30 May 2013
Difference between Brand and Goodwill: Goodwill is defined as the difference between the net assets of a company and the price paid by its purchaser. EMERGENCE OF BRANDS
THE BACKGROUND: The debate of the brands came to the force in the late 1980’s with the activities of a number of food companies. In early 1988, Nestle (UK) made a bid for Rowntree, with more than twice the Company’s market capitalisation at that time. Mc Dougall started capitalising the brands that they owned or acquired, implying that these brands possessed hidden values. The service sector companies like The Daily Telegraph Ltd, Lonhro plc etc have valued their brands and showed them in balance sheets. Thus began the hottest debate on brands in Balance Sheet.
THE PRESENT SITUATION
In UK – It had a divergent treatment for goodwill and brands. If brands can be shown as separable assets, they need not be written off, as goodwill should be. Brands should be fully amortised over their useful economic life of upto 20 years except in special circumstances. Homegrown brands are not allowed to be shown in the balance sheet, as it is very difficult to identify the cost of the brand developed. Many companies have incorporated brand values in their balance sheets. Wide Technical Report 780 UK had removed the differential treatment of brands. Now there is a distinction between brands and goodwill in UK practice. This means like Goodwill, brands should be written off immediately upon acquisition. WHY BRANDS SHOULD BE INCLUDED IN BALANCE SHEET
TRADITIONAL VIEW BLURRED: The traditional view is that any valuation figure, other than one supported by a specific purchase price on change of ownership is too arbitrary at all to be credible. Also the traditional view is that the balance sheet is not intended as a statement of corporate worth and that subsequently, inclusion of values of brands in fixed assets would mislead the figures in the balance sheet.
The flaw: First of all the view that only those assets which have substance or spatial dimension should be properly considered as a ‘valuable asset’ for accounting purposes is questionable. Any value fixed on a given brand is dubious, but many of the fixed assets that are shown in balance sheets have similar contestable figures- like land etc. Eg. Assets like ‘Hero Honda’ (two wheeler) after being used for 8 years are being offered for sale at Rs. 17,000 as against the cost of Rs.12, 000.
UNFAIR VIEW: The effect of the above is that in the failure to recognize brands and in the systematic undervaluation of assets (at historic costs) acknowledged to exist, companies maintain substantial unrevealed reserves. Such a practice can not be justified as fair in the interests of shareholders or investors. The shareholder has the right to be appraised of the totality of assets that are available with the company. Besides understatement of intangible assets like brands, when the company is using them to earn profits is not useful to the shareholders in judging the efficiency of management. We do value real estate on the basis of the future income. Similarly brands should be valued based on their future earnings potential. Adventurous bankers, (in UK), have started to talk about issuing backed securities and/ or using brand collateral as security for debt issues.
HOW DOES BRAND VALUATION EFFECT STOCK MARKET:
It is argued that the net worth of a company is readily calculable by the market price of the company. This price is reflective of the present and prospective returns there on. Then the difference between the above net worth of the company and as proclaimed by the company is of great importance to the shareholders and investors. Since the market prices are volatile, the shareholders, investors would rather prefer to look at the Balance sheet that includes future earnings potential of the company, than depending on the stock market prices. Brands in balance sheet would at least reduce his apprehensions since the inclusion lead to a fair picture of the rate of return. Further, the management’s efficiency is reflected in the ROI that is achieved by the company.
Ex. the ratio, PAT / Fixed assets + Net current assets, without brand value, this would show a much higher value. The ROI thus becomes a better indicator if brand value is included.
THE ADVANTAGES:
1. The inclusion of brand value in balance sheet gives a better picture of the company as having good assets and good brand value.
2. At the same time apparent return on assets (without inclusion of brands) will be brought down to more realistic figures.
3. In many of the takeovers, goodwill element in the price of the net assets has been increasing. Sometimes the price paid for goodwill is greater than the acquiring company’s net worth with the result that the consolidated accounts show negative shareholders equity. This looks preposterous. Some of the companies have reassessed the assets acquired in take overs and reclassified the goodwill as brands.
4. Company’s brand management will certainly be sharpened up (e.g. brand P&L accounts)
5. The Company’s debt equity ratio is improved i.e. it reduces the gearing ratio and so increases the Company’s borrowing capacity.
6. It particularly helps service sector companies where there are low assets levels, but strong cash flow and customer bases.
7. The company is more expensive to acquire which may deter hostile bids.
8. The asset value does not come down as long as it is maintained by proper promotional and advertising efforts. There is no depreciation and thus no impact on P&L.
9. The goodwill arising from an acquisition can be reduced.
10. Recognising the value of brands separately at the time of acquisition reduces the amount of goodwill that must be written off either directly to reserves or by amortisation over a number of years. Immediate write off has detrimental effect on consolidated reserves and confuses the real value of acquisition of the business whereas amortisation has a continuous adverse and unrealistic effect on future profits.
11. It helps better comparison between companies operating in similar markets, or between companies with varying mixes of acquired and homegrown brands.
12. Many creditors have found in an insolvency situation that some current assets such as inventory are relatively worthless even though classified as current asset. Also, we cannot recover goodwill but brands can be transferred and can be converted into cash.
13. For the businessmen brands are often the most important competitive advantage. It is the success or failure of brands that so often determines the manager’s success or failure. This concept will be translated into reality if brands are included in the balance sheet.
SHOULD BRAND BE AMORTISED?
The amortisation period is the period during which benefits are expected to arise. The life is deemed to be finite (prudence principle) but not fixed. Most of the businessmen find it easier to write off immediately against reserves and weaken the balance sheet than to touch the EPS by amortising brands. Most of the companies are inclined to amortise it. But the guidelines prescribed by the Accounting bodies are against it.
“DOUBLE COUNTING”:
The acquisition of the brand is reflected in the balance sheet at cost. The companies spend significantly on marketing support of brands which is charged through P&L account. If the brands are depreciated, this would lead to double counting.
SHOULD HOMEGROWN BRANDS BE VALUED AND AMORTISED?
In disallowing the capitalisation of homegrown brands, a degree of comparability between competing company is lost. Whether acquired or home grown, brands require considerable expenditure, generate substantial income and add substantial value to the company. Allowing home grown brands to be capitalised would eliminate this inconsistency.
Companies know more about homegrown brands. Thus it is easier to value them. If a business builds its own factory instead of buying one, we capitalize it; why should brands be treated differently?
If accounting laws force companies not to value home grown brands they could easily find a way out by selling the brands to another company and again buy back from them. Clearly this is the best evidence to show that homegrown brands have a value too.
IN USA: It is a standard practice to capitalise and amortise goodwill. No asset revaluation is permitted. All purchased intangibles must be treated in the same way as goodwill. Maintenance costs of goodwill and all other intangibles must be written off to expenses. Thus there is no incentive for US companies to distinguish brands from goodwill, as the resulting treatment would be identical.
IN AUSTRALIA: Acquired goodwill has to be amortised though the P&L account for a maximum period of 20 years. But unlike in UK and US, Australian has a modified historical cost accounting system, so that fixed assets may be revalued at market price every 3 to 5 years. Intangible assets like brands may be carried at market value. Acquired brands must initially be recorded at their cost of acquisitions. All brand names may be revalued with either upwardly or downwardly adjustments.
ELSEWHERE: In most countries the acquired brands are capitalised and then amortised through the P&L, the depreciation period varies considerably. Five years is the maximum in Japan, forty years in France, and the brands expected life in Germany.
The argument in favour of capitalising brand names is related to the old adage – out of sight (if it is written off) out of mind. If brands are capitalised, management is more likely to continue a process of maintaining the values.
A court appeal made a distinction between ‘CAT’ goodwill which is loyal to the business and stays with the buyer if it is sold and a ‘DOG’ goodwill which is loyal to the owner and thus is lost to the business in case of a sale. Hence ‘dog’ goodwill must be written off while ‘cat’ goodwill need to be.
IN INDIA: According to AS – 10, Accounting for Fixed Assets, issued by the Institute of Chartered Accountants, goodwill in general, should be recorded in the books only when some consideration in money or money’s worth has been paid for it. As a matter of financial prudence goodwill is written off over a period. However this is not mandatory.
No guidelines has been issued by ICAI on brand valuation, as it is a relatively new concept in India. Major MNC’s like Unilever group, Proctor and Gamble, Nestle and reputed Indian companies like Tatas, Reliance could benefit a great deal by valuing brands and including them in the balance sheet. Now that AS - 26 is applicable, the brands can be valued if and only if they are purchased and not self generated.
VALUATION OF BRANDS:
One of the most important reasons why a valuable asset like brands is not shown on the balance sheet is because of the complexity involved in its valuation. However if the company can show that it is the beneficial owner of a valuable asset then the seemingly serious difficulty of putting a firm price (value) on brand cannot be accepted as a reason ( by any accounting principle) for refusing to record the value of brands in balance sheet. There are various methods of valuation but each has its own draw backs. They are briefly discussed below:
METHODS OF VALUATION
01. Valuation based on the aggregate cost of all marketing, advertising and research and development expenditure devoted to the brand over a stipulated period.
02. Valuation based on premium pricing of a branded product over a non branded product.
03. Valuation at market price
04. Valuation based on customer related factors such as esteem, recognition or awareness.
05. Valuation based on potential future earnings discounted to present day values.
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