Suchy, Smith, IP Assets in a Flat World, final 102109-2
IP Assets in a Flat World . . . that Just Got Flatter in the Global Crisis
By Donna P. Suchy and Gordon V. Smith
We are learning new business words and concepts as we live through the worldwide economic
downturn. The media introduced us to “toxic” and now “legacy” assets, collateralized debt
obligations, and stimulus package. The terms “bail out” and “bad banks” have taken on a whole new
meaning and importance. Most of these new terms arise from issues surrounding financial assets and
There are also, however, some accounting concepts that appeared even before the financial crises.
These concepts are related to nonfinancial assets such as intellectual property intangibles (“IP
intangibles”) and other intangibles such as goodwill and customer relationships. The financial
reporting of IP intangibles has not drawn the public attention given to troubled mortgage securities,
but it could well be that the worldwide value of such assets far exceeds that of troubled financial
securities. The words “mark‐to‐market” and “impairment” describe the essential elements of these
new financial reporting standards that have received the attention of the worldwide business
community. We tend to focus on what is happening in our own country, but we must recognize that a
convergence of international accounting rules is resulting in homogenized standards for financial
reporting worldwide.1 The result is that any enterprise in any nation of the world that needs access to
world capital markets must communicate with that marketplace by financial statements that
conform to new international standards.
While these new financial standards relate to many different kinds of assets, IP intangibles present
some of the knottiest problems that deserve our attention because intangibles now comprise most of
the world’s business assets. We believe that it is important for professionals and businesspeople whose
work touches intellectual property to understand how these financial reporting standards will impact
them, their companies, their clients, and the business community. It is also inevitable that legal
professionals will be called upon to provide input for clients’ efforts to comply with these new
Under new accounting rules, some assets of a business enterprise must be reflected in financial
statements at their fair value rather than their cost.2 This requirement is triggered by merger and
acquisition activity that will no doubt strengthen again as we move through the current downturn. The
effect of this is trifold:
• The purchase price allocation must be based on estimates of fair value that will pass muster
in an audit. These estimates, at the end of the day, are the responsibility of company
management, though management may elect to obtain assistance from professionals in the
• The acquired assets will always carry with them an element of “value” in their rendition
on financial statements.
• IP intangibles will appear on the acquiring company’s financial statements perhaps for the
first time, in contrast to self‐created intangibles that have always been excluded.
Businesspeople and accountants have long struggled with the difference between quantifying assets
in terms of their “value” or their “cost.” This debate originally arose from recognition that the value of a
business enterprise (i.e., what someone might be willing to pay to purchase it) is unrelated either to the
rendition of its assets in the books of account or to the costs originally incurred to assemble its
Traditionally, business financial statements record tangible assets at their original cost and
exclude IP and other intangibles that the business has created or assembled. Those concerned with
the worth of the whole business enterprise commonly resorted to the concept of “goodwill” to
reconcile the difference between the recorded cost of underlying assets and the market value of the
complete asset assemblage. We now know that difference is more accurately represented by the
value of the intangibles, including the IP intangibles, that the enterprise has acquired or created.
The term “value” has been variously defined and described. We refer to “fair value” because
current accounting practice worldwide tends to use that term.3 “Cost” represents something
• Value = Price agreed between willing buyer and seller; or
• Value = Present value of future economic benefits;
• Cost = Specific price paid for goods or services at a particular point in time.
Most of us intuitively understand this distinction. For example, we know that when we purchase
an automobile from a dealer’s showroom, the total consideration—cash plus perhaps a trade‐in—is
the price of that auto at that time, or our cost. It is no mystery to anyone that what someone would be
willing to pay us for that auto the next day, week, or year will be something different. That is the
ever‐changing value of the auto.4 Our good common sense tells us that the value of our auto is going
to go down as it ages and as we put miles on it. So over time there will be an increasing difference
between its cost and its value.
A Bit of MarktoMarket History
The 1960s brought a surge in mergers and acquisitions in the United States. The then Accounting
Principles Board issued Opinions 16 and 17 requiring the allocation of an acquisition’s purchase
price among the assets acquired, both tangible and intangible, based on their “fair market value.”
These accounting allocations were rather crudely done, and there was little incentive for an acquiring
business to elaborately investigate the existence and value of the full panoply of intangibles, IP or
At that time, the Internal Revenue Code also called for such an allocation. There was a material
benefit in making a careful allocation for tax purposes because intangible assets—for example,
intellectual property—acquired might be separable from goodwill and generate a tax benefit through
amortization. Valuation professionals swung into action and figured out how to appraise intangibles
and support an amortizable life that would stand up in Tax Court. These were primarily U.S. issues then,
driven by our Tax Code.
The Financial Accounting Standards Board (“FASB”) in 1979, during a period when our annual
inflation rates were in the low teens, issued requirements for large U.S. companies to report income
adjusted for the effects of “general inflation” and the gain or loss in purchasing power on net
monetary items. This valuation of tangible assets only was to be presented in supplements to
financial statements, and did not replace traditional reporting.5 Compliance was poorly executed and
there was resistance among corporations to the added burden. Restatements were routinely
calculated by applying generalized price indexes to original costs. FASB eliminated the requirement
for these supplementary disclosures in 19846 and, in 1986, made those provisions voluntary.7 Few
corporations volunteered. In the years since, the accounting standards morphed into the current new
ones, and the federal tax regulations were legislated into nonissues.
While not the focus of this paper, there has been much debate, as our economic downturn unfolds,
about the appropriateness of the mark‐to‐market requirement because of the difficulty of
discovering the “fair value” of some troubled, mortgage‐related securities because “the market”
disappeared. The balance sheets of some major banks melted under the assumption that these
securities had zero or minimal value. This debate has not extended to other types of assets such as
intellectual property and other intangibles up to now.8
In June 2001, the FASB issued Statements of Financial Accounting Standards (SFAS) 141, 142, and
157 that give rise to this paper.9 Collectively, these Statements document the requirements for
purchase price allocation following an acquisition and define fair value. Generally, they echo the
standards introduced in APB 16 and 17 with more force and much more detail.
The International Accounting Standards Board (IASB) has acted correspondingly in its issuance of
International Financial Reporting Standards (IFRS).10 Approximately 100 nations either require or
permit the use of IFRS and many more (the United States included) are working towards convergence
with their own national financial reporting standards.
We note again that this entire discussion of the treatment of intellectual property and other
intangibles on financial statements now applies only to those assets acquired in business combinations.
Selfcreated intangibles continue to be excluded from financial statements.11
Accounting standards can be thought of as a system of checks and balances. For example, accounting
practice clearly recognizes that assets, of whatever kind, do not perpetually contribute to the earning
power of an enterprise. Machines wear out or, like buildings and processes, become obsolete. Patents
expire; brands mature, are phased out, or are superseded. All accounting systems attempt to reflect this
loss in value through a periodic charge called depreciation or amortization. The details of this are
irrelevant to our purpose here. The cardinal principle is, however, that financial statements must never
overstate a company’s assets. So our accounting friends have an “ace‐in‐the‐hole”—an impairment
standard. If, for any reason, an asset is deemed to have a value significantly less than its carrying
amount on the financial statements, then the carrying amount must be adjusted downward. The
amount of the adjustment is a reduction to net income. The impairment examination must be done
annually. One can easily visualize how the impairment word gets the attention of corporate
management intensely focused on earnings‐per‐share.
There are many impairment triggers in today’s world business environment. The purchase price
of an enterprise three years ago was probably much higher than it would be in today’s marketplace.
The three‐year‐old allocated price is on the acquirer’s financial statements. Is there impairment? In
addition, the earnings of the acquired enterprise are probably depressed due to today’s conditions.
Debt and equity returns are different today and that has an impact on the worth of the business and
its underlying assets. Employees may have been laid off and plants closed.
If the value of the acquired business is lower due to impairment, then the values of its underlying
assets are commensurately lower. Which asset groups are going to take the hit? We suggest that
intangibles (including “goodwill” and intellectual property) are likely to be high on that list because
we know that the value of those assets is very sensitive to external influences.
So, just as mark‐to‐market requires valuation expertise to make the allocation following an
acquisition, valuation expertise is again required in annual impairment reviews. These are growing
challenges because the need is now international and because intellectual property and other
intangibles are far more important business assets than they formerly were.
Impact on Business
The new financial reporting standards have had a significant impact on the business community. We
highlight some of the elements:
• Those enterprises that need access to capital markets need to comply NOW.
• Valuation skills need to be developed or acquired. There has been a (we hope) temporary
lull in merger and acquisition activity, but it will return. Additionally, while our focus has
been on valuation needs following an acquisition, valuation skills are often needed in
restructurings, though in our experience, there is more need for total enterprise values and
not valuations of individual underlying assets. Liquidations of bankruptcy estates also give
rise to a need for valuation skills.
• Valuation skills must include the ability to estimate remaining economic life for each asset
• Overpayment for an acquisition will likely result in a future impairment write‐down. Such
an event puts “overpayment” in clear focus to lenders, stockholders, and competitors,
whether that was the cause or not.
• An impairment write‐down can be a significant negative event. PricewaterhouseCoopers
reported in April that approximately $230 billion of impairment write‐downs were
announced by Fortune 500 companies from the third quarter 2008 through March 2009.
This was more than twice the amounts reported by the same group in the three years
leading up to this recent period.12 Individual impairment write‐downs that we observed
include CBS ($14 billion, October 30, 2008), Gannet ($300 billion, June 10, 2008), and
Delta Airlines ($6 billion, April 4, 2008).
• A misallocation can lead to an impairment write‐down. Allocated values assigned to
trademarks with an indefinite life or to goodwill need not be amortized. Such assets
therefore do not create amortization expense that reduces future earnings. So there is a
tension between a desire to maximize the allocation to trademarks and goodwill so as to
minimize amortization and perhaps putting oneself at risk for a future impairment write‐
The Audit Hurdle
While the Securities and Exchange Commission, or its counterpart in another country, is the final
arbiter of whether allocations of purchase price to intangibles are acceptable under the new financial
reporting standards, a company’s auditors are responsible for the critical review of management’s
allocation. So it is important for management, including in‐house or outside IP counsel, to understand
the requirements, especially for intangibles.
As an example, we can observe the guidelines for valuation methods and see how they fit with
intellectual property and other kinds of intangible assets. SFAS 157 describes a hierarchy of
techniques for valuation:13
Level 1: Estimates fair value based on the price, in an active market, of an identical asset or liability.
How useful is this for intellectual property and other intangibles? Not very, and not surprising. The
whole IP legal system is in place to prevent the existence of confusingly similar trademarks or closely
Level 2: Estimates fair value based on an observable price in a market, of a somewhat similar asset
or liability (“market‐corroborated”). Again, for intellectual property and other intangibles, the
comparability problem is present, together with the extreme difficulty of making adjustments to
Level 3: Estimates fair value based on assumptions about how market participants would price the
asset or liability. This is the tried‐and‐true capitalization of income method (aka present value of
future economic benefit, aka discounted cash flow) that is the staple for valuing intangibles.
We who are close to intellectual property know that its value can fluctuate greatly from a myriad
of external influences. We also know that the cost of intellectual property is nearly always irrelevant
to its value (think of the accidental discovery of 3M’s Post‐it® Note adhesive). Therefore, today’s
value of intellectual property is almost surely not yesterday’s or tomorrow’s. Impairment always
looms over us. There is no such thing, by the way, as value enhancement. Value on the books either
stays the same or diminishes.
The Legal Role
It is clear that compliance with current financial reporting standards requires a careful and
competent valuation of acquired intangibles. It is also clear that impairment testing is a recurring
challenge whose results are both public and important. We anticipate little patience with a “don’t ask,
don’t tell” approach to impairment testing. Investors and lenders are likely to be very quick to
question management (i.e., what did you know, when did you know it, did you thoroughly inform
your auditor?). We note that the PricewaterhouseCoopers report cited previously indicated that
investors have been observed to ignore noncash impairment charges. It may well be that in these
troubled times there is so much business bad news that a bit more has no real effect. As recovery
ensues, it would not surprise us if that investor attitude changes.
IP attorneys should be a part of the due diligence process in an acquisition. In addition to testing
the risk inherent in the acquisition, this is an opportunity to gather information essential to the
subsequent valuation. The valuation team will need to know if the target company’s intellectual
property is in good standing, with fees paid. An opinion about the relative strength of the intellectual
property will be important, as will an evaluation of pending litigation. Depending on the materiality
of litigation underway, it may be necessary to quantify the present value of possible outcomes.
Following the acquisition it is critical to ensure that the future plans of the buyer and the
conditions of IP ownership comport with economic remaining lives and fair values assigned.
Assigning significant value to a trademark that the acquiring company plans to abandon mandates a
future impairment write‐down, as does assigning an economic life for amortization purposes that is
too long, given the buyer’s expectations or plans. There are a myriad of factors to be considered, such
as the possibility of future sale of business units (along with the intellectual property dedicated to
them), and plans to discontinue operations. IP attorneys should be involved in evaluating existing
and potential licenses, including the financial and competitive strength of licensees. Are there
opportunities to extend patent protection through technology enhancements or modifications?
All of these factors and more can be important inputs to the valuations that must be made to
comply with the new financial reporting standards. And there is a very real financial stake in getting
Glossary of IP Accounting Terms
Impairment Simply put, impairment equates to a reduction in value. There are a myriad of reasons
why the value of any asset changes over time. When that change is downward, an impairment has
Impairment WriteDown Generally speaking, when the value of any asset drops below the amount
recorded in a company’s financial statements, those statements must be changed to reflect that
reduction, i.e. they must be “written down.”
Intangibles vs. Intellectual Property Intellectual property, such as patents, trademarks,
copyrights, or trade secrets, is a subset of intangible assets. IP is distinguished because its ownership
and exploitation are protected by law. Customer relationships wax and wane, employees come and
go, but the owner of a patent has a property right to exclusively exploit it and that right is protected
MarktoMarket Three years ago my company purchased my laptop computer for $1,950. That
price was equal to fair value at that time (else we would not have made the purchase). That amount
is shown on my company’s financial statements. Today, my laptop would probably fetch $300 in the
marketplace. That is its current fair value. If financial reporting standards require my company to
“mark the laptop to market,” then $300, rather than $1,950, would appear on my company’s financial
NonFinancial Assets Every business, large or small, is comprised of several kinds of assets. The
nonfinancial assets are the tangibles (land, buildings, machines, and the like) and the intangibles
(customer relationships, software, assembled workforce, and intellectual property).
SelfCreated vs. Acquired Intangibles Every successful enterprise is constantly creating intangible
assets. Customer relationships are won; employees are trained; R&D produces new technology; new
brands are introduced. These are self‐created intangibles. Occasionally an enterprise acquires another
business entity or product line and, in the process, obtains new intangible assets. These are acquired
intangibles and they are accounted for differently.
Donna P. Suchy, Legal U.S. IP counsel for Eastman Kodak in Rochester, New York, is the author of The
Fundamentals of IP Valuation. Ms. Suchy has written and lectured on the topics of patent prosecution, corporate
transactions, IP valuations, and IP law. She can be reached at firstname.lastname@example.org. Gordon V. Smith is
chairman of AUS, Inc., a multidiscipline consulting firm, and Distinguished Professor of IP Management at
Franklin Pierce Law Center. He has consulted with clients on IP business and economic issues for nearly 50
years. He can be reached at email@example.com
1. In the United States, generally accepted accounting principles (GAAP) are issued by the Financial Accounting Standards
Board (FASB), acting on authority of the Securities and Exchange Commission. International Accounting Standards (IAS) and
International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards Board (IASB)
overseen by the Trustees of the International Accounting Standards Foundation.
The FASB and IASB have embarked on a joint project—The Conceptual Framework—to develop converged accounting
standards. See http://www.fasb.org/project/conceptual_framework.shtml.
2. Simply stated, when Company A acquires Company B, Company A must allocate the purchase price among the
monetary, tangible, and intangible (including IP) assets of Company B, based on their fair value. The resulting allocated
purchase price is then entered on Company A’s financial statements.
3. For the purpose of this paper, the reader is encouraged to think of fair value as “market value” (i.e., a fair deal between a
willing buyer and a seller). That is exact enough for this discussion and appeals to our common sense. For a less appealing
discussion, see FASB’s Statement of Financial Accounting Standards No. 157.
4. It is quite understandable that there could be confusion about value and cost. When an enterprise acquires an asset,
presumably the price paid equals the asset’s value. Therefore, it is universally accepted that this amount is appropriate to be
recorded on the balance sheet (cash goes out; an asset comes in). Immediately after the purchase, however, the asset’s value
begins to change due to a myriad of external conditions, and value no longer equals the original price or the recorded cost.
There has existed, in recent years, increasing pressure to bring these two measurements into congruence, or at least to explain
the differences in a way that is clear and understandable to investors, regulators, and lenders.
5. Statement No. 33, Financial Accounting Standards Board, 1979:
The Board believes that this Statement meets an urgent need for information about the effects of changing prices. If that
information is not provided, resources may be allocated inefficiently; investors’ and creditors’ understanding of the past
performance of an enterprise and their ability to assess future cash flows may be severely limited; and people in government
who participate in decisions on economic policy may lack important information about the implications of their decisions.
6. Statement No. 82, Financial Accounting Standards Board, 1984.
7. Statement No. 89, Financial Accounting Standards Board, 1986.
8. For more on this debate, see Heidi N. Moore, Move to Ease “Mark” Rule May Subvert Treasury Plan, WALL ST. J., Apr. 1,
2009; Kara Scannell, FASB Eases MarktoMarket Rules, WALL ST. J., Apr. 3, 2009; Simon Nixon, Bookkeeping Rule Makers Need
to Avoid North Atlantic Rift, WALL ST. J., Apr. 8, 2009.
9. In June 2001, the Financial Accounting Standards Board issued two statements that substantially altered U.S. accounting
for intangible assets and intellectual property acquired in business combinations:
Statement of Financial Accounting Standards No. 141—Business Combinations (SFAS 141), revised in SFAS 141‐r in April
Statement of Financial Accounting Standards No. 142—Goodwill and Other Intangible Assets (SFAS 142).
The FASB issued SFAS 157, Fair Value Measurements, in September 2006, and has recently issued revisions. Taken together,
these three Statements comprise the core of the subject financial reporting regulations related to U.S. generally accepted
accounting practice (GAAP).
10. Refer to http://http://www.iasb.org for IAS 38—Intangible Assets and IFRS 3—Business Reorganizations.
11. As an example, we can observe on the financial statements of the Coca‐Cola Corporation, the presence of entries for
“Trademarks with indefinite lives, Goodwill, and Other Intangible Assets.” These are intangibles and intellectual property that
the company has acquired along with other assets in business combinations. We do not see any value representing the famous
CocaCola formula or trademarks.
12. See Goodwill Impairment Implications in the Current Market Turmoil, WALL ST. J., Apr. 10, 2009, at C9, available at
13. See SFAS 157, Summary, http://www.fasb.org, and the following paragraphs:
A21. To increase consistency and comparability in fair value measurements and related disclosures, this Statement
establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into
three broad levels.
A22. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting
entity has the ability to access at the measurement date.
A24. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or
liability, either directly or indirectly through corroboration with observable market data (market‐corroborated inputs).
A25. Level 3 inputs are unobservable inputs for the asset or liability, that is, inputs that reflect the reporting entity’s own
assumptions about the assumptions market participants would use in pricing the asset or liability (including assumptions
about risk) developed based on the best information available in the circumstances. Assumptions about risk include the
risk inherent in a particular valuation technique used to measure fair value (such as a pricing model) and/or the risk
inherent in the inputs to the valuation technique.