Intangible and legal assets (part I)

The last years of the previous century may be easily called a decade of intangible and legal assets. A lot of articles and specialist books have been written about this topic. It is generally accepted among the specialists and business practitioners that intangible and legal assets are the driving force and a very important item of a company value.

Theory and practice of the international business have developed the following terms: identification, valuation, and management of intangible assets. Identification of intangible assets is essential for describing the ownership value as well as projecting investment options. Valuation constitutes the basis for the management processes ( establishing goals, strategies, planning, investment structure and utilization as well as controlling), preparation of the business operations where intangible assets are involved ( pricing policy and strategy, negotiation goals, preparing contracts – clauses and real-options).

Incorrect identification or valuation of intangible assets may cause many major errors in the decision making considering financial standing or investments.

There are thus at least three major problem and many typical questions:

1. Problems with identification.
a. Which asset should be qualified as intangible?
b. Can every such asset be recorded? In which operations or accounting event can such record occur from the point of view of the accounting regulations and other business regulations (purchase, contribution of capital, donation, manufacturing operation, capital transaction and capital transformation, etc.) ?

2. Problems with valuation.

a. Who and how should valuate the intangible assets. In which operations this should be done, (should it depend on subject of valuation, type of business operation or available data etc.)?
b. Which methods and what procedures of valuation should be applied? Should the valuation be verified (by court expert or independent expert), and in which circumstances (for the registry court, Inland Revenue or in the case of negotiations in progress etc)?
c. Is the valuated asset subject to depreciation, including tax depreciation (how will it influence the level of the future profit and tax target) and in which circumstances (subject and type business operation)?

3. Problems with management.

a. Which, if any, items of intangible assets portfolio should be managed?
b. How should this process be organized (centralizing, outsourcing, joint venture)?
c. Which instruments of strategic and operational management should be applied (controlling, monitoring, strategic analysis)?
d. How should protection, risk management and internal audit be organized, in the case of the management of the intangible and legal assets portfolio?
e. How to integrate management of intangible assets with management of the company value?

Identification and valuation of intangible assets

Many classification methods have been created for the purpose of the identification of intangible assets. They are helpful in seeing the identification of intangible assets from various points of view.

First classification method. (according to Gordon V. Smith, Russell L. Parr. Valuation of Intellectual Property and Intangible Assets. Second edition. New York, 1994).

From the point of view of the above classification the intangible assets could be generally divided into:

1. individually identified,
2. unidentified (goodwill – total value, of intangible assets which are impossible to identify individually or ongoing concern – value of the company’s functioning).

Second classification method. (according to Lev Baruch, 2003).

1. Knowledge and new discoveries– (new products, services, patents communities, intranet, adaptation abilities)
2. Customers – trade marks, on-line distribution channels, marketing alliances.
3. Human resources –remuneration and motivation systems, trainings
4. Organizational structures – business and operation structure, information systems, controlling.

Third classification method (according to American Appraisal Associates, 2003).

1. Marketing – trade marks, internet domains.
2. Technological – hardware and software, patents, know-how, data bases.
3. Customer – contracts, production lists and order lists, customers lists, operations not bound by contract
4. Legal – lease and licensing contracts, managerial , advertising, requirement contracts
5. Artistic – intellectual rights to: books, articles, photos and films

Generally speaking, intangible assets and intellectual property are characterized by the following features: they are not material, from the financial reporting point of view they constitute the asset not always included in the balance sheet, rarely identified in a precise manner. Intangible assets determine the advantage that a company has over competition; they are impermanent and require careful management. Investing in intangible assets is associated with high profitability and with the increased risk level.

What does it mean that intangible asset has value?

First of all, it will be helpful to make a distinction between the facts of owning an intangible asset and the idea of its economic value. Let us suppose that a company bought licensing rights for a modern technology. After some time it turns out that the company does not employ this new technology in its operations, moreover it does not intend to use it in the future (we are excluding unusual circumstances such as blocking the operations of competition here). Initially we will find the intangible asset recorded in the balance sheet at the purchase value, but as we know now this licensing right is not bound to bring an profit in the future so its actual value is zero (or its value is negative if there are any expenses), this means that in the light of the definition of assets that item should not be included in the balance sheet.

Value in the economic sense is a total amount I am intending to pay today for all the future benefits of the ownership, expressed in one amount of money.

If so, does a long term contract have value? This of course depends on the character of the market and if the conditions of the contract are better than an average contract, its economic value will be expressed in a surplus value of the accumulated potential benefits that it will bring in the relation to the accumulated potential benefits of an average type of contract. In this case, intangible asset is documented as the total of above the average benefits it brings.

Models and methods used in the process of valuation of intangible assets are always a derivative of the valuation purpose. There are significant as well as only minor differences in the valuation method of evaluation when it is conducted for the purpose of contribution of capital (the problem of the ability of the intangible asset to be contributed), claims in court (claims for damage or unlawful use), the level of income tax, establishing the licensing conditions for the use, negotiation process of the capital transactions) management of intangible assets.

In the period of intensified privatization, processes and capital transformations, valuation of trade marks, know-how, licensing rights or unidentified intangible assets (goodwill) become more and more important.

There are the following general approaches to the valuation, within them particular methods, techniques and cost, market and remunerative procedures.

Simultaneous application of a number of different approaches and valuation methods is often required and it depends on the character of the valuation subject and decision making process or the required legal regulations. In no case, however, should the technique of ranking the basic methods according to their relative significance or calculating the weighed average value of the results obtained from different approaches and methods be used.

Andrzej Podszywałow
Janusz Tchórz