Accounting theory and practice, Volume 2 (of 3) : a textbook for colleges and…

INTANGIBLE ASSETS—PATENTS, FRANCHISES, GOOD-WILL General Considerations The final place among the assets of the balance sheet is given to the intangible items. Because this class of assets has so frequently been used for doubtful or illegitimate purposes, whatever the value given to them they should be shown boldly in a group by themselves and not merged with the values of tangible assets. Their real value, if any, should be open to verification. To list them with tangible items on the balance sheet is apt to raise a suspicion as to their validity much more than if they are shown in a group by themselves. Because the assets of this group are intangible is no reason in itself for the hasty judgment frequently made that therefore they are worthless. It is true, as above stated, that the doubtful uses to which they may be put have caused them to be viewed with suspicion. Yet they have an entirely legitimate use and oftentimes constitute the most valuable portion of the assets. Therefore, the values at which these intangible assets are carried on the books should always be open to investigation and capable of verification. It is purposed here to lay down the principles of the legitimate use of intangible assets, and to point out some of the wrong uses to which they easily lend themselves. The group comprises patents, copyrights, trade-marks, formulas, receipts, franchises, organization expense, going concern value, and good-will. Patents a Monopoly Grant A patent is “a grant made by the government to an inventor conveying and securing to him the exclusive right to make and sell his invention for a term of years.” The purpose of the government in making such grants is to encourage and stimulate individual ingenuity along lines that will ultimately redound to public welfare. Letters of patent are in the nature of a monopoly grant but, although extreme care is taken in their issuance to see that they cover really new devices, no governmental guarantee implies that the patentee shall have free and uncontested use of his invention. If encroachment is made upon his rights under the patent, the courts are open to him for protection and similar privileges are extended to all alike. Oftentimes, until infringement proceedings have established a clear and uncontested right and property in an invention, little commercial value attaches to it. Patents therefore tend to create a monopoly in the marketable product protected by them and accordingly have value so long as the right to monopoly continues. Purchase of Patents The valuation of patents owned and made use of by a business should always be on the basis of cost. If owned by purchase from the inventor, the consideration paid for the patent constitutes cost. When the consideration is cash, there is no question as to the valuation at cost. When payment is made in the capital stock of the purchasing concern the problem is the same here as in the proper valuation of other fixed assets purchased in the same way, referred to in Chapter XVII. The federal income tax law takes cognizance of this different basis for valuation and attempts to establish a true cash basis by allowing depreciation on patents, when purchased by means of stock, only on the basis of the cash value of the stock. Prevailing practice sponsors the bringing of patents onto the books at cost, as shown either by the cash paid for them or by the _par_ value of the stock issued for them. Except where deceit and fraud are the points at issue, no serious objection can be raised to the practice, for any overvaluation thus occasioned is absorbed in the product by means of the depreciation charge spread over the life of the patent. Any additional costs necessary to secure the full enjoyment of the rights granted under the patent are considered proper charges against the patent, as giving it additional value. Patents Developed within the Plant When the patent is not purchased from outside but is developed within the plant itself, only the costs of development and of securing the patent are proper charges to the asset as constituting its value. In some concerns an experimental laboratory is maintained for the purpose of working out improved methods and devices. Much of the work of such a laboratory is often fruitless so far as patentable devices are concerned, but if the entire effort is directed towards the development of patents, then the entire cost becomes a proper charge to whatever patents result from the effort. More often some portion of the laboratory organization is also used for other purposes. However developed, whether in the formal laboratory or in any other way, the full cost of development and of securing letters patent is the figure for the original valuation of the patent. This cost includes the labor and material used in the process, drawings, models—including discarded models—attorney’s fees, government fees, etc. As in the case of purchase, all the costs, whenever incurred, of defending the right to the patent or of prosecuting for infringements constitute additional elements of value, as only by such means can the real holder be made secure in the exclusive enjoyment of his right. It is hardly necessary to point out that if such proceedings and prosecution establish the right of the other party to a device which practically destroys or greatly diminishes the worth of the contested patents, not only must such costs usually be charged against revenue but also the whole or major portion of the value at which the patent is being carried. However, where the development of patents is one branch of a concern’s organization, costs of this nature may usually be absorbed by those patents which are successful. Because inflation of values is easy at this point, a careful investigation to establish the legitimacy of all such charges is always desirable. Each case must be judged on its merits. Patents Purchased and not Used Patented devices are sometimes purchased with no intent to use them. This may be for the purpose of eliminating competition, of forestalling obsolescence or supersession, and so of postponing the necessity of making expensive alterations that would be required to meet threatened competition, even to the point of scrapping a valuable organization. The ethics of such practice is not under review here. Correct accounting practice justifies the addition of the purchase price of such devices to the value of the asset, patents, and its periodic depreciation in regular course. Elements of Depreciation on Patents Patents are subject to depreciation. At the time of their purchase or acquisition, they should be valued at full cost, as stated above. At any subsequent time, value should be calculated on the basis of full cost less depreciation. The elements of depreciation as applied to patents are (1) time lapse, (2) supersession, and (3) obsolescence.