When one firm acquires another, it usually acquires a bundle of assets for which it pays a single price. That price represents the fair value for the business as a whole, but the fair values of the individual assets that change hands are rarely transparent. There is no single accepted formula to allocate the purchase price for an entire business across all of the different assets acquired and, most often, individual assets are not valued during the due diligence for the acquisition.

The Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) Nos. 141 and 142 stipulate that public companies must, among other things, report the fair value of acquired intangible assets. Intangibles that must be separately valued include, for example, patents, trademarks, copyrights, know-how (what economists call intellectual capital), employment agreements, non-compete agreements, and Internet domain names. The authors of this article believe that determining the fair value of these assets is not a matter of simple accounting; formula-driven, cookie-cutter approaches, or rules-of-thumb, too often ignore or downplay the specific market circumstances in which intangible assets are expected to be used.

As a result, those valuation methods do not provide defensible results. In this article, the authors describe the valuation requirements imposed by SFAS Nos. 141 and 142, and provide several examples of how an economic approach to valuing intangible assets provides accurate and defensible results that will enable companies (a) to effectively comply with these reporting requirements; and (b) to prepare appropriate contemporaneous documentation before acquisitions are consummated.

This article was republished with permission from International Tax Journal, Volume 30, Number 1, Winter 2004, Copyright (c) 2004 Aspen Publishers, Inc., http://www.aspenpublishers.com. All rights reserved.