What are the valuation approaches to measure intangible assets?

3. Income approach

Income approach uses a discounted cash flow methodology (e.g., net present value) to value an intangible asset based on income and expense data. That is, this approach measures the present value of expected future returns from the intangible asset.

In practice, the following income approaches are often used:

  • Excess earnings:  the present value of the earnings generated by the intangible asset (net of return generated by other assets).
  • Relief from royalty: it’s based on the expense a company would have to incur if it didn’t have the intangible asset (i.e., the savings from not having to pay the royalty).

When an income approach is used, a company has to estimate the future cash flows from the intangible asset, adjusted for the appropriate level of risk. To assign the appropriate risk measure, various financial methods can be used such as Arbitrage Pricing Theory (APT), Capital Asset Pricing Model (CAMP), etc.

Income approach, for instance, is used to measure the loss on impairment of limited-life intangibles and indefinite-life intangibles other than goodwill. When determining the value of limited-life intangibles, a company can perform two tests: recoverability test (i.e., future cash flows from the expected use and disposal of the intangible asset) and fair value test (i.e., expected net future cash flows discounted at the market rate of interest).

4. Market approach

Market approach uses actual sales information of similar intangible assets.  As the result, this approach is also called the “sales comparison” approach. The main disadvantage of market approach is that in many situations it cannot be applied in practice because of the nature of intangible assets. For example, there is no active market for some intangibles while certain intangible are unique and cannot be compared to similar intangibles (e.g., brands).

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