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Home > Human and Intellectual Capital Calculations > Goodwill and Patents

Human and Intellectual Capital Calculations

Goodwill and Patents

One could define both goodwill and patents as figments of the imagination, the former a financier’s and the latter an inventor’s. The accounting realm assigns real value to both, based on the theory that both will deliver real benefits in the future.


What It Measures

The value of two intangible assets.

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Why It Is Important

Since both goodwill and patents are intangible assets, their values will be whatever negotiators conclude. Still, their values need to be reflected in financial statements. Goodwill is created in the aftermath of an acquisition, and must appear on a balance sheet. The acquisition of a patent has a cost of its own, be it the price of internal development costs, or the purchase price paid to an inventor.

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How It Works in Practice

Ultimately, the assigned values of both assets are matters of opinion, however learned the opinions may be. Each must be considered separately.

Ordinarily, goodwill is completely ignored by accountants. Only when a company has been acquired by another does goodwill become an intangible asset. It then appears on a balance sheet in the amount by which the price paid by the acquiring company exceeds the net tangible assets of the acquired company. In other words:

Goodwill = Purchase price − Net assets

If, for example, an airline is bought for $12 billion and its net assets are valued at $9 billion, $3 billion of the purchase would be allocated to goodwill on the balance sheet.

The buyer will attribute the difference to any number of reasons that give a competitive advantage, such as a loyal and long-standing customer base, a strong brand, strategic location, or productive employees.

A patent’s value, meanwhile, will probably be the sum of its development costs, or its purchase price if acquired from someone else. It is usually to a company’s advantage to spread the patent’s value over several years. If so, the critical time period to consider is not the full life of the patent (17 years in the United States), but its estimated useful life.

For example, let’s say that in January 2000 a company acquired a patent issued in January 1995 at a cost of $100,000. It concludes that the patent’s useful commercial life is 10 years, not the 12 remaining before the patent expires. In turn, patent value would be $100,000, and it would be spread (or amortized in accounting terms) over 10 years, or $10,000 each year.

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Tricks of the Trade

  • Accounting for goodwill can vary by country, an issue that needs to be considered when evaluating or negotiating acquisitions of foreign-based companies. Moreover, the rules may change from time to time. In the United States, for example, goodwill no longer has to be amortized over 40 years.

  • The total value of a patent’s development costs may stretch over several years.

  • The cost of a patent ultimately may have little bearing on the future revenues and profits it brings.

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Further reading on Goodwill and Patents

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