Accounting for in-process R&D

Recent remarks by SEC officials about accounting techniques used to "manage" earnings are a wake-up call to preparers, auditors and users of financial statements. Among the SECs concerns are the huge writeoffs of acquired in-process research and development (R&D). In some recent transactions, 75% or more of the purchase price has been written off as in-process R&D, reducing goodwill that would otherwise have to be amortized against earnings.

Preparers, auditors and users of financial statements—including company audit committees—should use the following checklist to make sure that any writeoffs of in-process R&D are reasonable and can withstand scrutiny by the SEC.

Preparers and auditors of financial statements should refresh their memories by reviewing the applicable accounting guidance.

APB Opinion no. 16, Business Combinations , which says allocation of the purchase cost of a business should begin with identification of all the tangible and intangible assets acquired.

FASB Interpretation no. 4, Applicability of FASB Statement no. 2 to Business Combinations Accounted for by the Purchase Method , which says costs assigned to assets to be used in a particular R&D project and that have no alternative future use should be expensed at the acquisition date.

The SECs September 9, 1998, letter to the AICPAs SEC regulations committee, which is appended to an October 10 letter criticizing the treatment of capitalized assets as if they were attributes of in-process R&D, and which can be found on the SEC Web site at .

When valuing in-process R&D, corporate managers, financial executives, preparers, auditors and users of financial statements should be skeptical, taking into consideration

That the SEC has indicated it may object if, in the future, a companys auditor is used to appraise the value of acquired in-process R&D.

The methodology used to value in-process R&D and the developed technologyand what costs should be apportioned to each. Allocations of cash flows must give full recognition to the contribution of existing products, core technologies, brand names, customer lists, acquired contracts, trademarks and so forth.

That a valuation which assumes the buyer will make further investments in the technology after the acquisition is not acceptable.

Does your analysis make sense? Consider the value assigned to the in-process R&D compared to

The overall deal price. Is the difference between the amount allocated to in-process R&D and the deal price sufficient to purchase the company without the in-process R&D?

The relative proportion of due diligence dedicated to it.

The importance attached to the in-process R&D in the acquisition presentation to the board of directors.

The investment that the acquirer would have to have made to achieve similar research results independently.

The investment the acquirer would be willing to make in the in-process R&D if it already owned the core technology associated with it.

Specifically describe the in-process R&D, including

The nature of the project(s) acquired.

The value assigned to each individual project.

The status of the development, the stage of completion, and the complexity or uniqueness of the work completed at the acquisition date.

The nature and timing of the remaining efforts needed and the projected costs to complete the project(s), the anticipated completion date and the date(s) the acquirer will begin benefiting from the in-process R&D.

The material assumptions underlying the portion(s) of the purchase price allocated to the project(s).

The risks and uncertainties associated with completing development within a reasonable time and the risks if development is not completed in a reasonable time.

In subsequent filings, remember to describe or explain

The progress made toward completion of the in-process R&D project(s) and the effects of any delays.

Any material variations between the earlier projected results and actual results and how those variations will affect the acquirers return on investment.

Expected future results and financial condition.

Source: Adapted from a presentation by Christine Davine, associate chief accountant of the SEC, at the 1998 AICPA National Conference on Current SEC Developments. The SEC, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees.


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