Valuation of Intangible Assets
Intangible Assets refer to those kinds of Assets which do not have a physical existence or form but provide a long-term value for an organization or business. Some examples of intangible assets include copyrights, trademarks, patents, brands, etc.
Types and Categories of Intangible Assets
There are five types of intangible assets available according to the ICAI and they are as follows:
Contract-Based Intangible Assets
These types of intangible assets are developed as a result of the rights arising from business contracts.
Examples of such intangible assets are as follows
Licensing Agreements
Royalty Agreements
Lease Agreements
Employment contracts, etc.
Technology-Based Intangible Assets
These types of intangible assets are those which help in the creation of proprietary knowledge.
Examples of such intangible assets include
Software
Formulae
Know-how
Designs, etc.
Customer-Based Intangible Assets
These types of intangible assets are produced within an organization based on customer and client relationships during the business.
Examples of the same are
Customer Contracts
Customer Relationships
Customer Lists, Etc.
Marketing-Based Intangible Assets
These Intangible Assets are created during the business and again help in the company’s future growth.
Examples of the same are
Brand
Trade Name
Trademark, Etc.
Artistic-Based Intangible Assets
These Intangible Assets are created as a result of advantages and benefits arising as a result of artistic works.
Examples of such intangible assets are as follows:
Copyrights
Films
Music
Books, etc.
Approaches to Valuation of Intangible Assets
According to the Indian Valuation Standard 103, the approaches and methods used in the valuation of intangible assets are as follows:
Market Approach
Income Approach
Cost Approach
More than one approach to valuation can be used to value a particular intangible object as this gives a multiple value indication, thus defining a value spectrum for that specific intangible asset being valued.
Market Approach to Intangible Asset Valuation
The valuation of an intangible asset using market approaches and methods should be undertaken only when sufficient information from a comparable transaction of intangible assets is available. It is also essential to check if the guideline identical intangible asset is of the exact nature, age, function, and stage of life cycle as that of the intangible asset being valued. The transaction can help obtain the pricing multiples or the capitalization rate. This rate can be further used to arrive at the value of the intangible assets.
There are two methods of valuation under the market approach which are:
Price Multiples/ Capitalisation Rate
Under this method of market valuation of intangible assets, the multiples and capitalization rates arrived from comparable intangible assets are used. In addition to this, any differences between the asset in comparison and the asset being valued should be factored into that rate or multiples used.
Guideline Pricing Method
This method of valuing intangible assets uses information obtained from previous, older transactions of comparable intangible assets. This makes use of the price used in previous transactions. This valuation method of an intangible asset is complicated because reliable data of such transactions are challenging to obtain.
Income Approach to Intangible Asset Valuation
The income approach to the valuation of intangible assets is usually based on the expectations of future economic benefits or costs saved with the possession of that particular asset. Valuation of intangible assets under the Income Approach can be classified into the following:
Relief-from-royalty-method
This method of valuing intangible assets under the income approach values the intangible assets with the help of estimating the costs that have been saved as a result of owning the intangible asset rather than leasing the same and paying the royalties to a different organization. All costs and expenses associated with the intangible asset have to be adjusted.
Multi-period Excess Earnings Method (MEEM)
This method of valuing intangible assets is used to value those intangible assets that are the business’s primary assets. Suppose there are two or more intangible assets that are primary in the business. In that case, only one will be valued using this method. The other significant method will be valued using some other method.
The asset’s value is calculated by calculating the present value of incremental after-tax cash flows attributable to the particular asset for the rest of its remaining life. CAC, also known as the Contributory Asset Charge, is required to be charged in case of contributory assets that help the primary asset earn cash flows.
With-and-Without method or premium profit method
This method of valuing an intangible asset values the asset by taking in the present value of the differences between the projected cash flows over the remaining useful life of the intangible assets during which the business uses the intangible asset as well as when the business does not use the intangible asset. In the with-scenario, the business uses the intangible asset whereas, in the without-scenario, the business does not use the intangible asset to be valued. All other factors are considered constant.
Greenfield method
This method of valuing intangible assets is primarily used in the valuation of franchise agreements and is based on the fundamental assumption that the asset being valued is the only asset, and it includes all the other tangible and intangible assets which are acquired, leased, and created. Here, the CAC should be omitted. Instead, the replacement cost of the asset bought or acquired should be deducted.
Distributor method
This method of valuing intangible assets is similar to that of the MEEM method. It is used to value the other significant asset which has been left out by that method, most preferably the customer-based intangible assets. The basic theory behind this method is that each segment of a business is expected to generate profits.
Tax Amortization Benefits
Tax Amortization Benefits, in the case of intangible assets, play a significant role in evaluating the actual value of the intangible asset. These benefits have to be calculated
and added to the value of the intangible asset as they help reduce the tax burden and increase the value of the intangible asset. This needs to be computed in the income approach of valuation with the discount rate of the tax-saving calculated with the help of the WACC or the discount rate used to evaluate the intangible assets that are being valued. However, in the market and cost approach, TAB is assumed to be embedded in the value.
Cost Approach to Valuation of Intangible Assets
The cost approach to the valuation of Intangible Assets is similar to that of the ones used to evaluate tangible assets. This is based on the principle of substitution. This method is not applicable when the intangible asset being valued is unique and cannot be replaced. This approach has minimal applicability to intangible assets. It is mainly used when market and income approach valuation techniques cannot be applied and when the asset is acquired or internally generated intangible assets. There are two methods of valuation under the cost approach, and they are as follows:
Reproduction Cost Method
This is similar to the one used for tangible asset valuation. It values an intangible asset based on the cost incurred if one were to recreate a replica of that intangible asset. This would provide for the value of obsolescence. Since it is an intangible asset, the hypothetical costs of it being developed are taken into consideration.
Replacement Cost Method
This method is similar to the one used for tangible asset valuation. It values an intangible asset based on the cost incurred if one were to recreate the intangible asset with similar utility and not the replica. This would provide for the value of obsolescence. Since it is an intangible asset, the hypothetical costs of it being developed are taken into consideration.
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