Pharmaceutical, biotech, medical device and other life sciences companies frequently deal with the highly judgmental and complicated area of determining whether an acquisition, investment or license should be accounted for as a business combination or an asset acquisition. This distinction is important as the accounting for a business combination varies significantly from the accounting for an asset acquisition. The recognition of goodwill, deferred taxes and contingent consideration are the key differences under IFRS. A summary of the main differences between an asset and business acquisition is included in Appendix A. For more information on US GAAP see Stay Informed 2013–3.
Arrangements that on the surface appear to convey only assets, include other elements that, for accounting purposes, may mean they meet the definition of a business. This could be the case for acquisitions of intellectual property or other assets or in-licenses of intellectual property. The business combinations guidance can lead to many transactions being considered businesses, including many early-stage projects or in-licenses that grant the licensee rights to inputs and processes.
To assist in determining whether a company has acquired a business, it is helpful to consider the definition of a business provided in the business combinations guidance:
“A business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants. A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set to qualify as a business… However, a business need not include all of the inputs or processes that the seller used in operating that business if market participants are capable of acquiring the business and continuing to produce outputs, for example, by integrating the business with their own inputs and processes.”
This definition is important because it helps emphasise why it is often challenging to assess whether an acquisition of an entity, an asset, a group of assets or in-licenses of intellectual property constitutes a business. Specifically, a business only needs inputs and processes, not outputs.
Examples of inputs include intellectual property, the ability to obtain access to necessary materials or rights and a workforce. Examples of processes include a system or standard that when applied to the input, can create the output. This may include strategic management processes, operational processes and resource management processes, some of which may be inherent in employees retained following the acquisition.
Additionally, a company buying an entity, an asset, a group of assets or in-licensing intellectual property does not need to acquire all of the inputs or processes that the counterparty used in operating that particular business for it to still be considered a business combination as long as the missing elements can be replaced by market participants (for example, by integrating the business with their own inputs and processes). The easier it is to obtain the missing elements in a relatively short time period, the more likely the set of assets and activities are a business.