Centre for Accounting

Governance and
Taxation Research
The Challenge of
Reporting Intangible
Assets at Fair Value

Measuring Fair Value

17 October 2007

Bruce Wattie

Presentation Outline

Common Measurement Events

Definition of Fair Value
Types of Intangibles
Measuring Value
Valuation Techniques
Case Studies
Valuation Issues
Summary

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Common Measurement Events

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Common Measurement Events

Acquisition of an intangible asset

- e.g. purchase of a brand, customer list etc.
Purchase price allocation
- Purchase of shares or a business
- Allocation of purchase price across assets acquired
Impairment
- Carrying value of assets
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Definition of Fair Value

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Fair value concept

Fair Value is the amount for

which an asset could be
exchanged, or a liability settled
between knowledgeable, willing
parties in an arms length
transaction
Source: IFRS 3 Appendix A
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Fair Value

Hypothetical
Assumes an active market
Excludes non-market specific factors

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Types of Intangible Assets

Types of Intangible Assets

Contract-based
Licensing, royalty agreements
Service or supply contracts
Construction permits
Employee contracts
Use rights (drilling, water etc.)

Customer-related
Customer lists
Customer contracts & related relationships
Non-contractual relationships
Order / production backlog

Technology-based
Technology (patented, unpatented)
Trade secrets
Databases
Computer software

Artistic related
Books, magazines etc.
Musical works (compositions, song lyrics etc.)
Video and audiovisual material

Contract-based
Li
st
Marketing-related
Customer-related
is
Licensing,
Artistic
related royalty agreements
Technology-based
no
Trademarks
and trade names (Brands)
Marketing-related

Customer
lists
te

Service
or
supply
contracts

Books,
magazines
etc.

Technology
(patented,
unpatented)
xh

Trademarks
and
trade
names
(Brands)
Source: IFRS 3,

Trade
dress
au

Customer
contracts
&
related
relationships
Trade
dress
Illustrative Examples

Construction
permits
st
Musical
works
(compositions,
song lyrics etc.)
Trade
secrets

Internet
domain
names
ive
Internet
domain
names

Non-contractual
relationships
!
Newspaper
mastheads
and
Employee
contracts
Video
audiovisual
material
Databases
Non-compete
agreements
Newspaper
mastheads
Order
/
production
backlog
Use rights
(drilling,
water etc.)
Computer
software
Non-compete agreements

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Measuring Value

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Measuring Value

Economic value is a function of future cash flow

Intangibles are no different to other assets
- Factors that drive intangible asset value no different to
value drivers for other assets
- Value dependent on cash from using or selling the asset

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Measuring Value

Valuing intangibles in practice is challenging

Intangible assets often self generated
- No purchase price
Record of capital invested often doesnt exist
- No ready indicator of cost
Cash flow and value will be bundled
- Intangible assets may not generate cash flow in their own
right
- Value arises from use with other assets
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Valuation Techniques

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Valuation Techniques

Three broad approaches:

- Market or transactions approach
- Earnings approach
- Cost approach
There are subsets of each approach
Nature and form of asset will determine valuation approach

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Market/Transactions Approach

Benchmark value to observable market parameters/prices

Requires a market
Difficult to apply in New Zealand
- Limited transactions (reliable data limited)
- Translating offshore data to New Zealand

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Earnings Approach

Relief from royalty

- Benefit of avoided cost
Premium profits
- Incremental profit attributable to the intangible
Multi-period attributable cash flows
- Cash flows attributable to the intangible
These approaches are used in practice

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Cost

Actual costs (internal costs or acquisition costs)

Costs to replicate the asset
- Efficient, modern equivalent costs
Often difficult to apply in practice
- Lack of historical cost data
- Cost of replicating uncertain
Cost may not reflect intrinsic value
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Earnings Approach Case Studies

Two case studies

- Brand (relief from royalty)
- Customer relationships (multi-period cash flows)
Both approaches require:
- Attribution of earnings or cash flow
- Market-based valuation parameters

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Intangible Asset
Valuations
Case Study 1
Brand Valuation

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Case Study 1 : Brand Valuation

Relief from royalty

- Avoided cost of licensing from a third party
Critical inputs
- Royalty rate
- Revenue forecasts
- Brand costs
- Discount rate

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Case Study 1 : Brand Valuation

$000
Revenue
Royalty rate

Royalty income
Brand expenses
Income Tax
After Tax Royalty Cash Flow
Present Value Factor
Present Value of Cash Flow
Total Present Value
Terminal Value
Total Value

Year 1
2,500

Year 2
2,563

Year 3
2,627

Year 4
2,692

Year 5
2,760

4.0%

4.0%

4.0%

4.0%

4.0%

100
(25)
75
(23)
53

103
(26)
77
(23)
54

105
(26)
79
(24)
55

108
(27)
81
(24)
57

110
(28)
83
(25)
58

0.9513
50
216
462
678

0.8609
46

0.7791
43

0.7051
40

0.6381
37

Cross checks: affordability of royalty cost? Rules of thumb?

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Intangible Asset
Valuations
Case Study 2
Customer Relationships

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Case Study 2 : Customer Relationships

Cash flow valuation

Cash flow attributable to individual customers/groups of
customers (at the date of valuation)
Critical inputs
- Revenue and margin forecasts
- Rates of churn/customer life
- Contributory asset charges
- Discount rate
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Case Study 2 : Customer Relationships

$000
Forecast Revenue

Year 4
0

Year 5
0

(23,927)
52,573

0
0

0
0

20.0%

20.0%

0.0%

0.0%

13,353
(4,006)
9,347

12,244
(3,673)
8,571

10,515
(3,154)
7,360

0
0
0

0
0
0

(6,088)
(288)
(267)
(6,643)

(5,583)
(264)
(245)
(6,091)

(4,794)
(227)
(210)
(5,231)

0
0
0
0

0
0
0
0

Total Available Cash Flow

2,704

2,480

2,129

Present Value Factor

Present Value of Cash Flow

0.9513
2,572

0.8609
2,135

0.7791
1,659

0.7051
0

0.6381
0

Attrition rate

Customer Attrition
Revenue After Attrition
EBITDA Margin %

EBITDA
Income Tax
After Tax Cash Flow
Contributory Asset Charges
Fixed Assets
Working Capital
Workforce

Total Present Value

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Year 1
73,200

Year 2
75,700

Year 3
76,500

8.8%

19.1%

31.3%

(6,434)
66,766

(14,478)
61,222

20.0%

6,366

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Case Study 2 : Customer Relationships

Contributory asset charges

Attribution of cash flows to other assets
- Tangible assets
- Intangible assets
- Work-force in place

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Case Study 2 : Customer Relationships

HISTORICAL REVENUE
Revenue

Year -2
73,792

Year -1
74,365

FIXED ASSETS
Value of Fixed Assets
Remaining Life
Required Return
Fixed Asset Charge
Charge as a % of Revenue

Year -2
46,064
12.6
10.5%
6,755
9.2%

Year -1

WORKING CAPITAL
Net Non-Cash Working Capital
Working Capital % of Revenue
Return on Working Capital
Charge as a % of Revenue

Year -2
3,033
4.1%

Year -1 Average
3,056
4.1%
4.1%
10.5%
0.4%

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6,755
9.1%

Average

9.1%

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Case Study 2 : Customer Relationships

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HISTORICAL REVENUE
Revenue

Year -2
73,792

Year -1
74,365

WORKFORCE
Total Staff Costs
Annual Staff Training Costs
Staff Costs Less Training
Hiring Cost as % of Salary
Hiring Cost
Efficiency Cost
Workforce establishment cost
Post-Tax Cost
Post Tax Cost % of Revenue
Return on Workforce
Charge as a % of Revenue

Year -2
32,629
(228)
32,402
8.3%
2,689
1,620
4,082
2,857
3.9%

Year -1 Average
33,104
(378)
32,726
8.3%
2,716
1,636
3,975
2,782
3.7%
3.8%
10.5%
0.4%

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Valuation Issues

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Valuation Issues

Avoid double counting cash flows

Asset lives
Availability of market data
Reliability of data
Discount rates
Reconciliation and cross checks
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Summary

Summary

Intangible asset valuations are very challenging

Techniques not difficult conceptually
Challenges arise because of:
- Lack of market data intangibles not often traded in NZ
- Value often driven by a combination of assets
Unbundle and ascribe value to individual assets

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