Jack Ellis

Many users of Facebook-owned photo-sharing service Instagram were left furious on Tuesday after it was widely reported that the company had changed its terms of service in order to sell its customers’ photos for advertising purposes without obtaining their permission. It seems clear that Instagram – and by extension, Facebook – has lost brand equity as a result, with one user describing the updated terms as the company’s “suicide note”. While the uproar may be based on a misunderstanding, as Instagram’s chief executive has since tried to point out, it could mean further bad news for Facebook shareholders, who have had a rough ride since the social network’s IPO back in May.

Last month, IAM reported on Facebook’s extensive acquisitions of IP and other intangibles over the prior 12 months, and the need for the company to prove to its shareholders that such buys would be worthwhile in the long run. Facebook, which completed its takeover of Instagram in August, valued the goodwill in the photo sharing service at $435 million in a 10-Q form filed at the end of September. Other intangibles, including ‘tradename’ and ‘acquired technology’, among others, amounted to $86 million, according to the SEC filing. Altogether, the purchase of Instagram comprised a significant proportion of the intangible assets that were added to Facebook’s balance sheet over the past year.

Of course, current accounting practices only consider acquired intangible assets, and not those created and developed internally. Therefore, while it is apparent that the book value of Facebook’s intangibles increased by over 778% between September 2011 and September 2012, the social network’s home-grown IP and goodwill (which is presumably quite considerable in its own right) are not definitively represented on its balance sheet.

However, the fact that acquired intangibles can be booked means that any depreciation in their value must also be reported. Depending on the level of impairment that the alleged photo-rights grab has had on Instagram’s goodwill, Facebook may face a writedown on its purchase – a situation that Microsoft is all too familiar with, although under different circumstances.

Yesterday, Instagram moved to damp down the fury surrounding its policy revision, saying that it was never the company’s intention to claim a right to sell its users’ photographs. The company’s CEO said that the fallout was the result of “confusing” language that the company had used by “mistake”.

While that may be the case, the consequences could be incredibly costly – regardless of whether it ends up being represented as a loss on the balance sheet. Businesses live and die on the basis of how consumers perceive them – and for Instagram, considerable damage has already been done. The accounting of intangible assets – and the expression of their value as a monetary figure – is not a transparent or immediately comprehensible process. But the power of a good brand is something that investors and consumers alike can well understand. Whichever way you look at it, the owners of the Instagram brand – Facebook shareholders among them – stand to lose value from the $715 million they paid for it.