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Up to date on: 29.1.2008
Provided by: Hungarian Patent Office
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Quantitative evaluation methods

1. Cost based methods

Cost based approaches measure, quantitatively, the value of IP through the calculation of the costs incurred if the company were to develop a similar asset either in-house or externally.  The costs to produce the IP are taken to be its value. 

·        Historic Cost

The historic cost approach measures the costs incurred through the development of the IP, at the time it was developed.  

·        Replication Cost

The replication cost approach measures the amount of investment needed to develop similar IP, at the present time, in exactly the same way and achieving the same IP as currently exists.  The whole cost of research and development must be included in this calculation, including the costs of unsuccessful prototypes etc.

·        Replacement Cost

The replacement cost approach measures the amount of money that would be needed to develop the IP as it currently exists, but as the term “replacement” signifies, the costs of failed and unsuccessful research is not included.  It is easiest to think of this as measuring the cost of buying the already developed IP from an external source.                                                                                                                                                                                        

When are they used?

Approaches based upon the measurement of cost are generally used in accounting, bookkeeping and in accordance with accounting rules.  It is commonly agreed that cost based methods are only useful for bookkeeping purposes or as a supplement to an income approach (see later).  They are only relevant in historical cost based accounting systems or where taxation methods dictate their use.

Advantages and disadvantages of cost based methods

One advantage of the method is that IP becomes visible in the company’s books and IP awareness is increased.  The method is also a useful indicator of IP value in the case of IP assets whose future benefit is not yet evident.

There are many pitfalls associated with using the measurement of cost to determine the value of IP.  The main disadvantage is that there is no direct correlation between cost of development and the future revenue potential of assets.  It is a fact that IP that costs the most to produce, may not necessarily be the most valuable.  The same applies to IP which is many years old and has been written down in value.  This IP could still be the most valuable to the company, even though the historical cost approach does not show this. The measure of historic costs is unreliable with rapid technological advancement. It is not always possible to provide accurate information on the resources spent on development and there will always be a practical challenge to determine which costs to include or exclude.  Most importantly, cost based methods make no allowance for the future benefits which might accrue from the IP.  

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