How to do intangible asset valuation in Hong Kong?
A computed intangible value (CIV) is a method for valuing a company’s intangible assets, which are non-physical assets.
Calculating the value of an intangible asset can be difficult because it has no physical form and cannot be turned into cash. There are occasions, however, when determining the value of intangible assets is crucial. Owners intending to sell their business, for example, may hire a business appraiser to value the company’s intangible assets.
Valuation of Intangible Asset
A computed intangible value (CIV) is a method for valuing a company’s intangible assets, which are non-physical assets. Brand recognition, goodwill, patents, trademarks, copyrights, proprietary technologies, and customer lists are examples of intangible assets. The CIV considers a company’s pretax earnings, its average return on tangible assets, and the industry’s average return on tangible assets, among other things. Intangible assets are appraised by deducting the book value from the market value of a corporation. Opponents of this strategy claim that while market value varies over time, so does the worth of intangible assets, making it a poor gauge.
Understand intangible asset
Intangible assets are far more difficult to value accurately than tangible ones. Product inventory, buildings, land, and equipment are examples of tangible assets that are visible and easy to grasp. Because intangible assets are more difficult to evaluate, businesses may choose to hire a third-party business evaluator or appraiser to handle the laborious process of identifying and valuing the company’s distinctive assets. When a business is for sale, this process is even more important since doubts about asset value can lead to disagreements between the buyer and seller.
Example of Intangible Assets
There are two types of intangible assets: intellectual property and goodwill. These are further explained below.
- Intellectual property, such as a design, is anything you make with your thoughts. Other companies cannot replicate your intellectual property since you own the rights to it. Trademarks, patents, and license agreements are examples of intellectual property.
- Goodwill is a metric that assesses a variety of characteristics that influence the value of your brand. Your company’s reputation, strategies, client base, and employee interactions are all examples of goodwill.
HKAS 38 Intangible assets
The purpose of Hong Kong Accounting Standard (HKAS) 38 Intangible Assets is to prescribe the accounting treatment for intangible assets not covered by another Standard. According to HKAS 38, an entity must recognize an intangible asset if and only if certain criteria are met. In addition, HKAS 38 describes how the intangible assets are valued at their carrying value, and specific disclosures regarding them are required.
- intangible assets that fall under the scope of another Standard;
- financial assets, as defined in HKAS 39 Financial Instruments: Recognition and Measurement;
- intangible assets that fall under the scope of another Standard, HKAS 38 shall be applied in accounting for intangible assets.
- mineral rights and expenditures for mineral exploration, development, and extraction;
- Non-renewable resources include oil, natural gas, and other fossil fuels.
Valuing Intangible Assets
The worth of tangible assets is usually found as a specific number. To arrive at a total value, you add the value of each tangible thing. However, the value of your tangible assets does not reflect the whole worth of your company. It’s more difficult to determine the worth of your intangible than it is to determine the value of your tangible assets. It’s possible that the values of your intangibles aren’t black-and-white. Your intangible assets must be included in your small business value if you plan to sell your company.
Importance of Valuing Intangible Assets
Intangible assets are a key source of competitive advantage for businesses, as well as a key component of delivering customer and shareholder/stakeholder value. Here are some reasons why it is important to value intangible assets:
- Patents assist companies in protecting their inventions from unauthorized use
- For generating sales, developing trust, and increasing consumer loyalty, a company’s reputation, which is commonly assessed by goodwill and brand recognition, is critical.
- For developing long-term value, a company’s knowledge, skills, and processes are essential.
- Intangible assets are frequently more valuable to a company than actual assets. Their value may differ from one company to the next.
- Obtaining funding for intangible assets (can be done in the following ways: sales, licensing, and used as collateral).
Implications of Intangible Asset Valuation
Although intangible assets are becoming increasingly important to a company’s worth, existing accounting standards make it difficult to account for them in financial statements. This knowledge gap might have a negative impact on valuations. Simple accounting measures from business financial statements are no longer sufficient for values today.
How to value intangible assets?
A way of valuing a company’s intangible assets is calculated intangible value. This methodology tries to provide a fixed value to intangible assets that will not fluctuate with the company’s market value. A non-physical asset is an intangible asset. Patents, trademarks, copyrights, goodwill, brand recognition, customer lists, and proprietary technologies are examples of intangible assets.
Calculate the average pretax earnings
Analysts and investors use pretax earnings to compute the pretax earnings margin, which is a measure of a company’s profitability. The ratio of a company’s pre-tax earnings to total sales is known as the pretax earnings margin. The corporation is more profitable if the pretax profit margin is bigger.
Assume that Company ABC makes $100,000 in annual gross profit. It has $50,000 in operational expenses, $10,000 in interest expenses, and $500,000 in sales. Pretax earnings are determined by removing operational and interest costs from gross profit, i.e. $100,000 – $60,000 = $40,000. The pretax earnings margin for the current fiscal year (FY) is $40,000 / $500,000 = 8%.
However, Company XYZ has better profitability in dollars than Company ABC, with $750,000 in sales and $50,000 in pretax earnings. XYZ, on the other hand, has a smaller pretax earnings margin of $50,000 / $750,000 = 6.7%.
Calculate the average year-end tangible assets
Assets are extremely important to a company’s net worth and basic operations. One of the main reasons why firms have a balance sheet is to manage assets and their implications. The balance sheet is governed by the simple equation assets minus liabilities equals shareholders’ equity, which is reflected on the balance sheet.
Calculate the company’s return on assets
Return on assets (ROA) is a measure of a company’s profitability in relation to its total assets. The return on assets (ROA) tells a manager, investor, or analyst how well a company’s management is utilizing its assets to generate profits. The return on investment (ROI) is computed by dividing a company’s net income by its total assets. It can be stated as a formula as follows:
Calculate the industry average ROA
Return on assets is a metric that compares the value of a company’s assets to the profits it generates over a period of time. Managers and financial analysts use return on assets to measure how well a company is using its resources to create a profit. Formula for calculating industry average return on assets is to multiply the result of dividing a company’s net profit by its total assets by 100. On their income statements, public firms report net profit, and on their monthly, quarterly, or annual balance sheets, they reveal total assets.
Calculate excess ROA by multiplying the industry
Return on equity (ROE) and return on assets (ROA) are two of the most essential metrics for assessing how well a company’s management team is managing the capital entrusted to them. Financial leverage, or debt, is the major difference between ROE and ROA.
Calculate the three-year average corporate tax rate
A corporate tax is a tax imposed on a company’s profits. Taxes are levied on a company’s taxable income, which comprises revenue less the cost of goods sold (COGS), general and administrative (G&A) expenses, selling and marketing, R&D, depreciation, and other operating costs.
Calculate the net present value
Net Present Value (NPV) is the difference between the current value of cash inflows and withdrawals over a period of time. NPV is used in capital budgeting and investment planning, which can determine the profitability of a proposed investment or project. This value is the outcome of computations done to find the current value of a future stream of payments.
The simple equation assets govern the balance sheet
Valuation assignments must evaluate the worth of intangibles while considering their volatility, continuous generation, and protection and enforcement issues. Here are the methods to calculate intangible assets.
- Relief from Royalty Method (RRM) – The RRM calculates value based on hypothetical royalty rates that would be saved if the item were owned. The business does not have to pay for the use of an intangible asset if it owns it. The RRM is frequently used to value trademarks and software, and it combines components of the market (royalty rates for comparable assets) and income (estimates of revenue, growth, and tax rates) approaches.
- With and Without Method (WWM) – The value of an intangible asset is calculated using the WWM by subtracting the difference between a discounted cash flow model for the firm with the asset and a discounted cash flow model for the enterprise without the asset.
- Multi-Period Excess Earnings Method (MPEEM) – The MPEEM separates cash flows associated with a specific intangible asset, then discounts them to present value, as a version of the discounted cash-flow analysis. It’s most commonly used when a single asset is the principal source of a company’s value, and the asset’s cash flows can be separated from overall cash flows. The MPEEM can be used to value software and customer relationships, for example.
- Real Option Pricing – Option pricing models can be used to value assets that are not now generating cash flows but have the potential to do so in the future. One example is patent choices that have yet to be produced. These assets’ “temporal value” can be captured using option pricing models.
- Replacement Cost Method Less Obsolescence – Replacement cost method less obsolescence, like the cost approach, relies on creating a fresh replacement cost for the intangible asset—what it would cost to produce “from scratch”—and then adjusting for obsolescence, which is the equivalent of applying depreciation in the cost approach.
How can Eqvista help with the intangible asset valuation?
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