The draft proposal from the FinREC Task Force on in process research and development was just posted on the AICPA website.
Here's BVR coverage of pre-release comments on the report from members of the Task Force, as reported at the ASA National BV Conference last month:
Revised IP R&D Practice Aid to Go Beyond Earnings Approach
One of the best-attended sessions at the ASA’s National Business Valuation Conference this fall was the “IP R&D Practice Aid Current Developments Panel,” featuring Tony Aaron (Ernst & Young), David Dufendach (Grant Thornton), Ryan Kaye (Ernst& Young), and Ray Rath (PwC).
Part of the interest was generated by the fact that the panelists had seen the draft report coming out of this AICPA’s Financial Reports Executive Committee (FinREC) working group—but the public won’t get a first view for a while (no firm date has been announced but many hope to see the draft before year-end). The final report release is still scheduled for 2012, though delays are the norm.
What do we know so far? The newly revised IPR&D Practice Aid from the AICPA will significantly expand consideration of various valuation techniques, Tony Aaron, co-chair of the AICPA task force that’s revising the practice aid, told ASA attendees. “Compared to the 2001 first edition, in which the valuation chapter contained only 70 paragraphs, the revised chapter will have over 200,” he said.
The original practice aid also focused primarily on the multi-period excess earnings method (MPEEM), said David Dufendach, potentially casting the relief-from-royalty method in a negative light. The updated version will contain examples of MPEEM, the relief-from-royalty method, and decision tree analyses, thereby removing any perceived barriers to their use and according them appropriate weight.
The revised IP R&D guide will also discuss the “Greenfield approach,” the cost savings method, split methods, and more. “It really opens the doors to whatever we think is the appropriate methodology,” Dufendach added.
The audience had many practical questions for the panel, since there are so many assumptions related to in-process R&D valuations. Among them:
- If an appraiser is already using an excess earnings approach elsewhere in a valuation, is it sufficient to value IP R&D as well?
- How should appraisers handle the fact that IP R&D may include contributory charges from some other established asset?
- Can you handle the valuation of these assets by using a discount rate appropriate to a start-up operation, since in-process R&D may behave similarly from a risk point of view?
- How can appraisers take into account the fact that a license or operating rights to new intellectual property might be worth more to an experienced operator than to a new operator?
First, “the task force did not think it would be appropriate to combine tangible and intangible assets for impairment testing purposes,” said Ryan Kaye. But, intangibles that can be capitalized and are similar in nature can be combined into one single DCF analysis—if they ARE the same. “The management accountants and appraisers need to agree on the degree of disaggregation and the unit of account,” said Tony Aaron.
Second, the original practice aid had a primary focus on the multi-period excess earnings method—in fact, it coined the term. “The original guide had a long explanation on MPEEM, and a couple of paragraphs on some decision tree methods,” David Dufendach summarized. “The relief from royalty method was almost cast in a negative light.” Dufendach polled the ASA audience and found that 80% had used MPEEM, but only a handful had used other methods to appraise IPR&D. “So there’s a lot more guidance on other methodologies and when they might work in the update,” Dufendach continued.
“We’re not trying to push anyone toward the relief from royalty method,” Dufendach said. “You can’t use it unless the data’s there. But we are trying to open up the barriers to using other methods that might be appropriate in given situations.”
Is the ASA’s course on intangibles still current? The ASA is already adapting its popular course ASA 301 (Valuation of Intangibles) for the timing of this new practice aid, says Ray Rath (PwC), based on what is already known. He believes further adjustments to keep current with the FinREC Practice Aid will occur very quickly.
Other possible changes to anticipate in IP R&D valuation:
- Should “core technology” still be valued? “Those assets are still there, but much of that will now be considered enabling technology,” said Dufendach, “such as those technologies that are shared between existing product platforms and future products.” These enabling technologies might not meet the asset definitions of ASC 805, but they will be a factor in IPR&D valuations. “Another term in the practice aid is ‘technology migration,’” he said. These technologies might evolve during generations of product development.
- Another new term is “day 2 treatment.” Now that IPR&D assets can be capitalized in a business combination, the practice aid needs to look at the impairment models. The first group of these are the indefinite-lived intangibles. The practice aid allows for recognition of changes of status, such as when FDA approval is granted. “It can be assumed that the asset has increased in value because of events like this,” said Kaye, “so companies can elect not to conduct a separate impairment test.” For finite-lived intangibles, you’re still subject to the two-step process, the panel agreed.
- Defensive intangible assets, developed to prevent others from entering the market. may now also need to be tested. So, for instance, a company acquires a technology to protect its beachhead in a new technology. This acquisition becomes indefinite-lived IP R&D.