Financial Analysis
EQUITY, BUSINESS ENTITIES, ESTATES, INTANGIBLES, AND ECONOMIC VALUE

Special Topics:

FAS 2:
Accounting for Acquired
"In Process" Research and Development Costs
Substantial Acquisition Write-Offs

The valuation specialists at Arthur Consulting Group, Inc. have helped many clients to resolve multiple, complex issues associated with acquisitions. For example, ACG's skillful valuation of assets, along with the proper application of FAS 2, can effect an immediate write-off of applicable acquisition costs. In some cases, the write-off can be equal to the purchase price of the acquired company.

What is FAS 2?

Financial Accounting Standard Board Statement No. 2, Accounting for Research and Development Costs, allows acquiring companies to immediately write off the portion of acquisition costs considered to be "in process" research and development. For companies to comply with this standard, the FASB has set forth broad guidelines as to the activities that shall be classified as research and development:

"Research is planned research or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or services or a new process or in bringing about a significant improvement to an existing product or process."

"Development is the translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sales or use. It includes the conceptual formulation, design, and testing or product alternatives, construction of prototypes, and operation of pilot plants."

Elements of allowable costs include materials, equipment, facilities, personnel, intangibles, contracts, and indirect costs.

In an independent review of acquiring companies who have employed the accounting strategies permitted by FAS 2, The Wall Street Journal (December 2, 1996) reported, "In some cases, they (companies) have made the entire purchase price of companies vanish from the books on the day of acquisition."

Which companies benefit most from this type of valuation?

ACG recommends a preliminary study on any significant transaction. Specifically, companies which purchase high technology businesses, such as a software or pharmaceutical companies, tend to benefit substantially from an analysis of purchased assets. In any case, since FAS 2 offers no guidelines on the valuation of in-process research, studies should be performed by ACG's skilled professionals who have industry knowledge, along with an excellent history of providing thorough documentation for successful third-party reviews.

Examples of Research and Development That May Be Written Off Under FAS 2:

  • Laboratory research aimed at discovery of new knowledge
  • Searching for applications of new research findings or other knowledge
  • Conceptual formulation and design of possible product or process alternatives
  • Testing in search for or evaluation of product or process alternatives
  • Modification of the formulation or design of a product or process
  • Design, construction, and testing of pre-production prototypes and models
  • Design of tools, jigs, molds, and dies involving new technology
  • Design, construction, and operation of a pilot plant that is not of a scale economically feasible to the enterprise for commercial production.

 

 

 

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