Question

Merck and Johnson & Johnson

Question: Merck & Co., Inc. and Johnson & Johnson are two leading producers of healthcare products. Each has considerable assets, and each expends considerable funds each year toward the development of new products. The development of a new healthcare product is often very expensive, and risky. New products frequently must undergo considerable testing before approval for distribution to the public. For example, it took Johnson & Johnson 4 years and \(200 million to develop its 1-DAY ACUVUE contact lenses. Below are some basic data compiled from the financial statements of these two companies.

(all dollars in millions)	Johnson & Johnson	Merck
Total assets	\)53,317	\(42,573
Total revenue	47,348	22,939
Net income	8,509	5,813
Research and development expense	5,203	4,010
Intangible assets	11,842	2,765

Instructions

1. What kinds of intangible assets might a healthcare products company have? Does the composition of these intangibles matter to investors—that is, would it be perceived differently if all of Merck’s intangibles were goodwill than if all of its intangibles were patents?
2. Suppose the president of Merck has come to you for advice. He has noted that by eliminating research and development expenditures the company could have reported \)4 billion more in net income. He is frustrated because much of the research never results in a product, or the products take years to develop. He says shareholders are eager for higher returns, so he is considering eliminating research and development expenditures for at least a couple of years. What would you advise?
3. The notes to Merck’s financial statements note that Merck has goodwill of $1.1 billion. Where does recorded goodwill come from? Is it necessarily a good thing to have a lot of goodwill on a company’s books?

Short answer

Patents, goodwill, and trademark are intangible assets. Eliminating research and development expenses can reduce a company’s long-term prospects. Goodwill comes when one company has bought another company.

Step-by-step solution

Meaning of Intangible Assets 

Intangible assets are identified as non-monetary assets that have no physical existence, according to the International Financial Reporting Standards (IFRS). Intangible assets, like other assets, are intended to create future financial returns for the organization.

(a) Explaining the types of intangible assets that a healthcare products company might have.

Patents, goodwill, and trademarks are the key intangible assets that a healthcare goods firm might have. Because each of them has a distinct character, an investor would like often want to know the composition and significance of intangible assets.

(b) Explaining the condition of Merk & Co.

Many CEOs argue that investors are overly focused on the short term and don't recognize solid long-term planning. As a result, they argue that mandating current expenditure on research and development expenditure penalizes leaders who invest in the future.

As a result, when net income is low, it's tempting to reduce research and development spending, because this would result in a direct boost in current-year reported profits. Of course, this will have a negative impact on the company's long-term prospects.

(c) Explaining the condition of the goodwill

If a firm declares goodwill on its balance sheet, it can only mean one thing: the company has acquired another company. This is due to the fact that firms are not permitted to keep track of goodwill generated inside.

They may only report on the goodwill that has been acquired. Ironically, all you have to do to declare a high quantity of goodwill is overpay for another company—the more you pay price, the more goodwill you will report. Reporting a lot of goodwill is obviously not a good thing.