In certain scenarios, the cost of an asset acquisition may be less than the fair value of the individual assets acquired and liabilities assumed. When this occurs, the acquirer should (1) confirm that all liabilities assumed have been identified and recognized, (2) confirm that the fair values of the assets acquired and liabilities assumed have been appropriately measured, and (3) reassess whether there are any transactions (e.g., settlement of preexisting relationships) that should be recognized separate from the asset acquisition. See PPE 2.3.6 for additional information on recognizing separate transactions.

Once these steps are performed, the cost of the asset acquisition may still be less than the fair value of the individual assets acquired and liabilities assumed. However, because the measurement principle for asset acquisitions is based on a cost accumulation model, a bargain purchase gain should generally not be recognized in an asset acquisition. Instead, we believe the benefit should reduce the basis of the nonmonetary long-lived assets acquired. The benefit would be allocated using the relative fair value. However, similar to the scenario in which the cost of an asset acquisition exceeds fair value, any assets for which the subsequent application of GAAP would result in an immediate gain (e.g., financial assets, assets held for sale) should not be allocated a portion of the cost below fair value. In this scenario it would be appropriate to allocate a portion of the cost below fair value to indefinite-lived intangible assets as it would not result in an immediate impairment.

Example PPE 2-5 illustrates the allocation of consideration in an asset acquisition when the cost of the acquisition is less than the fair value of the acquired assets.

EXAMPLE PPE 2-5
Measurement and allocation of cost in an asset acquisition – cost is less than fair value

Company X acquires machinery, a building, land, and a financial asset and assumes accounts payable in exchange for cash consideration of $20 million. Company X incurs direct transaction costs of $2 million. The fair value of each of the acquired assets and the assumed liabilities are:

Company X concludes that the acquired assets do not constitute a business and instead represent an asset acquisition. The financial asset will be accounted for under ASC 321 subsequent to the asset acquisition. How should the asset acquisition be recognized and measured?

Company X would allocate total consideration transferred, inclusive of $20 million in cash paid to the seller, $2 million of assumed liabilities, and $2 million of direct transaction costs, to the acquired assets based on their relative fair value. Although the cost of the acquisition is less than the fair value of the individual assets acquired, a bargain purchase gain should not be recognized in an asset acquisition. Instead, Company X would recognize the benefit as a reduction to the relative fair values of the nonmonetary long-lived assets acquired. The financial asset would not be allocated a portion of the benefit since the financial asset is subject to recurring fair value measurement under ASC 321. The assumed accounts payable would not be allocated a portion of the benefit as liabilities acquired should be recorded at fair value. Accordingly, the cost of the acquisition would be allocated as follows:

*Because the financial asset and accounts payable should not be recognized below fair value, percentages are calculated based on eligible assets (i.e., machinery, building, and land).

As described in PPE 2.3.3, contingent consideration generally represents an obligation of the acquirer to transfer additional consideration to the seller if future events occur or conditions are met. It is often used to enable the buyer and seller to agree on the terms of an exchange when there are differing views on the value of the assets. Some acquisitions involve the purchase of in process research and development (IPR&D). Sometimes, the seller in an IPR&D exchange transaction continues to provide R&D services for a specified period following the transaction. In this scenario, the acquirer in the asset acquisition should determine which elements relate to the exchange transaction and which should be accounted for as a service transaction separate from the asset acquisition. See PPE 2.3.6 for additional information on transactions that are accounted for separately from an asset acquisition.

IPR&D acquisitions typically include an upfront payment and future contingent milestone payments based on the future success of the output of the IPR&D. As required by ASC 730, the portion of the purchase price allocated to IPR&D should be expensed immediately if it has no alternative future use. The acquirer would recognize the contingent milestone payments when probable and reasonably estimable, assuming the contingent consideration is not a derivative. Depending on the status of the IPR&D at the time of the contingent milestone payment, the acquirer may determine it appropriate to capitalize the payment as an intangible asset if the IPR&D meets the definition of an asset.

Example PPE 2-6 illustrates the accounting for contingent consideration related to IPR&D in an asset acquisition.

EXAMPLE PPE 2-6
Contingent consideration related to IPR&D in an asset acquisition

Company A, a pharmaceutical company, acquires IPR&D assets (that do not meet the definition of a business) related to an early stage drug candidate for $10 million. The IPR&D assets are acquired for a specific treatment and do not have an alternative future use. Company A agrees to pay a $2 million milestone payment to the seller if the drug candidate completes phase 2 trials within one year from the date of acquisition. Company A also agrees to pay a $5 million milestone payment to the seller if the drug receives FDA approval within three years from the date of acquisition. Nine months after the transfer of the assets to Company A, the drug candidate is successful in its phase 2 trials. Two years after the transfer of assets to Company A, the FDA approves the drug for commercial sales. For illustrative purposes, assume the contingent payments do not meet the definition of a derivative.

How should Company A account for the asset acquisition of IPR&D assets?

Company A should expense the $10 million upfront payment made to acquire the IPR&D assets. The transaction is an asset acquisition and the IPR&D assets have no alternative future use; thus, the amount paid for the IPR&D assets should be expensed in accordance with ASC 730. The entry to record the transaction would be (in millions):

When it is probable that the early stage drug candidate will successfully complete its phase 2 trials, Company A would recognize a liability and corresponding expense of $2 million. At the time of the contingent payment, the drug candidate still has no alternative future use, and thus it does not yet meet the definition of an asset. The entry to record the transaction would be (in millions):

When the drug candidate receives FDA approval, Company A would recognize a liability of $5 million for the milestone payment owed to the seller. However, at this point the drug is commercially viable and Company A would likely determine the drug meets the definition of an asset. Accordingly, Company A would capitalize the costs associated with this milestone payment. The entry to record the transaction would be (in millions):