Accounting Principles – Patents, Copyrights, Trademarks
The topics suggested by the subject of this chapter are frequently considered along with goodwill. They seem, however, to be of sufficient importance and so unlike goodwill as to warrant a discussion apart from that subject.
It frequently happens that where a concern is taken over by a corporation, the capital stock issued for the net assets of the concern does not equal the value placed upon the net assets. The amount of capital stock may be greater or less than the net assets. Where the capital stock is smaller in amount it need not be considered for the purpose of this discussion. Where it is greater it will give rise to a difference on the asset side. This difference may be absorbed by a revaluation of the assets but it is frequently termed patents, copyrights and goodwill. This practice is to be censured unless such assets actually exist and are reasonably worth, in the opinion of the directors, the value thus assigned to them. Goodwill merits separate consideration and will be taken up later. The things of interest concerning patents, copyrights and trademarks are their nature, how much they are worth when they are acquired, whether or not they may increase in value during their existence and how long they may be carried at the original or at the increased valuation.
A patent is an instrument issued by the federal government through its patent office to an inventor, protecting him against the possibility of having some other person make, use, or offer for sale a similar device, machine, manufacturing process, or composition of matter. Patents are issued for a term of seventeen years and may not be renewed except by an act of Congress.
A copyright is an instrument issued by the federal government through a bureau under the control of the librarian of Congress, whereby an author or artist is granted the exclusive right to publish and dispose of his work for a limited time. A copyright runs for twenty-eight years and may be renewed for a period of fourteen years.
A trademark is an instrument granted by the federal government to citizens of the United States, who, by registering in the patent office certain designs, insignia, symbols, marks, names, or other characteristic indications whereby their goods are identified and advertised for sale, are protected against the use of same by others. The registering of a trademark carries this protection for a period of thirty years, which may be extended for an additional thirty years.
The cost of securing a patent, a copyright, or registering a trademark is nominal and bears no relation whatsoever to the value of either of these forms of protection. That they are valuable at times is undisputed. To determine their value is a different matter. In the case of a growing concern which does not contemplate a change of any kind it may be perfectly satisfactory to carry these items at a nominal value or even not carry them at all. If a change in the ownership is about to take place surely as a rule the owners will wish to place a value upon them. It is also possible that even when no such change in ownership is anticipated, the concern owning such instruments may wish to value them. There are two means of accomplishing this purpose. One is to place an arbitrary value upon them. The other, which is the more scientific, is to capitalize what may be considered as excess income, or the income attributable to these agencies. For example, a concern, the combined capital and surplus of which is $100,000, earns $9,000 per year. It has earned 9% upon the investment. Assuming that 6% is the average return on investment in the line of business in which the concern in question is engaged, then it is clear that there is excess income of $3,000, which is to be attributed to some cause or other outside of the normal agencies which produce income. If there are either patents, copyrights or trademarks in existence and in use, what would seem more feasible then than to attribute the excess income of $3,000 to the possession and use of these special assets? On this theory the excess income is capitalized at 6%and $50,000 set up as the value of the special assets in question.
Irrespective of the basis used in valuing patents, copyrights and trademarks, a valuation once placed upon such assets is subject in somem events to extraordinary fluctuation. Patents which are effective today may be so closely approximated even without infringement within a short time so as to render the protective feature almost worthless. In a corresponding manner, copyrights while their life extends over a considerable number of years, cover as a rule publications, the sale of which is limited and soon over. Thus while the sale of a book might be protected for forty-two- years, in a comparatively short time in many instances there is nothing to protect. The value of trademarks probably continues longer and with greater stability than either patents or copyrights. However, it is not an unusual thing to have the sale of an article damaged by a similar article, sometimes with a trademark just sufficiently different so as not to violate the law, sometimes with a different trademark when the goods are of a cheaper grade or quality and sometimes when the same condition exists without any trademark. For these various reasons it would seem that if assets of this character are set up at all, they should be written down either gradually or within a short space of time. Probably no exception can be taken to the plan of writing them off over the term of years specified by the instrument, but it would certainly seem to be better policy to write them off as rapidly as possible if acquired by purchase and to carry them at a nominal value if acquired by issue.
A concern which acquires patents by issue has a choice of valuing them and carrying them in three different ways. They may be set up at a nominal value which usually means carrying them at $1.00, at an arbitrary value, or at a value based upon the earning power. Obviously if carried at a nominal value the question of writing them down does not arise. If they are set up at an arbitrary value or on the basis of their earning power, they may be written down or provision made for their depreciated value over a period of seventeen years. This theory is of course based on the fact that they continue in force and effect during this period.
A condition may arise here, however, which is analogous in its effect to that which a new machine has upon depreciation. The life of a machine may be fixed at twenty years and arrangements made to provide for its depreciation over that period of time. If, however, the type of machine suddenly becomes obsolete and is replaced by a machine of a newer type, then its loss in value becomes suddenly great and the net value which is in reality its book value less what it is worth as scrap must be immediately written off. In the case of machinery, however, it is not always the scrap value which is taken into consideration in fixing a value on the residue, but rather its value as a second hand machine. A machine which would be obsolete so far as its use in the United States Steel Corporation is concerned might be valuable to some manufacturing concern organized on a smaller scale and doing business in some small manufacturing town. If such machines were sold to small concerns the residual value would be the price at which they were sold rather than their scrap value, and in writing them off the sale price would be the amount deducted from the amount to be written off rather than the scrap value.
The analogy between machines and patents in respect to their valuation is to be considered only up to a certain point. A patent may be effective for seventeen years or it may become ineffective or partially ineffective as a protecting agency at almost any time. Manufacturer “A” may own a very valuable patent. It may entitle him to make, use, or sell some new and useful machine, manufacturing process, or composition of material. Manufacturer “B” may appear upon the scene with a similar design and although similar, sufficiently different to enable him to secure a patent without infringement, which device may be so much more up-to-date and eagerly sought after by the trade as to render practically valueless the patent of manufacturer “A.” Even if it does not have the effect of destroying the value of the first mentioned patent, it may make competition so keen as to modify greatly the protective benefits which formerly accrued to manufacturer “A” by virtue of the patent which he held. Thus having carried his patent either at an arbitrary value or at a value fixed by its earning power he is confronted with having to write down the asset either wholly, or in a large measure depending upon the extent to which the value of his patent as such has been impaired. There is no residual value in this case as in the case of machines. The patent has no value as scrap and naturally if it is of no value to the present owner it will presumably have no sales value. Thus conservatism would dictate against the policy of attempting to carry patents at arbitrary or scientific values on account of the contingencies which may suddenly arise.
The above remarks would seem to be equally applicable to copyrights and trademarks. In the latter case, however, there seems to be less possibility of these contingencies arising and stronger arguments in favor of carrying trademarks at other than nominal values.
A concern which purchases or acquires patents, copyrights or trademarks from previous owners is in a somewhat different position. Such concerns having acquired these assets in exchange for value may reasonably argue that the value is what such assets cost to acquire. The policy of writing them down will depend of course upon the judgment or desire of the proprietor, but the period over which the depreciation should be spread will be covered in the respective instances by the life of the instrument. Obviously he is entitled to spread the depreciation over the life of the respective instrument, but the conservative proprietor will write them off as rapidly as the business permits in order to insure himself against any contingencies which may detract suddenly from the value of the assets.
A franchise is an instrument granted by the government to individuals, corporations, or other types of legal organization, giving to such organization the exclusive right to transact specific lines of business within specified limits for a given number of years, or to use certain natural resources of the country, in consideration of certain sums of money, payable either all at one time or in installments. In brief a franchise is a contract between the government and some legal type of organization covering the above mentioned rights.
Franchises may be granted by the federal government, the states, counties or municipalities. The most common purposes for which franchises are granted are steam railroads, street railroads, telegraph and telephone systems, water systems, gas and electric light systems, power plants. They may also include the rights to obstruct water ways for reservoir purposes; the rights to use water falls and in fact the right to use any property which the government owns.
It would probably not be wrong to include among the franchise, rights for minor purposes such as the use of the streets for vending purposes or the right to sell merchandise upon the streets or from house to house. This form of franchise is looked upon in a different manner and the recipient of such right pays what is known as a license. The privilege conveyed upon him in return for the tax which he pays is of a restrictive nature as a rule, and can scarcely be considered as an asset since such rights are usually granted to all persons who are able to pay the license tax.
The distinguishing feature between a license and a franchise would seem then, to be, that while in the former case the privilege is granted freely to all who apply, whereas in the latter it is granted only to one organization, and thereby resembles a monopoly. By virtue of having acquired a monopoly the holder thereof is enabled as a rule to make larger profits. It is probable that a vendor selling knickknacks on the street would not consider his license as an asset. He would more properly consider it as expense of doing business. On the other hand a street railway company holding a franchise whereby it was permitted to construct and operate a system of tracks and cars in and about a given city, would be quite justified in considering the franchise as a very valuable asset. That franchises are considered as valuable assets which permit the holders thereof to operate to the exclusion of all others is evidenced, by the fact, that, a tax is imposed upon the corporations or individuals holding them. That it is difficult to determine the value of a franchise may be seen from the litigation resulting in the attempt of the State of New York to impose a franchise tax upon certain corporations operating within the state.
From an accounting point of view the matter of valuation is the principal point to be considered. If the franchise is acquired by direct grant it would seem that the matter of determining its value should be decided by what it is worth. It is worth what it will produce in the way of excess income. Such income it would seem should be measured by the monopoly profits which it brings in. To determine the monopoly profits is to compare the total profits in a given case with the normal average profits of a similar type of system.
Assuming in a given case that the net assets of a corporation owning a franchise are carried at $1,000,000, such net assets being represented by the capital stock and surplus and producing income of $300,000 per annum. It may be further assumed that the income consistent with the kind of organization in question is 10%, or $100,000. Comparison of the normal profits with the profits of the monopoly shows an excess of $200,000, due it may be assumed, to the franchise which the company holds and which amount may be considered as the monopoly profits. If the profit of $200,000 is due to the fact that the company holds a franchise, then apparently the franchise is worth what it will produce in the way of monopoly profits and should be capitalized at $2,000,000, on $200,000, divided by 10%.
In attempting to capitalize a franchise in this manner care should be taken to consider any amount or amounts which the company has paid or will have to pay for the franchise and the difference only in any case set up as the value of the asset. To illustrate this it might be supposed in the above mentioned case that the company paid $150,000 for the franchise at the time it was acquired. Under such conditions the $150,000 would be excluded from the net assets when determining their amount and in view of the fact that $150,000 would probably already appear on the books the difference only between such an amount and the new amount should be added. As used above, $1,850,000 would be added to the $150,000 appearing on the books, making the book value $2,000,000. If for example the company were to pay $50,000 a year for the franchise then $50,000 should be deducted from the $200,000 before capitalizing it at 10%, so that in this case the franchise would be valued at $1,500,000.
In both of the above cases the element of time appears and should be taken into consideration in the accounts. A franchise granted for any time less than perpetuity, is theoretically a wasting asset. Its value would be affected by the period of time for which it is granted. It is quite plain that a franchise granted for ten years unless renewable, is of no value at the end of the tenth year. A provision therefore should be made for depreciating its value either by writing it down or through the medium of a reserve; preferably by the latter method. The rapidity with which it is written off will depend upon the life of the franchise.
If a franchise is acquired from a former owner the matter of its valuation may differ from the cases above referred to. Where acquired by purchase rather than by direct grant they may be carried at cost, valued as above indicated, or carried at an arbitrary value. They are many times treated the same as patents, trademarks, goodwill, etc., and made to represent the difference between the net assets of the old concern and the capital stock of the new concern. This is to be objected to because of the reason that it does not usually represent the fact, but is merely an expedient for making the books balance. Under any circumstance provision should be made for depreciating such assets in accordance with the life of the franchise.
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