Accounting Assignment report writing Help on Financial Reports: Challenges in Coca Cola market approaches

Question ??. What are the critical challenges associated with valuing a firm with significant intangible assets?

Explanatory not- Cleary a number of issues abound , please ensure that in your analysis you consider that challenges associated with  the valuation of firms heavily reliant on intellectualproperties, such as patents and copyright. Consider how a patent portfolio could be valued and the various ways that intellectual properties can be employed.

Answer the question frame is:

Challenges associated with valuing a firm with significant intangible assets

According to International Financial Reporting Standards (IFRS 3A) an intangible asset is an identifiable non-monetary asset which does not have physical substance. Intangible assets result in additional income or cost savings and therefore have an impact on future cash flows of the company.

The biggest challenge of valuing a firm with significant intangible assets is that of accurately estimating future cash flows that will accrue because of these intangible assets. Take the case of a company like Coca-cola. It has tangible assets spread across the world which are in themselves worth billions. But Coca-Cola’s biggest asset is unarguably its brand name which is an intangible asset.

When using a valuation technique like Discounted Cash flow for valuing an asset (whether tangible or intangible asset) it is necessary to assess the future value which will accrue from the asset. In intangible assets this is even more imperative because they can be valued in no other way; there is no replacement or market value for intangible assets.

So when valuing the intangible asset like brand name of a company like Coca-cola one of the main challenges is to identify that portion of the future cash flows which can be attributed to the brand name of the company. These future cash flows can then be discounted at an appropriate discount rate to determine the present value of the brand name of Coca-cola.

International Financial Reporting Standard (IFRS) 3 requires that all intangible assets should be valued at their fair value. The IFRS 3 defines fair value as the amount for which an asset can be exchanged, or a liability settled between knowledgeable, willing parties in an arm’s length transaction (IFRS 3A).

The fair value is therefore also considered as exit value i.e. the value that the firm will get if it sells the asset. The three methods widely used for assessing the fair value of an intangible asset are:

i) Market approach in which the fair value of the intangible asset is estimated from the value of a similar asset which has recently been sold or bought in a market.

ii) Cost approach in which the fair value of the intangible asset is estimated on the basis of the money that would be required for repurchasing that intangible asset.

iii) Income approach is the most widely used method for valuing an intangible asset. In this approach, the intangible asset is valued by estimating the present value of the future cash flows that will occur from holding the intangible asset.

For a firm which is heavily reliant on intellectual properties such as patents and copyrights, valuation of intangibles assets is a prime activity which is highly challenging. In the new knowledge economy, driven by the information technology and internet sector, the number of firms who drive most of their value from patents and other intangible assets has increased significantly.

Patents give protection to a firm against competition during their tenure. During the patent period the firm therefore enjoys monopolistic power. So the income approach is the most valuable approach for valuing a firm enjoying a portfolio of patents (Copeland, Thomas E.; Tim Koller, Jack Murrin, 2000). The income that will accrue to the company during the patent protection period should be estimated.  A large part of this income (say almost 60 %) can be attributed to the patent. The present value of this income can then be calculated using a suitable discount rate for determining the value of the patent. In this way the value of all the patents in the portfolio can be estimated. Adding them up will give the value of the patent portfolio of the firm.

Other approaches like market approach or cost approach may not be appropriate for valuing patents because patents are inherently unique. There is no extant market for similar products. The cost approach can be used for valuing a patent where the value will be set equal to the research and development expenditure which has been incurred in developing the new technology which has earned the patent. However this cost approach to valuation can grossly undervalue the real value of the patent (Copeland, Thomas E.; Tim Koller, Jack Murrin, 2000).

Fair valuation of intangible assets like technology patents, intellectual property right, goodwill and brand name will continue to be a challenge because of the intrinsic nature of these assets. However, while choosing the valuation techniques, especially for reporting purposes, companies should remember one of the essential principles of accounting i.e. they should be conservative in their valuations.

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