognized for any unfavorable renewal options or unfavorable written purchase options if the exercise is beyond the control of the lessor.
If the lease is classified as an operating lease and provides for non-level rent payments, the acquiree will have recorded an asset or liability to recognize rent revenue on a straight-line basis. Such asset or liability would not be carried forward by the acquirer. Rather, the acquirer would recognize rent revenue prospectively on a straight-line basis. See BCG 2.5.17 for further information on deferred charges arising from leases when the acquiree is a lessor. Additionally, the presence of a straight-line asset or liability is presumed to be indicative of a favorable or unfavorable contract that should be recognized.
The acquired entity may also be a lessor in a lease other than an operating lease, such as a direct financing or sales-type lease. In those situations, the acquirer recognizes and measures a financial asset that represents the remaining lease payments (including any guaranteed residual value and the payments that would be received upon the exercise of any renewal or purchase options that are considered reasonably certain of exercise). Such investment would be recognized in accordance with ASC 840, based on the nature of the lease arrangement, and would typically include any value associated with the existing “in-place” lease. In addition to the financial asset, the acquirer would recognize and measure the residual value, if any, of the leased asset. Lastly, an intangible asset may be recognized for any value associated with the relationship the lessor has with the lessee.
Acquiree is a lessor (under ASC 842)
Leases are one of the limited exceptions to the recognition (ASC 805-20-25-17) and measurement (ASC 805-20-30-12) principles under ASC 805 and follow specific guidance for acquired leases under ASC 842 and ASC 805.
In a business combination, ASC 842-10-55-11 requires the acquirer to retain the acquiree’s previous lease classification, unless the lease is modified. If the lease is modified and the modification is not accounted for as a separate new lease, the modification is evaluated in accordance with the guidance on lessor lease modifications. See LG 5.6 for information.
If the acquiree is a lessor in an operating lease, the asset subject to the lease would be recognized and measured at fair value unencumbered by the related lease. In other words, the leased property (including any acquired tenant improvements) is measured at the same amount, regardless of whether an operating lease is in place. In accordance with ASC 805-20-25-12, an intangible asset or liability may also be recognized if the lease contract terms are favorable or unfavorable as compared to market terms. In addition, in certain circumstances, an intangible asset may be recognized at the acquisition date in accordance with ASC 805-20-30-5 for the value associated with the existing lease (referred to as an “in-place” lease, as further discussed in this section) and for any value associated with the relationship the lessor has with the lessee. Further, a liability may be recognized for any unfavorable renewal options or unfavorable written purchase options if the exercise is beyond the control of the lessor.
If the lease is classified as an operating lease and provides for non-level rent payments, the acquiree will have recorded an asset or liability to recognize rent revenue on a straight-line basis. Such asset or liability would not be carried forward by the acquirer. Rather, the acquirer would recognize rent revenue prospectively on a straight-line basis. See BCG 2.5.17 for further information on deferred charges arising from leases when the acquiree is a lessor. Additionally, the presence of a straight-line asset or liability is presumed to be indicative of a favorable or unfavorable contract that should be recognized.
The acquired entity may also be a lessor in a lease other than an operating lease, such as a direct financing or sales-type lease. In those situations, the acquirer recognizes and measures its net investment in the lease in accordance with ASC 805-20-30-25, which will be equal to the sum of the lease receivable and the unguaranteed residual asset. In applying this guidance, the acquirer will need to determine the fair value of the underlying asset that takes into account the terms and conditions of the lease. The acquirer would adjust the fair value of the underlying asset for any terms or conditions in the lease that are favorable or unfavorable (i.e., off market contract terms which could include rental payments, residual value guarantees, purchase options, renewal options, termination options, etc.).
As the acquirer will take into account the terms and conditions of the lease when determining the fair value of the underlying asset, the acquirer would not record a separate intangible asset or liability for any favorable or unfavorable terms of the lease. An intangible asset may be recognized for any value associated with the relationship the lessor has with the lessee (e.g., customer or tenant relationships).

ASC 805-20-30-25

For leases in which the acquiree is a lessor of a sales-type lease or a direct financing lease, the acquirer shall measure its net investment in the lease as the sum of both of the following (which will equal the fair value of the underlying asset at the acquisition date):

a. The lease receivable at the present value, discounted using the rate implicit in the lease, of the following, as if the acquired lease were a new lease at the acquisition date:
1. The remaining lease payments
2. The amount the lessor expects to derive from the underlying asset following the end of the lease term that is guaranteed by the lessee or any other third party unrelated to the lessor.
b. The unguaranteed residual asset as the difference between the fair value of the underlying asset at the acquisition date and the carrying amount of the lease receivable, as determined in accordance with (a), at that date.
The acquirer shall take into account the terms and conditions of the lease in calculating the acquisition-date fair value of an underlying asset that is subject to a sales-type lease or a direct financing lease by the acquiree-lessor.

Intangible assets related to “in-place” leases
There may be value associated with leases that exist at the acquisition date (referred to as “in-place” leases) when the acquiree is a lessor and leases assets through operating leases. That value may relate to the economic benefit of acquiring the asset or property with “in-place” leases, rather than an asset or property that was not leased. At a minimum, the acquirer would typically avoid costs necessary to obtain a lease, such as any sales commissions, legal, or other lease incentive costs. That value, in addition to any recognized customer-related intangible assets and favorable or unfavorable contract assets or liabilities, is typically recognized as a separate intangible asset in a business combination. Further, the underlying property subject to the operating leases would be measured at fair value, without regard to the underlying lease contracts.
Example BCG 4-6 illustrates the recognizable intangible and tangible assets related to operating leases of a lessor acquired in a business combination.
EXAMPLE BCG 4-6
Lease-related assets and liabilities (under ASC 842 and ASC 840)
Company A, the lessor of a commercial office building subject to various operating leases, was acquired by Company G during 20X0 in a business combination. Included in the assets acquired is a building fully leased by third parties with leases extending through 20X9. As market rates have fluctuated over the years, certain of the leases are at above-market rates and others are at below-market rates at the acquisition date. All of the leases are classified as operating leases, as determined by the acquiree at lease inception (ASC 840) / commencement (ASC 842).
How would Company G measure and record the assets and liabilities related to the lease arrangements upon acquisition?
Analysis
Using the acquisition method, Company G would consider the following in recognizing and measuring the assets and liabilities, if applicable, associated with the lease arrangements:
  • Building: A tangible asset would be recognized and measured at fair value. Although the building is fully leased, it should be valued without regard to the lease contracts under FAS 141(R).B147. Company G may also need to recognize other lease or building-related tangible assets (e.g., tenant or building improvements, furniture, and fixtures) not included in this example.
  • Favorable or unfavorable leases: Intangible assets or liabilities would be recognized and measured for the original lease contracts that are considered favorable or unfavorable, as compared to market terms at the acquisition date. For purposes of measuring the liability associated with an unfavorable lease, renewal provisions would likely be considered because there would be an expectation that a lessee would renew. On the other hand, it would be difficult to assume renewals of favorable leases as the lessees typically would not be economically motivated to renew.
  • “In-place” leases: An intangible asset that represents the economic benefit associated with the building being leased to others would be recognized because the acquirer would avoid costs necessary to obtain a lease (e.g., sales commissions, legal, or other lease incentive costs). The “in-place” lease value recognized should not exceed the value of the remaining cash payments under the lease; otherwise, the asset would be immediately impaired.
  • Customer (tenant) relationships: An intangible asset may be recognized, if applicable, for the value associated with the existing customer (tenant) base at the acquisition date. Such value may include expected renewals, expansion of leased space, etc.

Items to consider when recognizing lease-related assets and liabilities
Figure BCG 4-3 summarizes the typical items to consider in the recognition of assets and liabilities associated with lease arrangements in a business combination.
Figure BCG 4-3
Items to consider when recognizing lease-related assets and liabilities
Lease classification
Lease-related assets and liabilities
Acquired entity is a lessee in an operating lease (under ASC 840)
  • Intangible asset or liability - favorable or unfavorable rental rates (BCG 4.3.3.7)
  • Intangible asset or liability - premium paid for certain at-the-money contracts (BCG 4.3.3.6)
  • Purchase or renewal options
  • Leasehold improvements
Acquired entity is a lessee of a capital lease (under ASC 840)
  • Property under capital lease (recognized at an amount equal to the fair value of the underlying property if ownership is reasonably certain to transfer to the lessee)
  • Property under capital lease (recognized at an amount equal to the fair value of the leasehold interest if ownership is not reasonably certain to transfer to the lessee)
  • Leasehold improvements owned
  • Lease obligation, including lease payments for the remaining noncancellable term and possibly payments required under renewal and purchase options
  • Favorable or unfavorable rental rates, for capital leases that have not commenced
Acquired entity is a lessee in an operating lease or a finance lease (under ASC 842)
  • Intangible asset or liability - premium paid for certain at-the-money contracts (BCG 4.3.3.6)
  • Leasehold improvements

The following are not recorded as a separate intangible, instead they are included as an adjustment to the right-of-use asset:
  • Favorable or unfavorable rental rates
  • Purchase or renewal options
Acquired entity is a lessor in an operating lease (under ASC 842 and ASC 840)
  • Leased asset (including tenant improvements) recognized without regard to the lease contract
  • Intangible asset or liability - favorable or unfavorable rental rates
  • Unfavorable renewal or written purchase options
  • “In-place” leases
  • Customer (or tenant) relationships
Acquired entity is a lessor in a sales-type or direct financing lease (under ASC 842)
  • Net investment in the lease - equal to the sum of the lease receivable and the unguaranteed residual, measured following ASC 805-20-30-25
  • Customer (or tenant) relationships
Acquired entity is a lessor in a sales-type, direct financing, or leveraged lease (under ASC 840)
  • Financial asset for remaining lease payments (including any guaranteed residual value and the payments that would be received upon the exercise of any renewal or purchase options that are considered reasonably certain of exercise)
  • Residual value of leased asset, if any
  • Customer (or tenant) relationships

Acquiree entered into a sale and leaseback transaction prior to being acquired in a business combination (under ASC 842)
An acquiree may have previously applied sale and leaseback accounting in a transaction with a third party that was separate from the business combination. When the acquiree’s original sale and leaseback transaction qualified as a sale, the acquisition accounting will depend on whether the acquiree had previously recognized additional financing under ASC 842-40-30-2. Refer to LG 6 for more information on sale and leaseback transactions.
In the acquiree’s original sale and leaseback transaction, if the sale proceeds exceeded the fair value of the asset, the seller-lessee would have recorded a financing payable to the buyer-lessor for the excess, while the buyer-lessor would have recorded a financing receivable from the seller-lessee. The seller-lessee and the buyer-lessor would have allocated the contractual lease payments between the lease and the financing arrangement. In the subsequent acquisition accounting, the financing arrangement will continue to be recorded separate from the lease and will be recorded following ASC 805 (i.e., a financial liability when the acquiree was the seller-lessee, a financial asset when the acquiree was the buyer-lessor). The portion of the contractual payments relating to the lease will be used to record the lease in acquisition accounting. These lease-related payments will be used to assess whether there are any favorable or unfavorable terms of the lease that need to be included as an adjustment to the right-of-use asset (seller-lessee) or as an intangible asset or liability (buyer-lessor).
In the acquiree’s original sale and leaseback transaction, if the sale proceeds were less than the fair value of the asset, the seller-lessee and the buyer-lessor would have treated the shortfall as prepaid rent. Prepaid rent will not be recorded in acquisition accounting. The acquirer will use the remaining contractual lease payments to record the acquired lease, including the determination of favorable or unfavorable terms of the lease.
If the acquiree’s original leaseback transaction was a failed sale and leaseback transaction, the acquiree would have recorded the transaction as a financing arrangement and the seller-lessee would not have derecognized the underlying asset. The acquirer would retain the acquiree’s accounting as a failed sale and leaseback and continue to follow the guidance under ASC 842-40 to determine if and when a sale occurs. If the acquiree is the seller-lessee, the acquirer will value the tangible property independent from the financing arrangement. The financing arrangement will be recorded following ASC 805 (i.e., a financial liability when the acquiree was the seller-lessee in a failed sale and leaseback, a financial asset when the acquiree was the buyer-lessor in a failed sale and leaseback). Refer to LG 6.5 for more information on leaseback transactions not accounted for as a sale.
The following table summarizes the accounting for sale and leaseback transactions that an acquiree entered into with a third party prior to being acquired in a business combination.
Sale leaseback transaction (SLB)
Accounting considerations (ASC 842)
Acquiree is the buyer-lessor, SLB qualified for sale accounting
Acquirer values the acquired tangible property independently from the terms of the leaseback
Acquirer will continue to record any financing receivable from the seller-lessee (i.e., a financial asset)
After consideration of the contractual payments that relate to any financing receivable, the acquirer will record an intangible asset or liability for any favorable or unfavorable terms of the lease
Acquiree is the buyer-lessor, SLB did not qualify for sale accounting
Retain the acquiree’s accounting as a failed sale and leaseback transaction and continue to follow the guidance under ASC 842-40 to determine if and when a sale occurs
Acquirer will record the acquired financial asset (i.e., a loan receivable); the acquirer will not record the tangible property at the acquisition date
Acquiree is the seller-lessee, SLB qualified for sale accounting
Acquirer will continue to record any financing payable to the buyer-lessor (i.e., a financial liability)
After consideration of the contractual payments that relate to any financing payable, the acquirer will determine whether there are any favorable or unfavorable terms of the lease that need to be included as an adjustment to the right-of-use asset
Acquiree is the seller-lessee, SLB did not qualify for sale accounting
Retain the acquiree’s accounting as a failed sale and leaseback transaction and continue to follow the guidance under ASC 842-40 to determine if and when a sale occurs
Acquirer values the acquired tangible property independent from the terms of the leaseback
In accordance with ASC 842-40-25-5, the acquirer will record the acquired financing payable

Treatment of leases between an acquirer and an acquiree at the acquisition date
An acquirer may have a preexisting relationship with the acquiree in the form of an operating lease agreement (e.g., the acquirer is the lessor and the acquiree is the lessee). The lease contract will effectively be settled for accounting purposes as a result of the acquisition (as the acquirer consolidates the acquiree following the acquisition). The acquirer recognizes a gain or loss on the effective settlement of the preexisting relationship in an amount equal to the lesser of (a) the amount by which the lease is favorable or unfavorable from the perspective of the acquirer relative to market terms, or (b) the amount of any stated settlement provisions in the lease available to the counterparty to whom the contract is unfavorable. See BCG 2.7.2 for further information on the accounting for the settlement of preexisting relationships.
Question BCG 4-1 evaluates how an acquirer accounts for the acquisition of an existing lease arrangement with an acquiree.
Question BCG 4-1
Under ASC 842, how should the acquirer account for the acquisition of an existing lease arrangement with the acquiree (i.e., acquirer leased assets from acquiree) in its acquisition accounting?
PwC response
Before the acquisition, the acquirer would have recognized a right-of-use asset and a lease liability. As a result of the acquisition, the lease arrangement will cease to exist for accounting purposes because it will represent an intercompany relationship beginning on the acquisition date. The right-of-use asset and lease liability of the acquirer is derecognized upon settlement of the preexisting relationship. As a result, the acquirer should recognize a gain or loss for the effective settlement of a preexisting relationship. See BCG 2.7.2.1 for further information on calculating the settlement of preexisting relationships.
The acquired underlying asset would be recognized and measured at fair value. The acquirer should also reconsider the useful life of the formerly leased underlying asset.

4.3.4 Technology-based intangible assets

Technology-based intangible assets generally represent innovations on products or services but can also include collections of information held electronically.

4.3.4.1 Intangible assets used in research and development

Intangible assets used in research and development activities acquired in a business combination are initially recognized at fair value and classified as indefinite-lived assets until completion or abandonment. Research and development activities acquired in a business combination are not required to have an alternative future use to be recognized as an intangible asset. In subsequent periods, the intangible assets are subject to periodic impairment testing. Additionally, research and development projects should be capitalized at the project level for purposes of recognition, measurement, and subsequent impairment testing. Upon completion or abandonment of the research and development efforts, the reporting entity would need to reassess the useful life of the indefinite-lived intangible asset. Determining useful lives and potential impairment issues related to intangible assets used in research and development activities is discussed in BCG 8.2.4.
In December 2013, the AICPA issued the AICPA Accounting and Valuation Guide Assets Acquired to Be Used in Research and Development Activities (the IPR&D Guide). While the IPR&D Guide is non-authoritative, it reflects the input of financial statement preparers, auditors, and regulators and serves as a resource for entities that acquire in-process research and development (IPR&D) assets.
The IPR&D Guide addresses the recognition and measurement of IPR&D assets for all industries, but focuses primarily on the software, electronic devices, and pharmaceutical industries. In addition to having to meet the requirements of ASC 805-20-25-1 through ASC 805-20-25-3, the IPR&D Guide indicates that there must be persuasive evidence that the IPR&D project has substance and is incomplete in order for it to be recognized as an intangible asset. In other words, the acquiree must have performed more than an insignificant amount of research and development efforts that result in the creation of value prior to the acquisition, and there must still be remaining risks (e.g., technological) or regulatory approvals at the acquisition date.

4.3.4.2 Patented/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. As it is often sold with a related asset, the unpatented technology generally would meet the separability criterion.
Trade secrets are information, including a formula, pattern, recipe, compilation, program, device, method, technique, or process, that derives independent economic value from not being generally known and is the subject of reasonable efforts to maintain its secrecy. If the future economic benefits from a trade secret acquired in a business combination are legally protected, then that asset would meet the contractual-legal criterion. Even if not legally protected, trade secrets acquired in a business combination are likely to be identifiable based on meeting the separability criterion. That is, an asset would be recognized if the trade secrets could be sold or licensed to others, even if sales are infrequent or if the acquirer has no intention of selling or licensing them.

4.3.4.3 Computer software and mask works (intangible assets)

Mask works are software permanently stored on read-only memory chips. Mask works, computer software, and program formats are often protected legally, through patent, copyright, or other legal means. If they are protected legally, they meet the contractual-legal criterion. If they are not protected through legal or contractual means, these types of assets may still meet the separability criterion if there is evidence of sales or exchanges of the same or similar types of assets.

4.3.4.4 Databases, including title plants (intangible assets)

Databases are collections of information, typically stored electronically. Sometimes databases that include original works of authorship can be protected by legal means, such as copyrights, and if so, meet the contractual-legal criterion. More frequently, databases are information collected through the normal operations of the business, such as customer information, scientific data, or credit information. Databases, similar to customer lists, are often sold or leased to others and, therefore, meet the separability criterion.
Title plants are a historical record of all matters affecting title to parcels of land in a specific area. These assets are sold or licensed to others and, therefore, meet the separability criterion.

4.3.5 Customer-related intangible assets

Customer-related intangible assets include, but are not limited to: (1) customer contracts and related customer relationships, (2) noncontractual customer relationships, (3) customer lists, and (4) order or production backlog.
In many cases, the relationships that an acquiree has with its customers may encompass more than one type of intangible asset (e.g., customer contract and related relationship, customer list and backlog). The interrelationship of various types of intangible assets related to the same customer can pose challenges in recognizing and measuring customer-related intangible assets. The values ascribed to other intangible assets, such as brand names and trademarks, may impact the valuation of customer-related intangible assets as well. Also, because the useful lives and the pattern in which the economic benefits of the assets are consumed may differ, it may be necessary to separately recognize intangible assets that relate to a single customer relationship according to ASC 805-20-55-24.
Additionally, customer award or loyalty programs may create a relationship between the acquiree and the customer. Such programs may enhance the value of a customer-related intangible asset. These programs are expected to meet the contractual-legal criterion in ASC 805 because the parties have agreed to certain terms and conditions, have had a previous contractual relationship, or both. In addition to evaluating the need to recognize and measure a customer-related intangible asset for these programs, the acquirer must separately evaluate the need to recognize and measure any assumed liabilities related to these programs on the date of acquisition. The terms and conditions associated with these programs can impact the recognition and measurement of any related intangible assets.

4.3.5.1 Customer contracts and related customer relationships

A customer relationship exists between a company and its customer if (1) the company has information about the customer and has regular contact with the customer, and (2) the customer has the ability to make direct contact with the company.
If the entity has a practice of establishing relationships with its customers through contracts, the customer relationship would meet the contractual-legal criterion for separate recognition as an intangible asset, even if no contract (e.g., purchase order or sales order) is in place on the acquisition date. A practice of regular contact by sales or service representatives may also give rise to a customer relationship. A customer relationship may indicate the existence of an intangible asset that should be recognized if it meets the contractual-legal or separable criteria in accordance with ASC 805-20-55-25.
Overlapping customers
An acquirer may have relationships with the same customers as the acquiree (sometimes referred to as “overlapping customers”). If the customer relationship meets the contractual-legal or separable criteria, an intangible asset should be recognized for the customer relationships of the acquiree, even though the acquirer may have relationships with those same customers. Determining the fair value of the acquired asset will depend on facts and circumstances. The acquired customer relationship may have value because the acquirer has the ability to generate incremental cash flows based on the acquirer’s ability to sell new products to the customer.
The fair value of the overlapping customer relationship would be estimated by reflecting the assumptions market participants would make about their ability to generate incremental cash flows. See FV 7.3.4 for further information on the valuation of intangible assets.
Example BCG 4-7 and Example BCG 4-8 demonstrate the assessment of the contractual-legal criterion for various contract-related customer relationships.
EXAMPLE BCG 4-7
Cancellable and noncancellable customer contracts
An acquired business is a manufacturer of commercial machinery and related aftermarket parts and components. The acquiree’s commercial machines, which comprise approximately 70% of its sales, are sold through contracts that are noncancellable. Its aftermarket parts and components, which comprise the remaining 30% of the acquiree’s sales, are also sold through contracts. However, the customers can cancel those contracts at any time.
Should the acquirer recognize the cancellable and noncancellable customer contracts?
Analysis
Yes. The acquiree has a practice of establishing contractual relationships with its customers for the sale of commercial machinery and the sale of aftermarket parts and components. The ability of those customers that purchase aftermarket parts and components to cancel their contracts at any time would factor into the measurement of the intangible asset, but would not affect whether the contractual-legal recognition criterion has been met.
EXAMPLE BCG 4-8
Potential contracts being negotiated at the acquisition date
An acquiree is negotiating contracts with a number of new customers at the acquisition date for which the substantive terms, such as pricing, product specifications, and other key terms, have not yet been agreed to by both parties.
Should the acquirer recognize the potential customer contracts?
Analysis
No. Although the acquirer may consider these prospective contracts to be valuable, potential contracts with new customers do not meet the contractual-legal criterion because there is no contractual or legal right associated with them at the acquisition date. Potential contracts also do not meet the separability criterion because they are not capable of being sold, transferred, or exchanged, and therefore, are not separable from the acquired business. In this fact pattern, the value of these potential contracts would be included in goodwill. Changes to the status of the potential contracts subsequent to the acquisition date would not result in a reclassification from goodwill to an intangible asset. See ASC 805-20-55-7 for additional information.

Question BCG 4-2 considers whether an intangible asset should be recognized by the acquirer when the acquirer is a customer of the acquiree.
Question BCG 4-2
Should the acquirer recognize a customer relationship intangible asset when the acquirer is a customer of the acquiree?
PwC response
We believe that when the acquirer is a customer of the acquiree, it would not be appropriate for the acquirer to recognize a customer relationship intangible asset with itself since a “customer relationship” no longer exists after the acquisition. A customer relationship with oneself does not meet either the contractual-legal or the separable criterion and, therefore, would not be recognized as a separate intangible asset. In addition, from the perspective of the consolidated entity, the definition of an asset is not met since the asset cannot be disposed of and there are no future economic benefits from the customer relationship.
All preexisting relationships between two parties that have consummated a business combination should be evaluated to determine whether settlement of a preexisting relationship has occurred requiring accounting separate from the business combination in accordance with ASC 805-10-55-19(a). See BCG 2.7.2 for further information on the settlement of preexisting relationships between the acquirer and the acquiree.

4.3.5.2 Noncontractual customer relationships (intangible assets)

Customer relationships that do not arise from contracts between an acquiree and its customers (i.e., noncontractual customer relationships) do not meet the contractual-legal criterion. However, there may be circumstances when these relationships can be sold or otherwise exchanged without selling the acquired business, thereby meeting the separability criterion. If a noncontractual customer relationship meets the separability criterion, the relationship is recognized as an intangible asset in accordance with ASC 805-20-55-27.
Evidence of separability of a noncontractual customer relationship includes exchange transactions for the same or similar type of asset. These transactions do not need to occur frequently for a noncontractual customer relationship to be recognized as an intangible asset apart from goodwill. Instead, recognition depends on whether the noncontractual customer relationship is capable of being separated and sold or transferred. Noncontractual relationships that are not separately recognized, such as customer bases, market share, and unidentifiable “walk-up” customers, should be included as part of goodwill.

4.3.5.3 Customer lists (intangible assets)

A customer list represents a list of known, identifiable customers that contains information about those customers, such as name and contact information. A customer list may also be in the form of a database that includes other information about the customers (e.g., order history and demographic information).
A customer list does not usually arise from contractual or other legal rights and, therefore, typically does not meet the contractual-legal criterion. However, customer lists may be leased or otherwise exchanged and, therefore, meet the separability criterion. An acquired customer list does not meet the separability criterion if the terms of confidentiality or other agreements prohibit an acquiree from leasing or otherwise exchanging information about its customers. Restrictions imposed by confidentiality or other agreements pertaining to customer lists do not impact the recognition of other customer-related intangible assets that meet the contractual-legal criterion.
Customer list intangible assets generally have a relatively low fair value and a short life because of the nature of the customer information, how easily it may be obtained by other sources, and the period over which the customer information provides a benefit.

4.3.5.4 Customer base (intangible assets)

A customer base represents a group of customers that are not known or identifiable (e.g., persons who purchase newspapers from a newsstand or customers of a fast-food franchise or gas station). A customer base may also be described as “walk-up” customers. A customer base is generally not recognized separately as an intangible asset because it does not arise from contractual or legal rights and is not separable. However, a customer base may give rise to a customer list if information is obtained about the various customers. For example, a customer list may exist, even if only basic contact information about a customer, such as name and address or telephone number, is available.

4.3.5.5 Order or production backlog (intangible assets)

Order or production backlog arises from unfulfilled purchase or sales order contracts and may be significant in certain industries, such as manufacturing or construction. The order or production backlog acquired in a business combination meets the contractual-legal criterion and, therefore, may be recognized separately as an intangible asset even if the purchase or sales order contracts are cancellable. However, the fact that contracts are cancellable may affect the measurement of the fair value of the associated intangible asset.
Expand

Welcome to Viewpoint, the new platform that replaces Inform. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory.

Your session has expired

Please use the button below to sign in again.
If this problem persists please contact support.

signin option menu option suggested option contentmouse option displaycontent option contentpage option relatedlink option prevandafter option trending option searchicon option search option feedback option end slide