Identify and discuss the issues relating to the recognition of brand names, for both internally developed and purchased brand names.
Just like a person??™s reputation is one of their most valuable assets, brand names have also become one the most valuable assets of a company. Brand valuation are fast gaining credibility and making it onto balance sheets, recognising brands as revenue-generating assets (Siu, May 2002). It has become a mainstream business tool which, in addition to balance sheet reporting, is used for the following purposes: Merger and acquisition planning; Tax planning; Securities borrowing; Licensing and franchising; Investor relations; Brand portfolio reviews; Marketing budget determination; Resource allocation; Strategic marketing planning and internal communications. The following four are the fundamental recognition criteria to be recognized as an element in financial statements:
??? It has a relevant attribute measurable with sufficient reliability.
??? The information about it is capable of making a difference in user decisions.
??? The information is representational faithful and verifiable.
??? The information must be neutral.
In the present economy, however, intangible assets such as intellectual capital frequently create value. The International Accounting Standard 38 (IAS38) became effective from July 1999 that required the capitalisation of purchased goodwill and acquired intangible assets such as licenses, franchises, publishing, patents and brands (Heberden, Aug 2000).
Historically, intangible assets have always been considered ???risky??? assets. Expenditures on intangibles, which result in new technologies and brand names, are difficult to quantify and value. Of particular importance is the measurement of the cost of the assets being capitalized (Research and Development, Patents, and Employee training), and the use of expected present value. It is more difficult to measure the future benefits of intangibles than the benefits accruing from other assets such as investment in property, plant, and equipment because an asset of an entity is a result of past transactions or events. Traditional accounting systems fail to capture much of what goes on in business because these transactions are no longer the basis for much of the value created and destroyed. It is not limited to an arm??™s length transaction between a willing buyer and a willing seller. It may be an internal event that occurs within the entity. Therefore, the level of expenditure is not proportional to the eventual worth of the outcome (Leo, 2007).
Uncertainty and Irrelevance
Research is a series of events that converge. It is almost impossible to distinguish the turning point in the series of events that lead to a commercially successful product (Gelb and Siegel, 2000). The expensing of research & development (R&D) and advertising are required based upon the risk and uncertainty related to their benefits. The distinction between R & D, advertising, training, etc. and other recognized assets is not based on the definition of assets but rather on the practical consideration of coping with the effects of uncertainty complicated by the fact that the benefits may be realized far in the future. There exists some uncertainty relative to future economic benefit of internally generated intangible assets. Therefore the controversy focuses on risk and measurability issues as well.
Cost information being relevant or reliable
Recognition of elements of financial reports is subjected to decisions about trade offs between relevance and reliability. The relationship between future economic benefit of assets and net cash inflows to an entity is often indirect for both business enterprises and not-for-profit organizations. Therefore, the argument that a direct relationship between cost of an asset and its specific future revenues even with the benefit of hindsight is not worth (AASB 138, paragraph 27). Lev and Sougiannis (1996) provide evidence that capitalization of R & D yields statistically reliable and economically relevant information.
In accordance with AASB 3, if an intangible asset is acquired in a business combination, the cost of that intangible assets is its fair value at the acquisition date and should be recognised separately from goodwill if its fair value can be measured reliably, irrespective of whether the assets has been recognised before the business combination (AASB 138, paragraph 34). The object is to bring a greater deal of transparency to the acquisition process in requiring the companies to identify and value the assets they acquired. This may in itself lead to volatility in reported earnings. Hence, companies will be keen to ensure that intangible assets are fully identified and accounted for separately from goodwill as long as they won??™t under-perform.
D. Identify and discuss the issues relating to the measurement of brand names, for both internally developed and purchased brand names.
Following the identification of intangible assets, the next step is to determine the fair value of the intangible assets. The AASB provides guidance on determining fair value. A realisation that the full value of brand owning companies was neither explicitly shown in the accounts nor always reflected in stock market values led to a reappraisal of how intangible assets in general, and brands in particular, should be valued and disclosed (Heberden, Aug 2000).
In light of the fact that investors use financial statements to make future investment allocation decisions, capitalization of intangible assets is feasible whether purchased or internally generated. Below are the generalised views of concerning issues related to measurement of such assets.
Avoiding double counting of intangible assets value as two or more intangible assets may contribute to the same stream of earnings. For example, a well-known trademark and the underlying technology contributing as a separate but to the same increase in the profitability of an entity.
The costs of creating internally generated brands are required to be treated as expenses when they are incurred (Heberden, Aug 2000). There are clearly problems in accounting for internally generated brands; however, having no disclosure of their value is far from ideal. Capitalisation of internally generated brands is still remains questionable.
Useful measurement from recognition of in-process assets
Some internally generated intangibles are capitalized. For instant, costs incurred in creating a computer software product that is to be sold, leased, or marketed, is charged to R & D expense when incurred until technological feasibility has been established for the product. Technological feasibility, however, is a criterion that is difficult to apply. There is no such thing as a real, specific baseline design. Erlop (1996) argues that a company can apply the technological feasibility threshold as early or late as they choose. Kirk (1985) says the criterion of technological feasibility is difficult to define. Therefore it can lead to abuse. Financial analysts have consistently argued against capitalization of computer software because the useful life is relatively short lived compared to other R & D projects. Technologically feasible software is recognized as an asset, whereas other intangibles that are both more relevant and reliable, that have greater consequences in terms of both dollar amounts and useful lives, continue to be ignored (Gelb and Siegel, 2000).
One of the important challenges of accounting for intangible assets is selecting the appropriate economic life for each item or category. Some assets such as strong brand names may have a relatively long or even indefinite life, others such as customer relationships, may be amortised over a shorter period (Quiligan, Jun 2006)
Cross fertilisation and multigenerational factors (Leo, 2008)
The expensing of R & D and advertising are required based upon the risk and uncertainty related to their benefits. For example, there should be sufficient documentation between R & D expenditures and the ratio of successful/non-successful discoveries. For each company the success/failure ratio over an extended period of time should be documented (Sannella, 1995). A historic pattern of results could be required for the entity; however, its specifics are not objective evidence. If the entity does not have operating histories for new products or services, statistics for other products or services may be used if it can be demonstrated that these are products/services that are likely to be highly correlated. The payroll and payroll related costs for the activities of employees who are directly associated with, or devote time to, the advertising is to be reported as assets (Gelb and Siegel, 2000).
Determining the true value of brand names
Well-known appraisal methodologies are in place these days to value brand names. The most commonly used concept of all is called the ???relief from royalty???. This is based on the assumption that if brand has to be licensed from third party brand owner, a royalty rate on turnover will be charged for the privilege of using the brand (Heberden, Aug 2000). It involves estimating likely future sales and the applying an appropriate royalty rate to arrive at the income attributable to brand royalties in future years. The process of selecting an appropriate royalty rate range needs to be rigorous, as the value implications of a small change in the royalty rate can be significant. In the article Heberden, Aug 2000;???Measuring intangible assets??™ its mentioned
??? At times, it is difficult for an appraiser to obtain specific comparable licensing agreements. In fact, many thousands of licensing agreements have been negotiated at arm??™s length. They usually call for a royalty to be paid based on sales levels. Royalty percentages typically range from 1% to 5% of sales, depending upon the negotiation strength of the parties and the perceived value of the intangible assets being transferred. Because the IRS has expressed concern about royalty arrangements between controlled parties, appraisers like to get comparable figures from true arm??™s-length transactions. These transactions exist, they can be analysed, and they have been used numerous times in the appraisal process.???
??? AASB 138 2007; Intangible Assets (Cwlth).
??? Erlop, Osman June 16, 1996; ???When Does Life Begin Forbes??™, pg. 72-74.
??? Gelb, D. and P. Siegel. 2000; ???Intangible assets and corporate signalling??™, Review of Quantitative Finance and Accounting (15); pg. 307-323.
??? Heberden, Tim Aug 2000; Accountancy, South Africa; ???Measuring intangible assets??™, Accounting & Tax Periodicals, pg. 5.
??? John Wiley & Sons Australia Ltd, Milton, Queensland.
??? Kirk, D. J., June 12, 1985; Growing Temptation & Rising Expectation = Accelerating Regulation, FASB Viewpoints, pg 7.
??? Leo, K., Hoggett, J., Sweeting, J. and Radford, J. 2008 (LEO); Company Accounting, 7th edition.
??? Lev, B. and T. Sougiannis; 1996; ???The capitalization, amortization, and value-relevance of R & D??™, Journal of Accounting and Economics (21); pg. 107-137.
??? Quilligan, Laura Jun 2006; Accountancy, Ireland, Dublin; ???Intangible Assets identification and valuation under IFRS 3??™, Vol. 38, Iss. 3; pg. 10.
??? Siu, Michael May 2002; CA Charter, Sydney, Australia; ???Balancing brands??™, Accounting & Tax Periodicals, Vol. 73, Iss. 4; pg. 60.
??? Sannella, Alexander J., 1995; ???The Mid-Atlantic Journal of Business??™ (31), Analytical capitalization of research and development costs, pg. 75-102.