Recognizing intangible assets in a business combination

In this lesson you will

Apply the contractual-legal and separability criteria to identify intangible assets
Explain why an assembled workforce is subsumed into goodwill
Apply the ASU 2014-18 alternative for customer-related intangibles and noncompetes
Match common intangible classes to the valuation method usually used

The two criteria

The Master Glossary defines an identifiable intangible asset as one that meets either of two criteria:

Contractual-legal. It arises from contractual or other legal rights, whether or not those rights are transferable or separable. A license, a franchise agreement, a customer contract and a noncompete all qualify.
Separability. It is capable of being separated from the entity and sold, transferred, licensed, rented or exchanged, alone or together with a related contract, asset or liability. A customer list qualifies even without a contract, unless confidentiality terms prohibit selling it.

Meeting either one is enough. The acquirer recognizes the identifiable intangible assets of the acquiree even if the acquiree never recorded them, such as an internally developed brand.

Common classes

805-20-55-11 through 55-45 group the examples:

Marketing-related: trademarks, trade names, internet domain names, noncompetition agreements.
Customer-related: customer lists, order or production backlog, customer contracts and the related relationships, noncontractual customer relationships.
Artistic-related: plays, books, music, pictures, video.
Contract-based: licensing and royalty agreements, service contracts, construction permits, franchise agreements, broadcast rights, use rights such as drilling, water and timber cutting rights.
Technology-based: patented and unpatented technology, software, databases, trade secrets.

What is not recognized

An assembled workforce is not an identifiable asset under 805-20-55-6. Its value stays in goodwill. Potential contracts the acquiree is negotiating with new customers at the acquisition date are also not assets at that date (805-20-55-7).

Contract assets and contract liabilities

ASU 2021-08 changed a frequent source of differences. The acquirer now recognizes and measures contract assets and contract liabilities from revenue contracts under Topic 606, as if it had originated the contracts, instead of at fair value. In practice this keeps acquired deferred revenue from being written down to the cost of fulfilling the obligation plus a margin, and post-acquisition revenue looks like the acquiree's would have.

Valuation methods

The valuation follows Topic 820. Common pairings:

Customer relationships: multi-period excess earnings method, built on revenue from existing customers, an attrition rate and contributory asset charges.
Trade names and technology: relief-from-royalty method, using a royalty rate an owner would pay to license the asset.
Noncompete agreements: with-and-without method, comparing cash flows with and without the covenant.
Backlog: excess earnings on the remaining orders over a short period.

The discount rates for each intangible should reconcile, together with the rates on tangible assets and goodwill, to the internal rate of return implied by the purchase price.

The private company alternative

ASU 2014-18 lets a private company elect not to recognize separately from goodwill:

customer-related intangible assets, unless they are capable of being sold or licensed independently from the other assets of the business, and
noncompetition agreements.

805-20-25-31 gives mortgage servicing rights, commodity supply contracts, core deposits and customer information such as names and contact details as examples of customer-related assets that may still meet the criterion.

An entity that elects ASU 2014-18 must also adopt the goodwill amortization alternative in ASU 2014-02. The reverse is not true: a company can amortize goodwill without electing ASU 2014-18. ASU 2019-06 extended both alternatives to not-for-profit entities. Public business entities cannot use them.

After recognition

Each intangible needs a useful life under Topic 350. Finite-lived assets are amortized over the pattern of benefit, and indefinite-lived assets, such as some trade names, are tested for impairment at least annually. Record the class, life and method in the intangible assets rollforward workbook.

Worked example

Same acquisition, with and without the ASU 2014-18 election

Pinecrest Supply buys a regional distributor. The valuation identifies these intangibles at fair value:

Customer list with names and contact data, which the distributor could sell: $900,000
Customer contracts and relationships: $2,400,000
Trade name: $1,500,000
Noncompete with the selling founder: $300,000
Order backlog: $200,000
Assembled workforce: $700,000

Without the alternative: the workforce is never recognized. The other five are recognized: 900,000 + 2,400,000 + 1,500,000 + 300,000 + 200,000 = $5,300,000 of intangible assets. The $700,000 workforce value sits in goodwill.

With the ASU 2014-18 election (Pinecrest is a private company): the customer list is capable of being sold independently, so it stays at $900,000. The trade name is not customer-related and stays at $1,500,000. The relationships ($2,400,000), the backlog ($200,000) and the noncompete ($300,000) are subsumed into goodwill.

Recognized intangibles: 900,000 + 1,500,000 = $2,400,000. Goodwill rises by 2,400,000 + 200,000 + 300,000 = $2,900,000 compared with the first case.

Conclusion: the election moves $2,900,000 from separately amortized intangibles into goodwill, which Pinecrest must amortize under ASU 2014-02, generally over ten years.

Self-check

Answer each question before you open the answer.

A customer list is subject to a confidentiality agreement that prohibits its sale. Does it meet the separability criterion?
Show answer
No. Terms that prohibit selling or exchanging the information mean the list is not separable. It would still be recognized if it met the contractual-legal criterion, which a list without a contract does not.
Why is an assembled workforce not recognized?
Show answer
Under 805-20-55-6 it is not an identifiable asset separable from goodwill, so its value is subsumed into goodwill.
How does ASU 2021-08 change the measurement of acquired deferred revenue?
Show answer
Contract liabilities are measured under Topic 606 as if the acquirer had originated the contract, rather than at fair value, so deferred revenue is generally not written down.
Can a private company elect ASU 2014-18 without amortizing goodwill?
Show answer
No. An entity that elects ASU 2014-18 must also adopt the ASU 2014-02 goodwill amortization alternative.

Sources

Back to the syllabus

Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error