Appendix B. Economic Benefit, Timing, and Pattern
| Author | Russell L. Parr |
| Profession | President of Intellectual Property Research Associates |
| Pages | 507-529 |
APPENDIX B
ECONOMIC BENEFIT, TIMING,
AND PATTERN
The income approach to valuation discussed in the main text determines market valueas the
present value of future economic benets associated with a specic intellectual property.
A future stream of benets is dened and then discounted by a required rate of return to
reect the risk of actually receiving the future benets. When the future stream is forecast
based on a known history, a reliable pattern can be estimated. For untested intellectual
property, the future stream may follow many different patterns. This appendix discusses
the timing and pattern of future economic benets.
ECONOMIC LIFE DEFINED
For intellectual property and intangible assets, economic life is the period during which the
use of an asset is protable. Economic life ends when (1) it is no longer protable to use an
asset or (2) the property has become obsolete and it is more protable to use another asset.
A patent, for example, protects the rights of its possessor to exclude others from practicing
the protected invention. When the patent expires, exclusive protection ends and the patent
no longer has value.
Some of the ways to measure economic life are discussed ahead.
LEGAL/CONTRACTUALLIFE. Intangible assets and intellectual property have a recognized
legal or contractual life. These include:
•Patents—In general, the term of the patent lasts for 20 years from the date of ling
for a patent. For patents led prior to June 8, 1995, the term of patent is either
20 years from the earliest ling date or 17 years from the issue date, whichever is
longer.
•Copyrights—In general, a work that is created on or after January 1, 1978, is ordi-
narily given a term enduring for the author’s life plus an additional 70 years after
the author’s death.
•Trademarks—Legally, no restrictions exist as to the limitation of the registration of
a trademark over time and its continual renewals.
•Leases—Dened by a lease agreement.
•Supply or distribution contracts—Dened by a contract.
507
508 App. B Economic Benefit, Timing, and Pattern
•Subscriptions—Dened by a subscription agreement but often lasts longer when the
history of renewals is considered.
•Mortgages or other loan agreements—Dened by an agreement.
•License agreements—Dened by the agreement.
•Franchise agreements—Dened by the agreement.
In many cases, economic life is shorter than legal life. The effectiveness of a patent
may end before its legal life. An unexpired patent may be made obsolete by advancing
technology or because the product in which it was used has lost its place in the market.
INDEFINITE ECONOMIC LIFE. Economic life can last longer than its contractual life.
Alternatively, the economic life of a magazinesubscription or consumer loan contract may
be longer than its (legal) contract life if there is a history of renewals. Most often the legal
or contractual life is not controlling with respect to the economic life of intangible assets
and intellectual property. The economic life of these assets depends on their response to
a host of outside forces that must be measured by their overall inuence or by analyzing
the individual forces. This is not an entirely subjective process, however, as the following
discussion illustrates.
ECONOMIC LIFE, CAPITAL RECOVERY, AND VALUE
Value and economic life have a very close relationship, especially in the context of the
income approach. To fully appreciate this relationship, the various concepts of asset life
should be examined.
CAP ITAL R ECOV ERY. When a manager of a business or an accountant makes the decision
that an expenditure is an asset, then a recovery of that expenditure (depreciation expense)
must begin and continue as long as that expenditure is an asset (as long as there are future
economic benets).
When an asset is retired prematurely (vis-à-vis the recovery period), a loss occurs that is
equal to the unrecovered (undepreciated or unamortized) cost. When the service life turns
out to be longer than the capital recovery period, then the business enjoys earnings greater
than it otherwise would during the extended period, because depreciation or amortization
stops. In either case, there is a mismatch of the revenues generated by the asset and the cost
of ownership. For a business with many assets, the impact usually is not signicant when
the pluses and minuses are offset; nevertheless, an important accounting objective has not
been met.
A realistic economic life, giving consideration to all the factors that cause property retire-
ment, should be the basis for establishing capital recovery periods. One must be mindful,
however, that the period of capital recovery as determined by accounting or tax standards
may not adequately represent actual economic life. Therefore, use of this information in
the valuation process is fraught with peril.
There has been extensive scrutiny of the process of capital recovery for regulated utility
companies (or for the parts of former utility companies that remain rate-regulated). These
are very capital-intensive enterprises, and therefore depreciation expense is a signicant
cost of doing business. This signicant cost becomes part of the revenue requirement and
therefore is reected in consumer rates for service. This attention began in 1909 when the
Supreme Court decided the Knoxville v. Knoxville Water Company case (212 U.S. 1) and
To continue reading
Request your trial