Intangible assets and its methods of Valuation
After observing your company's
balance sheet, financial statements, and client records, you can have an idea
of your company's value. These sheets, lists, and statements only track your
tangible assets of your business without calculating the value of your
Every company has some kind of intangible
assets, whether they know it or not. So, we would understand the meaning of
Intangible assets and its methods of valuation along with its importance in
this article going forward.
What are intangible assets?
Tangible assets are any physical
assets: equipment, real estate, products, and even customers. These are the
things which can truly see and touch.
Intangible assets are
non-physical assets that play a role in your company's success. Periodically
intangible assets play in your organization's long-term growth. It can be
divided into two categories: those with indefinite useful lives, and
limited-life intangible assets.
An intangible asset that produces income for a specific time frame. The most common type of restricted
life intangible asset is a patent because patents have an agreed-upon term when
Economic Advantages of Intangible
Premiums (ex. Brand)
to entry (ex. Patent)
Advantages (ex. Distribution network)
Advantages (ex. Brand Name)
Savings (ex. Right to use a coal mine)
Requirements of the intangible asset valuation:
Below mentioned are the instances in which intangible asset valuation will be required and crucial to assess.
Reporting (Purchase price allocation, etc.)
and franchising (e.g. Brands, trademarks, etc.)
financing from banks or financial institutions
management review purposes
Methods of Intangible Assets
An article in CFA Institute
suggests that intangible assets are “increasingly critical to corporate value,
yet current accounting standards make it difficult to capture them in financial
As investment in intangible
assets have grown across the globe “the value of those assets as drivers of
enterprise value becomes more essential.”
The following five common
methodologies that “built on historical and prospective financial information
within the framework of current accounting standards” and explains how they can
be used to ascertain a firm’s competitive standing:
Relief from Royalty Method (RRM)
It is based on the hypothetical
royalty payments that would be saved by owning the asset rather than leasing or
licensing it. This method is mostly used to value intangibles that can be tied
to a specific revenue stream and where “data on royalties and license fees from other market transactions are available.”
Multiperiod Excess Earnings
This method is a “variation of
discounted cash-flow method.” MPEEM do not add those cash flows associated with
a single intangible asset and measures fair value by discounting them to
present value. This method is used primarily when one asset is the primary
driver of a firm’s value.
With and Without Method (WWM)
WWM estimates an intangible
asset’s value by calculating the difference between two discounted cash-flow
models: one based on the “status quo” for the business with the asset, and the
other without it. This method is often used to value noncompete agreements.
Real Option Pricing
It is used mostly for assets that
have the potential to generate cash flow in the future but are not doing so
now, such as undeveloped patents and/or undeveloped natural resource options.
“As with stock options,” the article notes, “a key challenge in the valuation
of real options is checking the underlying volatility.”
Replacement Cost Method, Less Obsolescence
It requires an assessment of the
replacement cost of the intangible asset, which is then adjusted for an
obsolescence factor relative to the intangible asset.