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Accounting of Intellectual capital

srividyaa (112 Points)

28 February 2008

I want notes on Valuation and Accounting of Intellectual capital?

Can anyone help me out?

Thanks and Regards

Srividyaa

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3 Replies

S.Srinivasaraghavan (Chief Financial Officer and Co) (11318 Points)
Replied 29 February 2008

This is a huge subject

Acceptable methods of the valuation of identifiable intangible assets and intellectual property fall into three broad categories. They are either

1.Market based
2.Cost based
3.Estimated future economic benefits based

In an ideal situation, an independent expert will always prefer to determine a market value by reference to comparable market transactions. This is difficult enough when valuing assets such as bricks and mortar because it is never possible to find a transaction that is exactly comparable. In valuing an item of intellectual property, the search for a comparable market transaction becomes almost futile. This is not only due to lack of compatibility, but also because intellectual property is generally not developed to be sold, and many sales are usually only a small part of a larger transaction and details are kept confidential. There are other impediments that limit the usefulness of this method, namely special purchasers, different negotiating skills, and the distorting effects of the peaks and troughs of economic cycles. In a nutshell, this summarises my objection to such statements as 'this is rule of thumb in the sector'.

Cost based methodologies, e.g. the cost to create or the cost to replace, assume that there is some relationship between cost and value, and the approach has very little to commend itself other than ease of use. The method ignores changes in the time value of money and ignores maintenance.

The method of valuation flowing from an estimate of future economic benefits can be broken down to four often-overlapping limbs; capitalisation of historic profits, gross profit differential methods, excess profits methods, the relief from royalty method and discounted cash flow analysis.

While the capitalisation process recognises some of the factors which should be considered, it has major shortcomings, mostly associated with historic earning capability. The gross profit differential methods are often associated with trade mark and brand valuation. The excess profits method is associated with earnings capability in order to induce investment and, while theoretically relying upon future economic benefits from the use of the asset, the method has difficulty in adjusting to alternative uses of the asset. Relief from royalty considers what the purchaser could afford, or would be willing to pay for the licence. The royalty stream is then capitalised reflecting the risk and return relationship of investing in the asset.