Investment and acquisition opportunities rely on the ability to consider and examine a business’s audited financial records and statements. As such, having a comprehensive understanding of these records is key to obtaining an accurate business valuation.
With this in mind, today, we’re looking at in-progress research and development projects, how they’re recorded on financial statements and how they can signal investment opportunities (or a lack of investment opportunities) for entrepreneurs and business owners looking to acquire new companies.
With many businesses filing their accounts under FRS101 or FRS102 standards, more and more research and development expenditure is being capitalised (i.e. recorded on balance sheets). Why? Because, while UK GAAP standards outline that certain expenditure could be capitalised, international standards (IFRS) are much more definitive.
Why does this matter?
It’s important to understand how accounts have been filed in order to gauge an accurate valuation of a company.
When one business looks to acquire another, the amount spent on acquisition often outweighs that of the ‘book value’ of the company. This is known as ‘goodwill’ and is a premium treated as an asset on a balance sheet - with the acquirer allocating this goodwill to resources expected to provide future economic value.
However, accounts filed under IFRS standards follow the stipulation that intangible assets should be recognised separately from goodwill.
What’s an intangible asset?
Businesses capitalising R&D expenditure will spread the total cost across financial statements to reflect the fact that the research and development in question will benefit the business over a number of years.
As such, income statements will feature amortised expenses for each year an asset is in use, as opposed to one big expense in the year of purchase. This will paint a more accurate picture of a business’s profits and overall stability.
If these assets have a physical form, they’re defined as tangible fixed assets. If your assets lack a physical form, such as in-progress R&D projects, they’re defined as intangible assets.
What impact does this have on valuation?
IFRS standards state that, if an intangible asset is obtained in a business acquisition, the cost of that asset is its fair value on the date of acquisition. This cost should be recognised separately from goodwill, and should account for the expected future economic benefits of an asset.
When considering a business acquisition, then, it’s paramount that any in-progress R&D is thoroughly studied in order for you to truly understand the value of that project. As an added intangible asset expense separate from goodwill, your ability to accurately evaluate the worth of in-progress R&D will help you to better understand whether there’s a worthwhile opportunity in any given acquisition or investment.
Need a hand understanding what R&D claims your business could benefit from? Get in touch with the experts at Lumo today. We can’t wait to hear from you.