SMART PILL
What’s IP Worth?
The SEC wants U.S. companies
to embrace international
accounting standards. That
means big changes in how IP is
valued on financial statements.
—By Jay Howell and Rick Nathan
JAMES YANG/CORBIS
For many companies, particularly in the technology sector,
IP represents by far the single
most valuable asset. However,
there is currently little public information reported to investors
about the composition and fair value
of companies’ IP. If useful measurement information about IP assets can
be developed and communicated to
investors, it is likely to significantly
enhance and improve investor’s perceptions of company value. Moreover,
if a company can identify IP and assign
fair value to it, the company can manage it, helping the asset realize optimum value.
The recent trend in accounting
and financial reporting standards is to
increasingly allow or require the use
of “fair value” information to measure
assets and liabilities reported in companies’ financial statements, in lieu
of applying historical cost. This trend
is being driven in large part at the
request of investors and other users
of accounting information to receive
more relevant performance information. The Financial Accounting Standards Board (FASB) Statement no.
157 defines fair value as “the price that
would be received to sell an asset or
paid to transfer a liability in an orderly
transaction between market participants at the measurement date.”
In its current state, accounting and
financial reporting is based on a mixed
attribute model. Financial assets and
liabilities are reported using fair value,
and nonfinancial assets and liabilities
are generally reported using historical
cost. For IP that is developed internally,
the costs of research and development
are generally expensed as incurred,
so no value is typically recorded as
an asset. However, purchased IP is
generally recorded at fair value when
it is acquired, unless still under development. This can result in a lack of
comparability—a company that has
acquired its IP reports the value of
the acquired IP as an asset whereas a
company that developed its IP internally does not typically report it as an
asset.
Understanding differences between
reporting of internally developed IP
versus acquired IP is important to
investors and management. If a company that acquired its IP later fails
to successfully commercialize it, the
company could be required to write-off the value of the IP, resulting in
investors learning that the acquisition
of the IP assets was a failure.
A company that internally devel-
oped its IP, however, would not have
an asset to impair if that IP is later
unsuccessful. In this situation, the
investors do not receive comparable
information regarding the loss in value
of the IP. For technology-based companies and other companies where IP
assets play a large role in performance,
reliable fair value information for IP
assets would be useful for both investors and management to use in assessing performance.
Currently, companies commonly
estimate the “fair value” of IP assets
when assessing how much to charge
when selling or licensing IP, and in certain litigation matters where the value
of IP is consequential in determining potential damages to an allegedly
harmed plaintiff asserting unauthorized
third party use. In these circumstances,
as well as the financial reporting of
company purchased IP, companies,
accountants and valuation professionals rely on generally accepted valuation
approaches and methods.
