This is the second of our January posts exploring the value problem. It’s a problem that affects me, you and Wall Street too...
Many of our readers and contributors will be familiar with why intangibles are so hard to account for. It’s an issue that goes to the heart of the accounting methodologies used around the world today. These are predominantly based on the double entry bookkeeping system.
Utilised perhaps as far back as the 12th Century BC, double entry bookkeeping was designed to capture financial transaction flows. However, internally developed intangible assets can rarely be described in a transactional way. They are usually developed over the course of a long and involved timeline. There are very few points along that timeline at which you can take an accurate value snapshot.
There are two fundamental ways to respond to this:
· First – Fight for the revolution. Refuse to conform to the tyranny imposed by the double entry bookkeeping system and take up arms! Declare from the rooftops that IP is an emerging asset class that doesn’t yet have fully defined value parameters that conform to transaction flows. Perhaps even cue some tears and sombre violins, the wringing of hands and so on to make your point.
· Second – Surrender. Lie down quietly with a whimper and use a process that essentially conforms to the double entry bookkeeping system.
It’s a generalisation, but most of the responses to the value problem that we see in the world of intangibles are in the first category. We’ll address those in this post and the second category in our posts in the following weeks.
There are multiple IP valuation methods recognised in Australia. None of them have garnered widespread acceptance, and they each tend to recognise very different aspects of the asset class. One enterprise may prefer to account for the value of an intangible in terms of what is spent on it, opting for the cost valuation method. Another may prefer to value the asset in terms of the royalties or cash flow it generates (or the amounts it would generate if out-licensed). Others may prefer to characterise the asset in terms of the value it would fetch if it were sold (the Comparable Market Transactions method).
The results from each method are also likely to vary considerably – if you use the cost method, your resulting figure is not likely to resemble the figure you would have obtained by using a valuation derived from royalties or cash flow generated (particularly if the intangible in question is in an early development phase).
While none of these methods explicitly require transactions to take place in order to work, they all look to transactional criteria to assess value. For instance, the Cost method relies on the recording of cost transactions so that an accrued figure can be arrived at. The Comparable Market Transactions method takes data from other transactions to get an indication of what the market would pay, and so on.
There are a couple of observations that can be made here. First, it is not possible to completely avoid transactional criteria in valuing our IP. At some point, we will need to rely on data derived from transactions, whether they directly contribute to the actual value figure or not. Second, it is almost impossible to arrive at an objective valuation figure for any one intangible. This means that the method you use should best reflect the use (or lack of use) of the intangible asset at the time.
Will these methods allow you to win the confidence of investors, boards and other stakeholders? Will you be able to use the results as hard numbers in your annual accounts sometime in the future? Perhaps on both counts - we can’t answer these questions with certainty. One thing is certain, though, you’re better off actually starting with one method, any method, instead of sitting on your hands. The cost methodology is as good as any to begin with – see Mary Adams’ proposal about this here. The results will, at the very least, provide your enterprise with more accurate data about what you spend, and whether there is a return on investment.
However, we’re happy to report that these aren’t the only methods available to you. In next week’s post, we’ll take a look at the attribution of value using strategic structures.
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