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4.5 Assets an acquirer does not intend to use (defensive assets)
Publication date: 15 Jun 2023
us Business combinations guide
The intended use of an asset by the acquirer does not affect its fair value. Rather, the acquirer should look to an asset’s highest and best use when measuring its fair value. The fair value of the intangible asset, therefore, should be based on assumptions made by market-participants, not acquirer-specific assumptions.
ASC 805-20-30-6 requires an entity to recognize and measure an asset acquired in a business combination at its fair value in accordance with ASC 820 based on the asset’s highest and best use by market-participants, irrespective of whether the acquirer intends to use the asset in the same manner. For example, an entity may acquire a trade name and decide to actively use it only for a short period of time, given its plan to rebrand the existing products sold under that trade name with its own trade name. An entity must consider market-participant assumptions in measuring an asset’s fair value. Acquirers will need to consider how others might use these assets, as well as how these assets might benefit other assets acquired, or those they already own.
Future impairment losses or higher depreciation charges in earlier periods may result because the acquirer’s use of an asset may differ from the asset’s highest and best use as determined by reference to market-participants. Additionally, there could be other postacquisition issues associated with measuring an asset based on its highest and best use (rather than an entity’s intended use). See FV 7.3.4.4 for further information on the valuation of intangible assets based on their highest and best use/market-participant assumptions.
An intangible asset acquired in a business combination that the acquirer does not intend to actively use but does intend to prevent others from using is commonly referred to as a “defensive intangible asset” or a “locked-up asset.” Notwithstanding the lack of active use by the acquirer, ASC 805 requires that fair value be determined through the lens of a market-participant. The asset is likely contributing to an increase in the cash flows of other assets owned by the acquirer. Conversely, an intangible asset acquired in a business combination that the acquirer does not intend to actively use and does not intend to prevent others from using is not a defensive intangible asset.
Example BCG 4-9 and Example BCG 4-10 demonstrate how to distinguish defensive intangible assets from other intangible assets.
EXAMPLE BCG 4-9
Defensive intangible asset
Defensive intangible asset
Company A, a consumer products manufacturer, acquires an entity that sells a product that competes with one of Company A’s existing products. Company A plans to discontinue the sale of the competing product within the next six months, but will maintain the rights to the trade name, at minimal expected cost, to prevent a competitor from using it. As a result, Company A’s existing product is expected to experience an increase in market share. Company A does not have any current plans to reintroduce the acquired trade name in the future.
Does the trade name represent a defensive intangible asset for Company A?
Analysis
Yes. Because Company A does not intend to actively use the acquired trade name, but intends to hold the rights to the trade name to prevent its competitors from using it, the trade name meets the definition of a defensive intangible asset in accordance with ASC 350-30-55-28G through ASC 350-30-55-28I.
EXAMPLE BCG 4-10
Not a defensive intangible asset
Not a defensive intangible asset
Company A acquires a business and one of the assets acquired is billing software developed by the acquired entity for its own use. After a six-month transition period, Company A plans to discontinue use of the internally developed billing software. In valuing the billing software in connection with the acquisition, Company A determines that a market-participant would use the billing software, along with other assets in the asset group, for its full remaining economic life (that is, Company A does not intend to use the asset in a way that is its highest and best use). Due to the specialized nature of the software, Company A does not believe the software could be sold to a third party without the other assets acquired.
How should Company A account for the billing software developed by the acquired entity for its own use?
Analysis
Although Company A does not intend to actively use the internally developed billing software after a six-month transition period, Company A is not holding the internally developed software to prevent its competitors from using it. Therefore, the internally developed software asset does not meet the definition of a defensive intangible asset in accordance with ASC 350-30-55-28J through ASC 350-30-55-28L. However, consistent with other separable and identifiable acquired intangible assets, Company A should recognize and measure an intangible asset for the billing software utilizing market-participant assumptions and amortize the intangible asset over the billing software’s expected remaining useful life to Company A.
As the value of many defensive assets will likely diminish over a period of time, judgment will be required to determine the period over which the defensive asset will either directly or indirectly contribute to the acquirer’s cash flows. Generally, the period over which a defensive intangible asset diminishes in fair value is an acceptable proxy for the period over which the reporting entity expects a defensive intangible asset to contribute directly or indirectly to the future cash flows of the entity. The amortization method used should reflect the pattern in which the fair value of a defensive intangible asset diminishes over time. For example, if the defensive asset acquired is a brand name, consumer preferences for the acquired asset may result in continuing value even if the brand is not being actively marketed. Further, the absence of the brand name in the marketplace will likely indirectly benefit other brand names (e.g., increase revenues) of the acquirer. However, the value of the defensive asset will likely diminish over time.
Excerpt from ASC 350-30-25-5
A defensive intangible asset, other than an intangible asset that is used in research and development activities, shall be accounted for as a separate unit of accounting. Such a defensive intangible asset shall not be included as part of the cost of an entity's existing intangible asset(s).
Excerpt from ASC 350-30-35-5A
A defensive intangible asset shall be assigned a useful life that reflects the entity's consumption of the expected benefits related to that asset. The benefit a reporting entity receives from holding a defensive intangible asset is the direct and indirect cash flows resulting from the entity preventing others from realizing any value from the intangible asset (defensively or otherwise). An entity shall determine a defensive intangible asset's useful life, that is, the period over which an entity consumes the expected benefits of the asset, by estimating the period over which the defensive intangible asset will diminish in fair value. The period over which a defensive intangible asset diminishes in fair value is a proxy for the period over which the reporting entity expects a defensive intangible asset to contribute directly or indirectly to the future cash flows of the entity.
It would be rare for a defensive intangible asset to have an indefinite life because the fair value of the defensive intangible asset will generally diminish over time as a result of a lack of market exposure or as a result of competitive or other factors. Additionally, if an acquired intangible asset meets the definition of a defensive intangible asset, it shall not be considered immediately abandoned.
As applicable, defensive assets need to be tested for impairment under the provisions of ASC 350 or ASC 360-10, depending on whether the asset is deemed an indefinite-lived or finite lived intangible asset, respectively. If fair value needs to be determined for purposes of an impairment assessment, the defensive asset’s fair value will be based on market-participant assumptions at that time and not acquirer-specific assumptions.
An acquired asset that an acquirer does not intend to actively use and does not intend to prevent others from using is not a defensive asset. An example could be a customized software program internally developed by the target. Similar to other market-participants, the acquirer may only plan to use the program for a short transition period until the target company is successfully transitioned to the acquirer’s existing software system. The acquirer’s initial measurement of the customized software program is based on it likely having limited value and a short economic life, since the acquired asset will only generate value to the acquirer and to market-participants over the transitional period. This type of an acquired asset would not be considered a defensive asset. Example BCG 4-11 provides an example of a defensive intangible asset.
EXAMPLE BCG 4-11
Defensive intangible asset
Defensive intangible asset
Company Z purchases Company B, an international widget manufacturer, which sells its products under a well-known trade name. Company Z intends to actively use the acquired trade name for only one year, and then rebrand the existing products sold under that trade name with its own trade name. After this transition period, Company Z will continue to hold the trade name as a defensive asset but will no longer market it.
How should Company Z recognize, initially measure, and subsequently measure the acquired trade name asset?
Analysis
Although Company Z intends to actively use the acquired trade name for only one year, ASC 805 requires Company Z to recognize and initially measure the acquired trade name asset at fair based on its highest and best use by market participants. Company Z should consider how others might use the trade name, as well as how the trade name might benefit other assets acquired, or those they already own. Company Z’s intent to actively use the acquired trade name for only one year is irrelevant for recognition and initial measurement of the asset.
The subsequent measurement of the defensive asset can be complicated as Company Z’s use of the trade name might differ from the asset’s highest and best use. It would be rare for a defensive intangible asset to have an indefinite life, so Company Z will likely need to assign the trade name a useful life. The useful life should reflect the entity's consumption of the expected benefits related to the trade name. Company Z will directly benefit from the cash flows related to the trade name during the one year that it is marketing the trade name. It will indirectly benefit by preventing others from realizing any value from the intangible asset. Additionally, the finite lived trade name will need to be tested for impairment under the provisions of ASC 360-10.
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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