The Financial Reporting Impact of Intellectual Property Activity

• Author: James Donohue/Mark A. Spelker
• Profession: Charles River Associates, Inc./J. H. Cohn LLP
• Pages: 291-306

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CHAPTER 16

The Financial Reporting Impact of

Intellectual Property Activity

James Donohue

Charles River Associates, Inc.

Mark A. Spelker

J. H. Cohn LLP

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In

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addition to considering the strategic and legal implications of intellectual prop-

erty (IP) activity, decision makers will also have to consider the resulting financial

accounting and reporting con sequences.

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While often an afterthought, IP ac tivities

frequently require financial accounting entries and disc losures that are reflected in

company’s financial statements. How intellectual property activity is treated depends

on many factors, including how the transaction was structured and documented.

Changing accounting guidance, which has increased IP-related guidance and disclo-

sures, also complicates this area. Understanding how IP activities are accounted for

from a financial reporting perspective can be an important consideration when eval-

uating intellectual property transactions.

IP Activity

In many organizations, IP activities are occurring every day in various areas. While

much focus is often on obvious IP activities, such as patent licenses or sales, IP activi-

ties also include many less obvious items. For example, daily research and develop-

ment (R&D) work can have various financial accounting–related consequences.

While perhaps impossible to list them all, general categories of IP activities can

include licensing and sales activity, R&D, IP filings and prosecution, litigation activ-

ity, settlements, mergers and acquisitions, and donations or abandonment. Each of

these categories can include various components that require some form of financial

statement recognition. For example, licensing activity could include the receipt of

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up-front and ongoing royalty payments that wi ll immediately, or eventually, be re-

corded as revenue. The entity paying the up-front and royalty amounts might record

the payment as an expense, or perhaps in some circumstances, capitalize the costs

on the balance sheet as an intangible asset.

Another way to view these IP categories is to consider the IP life cycle. The life

cycle of a patent, for example, would begin with the R&D work that is done to de-

velop the concept. Legal costs would be incurred to file an application and perhaps

obtain an issued patent. Various application and maintenance fees would be

incurred as well. The issued patent could be involved in various IP events during its

lifetime. Some patents might simply sit in the portfolio and protect a product, while

other patents might be licensed or sold individually, as a portfolio, or as part of the

larger business group or organization. The patent may also be used in a patent

infringement litigation that could result in a variety of outcomes, including litigation

expenses, a settlement, a damage award, or the finding that the patent was invalid or

not infringed. Finally, the patent mi ght be donated, abandoned, or, like ma ny pat-

ents, simply expire uneventfully.

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These IP life cycle activities could each require some form of financial account-

ing recognition in the owner’s financial statements. Given the complexities of finan-

cial accounting for each of these activities, we use the life cycle to illustrate the

potential financial accounting treatments and accounting guidance that could be rel-

evant to each intellectual property event. I n the following sections, we first review

some examples of relevant IP accounting guidance and then review how some pub-

lic companies have accounted for certain IP activities.

Relevant IP Accounting Guidance

Accounting guidance that is relevant to IP ranges from broad concepts statements to

specific guidance that explicitly discusses IP-related activity. While clearly not all in-

clusive, common IP accounting guidance includes

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:

&Financial Accounting Standards Board (FASB) Concepts Statement No. 6, Ele-

ments of Financial Statements.

&Statement of Financial Accounting Standards (SFAS) No. 2, Research and Devel-

opment (FASB ASC 730).

&SFAS No. 5, Accounting for Contingencies (FASB ASC 450).

&SFAS No. 141(R) (revised 2007), Business Combinations (FASB ASC 805).

&SFAS No. 142, Goodwill and Other Intangible Assets (FASB ASC 350).

&SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Asset

(FASB ASC 360).

&SFAS No. 157, Fair Value Measurement (FASB ASC 820).

&SEC Staff Accounting Bulletin 104, Topic 13 Revenue Recognition (FASB ASC

605).

&Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multi-

ple Deliverables (FASB ASC 605-25).

&Emerging Issues Task Force Issue No. 08-7, Accounting for Defensive Intangible

Assets (FASB ASC 350-30).

292 Intellectual Property Operations and Implementation