In Insolvency and Bankruptcy Board of India’s valuer exam, Intangible Asset Valuation comes under Valuation Applications chapter that carry 35% weightage. This includes Nature and classification of intangibles; Identification of nature of intangible assets: life of asset; based on function; acquired or internally generated; generating cash flow independently or not generating cash flow independently; intangible assets under development and research assets; Purpose of intangibles valuation: financial reporting under Ind AS, legal and tax reporting, estate and gift tax, amortization allowance, transfer of standalone intangible assets, transfer of intangible asset as part of transaction, collateral lending, franchises and brand license agreement, insolvency/ bankruptcy; Valuation Approaches: excess earnings method; relief-from-royalty method; premium profit method; greenfield method; distributor method; other valuation approaches as applicable; rate of return and discount rate for intangibles. And we must agree all these concepts need to be understood very deeply for the purpose of clearing IBBI Registered Valuer examination for Securities and Financial Asset class. You can expect 3 to 4 marks MCQ from Intangible Asset valuation in the IBBI registered valuer exam. In today’s blog we will discuss regarding Fixed Income Securities meaning, types, popular products and risks of investing in them.

An intangible asset is an asset that is not physical in nature. Goodwill, brand recognition and intellectual property, such as patents, trademarks, and copyrights, are all intangible assets. Intangible assets exist in opposition to tangible assets, which include land, vehicles, equipment, and inventory. Additionally, financial assets such as stocks and bonds, which derive their value from contractual claims, are considered tangible assets.

What are Intangible Assets?

An intangible asset is an asset that is not physical in nature, such as a patent, brand, trademark, or copyright. Businesses can create or acquire intangible assets. An intangible asset can be considered indefinite (a brand name, for example) or definite, like a legal agreement or contract. Intangible assets created by a company do not appear on the balance sheet and have no recorded book value.

An intangible asset can be classified as either indefinite or definite. A company’s brand name is considered an indefinite intangible asset because it stays with the company for as long as it continues operations. An example of a definite intangible asset would be a legal agreement to operate under another company’s patent, with no plans of extending the agreement. The agreement thus has a limited life and is classified as a definite asset.

While an intangible asset doesn’t have the obvious physical value of a factory or equipment, it can prove valuable for a firm and be critical to its long-term success or failure. For example, a business such as Coca-Cola wouldn’t be nearly as successful if it not for the money made through brand recognition.1 Although brand recognition is not a physical asset that can be seen or touched, it can have a meaningful impact on generating sales.

Valuing Intangible Assets

 Businesses can create or acquire intangible assets. For example, a business may create a mailing list of clients or establish a patent. If a business creates an intangible asset, it can write off the expenses from the process, such as filing the patent application, hiring a lawyer, and paying other related costs.

In addition, all the expenses along the way of creating the intangible asset are expensed. However, intangible assets created by a company do not appear on the balance sheet and have no recorded book value. Because of this, when a company is purchased, often the purchase price is above the book value of assets on the balance sheet. The purchasing company records the premium paid as an intangible asset on its balance sheet.

Calculated intangible value is a method of valuing a company’s intangible assets. This calculation attempts to allocate a fixed value to intangible assets that won’t change according to the company’s market value. An intangible asset is a non-physical asset. Examples of intangible assets include patents, trademarks, copyrights, goodwill, brand recognition, customer lists, and proprietary technology.

Because an intangible asset has no physical form and isn’t easily converted to cash, calculating its value can be challenging. However, there are times when calculating the value of intangible assets becomes critical. For example, owners looking to sell their company may hire a business appraiser to specifically value the company’s intangible assets.

Determining the Calculated Intangible Value

Finding a company’s calculated Intangible value involves seven steps:

1. Calculate the average pre-tax earnings for the past three years.
2. Calculate the average year-end tangible assets for the past three years.
3. Calculate the company’s return on assets (ROA).
4. Calculate the industry average ROA for the same three-year period as in Step 2.
5. Calculate excess ROA by multiplying the industry average ROA by the average tangible assets calculated in Step 2. Subtract the excess return from the pre-tax earnings from Step 1.
6. Calculate the three-year average corporate tax rate and multiply it by the excess return. Deduct the result from the excess return.
7. Calculate the net present value (NPV) of the after-tax excess return. Use the company’s cost of capital as a discount rate.

Valuation Models for Intangible Assets

Five of the more common valuation methods for intangible assets that are within the framework of the cost, market, and income approach are described below. These approaches can be integrated into an analysis of non-GAAP KPIs and other conceptual frameworks.

1. Relief from Royalty Method (RRM)

The RRM calculates value based on the hypothetical royalty payments that would be saved by owning the asset rather than licensing it. The rationale behind the RRM is fairly intuitive: Owning an intangible asset means the underlying entity doesn’t have to pay for the privilege of deploying that asset. The RRM is often used to value domain names, trademarks, licensed computer software, and in-progress R&D that can be tied to a specific revenue stream and where data on royalty and license fees from other market transactions are available. 

2. Multiperiod Excess Earnings Method (MPEEM)

The MPEEM is a variation of discounted cash-flow analysis. Rather than focusing on the whole entity, the MPEEM isolates the cash flows that can be associated with a single intangible asset and measures fair value by discounting them to present value. The MPEEM tends to be applied when one asset is the primary driver of a firm’s value and the related cash flows can be isolated from the firm’s overall cash flows. Early stage enterprises and technology firms are prime candidates for this approach. Computer software and customer relationships are among the sorts of assets that frequently generate such cash flows and could be assessed with fair value measurement using the MPEEM.

3. With and Without Method (WWM)

The WWM estimates an intangible asset’s value by calculating the difference between two discounted cash-flow models: one that represents the status quo for the business enterprise with the asset in place, and another without it. The WWM is often used to value noncompete agreements.

4. Real Option Pricing

As Aswath Damoradan noted, “the most difficult intangible assets to value are those that have the potential to create cash flows in the future but do not right now.” These assets have option characteristics that make them suitable to be valued using option pricing models and include undeveloped patent and undeveloped natural resource options, among others.

For a real option to have significant economic value, competition must be restricted in the event of the contingency. This is frequently the case for patents, which give the owner the right but not the obligation to exclude others from making, using, selling, offering for sale, or importing the patented invention. An undeveloped patent may have zero “intrinsic” value if the net present value of the underlying project is deemed to be zero or negative at the measurement date. Still, the patent may have considerable “time” value based on the possibility that the net present value of the project will turn out to be positive at some point over the life of the patent.

An option pricing model may be most suitable to capture the “time value” component of a patent that is not currently generating cash flows for the firm, but may have the potential to do so in the future. For instance, we can estimate the value of a patent on a drug that is undergoing the FDA approval process using a Black-Scholes option pricing formula.

5. Replacement Cost Method Less Obsolescence

This method requires an assessment of the replacement cost for the intangible asset new, that is “the cost to construct, at current prices as of the date of the analysis, an intangible asset with equivalent utility to the subject intangible, using modern materials, production standards, design, layout and quality workmanship.” The replacement cost is then adjusted for an obsolescence factor relative to the intangible asset. A simple replacement cost model for acquired software that adjusts for obsolescence and takes into account the tax impact of the asset’s amortization is shown below. It weighs the tax impact of the asset’s amortization, which is most relevant if the intangible asset is considered within the framework of the valuation of an overall enterprise. A pre-tax asset valuation may be more suitable under certain circumstances, particularly if the asset is valued on a stand-alone basis.

From this piece of information, you must have realised by now that how important this concept of Intangible Asset Valuation is from the point of view of IBBI registered valuer Examination. This concept of Intangible Asset Valuation is so relevant that at times in IBBI registered valuer exam questions come only from this topic alone for 3-5 marks. Therefore, Student’s unfamiliarity with Intangible Asset Valuation, its types, methods of valuation and other concepts related to this (as mentioned in IBBI Securities and Financial Asset class syllabus) assuming that these areas are complex is not justified. Therefore, I would like to encourage you all to study this concept precisely and adequately. You can easily score those 3 to 5 marks in valuer examination that will make the difference between passing and failing.

What is eventually important for you is to study strategically and work on your weak areas with complete dedication so that you could pass the IBBI registered valuer examination. And for passing that examination with a minimum of 60% marks, these small and easy areas make a lot of difference. RVMOCKTEST.ONLINE is there to help you in this path of becoming a Registered Valuer by making you exam ready. You can check your preparedness and identify your mistakes, by appearing in online mock tests of RVMOCKTEST.ONLINE that will boost your confidence and increase your chances of clearing in one single shot!!

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