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(discussed at 5.3 above and in Chapter 14). IAS 38 states that the fair value of an
intangible asset will reflect market participants’ expectations at the acquisition date
about the probability that the expected future economic benefits embodied in the asset
will flow to the entity. [IAS 38.33]. Like IFRS 3, IAS 38 incorporates IFRS 13’s definition
of fair value (see 5.3 above). [IAS 38.8].
There are three broad approaches to valuing intangible assets that correspond to the
valuation approaches referred to in IFRS 13. [IFRS 13.62]. These are the market, income
and cost approaches. The diagram below shows these valuation approaches, together
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with some of the primary methods used to measure the fair value of intangible assets
that fall under each approach, shown in the boxes on the right.
Observable Market Prices
Market Approaches
Comparable Market Transactions
Relief from Royalty
Income Approaches
Multi-Period Excess Earnings
Incremental Cash Flow
Indexed Historical Cost
Cost Approaches
Replacement Costs
IFRS 13 does not limit the types of valuation techniques an entity might use to measure
fair value. Instead the standard indicates that entities should use valuation techniques
that are appropriate in the circumstances and for which sufficient data are available,
which may result in the use of multiple valuation techniques. Regardless of the
technique(s) used, a fair value measurement should ‘maximis[e] the use of relevant
observable inputs and minimis[e] the use of the unobservable inputs.’ [IFRS 13.61]. The
resulting fair value measurement should also reflect an exit price, i.e. the price to sell
an asset. [IFRS 13.2].
In practice, the ability to use a market-based approach is very limited as intangible
assets are generally unique and are not typically traded. For example, there are
generally no observable transactions for unique rights such as brands, newspaper
mastheads, music and film publishing rights, patents or trademarks noted in
paragraph 78 of IAS 38, i.e. a number of the intangible assets that IFRS 3 and IAS 38
require an acquirer to recognise in a business combination.
The premise of the cost approach is that an investor would pay no more for an
intangible asset than the cost to recreate it. The cost approach reflects the amount that
would be required currently to replace the service capacity of an asset (i.e. current
replacement cost). It is based on what a market participant buyer would pay to acquire
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or construct a substitute asset of comparable utility, adjusted for obsolescence.
Obsolescence includes physical deterioration, technological (functional) and economic
obsolescence so it is not the same as depreciation under IAS 16. [IFRS 13.B8, B9]. This
approach is most often used for unique intangible assets constructed by the entity, e.g.
internally-developed software.
Income-based approaches are much more commonly used. These involve identifying
the expected cash flows or economic benefits to be derived from the ownership of the
particular intangible asset, and calculating the fair value of an intangible asset at the
present value of those cash flows. These are discussed further below.
For each asset, there may be several methodologies that can be applied. The methods
used will depend on the circumstances, as the assets could result in additional
revenue, cost savings, or replacement time. A discounted cash flow method may be
used, for example, in determining the value of cost-savings that will be achieved as
a result of having a supply contract with advantageous terms in relation to current
market rates.
Two income-based methods that are commonly used to value intangible assets are:
• the Multi Period Excess Earnings Method (‘MEEM’); and
• the Relief from Royalty method.
The MEEM is a residual cash flow methodology that is often used in valuing the primary
intangible asset acquired. The key issue in using this method is how to isolate the
income/cash flow that is related to the intangible asset being valued.
As its name suggests, the value of an intangible asset determined under the MEEM is
estimated through the sum of the discounted future excess earnings attributable to
the intangible asset. The excess earnings is the difference between the after-tax
operating cash flow attributable to the intangible asset and the required cost of
invested capital on all other assets used in order to generate those cash flows. These
contributory assets include property, plant and equipment, other identifiable
intangible assets and net working capital. The allowance made for the cost of such
capital is based on the value of such assets and a required rate of return reflecting the
risks of the particular assets. As noted at 5.5.4 below, although it cannot be recognised
as a separate identifiable asset, an assembled workforce may have to be valued for
the purpose of calculating a ‘contributory asset charge’ in determining the fair value
of an intangible asset under the MEEM.
The Relief from Royalty method is often used to calculate the value of a trademark
or trade name. This approach is based on the concept that if an entity owns a
trademark, it does not have to pay for the use of it and therefore is relieved from
paying a royalty. The amount of that theoretical payment is used as a surrogate for
income attributable to the trademark. The valuation is arrived at by computing the
present value of the after-tax royalty savings, calculated by applying an appropriate
royalty rate to the projected revenue, using an appropriate discount rate. The legal
protection expenses relating to the trademark and an allowance for tax at the
appropriate rate are deducted. The Relief from Royalty method was applied by adidas
AG in its 2015 financial statements.
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Extract 9.2: adidas AG (2015)
CONSOLIDATED FINANCIAL STATEMENTS [extract]
Notes [extract]
04
ACQUISITION OF SUBSIDIARIES AS WELL AS ASSETS AND LIABILITIES [extract]
The following valuation methods for the acquired assets were applied:
• Trademarks: The ‘relief-from-royalty method’ was applied for the trademarks/brand names. The fair value was
determined by discounting notional royalty savings after tax and adding a tax amortisation benefit, resulting from
the amortisation of the acquired asset.
It may be that the value of an intangible asset will reflect not only the present value of
the future post-tax cash flows as indicated above, but also the value of any tax benefits
(sometimes called ‘tax amortisation benefits’) that might generally be available to the
owner if the asset had been bought separately, i.e. not as part of a business combination.
Adidas AG discloses in the extract above that fair value of trademarks and similar rights
includes a tax amortisation benefit. Whether such tax benefits are included will depend
on the nature of the intangible asset and the relevant tax jurisdiction. If tax amortisation
benefits
are included, an asset that has been purchased as part of a business combination
may not actually be tax-deductible by the entity, either wholly or in part. This therefore
raises a potential impairment issue that is discussed in Chapter 20 at 8.3.1.
Because fair value is an exit price, the acquirer’s intention in relation to intangible
assets, e.g. where the acquirer does not intend to use an intangible asset of the acquiree
is not taken into account in attributing a fair value. This is explicitly addressed in IFRS 3
and IFRS 13 and discussed at 5.5.6 below and in Chapter 14 at 10.1.
5.5.3 Reacquired
rights
A reacquired right, that is a right previously granted to the acquiree to use one or more
of the acquirer’s recognised or unrecognised assets, must be recognised separately from
goodwill. Reacquired rights include a right to use the acquirer’s trade name under a
franchise agreement or a right to use the acquirer’s technology under a technology
licensing agreement. [IFRS 3.B35].
A reacquired right is not treated as the settlement of a pre-existing relationship.
Reacquisition of, for example, a franchise right does not terminate the right. The
difference is that the acquirer, rather than the acquiree by itself, now controls the
franchise right. The IASB also rejected subsuming reacquired rights into goodwill,
noting that they meet both contractual-legal and separability criteria and therefore
qualify as identifiable intangible assets. [IFRS 3.BC182-BC184].
Guidance on the valuation of such reacquired rights, and their subsequent accounting,
is discussed at 5.6.5 below.
Although the reacquired right itself is not treated as a termination of a pre-existing
relationship, contract terms that are favourable or unfavourable relative to current
market transactions are accounted for as the settlement of a pre-existing relationship.
The acquirer has to recognise a settlement gain or loss. [IFRS 3.B36]. Guidance on the
measurement of any settlement gain or loss is discussed at 11.1 below.
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5.5.4
Assembled workforce and other items that are not identifiable
The acquirer subsumes into goodwill the value of any acquired intangible asset that is
not identifiable as at the acquisition date.
5.5.4.A Assembled
workforce
A particular example of an intangible asset subsumed into goodwill is an assembled
workforce. IFRS 3 regards this as being an existing collection of employees that permits
the acquirer to continue to operate an acquired business from the acquisition date
without having to hire and train a workforce. [IFRS 3.B37].
Although individual employees might have employment contracts with the employer,
the collection of employees, as a whole, does not have such a contract. In addition, an
assembled workforce is not separable; it cannot be sold, transferred, licensed, rented or
otherwise exchanged without causing disruption to the acquirer’s business. Therefore,
it is not an identifiable intangible asset to be recognised separately from goodwill.
[IFRS 3.BC178].
Nor does the assembled workforce represent the intellectual capital of the skilled
workforce, which is the (often specialised) knowledge and experience that employees
of an acquiree bring to their jobs. [IFRS 3.B37]. Prohibiting an acquirer from recognising
an assembled workforce as an intangible asset does not apply to intellectual property
and the value of intellectual capital may well be reflected in the fair value of other
intangible assets. For example, a process or methodology such as a software program
would be documented and generally would be the property of the entity; the employer
usually ‘owns’ the intellectual capital of an employee. The ability of the entity to
continue to operate is unlikely to be affected significantly by changing programmers,
even replacing the particular programmer who created the program. The intellectual
property is part of the fair value of that program and is an identifiable intangible asset if
it is separable from the entity. [IFRS 3.BC180].
5.5.4.B
Items not qualifying as assets
The acquirer subsumes into goodwill any value attributed to items that do not qualify
as assets at the acquisition date.
• Potential contracts with new customers
Potential contracts that the acquiree is negotiating with prospective new customers at
the acquisition date might be valuable to the acquirer. The acquirer does not recognise
them separately from goodwill because those potential contracts are not themselves
assets at the acquisition date. Nor should the acquirer subsequently reclassify the value
of those contracts from goodwill for events that occur after the acquisition date. The
acquirer should, of course, assess the facts and circumstances surrounding events
occurring shortly after the acquisition to determine whether there was a separately
recognisable intangible asset at the acquisition date. [IFRS 3.B38].
• Contingent assets
If the acquiree has a contingent asset, it should not be recognised unless it meets the
definition of an asset in the IASB’s Framework (2001), even if it is virtually certain that
it will become unconditional or non-contingent. Therefore, an asset would only be
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recognised if the entity has an unconditional right at the acquisition date. This is
because it is uncertain whether a contingent asset, as defined by IAS 37 – Provisions,
Contingent Liabilities and Contingent Assets – actually exists at the acquisition date.
Under IAS 37, it is expected that some future event will confirm whether the entity has
an asset. [IFRS 3.BC276]. Contingent assets under IAS 37 are discussed in Chapter 27
at 3.2.2. [IAS 37.33].
• Future contract renewals
In measuring the fair value of an intangible asset, the acquirer would take into account
assumptions that market participants would use when pricing the intangible asset, such
as expectations of future contract renewals. It is not necessary for the renewals
themselves to meet the identifiability criteria. [IFRS 3.B40]. Any value attributable to the
expected future renewal of the contract is reflected in the value of, for example, the
customer relationship, rather than being subsumed within goodwill.
However, any potential contract renewals that market participants would consider in
determining the fair value of reacquired rights would be subsumed within goodwill. See
the discussion at 5.6.5 below.
5.5.5
Assets with uncertain cash flows (valuation allowances)
Under IFRS 3, the acquirer may not recognise a separate provision or valuation allowance
for assets that are initially recognised at fair value. Because receivables, including loans, are
to be recognised and measured at fair value at the acquisition date, any uncertainty about
collections and future cash flows is included in the fair value measure (see Chapter 45
at 3.3.4). [IFRS 3.B41]. Therefore, although an acquiree may have assets, typically financial
assets such as receivables and loans, against which it has recognised a provision or valuation
allowance for impairment or uncollectible amounts, an
acquirer cannot ‘carry over’ any
such valuation allowances nor create its own allowances in respect of those financial assets.
Subsequent measurement of financial instruments under IFRS 9 is dealt with in
Chapter 46. Chapter 47 at 7.4 deals specifically with the interaction between the initial
measurement of debt instruments acquired in a business combination and the
impairment model of IFRS 9.
5.5.6
Assets that the acquirer does not intend to use or intends to use in a
way that is different from other market participants
An acquirer may intend not to use an acquired asset, for example, a brand name or
research and development intangible asset or it may intend to use the asset in a way
that is different from the way in which other market participants would use it. IFRS 3
requires the acquirer to recognise all such identifiable assets, and measure them at their
fair value determined in accordance with their highest and best use by market
participants (see 5.3 above and in Chapter 14 at 10.1). This requirement is applicable
both on initial recognition and when measuring fair value less costs of disposal for
subsequent impairment testing. [IFRS 3.B43]. This means that no immediate impairment
loss should be reflected if the acquirer does not intend to use the intangible asset to
generate its own cash flows, but market participants would.
However, if the entity is not intending to use the intangible asset to generate cash flows,
it is unlikely that it could be regarded as having an indefinite life for the purposes of
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IAS 38, and therefore it should be amortised over its expected useful life. This is likely
to be relatively short.
Example 9.11: Acquirer’s intention not to use an intangible asset
Entity A acquires a competitor, Entity B. One of the identifiable intangible assets of Entity B is the trade
name of one of Entity B’s branded products. As Entity A has a similar product, it does not intend to use that
trade name post-acquisition. Entity A will discontinue sales of Entity B’s product, thereby eliminating
competition and enhancing the value of its own branded product. The cash flows relating to the acquired
trade name are therefore expected to be nil. Can Entity A attribute a fair value of nil to that trade name?