Intellectual property (IP) can be and often is a crucial part of a company’s value. It includes trademarks, invention patents, designs, copyrights, trade secrets, software, technologies, and other items created by employees or third parties within the company.

However, often when looking at a company’s balance sheet, IP and its value are usually not found. Companies frequently face challenges when it comes to valuing IP. Does not having a clearly defined value mean it doesn’t exist? Definitely not, and this issue needs to be addressed immediately.

Why is it important to account for IP as an asset? There are several reasons, with the most important listed below:

1. Accurate representation of the company’s status and assets.

For many companies, especially in sectors like technology, medicine, and pharmaceuticals, intellectual property is a significant contributor to their overall value and often the only asset they possess. Accurate IP accounting ensures that financial statements reflect the true value of the company. This helps analysts and investors make informed decisions about the company’s financial health and growth potential.

Additionally, clear identification of IP helps in making informed decisions about the future actions regarding the entire IP portfolio.

2. Investment.

External investors would invest in a company only if the company has accounted for its IP as an asset; otherwise, investment is difficult because the investor cannot see the true value of the company.

3. IP Sale and Taxes.

Creating groundbreaking technology or other IP and selling it without accounting for it can result in paying significantly more taxes than if the IP had been accounted for.

4. Financial Performance.

Better financial indicators: Recognizing IP as an asset strengthens the company’s balance sheet by increasing total assets. This positively affects financial metrics, such as return on assets (ROA) and equity ratio, providing a clearer view of the company’s financial performance.

5. Compliance with Accounting Standards.

Business accounting standards dictate that company expenses must be accounted for as assets rather than expenses. Opposite accounting practices are not in line with business accounting standards.

6. Taxes.

Amortization and deductions: IP assets can be amortized over their useful life. Companies can deduct amortization expenses, reducing taxable income.

7. IP Sale and Licensing.

Properly accounting for IP facilitates determining and negotiating the price for IP sales or licensing to third parties.

8. IP as Collateral.

IP can be used as collateral when seeking loans or other financing. Creditors often consider IP value when assessing the company’s creditworthiness, allowing companies with valued IP to secure better financing terms.

How to Account for IP?

IP is accounted for as the paid or payable amount of money allocated to create IP. This amount typically includes:

· Costs of materials and services used or consumed in creating IP;
· Compensation and related taxes for employees or third parties directly involved in creating IP;
· Received support or other financing allocated for IP creation;
· Depreciation of tangible assets, amortization of intangible assets if those assets were used in creating IP;
· Other expenses.

All costs must be directly related and attributable only to the creation of IP. For example, general administrative expenses are not included in the cost since they are not directly related to asset creation. The company must justify that the expenses are directly related to IP creation.

Once the amount allocated to IP is determined, it should be accounted for as long-term intangible assets.

All the above conditions and requirements (like other financial accounting principles, methods, and rules) should be established in the accounting policy (or the procedure for recording and valuing business transactions). This document is approved by the company’s management. There is no requirement for shareholder approval unless otherwise specified in the company’s documents.

The information provided above is general knowledge. For each case, please consult TRINITI JUREX.