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US GAAPâIssues and Solutions for the Pharmaceuticals and Life Sciences Industries 62.Pre-existing relationships in a business combination Background Relevant guidance CompanyÂ A in-licenses a Phase I compound from CompanyÂ B in 20X5. With the in-license agreement, CompanyÂ A acquires the global exclusive rights to develop and commercialize the asset, including rights to manufacture, market, and sell any successful product. The rights granted are for 25 years, the full protected life of the intellectual property. CompanyÂ B retains the ownership (legal title) of the initial intellectual property. The acquirer and acquiree may have a relationship that existed before they contemplated the business combination, referred to here as a preexisting relationship. A preexisting relationship between the acquirer and acquiree may be contractual or non-contractualâ¦ [ASC 805-10-55-20]. The terms of the in-licensing agreement are that CompanyÂ A pays $300 million upfront and, if commercialized, a 5% royalty on all sales. CompanyÂ A is responsible for all development of the product and any incremental intellectual property completed by CompanyÂ A is owned by CompanyÂ A. The product has successfully moved to pre-Food and Drug Administration (âFDAâ) approval (i.e.,Â Phase III). CompanyÂ A acquires CompanyÂ B for $2 billion in 20X3, and the acquisition is accounted for as a business combination. There was no stated settlement provision provided for by the in-license agreement. Assume that the market rate to in-license the intellectual property is the same as above: $300Â million of payments plus a 5% royalty. However, the market rate to in-license both initial intellectual property and the incremental intellectual property would be a 20% royalty (which is equivalent to the $2 billion in fair value of the company). The higher cost reflects the fact that a Phase III asset is more likely to generate positive cash flows compared to a Phase I asset. 82 PwC If the business combination in effect settles a pre-existing relationship, the acquirer recognizes a gain or loss, measured asÂ follows: â¢ For a pre-existing non-contractual relationship, such as a lawsuit, fair value â¢ For a pre-existing contractual relationship, the lessor of theÂ following: â T he amount by which the contract is favorable or unfavorable from the perspective of the acquirer when compared with pricing for current market transactions for the same or similar itemsâ¦ â T he amount of any stated settlement provision in theÂ contract available to the counterparty to whom theÂ contract is unfavorableâ¦ [ASCÂ 805â10â55â21].