How do you value in-process research and development (IPR&D)?

Full Explanation

In-process research and development represents R&D projects acquired in a business combination that have not yet reached technical feasibility or commercial launch. Under IFRS 3 and ASC 805, IPR&D must be recognised as a separate intangible asset at fair value, rather than being subsumed into goodwill. The valuation typically uses a multi-period excess earnings method with several key adjustments. First, projected cash flows are probability-weighted to reflect the likelihood of successful completion — a pharmaceutical compound in Phase II trials might have a 30-40% probability of reaching market, while a software feature nearing beta might have 80-90%. Second, the discount rate is typically higher than for other intangibles, reflecting the additional completion risk. Third, the cash flow projections must account for the remaining costs to complete the R&D, which reduce the present value. Fourth, contributory asset charges are deducted for supporting assets. Post-acquisition, IPR&D is not amortised while still in process but is tested for impairment. Once the project is completed or abandoned, it either begins amortisation (if completed) or is written off (if abandoned). IPR&D valuations are particularly common in pharma, biotech, and technology acquisitions where the target's primary value lies in its development pipeline rather than current revenue.

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