How is in-process R&D treated in a business combination under US GAAP and IFRS?

Question

AcadiFi · Accepted Answer

You're right that this changed dramatically, and it's a favorite CFA Level II test point because of the counter-intuitive post-acquisition treatment.

**Current Treatment (ASC 805 / IFRS 3)**

At the acquisition date, in-process research and development (IPR&D) is:

1. **Recognized as a separate intangible asset at fair value** — In this case, $90M
2. **Classified as an indefinite-lived intangible** until the project is completed or abandoned
3. **Not amortized** while in progress — instead, tested for impairment at least annually

**Post-Acquisition Outcomes**

| Scenario | Treatment |
|---|---|
| Project completed successfully | Reclassify to definite-lived intangible, begin amortization over useful life |
| Project abandoned | Write off entire carrying amount as an expense |
| Still in progress | Continue annual impairment testing, no amortization |

**Praxeon–Cellvance Example**

At acquisition: Praxeon records the Phase II drug project at $90M as an indefinite-lived intangible.

Year 1: Project still in Phase II trials. Praxeon performs impairment test — no impairment. The $90M sits on the balance sheet with zero amortization expense.

Year 2: The drug receives FDA approval. Praxeon reclassifies it to a definite-lived intangible with an estimated 12-year commercial life. Amortization begins: $90M / 12 = $7.5M per year.

Alternative Year 2: Clinical trials fail. Praxeon writes off the entire $90M as an impairment loss.

**Old Rule vs. New Rule**

Before ASC 805 (pre-2009), acquired IPR&D was immediately expensed at acquisition. This was problematic because:
- It created a huge Day 1 charge that depressed acquisition-year earnings
- Subsequent periods had artificially high earnings (no amortization of the R&D asset)
- Companies used it as an earnings management tool — overstating the IPR&D allocation to front-load expenses

**Analyst Adjustments**

As an analyst reviewing Praxeon, you should:
- Monitor the annual impairment test disclosures for IPR&D
- Assess whether the $90M fair value is reasonable given the drug's development stage and probability of success
- Recognize that once amortization begins, reported earnings will decline

Practice IPR&D questions in our CFA Level II question bank.

How is in-process R&D treated in a business combination under US GAAP and IFRS?

Master Level II with our CFA Course

Related Questions

Practice Questions