Valuation of intangibles
What is an intangible asset?
The term 'intangible asset' has both legislative and industry definitions.
Intangible assets are typically categorised as follows:
- identifiable intangible assets (excluding intellectual property and goodwill)
- intellectual property
Accounting Standard AASB 138 Intangible assetsExternal Link provides a detailed definition of an intangible asset (refer paragraphs 8-17). For example, in Paragraph 8 an intangible asset is defined as:
an identifiable non-monetary asset without physical substance.
And Paragraph 12 states:
An asset meets the identifiability criterion in the definition of an intangible asset when either it:
(a) is separable, that is, is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability
(b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
AASB 138 also contains detailed information relating to accounting recognition criteria for an intangible asset (refer Paragraphs 21-23):
An intangible asset shall be recognised if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity…
Accounting Standard AASB 3 Business combinations provides a number of examples of intangible assets that meet the definition and recognition criteria (as outlined in AASB 138) within the context of a business combination.
There are both legislative and industry definitions for Intellectual property.
From an industry perspective, the World Intellectual Property Organization (WIPO)External Link defines intellectual property as follows:
Intellectual property refers to creations of the mind: inventions, literary and artistic works, and symbols, names, images, and designs used in commerce.
Intellectual property is divided into two categories: Industrial property, which includes inventions (patents), trademarks, industrial designs, and geographic indications of source; and Copyright, which includes literary and artistic works such as novels, poems and plays, films, musical works, artistic works such as drawings, paintings, photographs and sculptures, and architectural designs. Rights related to copyright include those of performing artists in their performances, producers of phonograms in their recordings, and those of broadcasters in their radio and television programs.
The World Trade Organization (WTO)External Link defines intellectual property rights as follows:
…the rights given to persons over the creations of their minds. They usually give the creator an exclusive right over the use of his/her creation for a certain period of time.
These rights include patents, trademarks, copyright, industrial designs and trade secrets.
Within the context of the Australian federal income tax law, section 995-1 of the ITAA 1997 defines intellectual property as the rights (including equitable rights) an entity has under Commonwealth law (or equivalent rights under a foreign law) as the owner or licensee of a:
- registered design
Tax law does not define 'goodwill'. However, the term is defined in a range of industry applications. AASB 3 Business Combinations defines goodwill as:
Future economic benefits arising from assets that are not capable of being individually identified and separately recognised.
AASB 3 also describes how goodwill is measured (refer Paragraph 51(b):
…the excess of the cost of the business combination over the acquirer's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities…
In the wake of Commissioner of Taxation v. MurryExternal Link (1998) HCA 42 (16 June 1998), we have published Taxation Ruling TR 1999/16External Link: Income tax: capital gains: goodwill of a business. This ruling provides guidance regarding the meaning we assign to goodwill.
For guidance in relation to goodwill and consolidation, refer to TR 2005/17:External Link Goodwill identification and tax cost setting for the purposes of Part 3-90 of the Income Tax Assessment Act 1997.
Valuing intangible assets and intellectual property
The valuation of intangible assets, including intellectual property but excluding goodwill, is based on a number of established valuation methods using market-based, income-based, cost-based and probabilistic approaches.
These methods include:
- comparable transactions
- incremental income
- excess earnings
- relief from royalty
- replacement or reproduction cost
- simulation analysis.
A significant amount of published material is available regarding these (and other) methods. Therefore, this guide focuses on how you apply these methods within the context of existing legislation, ATO practice (such as rulings) and established industry approaches.
When you value intangible assets (other than goodwill), we expect to see a number of factors taken into account. These factors include:
- any relevant factor described in Valuation of a business (accounting for the specific interest)
- a description of the specific intangible asset or item of intellectual property and substantiation that the intangible asset or item of intellectual property is adequately categorised (that is, under the separability and/or contractual/legal criteria)
- a description of the complementary assets used in generating value for the intangible asset or item of intellectual property, and the calculation of any value allocation or charge needed to account for the use of those assets
- an analysis of the useful or effective life of the intangible asset or item of intellectual property
- an analysis of the obsolescence factors affecting the intangible asset or item of intellectual property (such as functional, economic, legal and technical factors)
- the legal rights associated with the intangible asset or item of intellectual property
- evidence that the intangible asset or item of intellectual property derives incremental value (for instance, establishing proof of the value generated by the aesthetic elements of an industrial design versus the utilitarian nature embedded within the design)
- expert reports, where relevant (for instance, the results of any prior art search from an intellectual property attorney).
The valuation of goodwill is generally based on the calculation of a residual value. In basic terms, this approach requires the valuation of the net identifiable assets of the business (market-adjusted) and the valuation (market value) of the equity of the business.
A residual value may be derived by subtracting the value of the net identifiable assets of the business from the value of equity of the business. As a general rule, the calculation of a residual value will be the most appropriate method for deriving goodwill. However, other methods may be accepted if they are appropriate to the circumstances.
Further details on valuing goodwill can be found in part E: Allocating value to underlying assets.