The Impact of SFAS 141 & 142 on Intangible Asset Management By Daryl Martin and David Drews* – IPmetrics LLCIn part one of this series, we discussed the concept of intellectual property used ascollateral for securitization and lending. In part two, the importance of context recognition inestablishing accurate asset values was the topic. This final installment will explore theimpact that two recent statements of financial accounting standards (“SFAS”) have had onthe management of acquired intangible assets. The statements are SFAS 141, BusinessCombinations, and SFAS 142, Goodwill and Other Intangible Assets.SFAS 141 requires that the purchase price for an acquired company be allocated amongthe assets acquired, including all tangible and intangible assets. Any intangible asset that isassociated with contractual or legal rights, such as a trademark, patent or copyright, mustbe recognized separately from goodwill. An intangible asset that can be separated from theoperation and sold, licensed or rented independently must also be recognized separatelyfrom goodwill. Those intangible assets that meet these requirements are typicallysegregated according to the following categories: Marketing-related intangibles, such as trademarks and domain names; Customer-related intangibles, such as customer lists; Artistic-related intangibles, such as musical compositions; Contract-related intangibles, such as licensing agreements; and, Technology-related intangibles, such as patents and software.Any portion of the purchase price remaining beyond the identified assets is attributed togoodwill. Goodwill is defined as the excess of the purchase price over the fair value of theacquired assets.Once the intangibles have been identified and categorized, the assets are furthercategorized according to the requirements of SFAS 142. Under SFAS 142, the assets arerecognized at the reporting unit level of the organization, which is one level below theoperating unit designation. An operating unit is deemed to be one in which revenues andexpenses are recorded separate from other operations of the business. These reportingdesignations were chosen to mirror the practices typically followed by management.SFAS 142 further requires that the intangible assets be designated as either finite-lived orindefinite-lived assets. The finite-lived assets are booked at their fair value and must beamortized over their remaining useful lives. The indefinite–lived assets are booked at fairvalue and are subject to an annual impairment test rather than amortization.* Daryl Martin is managing principal and David Drews is president of IPmetrics LLC, an intellectual property consulting firm. You can reach them at 858-538-1533, or by email at firstname.lastname@example.org and email@example.com, respectively.
The Impact of SFAS 141/142 on IP Management Fair value, the standard referred to for assets in SFAS 142, is slightly different than fair market value, which is the usual standard of value utilized in intangible asset valuations. Fair market value is typically defined as the price at which an asset would change hands between a willing buyer and a willing seller, with neither being under compulsion to act and both having reasonable knowledge of all relevant facts. It is constructed as a hypothetical transaction between typical parties, rather than as a transaction between specified parties. On the other hand, fair value is defined as the price at which the asset would change hands in a current transaction between willing parties. The buyer and seller in this instance are understood to be identified rather than hypothetical. This distinction can have significant ramifications when one of the identified parties differs in a material way from a “typical” party to these kinds of transactions. For example, the buyer may be the largest player in the subject industry and therefore has a larger capital base to draw upon. Like the identified indefinite-lived assets, goodwill is also subject to an annual impairment test. If the value of these assets is found to have been impaired, they are written down to their current fair value. There is no mechanism allowed in the statement for recovering the value written off in a prior impairment test. It is important to note that indefinite-lived assets and goodwill may be subject to impairment tests on a more frequent basis as a result of material events such as a current period net loss, a decline in market capitalization or other adverse change in the factors used to value the asset initially. They may also be converted to a finite-lived asset should circumstances demand such an action. The over-riding concern is that the accounting treatment of the assets reflects the actual behavior and usage of the assets. Determining whether an asset is finite-lived or indefinite-lived is usually straightforward. It is dependent upon the nature of the asset being analyzed. Assets such as patents that have a specific expiration date are obviously included in the finite-lived category. Licenses, leases and other contract-related assets that have a specific expiration date typically fall into this category as well. However, the stated expiration date may not define the remaining useful life of the asset. It is important to understand that the expected useful life of the asset may be impacted by the effects of obsolescence, demand, competition and the expected useful life of other assets necessary to effectively utilize the subject asset. The determinants of whether an asset is finite or indefinite-lived can vary among similar assets. Two determinants of remaining useful life that illustrate this potential variability are functional and economic. Functional asset lifespans are determined by the ability of the asset to continue to perform its intended function. Economic lifespans are determined by the asset’s ongoing ability to generate income or revenue. For example, one trademark may be designated as indefinite-lived because its ability to generate revenue is expected to continue unabated for the foreseeable future whereas a different trademark may be designated as finite-lived since its expected utility is relatively short. The key to an accurate designation of remaining useful life, whether finite or indefinite, is a thorough understanding of the asset’s future prospects and the competitive environment in which it operates. IPmetrics.net Page 2