Formation of the initial cost of intangible assets for accounting purposes

The assessment of the value of intangible assets can be considered as a comprehensive assessment of the company's fixed assets, including intangible, capital assets and an assessment of the capitalization of the enterprise as a whole.

Assets, both tangible and intangible, have a specific value and market value. It is important to clearly understand all the factors affecting the company's capitalization.

In the context of the country's transition to an innovative path of development, the role of the institution of intellectual property (IP) is increasing, which should contribute to the production of knowledge-intensive, competitive products that ensure high rates of development and structural transformations in the economy.

The process of creating and using intellectual property requires effective management through the development of an integrated system for identifying, registering and managing IP objects.

Currently, every organization investing in the creation of new products and objects, engaged in innovative development, needs to create an intellectual property management system.

Intangible assets can be recognized as assets whose useful life exceeds 12 months, the value of which can be measured quite accurately. Assets must have characteristics that distinguish this object from others, including similar ones. Intangible assets do not have a physical form, can be used in the activities of the organization, and are capable of bringing economic benefits to the organization.

There are three criteria for measuring the value of intangible assets, succinctly formulated by the American economist Leonard Nakamura:

• as a financial result from investments in R&D, software, promotion of the company’s brand, etc.;
• as the costs of creating and developing the results of intellectual activity, purchasing licenses, etc.;
• from the point of view of increasing operating profit through the use of intangible assets.

Methods for estimating the value of intangible assets

The separation of intangible assets into an independent accounting object presupposes the mandatory resolution of issues regarding their valuation. According to IFRS (IAS 38 “Intangible Assets”), three well-known approaches can be applied to the valuation of intangible assets, as well as to the valuation of any asset:

Comparative (market) approach

This approach is based on the idea that a rational investor or buyer will not pay for a specific item of intangible assets more than the amount it would cost him to purchase another item of intangible assets with comparable utility (comparable quality). The comparative (market) approach to the valuation of intangible assets involves determining the value of an intangible asset received by an organization based on the price at which similar intangible assets are acquired in comparative circumstances.

If, when valuing an intangible asset, a sufficient number of analogues can be found, the value of its value obtained using this approach will be the most accurate in comparison with the values ​​determined by other approaches, i.e. will have minimal error. This is the main advantage of the comparative (market) approach.

However, the use of a comparative (market) approach to evaluate intangible assets is difficult due to the fact that such objects are practically unrepeatable. There are objects, such as patents, trademarks or rights to works of art, for which it is simply impossible to find analogues. In addition, intangible assets are most often sold as part of a business; their separate sale occurs quite rarely.

Cost-effective approach

When applying the cost approach, the value of an intangible asset is determined based on the amount of costs for its creation or acquisition. The main advantage of the cost approach is the ease of obtaining initial data for calculating the value of intangible assets; in addition, all costs can be documented.

It should be noted that currently, in accordance with Russian accounting regulations (PBU), intangible assets are accepted for accounting at their actual (initial) cost, calculated on the basis of the cost approach. According to International Financial Reporting Standards (IFRS), this type of valuation is called cost.

The procedure for calculating the actual (initial) cost of intangible assets depends on the route of their receipt into the organization. As you know, intangible assets can enter an organization in various ways. Among them are the following:

• purchase for a fee;
• creation within the organization;
• exchange for other property;
• free receipt;
• making a contribution to the authorized capital;
• privatization of state and municipal property.

One of the disadvantages of the cost approach is the discrepancy between present costs and their future costs. Existing methods for assessing intangible assets within the cost approach do not fully take into account inflationary changes in the purchasing power of money, as well as the ability of money to generate income, provided they are wisely invested in alternative projects.

Income approach

Unlike the cost approach, the income approach allows you to evaluate the possible economic benefits that intangible assets can bring. In foreign practice, such benefits are usually called fair value.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (IFRS 13 Fair Value Measurement).

In the economic literature, the issue of using fair value in domestic accounting practice as a type of valuation of accounting objects is currently the subject of debate. The arguments in favor of fair value accounting are that fair value provides a more objective basis for estimating future cash flows than the cost method, provides a basis for comparability of asset information, is best combined with active management principles and facilitates a more objective assessment of performance. management work.

One of the main disadvantages of fair value accounting is the significant difficulty in determining fair value in the absence of an active market. They entail another negative aspect associated with the use of fair value - high labor intensity and large additional costs caused by the need to attract professional appraisers.

Economists believe that a significant disadvantage of valuing assets at fair value is the impossibility of documenting this valuation in many cases and the likelihood of manipulation with valuations, which will not allow accounting to perform one of its main functions - control. As is known, the control function of accounting is performed only when reflecting accomplished facts of the organization’s economic activity. In addition, accounting information has legal force if it is supported by relevant documents.

It seems that fair value can be used in domestic practice, but not in current accounting, but when disclosing information in explanations to the main forms of financial statements. The information included in the explanations does not have to be generated in the accounting accounts; it can be determined by calculation. Consequently, it is possible to evaluate intangible assets at fair value determined on the basis of the income approach for the purposes of disclosing information about them in the financial statements.

A problematic issue that arises when assessing an organization's assets at fair value is the choice of an indicator that most reliably reflects this value.

There are many approaches to determining fair value, and therefore indicators that reflect it. For example, under certain conditions, fair value may be expressed by market value, replacement cost taking into account depreciation, discounted value and other types of values. In foreign practice, most often the best indicator of the fair value of an asset is its market value. However, these concepts are not equal.

Market value fully corresponds to the concept of fair value only in active market conditions, i.e. a market in which prices are determined by supply and demand, transactions are carried out quite often, without coercion, and the parties involved are independent of each other. Due to the specific nature of intangible assets, there is practically no active market for them.

As already noted, one measure of fair value may be present value. Using the discounting method to determine the fair value of an organization's assets has a number of advantages.

Firstly, the discounting method allows you to overcome fairness only at the time of the transaction. Secondly, its use takes into account the utility of the asset in terms of the future economic benefits associated with owning the asset. Thirdly, discounted value is less susceptible to fluctuations in market conditions, since it is based on factors that most fully take into account the possible characteristics of assets: cash flows generated by assets over time and all kinds of risks.

What is the valuation of intangible assets and when might it be needed?

The rapid development of high technologies in recent decades has led to the fact that the effective operation of enterprises in many industries has become impossible without the use of a variety of intangible assets. Otherwise, such firms simply cannot withstand the enormous competition and receive profits that are less than expected.

Intangible assets are company property that does not have a real physical embodiment. Moreover, by analogy with fixed assets, it has a useful life of at least 1 year, is used in commercial activities and directly participates in generating the enterprise’s profit.

All intangible assets can be divided into 4 groups:

• Goodwill (company price, business reputation);
• Investment costs (payment for consultations when creating an enterprise, etc.);
• Property rights – lease, license for natural resources;
• Intellectual property – patents, licenses, know-how and much more.

Example

An enterprise trademark is one of the most common types of intellectual property. For a long-running and successful company, the cost of a trademark may be higher than the price of fixed assets. However, to put it on the balance sheet, a special procedure is required - assessment.

Valuation of intangible assets is the determination of the market value and value of an asset using a variety of technical, statistical, mathematical and other methods. It includes a professional examination of the objects themselves, the rights to use them and documents of protection.

Read about the rules by which an independent examination is carried out in our related article.

The chosen valuation method directly depends on the type of intangible asset. However, in any case, the appraisal company will adhere to the rules set out in the federal standard FSO-11, which regulates the examination of intangible assets.

An assessment is required in the following cases:

• when using intellectual property as a contribution to the authorized capital;
• when determining damage from unauthorized use of intangible assets by third parties;
• to add assets to the balance sheet of the enterprise;
• to optimize taxation – intangible assets on the balance sheet are subject to depreciation, which means they reduce the income tax base;
• when lending or attracting investments - to increase the value of the authorized capital and improve the balance sheet structure;
• when a business is assessed (read a separate article about this) – goodwill is a significant part of the price of the enterprise.

Like any other property, intangible assets have different types of value - replacement, insurance, market, investment, collateral - depending on the purpose of the assessment. One of the key types of cost is the initial cost, that is, the one at which the asset will be placed on the balance sheet after receipt.

Methods for determining the initial value of assets:

The assessment of the value of intangible assets is carried out according to the same principles as determining the value of fixed assets, real estate, etc. In this case, three fundamental approaches are used: comparative, cost and income.

Cost of intangible assets

Today there is no data on the value of intellectual property, and the stock market is underdeveloped. Therefore, of the methods listed above, it is necessary to highlight the costly one. It allows you to study the cost of each component of an intangible asset, and then, by summing it up, determine its final price.

The procedure for assessing intellectual property objects includes several stages. First, the structure of intangible assets is analyzed and its components are determined. Then the elements are assessed individually and the most suitable method for analyzing the components is selected and calculations are made.

At the third stage, the degree of wear and tear of the components of the IP object is examined. Depreciation in this case means loss of usefulness and, accordingly, value. Thus, the evaluation of a patent takes into account obsolescence associated with the emergence of new, improved analogues of the patented invention.

At the end, the residual value of all parts of the intellectual property is calculated and its total assessment is made. The residual value of an intangible asset can be calculated by subtracting accumulated depreciation from its original cost.

By assessing the market value of intangible assets and other results of intellectual activity, the following tasks can be solved:

1. increasing the company's capitalization;
2. allocation of additional assets that have independent commercial interest;
3. assessment of the amount of material damage resulting from the illegal use of intangible assets by third parties.

Intelligence and Energy

The assessment of intangible assets is of enormous importance for companies operating in any high-tech industry, for example, in the energy sector. In a highly competitive industry, only the unique nature of an enterprise's intellectual property can provide sufficiently strong and high barriers in the long term. This will make it possible to receive stable income in the market from the monopoly use of new technologies or the sale of patents and licenses.

The main problems of domestic companies operating in the energy market is the lack of a regulatory framework confirming the development, creation and use of intellectual property. The management of intellectual property of domestic energy enterprises, as a rule, is carried out by specialists who do not know the mechanisms of legal regulation to protect against unfair competition.

Creating an effective system for managing an enterprise's intellectual property can reduce innovation risks and facilitate the process of introducing innovative technologies to the energy market.

Of course, if an organization is well known and has already established a reputation through a long history in the market, the value of intellectual property may represent a significant portion of its total value.

However, we have to admit that the value of intellectual property is quite often underestimated in Russian business practice. Meanwhile, the skillful use of information about the real value of intangible assets can significantly strengthen the market position for a company of any size.

Features of assessing the value of intangible assets

The complexity of assessing intangible assets is primarily due to the complexity of quantifying the results of the commercial use of these assets that are at one or another stage of development, industrial development or use, due to the influence of a number of multidirectional factors.

Here we review methods for valuing intellectual property and discuss full ownership rights to it. But in practice, much more often it is necessary to determine the value of individual parts of property rights to use intellectual property, and a specific task arises of assessing the value of several license agreements.

The experience of Western countries shows that to estimate the value of such contracts, the method of standard royalty rates, such as the rate for the use of an IP object, can be used. The rate is calculated depending on the profitability of using a given object, as well as on the period of use of the intellectual property object, production volumes, costs of its creation, as well as a number of other factors. Basically, licensing rates are determined as a percentage of the unit price of the product produced through the use of the IP object, of net income, or of the sales amount of the patented product.

What approaches are used when assessing intangible assets - 3 main approaches

Valuation of intangible assets is a rather complex procedure that requires high professionalism of the performer.

The main difficulties lie in the lack of physical form of the object, and often in the inability to clearly classify it.

Let's consider the essence of the main approaches to assessment.

Approach 1. Comparative

The valuation is based on the value of similar assets. In case of discrepancies in quality characteristics, special coefficients are used.

The method is not always applicable, because It can be difficult to find similar intangible assets on the market.

Approach 2. Costly

The value of an asset is based on the actual costs of creating or acquiring it. Difficult to use in cases where the object is inseparable from others. At the same time, the assessment of intangible assets acquired for a fee is carried out primarily using cost approach methods.

Approach 3. Profitable

Considers the value of an object as an increase in the income that the company received from the use of intangible assets. In this case, the assessment may be relatively inaccurate, because factor analysis is used.

Example

If we consider the assessment of the value of intangible assets using the example of a trademark, it is easy to see that not all types of assessments are suitable. The comparative approach does not “work”, since it is difficult to find analogues on the open market.

The cost approach does not give an accurate picture, because the real cost of a trademark is formed much later and sometimes exceeds the costs of its creation. The income approach is considered optimal, and if it is impossible to use it, the appraiser bases conclusions on the cost approach.

Read about how property valuation is carried out in the corresponding article.

Economic effect

When assessing intellectual property, the most difficult task is to determine the economic effect of using an intangible asset. An important task is to determine the share of net income received specifically from the use of the asset being valued, for which factor analysis is usually used. For example, the use of an invention allows you to obtain net income by reducing production costs, increase the cost of products by improving their quality, increase sales volume, and reduce income taxes.

A serious difficulty in determining the value of intangible assets is that investment is required to introduce them into production. Part of the net income from the implementation of an investment project is the income from the use of the IP object. In this regard, it is necessary to first develop an investment project, draw up a business plan in which to calculate the expected net annual income. Then, highlight that part of the income that can be attributed to the intangible asset used.

In this case, the share coefficient is calculated taking into account the savings factor, and the use of some inventions allows you to reduce the amount of income tax.

When assessing intangible assets, an increased premium is determined for risk, since investments in these assets are highly risky. The use of intangible assets in the business turnover of a company allows you to optimize income tax. But first, it is necessary to carry out a competent assessment of the value of intangible assets; they must be placed on the company’s balance sheet as IP objects.

Valuation of a company's intangible assets is the determination of the value of five main types of intellectual property: copyright, trade secrets, industrial property, goodwill, and other (non-traditional) types of intellectual property.

When assessing the value of IP objects, it is necessary to take into account the objects included and not included in the balance sheet of the enterprise. For example, business reputation (goodwill) is not taken into account in the company's balance sheet. But this intangible asset must be taken into account when assessing the value of a business, since in some cases it can have a significant impact on the company’s capitalization.

IFRS, Dipifr

An assessment of the value of intangible assets, or intangible assets for short, is necessary for their recognition in the balance sheet. In general, the valuation principles do not differ from those for tangible assets: the initial valuation is made at the cost of acquisition or creation (at cost). If an intangible asset is acquired in a business combination, the fair value of such intangible asset must be determined. To prepare the article, materials were used from the official website of the International Standards Council (iasb.org).

The assessment of the value of an intangible asset depends on the method of its acquisition. Intangible assets acquired as part of a business acquisition (business combination) must initially be recognized in the consolidated financial statements at fair value. If intangible assets were acquired separately or created internally (as a result of R&D), then such assets are measured at cost. In the first case, the problem is how to measure fair value . In the second case, all the figures are known, and the issue of assessing intangible assets comes down to determining which expenses can be capitalized into the cost of an intangible asset, and which are expenses of the period.

In this regard, consideration of the topic of assessing the value of intangible assets must be divided into two parts:

1. assessment of the fair value of intangible assets acquired during the purchase of a business 2. assessment of the cost of intangible assets when purchased or created within the company

The second part of the article, concerning the assessment of intangible assets when acquired or created within a company, is published separately.

Valuation of intangible assets acquired when purchasing a business

According to IFRS 3 Business Combinations, if an intangible asset is acquired as part of a business combination, the cost of the intangible asset is equal to its fair value at the acquisition date. If the fair value of the intangible asset is known, then everything is simple:

Example 1: Business Combination - Valuation of Intangible Assets

On January 1, 2014, Alpha (the buyer) purchased all of the issued shares of Beta (the subsidiary). The following information is available about the carrying and fair value of the acquiree's intangible assets:

In 2014, Alpha company incurred additional expenses in the amount of RUB 200,000 for research work on the acquired R&D project. Alpha is still unable to demonstrate the technical feasibility and commercial viability of the project.

What amount should be recorded for intangible assets in the consolidated statements on the date of purchase of the subsidiary?

Solution

1) As of January 1, 2014 (the date of acquisition of the subsidiary), intangible assets must be reflected in the consolidated statements at their fair value:

There is a slight complication here regarding the recognition of subsequent costs of the research project. Although this research project was recognized as an intangible asset, subsequent costs of ₽200,000 are recognized as an expense as incurred (as these costs are at the research stage).

Yes this is true! If a research project was acquired as part of a business purchase and its fair value can be determined, then it is recognized as an intangible asset. But subsequent project costs are written off as expenses if the company cannot demonstrate that all six points have been met to “move” the project into the development stage!

paragraph 43, IAS 38 Subsequent costs of an in-progress research and development project acquired separately or as part of a business combination and recognized as an intangible asset: ● (a) are recognized as an expense when incurred if they are research costs; ● (b) are recognized as an expense when incurred if they are development costs that do not meet the criteria for recognition as an intangible asset in paragraph 57; and ● (c) increase the carrying amount of the acquired research and development work in progress if it is development expenditure that meets the recognition criteria in paragraph 57.

Paragraph 57 of IAS 38 is precisely the paragraph that lists the criteria for moving to the development stage and capitalizing subsequent costs.

Why is the research project even recognized in the consolidated financial statements in this case?

It would seem that, according to IFRS 38, expenses at the research stage should be written off as period expenses. The subsidiary reporting under IFRS undoubtedly did just that - it wrote off the expenses for operating profitability. In the table, in the “book value” column, only “license” has a book value, i.e. In the reporting of the subsidiary as part of the intangible assets, only the license was reflected. Internally generated brands and customer lists are not recognized in the same way as research expenses. What happens when Beta Company is acquired by Alpha Company?

In short, IFRS 3 “Business Combinations” (the main consolidation standard) requires recognizing separately from goodwill all identifiable acquired assets that meet the definition of an asset (clause 10, clause 11 of IFRS 3). In relation to intangible assets acquired in business combinations, the asset recognition criteria (high likelihood of future economic benefits and reliable measurement of value) are always considered to be met (clause 33 of IFRS 38). In fact, the very fact of buying a company indicates that the buyer expects future economic benefits from everything he bought. For a research project, this may include closing access to a competing technology (a competing project was bought and closed). Uncertainty about the outcome of an individual project is reflected in the estimate of its fair value. Thus, if the acquirer of a business can identify intangible assets separately from goodwill and can estimate their fair value, then such assets are recognized in the consolidated statements (regardless of whether they were recognized in the individual statements of the subsidiary).

International standards allow the recognition of internally created trademarks (brands), customer lists as a result of business combination transactions. But qualified personnel are not recognized as intangible assets at all; control criteria are never met for them.

BC 174, IFRS 3 The IASB concluded that recognizing intangible assets separately on a fair value basis, rather than including them in goodwill, provides users of financial statements with improved information, even if a significant degree of judgment is required to measure fair value. .

You can agree or disagree with the International Standards Council's reasoning, but the principles are what they are.

Identification of intangible assets during consolidation

Methods for identifying identifiable intangible assets vary depending on the specific situation; it is difficult to come up with a universal algorithm. It is important to understand the business of the acquired company, what its intangible resources are, how they are used to generate profits, and how they can be transformed into identifiable intangible assets. In other words, the question needs to be asked: what was paid for?

The subsidiary's financial information will likely have important proxies. For example, high advertising expenditures may be an indicator of the relative importance of a brand name, logo, and similar marketing-related intangible assets. If a company incurs significant research and development expenses, it is likely to create technology-based intangible assets. The relative importance of customer service expenses may indicate possible customer relationship intangibles.

If a business depends on specific usage rights, such as access to licensing agreements or infrequent supplies of raw materials, this may indicate the presence of relevant intangible assets. Examples are long-term contracts for the supply of energy, water or metal.

Goodwill previously recognized by the acquired (subsidiary) company should not be taken into account. However, some assets that were fully depreciated in the subsidiary's accounting may still be in use and meet the definition of identifiable intangible assets.

An asset satisfies the identifiability criterion if it:

• (a) is separable , that is, can be separated or separated and sold, transferred, licensed, leased or exchanged individually or together with a related contract, asset or liability, whether or not the company intends to do so ; or
• (b) results from contractual or other legal rights , regardless of whether those rights are transferable or severable from the entity or from other rights and obligations.

Of course, most of the intangible assets recognized are assets based on contractual or legal rights. These are: registered trademarks, patented technologies, licenses to use something, franchising agreements, Internet domain names, permits for licensed activities. But there are intangible assets that are identified based on the separability criterion: customer lists, research projects, databases.

Fair value measurement methods in brief

Estimating fair value is the most difficult part of the job. In example 1, the “fair value” column is already filled in. In practice, the assessment of the fair value of intangible assets will either be entrusted to an independent appraiser who has experience in such assessments, or management will have to do it themselves.

In short, there are generally three methods for estimating fair value:

1. market - comparison of the asset in question with similar assets that have been bought and sold in recent market transactions
2. profitable - discounting expected future cash flows from an asset
3. costly - an estimate of the costs that will be incurred to replace an asset

In fact, the first method is a comparative method of assessment, and the other two are calculation methods.

Market valuation method

The most reliable estimate of the fair value of an intangible asset under IFRS 13 is the current quoted price for an identical asset in an active market , the bid price. If current prices are not available, the basis for measuring fair value may be the price of the most recent similar transaction, provided that there have been no significant changes in economic conditions between the date of that transaction and the date the fair value is measured.

An active market is a market where all of the following conditions are true:

• (a) the objects traded on the market are of a homogeneous nature;
• (b) buyers and sellers willing to transact can generally be found at any time;
• (c) pricing information is publicly available.

This all sounds great in theory, but in reality there is usually no active market for intangible assets. An active market simply cannot exist for brands, print titles, music and film rights, patents or trademarks, since each such asset is unique. Only for certain intangible assets can market prices be used to estimate fair value. For example, in some jurisdictions an active market exists for freely transferable licenses for certain activities: taxi services, fishing licenses or production quotas. In general, intangible assets are sometimes bought and sold, but such transactions are relatively infrequent. In addition, price information is often not available to the public because many transactions are conducted through private arrangements between buyers and sellers (not on the open market). It is really difficult to find examples of transactions and prices for identical or similar intangible assets. But even if such examples can be found, the price paid for one particular asset cannot reliably indicate the fair value of another, since most intangible assets differ in their characteristics. And adjustments to observed prices to estimate the value of a particular asset can be highly subjective.

Therefore, in most cases, the fair value of intangible assets must be estimated using indirect valuation methods. These are cost-effective and profitable methods. Calculation methods for measuring fair value for accounting purposes are discussed in more detail in a separate article.

Other articles:

Intangible assets: what they include in accounting, examples, accounting according to IFRS 38

IFRS 13: fair value measurement provisions explained

Discounting in IFRS. Learning to discount using the Dipifr exam problems

What is an IPO? Initial public offerings using the example of Twitter, Google and Facebook

The South Sea Company and England's national debt

Statistics on the application of IFRS 38 in practice

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Future Benefits

The traditional system of accounting for intangible assets and intellectual property in a company occurs in the same way as accounting for tangible assets. This leads to the fact that cash flows and profit flows based on accounting data distort the actual value of intangible assets and the company's capitalization. The cost of intangible assets plays an important role in determining the total value of an enterprise.

To create a full-fledged IP management system in an organization, it is necessary to bring the legal framework of the enterprise into compliance with the legislation of the Russian Federation in terms of accounting for intangible assets.

Intellectual property can bring significant economic benefits to a company in the future, for example, in the provision of services, in production, for management needs or in business activities.

Thus, an organization has the right to receive those economic benefits that intangible assets will bring to it in the future, if it has properly executed documents confirming the existence of the asset itself and the rights to it, and also has control over IP objects.

Effective management of intangible assets and their involvement in turnover is one of the conditions for increasing the competitiveness of an enterprise. Therefore, it is important to consider intellectual property not only from the point of view of its protection, but also from the point of view of assessing its practical market value.