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30 Nov Recognizing Intangible Assets in an Acquisition

The assets—both tangible and intangible—of a business often represent a very large component of any deal. Additionally, some transactions include large amounts of goodwill, putting the price of both securities and assets well above typical fair market value. Assessing both tangible and intangible assets in this process has been laid out by the FASB in detail here and even more recently here.

The FASB defines intangible assets as “assets (not including financial assets) that lack physical substance.” In most transactions we might think of goodwill as such an intangible asset. However, for the purposes of the FASB, intangible asset does not refer to goodwill. It is everything with the exception of goodwill. The FASB’s objective with Statement 142 and more recently with Topic 350 was to make the recognition of intangibles based more as a reflection of actual business operations thus separating goodwill from all other operational intangible assets of the business.

How are intangibles recognized by an acquirer?

When such an intangible asset is acquired as part of some sort of business combination, it is necessary the acquirer separate the asset from goodwill if:

1. It arises from a legal or contractual right
2. It is actually separable

Separable means that the acquirer is able to parse or divide the asset outside of the target business and potentially sell, rent, license or exchange to another company or entity. A legal right or some form of contractual obligation may give rise to an intangible asset even if it cannot be separately sold or transferred. A “separable” asset is always defined in this case as intangible even if the acquirer does not intend to subsequently or separately divest of the asset after the overall transaction is completed.

Here are some prime examples of such intangibles.

Patent or IP expiring in 15 years—Because patents and IP are a legal right, regardless of whether or not there is an intent to sell, they are by definition an intangible asset.

Customer lists—Such customer lists may not represent a legal right, but they are separable as part of a business combination. Thus, they are considered an intangible asset.

Employee five year non-compete agreements—Because such an agreement is based on a contractual right it is an intangible asset. The one exception would be at-will employee contracts unless an employment agreement is in place.

Tech that is un-patentable—Because technology is separable, regardless of the ability to claim so as a legal right, it is still considered an intangible asset. A specific example could include software code that is not patented, but is an asset that could be easily transferred.

In the event that an asset acquired during an M&A transaction does not qualify as an intangible based on these definitions, the asset will then be included as goodwill.

How goodwill is calculated for M&A

The excess of the purchase price of the target business over the fair market value of the net assets is known as acquired goodwill. When determining the net assets, the acquirer will look at both tangible and intangible assets (excluding goodwill) less assumed liabilities. In short, goodwill is the total of intangibles that do not meet the separation requirements previously discussed above.

In short form: Goodwill = Assets (both tangible and intangible) – Existing Goodwill – Assumed Liabilities

Intangible Treatment for M&A

If we’re following the rules laid out by the FASB, there are four requisite steps when it comes to the treatment of intangibles when a business combination occurs:

1. The acquirer must recognize separable and thus qualifying intangibles at their Fair Market Value (FMV). FMV is typically estimated at what the asset could be bought or sold for in the open market between two willing and reasonable parties, not necessarily the price for which the asset could be liquidated.

2. The useful economic life of the asset must be estimated. This is the length of time the asset is expected to contribute to future cash flows of the business. Once the economic life of the asset is complete, no value is assumed unless particular criteria are met.

3. In each reporting period the acquirer will deduct the amortization expense against the intangible asset in each period. This is typically done in straight-line fashion unless of course some other method better reflects the reality of the amortization. Throughout the useful life of the asset and in each reporting period the acquiring firm must evaluate the remaining useful life of the asset to determine the reasonableness of the original economic life assumption.

4. Regular impairment tests must also occur when any indication comes to light that might indicate any of the assets have been impaired. Timing on impairment tests for useful life of an asset is different from the timing for goodwill or for an intangible asset with an indefinite life. Assets with a finite life (both tangible and intangible) as well as goodwill are typically assessed annually for impairment and may be marked down to the lower of cost or FMV.

If the useful economic life of an intangible asset is found to be of an indefinite timeline, the acquirer will be required to test the asset for impairment on an annual basis and sometimes even more often. Write-downs on the asset only occur when the comparison between book value and FMV of the asset yields a negative spread.

Please note, much of what has been discussed here is within the realm of larger, complex and public transactions. In addition, please note this information does not constitute accounting, tax, legal or investment advice. Please seek knowledgeable help when performing complex business transactions.

  • Peter Bell

    Great post Nate.

    I’m curious though how that goodwill is valued in the valuation process? I was under the impression that goodwill was the value excess of fair market value and assets, so would’t intangible assets and goodwill be the same? Or are they noted differently on the balance sheet?


    • Nate Nead

      Hi Peter. Thank you for commenting. In this case, any goodwill would be considered an intangible asset, but not all intangible assets are goodwill. In fact, many “intangibles” such as patents, trademarks, formulas, etc. fall outside of goodwill and are valued separately. In fact, many patent, trademark and formula values can be quantified based on their useful life and have fairly specific valuation parameters. This is what separates identifiable intangibles from unidentifiable intangibles. The former fall into the area where specific labeling is available. The latter are more difficult.

      Here’s the best way to put it:

      Goodwill, as a typical unidentifiable intangible asset, cannot exist independently of the business, nor can it be sold, purchased or transferred separately without carrying out the same transactions for the business as a whole.

  • Some observations. Kieso defines “goodwill as representing future economic benefits arising from ‘other assets’ in a business combination that are not individually identified and separately recognized. Referred to as the ‘most intangible’ of the intangible assets relative to the business as a whole. Only way to sell goodwill is to sell the business! The acquired company may have previously written-off brand name, patents or customer lists.”

    Many M&A have often found that goodwill was significantly overvalued and not justified. I would hesitate to include non-compete agreements given prior case law in this area and customer-lists as an asset may not follow an M&A transaction. One final thought, correct that annual impairment tests may result in write-downs however I would question how such ‘impairment observations’ were derived. The concept of representational faithfulness is very appropriate when it comes to intangibles.

    • Nate Nead

      Excellent points Peter. I like the idea of “representational faithfulness” when it comes to impairment observations. So much is conjecture, smoke and mirrors. Unfortunately many businesses have been acquired for excessive amounts which required a large amount of goodwill to be added with the “strategic” or defense-position justification on which the acquisition was made. Many of these deals were only to be sadly written-off later. Such a shame. The valuation of intangibles is difficult and ethereal at best. At worst it’s conjecture and hearsay.