How to use accounting for IPR
According to accounting standard 10 for fixed assets, assets are grouped into various categories. Patents, Trademark and design are grouped together for accounting. This category fall under intangible assets.
So how we define Intangible assets?
According to IND AS 26, Intangible assets is defined as:
- An Identifiable non-monetary asset.
- Held to be used in production or supply of goods or services.
- Held for rental to others.
- Held for administrative process.
- Without physical substance
Goodwill is not a part of intangible assets and cannot be considered as asset. All the items defined in IND AS 26 are not intangible asset. Criteria for determination consists of 3 main parameters: Identifiability, control and future economic benefit.
- Identifiability- An asset is identifiable if it either
- is separable, i.e. is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so;
2. arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
- Control- An entity has the power to control as asset if it can obtain the economic benefit from it and restrict others from its benefit. Benefits from intangible asset come from legal rights that the company have and can be enforced by court. Legal rights are not necessary as the entity can get the benefits from the asset in other ways also.
- Future economic benefit- This consist of benefit that a company can get from an intangible asset in the form of revenue from the sale of service or a product, cost saving, any benefit that the company can get from using the asset.
Recognition criteria for an Intangible asset
An intangible asset shall be recognized if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
(b) the cost of the asset can be measured reliably.
An intangible asset shall be measured initially at cost.
Internally generated Intangible asset
Recognition of internally generated intangible asset is hard because:
- Identifying that an identifiable asset can generate expected future economic benefits.
- Determining the cost of the asset reliably.
Internally developed intangible assets do not appear as such on a company’s balance sheet as it does not have a price that can be used to assign fair market value.
To solve this problem whether intangible asset meets the recognition criteria or not, Company can classify the asset generation into:
- Research Phase
- Development Phase
Research Phase- No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research (or on the research phase of an internal project) shall be recognised as an expense when it is incurred.
Development phase- An intangible asset arising from development (or from the development phase of an internal project) shall be recognised if, and only if, an entity can demonstrate all of the following:
- the technical feasibility of completing the intangible asset so that it will be available for use or sale.
- its intention to complete the intangible asset and use or sell it.
- its ability to use or sell the intangible asset.
- how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
- the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
- its ability to measure reliably the expenditure attributable to the intangible asset during its development.
Following parameters needs to be matched before an intangible asset can be recognised:
- Technical feasibility of completing the asset.
- Company’s intention to complete it and use/sell it.
- How asset will generate future economic benefits.
- Availability of resources to complete the development and to use or sell the intangible asset
- Its ability to measure the expenditure attributable to the intangible asset during its development reliably.
Recognition of an Expense
Expenditure on an intangible item shall be recognised as an expense when it is incurred unless:
- it forms part of the cost of an intangible asset that meets the recognition criteria;
- the item is acquired in a business combination and cannot be recognised as an intangible asset. If this is the case, it forms part of the amount recognised as goodwill at the acquisition date.
Expenditure on an intangible item that was initially recognised as an expense shall not be recognised as part of the cost of an intangible asset at a later date.
Amortisation of intangible assets with finite life
For an intangible asset with a finite useful life the depreciable amount of is allocated on a systematic basis over its useful life. Amortisation begins when the asset is available for use. The amortisation method used will reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the company. If that pattern cannot be determined reliably, the straight-line method should be used. The amortisation charge for each period will be recognised in profit or loss.
The residual value of an intangible asset with a finite life is considered to be zero unless.
- Commitment by third party to purchase it at the end of the useful life.
- There is an active market for it at the end of its useful life.
Review of amortisation period
At the end of each year, the amortisation period and method for an intangible asset with a finite life is reviewed. If any difference is found in the expected useful life of the asset from previous estimates then amortisation period should be changed accordingly. And if there is a change in the expected consumption of the future economic benefits related with the asset, amortisation method should be change to reflect the change pattern.
Intangible asset with indefinite life
An intangible asset with an indefinite useful life will not be amortised. And the useful life is reviewed each year to check whether the conditions prevails to support an indefinite useful life for the asset. If not then change the useful life assessment from indefinite to finite. And use finite accounting standards.
Monetising IP and Accounting
Before monetising your Intellectual property, you need to find out its value. This can be done in 2 ways:
- By using Quantitative methods- It relies on measurable data or numerical information to produce an estimate of the value of your assets
- By using Qualitative methods- This valuation attempt to provide a non-monetary estimate of the value of intellectual property by rating it on the basis of its strategic impact, and other intangible metrics that do not rely solely on numbers.
Quantitative methods have 4 methods through which one can find the value of IP.
- Cost based
- Market based
- Income based
- Option based
Qualitative methods have 3 methods through which one can find the value of IP.
- Value Indicator Based
- Competitive advantage
Following methods can be used to monetize IP:
- Outright Sale- This is the fastest method to monetize your IP by selling it to interested buyer.
- Licensing the patent to another company allows that company to make use of the invention in exchange for paying you a royalty.
- Patent pooling is another option which can be used. Pool it with other related patents so that it become easier for interested company to licence them and use them.
- Using IP as a Collateral- Financial institutions around the globe recognize IP assets as collaterals and offer loans to IPR owners based on the evaluation of the worth of the IPR.