Intangible Asset Valuation:
Dr. Stephen Ruth
May 2, 2000
The last fifty years have witnessed a transition from a world economy driven by industry to one increasingly driven by intellectual capital.1 The last fifty years have also witnessed an increasing gap between market valuations of firms and values recorded in firms’ financial statements. Intellectual capital, represented in accounting parlance by intangible assets, accounts for an increasing proportion of firms’ values. Yet, current accounting methods do not effectively capture the values of firms’ intangible assets. The stock market’s increasing volatility and speculative nature may at least partially be a consequence of the diminishing representativeness of existing valuation measures. Improved intangible asset valuation measures are clearly needed to better guide investor and management decisions, facilitate comparisons between firms, and provide overall measures of firms’ values.
A range of definitions exist for “intangible assets.”2 A broad definition of intangible assets proffered by accounting standard bodies is “nonphysical sources of probable future economic benefits to an entity, or alternatively all the elements of a business enterprise that exist in addition to monetary and tangible assets.” A similar narrower definition is “nonphysical sources of probable future economic benefits to an entity that have been acquired in an exchange or developed internally from identifiable costs, have a finite life, have a market value apart from the entity, and are owned or controlled by the entity. “ If one is not enlightened by these definitions, one is not alone. These definitions give intangible assets an unclear, almost mystical quality.
Intangible assets are categorized into seven general groups.3 These seven groups are brand equity, intellectual capital, structural capital, customer equity, supplier relations, goodwill, and other. As the name suggests, brand equity refers to the capacity of a brand to sustain and encourage economic demand. This includes marketing efforts such as advertising. Intellectual capital refers to research and development; intellectual property-- patents, trade names, trademarks, and copyrights--, trade secrets, internally developed computer software and drawings, and other proprietary technology. Structural capital refers to the assembled workforce—specifically, employee training, contracts, and relationship to management. It also refers to company leadership capability, organizational capacity for salable innovation, organizational learning capacity, leaseholds, franchises, licenses, and mineral rights. Customer equity refers to customer lists, customer loyalty and satisfaction, and distribution relationships and agreements. Supplier relations refer to equity interests in suppliers, contracts, and supplier reliability. Goodwill and “other” are essentially catch-all groups that are not captured by any of the other intangible asset groups. Goodwill is often thought of as the most intangible of intangible assets. Goodwill is also an accounting item that refers to the excess paid over market value of net identifiable assets and is recognized when companies are merged or purchased. Goodwill does not reflect internally developed intangible assets. The “other” category refers to such things as advantageous relationships with the government and covenants not to compete. In short, intangible assets include many things whose revenue generating effects are difficult to quantify.