Intangible Assets Valuation Methodologies - Assignment Example

Table of Contents - Cost based approach 2 - Market based approach 3 - Income based approach: The Relief from Royalty Approach 3 - contract 5 - Internally Generated Computer Software 5 Conclusion 5 References 6 Introduction  Intangible assets are recognized when it is probable that economic benefit will flow to the entity in future and the cost of the asset can be measured reliably. The asset is initially recognized according to cost model and later is recognized at fair value according to IFRS 13. IFRS 13 measures the fair value of assets or liabilities; recognition through IFRS 13 is to bring comparability and consistency in financial statements and reporting. IFRS 13 has introduced some methods of valuation of assets through fair value (Anson and Drews, 2007). - Cost based approach The basis of cost based valuation is based on substitution principles. Cost based valuation approach is to measure the future benefit from the ownership of the tangible asset. The valuation of intangible assets is affected by the cost of substitute intangible asset. The cost based valuation approach also includes the new reproduction cost of the asset after deducting the tax. The cost approach measures the total cost of the duplicate intangible asset of same functionality in current prices. Functionality of the intangible asset is the performance of the job for which it was introduced. According to the cost based valuation approach of intangible assets include direct cost, indirect cost, the developer’s profit of the intangible asset and opportunity cost. The direct and indirect cost of intangible assets are easily identified and quantified while developer’s profit is comparatively difficult as it can be calculated through different procedures. All the four types of costs including direct, indirect, developer’s profit and opportunity cost are included in the valuation of intangible asset through cost based approach. The valuation should also include the physical deterioration, functional and economic obsolesce. The depreciation on the intangible asset is subtracted from the current value. Formula for valuation of intangible asset: New Replacement cost – physical deterioration – functional obsolesce – economic obsolesce The depreciation of intangible assets doesn’t mean physical wear and tear; it is the usage of the intangible asset (Holloway and Reilly, 2012). - Market based approach Market based valuation approach is the perception of the economic value of the intangible asset. This valuation approach is based on supply and demand and market efficiency. The value of an intangible asset can valued from the sale or transfer of the asset with same features in the same market. This approach is more suitable for active assets so that several examples can be found for the valuation of the asset. Market based valuation is more logical, practical and applicable on intangible assets. The most reliable fair value is the quoted market price of the intangible asset in the active market. The first step in valuation through market approach is collection of data from transactional market. The next important step is to identify and analyze similar units. The final step of valuation is to consider the dynamics of the market and its effect on the valuation. This method of valuation is less appropriate for intangible assets (Administrator, 2014). - Income based approach (excess earnings)  Income approach is based on anticipation principle. The income approach of excessive earning value an intangible asset by determining the cash flow generated by the asset. The expected future cash flow is discounted via present value to calculate the current value of the cash flows from the asset. This valuation method considers the future cash flow, the number of years of the cash flows and the risk associated with the cash flow from the asset. The discount rate incorporate all the risks associated with the intangible asset. This valuation method considers the expected revenue and income from the intangible asset and the remaining useful life of the specific intangible asset. This valuation is appropriate in case of measureable amount of cash flow from the asset (Eales, 2011). - Income based approach: The Relief from Royalty Approach The income based approach of relief from royalty determines value by calculating the present values from the royalty of the intangible assets. The company has the ownership of the asset therefore don’t need to pay the royalty. This method considers the expected future revenue of the asset over its remaining useful life and finally applying the royalty rate of the asset to it. The royalty is a part of valuation approach. The royalty rate is determined by calculating the portion of the royalty attributed to the intangible asset. The discount rate is applied to the royalty payment to incorporate all the risks associated with the intangible asset.  The royalty rates for trademarks range from 5% to 15% of operating sales. The royalty payment for technologies varies from 0.25% to 20% (Administrator, 2014).  Licensor rights+ licensee rights = trademark value - Brands and trademarks Brand or Trademark is a word or symbol used to identify products of the company for differentiating it from products of other companies. Trademark helps the customers in identifying the product of the company with specific price and quality. Trademark is a representative of the business logo or brand. The image and text is specified to the specific company and cannot be used by others. Trademark is very important to business; trademark is valued at cost of acquisition. For example if a company purchases a product with brand so the product is of high value to the company’s financial statements. Trademark is not amortized and has indefinite life. The market approach measures the value of a brand or trademark by comparing the price paid by other purchasers therefore it is not a reliable value. The value calculated by cost approach is also not a reliable measure and can only help in validating the income approach. Income approach is most reliable method of measuring the value of a brand by considering the present value of the expected benefit to be received over the useful life of the brand (Robert, 2011). - Patents patent is a right to manufacturer to manufacture and sell the product. The owner holds the registration certificate of the patent or any other indicator of the ownership of the patent. Patent can be valued through several methods however the most suitable measure of valuation according to my understanding is through cost based model of valuation. The value of the patent is based on the cost incurred to acquire the patent by the entity. A reliable market is not available for patents to value it through fair value (Fishiplaw.com, 2014). - Customer contract Customer contracts are contractual rights of the entity by developing relationship with its customers. Customer contracts are intangible assets in form of a legal document. The most appropriate method of valuing customer contract is through income based valuation approach as the contracts are valued by the expected benefit to the entity from the contract. Contract is valued by the following formula: Contract Value = Deposits + ((Anticipated Value of Contractual Income – Deposits) * Discount Rate) + Value of Ancillary Economic Benefits + (Recoveries * Discount Rate) – Transactions Costs The excess earning method of income approach represents the customer contract on the financial reporting (Incrementaladvantage.com, 2014). - Internally Generated Computer Software Internally generated computer software is an intangible asset that can be appropriately valued by cost based valuation approach. Cost of internally generated computer software is recognized when the objective of the asset is defined, demonstrating the technical feasibility of the project and the funding is provided. The valuation includes expensing the cost incurred in the preliminary stage of the project and the cost associated with the post implementation of the project. The cost incurred during the development stage is capitalized. The cost to be capitalized includes software configuration and interface, coding, hardware installation and testing at developing stage (Usg.edu, 2014). Conclusion After drafting this report, I learned many things about intangible assets and their valuation according to IFRS 13 fair value. I completely studied the different valuation methodologies and its application on different intangible assets and valuation. I also came to know the appropriate valuation method and their selection criteria. References Administrator, W. (2014). Traditional Intangible Assets Valuation Techniques | CONSOR. [online] Consor.com. Available at: http://www.consor.com/intellectual-property-advice/traditional-intangible-assets-valuation-techniques.html [Accessed 1 Aug. 2014]. Anson, W. and Drews, D. (2007). The intangible assets handbook. 1st ed. Chicago, Ill.: American Bar Association, Section of Business Law. Eales, J. (2011). Valuation of Intangibles under IFRS 3R, IAS 36 and IAS 38. 1st ed. [ebook] Available at: http://www.oecd.org/tax/transfer-pricing/47421362.pdf [Accessed 1 Aug. 2014]. Fishiplaw.com, (2014). Chaper 12 - Valuing Patents. [online] Available at: http://www.fishiplaw.com/chaper-12-valuing-patents [Accessed 1 Aug. 2014]. Holloway, B. and Reilly, R. (2012). Intangible Asset Valuation Approaches and Methods. 1st ed. [ebook] Available at: http://www.willamette.com/insights_journal/12/autumn_2012_2.pdf [Accessed 1 Aug. 2014]. Incrementaladvantage.com, (2014). Opening the Kimono on Contract Valuation | Incremental Advantage: Intellectual Property Valuation | Financial Modeling | Strategic Planning | Negotiations. [online] Available at: http://www.incrementaladvantage.com/articles-objective-analysis/opening-the-kimono-on-contract-valuation/ [Accessed 1 Aug. 2014]. Robert, S. (2011). Brand Valuation: the methodologies. 1st ed. [ebook] Available at: http://shop.bsigroup.com/upload/Standards%20&%20Publications/IPM_Brand_Valuation_article.pdf [Accessed 1 Aug. 2014]. Usg.edu, (2014). 7.11 Intangible Assets - Business Procedures Manual - University System of Georgia. [online] Available at: http://www.usg.edu/business_procedures_manual/section7/C1319 [Accessed 1 Aug. 2014]. Read More