Valuation of Intangible Assets
Every income method for intangibles is a way of isolating cash flows the business earns jointly.
An intangible asset is an identifiable non-monetary asset without physical substance: a brand, a patent, a customer contract, software, a telecom licence. ICAI Valuation Standard 302 lists why valuers are asked to value them: purchase price allocation under Ind AS 103, impairment testing under Ind AS 36, transfer pricing, slump sales, licensing deals, collateral, litigation and sweat equity.
The hard part is isolating the cash flows that belong to one intangible when the business earns them jointly with its plant, working capital, people and other intangibles. Each income method is a different way of doing that.
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Identifiable or Goodwill?
Under VS 302, an intangible is identifiable if either test is met. Anything that fails both stays in goodwill.
- check_circleSeparable: it can be sold, transferred, licensed, rented or exchanged, alone or with a related contract or asset.
- check_circleContractual or legal: it arises from contractual or other legal rights, even if those rights cannot be separated.
- check_circleGoodwill is the residual after valuing identified assets and liabilities. It typically includes synergies and the assembled workforce.
Categories and Usual Methods
Marketing-based
Examples
Trademarks, brands, trade names, domain names
Method often used
Relief from royalty
Customer-based
Examples
Customer contracts and relationships, order backlog
Method often used
Multi-period excess earnings (MEEM), or the distributor method when MEEM is used for another asset
Contract-based
Examples
Licences, non-compete, royalty and lease agreements
Method often used
With and without method (non-compete); greenfield (licences, franchises)
Technology-based
Examples
Patents, know-how, software, processes, formulae
Method often used
Relief from royalty, MEEM, or cost approach for internal software
Artistic-based
Examples
Films, music, books
Method often used
Income approach on projected royalties or receipts
| Category (VS 302) | Examples | Method often used |
|---|---|---|
| Marketing-based | Trademarks, brands, trade names, domain names | Relief from royalty |
| Customer-based | Customer contracts and relationships, order backlog | Multi-period excess earnings (MEEM), or the distributor method when MEEM is used for another asset |
| Contract-based | Licences, non-compete, royalty and lease agreements | With and without method (non-compete); greenfield (licences, franchises) |
| Technology-based | Patents, know-how, software, processes, formulae | Relief from royalty, MEEM, or cost approach for internal software |
| Artistic-based | Films, music, books | Income approach on projected royalties or receipts |
Worked Example: Relief From Royalty for a Brand
Illustrative. A Kolkata FMCG brand with revenue of ₹100, 110 and 120 crore over a three-year remaining life; arm's-length royalty 5%; tax 25%; discount rate 14%.
1
Royalty saved (5%)
5.00
After tax (× 0.75)
3.75
Discount factor at 14%
0.8772
Present value
3.29
2
Royalty saved (5%)
5.50
After tax (× 0.75)
4.13
Discount factor at 14%
0.7695
Present value
3.17
3
Royalty saved (5%)
6.00
After tax (× 0.75)
4.50
Discount factor at 14%
0.6750
Present value
3.04
Total
Royalty saved (5%)
After tax (× 0.75)
Discount factor at 14%
Present value
₹9.50 crore before TAB
| Year | Royalty saved (5%) | After tax (× 0.75) | Discount factor at 14% | Present value |
|---|---|---|---|---|
| 1 | 5.00 | 3.75 | 0.8772 | 3.29 |
| 2 | 5.50 | 4.13 | 0.7695 | 3.17 |
| 3 | 6.00 | 4.50 | 0.6750 | 3.04 |
| Total | ₹9.50 crore before TAB |
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VS 302 then allows a tax amortisation benefit (TAB) to be added if appropriate, for the tax saving a buyer would get by amortising the acquired asset. TAB is generally added under the income approach only, because its value is taken to be embedded in market and cost approach values.
Judgements Specific to Intangibles
- Useful life
- The shorter of the economic life and the legal life. Economic life for valuation is not the accounting or tax amortisation period.
- Attrition
- Expected loss of customers over time, from history, at a constant or age-dependent rate. It drives the life of customer-based intangibles.
- Contributory asset charges
- In MEEM, a return on and of every other asset (working capital, fixed assets, workforce, other intangibles) deducted to isolate the subject asset's excess earnings.
- Discount rate
- Usually above the business's WACC, since intangibles are generally riskier than tangible assets. Rates are tested together through the weighted average return on assets (WARA).
How the Valuation Examination Tests This
Expect method-matching questions (which method for a non-compete, a franchise, a customer list) and small calculations like the royalty example. The traps: forgetting to tax-effect the royalty, using MEEM for two intangibles at once (VS 302 says MEEM values the primary intangible and another method values the rest, unless both are significant), leaving out contributory asset charges, and adding TAB to a market-approach value.
FAQs
What is the relief from royalty method?expand_more
It values an intangible as the present value of the after-tax royalties the owner avoids by owning it rather than licensing it from a third party. It is common for brands, trademarks and patents.
What is the difference between MEEM and the with and without method?expand_more
MEEM takes the cash flows of the business and deducts charges for every other contributing asset, leaving the subject asset's excess earnings. The with and without method compares business cash flows with and without the asset, and values the difference.
Is goodwill an intangible asset for valuation?expand_more
Goodwill is the residual that remains after identifiable assets are valued, so it is not identifiable on its own. VS 302 distinguishes it from identifiable intangibles by the separability and contractual-legal tests.
Why is the discount rate for an intangible higher than WACC?expand_more
Intangibles are usually riskier than the business as a whole and harder to sell. VS 302 asks the valuer to reconcile intangible rates with the overall WACC using WARA.
Next steps
- WACC and CAPMarrow_forward
- Ind AS 113arrow_forward
- DCF valuationarrow_forward
- SFA mock testarrow_forward
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