Putting a Value on Intellectual Property

Over the decades, IBM has amassed an awesome global portfolio of more than 30,000 patents in computer hardware, software and telecommunications--not to mention tens of thousands of valuable copyrights for its programs, languages and documentation.

So what’s this sweeping landscape of high-tech intellectual property actually worth? If you look at the financial statements, you’ll find IBM’s massive intellectual property holdings are worth less than swampland in Florida. Why? Because the accountants don’t consider IBM’s intellectual property to be an “asset.” (In fact, it’s the swampland that would be booked as an “asset.”)

But Texas Instruments has gotten Japanese computer chip companies such as NEC to pay hundreds of millions of dollars in fees for its basic semiconductor patents. Does that make TI’s intellectual property a financial asset? Nope. No matter what industry you’re in, generally accepted accounting principles treat intellectual property as intangible and invisible.

Consider Merck & Co., one of America’s most innovative and admired pharmaceutical houses. Through its extensive patents, Merck holds some of the most lucrative intellectual property in the health care business. But the balance sheet can’t mention that.

“The fact that intellectual property is not included as an asset on the balance sheet is a deficiency in current accounting rules. The best way to address that deficiency requires further study by industry, and this is a key area of focus in Merck finance,” says Merck Chief Financial Officer Judy C. Lewent.

“If you do put value on intangibles like intellectual property,” warns Vic Siber, IBM’s senior corporate counsel for intellectual property law, “they are subject to discussion and dispute.”

What a mess! At precisely the time when people are recognizing the value and importance of intellectual property as a key ingredient in global competitiveness, accounting rules rigorously forbid them from acknowledging that. So we now have the unfortunate situation where traditional accounting measures actually conceal--rather than reveal--the assets that are of real value to a company.

Thus, the bioprocessing plant that makes the life-saving pharmaceutical is an asset; the patent that bestows the monopoly right to produce it is not. The wafer fabrication plant that produces the custom-designed silicon chip is an asset; the copyright that protects that design from infringement is ignored.

The result is an unhealthy charade where companies and their financial scorekeepers politely agree to ignore reality. That just can’t last.

“Basically, there is no logic to this,” asserts Columbia University accounting professor John Burton, a former Securities and Exchange Commission chief accountant. “If you actually buy a patent, you can call it an asset. If you develop one from your internal research and development efforts, you can’t because R&D; money is treated as an expenditure, not as an investment.”

While acknowledging how difficult it is to assess the value of an intellectual property asset, Burton and several other accountants argue that management should have the right--and maybe even has an obligation--to assign a publicly disclosed value to the intellectual property assets it has created and acquired.

“Where a dollar of cost is not equal to a dollar of value, the traditional accounting model breaks down,” says Burton. “We need to start dealing with uncertainties posed by research and development spending in more realistic ways than just ignoring it.”

Indeed, Burton argues that this unwillingness to come to grip with uncertainty “signals that the accounting profession is more interested in preventing legal liability than presenting a fair representation of the financial situation . . . in the current legal environment, there is very little incentive to make public disclosure in financial statements.”

To be sure, many experts argue that such disclosure isn’t necessary--Wall Street analysts and others look beyond the balance sheet and incorporate their assessments of intellectual property value into their valuation of a company’s stock. Of course, by that logic, why bother to have companies disclose anything at all? If the top management of America’s most innovative companies--the Motorolas, the Mercks, the Microsofts--publicly claim that their intellectual property is essential to their financial health, they should have the guts--and the opportunity--to put their valuation of their property before the marketplace. Indeed, the SEC and the Financial Accounting Standards Board (which defines accounting rules) should insist on it.

Putting intellectual property on the balance sheet would force top management to more carefully examine the potential value of R&D; efforts. Companies might become more proactive in managing their licensing, patent enforcement and copyright protection activities. In essence, management would be forced to manage intellectual property as a real asset. Isn’t that what it should be doing anyway?