In the first intangible assets article, we discussed the “economic phenomena” of intangible assets and the tests for its economic value and legal existence. These tests, if passed, may indicate the existence of identifiable intangible assets. Intangible assets have two general categories: real and personal property.
Intangible real property includes fractional ownership interests in real estate, including leases, easements, air rights and subsurface rights. Intangible personal property includes patents, copyrights, secret processes and formulas, goodwill, trademarks, brand names and franchises. Identifiable intangible assets are also divided by similar nature and function and by similar economic analysis methods. The general categories, which do not include patents and copyrights (see below), are as follows:
- Technology Intangibles: engineering drawings, proprietary technology, technical know-how, systems and procedures, technical manuals and documentation.
- Customer Intangibles: proprietary customer, client, patient and even mailing lists, whether they are made up of customers or prospects and customer and referral relationships.
- Contracts Intangibles: certificates of need, licenses, affiliation agreements and non-competition agreements.
- Data Processing Intangibles: computer software and automated databases.
- Human Capital Intangibles: trained and assembled workforce and employment agreements.
- Marketing Intangibles: trademarks, trade names or franchise agreements.
- Location Intangibles: beneficial leasehold interests.
- Goodwill: all other intangible assets not separately identified and valued.
Intellectual property is a special classification of intangible assets that enjoy special legal recognition and protection. Unlike other intangible assets created in the normal course of business, intellectual property is created by specific and conscious human intellectual activity. Because of this creative process, intellectual property is generally registered under and protected by specific Federal and State statutes.
Like other intangible assets, intellectual property has economic value and legal existence and is also categorized according to similarities in nature, features, methods of economic analysis, methods of creation and legal protection. Patents and patent applications are categorized as innovative and their worth depends on the patent’s economic and legal life and the strength of the patent claim, which is difficult to determine if the patent has never withstood litigation. Copyrights are categorized as creative and are trickier to value than patents because their practical value may be short lived even though they have a long legal life. This is especially true for technical works that quickly become outdated and the previous success of the author’s written work.
Customer lists are especially valuable to a business if the relationships are ongoing. Consider, for example, a magazine’s list of advertisers who makeup a significant chunk of its overall revenue. Without this list, therefore, the magazine would be less future profitable in the future. The same company may have a favorable supplier contract that allows it to purchase paper at below-market. Or it may have a contract that allows it to sell its magazines for a higher-than-normal markup through certain retailers. The longer the term of the beneficial contracts, the greater the value to a company. The magazine may have developed proprietary data processing software specific to their businesses that provides efficiencies that save the company time and money. Without the software, the benefits wouldn’t otherwise be realized. Franchises with long track records and well-recognized brands have significant market value over newer, lesser-known franchises. This magazine may dominate its market and industry because of its well-known trademark and trade name.
Until recently, intangible assets were booked at cost and amortized over as many as 40 years. SFAS 142 eliminated this practice for fiscal years beginning after December 15, 2001. The new accounting rule now requires that intangible assets and goodwill must be separately identified, be valued or tested annually and written down to fair market value if they have depreciated or have been ‘impaired’. The value in excess of the net tangible and identifiable intangible assets is goodwill. The new rule assumes that these assets have unique and indefinite useful lives and that their values do not necessarily decline over time. Weakening market and business conditions, and not accounting rules, will determine the depreciation of the asset. Strengthening market and business conditions can never appreciate or write up the asset. The ‘rule requires the fair value’ and not the fair market value as the standard of value. This standard is similar to the ‘investment value’ that assumes an intrinsic or synergistic value to a specific buyer, which is not the value paid for by a hypothetical buyer under the fair market value standard.
Other than in intangible assets, valuations by a business valuation analyst are important in financial, tax and litigation matters.
The preceding article is intended as general information and should not be considered legal, tax, accounting or other expert advice. As the author, I represent that neither the information nor its impact is comprehensive. If legal, tax, accounting or other expert advice is required, please use a qualified and competent professional.