Management Accounting-Financial Strategy: Many Students Find Intangible Assets Hard to Handle, William Parrott Explains Three Methods of Calculating the Total Value of a Firm's Intangibles

Article excerpt

Basic valuation techniques are examined in almost every P9 paper and candidates generally fare poorly on such questions. In particular, they often fail to make any attempt to value intangible assets. Some even seem to believe that, if there are no intangibles shown in a financial statement, there are none to value. In some respects this is not surprising, because the previous time they were asked to consider intangibles was when they took P7 (Financial Accounting and Tax Principles), which would have been quite a while ago for some. As a result, they often find it hard to imagine the wide variety of intangibles that may exist. This, of course, makes valuing them all the more difficult.

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Intangibles are assets that do not have a real physical presence. Brands, patents, goodwill, the knowledge of a firm's workforce and even its corporate strategy are all assets that aren't tangible but still add value. It's virtually impossible to create an exhaustive list of potential intangible assets, but it should be noted that some--eg, a firm's patents and trademarks--are more "tangible" than others--eg, its strategy and knowledge base. Indeed, where an intangible asset has a recognisable description, is capable of being owned, is transferable, is subject to legal existence and protection--and where there is tangible evidence of its existence--it can be valued separately from the business as a whole. The valuation of these separately identifiable intangibles is outside the scope of this article, but it is useful to be aware that certain components of a company's total intangibles are easier than others to value.

Ethical issues can also arise. For example, it's generally accepted that the skills, knowledge and capabilities of employees have a value to their company. But the calculation of this value would seem to suggest that the company owns its staff, which may be distasteful to some people.

The measurement of the total value of intangibles has always been problematic. The task is made harder by the fact that values can change rapidly. For instance, the image and hence value of a brand can be seriously harmed by a product scandal of one sort or another. Equally, the value attributable to a firm's workforce could be reduced significantly by the loss of key people.

But the fact that it's hard doesn't mean that it shouldn't be attempted. The three following methods can be used to calculate the total value of a firm's intangible assets:

* Market capitalisation and tangible asset value.

* Calculated intangible value (CIV).

* Intangible to tangible asset ratio.

Method 1: market capitalisation and tangible asset value

The market capitalisation of a company is its total value, reflecting the value of both its tangible and intangible assets. The book value of its tangible net assets can be taken from the financial statements. The difference between the market capitalisation and the tangible net assets should provide a value for the intangibles.

One problem with this approach is that the value of the tangible assets in the financial statements may be out of date. So the method can be refined to reflect the cost of replacing its property, plant and equipment. But replacement costs are themselves often hard to determine.

If the company in question is not listed, the total equity value could be calculated using another approach--the dividend valuation model or the price/earnings ratio method, for example.

Method 2: calculated intangible value

The CIV method calculates the value of the intangibles as the present value of the firm's earnings that are in excess of the earnings expected given the returns provided by a similar company. The industry average returns could be used if no data is available from a similar company.

A weakness of this approach is that any similar company will be making its return on both tangible and intangible assets, so in effect the CIV is a measure of the additional intangible assets the company has over those of a similar company

Method 3: intangible to tangible asset ratio

A ratio of intangible assets to tangible assets from a similar company or an industry average ratio can be applied to the tangible assets of a company to calculate an intangible asset value. …