Complete detection of all IFRS 3 intangibles explains it all, because detecting intangible assets can be a complex and challenging matter. Strategies to detect identifiable intangible assets vary depending on the facts and circumstances of the business combination and usually require a full review of the transaction. It is important to understand the business of the acquiree, what intangible resources it depends on and how these may translate into identifiable intangible assets. It should be possible to explain the acquired business in terms of the resources it uses to generate profits and how these are reflected in the acquiree’s assets and liabilities. In other words ask the question: what has been paid for?
Use the business case and transaction case to find intangibles Complete detection of all IFRS 3 intangibles
Points to think of or questions to ask yourself in the business case and the transaction case:
Business case review
A thorough review of the acquiree’s business is the most important step in detecting intangible assets in a business combination. Understanding the business rationale for the combination from the perspective or the acquirer, the acquiree’s business resources and how the acquired business generates revenues provides the most useful insights into its intangible assets.
Review of financial information
A review of historical and prospective financial information is a safe starting point to understand the relative importance of non-current tangible assets, working capital (ie cash and cash equivalents, inventories and work in progress, trade receivables and payables) as well as financing arrangements. These assets are usually readily observable as they are included on the acquiree’s balance sheet. Complete detection of all IFRS 3 intangibles
Intangible assets are often not included either in internal financial information used in the acquired business or in its published financial statements (if any). However, financial information is likely to provide important indirect indicators. For example, high marketing-related expenditure may be an indicator of the relative importance of trademarks and similar marketing-related intangible assets. If the entity incurs significant expenditure on research and development, it is likely to generate technology-based intangible assets. The relative significance of expenses that are related to customer care may point to the significant customer relationship intangible assets. Complete detection of all IFRS 3 intangibles
Characteristics of the acquired business
The review of financial information should be accompanied by a full commercial analysis of the acquired business: Complete detection of all IFRS 3 intangibles
- the product portfolio may provide further useful insights into the existence and characteristics of technology-based intangible assets. If current or new products are based on what is sometimes referred to as ‘core technology’ or a common ‘product platform’, then further analysis should assess the role of the underlying technology
- the relative importance of branding or other marketing strategies needs to be assessed to determine the existence of marketing-related intangible assets such as trademarks, brands, logos or similar assets Complete detection of all IFRS 3 intangibles
- an analysis of the customer base is usually carried out to determine whether identifiable customer relationship intangible assets exist. Whether the customers are known to the business, their behaviour and loyalty may all be considered in detecting a related intangible asset Complete detection of all IFRS 3 intangibles
- where a business depends on specific rights of use, such as access to license agreements or rare supplies of raw material, then this may indicate supplier-related contractual intangible assets. Examples are long-term energy or metal supply agreements. Permits to operate or service-specific assets such as a hydroelectric power plant, a TV station or simply a property under a lease contract are also examples of specific rights of use (amongst many other examples) Complete detection of all IFRS 3 intangibles
- if business locations are crucial, for example if the acquired business is a retailer, then this may also indicate value. However, in cases other than operating lease contracts, this is generally not an identifiable intangible asset, but a measurement element of the underlying property Complete detection of all IFRS 3 intangibles
- the acquiree’s workforce is also often considered a key asset of the business under review. The existence of a well-trained and organised team saves the acquirer from having to hire and train the people necessary to run the business and thus represents future economic benefits. Nevertheless, recognition of the assembled workforce is specifically prohibited under IFRS 3 B37 and IAS 38 15. The workforce may however affect the fair value measurement of other intangible assets Complete detection of all IFRS 3 intangibles
- industry-specific intangible assets may be identified by assessing the relevance of assets typically found in a specific economic environment. For example, customer ‘core deposits’ may be a typical example for an intangible asset commonly found in financial institutions. Other industries may rely on copyrighted material, such as pictures or photographs or similar ‘artistic intangibles’.
The business model review should be complemented by management’s judgment. The acquirer’s management usually has post-combination objectives and may already have identified the acquiree’s resources – both tangible and intangible – in developing its post-combination strategy. This may not directly ‘translate’ into the general requirements for identifiable intangible assets under IFRS 3, but nevertheless draws out key elements of the acquired business that represent value for the acquirer. It may also be helpful to take into account the judgment of the acquiree’s management team as it has experience with the business model and existing key inputs that may be ‘translatable’ into identifiable intangible assets.
The transaction case
The purchase agreement that affects the business combination is usually a very important source in finding potential identifiable intangible assets. The agreement and its accompanying annexes and disclosure documents will usually refer to specific trademarks, patents and other intangible assets that are established by contractual or other legal rights. Legal, accounting and commercial due diligence reports (if available) are also likely to contain important references. For example, often times there are information memorandums prepared on the target business. Additionally, any Board approval documents may be useful as reference materials. Complete detection of all IFRS 3 intangibles
The detection of identifiable intangible assets depends on the context of the acquisition. Useful sources to detect identifiable intangible assets in the context of a business combination are for example: Complete detection of all IFRS 3 intangibles
Both parties to a business combination may have also expressed their views on potential intangible assets in external documents that relate to the combination. It may therefore also be necessary to review website material and press releases of both the acquirer and the acquiree. These tend to point out unique characteristics of the business under review, which in turn may translate into identifiable intangible assets. Where records are not readily available from the acquired business, it may also be helpful to contact the relevant authorities to ensure the completeness of potential intangible assets that are legally protected through a registration (such as trademarks or patents). Complete detection of all IFRS 3 intangibles
The acquiree may have reported various intangible assets in its pre-combination financial statements. This is clearly a useful indicator of identifiable intangible assets but further analysis will be required. Typically, intangible assets recorded by the acquiree will be purchased assets that meet the contractual-legal criterion. However, some items recorded by the acquiree may not qualify for recognition in accordance with IFRS, as follows: Complete detection of all IFRS 3 intangibles
- Some GAAPs require or allow, for example, the recognition of start-up costs – these do not meet the definition of an asset under IFRS
- Goodwill previously recognised by the acquiree should also not be taken into consideration. Complete detection of all IFRS 3 intangibles
Conversely, some assets that have been fully depreciated or amortised by the acquiree may still be in use and meet the definition of identifiable intangible assets.
Determining which identifiable intangible assets require measurement
A complete review of the acquired business’s intangible assets is necessary to enable proper implementation of IFRS 3. However, not every identifiable intangible asset needs to be measured and recognised individually:
- some assets are grouped with other assets on the basis of the specific requirements in IFRS 3 and IAS 38 Complete detection of all IFRS 3 intangibles
- similar identifiable assets may also be combined for practical reasons or to avoid double-counting Complete detection of all IFRS 3 intangibles
- some identifiable intangible assets may be considered immaterial. Complete detection of all IFRS 3 intangibles
Groups of intangible assets
Generally, all identifiable intangible assets that are acquired in a business combination are measured independently. Nevertheless, intangible assets that do not meet the contractual-legal criterion for identifiability but are otherwise separable from the acquired entity may sometimes only be separable as a group with (an)other tangible or intangible asset(s). This situation may cause problems in measuring the individual fair value of the intangible asset reliably. In these circumstances, the group of assets may be treated as a single asset for accounting purposes, including fair value measurement (IAS 38 36). Complete detection of all IFRS 3 intangibles
Interdependencies of core technology and customer relationship assets
In a business combination, both a customer relationship intangible asset and core technology are detected as identifiable intangible assets. The core technology is used to generate income from ongoing customer relationships. The customer relationships, on the other hand, cannot be used to generate any income that does not relate to the core technology.
In this scenario a detailed assessment is required to determine whether these resources need to be combined for accounting (and measurement) purposes or whether they are two separable assets.
A similar principle applies to certain groups of complementary assets that comprise a brand. In accordance with IAS 38 37 the acquirer combines a trademark or a service mark and other related intangible assets into a single identifiable intangible asset if the individual fair values of the complementary assets are not measurable reliably on an individual basis. IFRS also permits a combined approach for groups of complementary intangible assets comprising a brand even if fair values of individual intangible assets in the group of complementary assets are reliably measurable provided the useful lives are similar (IAS 38 37). Complete detection of all IFRS 3 intangibles
Complementary assets comprising a brand
The cutting edge ‘¥Ð’ core technology is considered an identifiable intangible asset in a business combination. All of the acquiree’s products are based on ‘¥Ð’ and the technology is also advertised to customers under the ‘¥Ð’ brand using a website that is accessible under www.yd.com. The ‘¥Ð’ brand is protected against third-party use by a registered trademark and no other technology can be reasonably marketed using this trademark. The www.yd.com domain name is also registered. It is expected that when ¥Ð technology is withdrawn from the market, then the trademark and the domain name will both be of little or no value. The remaining useful life of the three different intangible assets is expected to be similar.
Given the fact pattern, the acquirer concludes that neither the trademark nor the domain name would be reliably measurable without taking into account the core technology they relate to. The core technology, the trademark and the domain name are therefore considered a single identifiable intangible asset.
Other combinations of assets with similar economic characteristics
Although IFRS refers to combining intangible assets only in limited circumstances (as described above), judgment is required in practice to determine the appropriate level of aggregation. This is sometimes referred to as the ‘unit of account’ issue. In the absence of specific guidance on unit of account issues, it may be appropriate to extend the approach set out for brands to groups of similar assets in general. Complete detection of all IFRS 3 intangibles
Materiality considerations will often justify treating large groups of similar assets (eg customer relationship assets) on a portfolio basis. However, in determining whether separate identifiable intangible assets may be similar enough to be measured on a combined basis consideration should be given to:
- general characteristics of the intangible assets under review Complete detection of all IFRS 3 intangibles
- related services and products Complete detection of all IFRS 3 intangibles
- functionality and/or design and other shared features of the intangible assets Complete detection of all IFRS 3 intangibles
- similar legal or regulatory conditions that affect the intangible assets Complete detection of all IFRS 3 intangibles
- geographical regions or markets Complete detection of all IFRS 3 intangibles
- the economic lives of the assets. Complete detection of all IFRS 3 intangibles
Depending on the facts and circumstances, it may be preferable to combine similar assets for measurement purposes and subsequent accounting.
These factors may result in reporting different intangible assets on a combined basis (or even combinations of intangible and tangible assets). Material, identifiable intangible assets should not however be combined with goodwill. If similar intangible assets are combined for measurement purposes they should in our view also be accounted for subsequently on the same combined basis.
The acquirer entity should not measure the intangible assets on a combined basis and then disaggregate them for subsequent amortisation purposes.
Different patents relating to same technology
A number of different patents which all relate to the same technology are identified in a business combination. It is concluded that the patents contribute to the same income stream. The patents also have similar remaining useful lives and are therefore considered as a portfolio. As a result, the entity then measures, recognises and subsequently accounts for the underlying core technology rather than a number of different intangible assets.
Customer bases in separate markets
SalesCorp is active in the North American market as well as in the European market. SalesCorp’s customers in North America are independent from its customers in Europe. SalesCorp also provides different products to its different groups of customers. Given these circumstances, and providing that the asset definition and the identifiability criteria are met, it is decided that SalesCorp has two customer bases that should be accounted for as separate identifiable intangible assets.
It is not necessary to measure the fair value of specific intangible assets if they are demonstrably immaterial. Both qualitative and quantitative factors should be considered in evaluating materiality. Indicators of materiality (or immateriality) might include: Complete detection of all IFRS 3 intangibles
- the function of the identifiable intangible asset in the business model – can the business model be explained without the intangible asset?
- will the acquired entity ‘maintain’ the subject asset – ie will it incur significant expenditure necessary to protect its value, and will it monitor relevant rights?
- the remaining useful life of the intangible asset. Extended remaining useful lives may result in future economic benefits that are not available in the short term and which are therefore not immediately perceptible. Future economic benefits of the intangible asset under review may nevertheless be material.
Consideration of materiality
An entity acquires a patent in a business combination. The patent meets the definition of an asset and also the contractual legal-criterion for identifiability. However, the patent protects outdated technology that is almost irrelevant for products and services in the relevant markets at the date of acquisition. Furthermore, the patent protection will expire in less than two years from the date of acquisition. It is therefore concluded that the patent’s fair value is immaterial.
Intangible assets and the identifiable criteria
Intangible assets are assets, excluding financial assets that lack physical substance. In determining whether an identifiable intangible asset should be recognized separately from goodwill, the acquirer should evaluate whether the asset meets either of the following criteria: Complete detection of all IFRS 3 intangibles
- Contractual-legal criterion: The intangible asset arises from contractual or other legal rights (regardless of whether those rights are transferable or separable from the acquired business or from other rights and obligations) in accordance with IFRS 3 B32. Complete detection of all IFRS 3 intangibles
- Separability criterion: The intangible asset is capable of being separated or divided from the acquired business and sold, transferred, licensed, rented, or exchanged. An intangible asset that the acquirer would be able to sell, license, or otherwise exchange for something of value meets the separability criterion, even if the acquirer does not intend to sell, license, or otherwise exchange it. If an intangible asset cannot be sold, transferred, licensed, rented, or exchanged individually, it is still considered separable if it can be sold, transferred, licensed, rented, or exchanged in combination with a related contract, asset, or liability. However, there cannot be restrictions on the transfer, sale, or exchange of the asset in accordance with IFRS 3.B33.
Common identifiable intangible assets
These steps describe general approaches for detecting identifiable intangible assets in a business combination. Practitioners also often ask for a ‘checklist’ of the intangible asset types most commonly identified in business combinations. Any such checklist should be treated with a degree of caution. Best practice is to maintain a wide focus in the detection phase so that relevant identifiable intangible assets are not overlooked. The intangibles to be identified vary in each case and depend greatly on the industry of the acquired business and the circumstances of the business combination. Complete detection of all IFRS 3 intangibles
Despite the limitations of any checklist, a list of common examples can help to focus the analysis and provide an indication of possible end results. Accordingly, ‘Case value intangibles in a business combination’ discusses a number of intangible asset types that are commonly detected in business combinations, including customer relationships, trademarks or non-compete agreements (and common measurement methods used to estimate their fair values). Complete detection of all IFRS 3 intangibles
Illustrative examples within IFRS 3 IE 18 – 44
Marketing-related intangible assets are primarily used in the marketing or promotion of products or services. They are typically protected through legal means and, therefore, generally meet the contractual-legal criterion for recognition separately as an intangible asset. Complete detection of all IFRS 3 intangibles
The following sections discuss common marketing-related intangible assets recognized and measured in a business combination. Complete detection of all IFRS 3 intangibles
– Trademarks, trade names, and other types of marks
Trademarks, trade names, and other marks are often registered with governmental agencies or are unregistered, but otherwise protected. Whether registered or unregistered, but otherwise protected, trademarks, trade names, and other marks have some legal protection and would meet the contractual-legal criterion. If trademarks or other marks are not protected legally, but there is evidence of similar sales or exchanges, the trademarks or other marks would meet the separability criterion. Complete detection of all IFRS 3 intangibles
A brand is the term often used for a group of assets associated with a trademark or trade name. An acquirer can recognize a group of complementary assets, such as a brand, as a single asset apart from goodwill if the assets have similar useful lives and either the contractual-legal or separable criterion is met. Complete detection of all IFRS 3 intangibles
– Trade dress, newspaper mastheads, and internet domain names
Trade dress refers to the unique color, shape, or packaging of a product. If protected legally (as discussed above in relation to trademarks), then the trade dress meets the contractual-legal criterion. If the trade dress is not legally protected, but there is evidence of sales of the same or similar trade dress assets, or if the trade dress is sold in conjunction with a related asset, such as a trademark, then it would meet the separability criterion. Complete detection of all IFRS 3 intangibles
Newspaper mastheads are generally protected through legal rights, similar to a trademark and, therefore, would meet the contractual-legal criterion. If not protected legally, a company would look at whether exchanges or sales of mastheads occur to determine if the separability criterion is met. Complete detection of all IFRS 3 intangibles
Internet domain names are unique names used to identify a particular Internet site or Internet address. These domain names are usually registered and, therefore, would meet the contractual-legal criterion found in IFRS 3 IE22. Complete detection of all IFRS 3 intangibles
– Non competition agreements
Non competition (“non compete”) agreements are legal arrangements that generally prohibit a person or business from competing with a company in a certain market for a specified period of time. An acquiree may have preexisting non compete agreements in place at the time of the acquisition. As those agreements arise from a legal or contractual right, they would meet the contractual-legal criterion and represent an acquired asset that would be recognized as part of the business combination. The terms, conditions, and enforceability of non compete agreements may affect the fair value assigned to the intangible asset, but would not affect their recognition. Complete detection of all IFRS 3 intangibles
Other payments made to former employees that may be described as non compete payments might actually be compensation for services in the postcombination period.
A non compete agreement negotiated as part of a business combination generally prohibits former owners or key employees from competing with the combined entity. The agreement typically covers a set period of time that commences after the acquisition date or termination of employment with the combined entity. A non compete agreement negotiated as part of a business combination will typically be initiated by the acquirer to protect the interests of the acquirer and the combined entity. Complete detection of all IFRS 3 intangibles
Transactions are to be treated separately if they are entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer. As such, non compete agreements negotiated as part of a
business combination should generally be accounted for as transactions separate from the business combination. For example, if an entity pays CU20 million to acquire a target, including a non compete agreement with a fair value of CU2 million, the non compete agreement should be recognized separately at a fair value of CU2 million. The remaining purchase price (CU18 million) will be allocated to the net assets acquired, excluding the non compete agreement, but including goodwill. Complete detection of all IFRS 3 intangibles
A noncompete agreement will normally have a finite life requiring amortization of the asset. The amortization period should reflect the period over which the benefits from the non compete agreement are derived. Determining the period is a matter of judgment in which all terms of the agreement, including restrictions on enforceability of the agreement, should be considered.
Customer-related intangible assets include, but are not limited to: (1) customer contracts and related customer relationships, (2) non contractual customer relationships, (3) customer lists, and (4) order or production backlog. Complete detection of all IFRS 3 intangibles
In many cases, the relationships that an acquiree has with its customers may encompass more than one type of intangible asset (e.g., customer contract and related relationship, customer list, and backlog). The interrelationship of various types of intangible assets related to the same customer can pose challenges in recognizing and measuring customer-related intangible assets. The values ascribed to other intangible assets, such as brand names and trademarks, may impact the valuation of customer-related intangible assets as well. Also, because the useful lives and the pattern in which the economic benefits of the assets are consumed may differ, it may be necessary to separately recognize intangible assets that relate to a single customer relationship according to IFRS 3 IE27. Complete detection of all IFRS 3 intangibles
Additionally, customer award or loyalty programs may create a relationship between the acquiree and the customer. Such programs may enhance the value of a customer-related intangible asset. These programs are expected to meet the term “contractual” in IFRS 3 because the parties have agreed to certain terms and conditions, have had a previous contractual relationship, or both. In addition to evaluating the need to recognize and measure a customer-related intangible asset for these programs, the acquirer must separately evaluate the need to recognize and measure any assumed liabilities related to these programs on the date of acquisition. Given the range of terms and conditions associated with these programs, careful consideration should be given in assessing the recognition and measurement of any related intangible assets.
The following sections discuss the common customer-related intangible assets recognized and measured in a business combination.
A customer relationship exists between a company and its customer if (1) the company has information about the customer and has regular contact with the customer, and (2) the customer has the ability to make direct contact with the company.
If the entity has a practice of establishing relationships with its customers through contracts, the customer relationship would meet the contractual-legal criterion for separate recognition as an intangible asset, even if no contract (e.g., purchase order or sales order) is in place on the acquisition date. A practice of regular contact by sales or service representatives may also give rise to a customer relationship. A customer relationship may indicate the existence of an intangible asset that should be recognized if it meets the contractual-legal or separable criteria in accordance with IFRS 3 IE28. Complete detection of all IFRS 3 intangibles
– – – Overlapping customers
An acquirer may have relationships with the same customers as the acquiree (sometimes referred to as “overlapping customers”). If the customer relationship meets the contractual-legal or separable criteria, an intangible asset should be recognized for the customer relationships of the acquiree, even though the acquirer may have relationships with those same customers. determining the fair value of the acquired asset will depend on facts and circumstances. The acquired customer relationship may have value because the acquirer has the ability to generate incremental cash flows, based on the acquirer’s ability to sell new products to the customer.
The fair value of the overlapping customer relationship would be estimated by reflecting the assumptions market-participants would make about their ability to generate incremental cash flows. For example, if market-participants may not receive much value from the relationship, the resulting intangible asset may have a nominal value. However, if market-participants would expect to receive significant value from the relationship with the acquired customer, the resulting intangible asset may have significant value. See IFRS 13 Fair Value Measurement for further information on valuation of intangible assets. Complete detection of all IFRS 3 intangibles
The following two examples demonstrate the assessment of the contractual-legal criterion for various contract-related customer relationships.
EXAMPLE – Cancellable and non cancellable customer contracts
An acquired business is a manufacturer of commercial machinery and related aftermarket parts and components. The acquiree’s commercial machines, which comprise approximately 70% of its sales, are sold through contracts that are non cancellable. Its aftermarket parts and components, which comprise the remaining 30% of the acquiree’s sales, are also sold through contracts. However, the customers can cancel those contracts at any time.
Should the acquirer recognize the cancellable and non cancellable customer contracts?
Analysis Complete detection of all IFRS 3 intangibles
The acquiree has a practice of establishing contractual relationships with its customers for the sale of commercial machinery and the sale of aftermarket parts and components. The ability of those customers that purchase aftermarket parts and components to cancel their contracts at any time would factor into the measurement of the intangible asset, but would not affect whether the contractual-legal recognition criterion has been met.
EXAMPLE – Potential contracts being negotiated at the acquisition date
An acquiree is negotiating contracts with a number of new customers at the acquisition date for which the substantive terms, such as pricing, product specifications, and other key terms, have not yet been agreed to by both parties. Complete detection of all IFRS 3 intangibles
Should the acquirer recognize the potential customer contracts?
Analysis Complete detection of all IFRS 3 intangibles
Although the acquirer may consider these prospective contracts to be valuable, potential contracts with new customers do not meet the contractual-legal criterion, because there is no contractual or legal right associated with them at the acquisition date. Potential contracts also do not meet the separability criterion, because they are not capable of being sold, transferred, or exchanged, and
therefore, are not separable from the acquired business. In this fact pattern, the value of these potential contracts is included in goodwill. Changes to the status of the potential contracts subsequent to the acquisition date would not result in a reclassification from goodwill to an intangible asset.
However, the acquirer should assess the facts and circumstances surrounding the events occurring shortly after the acquisition to determine whether a separately recognizable intangible asset existed at the acquisition date in accordance with IFRS 3 B38. Complete detection of all IFRS 3 intangibles
– – Non contractual customer relationships
Customer relationships that do not arise from contracts between an acquiree and its customers (i.e., non contractual customer relationships) do not meet the contractual-legal criterion. However, there may be circumstances in which these relationships can be sold or otherwise exchanged without selling the acquired business, thereby meeting the separability criterion. If a non contractual customer relationship meets the separability criterion, the relationship is recognized as an intangible asset in accordance with IFRS 3 IE31.
Evidence of separability of a non contractual customer relationship includes exchange transactions for the same or similar type of asset. These transactions do not need to occur frequently for a non contractual customer relationship to be recognized as an intangible asset apart from goodwill. Instead, recognition depends on whether the non contractual customer relationship is capable of being separated and sold or transferred. Non contractual relationships that are not separately recognized, such as customer bases, market share, and unidentifiable “walk-up” customers, should be included as part of goodwill. Complete detection of all IFRS 3 intangibles
– – Customer lists
A customer list represents a list of known, identifiable customers that contains information about those customers, such as name and contact information. A customer list may also be in the form of a database that includes other information about the customers (e.g., order history and demographic information).
A customer list does not usually arise from contractual or other legal rights and, therefore, typically does not meet the contractual-legal criterion. However, customer lists may be leased or otherwise exchanged and, therefore, meet the separability criterion. An acquired customer list does not meet the separability criterion if the terms of confidentiality or other agreements prohibit an acquiree from leasing or otherwise exchanging information about its customers. Restrictions imposed by confidentiality or other agreements pertaining to customer lists do not impact the recognition of other customer-related intangible assets that meet the contractual-legal criterion.
Customer list intangible assets generally have a relatively low fair value and a short life because of the nature of the customer information, how easily it may be obtained by other sources, and the period over which the customer information provides a benefit. Complete detection of all IFRS 3 intangibles
– – Customer base
A customer base represents a group of customers that are not known or identifiable (e.g., persons who purchase newspapers from a newsstand or customers of a fast-food franchise or gas station). A customer base may also be described as “walk-up” customers. A customer base is generally not recognized separately as an intangible asset because it does not arise from contractual or legal rights and is not separable. However, a customer base may give rise to a customer list if information is obtained about the various customers. For example, a customer list may exist, even if only basic contact information about a customer, such as name and address or telephone number, is available.
– – Order or production backlog
Order or production backlog arises from unfulfilled purchase or sales order contracts and may be significant in certain industries, such as manufacturing or construction. The order or production
backlog acquired in a business combination meets the contractual-legal criterion and, therefore, may be recognized separately as an intangible asset, even if the purchase or sales order contracts are cancellable. However, the fact that contracts are cancellable may affect the measurement of the fair value of the associated intangible asset.
The following example demonstrates the recognition of customer-related intangible assets due to purchase orders. Complete detection of all IFRS 3 intangibles
EXAMPLE – Identification of customer-related intangible assets due to purchase orders
Company M is acquired in a business combination by Company Y and has the following two customers: Complete detection of all IFRS 3 intangibles
- Customer A is a recurring customer that transacts with Company M through purchase orders and certain purchase orders are outstanding at the acquisition date.
- Customer B is a recurring customer that transacts with Company M through purchase orders; however, there are no purchase orders outstanding at the acquisition date.
Should Company Y recognize the customer-related intangible assets due to purchase orders?
Analysis Complete detection of all IFRS 3 intangibles
Company Y assesses the various components of the overall customer relationship that may exist for the acquired customers. As a result of this assessment, Company Y would recognize an intangible asset(s) for Customers A and B based on the contractual-legal criterion. The customer relationship with Customer A meets the contractual-legal criterion as there is a contract or agreement in place at the acquisition date. Customer B’s customer relationship also meets the contractual-legal criterion as there is a history of Company M using purchase orders with this customer, even though there are no purchase orders outstanding on the acquisition date. Company Y should considered whether a production backlog exists related to acquired sales orders. This may meet the contractual-legal criterion for separate recognition. Complete detection of all IFRS 3 intangibles
Artistic-related intangible assets are creative assets that are typically protected by copyrights or other contractual and legal means. Artistic-related intangible assets are recognized separately in accordance with IFRS 3 IE33 if they arise from contractual or legal rights, such as copyrights. Artistic-related intangible assets include (1) plays, operas, ballets; (2) books, magazines, newspapers, other literary works; (3) musical works, such as compositions, song lyrics, advertising jingles; (4) pictures and photographs; and (5) video and audiovisual material, including motion pictures or films, music videos, and television programs. Copyrights can be assigned or licensed, in part, to others. A copyright-protected intangible asset and related assignments or license agreements may be recognized as a single complementary asset, as long as the component assets have similar useful lives.
Contract-based intangible assets
Contract-based intangible assets represent the value of rights that arise from contractual arrangements. Customer contracts are one type of contract-based intangible assets. Contract-based intangible assets include (1) licensing, royalty, and standstill agreements; (2) advertising, construction, management, service, or supply contracts; (3) construction permits; (4) franchise agreements; (5) operating and broadcast rights; (6) contracts to service financial assets; (7) employment contracts; (8) use rights; and (9) lease agreements. Contracts whose terms are considered at-the-money, as well as contracts in which the terms are favorable relative to market may also give rise to contract-based intangible assets. If the terms of a contract are unfavorable relative to market, the acquirer recognizes a liability assumed in the business combination. See Favorable and unfavorable contracts below for further information on favorable and unfavorable contracts.
The following sections discuss the common contract-based intangible assets recognized and measured in a business combination. Complete detection of all IFRS 3 intangibles
– Contracts to service financial assets
Contracts to service financial assets may include collecting principal, interest, and escrow payments from borrowers; paying taxes and insurance from escrowed funds; monitoring delinquencies; executing foreclosure, if necessary; temporarily investing funds pending distribution; remitting fees to guarantors, trustees and others providing services; and accounting for and remitting principal and interest payments to the holders of beneficial interests in the financial assets. Complete detection of all IFRS 3 intangibles
Although servicing is inherent in all financial assets, it is not recognized as a separate intangible asset unless (1) the underlying financial assets (e.g., receivables) are sold or securitized and the servicing contract is retained by the seller; or (2) the servicing contract is separately purchased or assumed. Complete detection of all IFRS 3 intangibles
If mortgage loans, credit card receivables, or other financial assets are acquired in a business combination, along with the contract to service those assets, then neither of the above criteria has been met and the servicing rights will not be recognized as a separate intangible asset. However, the fair value of the servicing rights should be considered in measuring the fair value of the underlying mortgage loans, credit card receivables, or other financial assets. Complete detection of all IFRS 3 intangibles
– Employment contracts
Employment contracts may result in contract-based intangible assets or liabilities according to IFRS 3 IE37. An employment contract may be above or below market in the same way as a lease or a servicing contract. See At-the-money contracts below for further information on at-the-money contracts. However, the recognition of employment contract intangible assets and liabilities is rare in practice. Employees can choose to leave employment with relatively short notice periods, and employment contracts are usually not enforced. In addition, the difficulty of substantiating market compensation for specific employees may present challenges in measuring such an asset or liability. Complete detection of all IFRS 3 intangibles
An exception might be when a professional sports team is acquired. The player contracts may well give rise to employment contract intangible assets and liabilities. The athletes often work under
professional restrictions, such that they cannot leave their contracted teams at will and play with another team to maintain their professional standing. Player contracts may also be separable, in that they are often the subject of observable market transactions. Complete detection of all IFRS 3 intangibles
Preexisting employment contracts in the acquired business may also contain non competition clauses. These non competition clauses may have value and should be assessed separately as intangible assets when such contracts are part of a business combination. See non competition agreements above for further information on non competition agreements.
– – Assembled workforce
An assembled workforce is defined in IFRS 3 B37 as an existing collection of employees that permits an acquirer to continue to operate from the date of the acquisition. Although individual employees may have employment agreements with the acquiree, which may, at least theoretically, be separately recognized and measured as discussed in above, the entire assembled workforce does not have such a contract. Therefore, an assembled workforce does not meet the contractual-legal criterion. Furthermore, the Board concluded that an assembled workforce is not considered separable, because it cannot be sold or transferred without causing disruption to the acquiree’s business. An assembled workforce is not an identifiable intangible asset that is to be separately recognized and, as such, any value attributable to the assembled workforce is included in goodwill. Complete detection of all IFRS 3 intangibles
IFRS does not permit an assembled workforce to be recognized in asset acquisitions. See Accounting treatment acquisition of a business or assets for information on the accounting for asset acquisitions. The intellectual capital that has been created by a skilled workforce may be embodied in the fair value of an entity’s other intangible assets that would be recognized at the acquisition date as the employer retains the rights associated with those intangible assets. For example, in measuring the fair value of proprietary technologies and processes, the intellectual capital of the employee groups embedded within the proprietary technologies or processes would be considered.
– Collective bargaining agreements
A collective bargaining or union agreement typically dictates the terms of employment (e.g., wage rates, overtime rates, and holidays), but does not bind the employee or employer to a specified duration of employment. The employee is still an at-will employee and has the ability to leave or may be terminated. Therefore, similar to an assembled workforce, typically no intangible asset would be separately recognized related to the employees covered under the agreement. However, a collective bargaining agreement of an acquired entity may be recognized as a separate intangible asset or liability if the terms of the agreement are favorable or unfavorable when compared to market terms. Complete detection of all IFRS 3 intangibles
– Use rights
Use rights, such as drilling, water, air, mineral, timber cutting, and route authorities’ rights are contract-based intangible assets. Use rights are unique in that they may have characteristics of both
tangible and intangible assets. Use rights should be recognized based on their nature as either a tangible or intangible asset. For example, mineral rights, which are legal rights to explore, extract, and retain all or a portion of mineral deposits, are tangible assets in accordance with IFRS 3 IE38.
– Insurance and reinsurance contract intangible assets
An intangible asset (or a liability) may be recognized at the acquisition date for the difference between the fair value of all assets and liabilities arising from the rights and obligations of any acquired insurance and reinsurance contracts and their carrying amounts. Complete detection of all IFRS 3 intangibles
– Favorable and unfavorable contracts
Intangible assets or liabilities may be recognized for certain off balance sheet contracts, such as operating lease arrangements (prior to adopting IFRS 16), whose terms are favorable or unfavorable compared to current market terms. In making this assessment, the terms of a contract should be compared to market prices at the date of acquisition to determine whether an intangible asset or liability should be recognized. If the terms of an acquired contract are favorable relative to market prices, an intangible asset is recognized. On the other hand, if the terms of the acquired contract are unfavorable relative to market prices, then a liability is recognized. The Board has characterized the differences in contract terms relative to market terms as assets and liabilities, but these adjustments in value are unlikely to meet the definitions of an asset and liability under the IFRS accounting frameworks. Within this guide, these adjustments are referred to as assets and liabilities for consistency with the treatment by the Board. Complete detection of all IFRS 3 intangibles
A significant area of judgment in measuring favorable and unfavorable contracts is whether contract renewal or extension terms should be considered. Generally, an unfavorable contract would not be recorded as a result of a contract renewal or extension. The following factors should be considered in determining whether to include renewals or extensions:
- Whether renewals or extensions are discretionary without the need to renegotiate key terms or within the control of the acquiree. Renewals or extensions that are within the control of the acquiree would likely be considered if the terms are favorable to the acquirer.
- Whether the renewals or extensions provide economic benefit to the holder of the renewal right. The holder of a renewal right, either the acquiree or the counterparty, will likely act in their best interest. For example, if the acquiree is the lessee in a favorable operating lease, the renewals would likely be considered, because the acquirer would likely plan to exercise the renewal right and realize the acquiree’s benefit of the favorable terms. If the acquiree is the lessor in a favorable operating lease, the acquirer would usually not presume that the lessee (third party) would renew its unfavorable lease. Complete detection of all IFRS 3 intangibles
- Whether there are any other factors that would indicate a contract may or may not be renewed. Complete detection of all IFRS 3 intangibles
Each arrangement is recognized and measured separately. The resulting amounts for favorable and unfavorable contracts are not offset.
The following two examples demonstrate the recognition and measurement of favorable and unfavorable contracts. Complete detection of all IFRS 3 intangibles
EXAMPLE – Favorable purchase contract
Company N acquires Company O in a business combination. Company O purchases electricity through a purchase contract, which is in year three of a five-year arrangement. At the end of the original term, Company O has the option at its sole discretion to extend the purchase contract for another five years. The annual cost of electricity per the original contract is CU80 per year, and the annual cost for the five-year extension period is CU110 per year. The current annual market price for electricity at the acquisition date is CU200; and market rates are not expected to change during the original contract term or the extension period. For the purpose of this example, assume that Company N does not account for the contract as a derivative.
How should Company N account for the acquired favorable purchase contract?
Analysis Complete detection of all IFRS 3 intangibles
Company O’s purchase contract for electricity is favorable. Both the original contract and extension terms allow Company O to purchase electricity at amounts below the annual market price of CU200. Because the contract terms are favorable based on the remaining two years of the original contractual term and the extension terms are favorable, Company N would likely consider the five-year extension term as well in measuring the favorable contract. Complete detection of all IFRS 3 intangibles
EXAMPLE – Unfavorable purchase contract
Assume the same facts above, except that the current annual market price for electricity at the acquisition date is CU50 per year and market rates are not expected to change during the original contract term or the extension period. Complete detection of all IFRS 3 intangibles
How should Company N account for the acquired unfavorable purchase contract?
Company O’s purchase contract is unfavorable. Both the original contract and extension term require it to pay amounts in excess of the current annual market price of CU50. While Company N would recognize and measure a liability for the two years remaining under the original contract term, the extension term would not be considered in measuring the unfavorable contract because Company N can choose not to extend the unfavorable contract. Complete detection of all IFRS 3 intangibles
The fair value of an intangible asset or liability associated with favorable and unfavorable contract terms would generally be determined based on present-value techniques. For example, the difference between the contract price and the current market price for the remaining contractual term, including any expected renewals, would be calculated and then discounted to arrive at a net present-value amount. The fair value of the intangible asset or liability would then be amortized over the remaining contract term, including renewals, if applicable.
– At-the-money contracts
At-the-money contracts should be evaluated for any intangible assets that may need to be separately recognized. At-the-money contract terms reflect market terms at the date of acquisition. However, the contract may have value for which market participants would be willing to pay a premium because the contract provides future economic benefits.
In assessing whether a separate intangible asset exists for an at-the-money contract, an entity should consider other qualitative reasons or characteristics, such as (1) the uniqueness or scarcity of the contract or leased asset; (2) the unique characteristics of the contract; (3) the efforts to date that a seller has expended to obtain and fulfill the contract; (4) the potential for future contract renewals or extensions; or 5) exclusivity. The existence of these characteristics may make the contract more valuable, resulting in market participants being willing to pay a premium for the contract. Complete detection of all IFRS 3 intangibles
Technology-based intangible assets
Technology-based intangible assets generally represent innovations on products or services, but can also include collections of information held electronically.
The following sections discuss the common technology-based intangible assets recognized and measured in a business combination.
– Intangible assets used in research and development activities
Intangible assets used in research and development activities acquired in a business combination are initially recognized at fair value and classified as indefinite-lived [not available for use] assets until completion or abandonment. Research and development activities acquired in a business combination are not required to have an alternative future use to be recognized as an intangible asset. In subsequent periods, the intangible assets are subject to periodic impairment testing. Additionally, research and development projects should be capitalized at the project level for purposes of recognition, measurement, and amortization or subsequent impairment testing. Complete detection of all IFRS 3 intangibles
The accounting for subsequent research and development expenditures differs under IFRS 3, subsequent costs incurred for acquired projects that are in the development stage are capitalized, subject to impairment testing, if they meet the recognition criteria. If they do not, then subsequent costs are expensed. Complete detection of all IFRS 3 intangibles
– Patented technology, unpatented technology, and trade secrets
Patented technology is protected legally and, therefore, meets the contractual-legal criterion for separate recognition as an intangible asset. Unpatented technology is typically not protected by legal or contractual means and, therefore, does not meet the contractual-legal criterion. Unpatented technology, however, is often sold in conjunction with other intangible assets, such as trade names or secret formulas. As it is often sold with a related asset, the unpatented technology generally would meet the separability criterion.
Trade secrets are information, including a formula, pattern, recipe, compilation, program, device, method, technique, or process, that derives independent economic value from not being generally known and is the subject of reasonable efforts to maintain its secrecy. If the future economic benefits from a trade secret acquired in a business combination are legally protected, then that asset would meet the contractual-legal criterion. Even if not legally protected, trade secrets acquired in a business combination are likely to be identifiable based on meeting the separability criterion. That is, an asset would be recognized if the trade secrets could be sold or licensed to others, even if sales are infrequent or if the acquirer has no intention of selling or licensing them.
– Computer software, mask works, databases, and title plants
Mask works are software permanently stored on read-only memory chips. Mask works, computer software, and program formats are often protected legally, through patent, copyright, or other legal means. If they are protected legally, they meet the contractual-legal criterion. If they are not protected through legal or contractual means, these types of assets may still meet the separability criterion if there is evidence of sales or exchanges of the same or similar types of assets. Complete detection of all IFRS 3 intangibles
Databases are collections of information, typically stored electronically. Sometimes databases that include original works of authorship can be protected by legal means, such as copyrights, and if so, meet the contractual-legal criterion. More frequently, databases are information collected through the normal operations of the business, such as customer information, scientific data, or credit information. Databases, similar to customer lists, are often sold or leased to others and, therefore, meet the separability criterion. Complete detection of all IFRS 3 intangibles
Economic benefits that usually do not constitute identifiable intangible assets
Other resources are commonly found in business combinations but do not meet the definition of an identifiable intangible asset. As such, they may affect the value of other assets, liabilities and contingent liabilities or they are simply included in goodwill. Normally, they would however not be recognised as identifiable intangible assets:
While these items are usually not recognised separately from goodwill under IFRS, they may still be important or even essential to the acquired business. Some of these items (the assembled workforce for example) may need to be valued in order to determine the values of other assets that do need to be recognised. Complete detection of all IFRS 3 intangibles
See also: The IFRS Foundation