Accounting for Intangible Assets – Valuation and Reporting Strategies

Quantifying intangibles can be difficult, although they constitute a significant portion of a company’s total value.

Music production firms may recognize song rights and brand recognition as assets used in financial reports; however, these values can change making it hard to appraise them.

Methods of Valuation

The value of a business’ intangible assets like trademarks, patents or customer relationships account for much of their worth but due to their legal nature as intellectual property rights without physical presence they frequently prove elusive when trying to establish accurate valuations.

Companies need to evaluate their intangible assets regularly for indications of impairment. While some may become outdated because of technological advancements others could have longer useful life expectancy following contract extensions.

Market Techniques

Intangible assets do not exist physically yet they bring tremendous value to any firm. Examples include copyrights, goodwill and trademarks that provide tangible IP protection for innovations thereby establishing brand awareness and giving the company an upper hand in the market place.

The market approach bases fair value assessment on comparable transactions where similar intangibles were sold; thus there is need for reliable information about such sales including royalty rates or prices paid on alike trademarks.

Income-based methods such as discounted cash flows analysis or earnings multiplier models are usually preferred when valuing those intangibles expected to earn future income but this requires making many assumptions about revenues, costs and discount rate. A relief from royalty method which combines features from market (royalty rates charged by other companies) with income based approaches (predictions concerning revenue growth, cost saving opportunities and tax levels) has gained popularity recently.

Income Approach

This approach projects the future economic benefits or cash flows and discounts them back taking into consideration timing differences over which risk might materialize thus arriving at present value. It comprises two techniques namely – relief from royalty method which estimates possible royalty payments; profit split analysis that apportions anticipated profits resulting from licensing agreements/intangible asset utilization between parties involved.

Unlike tangible assets, intangibles are not depreciated but amortized over their useful life and tested for impairment annually; Examples of such include goodwill, brand recognition and customer relationships.

When companies acquire intangible assets through purchase rather than development internally it may lead to different treatment of the acquired items which can affect balance sheet ratios as well as earnings reports hence analysts should be mindful about adjusting assumptions/models accordingly for comparability reasons.

Cost Approach

Although many intangible assets like client lists or copyright have high values attached to them, unlike physical objects where value is determined by market forces thus appearing automatically on a balance sheet, one has to establish how much its worth through various valuation methods.

Amortization is a commonly used approach for the valuation of intangible assets which involves spreading out their costs over their economic lives (generally finite useful life). This method is commonly used when assessing patents or customer relationships and can also be applied to natural resources that are mostly undeveloped.

Relief from Royalty Method

Many intangible assets have finite useful lives hence they need to be amortized over time starting with the original cost. This method works the same way as depreciation does on tangible assets but it should not be used for those with indefinite useful lives since this will violate impairment testing procedures.

Relief from Royalty Method – Under this method, evaluators forecast sales volumes for a product then estimate royalties that might have been agreed upon in an arms’ length transaction, deducting taxes from this value to come up with brand worth. Although more steps are involved in comparison to other methods, sometimes data limitations force one into using it because you must have deep knowledge about particular industry so as to make correct estimates of value.