1. The Impact of SFAS 141 & 142
on Intangible Asset Management
By Daryl Martin and David Drews* – IPmetrics LLC
In part one of this series, we discussed the concept of intellectual property used as
collateral for securitization and lending. In part two, the importance of context recognition in
establishing accurate asset values was the topic. This final installment will explore the
impact that two recent statements of financial accounting standards (“SFAS”) have had on
the management of acquired intangible assets. The statements are SFAS 141, Business
Combinations, and SFAS 142, Goodwill and Other Intangible Assets.
SFAS 141 requires that the purchase price for an acquired company be allocated among
the assets acquired, including all tangible and intangible assets. Any intangible asset that is
associated with contractual or legal rights, such as a trademark, patent or copyright, must
be recognized separately from goodwill. An intangible asset that can be separated from the
operation and sold, licensed or rented independently must also be recognized separately
from goodwill. Those intangible assets that meet these requirements are typically
segregated according to the following categories:
 Marketing-related intangibles, such as trademarks and domain names;
 Customer-related intangibles, such as customer lists;
 Artistic-related intangibles, such as musical compositions;
 Contract-related intangibles, such as licensing agreements; and,
 Technology-related intangibles, such as patents and software.
Any portion of the purchase price remaining beyond the identified assets is attributed to
goodwill. Goodwill is defined as the excess of the purchase price over the fair value of the
acquired assets.
Once the intangibles have been identified and categorized, the assets are further
categorized according to the requirements of SFAS 142. Under SFAS 142, the assets are
recognized at the reporting unit level of the organization, which is one level below the
operating unit designation. An operating unit is deemed to be one in which revenues and
expenses are recorded separate from other operations of the business. These reporting
designations were chosen to mirror the practices typically followed by management.
SFAS 142 further requires that the intangible assets be designated as either finite-lived or
indefinite-lived assets. The finite-lived assets are booked at their fair value and must be
amortized over their remaining useful lives. The indefinite–lived assets are booked at fair
value and are subject to an annual impairment test rather than amortization.
* Daryl Martin is managing principal and David Drews is president of IPmetrics LLC, an intellectual property consulting firm.
You can reach them at 858-538-1533, or by email at dmartin@ipmetrics.net and ddrews@ipmetrtics.net, respectively.

2. The Impact of SFAS 141/142 on IP Management
Fair value, the standard referred to for assets in SFAS 142, is slightly different than fair
market value, which is the usual standard of value utilized in intangible asset valuations.
Fair market value is typically defined as the price at which an asset would change hands
between a willing buyer and a willing seller, with neither being under compulsion to act and
both having reasonable knowledge of all relevant facts. It is constructed as a hypothetical
transaction between typical parties, rather than as a transaction between specified parties.
On the other hand, fair value is defined as the price at which the asset would change hands
in a current transaction between willing parties. The buyer and seller in this instance are
understood to be identified rather than hypothetical. This distinction can have significant
ramifications when one of the identified parties differs in a material way from a “typical” party
to these kinds of transactions. For example, the buyer may be the largest player in the
subject industry and therefore has a larger capital base to draw upon.
Like the identified indefinite-lived assets, goodwill is also subject to an annual impairment
test. If the value of these assets is found to have been impaired, they are written down to
their current fair value. There is no mechanism allowed in the statement for recovering the
value written off in a prior impairment test. It is important to note that indefinite-lived assets
and goodwill may be subject to impairment tests on a more frequent basis as a result of
material events such as a current period net loss, a decline in market capitalization or other
adverse change in the factors used to value the asset initially. They may also be converted
to a finite-lived asset should circumstances demand such an action. The over-riding
concern is that the accounting treatment of the assets reflects the actual behavior and
usage of the assets.
Determining whether an asset is finite-lived or indefinite-lived is usually straightforward. It is
dependent upon the nature of the asset being analyzed. Assets such as patents that have
a specific expiration date are obviously included in the finite-lived category. Licenses,
leases and other contract-related assets that have a specific expiration date typically fall into
this category as well. However, the stated expiration date may not define the remaining
useful life of the asset. It is important to understand that the expected useful life of the
asset may be impacted by the effects of obsolescence, demand, competition and the
expected useful life of other assets necessary to effectively utilize the subject asset.
The determinants of whether an asset is finite or indefinite-lived can vary among similar
assets. Two determinants of remaining useful life that illustrate this potential variability are
functional and economic. Functional asset lifespans are determined by the ability of the
asset to continue to perform its intended function. Economic lifespans are determined by
the asset’s ongoing ability to generate income or revenue. For example, one trademark
may be designated as indefinite-lived because its ability to generate revenue is expected to
continue unabated for the foreseeable future whereas a different trademark may be
designated as finite-lived since its expected utility is relatively short. The key to an accurate
designation of remaining useful life, whether finite or indefinite, is a thorough understanding
of the asset’s future prospects and the competitive environment in which it operates.
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3. The Impact of SFAS 141/142 on IP Management
Finite-lived assets are amortized over the remaining life of the asset. This is typically done
according to the pattern in which the economic benefits associated with the asset are used
up. If the actual pattern in which the economic benefits of the asset are used up cannot be
determined, the asset is amortized according to a straight-line method.
The impact of these choices on financial results can be significant. If the asset is
designated as having a finite life, its value is amortized over the remaining useful life and
the annual amortization cost is taken against earnings for the period. However, if the asset
is designated as having an indefinite life, the asset is carried at its fair value on the balance
sheet and may have no impact on earnings at all if there is no impairment in its fair value
going forward.
While there may seem to be incentives associated with the decisions, it is important to
designate all acquired assets according to their actual circumstances. Of course, these
may vary due to differing opinions on future prospects for the assets. What is also
important is to understand the financial impact in each case. For finite-lived assets, the
amortization cost will lower taxable income, but will also have a negative impact on
earnings. For the indefinite-lived assets, earnings will be unaffected by any amortization
costs, but the company’s taxable income will be higher than if the assets were designated
as having a finite lifespan. Along with top-line, margin and strategic considerations, the
potential financial impact of the acquired intangible assets needs to be examined from this
perspective prior to the purchase.
In the current regulatory environment, the SEC and other watchdogs are reviewing these
claims very closely. They will gladly restate your earnings for you if the accounting
treatment of any acquired assets is not done according to the established guidelines. The
ensuing earnings or tax surprise, seasoned by a liberal dose of fines and bad publicity,
should be enough to persuade everyone to attempt to get it right the first time.
This article was originally published in November 2005 by The Secured Lender.
* Daryl Martin is managing principal and David Drews is president of IPmetrics LLC, an intellectual property consulting firm.
You can reach them at 858-538-1533, or by email at dmartin@ipmetrics.net and ddrews@ipmetrtics.net, respectively.
© 2010 IPMETRICS LLC. All rights reserved.
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