Valuations of intangible assets in accounting

A company may argue that is has two kinds of intangible assets (e.g. brands), those that it purchased from other companies and those that it develops internally (home grown). The valuation procedures differ radically.

Those that were acquired through purchase can be valued at their purchase price, although it may prove difficult to allocate a specific sum to one intangible asset from the price paid to acquire the entire company.

The major valuation problem surrounds the homegrown intangible assets that grow in value over many years. Two methods may be used:

Historic Cost

This method requires that all costs spent in developing and maintaining the intangible asset be capitalised. Previously written-off costs such as marketing, advertising, red associated with the intangible asset are ''written-back'' into the financial statements. Because this action does not affect the current year's profit and loss account the adjustment is made through the reserves.

The shortcomings of historic cost recognition model are as follows:

• It fails to reflect the correct amount of depreciation on up-to-date asset values
• Balance sheets are understated because assets are valued at historic cost rather than replacement cost, in most circumstances a more relevant basis for managerial decision.

Imagine the use of historic cost model for valuating an 18-year-old patent:

Based on the historic cost model, the value of a patent is composed of all the cost related to obtaining and maintaining the patent. It is easy to see, that significantly lower cost had been spent on a newly acquired patent with great business opportunity compared to an old, technologically obsolete patent. Thus the historic cost model does not reflect the real business value of intellectual property.

Furthermore, as the value of a patent is composed of all the cost related to obtaining and maintaining, the followings are accounted:

• Cost of patent attorney of filing
• Application fee
• Maintenance fee
• Cost of purchase/royalty
• Costs of enforcement
• Mitigation costs paid

Therefore, a badly formulated patent with a weak position (e.g. the scope of the patent being too broad, thus continuously attacked by competitors) has a much higher historic cost than a well prepared one.

Additionally, a dependent patent’s historic cost contains the fee requested by the patent holder of the original patent for secondary application in contrast to a real novel technology where such cost does not exist.

Earnings Method

In contrast to the historic cost model that looks back, the earnings method looks forward. Under this method management must attempt to attribute the actual earnings of the company to a specific intangible asset and than apply a multiplier to this figure which reflects the intangible asset strength (i.e. future stability, development, growth, profit contribution etc.) over the foreseeable future. However, this method is based very much on subjectivity.

Areas of controversy are presently the subjects of vigorous debates within the accounting profession:

• Goodwill - the difference between the fair value of net assets acquired in a corporate acquisition and the price paid for these assets. It is far from clear what the best accounting policy is for this amount and companies currently select a variety of treatments, each of which has a different impact on earnings.
• Brands - one specific component of goodwill associated with the image and market potential of certain products. Some companies have been keen to put brands on their balance sheets but financial commentators wait with interest how the will account for the brands' diminution in value.

First of all, IFRS-rules want to show a true and fair view of the company. This is also one of the purposes of US-GAAP. However, within the IFRS the valuation and presentation rules are not as rigid as in US-GAAP and the idea of protecting the creditors is valued higher than in US-GAAP.

Like US-GAAP, IFRS rules are also not made to replace managerial accounting as they are designed for the reporting to shareholders and not for the direct control of operations within the company and the market.