FAR: Understanding Allowability of Identifiable Intangible Assets

Business combinations (mergers and acquisitions) are complex structures that create complicated accounting issues for consultants – especially when there are government contracts involved. Tax implications, fees, retention agreements, severance pay, accounting, and legal – and the list goes on. One critical component of cost in a business combination that is frequently misunderstood related to Federal Acquisition Regulations (FAR) Part 31, concerns the allowability of the underlying value of identifiable intangible assets recognized under the purchase method of accounting.

How assets are identified and valued in a business combination plays a crucial role in government contracting, yet their treatment under FAR Part 31 can be controversial among industry professionals. Here, this blog dives deeper into the distinction between identifiable and unidentifiable intangible assets to aid in understanding the costs that are allowable as part of overhead.

Navigating the Complexities of Identifiable Intangible Assets

The measurement and definitions of assets are found first and foremost from the Accounting Standards Codification (ASC), and specifically on this topic, ASC 805 Business Combinations. Under ASC 805, firms are required to use the purchase method of accounting in a business combination. This distinction is significant because: 1) it defines the valuation method as the purchase method of accounting; and 2) requires recognition of the assets acquired at fair value. ASC 805 also clearly defines asset categories as those that are tangible and intangible, and identifiable and unidentifiable.

Regarding identifiable intangible assets, ASC 805 defines them as those that are separable or capable of being separated from the entity to be sold or transferred either individually or together with other related assets. They are assets such as trademarks, logos, non-compete agreements, customers, and contracts/backlogs, to name just a few items. They have no physical substance or form.

The FAR similarly defines intangible capital assets as “an asset that has no physical substance, has more than minimal value, and is expected to be held by an enterprise for continued use or possession beyond the current accounting period for the benefits it yields.”

Much of the confusion regarding allowability of such assets arises from the fact that the FAR language in 31.205-52 does not line up directly or in tandem with the ASC or generally accepted accounting principles (GAAP) language. What constitutes an identifiable intangible asset by category, or specifically how it should be valued is not defined in the FAR. However, the FAR does require that costs be accounted for under GAAP (FAR 31.201-2(a)(3)). Because GAAP is required, fair value measurement is required.

Moving On to Unidentifiable Intangible Assets

On the flip side, unidentifiable intangible assets are not separable from the company – things like brand recognition and goodwill. Goodwill is an unidentifiable intangible asset that arises when the acquiring company pays more than the fair value of identifiable individual assets acquired, less liabilities assumed.

In the FAR, goodwill is expressly unallowable. FAR 31.205-49 defines it as follows, “Goodwill, an unidentifiable intangible asset, originates under the purchase method of accounting for a business combination when the price paid by the acquiring company exceeds the sum of the identifiable individual assets acquired less liabilities assumed, based upon their fair values.”

The specificity of the purchase method of accounting is important, as it requires the recognition of all assets acquired at fair value as already mentioned. ASC 805 requires the identification of assets acquired and liabilities assumed at their fair values, REGARDLESS of whether they had been recorded in the financial statements of the acquired entity. Any cost recognized above the fair values assessed for the identifiable intangible assets by definition is goodwill and is an unallowable cost.

Clarifying FAR 31.205-52(b)

What does this mean for allowability purposes under FAR? FAR 31.205-52 (b) states, “For intangible capital assets, when the purchase method of accounting for a business combination is used, allowable amortization and cost of money shall be limited to the total of the amounts that would have been allowed had the combination not taken place.” The last part of this clause is what causes the greatest amount of confusion in determining whether the identifiable intangible assets are allowable or not.

The fair value measurement is what would have been allowed had the combination not taken place. That measurement is required by GAAP. Anything measured above the fair value is goodwill and is unallowable. The fair value measurement of identifiable intangible assets does not create new assets; it simply gives estimated values to already existing assets as required under ASC 805. Additionally, the requirement is to recognize those intangible assets SEPARATE from goodwill.

When applying FAR 31.205-52(b) to identifiable intangible assets, the valuation of the identifiable intangible assets is at fair value per the requirements of ASC 805. And amortization of those costs is based on the fair value assessed. The intent of this part of the FAR is to prevent amortization of costs assessed ABOVE the fair values, which would be goodwill. Simply stated, the FAR allows the fair value, and disallows costs that are written up above fair values.

Next Steps

Government contracting can be a significant revenue stream for many firms. Effectively managing costs under government contracting demands a sophisticated grasp of accounting principles and regulatory intricacies between what is required under GAAP and the interaction of those costs with the FAR.

In case you missed it, watch our on-demand webinar as we delve into strategies to revamp your bonus/incentive plan, positioning it to not only yield results but to align with the stipulations of the FAR. This is your opportunity to enhance team and organizational performance for your firm.

If you need guidance from seasoned FAR experts – reach out to us! Our team has an unusual passion for all things FAR, so we would love to help you succeed and comply.