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Intangible value: delineating between shades of gray: how do you quantify things you can't feel, see or weigh?


* Intangible assets are a big part of contemporary business, and many executives think innovation and related intangible assets now represent the principal basis for growth. CPA/ABVs and CFOs need to be able to value intangible assets for reasons that include the sale of a business, financial reporting, litigation, licensing, bankruptcy, taxation, financing and strategic planning.

* Most guidance relating to the recognition and valuation of intangible assets comes from accounting and tax regulation. Congress and FASB have pushed for greater disclosure and clarity in recent legislation.

* CPA/ABVs and other valuation analysts engaged to identify and value intangible assets must possess a broad base of knowledge on valuation, knowledge of the relevant industry and sound judgment to support their decision making.

* Criteria for the identification of intangible assets include the following: legal existence and protection (that is, it may be identified apart from goodwill if it arises from contractual or other legal rights), private ownership, transferability, and evidence of its existence such as a contract, license, registration, listing or documentation. Most intangible assets fall into one of five categories: marketing-related, customer-related, artistic-related, contract-related or technology-related.

* One popular methodology used to value intangible assets is the discounted cash flow methodology, which typically is used to value assets such as technology, software, customer relationships, covenants not-to-compete, strategic agreements, franchises and distribution channels. Under this methodology, the value of an asset reflects the present value of the projected earnings the asset will generate. Other methodologies can be used, too.

* It's a good idea to value an intangible asset using multiple approaches, as applicable, for example to capture the historical development cost, the future economic benefit and any other components that may have a material effect on the final value such as capital charges, functional and economic obsolescence, product sales cycles, synergistic opportunities and tax issues, to name a few.


Intangible assets play a critical role in business today. Many executives believe they have replaced fixed assets, the historical business-growth benchmark, as the key to a company's competitive sustainability. Many even think innovation and related intangible assets represent the principal basis for growth. While it is easy to argue that intangible assets are valuable, it is not so easy for CPA/ABVs and other valuation analysts to accurately capture a value for them. So how do you quantify something you can't feel, see or weigh? In this article, we attempt to answer the question of how CPA/ABVs can best identify and value these types of assets.


Businesses need a systematic method for analyzing the value of intangible (nonphysical) assets for reasons that include financial reporting, litigation, licensing, bankruptcy, taxation, financing and strategic planning, among others. Such assets include franchises, trademarks, patents, copyrights, goodwill, equities, mineral rights, securities and contracts granting rights and privileges of value to the owner. So far, most guidance and literature relating to the recognition and valuation of intangible assets come from accounting and tax regulations. For instance, FASB requires purchasers of a business to allocate the total consideration paid in a business combination or net asset transfer to the acquired assets and liabilities according to their fair values.

Congress and FASB have pushed for greater disclosure and clarity in recent legislation such as the Sarbanes-Oxley Act, FASB Statement no. 141, Business Combinations, and FASB Statement no. 142, Goodwill and Other Intangible Assets. In particular, statements no. 141 and no. 142 give specific guidance on defining and measuring intangible assets. Here we will focus on some of the methods and approaches these standards suggest as well as explore other professional practices.


Client companies and their valuation analysts sometimes have difficulty simply identifying the intangible assets companies possess or have acquired in a recent business combination, let alone assigning a reasonable value to those assets. Often management will avoid the entire exercise of valuing intangibles because it involves so much subjectivity Some managers argue that, while intangible assets may be an essential component in their businesses and necessary to sustain a competitive advantage, there is little incentive to identify such assets because once they are recognized they will have to be amortized over their useful lives and, subsequently, will have a negative effect on earnings.

Nor does the financial community have a large body of clear guidance on how best to recognize and value intangible assets. The available guidance offers many viewpoints and methodologies, which are informed by the background of the writer, the type of intangible asset being valued and the purpose of the valuation. CPA/ABVs and other valuation analysts engaged to identify and value intangible assets must necessarily possess a broad base of knowledge on the topic, knowledge of the relevant industry and sound judgment to support their assumptions and methodologies.


Most identifiable intangible assets fall into one of five categories: marketing-related, customer-related, artistic-related, contract-related or technology-related. There are numerous accounting, legal and tax-related definitions of an intangible asset. However, most of these definitions identify intangibles using several similar criteria. Regulatory and accounting literature in particular specifies that an intangible asset possesses the following characteristics: legal existence and protection, private ownership, transferability, and evidence of its existence (such as a contract, license, registration, listing or other documentation).

Under Statement no. 141, to recognize an acquired intangible asset apart from goodwill, one of two criteria needs to be met (either or both criteria can meet the requirements). The first test, which is known as the contractual/legal test, states that an intangible asset may be identified apart from goodwill if it arises from contractual or other legal rights. The second criterion is the separability test, which states that if an intangible asset is capable of being separated or divided from the acquired entity (that is, it can be sold, transferred, licensed, rented or exchanged regardless of whether there is an intent to do so) it should be identified as an intangible asset. For example, technology is typically developed in-house and thus does not meet the contractual test; however, it can be separated from the acquired entity and is frequently licensed, rented or sold from one entity to another in the course of general operations.


Once an intangible asset has been identified, it needs to be valued. Despite intangible assets' lack of physical substance and relationship to other assets, which makes them difficult to isolate and measure, there are several methodologies to value an identified intangible asset. We will briefly highlight four of the most common methodologies (see sidebar "Valuing Intangible Assets--a Fast-Growing, Demanding Niche").

Discounted cash flow. One of the most popular means to value intangible assets is the discounted cash flow methodology. This method typically is used to value some of the more widely known intangible assets such as technology, software, customer relationships, covenants not-to-compete, strategic agreements, franchises and distribution channels. Under this methodology, the value of an asset reflects the present value of the projected earnings that will be generated by the asset after taking into account the revenues and expenses of the asset, the relative risk of the asset, the contribution of other assets, and a discount rate that reflects the time value of invested capital.

Relief-from-royalty. Another commonly used methodology is the relief-from-royalty approach. This methodology often is used to value trade names and trademarks. Under this method, the value of an asset is equal to all future royalties that would have to be paid for the right to use the asset if it were not acquired. A royalty rate is selected based on discussions with management regarding, among other factors, the importance of the asset, effectiveness of constraints imposed by competing assets, ability of competitors to produce similar assets, and market licensing rates for similar assets. The royalty rate is applied to the expected revenues generated or associated with the asset. The hypothetical royalties are then discounted to their present value.

For example, our firm recently relied on this method to value a portfolio of trade names and trademarks of a health services provider that was acquired by a major publicly traded company specializing in health care and wellness services. The most difficult and time-consuming component of this approach typically involves determining what to record as the appropriate royalty rate for the right to use the asset.

Royalty rates for trade names and trademarks vary widely among industries depending on the nature of the proprietary property, its role in the business, the specific industry and the marketplace. Relying on benchmarks from health services journals, royalty rate studies and discussions with licensing professionals, we observed rates for health-service trademarks ranged from 0% to 5%. We selected a rate on the low end of this range after considering a number of factors, including the trademarks' newness (brief track record), intense market competition, certain technology risks, profitability and limited name recognition. Guided by these factors we calculated future expected cash flows and, thus, the value of this portfolio (see "20 Steps for Pricing a Patent," JofA, Nov. 04, page 31, and "Damages Aren't Always Patently Obvious," JofA, Nov. 04, page 36).

Comparable (Guideline) Transactions. A comparable transactions approach is typically employed to value marketing-related intangible assets. The value of an asset is based on actual prices paid for assets with functional or technical attributes similar to the subject asset. Using this data, relevant market multiples or ratios of the total purchase price paid are developed and applied to the subject asset. Since no two assets are perfectly comparable, premiums or discounts may be applied to the subject asset given its attributes, earnings power or other factors. Internet domain names and newspaper mastheads sometimes are valued with a comparable transactions approach. The CPA/ABV or other valuation analyst can gather data from various industry sources and use them to create information relating to key sale characteristics. For example, in the valuation of Internet domain names, purchasers look for brand recognition, e-commerce value, recall value, frequency of name-related searches, letter count and pay-per-click popularity.

Avoided cost. The last approach we will mention is the avoided-cost approach. This method is popular as it is based on historical data, which is usually available and does not rely on the subjective assumptions employed under the other, previously mentioned methodologies. Under the avoided-cost method, the value of an asset is based on calculating the costs avoided by the acquiring company when obtaining a pre-existing, fully functional asset rather than incurring the costs to build or assemble the asset. The savings realized may include actual and opportunity costs associated with avoided productivity losses.

The avoided-cost approach can be a useful method to value technology. Using the economic principle of substitution, whereby an informed purchaser would pay no more for an asset than the cost of purchasing or producing a substitute asset with the same utility as a company's current technology, CPA/ABVs and other valuation analysts will collect estimates from company management on the number of employees and salaries associated with developing the technology, potential benefits associated with those employees/programmers, and ancillary expenses such as overhead, administrative, travel and meal costs associated with the technology.

In addition, the CPA/ABV needs to consider replacement costs, reproduction costs, depreciation and obsolescence when utilizing this approach. Lastly, it is necessary to calculate tax effects on expected cash flows, while accounting for any amortization tax benefit, to ascertain the final value of technology for the avoided-cost approach.

When valuing any single intangible asset, two final points are important. First, an intangible asset should be valued using multiple approaches, as applicable. As noted, the process of valuing intangible assets is prone to subjectivity and the use of several approaches will help to zero in on a credible value. For example, while the avoided-cost methodology may capture the historical development cost as well as the individual facts and circumstances surrounding the creation of an asset, it will not capture the future economic benefit of an asset that a discounted cash flow methodology would address.

Second, depending on the asset under review, it will be necessary to address and consider other components that may have a material effect on the final intangible asset value such as capital charges, functional and economic obsolescence, product sales cycles, synergistic opportunities and tax issues, to name a few. Valuation analysts often are very helpful in sorting through these complex matters.


While the standards statements that guide current practice took effect about five years ago, accounting and financial pronouncements are ever-changing. Through recent pronouncements such as Statement of Financial Accounting Standards no. 157, Fair Value Measurement, and the pending replacement of Statement no. 141 with the proposed Statement no. 141(R), FASB is making substantial revisions to required GAAP to increase the use and impact of the fair value standard. As a result, the manner to identify and measure intangible assets is also changing.

Currently, intangibles are identified from a buyer's perspective. For example, in a business combination, an acquirer will only recognize the assets it seeks from the acquisition (that is, a buyer will not recognize a seller's trade name, even if that asset possesses value in the market, if it knows at the time of the acquisition that it will drop the name). The recent pronouncements, however, shift the perspective from that of a buyer to that of a market participant, which will require the buyer to recognize all assets that possess a value, whether or not the buyer will retain or utilize the intangible assets it acquires.

Consequently, this shift in perspective is having a significant impact on how items are reported, specifically in two principal areas. First, from the eyes of a market participant, a greater number of intangible assets may need to be identified. No longer will buyers be at liberty to exclude intangible assets that management teams view as valueless to their particular organizations. Correspondingly, goodwill on a buyer's balance sheet will decrease. Second, as a result of having more intangible assets recorded on their balance sheets, buyers will be forced to amortize those previously unidentified intangible assets according to their useful lives. Thus, under this new perspective, buyers may see more identified intangible assets on their balance sheets and less earnings on their income statements as a result of higher noncash charges.

How interested parties view these changes will vary widely. For instance, auditors and regulatory agencies may support the recent FASB pronouncements and general espousal of the revised fair value standard, which can be viewed as more conservative than current practice and are more likely to prevent an earnings overstatement. A chief financial officer or other senior executive, on the other hand, likely would resist those changes, due to their potential negative effect on earnings. Technology or biotechnology firms might be less concerned with earnings and more concerned with the possibility of goodwill impairment, and therefore seek to identify as many intangible assets as possible. Market observers and financial analysts might be indifferent to these changes, as they will not have an expected impact on cash flows and not affect operations prior to EBITDA.

The identification and measurement of intangible assets are not simple tasks, and as the proposed statements take effect they will arguably make the process more complicated for management and their advisers. However, as the approaches and methods used to both identify and value intangible assets are more frequently practiced and refined, the process likely will become easier--less a matter of delineating between shades of gray and more one of dotting the i's and crossing the t's.



To find out more about the AICPA's Accredited in Business Valuation (ABV) credential, visit, call the ABV Hotline at 201-938-3828 or download a copy of the ABV Handbook at


* AICPA ABV E-valuation Alert.

* CPA Consultant.

* CS E-News, Newsletter of the AICPA Consulting Services Section.


* AICPA Code of Professional Conduct,

* Understanding Business Valuation: A Practical Guide to Valuing Small to Medium-Sized Businesses, by Gary R. Trugman (# 056600JA).

For more information or to make a purchase, go to or call the Institute at 888-777-7077.


* Fair Value for Financial Reporting: Meeting the New FASB Requirements, by Alfred King; New Jersey: John Wiley, 2006.

* Financial Valuation: Applications and Models, by James R. Hitchner; New Jersey: John Wiley, 2003.

* Handbook of Business Valuation and Intellectual Property Analysis, by Robert Reilly and Robert Schweihs; New York: McGraw-Hill, 2004.

* Valuation and Economic Profit, by Jeffrey Cohen; New Jersey: John Wiley, 2005.

* Valuation for Financial Reporting, by Michael Mard, et al.; New Jersey: John Wiley, 2002.

* Valuing Intangible Assets, by Robert Reilly and Robed Schweihs; New York: McGraw-Hill, 1998.

So Much for What?

Although 49% of participating senior executives said they relied on intongible assets to create shareholder wealth, only 5% systematically measured and trocked intongible asset performance.

Source: Accenture Ltd., survey of senior executives, 2003.

RELATED ARTICLE: Valuing intangible assets--fast-growing, demanding niche.

Valuing intangible assets is a tough professional services arena, but skilled valuation analysts such as CPA/ABVs are up to the challenge. The success of an intangible assets valuation depends on a "meeting of the minds" that the client, its representative attorney and the appraiser clearly understand. To achieve this, the engagement framework should specify:

* The purpose of the engagement.

* The standard of value to be used (fair value for financial reporting purposes, fair market value or investment value, for example).

* Identification of assets/property to be valued.

* Date of valuation.

* Premise of value.

* Timing of the report.

* Details affecting the engagement's planning and acceptance.

Indeed, the beginning of the assignment or "the pre-beginning of the assignment, is the most important part of the valuation process," says Gary R. Trugman, CPA/ABV.

Credible valuations of intangible assets (including intellectual properties) are grounded in consistent application of approaches and methodologies accepted by the business valuation community at large. Three common approaches for appraising intangible assets are: income, market, and asset-replacement cost, for example. A CPA/ABV or other valuation analyst needs to know the strengths and weaknesses of each approach (and the related methodologies) specific to the property/asset being valued.

The accompanying text discusses four methodologies: discounted cash flows, relief-from-royalty, comparable transactions and avoided-cost. The first two methods are the income approach, and the other two are the market and asset-replacement approach, respectively. The income approach--commonly used to value intangible assets--calls for methods that include direct capitalization, profit split, excess earnings and loss of income. An asset-replacement cost approach also should consider the reproduction and replacement cost as well as the cost avoidance method. Success is in the details.

--Robert P. Gray

Robert P. Gray, CPA/ABV, CFE, FACFEI, of Parente Randolph, Dallas, has an extensive background in financial/accounting analyses, business valuation, economic damages, forensic investigation and litigation. He is a member of the AICPA's Forensic and Litigation Services Committee, which provides professional guidance to CPAs who perform fraud investigations and determine economic damages. His e-mail address is

Marc G. Olsen, M.S. economics, and Michael Halliwell, MBA, are director and managing director, respectively, of valuation services for the Taylor Consulting Group, Inc., Atlanta. They have extensive experience in valuing intangible assets for a variety of clients. Their e-mail addresses are molsen@ and mhalliwell@taylorconsultinggroup. com.
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Author:Halliwell, Michael
Publication:Journal of Accountancy
Date:May 1, 2007
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