What recognition, if any, should be made of the infringement litigation in the financial statements…

(Accounting for Patents) On June 30, 2012, your client, Ferry Company, was granted two patents covering plastic cartons that it had been producing and marketing profitably for the past 3 years. One patent covers the manufacturing process, and the other covers the related products. Ferry executives tell you that these patents represent the most significant breakthrough in the industry in the past 30 years. The products have been marketed under the registered trademarks ever tight, Duratainer, and Sealrite. Licenses under the patents have already been granted by your client to other manufacturers in the United States and abroad and are producing substantial royalties. On July 1, Ferry commenced patent infringement actions against several companies whose names you recognize as those of substantial and prominent competitors. Ferry’s management is optimistic that these suits will result in a permanent injunction against the manufacture and sale of the infringing products as well as collection of damages for loss of profits caused by the alleged infringement. The financial vice president has suggested that the patents be recorded at the discounted value of expected net royalty receipts.

Instructions

(a) What is the meaning of “discounted value of expected net receipts”? Explain.

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(b) How would such a value be calculated for net royalty receipts?

(c) What basis of valuation for Ferry’s patents would be generally accepted in accounting? Give supporting reasons for this basis.

(d) Assuming no practical problems of implementation, and ignoring generally accepted accounting principles, what is the preferable basis of valuation for patents? Explain.

(e) What would be the preferable theoretical basis of amortization? Explain.

(f) What recognition, if any, should be made of the infringement litigation in the financial statements for the year ending September 30, 2012? Discuss.

 

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