In an age of information and innovation, a business’ most valuable assets are no longer confined to physical structures or tangible resources. The economy has shifted from a reliance on transforming raw materials into psychical products towards a technology-led society. Intangible assets, such as beloved brand names, cutting-edge patents, proprietary software and loyal customer relationships have now become the lifeblood of businesses and the currency of success.
At Price Bailey, we are increasingly involved with clients for whom this rings true. Consequently, our valuation experts are regularly asked to provide a valuation opinion in regards to the ideas, designs and processes that a business leverages on a day-to-day basis. Often we find that for many businesses both new and old, the evaluation of intangible assets has become an intricate puzzle, demanding a reimagining of valuation methodologies to unlock the true power they offer. To start to unpick that puzzle, in the first article in our series on understanding the value of intangible assets, we start by providing you with an introduction to intangible assets, their treatment under accounting principles and consider the occasions when you might need to consider a formal valuation.
What are Intangible assets?
Intangible assets refer to assets that lack a physical presence, but hold significant value for businesses. They are the non-monetary resources and rights that contribute to a company’s competitive advantage, market position, and overall value. Unlike tangible assets such as buildings or equipment that can be seen or touched, intangible assets are more indefinable and include intellectual property (IP), brand recognition, patents, copyrights, trademarks, proprietary technology, customer relationships, software, licenses, and goodwill, among others.
Intangible assets can exist in the form of ideas, knowledge, or legal rights. Despite their intangibility, this class of assets can be critical drivers of innovation, future growth potential and ultimate business success. Creating unique advantages, such as market disruption and barriers to entry for competitors, customer loyalty, and the ability to differentiate products or services.
Valuing intangible assets, however, poses a complex challenge as their worth often lies in their potential to generate future economic benefit, rather than their present market value. Nevertheless, recognising and properly accounting for these intangibles is essential for accurately assessing a company’s overall value, facilitating informed decision-making, attracting investment, and understanding the true potential of a business in a knowledge-driven economy.
How are intangible assets accounted for?
A company’s ability to recognise intangible assets will depend on the accounting standards the company uses to guide the reporting within their financial statements. One of two common standards is typically followed by UK-based companies: FRS 102 or IFRS. Generally, these standards require specific criteria to be met before an internally generated intangible asset can be recognised on the balance sheet, such as demonstrating that the asset has probable future economic benefits and reliable measurement criteria.
When it comes to internally generated intangible assets, both IFRS and FRS 102 prescribe a two-phase approach for recognition:
- Research Phase: Expenditures incurred during this phase, such as research and analysis of new processes, systems, or products, are recognised as expenses in the profit and loss statement (P&L).
- Development Phase: In contrast, the costs associated with developing an intangible asset can be recognised on the balance sheet during this phase. ‘Development costs’ involve applying the findings of research to design, creating prototypes or pre-release products or services, and developing the necessary infrastructure to support the launch of a new product or service. It is important to ensure that the development phase can be readily distinguished from the research phase.
A company operating under FRS 102 generally has greater flexibility to recognise intangible assets on its balance sheet, provided these assets are separable (i.e. they can be readily separated from the business) or arise from contractual or legal rights. This distinction grants companies some discretion in recognising their intangible assets, which can potentially enhance the strength of their balance sheet.
Under IFRS, however, internally generated intangible assets are subject to stricter criteria. It requires that the asset meets certain criteria to be recognised, such as the ability to measure its cost reliably, the probability of generating future value, and control over the asset. Costs incurred during the research phase are expensed as incurred, while costs incurred during the development phase can be capitalised and recognised as an intangible asset on the balance sheet.
It is important for companies to carefully assess and document the process of intangible assets that are internally generated, including the costs incurred, the stages of development, and the criteria met for recognition. Seeking professional expertise, such as engaging a qualified valuation expert or accounting specialist, can be beneficial in ensuring compliance with accounting standards and providing accurate valuations.
Speak to your accountant and advisors or contact one of our team using the form below, if you are uncertain that your intangible assets are accurately reflected in your balance sheet.
Accurately accounting for intangible assets is not only important for compliance and reporting purposes. Beyond the formal recognition of intangible assets on the balance sheet, there are instances where the company or its shareholders may require a valuation of these assets, such as:
- Disclosures: Valuation of intangible assets may be necessary to support disclosure requirements within the company’s financial statements, particularly for impairment testing. Additionally, if an individual sells intangible assets and reports a gain on their tax return, determining the base cost of such assets may require a formal valuation.
- Enhancing Intellectual Property Protection: Valuations of intangible assets support the identification and protection of intellectual property (IP). By understanding the value of IP assets, founders can make informed decisions regarding IP management, licensing, or transferring assets to separate entities for protection and tax purposes.
- Transactions: Valuing intangible assets can be crucial in negotiations for the sale or purchase of a business. It aids in the process of Purchase Price Allocation, where the purchase price is attributed to specific assets on the balance sheet following the acquisition. This valuation assists all parties in understanding the value allocation and can help to buyers/sellers assess what a fair offer is. In case of shareholder disputes, a valuation can support the distribution of assets among shareholders.
- Restructuring: Businesses often protect their IP through various means, such as transferring it to an “IP Holding Company.” To facilitate such transfers, a valuation may be necessary to support the transaction and incorporate it into tax computations. Additionally, if a group is subject to Transfer Pricing requirements, a valuation might be necessary to comply with those regulations.
In these scenarios, seeking a professional valuation of intangible assets can provide valuable insights and support decision-making processes, ensuring transparency, compliance, and fair negotiations.
There are a variety of reasons for why a company, or its shareholders, may seek a valuation of their intangible assets. Ultimately, however, failure to recognise their worth may lead to undervaluation, missed investment opportunities, and an incomplete understanding of a company’s financial health.
If you’d like to understand more about how intangible assets are valued, the common methodologies for doing so are discussed in our next article coming soon.
Are you in the process of a restructure or M&A transaction, and wondering what your IP may be worth? If you are in this situation, then contact our team using the form below.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.