Electronic copy available at: http://ssrn.com/abstract=2254168

Assessment of Intangible Assets vis-à-vis Companies Capital

Ankita Guha

B.Tech, LLB (IP), 2nd Year Student, Rajiv Gandhi School of Intellectual Property Rights,

IIT Kharagpur

Electronic copy available at: http://ssrn.com/abstract=2254168

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CONTENTS

CONTENTS ...............................................................................................................................2

Chapter 1 ....................................................................................................................................3

INTRODUCTION...................................................................................................................3

1.1 Intangible Assets ...........................................................................................................3

1.2 Key Concepts ................................................................................................................5

Chapter 2 ....................................................................................................................................6

ACCOUNTING TREATMENT ..............................................................................................6

2.1 Recognition of IA ..........................................................................................................6

2.2 Separate Acquisition ......................................................................................................7

Chapter 3 .................................................................................................................................. 10

VALUATION METHODOLOGY UTILIZED IN BUSINESS ENTERPRISE ...................... 10

3.1 Explanation ................................................................................................................. 11

3.2 Presentation And Disclosure of Intangible Assets ........................................................ 12

Chapter 4 .................................................................................................................................. 14

INTANGIBLE ASSETDISCLOSURE AND POSITION OF INDIA .................................... 14

4.1 Study on Percentage Disclosure of Intangible Assets across Some of the Countries ..... 14

4.2 Study on Percentage Disclosure of Intangible Assets across Different Industrial Sector

.......................................................................................................................................... 15

4.3 Study on Percentage Disclosure of Intangible Assets by Some of the Major Indian

Giants ................................................................................................................................ 16

Chapter 5 .................................................................................................................................. 18

CONCLUSION ..................................................................................................................... 18

References ................................................................................................................................ 19

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CHAPTER 1

INTRODUCTION

The management of Intangible Assets is emerging as an increasing important system for

delivering sustainable macro-economic competitiveness. Intangible Assets form the basis for

new products and services the commercialization of which can lead to significant value creation.

Moreover the effective management of Intangible Assets provides countries with a defensive

strategy against an over-reliance on the importation of goods. In case of ineffective management,

assets are created but not exploited.

1.1 INTANGIBLE ASSETS

IAS 38 applies to all Intangible Assets that are not specifically dealt with in another IAS.

IASB (International Accounting Of Standards Board), a resource controlled by the entity as a

result of past events and from which future economic benefits are expected to flow to the entity.

Example: -

Brand names, computer software, and licenses, franchises & intangibles development.

Acquisition, development, maintenance, or enhancement of intangible resources such as

scientific or technical knowledge.

Design and implementation of new processes, or systems.

Intellectual property1 including patents2, copyrights, motion picture films and

trademarks3 (including brand names and publishing titles).

1 IP acquires its essential characteristics feature from which value emanates from the legal system. The law bestows right to people who create things embodying new ideas or ways of expressing ideas and to those who use certain marks to distinguish their product or service. It is this unique characteristic of intellectual property that causes it to be a subset of intangible assets of a business enterprise. This property might have resulted from arduous and costly research or simply by fortuitous discovery and may contribute significantly to the earning power of an enterprise of which they constitutes a part.

2 A patent gives to the inventor a new and useful product or method bestowing exclusive right to make and sell product or to use that process for a period of 20 years.

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Lists of users of a service, acquired fishing licenses, acquired import quotas, and

relationships with users of a service.

This Standard prescribes the accounting treatment of intangible assets including:

The definition of an intangible asset.

Recognition as an asset.

Determination of carrying amount.

Determination and treatment of impairment losses.

Disclosure requirements.

IAS 38 specifies that internally generated goodwill, brands, mastheads, publishing titles,

customer lists & similar items should not be recorded as assets.

IAS 38 does not apply to:

Standards Areas IAS 2 (Inventories), IAS 11 (Construction Contracts)

IA, held for sale in the ordinary course of business

IAS 12 (Income Taxes) Deferred tax assets IAS 17 Leases IAS 19 Employee Benefits IFRS 3 (Business Combination) Goodwill arising on a business combination IAS 27, IAS 28, IAS 31, IAS 39 Financial Asset IFRS 6 Recognition & measurement of exploration

and evaluation of assets on minerals IFRS 5 Non-current intangible assets classified as held

for sale (included in the disposal group that is classified as held for sale)

Deferred acquisition costs & intangible assets arising in insurance undertakings from contracts with policyholders.

3 A trademark is a word(s), logo, design, number(s) that is used to distinguish a person’s product or service from those of the others and it can be the brand name of the product or service but it cannot be a generic name of the product or service itself.

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1.2 KEY CONCEPTS

An IA, is an identifiable non-monetary asset without physical substance,

Which is identifiable

That is separable, i.e. capable of being separated or divided from the entity &

sold, transferred, licensed, rented or exchanged either individually or together

with a related contract.

Arising from contractual or other legal rights or binding arrangements,

regardless of whether those rights are transferable or separable from the entity

or other rights & obligations.

Controllable & generates future economic benefit.

That is capable of being separated from the entity & sold, transferred, licensed, rented or

exchanged – either individually or together with a related contract, asset or liability and

That is clearly distinguishable and controlled separately from goodwill4.

4Goodwill is the cost of the business combination less the fair value of the target’s assets and liabilities at the acquisition date and is essentially, is the premium paid on the combination.

Goodwill is, however, one of the most fragile intangible assets and can be eroded very quickly and for this reason, goodwill from business combinations is not amortized, but subject to annual impairment testing.

Goodwill is thereby impaired when the value of the asset is lower than the carrying amount.

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CHAPTER 2

ACCOUNTING TREATMENT

An IA is recognized as an asset if:

Is it probable that future economic benefits attributable to the asset will flow to the entity

The cost of the asset can be measured reliably.

An entity shall assess the probability of expected future economic benefits using reasonable and

supportable assumptions that represents management’s best estimate of the set of economic

conditions that will exist over the useful life of the asset.

2.1 RECOGNITION OF IA

An Intangible Asset shall be recognized iff:

It is probable that the expected future economic benefits or service potential that are

attributable to the asset will flow to the entity.

The cost or fair value of the asset can be measured reliably.

On initial recognition an IA is measured at cost whether it is acquired externally or generated

internally.

The cost of an IA comprises of:

Purchase price.

Import duties.

Non-refundable purchase taxes.

Professional & legal fees.

Directly-attributable expenditure including staff pay & benefits on preparing the asset for

its intended use including testing.

Deductions such as trade discounts and rebates.

Exchange transaction or to internally generate an intangible asset.

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2.2 SEPARATE ACQUISITION

If an IA is acquired in exchange for equity instruments, the cost of the asset is the fair value of

those equity instruments.

If an IA is acquired in a business combination, the cost of that asset is its fair value at

acquisition.

The current bid price in an active market provides the most reliable measurement of fair value.

If no active market exists for an IA, its fair value is the amount that the undertaking would have

paid for the asset, at the acquisition date, in an arm’s length transaction between knowledgeable

and willing parties, on the basis of the best information available.

IA acquired frees of charge or for a nominal consideration by way of a Govt. grant may be

initially record both the asset and the grant at:

Fair value.

(Nominal amount + any attributable costs).

All other expenses related to the following categories are expensed. They include:

Internally generated brands, mastheads, publishing titles, customer lists etc.

Start-up costs.

Training costs.

Advertising & promotion.

Relocation & reorganization expenses.

Redundancy & other termination costs.

Subsequent to initial recognition, an entity should choose either the Cost Model or the

Revaluation Model as its accounting policy for IA & should apply that policy to an entire class

of IA:

Cost Model : The carrying amount of an IA is its cost less accumulated amortization.

Assets classified as held for sale are shown at the lower of fair value less costs to sell and

carrying amount.

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Revaluation Model: The carrying amount of an item of IA is its fair value less

subsequent accumulated amortization and impairment losses.

Assets classified as held for sale are shown at the lower of fair value less costs to sell and

carrying amount. Increase in carrying amount will be recognized in other comprehensive

income and accumulated in equity under the head revaluation surplus. Decrease would be

recognized in the profit or loss.

For an internal project to create an IA, the research phase & development phase should be

distinguished from one another. No IA arises from research thus research expenditure is

treated as an expense.

Development expenditure is recognized as an IA, if all of the followed can be

demonstrated:

The technical feasibility of completing the IA, so that it will be available for use

or sale.

The availability of adequate technical, financial and other resources to complete

the development & to use or sell the intangible asset.

The intention to complete the intangible asset and use or sell it.

The ability to use or sell the IA.

How the IA will generate probable future economic benefits.

The ability to measure the expenditure.

Internally generated brands, mastheads, publishing titles, customer lists & items similar in

substance shall not be recognized as IA.

The cost of an internally generated asset is the total costs, incurred from the date when the asset

first meets the recognition criteria that can be directly attributed or allocated to it on a reasonable

& consistent basis.

There can be no reinstatement of expenditure, recorded as an expense in previous interim or

annual financial statements.

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The cost comprises all expenditure creating, producing & preparing the asset for its intended use

including:

Expenditure on materials & services used in generating the asset

The employment costs of personnel directly engaged in producing the asset.

Any expenditure that is directly attributable to the asset, such as fees to register a legal

right & the amortization of patents and license.

Overheads that is necessary to generate the asset.

Interest.

The following are not components of the cost of an internally-generated IA:

a) Selling, administrative and other general overhead expenditure, unless this expenditure can be

directly attributed to preparing the asset for use.

b) Clearly-identified inefficiencies and initial operating losses, incurred before an asset achieves

planned performance.

c) Expenditure on training staff to operate the asset.

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CHAPTER 3

VALUATION METHODOLOGY UTILIZED IN BUSINESS ENTERPRISE

The following methodology usually the Business Enterprises follows:

1. Cost Approach.

2. Market Approach.

3. Income Approach.

Cost Approach seeks to measure future benefits of ownership by quantifying the amount of

money required to replace the future service and thereby commiserating with the economic value

of the usage which the property can provide during its life.

Market Approach, most direct valuation technique reflecting the value obtained as a result of

consensus of what others in the market place have judged it to be.

Income Approach focuses on the income producing capability and measuring the present value

of the net economic benefit over the life of the asset and is best suited for measuring Intellectual

Property Assets.

Intangible Assets of a company is usually classified under the following four main categories:

1. Human-resources.

2. External Assets.

3. Internal Assets.

4. Intellectual Property Assets

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3.1 EXPLANATION

At 1st November 2007, the process met the criteria for recognition as an IA. The fair value of the

know-how in the process is 2000.

An undertaking is developing a new production process. During 2008, expenditure incurred was

4000, of which 3600 was incurred before 1 November 2008 and 400 were incurred between 1st

November 2008 and 31st December 2008.

Yea

r

Tota

l

Expe

nditu

re

Dur

ing

Expe

nditu

re

Incu

rred

Dur

ing

Expe

nditu

re

Incu

rred

IA Id

entif

ied

Fair

Val

ue

Cos

t Of T

he

Proc

ess

Impa

irmen

t

Loss

(Tot

al

2007 - - - Nov - Yes 2000 - -

2008 4000 Jan - Oct 3600 Nov - Dec 400 400 - - -

2009 10000 - - - - - 9000 10,400 1400

Table 1: Showing the Valuation of IA for a Particular New Production Process.

At the end of 2008, the process is recorded as an IA at a cost of 400 (costs incurred since 1st

November 2008). The 3600 expenditure incurred before 1st November 2008 is recorded as an

expense, as the recognition criteria were not met until 1st November 2008.

During 2009, expenditure incurred is 10,000.At the end of 2009, the fair value based on future

cash flows, of the know-how in the process is 9000 and the cost of the process is 10,400

(Expenditure of 400 recorded at the end of 2008 plus 10000 expenditure recorded in 2009).The

undertaking records an impairment loss of 1400, to adjust the carrying amount of the process

10400 to its recoverable amount 9000. This impairment loss may be reversed in a subsequent

period, if the requirements for the reversal of an impairment loss are met.

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3.2 PRESENTATION AND DISCLOSURE OF INTANGIBLE ASSETS

Each class of IA should distinguish between internally generated and other intangibles.

Accounting policies, should specify

Measurement bases.

Amortization5 methods.

Useful lives or amortization rates.

Income statement & notes, should disclose

The amortization charge for each class of asset including the line item in which it is

included and

The total amount of research & development costs recognized as an expense.

Balance sheet & notes, should disclose the following:

Gross carrying amount (book value) less accumulated amortization for each class of asset

at the beginning and the end of the period.

Whether the useful lives are indefinite or finite. If finite, amortization rate, method &

useful life.

Line items of the statement of comprehensive income in which amortization of intangible

assets is included.

Detailed itemized reconciliation of movements in the carrying amount during the period

showing

Additions, indicating separately, those from internal development and

through business combinations.

Increases or decreases during the period resulting from revaluations &

from impairment losses recorded or reversed directly in equity.

Impairment loses recorded in the income statement during the period.

Impairment losses reversed in the income statement during the period.

5Amortization is the systematic allocation of the depreciable amount of an intangible asset over its useful life.

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Amortization recorded during the period.

Net exchange differences arising on the translation of the financial

statements of a foreign undertaking.

Other changes in the carrying amount, during the period.

If an IA asset has indefinite useful life, factors supporting assessment.

Carrying amount of intangibles pledged as security.

Carrying amount of intangibles whose title is restricted.

Capital commitments for the acquisition of intangibles.

A description, the carrying amount, and the remaining amortization period of any

intangible that is material to the financial statements of the entity as a whole.

For IA acquired by way of a government grant & initially recognized at fair value

The fair value initially recognized for these assets.

Their carrying amount.

Whether they are measured at Cost or Revaluation model.

Additional disclosures required for revalued amounts are as follows:

Effective date of the revalued intangible assets.

Carrying amount of each class of IA had it been carried in the financial statements on the

historical cost basis.

Amount as well as a detailed reconciliation of the balance of the revaluation surplus.

Any restrictions on the distribution of the revaluation surplus.

Methods & significant assumptions applied in estimating the assets’ fair value.

The entity shall disclose the aggregate amount of research & development expenditure

recognized as an expense during the period.

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CHAPTER 4

INTANGIBLE ASSETDISCLOSURE AND POSITION OF INDIA

The transition of Indian economy from production to knowledge podium and the growing

software & IT, financial services, business outsourcing, media, healthcare, pharmaceutical

industries etc. have lead to increasing investments in intangible assets by the companies. In such

knowledge-driven global marketplace, intangible assets such as intellectual property, brands,

customer relationship and talent hold much more value than tangible 'visible' assets such as

capital, land, buildings, machinery etc.

4.1 STUDY ON PERCENTAGE DISCLOSURE OF INTANGIBLE ASSETS ACROSS SOME OF THE

COUNTRIES

Global Intangible Tracker (GIT)6 conducted an extensive global study in 2007 on intangibles

assets. According to this study, India was ranked third in the world with the highest intangible

component as a percentage of the total enterprise value (TEV); measured in terms of value of

disclosed and undisclosed tangible and intangible assets.

Name Of Country Disclosure of IA (%)

US 75

Switzerland 74

India 65

China 58

UAE 55

Japan 44

South Korea 25

Table 2: Showing Percentage of Disclosure of IA globally according to GIT

6http://www.sme.in/Currentnews.aspx?NewsID=1832, Last Accessed: 10th Nov, 2012, Time : 17:21 HRS.

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Fig 1: Graphical Distribution of Intangible Assets across Some of the Countries

4.2 STUDY ON PERCENTAGE DISCLOSURE OF INTANGIBLE ASSETS ACROSS DIFFERENT INDUSTRIAL

SECTOR

Study also shows the industrial sector wise division of different along with their percentage

disclosure in the year of 2007-20087.

Industry Name % Disclosure of Intangible Assets

Software, IT, ITES 79

Construction, Electricity 57

Drugs & Pharmaceuticals 55

Automotive, Telecom, Media 44

Banking, Finance, Textile 37

Table 3: IA disclosure among the various Indian Industries

7Id, 10

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Fig 2: Industrial Sector wise disclosure of IA

4.3 STUDY ON PERCENTAGE DISCLOSURE OF INTANGIBLE ASSETS BY SOME OF THE MAJOR INDIAN

GIANTS

Study done during the year of 2007-2008 shows some of the major Indian companies and their

percentage disclosure of the IA so developed8

Company Name % Disclosure Of These Company (2007-08)

Infosys 81

Dr. Reddy’s Laboratories 55

Tata Steel 53

Reliance Industries 50

Dabur India 42

Others 22

Table 4: Percentage Disclosure of Intangible Assets in Some of the Major Indian Companies

8http://www.intangiblecapital.org/index.php/ic/article/view/198/166, Last Accessed: 10th Nov, 2012, Time : 18:00 HRS.

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Fig 3: Graphical Representation Of Some of the Major Indian Companies

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CHAPTER 5

CONCLUSION

Intangible Assets evaluation forms an integral part of the business organization and in company

structure as well. Usually Intangible Assets evaluation forms an integral part during Company

Restructuring and during Insolvency or Winding Up.

But now a day it is implemented by almost all big global giants in order to understand the market

perspective of economic contributions among complementary assets.

In case of Indian companies it is relatively low compared to other countries. It is usually

unorganized and unsystematic due to the lack of an established accepted framework. Usually

different countries employ different Economic Financial Models to evaluate company’s capital.

Again some of the companies are not aware of the benefit of disclosing IA to stake holders while

other considers it to be an internal management issues.

There is a need to develop an index of Intangible Assets disclosure to incorporate both

quantitative as well as qualitative description of Intangible Assets.

It is one of the most important system for driving company value & competitiveness. However

very few corporations are aware of the potential of their intellectual assets and even fewer

companies have strategies for extracting maximum value from their intellectual assets.

Effective management of intellectual assets requires portfolio approach encompassing both

defensive and offensive strategies.

Defensive strategies need to be focused on the pro-active monitoring of competitor behavior and

ensuring that intellectual assets have adequate protection in this regard.

Offensive strategies on the other hand is based on the commercial exploitation of intellectual

assets in core and non-core applications and must be done in a manner ensuring maximum return

on investment & sustainable business competitiveness.

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REFERENCES

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Management Technologies Foundation”.

2. “Valuation of Intellectual Property Assets, The foundation for risk management and financing”,

Zareer Pavri of PricewaterhouseCoopers, INSIGHT conference April 1999.

3. “Accounting for Intangibles: Financial reporting and value creation in the knowledge economy, A

Research Report for The Work Foundation’s Knowledge Economy Programme”, Ricardo Blaug and

Rohit Lekhi, Research Republic LLP.

4. “The Rembrandt in the Corporate Attic, Extracting maximum value from intellectual assets”, Tauriq

Keraan, Deloitte 2010.

5. “IAS 38, Intangible Assets”, IFRS (International Financing Reporting Standards), 2012.

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Accounting Research Foundation, Institute of Public Enterprise, Hyderabad, 2009.

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Expectations” Stewart Thornhill, Guy Gellatly, International Entrepreneurship and Management

Journal 1, Pg 135-148, 2005.

8. “Intangible Assets”, International Public Sector Accounting Standards Board, International

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Statistics Series, 2011.

10. 'Constructing Intellectual Capital Statements', Bukh, P.N., Larsen, H.T. and Mouritsen, J. (2001)

Scandinavian Journal of Management 17(1): 87-108.

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California, Berkeley, Working Paper No. 93-207.

12. “Intangibles: A Synthesis of Current Research”, Kaufmann, L. and Schneider, Y. (2004), Journal of

Intellectual Capital 5(3): 366-388.

13. “Intangible capital aspects of advertising and R & D expenditures”, Hirschey, M. (1982, June),

Journal of Industrial Economics, 30(4), 375–390.