Valuing IP Post-Sarbanes-Oxley: It's No Longer a Matter of Making a Best Estimate
EXECUTIVE SUMMARY * ALTHOUGH SARBANES-OXLEY SETS NO SPECIFIC requirements for CPAs valuing intellectual property, it does put greater emphasis on accurate valuation of all assets and imposes punishments on CEOs and CFOs for failure to do so. * INTANGIBLE ASSETS OF ALL KINDS, INCLUDING PATENTS, brand names, in-process research and the like, have become increasingly important to the economic value of a business. This makes it critical to accurately disclose the facts about intellectual property. * SARBANES-OXLEY ISN'T THE ONLY RECENT development affecting IP valuation. FASB Statement nos. 141 (intangible asset identification upon acquisition) and 142 (annual intangible asset fair value measurement) require companies to measure and report on the financial performance of acquired intangible assets. * VALUING IP RAISES COMPETITIVE ISSUES over divulging asset values companies might prefer to keep secret. Companies must balance their need to protect proprietary information with disclosure requirements. * CPAs CAN HELP COMPANIES CHOOSE FROM AMONG several methods for valuing IP assets. These include the market, cost and income approaches. With the market approach, a company compares its IP assets with similar assets in the marketplace that have a known value. The cost approach values IP based on the cost to obtain it; the income approach values it based on its income-producing ability. ********** Before 2002, identifying and valuing intellectual property (IP) was more art than science. But in that year Congress passed the Sarbanes-Oxley Act and FASB issued new accounting standards for measuring and reporting on intangible assets. In this high-pressure environment CPAs will find IP valuation is no longer a matter of making a best estimate. As regulators begin to seek greater clarity in the asset values of publicly traded companies and require them to make more transparent disclosures, the onus is on CPAs to apply more scientific rigor to their IP valuations. But certifying with mathematical exactitude the full value of intangibles such as patents, brands, in-process research and other IP assets can be problematic. This article describes the valuation issues CPAs face with intangible assets, the rules they must follow and how they can avoid some pitfalls in the search for a value that meets all requirements. VALUATION CHALLENGES When it comes to valuing IP, there is nothing in Sarbanes-Oxley that says, "Do this or do that," says James Rigby, CPA, a managing director in the Los Angeles office of the Financial Valuation Group, a consulting firm specializing in valuation and performance issues. "What Sarbanes-Oxley does do is imply a greater responsibility for recording IP assets on the financial statements. The legislation didn't change anything in terms of what people should be doing. It just imposed greater responsibility and punishment." Sarbanes-Oxley says companies "must be more rigorous, accurate and inclusive as far as the material effect of all assets on the bottom line, and then sign off that the numbers are on the money," agrees Gary Morris, a partner and IP specialist in the Washington, D.C., office of law firm Kenyon & Kenyon. While this level of accuracy generally includes IP, it's virtually impossible to accomplish with intangible assets such as a patent, copyright or brand name. Sarbanes-Oxley and FASB Statement no. 141, Business Combinations, and Statement no. 142, Goodwill and Other Intangible Assets, converge with another trend--the increasing importance of intangibles to the value of a business. "IP has increased economic value, requires review by top executives and is garnering enhanced interest from regulators," says Edward Black, a partner and head of the IP practice group at Boston-based law firm Ropes & Gray. Twenty years ago, intangible assets weren't that important--bricks and mortar were the key assets. …