Accounting for Trade Dress

Companies need to accurately value their product’s unique packaging or appearance.


RECENT FASB RULE CHANGES HAVE MADE IT IMPORTANT for CPAs to understand the concept of “trade dress” and its impact on a company’s financial statements. Trade dress refers to the unique packaging or appearance of a company’s product, such as the red and white Campbell’s soup can label.

IN ALL BUSINESS COMBINATIONS AFTER JUNE 30, 2001, an acquiring company must separately value the acquired company’s trade dress. CPAs also must perform an annual test, comparing the current fair value of a company’s trade dress to its recorded amount and recognizing an impairment loss if it has gone below this amount.

OVER THE LAST TWO DECADES, THE COURTS HAVE greatly expanded trade dress protection to include the totality of elements used to present a product, including its design and features such as size, shape, color, texture and even sales technique. Companies can register specific elements of a product’s trade dress as trademarks under the Lanham Act of 1946.

USING RECENT U.S. SUPREME COURT RULINGS, CPAs can help companies establish and enhance the value of their trade dress by assembling the proper documentation. Factors the courts will look at include direct consumer testimony, sales and the behavior of competitors.

AS THE TRADE DRESS RULES EVOLVE IN THE COURTS and in state legislatures, CPAs need to keep up with these changes to ensure a company properly values these intangible assets for financial reporting purposes.

ELISE K. PROSSER, PhD, is assistant professor of marketing at the School of Business Administration, University of San Diego. Her e-mail address is . JAMES K. SMITH, CPA, JD, PhD, is assistant professor of accounting at the University of San Diego. His e-mail address is .

s a result of rule changes by the Financial Accounting Standards Board, “trade dress” has become an important concept for CPAs to understand. Statement no. 141, Business Combinations, requires companies entering into such combinations after June 30, 2001, to separately value the acquired company’s significant intangible assets. Statement no. 142, Goodwill and Other Intangible Assets, requires companies to value these assets at least annually. One asset companies must value under these rules is trade dress, which refers to a company’s unique packaging or the design presentation of its product. Competitors are not allowed to imitate another company’s trade dress in a manner that confuses consumers. The value of a company’s trade dress—such as the red-and-white label of a Campbell’s soup can—is subjective and largely influenced by how broadly or narrowly the statutes and court decisions define trade dress protection.

The Lanham Act of 1946 established the applicable federal law, but the courts’ interpretation often has more influence on what trade dress law protects. Several recent U.S. Supreme Court decisions are the culmination of 22 years of change in this area, with trade dress rules first becoming significantly more liberal, then more conservative over the last seven years. Each expansion or contraction of these rules has important implications for the value of a company’s trade dress and may lead to financial statement losses under Statement no. 142.

CPAs need to keep abreast of legal developments in this area to accurately value trade dress for purposes of Statement nos. 141 and 142. In addition, familiarity with these rules will allow accountants to help a company document the creation and maintenance of its trade dress. Recent court decisions indicate this type of documentation is necessary before certain types of trade dress are entitled to protection.
What Is Trade Dress?
The red and white Campbell’s soup can label.
The shape of a Coca-Cola bottle.
McDonald’s golden arches.
The design and decor of a TGI Friday’s restaurant.
The bright yellow Cheerios box.

FASB 141 AND 142
Statement no. 141 requires all companies entering into business combinations after June 30, 2001, to use the “purchase” method of accounting and eliminates the “pooling” method. (See “Say Goodbye to Pooling and Goodwill Amortization,” JofA , Sep.01, page 31, for more details.) The purchase method requires the acquiring company to separately recognize all of the acquired company’s significant intangible assets including goodwill (the difference between the purchase price and the fair market value of the acquired company’s net assets). The company also must recognize any other intangible assets that either arise from a contractual or other legal right or can be separated from the acquired entity and sold, transferred, licensed, rented or exchanged. Trade dress is among the intangible assets listed in Statement no. 141 that meet at least one of these two criteria. As a result, an acquiring company in a business combination is required to separately value the acquired company’s trade dress.

One controversial aspect of Statement no. 141, raised during its public comment period, was the negative effect it might have on earnings as a result of the amortization of additional intangible assets. FASB addressed some of these concerns in Statement no. 142 by replacing the amortization of intangible assets that have an indefinite life with an annual impairment test. Under these rules, trade dress has an indefinite life and is subject to an annual impairment test. The test requires CPAs to compare the current fair value of a company’s trade dress to its recorded amount and recognize an impairment loss if fair value has gone below that amount. Companies also recognize impairment losses between annual tests whenever events—such as a major legal ruling—occur to indicate the entity’s trade dress might be impaired. The impairment test replaces amortization for fiscal years beginning after December 15, 2001.

The traditional definition limited protection to a product’s packaging or “dressing.” The courts have greatly expanded this protection over the last two decades to include both the totality of elements used to present a product (for example, the distinctive decor of a restaurant) and the product’s design (such as the shape of a flashlight). Trade dress now is broadly defined to cover a product’s total image and may include features such as size, shape, color, texture and even sales techniques. Examples of protected trade dress include the design of a magazine cover, the shape of an automobile, the design of a golf hole, the shape of a cracker and the cowboy imagery used to promote a brand of cigarettes.

Companies can register specific elements of a product’s trade dress as trademarks under the Lanham Act, but registration is not required for protection. The majority of cases involve unregistered trade dress, which is protected by section 43(a) of the act. In either instance, federal courts have three requirements for successful litigation: The trade dress in question must be distinctive, it must be nonfunctional and a competitor’s imitation of it must confuse the consumer.

For a company such as Coca-Cola to gain protection for its trade dress, the imitator’s packaging must cause confusion about the source of the product.

A company meets the distinctiveness requirement by showing its trade dress is either inherently distinctive or has acquired this trait through secondary meaning. Trade dress is inherently distinctive if its intrinsic nature almost automatically tells a consumer the source of the product. For example, the appearance and decor of a Mexican restaurant was held to be inherently distinctive in the landmark Supreme Court case Two Pesos Inc. v. Taco Cabana Inc., 505 US 763 (1992). Acquiring distinctiveness through secondary meaning is more difficult to prove and requires a concerted effort on the company’s part to associate a product with its unique trade dress. For example, the Volkswagen Beetle has almost certainly acquired distinctiveness over many years as a result of extensive advertising and promotional efforts. Courts look at a number of factors, including the company’s advertising and promotional efforts.

If the design of a product is not essential to its purpose, the courts will consider it nonfunctional and perhaps entitled to trade dress protection.

The nonfunctional requirement was intended to prevent companies from obtaining perpetual monopolies on products. Any aspect of a product’s trade dress that is functional is not entitled to protection. Trade dress is functional if it is essential to the use or purpose of the product. For example, the dual-spring design of a road sign was considered functional and not entitled to protection in a 2001 Supreme Court case TrafFix Devices Inc. v. Marketing Displays Inc., 532 US 23 (2001). On the other hand, the courts may consider the design of a product or its packaging—such as a pillow-shaped breakfast cereal—not essential to its purpose, making the attribute nonfunctional and perhaps entitled to trade dress protection.

For a company to obtain protection, the imitator’s trade dress must cause confusion about the source of a product. To determine whether such confusion exists, courts typically consider a number of factors, such as the similarity of the two trade dresses, the sophistication of the relevant consumer group, the defendant’s intent and any evidence presented of actual confusion. For example, consumers might be confused if a generic pain reliever used the same red and yellow color pattern that Tylenol uses for its capsules.

The requirements for trade dress protection and the definition of what relevant laws protect have undergone significant changes (see time line in exhibit 1, at right). The courts and state legislatures liberalized trade dress rules from 1980 through 1994 and then made certain areas more stringent after 1994. These trends are reflected in exhibit 2, below, which shows the number of trade dress cases litigated annually in federal district court and the federal courts of appeals since 1944. Exhibit 2, shows a surge in cases starting in the early 1980s, with the number steadily increasing through 1994. Cases declined after 1994 as the legislative rules and court decisions became more restrictive. CPAs need to be aware of these trends because they have a considerable impact on the value of companies’ trade dress for financial reporting purposes.
Exhibit 1: Trade Dress Time Line
1946. Federal trade dress laws codified in the Lanham Act.

Early 1980s. Courts expand the definition of trade dress to include product shape and design.

1981. Fifth Circuit Court of Appeals liberalizes the distinctiveness requirement by allowing that trade dress can be inherently distinctive without having to show it has acquired distinctiveness through secondary meaning.

1988. Congress expands the definition of and remedies for trade dress within section 43(a) of the Lanham Act of 1946.

1992. U.S. Supreme Court rules that trade dress is inherently distinctive in Two Pesos v. Taco Cabana.

Mid-1990s to present. The trend in trade dress rulings shifts from liberal (rulings that made it easier to prove trade dress infringement) to conservative (rulings that make it more difficult). Various appeals courts begin the conservative trend with a series of rulings in the mid-1990s.

1995. Supreme Court holds that color by itself is never inherently distinctive and requires secondary meaning in Qualitex Co. v. Jacobson Products.

1999. Congress amends the Lanham Act to place the burden of proving nonfunctionality on the plaintiff in cases of unregistered trade dress.

2000. Supreme Court holds that product design, unlike product packaging, is never inherently distinctive and requires secondary meaning in Wal-Mart v. Samara Bros.

2001. Supreme Court strengthens the nonfunctional requirement in TrafFix Devices v. Marketing Displays.

In the early 1980s the courts expanded trade dress protection. They went from protecting product packaging only to also protecting a product’s design (shape). This change allowed the distributors of Rubik’s cube to protect both the packaging and the appearance of its product in Ideal Toy Corp. v. Plawner Toy Manufacturer Corp., 685 F2d 78 (3rd Cir., 1982). Another major expansion occurred in 1981 when the Fifth Circuit Court of Appeals liberalized the distinctiveness requirement by allowing trade dress to be inherently distinctive. Before this ruling, courts required trade dress to have acquired distinctiveness through secondary meaning before it was entitled to protection.

The Fifth Circuit ruling was a major breakthrough because proving inherent distinctiveness might require a company to show only that its trade dress was unique or even unusual. Establishing acquired distinctiveness requires proof of a major promotional and advertising effort. For example, the manufacturer of an igloo-shaped dog house was only able to establish that its product had acquired distinctiveness after proving the company had conducted a seven-year advertising campaign that resulted in the public’s associating the shape of the dog house with the company ( Dogloo Inc. v. Northern Insurance Co. of New York, 907 F Supp 1383 (1995)).

The majority of courts followed the Fifth Circuit ruling, but there was still uncertainty until the Supreme Court agreed in Two Pesos that trade dress could be inherently distinctive.

Exhibit 2: Trade Dress Cases in Federal Court

Source: Derived from Westlaw federal case database.

  Three Supreme Court cases within the last seven years reversed the trend toward liberalized trade dress rules, particularly regarding the distinctiveness standard. Qualitex Co. v. Jacobson Products Co., 514 US 159 (1995) held that a company’s use of color, by itself, is never inherently distinctive and must have acquired distinctiveness through secondary meaning. The green-gold coloring of a dry cleaner’s press pads at issue in this case thus would have had to acquire distinctiveness through secondary meaning to be entitled to protection.

Wal-Mart Stores v. Samara Bros., 529 US 205 (2000), further restricted the distinctiveness standard. The Supreme Court held that companies must prove trade dress claims based on product design through the acquired distinctiveness standard. The Court differentiated the more liberal Two Pesos standard by ruling it applied only to product packaging. As a result, companies seeking to protect product-packaging trade dress can prove either it is inherently distinctive or it has acquired distinctiveness while companies seeking to protect product design are limited to the acquired distinctiveness standard.

For example, a snack food manufacturer may be able to prove that its packaging is inherently distinctive merely by showing it has a unique or unusual design. A golf-club maker, on the other hand, may need to plan years of advertising and promotional efforts to show that its club (product design) has acquired distinctiveness in the minds of consumers. In Wal-Mart, t he Supreme Court recognized that it is sometimes difficult to differentiate product-packaging cases from product-design cases and said that in such uncertain situations companies must meet the acquired distinctiveness standard.

A golf-club maker may need to plan years of advertising and promotional efforts to prove its club has acquired distinctiveness in consumers’ minds.

The trend toward more restrictive interpretations continued in TrafFix Devices Inc., with the Supreme Court’s limiting when trade dress is considered functional and not protected. CPAs should understand that the Court decisions in these three cases are likely to make it more difficult for businesses to successfully litigate trade dress cases and may drive down the value of certain companies’ trade dress.

The rulings, however, create opportunities for CPAs to help companies establish and enhance the value of their trade dress. Some of the decisions were very specific on the documentation needed to confirm that a company’s trade dress has acquired distinctiveness through secondary meaning. Establishing such meaning “does not happen by accident. Instead, it requires affirmative and deliberate actions by the person seeking to establish legal rights” in the trade dress ( Chrysler Corp. v. Vanzant, 44 F Supp 2d 1062, 1074 (1999)).

It’s more difficult for a company to prove that a product’s design has taken on secondary meaning. The Volkswagen Beetle, for example, has almost certainly acquired distinctiveness as a result of extensive advertising and promotional efforts.

Courts look to these factors to determine whether trade dress has acquired secondary meaning. CPAs will find them valuable as well when advising employers and clients.

Exclusivity, length and manner of use. This involves evidence that the company has used the trade dress exclusively for more than a short period of time. Changing the trade dress by altering the product packaging or appearance or by discontinuing its use for any period makes it difficult to prove secondary meaning.

Advertising. Companies need to document the amount and manner of advertising for the product. Obviously, the more spent the better. The advertising needs to establish a link between the trade dress and the company or product. For example, Prestone might have had a better case for establishing secondary meaning for the trade dress of its antifreeze if its advertising had encouraged consumers to look for the “familiar yellow jug” instead of featuring the product as a whole ( First Brands Corp. v. Fred Meyer Inc., 809 F2d 1378 (9th Cir., 1987)).

Direct consumer testimony. Any direct testimony a company can obtain from consumers about their association between the trade dress and the product is helpful in establishing secondary meaning.

Consumer surveys. Survey evidence showing a link in the consumer’s mind between the trade dress and the product or company has been held to be the most direct and persuasive evidence of secondary meaning.

Unsolicited media coverage. Evidence of unsolicited media coverage of the product, particularly if it refers to the product’s trade dress, supports secondary meaning.

Sales. Evidence indicating large amounts of sales and customers, while not sufficient by itself to prove secondary meaning, is relevant to a claim that trade dress has acquired secondary meaning.

Competitors’ behavior. Evidence of the intentional copying of a company’s trade dress by a competitor supports secondary meaning.

Other promotional efforts. Any other efforts by the company to promote a connection between the trade dress and the product can also be helpful.

Management accountants need to help a company document each of these factors from the moment it introduces a product to the market. While none of the factors by themselves may prove to the courts that the trade dress has acquired secondary meaning, documentation the company has satisfied a number of these considerations may prove more persuasive.

The trade dress rules are sure to continue evolving and accountants need to pay close attention to legal developments so they can properly serve their clients and employers. CPAs can keep track of changes in trade rules through the popular press, which is sure to report major developments, and by consulting with attorneys specializing in this area. By keeping up with the changes, they can ensure proper valuation of a company’s trade dress for financial reporting purposes. CPAs can also help the company document and protect the design and packaging of its products. A business that fails to successfully protect its trade dress from “copy cat” competitors may soon find itself a victim of declining sales and diminished profits.


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