The impact of intellectual property laws on accounting
practices
Introduction
Intellectual property laws seek to protect creations and inventions of the human intellect that
have commercial value. This includes copyright, patents, trademarks, industrial designs and
trade secrets. As businesses increasingly rely on intellectual property as an asset class,
accounting practices have had to evolve to properly account for and report on these intangible
assets. This paper will examine how key intellectual property laws including copyright, patents
and trademarks impact the accounting treatment and financial reporting of intangible assets.
Copyright
Copyright automatically protects original works of authorship including literary, dramatic, musical
and artistic works such as books, articles, software, plays, films, music, drawings and
photographs. Once a work is fixed in a tangible form of expression, copyright protection exists
immediately without registration. The main accounting implication of copyright is the
capitalization and amortization of costs relating to the creation or acquisition of copyrighted
works.
Capitalization of internally generated copyrights
When a company directly incurs costs to produce copyrighted works for sale or license, these
costs are typically capitalized as intangible assets in accordance with IAS 38 Intangible Assets.
Capitalization begins when it is probable that expected future economic benefits will flow to the
company and the costs can be reliably measured. Costs typically capitalized include personnel
costs such as compensation of creative talent like writers, artists and programmers as well as
any third party costs incurred.
Once capitalized, internally generated copyrights are amortized over their estimated useful lives
which is generally the period over which economic benefits are expected to flow to the company.
Useful lives are reassessed at least annually with any changes accounted for prospectively as a
change in accounting estimate. Amortization expense is recorded as the cost of sales or
operating expenses depending on the nature of the copyrighted work. Impairment reviews are
also required when indicators of impairment exist to write down the carrying amount to the
recoverable amount which is the higher of value in use or fair value less costs of disposal.
Capitalization of acquired copyrights
When copyrighted works are acquired from third parties through business combinations or
purchases, IFRS requires the assets and liabilities acquired, including identifiable intangible
assets, to be recognized separately from goodwill at fair value. Common identifiable intangible
assets arising from acquisitions include copyright portfolios, customer lists, order or production
backlogs, music catalogs, film libraries and software. These intangible assets are measured at
fair value which is often determined using an income approach such as the multi-period excess
earnings method or with-and-without method.
Acquired copyrights are then amortized over their estimated useful lives which is generally the
legal term of the copyright if finite or indefinite if the legal term is perpetual. Useful lives are
assessed each reporting period for reasonableness. Impairment reviews are done if indicators
of impairment exist such as a significant adverse change in legal factors or market demand and
value in use is less than carrying amount. Any resulting impairment loss is recognized
immediately in net income.
Accounting for copyright license agreements
Companies may generate revenue by licensing or sublicensing their copyrights to third parties.
Depending on the terms of the license agreement, revenue is recognized either over the license
period (right to use model) or at a point in time (right to access model). Key points to consider
include:
- Nature of the promise - Providing access vs right to use over time
- Timing of transfer of control - At inception or over license period
- Licensor's ongoing involvement - Significant ongoing obligations affect revenue recognition
- Renewal options - May impact the duration of the license term
License fees received upfront are typically initially deferred as contract liabilities/deferred
revenue and recognized as revenue over the license period on a straight-line basis. Guaranteed
minimum royalties receivable periodically over the license term continue to be recognized as
revenue as installments become due. Contingent royalties based on licensee's sales are
recognized as revenue in the period earned.
Patents
A patent provides the owner the right to exclude others from making, using, selling or importing
the patented invention for a limited period. From an accounting perspective, costs incurred to
register, defend and maintain patents are either capitalized as intangible assets or expensed as
incurred depending on the patent stage and probability of future economic benefits:
- Research costs are always expensed as they relate to general research aimed at gaining new
scientific or technical knowledge.
- Development costs are capitalized once technological and economic feasibility is established
based on a working model or prototype.
- Registration costs incurred after technological feasibility is established such as attorney fees
are capitalized as intangible assets.
- Post-issuance legal defense costs are expensed as incurred unless they are required to
defend the validity of the patent registration.
Capitalized patent costs are then amortized over the legally enforceable term of the patent
which is typically 20 years from the application date. Impairment tests are done if indicators exist
that the carrying amount may not be recoverable.
For patented products or processes, unpatented technology or trade secrets embedded within
tangible goods or services are accounted for as part of inventory or cost of goods sold
respectively. Patent license agreements follow same accounting as copyright licenses discussed
above.
Trademarks
A trademark identifies and distinguishes the source of goods or services of one party from those
of others in the marketplace. Trademark costs incurred in the development stage are expensed
as they do not meet the definition of an asset. However, registration and legal defense costs
incurred after the mark is placed in service are capitalized as intangible assets provided they
are not indefinite in nature:
- Indefinite lived trademarks such as brands, logos or slogans are not amortized but subjected
to annual impairment testing.
- Finite lived trademarks where future economic benefits are limited to legal life are amortized
over the expected useful life. Useful lives range between 10-30 years and are reassessed
annually.
Acquired trademarks from business
combinations or asset purchases are recognized separately at fair value. Similar to other
identifiable intangible assets, fair value is determined based on an income approach by
discounting estimated future cash flows attributable to the trademark. Trademark license
agreements follow the same revenue recognition principles as copyrights and patents.
Research and Development
From an accounting perspective, whether research and development (R&D) costs can be
capitalized or must be expensed impacts net income. IAS 38 requires R&D costs to be
capitalized only after technical and economic feasibility of the asset for sale or use has been
established. All other R&D costs are expensed.
Key considerations for capitalization include whether:
- Project is technically feasible based on a prototype/working model
- Use/sale of resulting product/process is technically & commercially feasible
- Resources exist/will be available to complete development
- Entity intends and has ability to use/sell resulting intangible asset
Costs eligible for capitalization include materials, employee salaries and third party expenses
directly attributable to the project. Capitalized R&D costs are amortized over the life of the
underlying asset or product. Internal R&D remains an exempt alternative under IAS 38 and
companies may elect to continue expensing these costs.
Goodwill and business combinations
Goodwill arising on a business combination represents the excess of acquisition cost over the
acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent
liabilities of the acquiree. Goodwill does not generate independent cash flows and must be
tested for impairment at least annually by comparing the recoverable amount (higher of value in
use or fair value less costs of disposal) with the carrying amount.
Any resulting goodwill impairment loss is recognized in net income immediately and cannot be
subsequently reversed. Goodwill is allocated to the CGUs expected to benefit from the
synergies of the combination. Significant assumptions used in value in use calculations such as
forecasts, growth rates and discount rates are disclosed in the notes to avoid misrepresentation.
Acquired intangibles including intellectual property help support the measurement of goodwill
and related impairment testing.
Tax considerations
From a tax perspective, the accounting treatment of intellectual property impacts both current
and deferred taxes:
Current Taxes
- Capitalized intangible asset costs are deductible for tax over time as per
depreciation/amortization schedules
- Certain R&D and IP defense costs may qualify for immediate deduction or tax credits
- Capital gain/loss on disposal of intellectual property impacts current tax
Deferred Taxes
- Temporary differences between accounting and tax base of intangible assets give rise to both
deferred tax assets and liabilities
- Amortization period differences cause timing differences requiring deferred tax computation
- Impairment losses have no tax effect whereas goodwill impairments are permanent differences
- Fair value uplifts on acquired intangibles create deductible temporary differences
Entities disclose their accounting policy for deferred taxes, analyze recoverability of deferred tax
assets and reconcile effective tax rates in the financial statements. Tax filings may require more
detailed IP asset schedules for tax depreciation.
Financial statement presentation
Intellectual property assets are classified as either indefinite life intangible assets not subject to
amortization or finite life intangible assets amortized over their useful lives. Certain presentation
requirements exist:
- Separately disclose major intangible asset classes in the statement of financial position
- Provide narrative description of each class including useful lives and amortization methods
- Disclose reconciliation of carrying amounts in the notes including additions, disposals,
amortization
- Impairment losses should be disclosed separately on the face of income statement
- Allocate goodwill impairment losses between CGUs in the notes
- Disclose key assumptions used in impairment tests such as discount rates
Related party disclosures are given for IP transfers between group entities. Commitments and
contingencies for IP registrations and litigation are presented. Unamortized balance of
capitalized R&D as well as research and development expenses are disclosed.
Conclusion
In summary, intellectual property laws have significantly impacted accounting practices by
necessitating the capitalization, amortization, impairment testing and disclosure of intangible
assets. Strict IFRS requirements exist regarding the identification, measurement and
presentation of intellectual property and related goodwill arising on acquisitions. Companies
must adopt policies and processes to account for and value self-generated and acquired
intangible assets, along with the related tax and financial statement disclosure implications.
Overall, evolving intellectual property laws have placed increased focus on appropriately
recognizing and reporting these critical business assets in the financial statements.
Intellectual property laws seek to protect creations and inventions of the human intellect that
have commercial value. This includes copyright, patents, trademarks, industrial designs and
trade secrets. As businesses increasingly rely on intellectual property as an asset class,
accounting practices have had to evolve to properly account for and report on these intangible
assets. This paper will examine how key intellectual property laws including copyright, patents
and trademarks impact the accounting treatment and financial reporting of intangible assets.
Copyright
Copyright automatically protects original works of authorship including literary, dramatic, musical
and artistic works such as books, articles, software, plays, films, music, drawings and
photographs. Once a work is fixed in a tangible form of expression, copyright protection exists
immediately without registration. The main accounting implication of copyright is the
capitalization and amortization of costs relating to the creation or acquisition of copyrighted
works.
Capitalization of internally generated copyrights
When a company directly incurs costs to produce copyrighted works for sale or license, these
costs are typically capitalized as intangible assets in accordance with IAS 38 Intangible Assets.
Capitalization begins when it is probable that expected future economic benefits will flow to the
company and the costs can be reliably measured. Costs typically capitalized include personnel
costs such as compensation of creative talent like writers, artists and programmers as well as
any third party costs incurred.
Once capitalized, internally generated copyrights are amortized over their estimated useful lives
which is generally the period over which economic benefits are expected to flow to the company.
Useful lives are reassessed at least annually with any changes accounted for prospectively as a
change in accounting estimate. Amortization expense is recorded as the cost of sales or
operating expenses depending on the nature of the copyrighted work. Impairment reviews are
also required when indicators of impairment exist to write down the carrying amount to the
recoverable amount which is the higher of value in use or fair value less costs of disposal.
Capitalization of acquired copyrights
When copyrighted works are acquired from third parties through business combinations or
purchases, IFRS requires the assets and liabilities acquired, including identifiable intangible
assets, to be recognized separately from goodwill at fair value. Common identifiable intangible
assets arising from acquisitions include copyright portfolios, customer lists, order or production
backlogs, music catalogs, film libraries and software. These intangible assets are measured at
fair value which is often determined using an income approach such as the multi-period excess
earnings method or with-and-without method.
Acquired copyrights are then amortized over their estimated useful lives which is generally the
legal term of the copyright if finite or indefinite if the legal term is perpetual. Useful lives are
assessed each reporting period for reasonableness. Impairment reviews are done if indicators
of impairment exist such as a significant adverse change in legal factors or market demand and
value in use is less than carrying amount. Any resulting impairment loss is recognized
immediately in net income.
Accounting for copyright license agreements
Companies may generate revenue by licensing or sublicensing their copyrights to third parties.
Depending on the terms of the license agreement, revenue is recognized either over the license
period (right to use model) or at a point in time (right to access model). Key points to consider
include:
- Nature of the promise - Providing access vs right to use over time
- Timing of transfer of control - At inception or over license period
- Licensor's ongoing involvement - Significant ongoing obligations affect revenue recognition
- Renewal options - May impact the duration of the license term
License fees received upfront are typically initially deferred as contract liabilities/deferred
revenue and recognized as revenue over the license period on a straight-line basis. Guaranteed
minimum royalties receivable periodically over the license term continue to be recognized as
revenue as installments become due. Contingent royalties based on licensee's sales are
recognized as revenue in the period earned.
Patents
A patent provides the owner the right to exclude others from making, using, selling or importing
the patented invention for a limited period. From an accounting perspective, costs incurred to
register, defend and maintain patents are either capitalized as intangible assets or expensed as
incurred depending on the patent stage and probability of future economic benefits:
- Research costs are always expensed as they relate to general research aimed at gaining new
scientific or technical knowledge.
- Development costs are capitalized once technological and economic feasibility is established
based on a working model or prototype.
- Registration costs incurred after technological feasibility is established such as attorney fees
are capitalized as intangible assets.
- Post-issuance legal defense costs are expensed as incurred unless they are required to
defend the validity of the patent registration.
Capitalized patent costs are then amortized over the legally enforceable term of the patent
which is typically 20 years from the application date. Impairment tests are done if indicators exist
that the carrying amount may not be recoverable.
For patented products or processes, unpatented technology or trade secrets embedded within
tangible goods or services are accounted for as part of inventory or cost of goods sold
respectively. Patent license agreements follow same accounting as copyright licenses discussed
above.
Trademarks
A trademark identifies and distinguishes the source of goods or services of one party from those
of others in the marketplace. Trademark costs incurred in the development stage are expensed
as they do not meet the definition of an asset. However, registration and legal defense costs
incurred after the mark is placed in service are capitalized as intangible assets provided they
are not indefinite in nature:
- Indefinite lived trademarks such as brands, logos or slogans are not amortized but subjected
to annual impairment testing.
- Finite lived trademarks where future economic benefits are limited to legal life are amortized
over the expected useful life. Useful lives range between 10-30 years and are reassessed
annually.
Acquired trademarks from business
combinations or asset purchases are recognized separately at fair value. Similar to other
identifiable intangible assets, fair value is determined based on an income approach by
discounting estimated future cash flows attributable to the trademark. Trademark license
agreements follow the same revenue recognition principles as copyrights and patents.
Research and Development
From an accounting perspective, whether research and development (R&D) costs can be
capitalized or must be expensed impacts net income. IAS 38 requires R&D costs to be
capitalized only after technical and economic feasibility of the asset for sale or use has been
established. All other R&D costs are expensed.
Key considerations for capitalization include whether:
- Project is technically feasible based on a prototype/working model
- Use/sale of resulting product/process is technically & commercially feasible
- Resources exist/will be available to complete development
- Entity intends and has ability to use/sell resulting intangible asset
Costs eligible for capitalization include materials, employee salaries and third party expenses
directly attributable to the project. Capitalized R&D costs are amortized over the life of the
underlying asset or product. Internal R&D remains an exempt alternative under IAS 38 and
companies may elect to continue expensing these costs.
Goodwill and business combinations
Goodwill arising on a business combination represents the excess of acquisition cost over the
acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent
liabilities of the acquiree. Goodwill does not generate independent cash flows and must be
tested for impairment at least annually by comparing the recoverable amount (higher of value in
use or fair value less costs of disposal) with the carrying amount.
Any resulting goodwill impairment loss is recognized in net income immediately and cannot be
subsequently reversed. Goodwill is allocated to the CGUs expected to benefit from the
synergies of the combination. Significant assumptions used in value in use calculations such as
forecasts, growth rates and discount rates are disclosed in the notes to avoid misrepresentation.
Acquired intangibles including intellectual property help support the measurement of goodwill
and related impairment testing.
Tax considerations
From a tax perspective, the accounting treatment of intellectual property impacts both current
and deferred taxes:
Current Taxes
- Capitalized intangible asset costs are deductible for tax over time as per
depreciation/amortization schedules
- Certain R&D and IP defense costs may qualify for immediate deduction or tax credits
- Capital gain/loss on disposal of intellectual property impacts current tax
Deferred Taxes
- Temporary differences between accounting and tax base of intangible assets give rise to both
deferred tax assets and liabilities
- Amortization period differences cause timing differences requiring deferred tax computation
- Impairment losses have no tax effect whereas goodwill impairments are permanent differences
- Fair value uplifts on acquired intangibles create deductible temporary differences
Entities disclose their accounting policy for deferred taxes, analyze recoverability of deferred tax
assets and reconcile effective tax rates in the financial statements. Tax filings may require more
detailed IP asset schedules for tax depreciation.
Financial statement presentation
Intellectual property assets are classified as either indefinite life intangible assets not subject to
amortization or finite life intangible assets amortized over their useful lives. Certain presentation
requirements exist:
- Separately disclose major intangible asset classes in the statement of financial position
- Provide narrative description of each class including useful lives and amortization methods
- Disclose reconciliation of carrying amounts in the notes including additions, disposals,
amortization
- Impairment losses should be disclosed separately on the face of income statement
- Allocate goodwill impairment losses between CGUs in the notes
- Disclose key assumptions used in impairment tests such as discount rates
Related party disclosures are given for IP transfers between group entities. Commitments and
contingencies for IP registrations and litigation are presented. Unamortized balance of
capitalized R&D as well as research and development expenses are disclosed.
Conclusion
In summary, intellectual property laws have significantly impacted accounting practices by
necessitating the capitalization, amortization, impairment testing and disclosure of intangible
assets. Strict IFRS requirements exist regarding the identification, measurement and
presentation of intellectual property and related goodwill arising on acquisitions. Companies
must adopt policies and processes to account for and value self-generated and acquired
intangible assets, along with the related tax and financial statement disclosure implications.
Overall, evolving intellectual property laws have placed increased focus on appropriately
recognizing and reporting these critical business assets in the financial statements.
Intellectual property laws seek to protect creations and inventions of the human intellect that
have commercial value. This includes copyright, patents, trademarks, industrial designs and
trade secrets. As businesses increasingly rely on intellectual property as an asset class,
accounting practices have had to evolve to properly account for and report on these intangible
assets. This paper will examine how key intellectual property laws including copyright, patents
and trademarks impact the accounting treatment and financial reporting of intangible assets.
Copyright
Copyright automatically protects original works of authorship including literary, dramatic, musical
and artistic works such as books, articles, software, plays, films, music, drawings and
photographs. Once a work is fixed in a tangible form of expression, copyright protection exists
immediately without registration. The main accounting implication of copyright is the
capitalization and amortization of costs relating to the creation or acquisition of copyrighted
works.
Capitalization of internally generated copyrights
When a company directly incurs costs to produce copyrighted works for sale or license, these
costs are typically capitalized as intangible assets in accordance with IAS 38 Intangible Assets.
Capitalization begins when it is probable that expected future economic benefits will flow to the
company and the costs can be reliably measured. Costs typically capitalized include personnel
costs such as compensation of creative talent like writers, artists and programmers as well as
any third party costs incurred.
Once capitalized, internally generated copyrights are amortized over their estimated useful lives
which is generally the period over which economic benefits are expected to flow to the company.
Useful lives are reassessed at least annually with any changes accounted for prospectively as a
change in accounting estimate. Amortization expense is recorded as the cost of sales or
operating expenses depending on the nature of the copyrighted work. Impairment reviews are
also required when indicators of impairment exist to write down the carrying amount to the
recoverable amount which is the higher of value in use or fair value less costs of disposal.
Capitalization of acquired copyrights
When copyrighted works are acquired from third parties through business combinations or
purchases, IFRS requires the assets and liabilities acquired, including identifiable intangible
assets, to be recognized separately from goodwill at fair value. Common identifiable intangible
assets arising from acquisitions include copyright portfolios, customer lists, order or production
backlogs, music catalogs, film libraries and software. These intangible assets are measured at
fair value which is often determined using an income approach such as the multi-period excess
earnings method or with-and-without method.
Acquired copyrights are then amortized over their estimated useful lives which is generally the
legal term of the copyright if finite or indefinite if the legal term is perpetual. Useful lives are
assessed each reporting period for reasonableness. Impairment reviews are done if indicators
of impairment exist such as a significant adverse change in legal factors or market demand and
value in use is less than carrying amount. Any resulting impairment loss is recognized
immediately in net income.
Accounting for copyright license agreements
Companies may generate revenue by licensing or sublicensing their copyrights to third parties.
Depending on the terms of the license agreement, revenue is recognized either over the license
period (right to use model) or at a point in time (right to access model). Key points to consider
include:
- Nature of the promise - Providing access vs right to use over time
- Timing of transfer of control - At inception or over license period
- Licensor's ongoing involvement - Significant ongoing obligations affect revenue recognition
- Renewal options - May impact the duration of the license term
License fees received upfront are typically initially deferred as contract liabilities/deferred
revenue and recognized as revenue over the license period on a straight-line basis. Guaranteed
minimum royalties receivable periodically over the license term continue to be recognized as
revenue as installments become due. Contingent royalties based on licensee's sales are
recognized as revenue in the period earned.
Patents
A patent provides the owner the right to exclude others from making, using, selling or importing
the patented invention for a limited period. From an accounting perspective, costs incurred to
register, defend and maintain patents are either capitalized as intangible assets or expensed as
incurred depending on the patent stage and probability of future economic benefits:
- Research costs are always expensed as they relate to general research aimed at gaining new
scientific or technical knowledge.
- Development costs are capitalized once technological and economic feasibility is established
based on a working model or prototype.
- Registration costs incurred after technological feasibility is established such as attorney fees
are capitalized as intangible assets.
- Post-issuance legal defense costs are expensed as incurred unless they are required to
defend the validity of the patent registration.
Capitalized patent costs are then amortized over the legally enforceable term of the patent
which is typically 20 years from the application date. Impairment tests are done if indicators exist
that the carrying amount may not be recoverable.
For patented products or processes, unpatented technology or trade secrets embedded within
tangible goods or services are accounted for as part of inventory or cost of goods sold
respectively. Patent license agreements follow same accounting as copyright licenses discussed
above.
Trademarks
A trademark identifies and distinguishes the source of goods or services of one party from those
of others in the marketplace. Trademark costs incurred in the development stage are expensed
as they do not meet the definition of an asset. However, registration and legal defense costs
incurred after the mark is placed in service are capitalized as intangible assets provided they
are not indefinite in nature:
- Indefinite lived trademarks such as brands, logos or slogans are not amortized but subjected
to annual impairment testing.
- Finite lived trademarks where future economic benefits are limited to legal life are amortized
over the expected useful life. Useful lives range between 10-30 years and are reassessed
annually.
Acquired trademarks from business
combinations or asset purchases are recognized separately at fair value. Similar to other
identifiable intangible assets, fair value is determined based on an income approach by
discounting estimated future cash flows attributable to the trademark. Trademark license
agreements follow the same revenue recognition principles as copyrights and patents.
Research and Development
From an accounting perspective, whether research and development (R&D) costs can be
capitalized or must be expensed impacts net income. IAS 38 requires R&D costs to be
capitalized only after technical and economic feasibility of the asset for sale or use has been
established. All other R&D costs are expensed.
Key considerations for capitalization include whether:
- Project is technically feasible based on a prototype/working model
- Use/sale of resulting product/process is technically & commercially feasible
- Resources exist/will be available to complete development
- Entity intends and has ability to use/sell resulting intangible asset
Costs eligible for capitalization include materials, employee salaries and third party expenses
directly attributable to the project. Capitalized R&D costs are amortized over the life of the
underlying asset or product. Internal R&D remains an exempt alternative under IAS 38 and
companies may elect to continue expensing these costs.
Goodwill and business combinations
Goodwill arising on a business combination represents the excess of acquisition cost over the
acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent
liabilities of the acquiree. Goodwill does not generate independent cash flows and must be
tested for impairment at least annually by comparing the recoverable amount (higher of value in
use or fair value less costs of disposal) with the carrying amount.
Any resulting goodwill impairment loss is recognized in net income immediately and cannot be
subsequently reversed. Goodwill is allocated to the CGUs expected to benefit from the
synergies of the combination. Significant assumptions used in value in use calculations such as
forecasts, growth rates and discount rates are disclosed in the notes to avoid misrepresentation.
Acquired intangibles including intellectual property help support the measurement of goodwill
and related impairment testing.
Tax considerations
From a tax perspective, the accounting treatment of intellectual property impacts both current
and deferred taxes:
Current Taxes
- Capitalized intangible asset costs are deductible for tax over time as per
depreciation/amortization schedules
- Certain R&D and IP defense costs may qualify for immediate deduction or tax credits
- Capital gain/loss on disposal of intellectual property impacts current tax
Deferred Taxes
- Temporary differences between accounting and tax base of intangible assets give rise to both
deferred tax assets and liabilities
- Amortization period differences cause timing differences requiring deferred tax computation
- Impairment losses have no tax effect whereas goodwill impairments are permanent differences
- Fair value uplifts on acquired intangibles create deductible temporary differences
Entities disclose their accounting policy for deferred taxes, analyze recoverability of deferred tax
assets and reconcile effective tax rates in the financial statements. Tax filings may require more
detailed IP asset schedules for tax depreciation.
Financial statement presentation
Intellectual property assets are classified as either indefinite life intangible assets not subject to
amortization or finite life intangible assets amortized over their useful lives. Certain presentation
requirements exist:
- Separately disclose major intangible asset classes in the statement of financial position
- Provide narrative description of each class including useful lives and amortization methods
- Disclose reconciliation of carrying amounts in the notes including additions, disposals,
amortization
- Impairment losses should be disclosed separately on the face of income statement
- Allocate goodwill impairment losses between CGUs in the notes
- Disclose key assumptions used in impairment tests such as discount rates
Related party disclosures are given for IP transfers between group entities. Commitments and
contingencies for IP registrations and litigation are presented. Unamortized balance of
capitalized R&D as well as research and development expenses are disclosed.
Conclusion
In summary, intellectual property laws have significantly impacted accounting practices by
necessitating the capitalization, amortization, impairment testing and disclosure of intangible
assets. Strict IFRS requirements exist regarding the identification, measurement and
presentation of intellectual property and related goodwill arising on acquisitions. Companies
must adopt policies and processes to account for and value self-generated and acquired
intangible assets, along with the related tax and financial statement disclosure implications.
Overall, evolving intellectual property laws have placed increased focus on appropriately
recognizing and reporting these critical business assets in the financial statements.
Intellectual property laws seek to protect creations and inventions of the human intellect that
have commercial value. This includes copyright, patents, trademarks, industrial designs and
trade secrets. As businesses increasingly rely on intellectual property as an asset class,
accounting practices have had to evolve to properly account for and report on these intangible
assets. This paper will examine how key intellectual property laws including copyright, patents
and trademarks impact the accounting treatment and financial reporting of intangible assets.
Copyright
Copyright automatically protects original works of authorship including literary, dramatic, musical
and artistic works such as books, articles, software, plays, films, music, drawings and
photographs. Once a work is fixed in a tangible form of expression, copyright protection exists
immediately without registration. The main accounting implication of copyright is the
capitalization and amortization of costs relating to the creation or acquisition of copyrighted
works.
Capitalization of internally generated copyrights
When a company directly incurs costs to produce copyrighted works for sale or license, these
costs are typically capitalized as intangible assets in accordance with IAS 38 Intangible Assets.
Capitalization begins when it is probable that expected future economic benefits will flow to the
company and the costs can be reliably measured. Costs typically capitalized include personnel
costs such as compensation of creative talent like writers, artists and programmers as well as
any third party costs incurred.
Once capitalized, internally generated copyrights are amortized over their estimated useful lives
which is generally the period over which economic benefits are expected to flow to the company.
Useful lives are reassessed at least annually with any changes accounted for prospectively as a
change in accounting estimate. Amortization expense is recorded as the cost of sales or
operating expenses depending on the nature of the copyrighted work. Impairment reviews are
also required when indicators of impairment exist to write down the carrying amount to the
recoverable amount which is the higher of value in use or fair value less costs of disposal.
Capitalization of acquired copyrights
When copyrighted works are acquired from third parties through business combinations or
purchases, IFRS requires the assets and liabilities acquired, including identifiable intangible
assets, to be recognized separately from goodwill at fair value. Common identifiable intangible
assets arising from acquisitions include copyright portfolios, customer lists, order or production
backlogs, music catalogs, film libraries and software. These intangible assets are measured at
fair value which is often determined using an income approach such as the multi-period excess
earnings method or with-and-without method.
Acquired copyrights are then amortized over their estimated useful lives which is generally the
legal term of the copyright if finite or indefinite if the legal term is perpetual. Useful lives are
assessed each reporting period for reasonableness. Impairment reviews are done if indicators
of impairment exist such as a significant adverse change in legal factors or market demand and
value in use is less than carrying amount. Any resulting impairment loss is recognized
immediately in net income.
Accounting for copyright license agreements
Companies may generate revenue by licensing or sublicensing their copyrights to third parties.
Depending on the terms of the license agreement, revenue is recognized either over the license
period (right to use model) or at a point in time (right to access model). Key points to consider
include:
- Nature of the promise - Providing access vs right to use over time
- Timing of transfer of control - At inception or over license period
- Licensor's ongoing involvement - Significant ongoing obligations affect revenue recognition
- Renewal options - May impact the duration of the license term
License fees received upfront are typically initially deferred as contract liabilities/deferred
revenue and recognized as revenue over the license period on a straight-line basis. Guaranteed
minimum royalties receivable periodically over the license term continue to be recognized as
revenue as installments become due. Contingent royalties based on licensee's sales are
recognized as revenue in the period earned.
Patents
A patent provides the owner the right to exclude others from making, using, selling or importing
the patented invention for a limited period. From an accounting perspective, costs incurred to
register, defend and maintain patents are either capitalized as intangible assets or expensed as
incurred depending on the patent stage and probability of future economic benefits:
- Research costs are always expensed as they relate to general research aimed at gaining new
scientific or technical knowledge.
- Development costs are capitalized once technological and economic feasibility is established
based on a working model or prototype.
- Registration costs incurred after technological feasibility is established such as attorney fees
are capitalized as intangible assets.
- Post-issuance legal defense costs are expensed as incurred unless they are required to
defend the validity of the patent registration.
Capitalized patent costs are then amortized over the legally enforceable term of the patent
which is typically 20 years from the application date. Impairment tests are done if indicators exist
that the carrying amount may not be recoverable.
For patented products or processes, unpatented technology or trade secrets embedded within
tangible goods or services are accounted for as part of inventory or cost of goods sold
respectively. Patent license agreements follow same accounting as copyright licenses discussed
above.
Trademarks
A trademark identifies and distinguishes the source of goods or services of one party from those
of others in the marketplace. Trademark costs incurred in the development stage are expensed
as they do not meet the definition of an asset. However, registration and legal defense costs
incurred after the mark is placed in service are capitalized as intangible assets provided they
are not indefinite in nature:
- Indefinite lived trademarks such as brands, logos or slogans are not amortized but subjected
to annual impairment testing.
- Finite lived trademarks where future economic benefits are limited to legal life are amortized
over the expected useful life. Useful lives range between 10-30 years and are reassessed
annually.
Acquired trademarks from business
combinations or asset purchases are recognized separately at fair value. Similar to other
identifiable intangible assets, fair value is determined based on an income approach by
discounting estimated future cash flows attributable to the trademark. Trademark license
agreements follow the same revenue recognition principles as copyrights and patents.
Research and Development
From an accounting perspective, whether research and development (R&D) costs can be
capitalized or must be expensed impacts net income. IAS 38 requires R&D costs to be
capitalized only after technical and economic feasibility of the asset for sale or use has been
established. All other R&D costs are expensed.
Key considerations for capitalization include whether:
- Project is technically feasible based on a prototype/working model
- Use/sale of resulting product/process is technically & commercially feasible
- Resources exist/will be available to complete development
- Entity intends and has ability to use/sell resulting intangible asset
Costs eligible for capitalization include materials, employee salaries and third party expenses
directly attributable to the project. Capitalized R&D costs are amortized over the life of the
underlying asset or product. Internal R&D remains an exempt alternative under IAS 38 and
companies may elect to continue expensing these costs.
Goodwill and business combinations
Goodwill arising on a business combination represents the excess of acquisition cost over the
acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent
liabilities of the acquiree. Goodwill does not generate independent cash flows and must be
tested for impairment at least annually by comparing the recoverable amount (higher of value in
use or fair value less costs of disposal) with the carrying amount.
Any resulting goodwill impairment loss is recognized in net income immediately and cannot be
subsequently reversed. Goodwill is allocated to the CGUs expected to benefit from the
synergies of the combination. Significant assumptions used in value in use calculations such as
forecasts, growth rates and discount rates are disclosed in the notes to avoid misrepresentation.
Acquired intangibles including intellectual property help support the measurement of goodwill
and related impairment testing.
Tax considerations
From a tax perspective, the accounting treatment of intellectual property impacts both current
and deferred taxes:
Current Taxes
- Capitalized intangible asset costs are deductible for tax over time as per
depreciation/amortization schedules
- Certain R&D and IP defense costs may qualify for immediate deduction or tax credits
- Capital gain/loss on disposal of intellectual property impacts current tax
Deferred Taxes
- Temporary differences between accounting and tax base of intangible assets give rise to both
deferred tax assets and liabilities
- Amortization period differences cause timing differences requiring deferred tax computation
- Impairment losses have no tax effect whereas goodwill impairments are permanent differences
- Fair value uplifts on acquired intangibles create deductible temporary differences
Entities disclose their accounting policy for deferred taxes, analyze recoverability of deferred tax
assets and reconcile effective tax rates in the financial statements. Tax filings may require more
detailed IP asset schedules for tax depreciation.
Financial statement presentation
Intellectual property assets are classified as either indefinite life intangible assets not subject to
amortization or finite life intangible assets amortized over their useful lives. Certain presentation
requirements exist:
- Separately disclose major intangible asset classes in the statement of financial position
- Provide narrative description of each class including useful lives and amortization methods
- Disclose reconciliation of carrying amounts in the notes including additions, disposals,
amortization
- Impairment losses should be disclosed separately on the face of income statement
- Allocate goodwill impairment losses between CGUs in the notes
- Disclose key assumptions used in impairment tests such as discount rates
Related party disclosures are given for IP transfers between group entities. Commitments and
contingencies for IP registrations and litigation are presented. Unamortized balance of
capitalized R&D as well as research and development expenses are disclosed.
Conclusion
In summary, intellectual property laws have significantly impacted accounting practices by
necessitating the capitalization, amortization, impairment testing and disclosure of intangible
assets. Strict IFRS requirements exist regarding the identification, measurement and
presentation of intellectual property and related goodwill arising on acquisitions. Companies
must adopt policies and processes to account for and value self-generated and acquired
intangible assets, along with the related tax and financial statement disclosure implications.
Overall, evolving intellectual property laws have placed increased focus on appropriately
recognizing and reporting these critical business assets in the financial statements.
Intellectual property laws seek to protect creations and inventions of the human intellect that
have commercial value. This includes copyright, patents, trademarks, industrial designs and
trade secrets. As businesses increasingly rely on intellectual property as an asset class,
accounting practices have had to evolve to properly account for and report on these intangible
assets. This paper will examine how key intellectual property laws including copyright, patents
and trademarks impact the accounting treatment and financial reporting of intangible assets.
Copyright
Copyright automatically protects original works of authorship including literary, dramatic, musical
and artistic works such as books, articles, software, plays, films, music, drawings and
photographs. Once a work is fixed in a tangible form of expression, copyright protection exists
immediately without registration. The main accounting implication of copyright is the
capitalization and amortization of costs relating to the creation or acquisition of copyrighted
works.
Capitalization of internally generated copyrights
When a company directly incurs costs to produce copyrighted works for sale or license, these
costs are typically capitalized as intangible assets in accordance with IAS 38 Intangible Assets.
Capitalization begins when it is probable that expected future economic benefits will flow to the
company and the costs can be reliably measured. Costs typically capitalized include personnel
costs such as compensation of creative talent like writers, artists and programmers as well as
any third party costs incurred.
Once capitalized, internally generated copyrights are amortized over their estimated useful lives
which is generally the period over which economic benefits are expected to flow to the company.
Useful lives are reassessed at least annually with any changes accounted for prospectively as a
change in accounting estimate. Amortization expense is recorded as the cost of sales or
operating expenses depending on the nature of the copyrighted work. Impairment reviews are
also required when indicators of impairment exist to write down the carrying amount to the
recoverable amount which is the higher of value in use or fair value less costs of disposal.
Capitalization of acquired copyrights
When copyrighted works are acquired from third parties through business combinations or
purchases, IFRS requires the assets and liabilities acquired, including identifiable intangible
assets, to be recognized separately from goodwill at fair value. Common identifiable intangible
assets arising from acquisitions include copyright portfolios, customer lists, order or production
backlogs, music catalogs, film libraries and software. These intangible assets are measured at
fair value which is often determined using an income approach such as the multi-period excess
earnings method or with-and-without method.
Acquired copyrights are then amortized over their estimated useful lives which is generally the
legal term of the copyright if finite or indefinite if the legal term is perpetual. Useful lives are
assessed each reporting period for reasonableness. Impairment reviews are done if indicators
of impairment exist such as a significant adverse change in legal factors or market demand and
value in use is less than carrying amount. Any resulting impairment loss is recognized
immediately in net income.
Accounting for copyright license agreements
Companies may generate revenue by licensing or sublicensing their copyrights to third parties.
Depending on the terms of the license agreement, revenue is recognized either over the license
period (right to use model) or at a point in time (right to access model). Key points to consider
include:
- Nature of the promise - Providing access vs right to use over time
- Timing of transfer of control - At inception or over license period
- Licensor's ongoing involvement - Significant ongoing obligations affect revenue recognition
- Renewal options - May impact the duration of the license term
License fees received upfront are typically initially deferred as contract liabilities/deferred
revenue and recognized as revenue over the license period on a straight-line basis. Guaranteed
minimum royalties receivable periodically over the license term continue to be recognized as
revenue as installments become due. Contingent royalties based on licensee's sales are
recognized as revenue in the period earned.
Patents
A patent provides the owner the right to exclude others from making, using, selling or importing
the patented invention for a limited period. From an accounting perspective, costs incurred to
register, defend and maintain patents are either capitalized as intangible assets or expensed as
incurred depending on the patent stage and probability of future economic benefits:
- Research costs are always expensed as they relate to general research aimed at gaining new
scientific or technical knowledge.
- Development costs are capitalized once technological and economic feasibility is established
based on a working model or prototype.
- Registration costs incurred after technological feasibility is established such as attorney fees
are capitalized as intangible assets.
- Post-issuance legal defense costs are expensed as incurred unless they are required to
defend the validity of the patent registration.
Capitalized patent costs are then amortized over the legally enforceable term of the patent
which is typically 20 years from the application date. Impairment tests are done if indicators exist
that the carrying amount may not be recoverable.
For patented products or processes, unpatented technology or trade secrets embedded within
tangible goods or services are accounted for as part of inventory or cost of goods sold
respectively. Patent license agreements follow same accounting as copyright licenses discussed
above.
Trademarks
A trademark identifies and distinguishes the source of goods or services of one party from those
of others in the marketplace. Trademark costs incurred in the development stage are expensed
as they do not meet the definition of an asset. However, registration and legal defense costs
incurred after the mark is placed in service are capitalized as intangible assets provided they
are not indefinite in nature:
- Indefinite lived trademarks such as brands, logos or slogans are not amortized but subjected
to annual impairment testing.
- Finite lived trademarks where future economic benefits are limited to legal life are amortized
over the expected useful life. Useful lives range between 10-30 years and are reassessed
annually.
Acquired trademarks from business
combinations or asset purchases are recognized separately at fair value. Similar to other
identifiable intangible assets, fair value is determined based on an income approach by
discounting estimated future cash flows attributable to the trademark. Trademark license
agreements follow the same revenue recognition principles as copyrights and patents.
Research and Development
From an accounting perspective, whether research and development (R&D) costs can be
capitalized or must be expensed impacts net income. IAS 38 requires R&D costs to be
capitalized only after technical and economic feasibility of the asset for sale or use has been
established. All other R&D costs are expensed.
Key considerations for capitalization include whether:
- Project is technically feasible based on a prototype/working model
- Use/sale of resulting product/process is technically & commercially feasible
- Resources exist/will be available to complete development
- Entity intends and has ability to use/sell resulting intangible asset
Costs eligible for capitalization include materials, employee salaries and third party expenses
directly attributable to the project. Capitalized R&D costs are amortized over the life of the
underlying asset or product. Internal R&D remains an exempt alternative under IAS 38 and
companies may elect to continue expensing these costs.
Goodwill and business combinations
Goodwill arising on a business combination represents the excess of acquisition cost over the
acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent
liabilities of the acquiree. Goodwill does not generate independent cash flows and must be
tested for impairment at least annually by comparing the recoverable amount (higher of value in
use or fair value less costs of disposal) with the carrying amount.
Any resulting goodwill impairment loss is recognized in net income immediately and cannot be
subsequently reversed. Goodwill is allocated to the CGUs expected to benefit from the
synergies of the combination. Significant assumptions used in value in use calculations such as
forecasts, growth rates and discount rates are disclosed in the notes to avoid misrepresentation.
Acquired intangibles including intellectual property help support the measurement of goodwill
and related impairment testing.
Tax considerations
From a tax perspective, the accounting treatment of intellectual property impacts both current
and deferred taxes:
Current Taxes
- Capitalized intangible asset costs are deductible for tax over time as per
depreciation/amortization schedules
- Certain R&D and IP defense costs may qualify for immediate deduction or tax credits
- Capital gain/loss on disposal of intellectual property impacts current tax
Deferred Taxes
- Temporary differences between accounting and tax base of intangible assets give rise to both
deferred tax assets and liabilities
- Amortization period differences cause timing differences requiring deferred tax computation
- Impairment losses have no tax effect whereas goodwill impairments are permanent differences
- Fair value uplifts on acquired intangibles create deductible temporary differences
Entities disclose their accounting policy for deferred taxes, analyze recoverability of deferred tax
assets and reconcile effective tax rates in the financial statements. Tax filings may require more
detailed IP asset schedules for tax depreciation.
Financial statement presentation
Intellectual property assets are classified as either indefinite life intangible assets not subject to
amortization or finite life intangible assets amortized over their useful lives. Certain presentation
requirements exist:
- Separately disclose major intangible asset classes in the statement of financial position
- Provide narrative description of each class including useful lives and amortization methods
- Disclose reconciliation of carrying amounts in the notes including additions, disposals,
amortization
- Impairment losses should be disclosed separately on the face of income statement
- Allocate goodwill impairment losses between CGUs in the notes
- Disclose key assumptions used in impairment tests such as discount rates
Related party disclosures are given for IP transfers between group entities. Commitments and
contingencies for IP registrations and litigation are presented. Unamortized balance of
capitalized R&D as well as research and development expenses are disclosed.
Conclusion
In summary, intellectual property laws have significantly impacted accounting practices by
necessitating the capitalization, amortization, impairment testing and disclosure of intangible
assets. Strict IFRS requirements exist regarding the identification, measurement and
presentation of intellectual property and related goodwill arising on acquisitions. Companies
must adopt policies and processes to account for and value self-generated and acquired
intangible assets, along with the related tax and financial statement disclosure implications.
Overall, evolving intellectual property laws have placed increased focus on appropriately
recognizing and reporting these critical business assets in the financial statements.
