Value through Transactional Constructs

Now, finally we’ve arrived at the third category of ways to overcome the value problem.

Those of us who are waiting until the accounting profession develops an accurate measure for valuing IP could be waiting a while for the reasons we've already discussed.   The main issue is that it’s almost impossible to get value metrics that are truly accurate.
   

It could be that in looking for firm and unshakeable metrics, we’re barking up the wrong tree. 

Let's take a step backwards for a moment and ask why it is that we want firm metrics.   Some of the things we're probably looking for are:

• An indication of how the development of our intangible assets have progressed
• Some understanding of how much more development is required
• An indication of what the market might pay for each of our intangible assets
• An idea of the likely return on investment in our intangibles
• Some hard baseline data for modelling potential outcomes for R&D projects
• Ways to keep score of our progress on the balance sheet
• Reasons for motivating stakeholders to commit in some way

As we've mentioned, financial alchemy and use of strategic structures might help with some of these goals.   However, some consider these methods to be unsatisfactory, because they're not broad brush solutions to the value problem.
  

In some ways, this is not dissimilar from the problem that faced one John Irvin Beggs in the latter part of the 19th Century.   Who, you say?   Beggs was the father of depreciation techniques.  In Beggs' time, the issue wasn't dealing with intangibles.   It was the tangible assets that were causing the problem.   Most capital assets like machinery and plant would decline in value over time, but there was no accounting method to deal with how it happened until disposal.   This was frustrating, because it was difficult to forecast when new capital expenditure was due.  

To solve this problem, what Beggs did was introduce a transactional construct to assist accounting technique.   He observed that while you couldn't provide an exact quantum for every decline in value, you could still describe that decline in a transactional way.   So, two widget machines owned by two different companies will generally decline at a rate of 40% per year. 

Now of course, depreciation doesn't explain exactly what happens to each of those machines.   One of the companies might have maintained their widget machine badly, while the other company kept their machine in pristine condition.   When they both go to sell their machines, it is likely that they'll each get different resale profits - one of them will be better off.   However, prior to that point, the two company balance sheets will most likely come out with identical results. 

Nevertheless, even though the concept of depreciation wasn't an exact science, Beggs' work made life a lot easier for decision makers, because they could then set their budgets more accurately.   It's now acceptable accounting technique throughout the world.   Of course, the question is, could we introduce the same type of construct to deal with the value problem?

Of course, if a construct of this kind would have to show how an intangible appreciates over time.   While this would be difficult to work out, it's not impossible.   Intangible assets are unique, but their earning capacity usually isn't.   A new drug will typically generate so much in income per year during the life of its major patents.   A developing technology will usually fetch a license fee that is similar to other types of technology already being licensed in the category.   The future earnings capacity of a brand could be the hardest to work out, but there are ways to project this reliably if enough parallel data exists.  

Having an idea of what a key innovation is likely to earn for you is very useful, because from that information, you can work out a ceiling value.   Then it's just a question of amortising that increase in your books over the course of the development project to reach that ceiling value at the apex.   It won't be an exact science, of course.   The final results are likely to differ widely from the actual increase in value, or even the final earnings figures - which is exactly the problem with depreciation.   But even without exact figures, this approach will go some way to helping managers pitch their budgets and projections.

The other point about this type of analysis, of course, is that it could only ever be used internally (for working papers and shorthand projections) until accounting standards recognise it.   However, the more it is used, the more likely it is to garner that acceptance in the long run.