Chapter 8, Part II: Intangible Assets Patents, copyrights, trademarks Characteristics Recognition, Valuation

Chapter 8, Part II: Intangible Assets
Characteristics
Recognition, Valuation
Purchased / Internally-created intangibles
Patents, copyrights, trademarks
Goodwill
Research and development costs
1
Characteristics of intangible assets
• Intangible assets
– do not physically exist,
– are long-term in nature, and
– are non-monetary assets.
• Common types of intangibles
–
–
–
–
–
patents, copyrights, trademarks or trade names
franchises, licenses
quality of management
knowledge of workforce
customer loyalty
2
Recognition and Valuation
•
Recognition debate
– Asset definition (IASB Framework for the Preparation of FinSt §49a)
1. expected to provide future benefits to the reporting entity
2. owned or controlled by the reporting entity
3. result of a past transaction or event
– Recognition test
1. see 1. above
2. cost or value can be measured reliably
3
Recognition and Valuation
•
Examples where application of criteria is under debate:
– Coca-Cola spends millions of dollars, euros, pesos etc. on advertising
every year to promote new and existing products.
– Hewlett-Packard possibly spends large sums training its customer
service personnel in copier maintenance.
– Pfizer spends billions on research to find new drugs.
Traditional opinion: no asset because future benefit as opposed to
current effect cannot be assessed: expense as incurred!
Alternative opinion: Imagine effect on future performance when
these strategic investments would be abandoned!
4
Recognition criteria
Costs incurred to
acquire/create intangible
assets
Is it identifiable?
no
Was it
internally
created?
yes
yes
no
yes
definite life?
no
capitalize as goodwill or
other intangible asset /
annual impairment test
Is it identifiable?
definite life?
yes
yes
capitalize as
intangible asset /
amortize over asset‘s
useful life
no
no
expense as incurred
5
Valuation of Purchased Intangibles
•
•
if acquired for cash or on credit
Æ record at cost
if acquired for stock or other assets
Æ fair market value
– of the compensation given or
– of the intangible received
whichever is more evident
Valuation of purchased intangibles similar to that for tangible
assets.
6
Valuation of Internally-Created Intangibles
follow accounting approach for selfcreated tangible assets
accounting
alternative
Expense as incurred
7
Patents
•
exclusive right granted by the government for a certain period of
time to make a particular product or use a specific process
– patent protection usually for up to 20 years
– usually a yearly fee has to be paid to maintain patent protection
•
Expensing: amortize over useful life
– useful life sometimes shorter than legal life Æ impairment of asset
•
Self-invented products/processes
– research cost must be expensed as incurred
– development cost are
• capitalized under certain restrictions [IAS]
to record purchase of a patent:
Patent
Cash
18.000
18.000
to record amortization expense:
Patent amortization expense
Patent
3.000
3.000
8
Copyrights, Trademarks and Trade Names
•
Copyright
– an exclusive right granted by the government to publish and sell literary,
musical, or other artistic materials for a period of the author‘s life plus
fifty years
– not renewable
– record at acquisition cost and amortize over useful life
•
Trademarks and Trade Names
– registered symbol or name that can be used only by its owner to identify
a product, service, or enterprise
– indefinite number of renewals for periods of 20 years
– debit trademark or brand name for the acquisition cost and amortize
over a reasonable period
– indefinite-life intangible under US-GAAP and IAS
9
Goodwill
•
•
some intangible assets are not specifically identifiable
Æ subsumed under „goodwill“
only purchased goodwill is recorded
Æ arises in mergers and acquisitions
identifiable only with the business as a whole
Goodwill = cost of identifiable net assets – fair value of identifiable net
assets
•
Origin: price to be paid for a business has to compensate the seller
for the future earnings given up
– earnings value usually higher than book value of the equity
Note: Not all intangible assets that are acquired are „goodwill“!
10
Goodwill – an example
•
The balance sheet of CityCable, an imaginary local cable provider,
looks as follows
Assets
Cash
Receivables
Office equipment, net
Property
Licenses
Equities
15.000
8.000
35.000
90.000
2.000
150.000
•
•
Current liabilities
Owners' capital
Retained earnings
80.000
45.000
25.000
150.000
CountyCable wants to acquire CityCable. The offer of € 120.000
goes to the owners of CityCable.
How much goodwill is involved, if any?
11
Accounting for goodwill
The following alternative treatments are reasonable:
1. writing-off goodwill against reserves
–
–
–
very conservative
does an asset exist at all?
arguments in favor of this view:
• quite a number of M & As faced serious problems when they tried
to unite different corporate cultures
• useful life is difficult to determine
2. amortize goodwill over its useful life
3. retain goodwill infinitely but test for impairment and charge it to
expense, if necessary
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2. Amortize goodwill over its useful life
•
•
•
goodwill clearly has potential future benefits
value of goodwill, however, eventually disappears
arguments to support this view:
– expected synergies do materialize (even if not to the full extent)
– matching cost and revenues
– current earnings opportunities disappear; they have to be replaced by
new ones in order to maintain earnings power
•
argument against this view:
– difficult determination of useful life
Note: Amortization of goodwill over its useful life – with the rebuttable
presumption of a limit of 20 (40) years – used to be the standard
under IAS (US-GAAP).
Now both IFRS and US-GAAP prescribe an annual impairment test,
i.e. goodwill is assumed to have an indefinite life.
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3. Retain goodwill indefinitely unless
reduction in value occurs
•
•
•
goodwill is not considered an asset subject to wearout
at least annual tests for impairment
arguments to support this view
– some form of goodwill will always be an asset
– avoids (questionable) determination of useful life
•
arguments against this view
– reduced usefulness of financial statements because of extraordinary
write-offs
– accounting manipulation
14
The impairment model (under FASB Statement 142/
ASC 350, Goodwill and other intangible assets)
•
Step 1 – the fair value of the reporting unit as a whole is compared
to the book value of the reporting unit (including goodwill) and, if a
deficiency exists, impairment would need to be calculated.
– Fair value is an ambiguous term:
• market value (what could be recovered from disposing the asset
today)
• replacement cost (current cost)
• discounted value of future cash flows from the asset
•
Step 2 – the impairment is measured as the difference between the
implied fair value of goodwill and its carrying amount
– The implied fair value of goodwill is the difference between the fair value
of the reporting unit as a whole less the fair value of the reporting unit‘s
individual assets and liabilities, including any unrecognized intangible
assets.
15
Discounted value of cash flows
•
Basis: a discount rate r (the cost of capital)
– the discount rate is an implied interest rate that makes cash flows of
different due dates comparable
– one € today is worth € (1 + r) one year ahead
– r difficult to determine
•
Let ct be the sequence of cash flows expected from the asset; the
asset‘s present value is then:
∞
ct
PV = ∑
t
(
)
1
+
r
t =1
16
CityCable Example cont‘d
•
•
... Fair value of CityCable Division now assumed to be € 100.000
Step 1
Cash
Receivables
Office equipment (net)
Property
Licenses
Goodwill
Less: Liabilities
•
Net assets
Step
2
€ 15.000
5.000
23.000
120.000
2.000
35.000
80.000
€ 100.000 < € 120.000
120.000
Fair value of CityCable Division
Net identifiable assets (exluding goodwill)
Implied value of goodwill
Fair value of reporting unit
lower than book value
including goodwill:
€ 100.000
85.000
15.000
Impairment because
implied value less than
carrying amount of
goodwill.
17
Where does all the equity come from to
absorb such a loss?
•
•
consider two corporations, GIANT and DWARF. GIANT intends to
acquire DWARF by issuing additional shares.
Situation before the acquisition:
GIANT has 200.000 shares, € 1
par value, outstanding. These
shares were issued at par.
GIANT also has bank debt of €
800.000.
DWARF has 10.000 shares, € 10
par value, outstanding. These
shares were issued at par.
DWARF also has bank debt of €
200.000.
GIANT
DWARF
A = 1.000.000
L = 800.000
OE = 200.000
A = 300.000
L = 200.000
OE = 100.000
18
•
DWARF‘s research department seems to have found a drug that
fosters rapid growth and that‘s why GIANT is eager to acquire
DWARF. DWARF‘s stock price is up to € 40, while GIANT‘s stock
price is noted at € 8. The acquisiton price for DWARF is € 400.000
and to finance the acquisition GIANT issues 50.000 new shares, € 1
par value, at € 7 over par.
•
Assuming, for simplicity, that the book value of DWARF‘s assets is
equal to their market value we note that GIANT acquires net assets of
€ 100.000 for a price of € 400.000, i.e. goodwill of € 300.000 is
involved here (assuming that no other intangible asset is identifiable).
"NEW" GIANT
A = 1.000.000
300.000
L = 800.000
200.000
300.000
OE = 200.000
50.000
350.000
19
•
•
A year passes. Assume „NEW“ GIANT‘s revenues just were equal
to expenses from transactions with customers.
An impairment test for DWARF Division of GIANT at year-end
revealed the following, assuming the book value of net assets
remained unchanged but the fair value of the division dropped to €
250.000
•
•
•
Fair value of DWARF Division:
Less assumed FV of individual net assets
Implied fair value of goodwill
•
Book value of goodwill
300.000
•
Goodwill impairment
150.000
€ 250.000
100.000
150.000
20
•
Goodwill impairment loss will be reported as a separate line on the
income statement, and „NEW“ GIANT reports goodwill totaling €
150.000 on the balance sheet.
•
The corresponding reduction on the equities side goes to additional
paid-in capital (share premium) Æ no cash effects
21
Research and Development Costs
•
•
R&D creates intangible assets Æ patents, copyrights
– Research is defined as activities aimed at the discovery of new
knowledge.
– Development is the translation of research findings into a plan or
design for a new product or process, or for a significant
improvement to an existing product or process.
Accounting treatment
– research and development costs are expensed as incurred
– research costs are expensed as incurred; development cost
must be capitalized (IAS)
22
Notes on R&D accounting
•
•
research and development is an ongoing task for businesses Æ if
effort levels over time are comparable, difference between
capitalizing and charging to expense is not substantial for the
income statement
most research projects fail
Æ research costs do not represent future benefits
– FASB cites studies that 30-90% of all new products fail and that threefourths of new product expenses got unsuccessful products
•
•
Æ development costs often do not represent future benefits either
hard to trace specific costs to specific profitable projects
difficulty to separate research from development activities
– gives companies a de-facto choice under IAS
Æ differences between IAS and US-GAAP not as material as they seem
at first sight
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