Valuation of Intangible Assets: What Are The Top Methods?

Assets are resources owned or controlled by a company. These resources also come with a future inflow of economic benefits. Usually, these include items such as property, plant, equipment, patents, inventory, etc. Companies use these items to conduct business and generate profits. Every company needs assets to survive and stay active within its specific industry.

The accounting for assets is straightforward. Companies must record these when they acquire them. Later, they must adjust them for specific events. Using the guidance on how companies account for assets comes from accounting standards.

Usually, they use similar rules within particular provisions applying to some areas. For example, companies following the IFRS use IAS 16 as guidance when accounting for fixed assets.

The accounting standards frameworks may differ in their guidance when accounting for assets.

These differences are clearer in the requirements for intangible assets. While GAAP and IFRS allow companies to recognize these assets, they have different provisions.

One of the areas impacted by those in the valuation of intangible assets. Before discussing that area, it is crucial to study these assets.

What are Intangible Assets?

Simply put, intangible assets are resources that do not have a physical existence. These are items that companies can develop or capitalize on from their activities. However, they cannot hold a physical form. If an asset has a physical existence, it is tangible and does not fall under this category.

In some cases, intangible assets may be contained in or on a physical substance. Nonetheless, the definition of intangible assets may differ under accounting standards.

IFRS defines intangible assets as “identifiable, non-monetary assets without physical substance”.

This definition is crucial in understanding what these assets include. Primarily, intangible assets must be identifiable. If companies cannot identify a resource, they cannot recognize them under this category. On top of that, these are non-monetary assets. It implies they are not money held or received in a monetary form.

The non-monetary part of the definition is crucial in identifying intangible assets. Some financial assets, such as stocks and bonds, may not have a physical form. However, they do not fall under intangible assets.

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These items derive their value from contractual obligations. In accounting, they are considered tangible assets rather than intangible. However, they fall under a different accounting standard.

Intangible assets are common for companies in the modern business world. Most companies incur expenses in various areas that they capitalize as a part of their resources. On top of that, they can obtain intellectual property as well. While they do not have a physical existence, they can be equally crucial as tangible assets.

Overall, intangible assets are any resources companies own or control that don’t have a physical form. These resources are crucial in running a business and generating profits.

However, they differ from other items in their accounting and treatment. Intangible assets may include patents, goodwill, copyrights, trademarks, etc. However, not all of these items will appear on the balance sheet.

What is the accounting for Intangible Assets?

Before discussing the valuation of intangible assets, it is crucial to understand their accounting. The treatment for these assets differs under GAAP and IFRS. While the former allows companies to recognize an intangible asset, IFRS does not have the same rules. The primary difference between the two frameworks in this area is the identifiability factor. As mentioned, the definition of intangible assets under IFRS requires them to be identifiable.

The IFRS also guide companies on what identifiability constitutes. Two factors determine whether an intangible asset is identifiable.

First, it must be separable from the company. It must also be capable of being sold or transferred. In most cases, intangible assets are inseparable from the underlying company. Therefore, the accounting treatment for intangible assets for IFRS does not allow companies to recognize them.

Secondly, intangible assets must arise from contractual or other legal rights. In this case, even if they are not separable or transferrable, companies can record them. This factor allows companies to record assets such as goodwill from business combinations. Similarly, they can recognize any intellectual property acquired from contractual rights.

The IFRS allows companies to record intangible assets at their cost. However, they must demonstrate that this cost is reliably measurable. Once they do so, they can recognize the intangible assets in the balance sheet.

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In some cases, using various methods to evaluate intangible assets will also be crucial in determining their value. Later, companies can choose to keep that asset on the cost model or use the revaluation model.

Apart from the recognition criteria, IFRS also guides on other areas for intangible assets. For example, they include impairment and amortization of those assets. The accounting treatment for intangible assets under GAAP differs significantly from this approach. However, the valuation of intangible assets may still be relevant for companies that use GAAP.

Valuation Of Intangible Assets: What are the top methods?

The valuation of intangible assets is not as straightforward as fixed or tangible assets. Nonetheless, it has become a crucial area for most companies.

Since these companies invest in more intangible assets than ever, their accurate valuation is critical. Companies can use various valuation methods for intangible assets. These usually use three classic approaches. However, there are five methods used to achieve that.

The top methods for the valuation of intangible assets include the following five.

Relief from Royalty Method (RRM)

The relief from the royalty method allows intangible assets by establishing hypothetical royalty payments. It requires considering how much a company would save by owning the asset instead of obtaining it through a license.

This approach is most common for items such as trademarks, computer software, etc. The RRM method uses the income approach as a base to evaluate intangible assets.

Multiperiod Excess Earnings Method (MPEEM)

The multiperiod excess earnings method is another method based on the income approach. It uses discounted cash flows from a single intangible asset to measure its fair value.

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Usually, it provides the best result when a single intangible asset contributes to a company’s value. However, the calculations in the MPEEM can get complex. This approach is usually prevalent in evaluating computer software and customer relationships.

With and Without Method (WWM)

The with and without method also uses discounted cash flow models. However, it requires calculating discounted cash flows under two models.

One of these involves the status quo for a company that owns the asset while the other doesn’t. The difference between the two models can help establish the value of the underlying intangible asset. Usually, the WWM method is most common for non-compete agreement valuations.

Real Option Pricing

The real option pricing method is prevalent for intangible assets that give ruse to future cash flows. However, these assets do not have any current cash flow streams.

Usually, it is common for undeveloped resources or patents. In this method, intangible assets get their value from option pricing models. For example, these may include the Block-Scholes opting pricing model.

Replacement Cost Method Less Obsolescence

The replacement cost method allows companies to use the replacement cost for an intangible asset. Once they use that cost, they must modify it for an obsolescence factor.

This factor may vary from one intangible asset to another. Most commonly, it involves adjusting the tax impact of the amortization for that asset. However, those factors may vary based on the underlying circumstances.

Conclusion

Intangible assets include resources that do not have a physical form. These assets are as crucial to a company’s growth as tangible or fixed assets.

However, the accounting for intangible assets varies depending on the accounting framework. Companies can also use several methods to evaluate intangible assets, as listed above.