This document summarizes the key issues around accounting for intangible assets. It discusses how intangibles make up a large portion of company value today but are not fully recognized or valued on financial statements. It reviews different techniques for valuing intangibles like cost, market, and income approaches. It also analyzes how some companies have improved disclosure of intangibles but more recognition is still needed. International standards also account for intangibles better than US GAAP. The conclusion is that valuation methods exist but standards are outdated and not reflecting the true value of intangibles.

1. They May Exist, But You
Can’t Touch
A Review of How the Post-Sarbanes Environment has
Impacted the Importance, Presentation, and
Valuation of Intangible Assets
Jerrad Howard
This Creation is © Jerrad T. Howard. All
Rights Reserved.

2. Interactive Exercise
Which would you prefer to purchase given price and
features (ie. size, color) are equal? Why?
Apple iPod Microsoft Zune

3. Abstract
Why Should We Value Intangibles?
What are the current valuation techniques?
How are current entities representing
Intangibles to investors?
How Do International Standards Differ?

4. How Important Are Intangibles?
• Lev, 2001: Intangibles have changed the nature
of the Corporation Itself
• IM&A, 2005: 60 to 80 % of Company Assets are
Intangibles.
• Federal Reserve: US Corporations spend $1
Trillion Annually on Intangible Investments, equal
to Tangible Investments

5. An Example Of Unaccounted Value
• Coca-Cola President once claimed that if
all physical assets were destroyed, the
Company could survive… if Intangibles
were not impaired
• Senkus, 2005: Coca-Cola’s 2003
Financial Statements are misleading:
• Listed Assets of $25.3B
• Stock Valued Company at $112B

6. Examples of Intangible Assets And
Their Impact on Business
 Goodwill and Brand Reputation
 Patents
 Trademarks, Trade names, and Slogans
 Trade Secrets
 Other Internally Generated Items
IE. Customer Lists & Licensing
Agreements

7. Examples of Valuable
Intangibles
 American Airlines SABRE Reservation System
1996: Worth $3.3B to a $6.5B Firm
1960: Developed with RnD of $40M
 International Pulp & Paper Company
Re-emergence from Bankruptcy
 CISCO Market Performance vs. GM
GM, 2000: $88.19B
 CISCO, 2000 : $555.44B

8. Cydney Tune’s Arguments for
Recognition of Intangible Assets
• Tune (IM&A, 2005): SOX should require valuation
of Intangibles
• Disclosures have increased, but no values
• MGT is resistant to disclose any information
• Should at least require
– IP Risks
– Prosecution
– License Agreement Expiration
– Expiration of Protection
– Material Handling
– Current Strategy

9. Hoffman’s (2005) Arguments for
Recognition of Intangible Assets
• Previous lack of recognition due to inability to
value
• Lack of Intangible Recognition causes:
• Increased Cost of Capital
• Misleading Results and Conclusions
• Lost Economical Growth

10. Lev Arguments for Recognition (cont.)
• Lev, 2001: Intangibles are the main driver of
corporate success.
• Omission has reduced effectiveness of Financial
Statements.
• Redaction of these “Investments” misleads
Investors regarding future cash flows.
• Deng, Lev, Narin, 1999: Patent Citations
influence on future earnings
• Patent Attributes have high correlation with
– Market to Book Ratios
– Future Estimated Stock Performance

11. Disclosure vs. Recognition
• Difference Between Recognition and Disclosure
• Why would simply disclosure not be adequate?
• IM&A, 2005: Companies are not maintaining
value schedules.
– Tune: Refuse to disclose because could negatively
impact investor decisions
– Disclosures may release confidential information, but
Recognition of Dollar Values wouldn’t
• Information regarding intangibles is hard to
comprehend.

12. Disclosure vs. Recognition (cont.)
• Grooves, 1994: Disclosures are of little-to-no
meaning to investors.
• Financial Statements are Cumbersome
• Investors place more emphasis on recognized
items.
• Lev, 2004: Investors are failing to comprehend
Intangibles’ information under current practices
• Over-valuing: Dot-Com Entities
• Under-Valuing: Research-Intensive Entities

13. Basu’s Arguments Against Recognition
of Intangible Assets (Basu, 2008)
1. Current day importance of Intangibles is nothing unique.
• Today’s fierce competition and business
environment is unique
2. All tangible and profit-generating ideas were once
intangible in nature.
• Marketing and Manufacturing Processes do not take
physical embodiments
3. Assets only have worth in that they generate wealth
• Reilly & Schweihs, 1998: Intangibles generate
wealth by use of; forbearance of use; and ownership

14. Basu’s Arguments Against Recognition
of Intangible Assets (cont.)
4. Intangibles provide highly uncertain, volatile, and
ambiguous future benefits.
• Hypocritical given current macro-environment and
FASB treatment of Securities
• Lev’s research also indicates R&D risks are
exaggerated
5. Intangibles are prone to obsolescence or legal
challenge, and are unable to be separated from
tangible assets.
• Why does this matter? Further developments on
Capital Assets are allowed to be Capitalized.

15. Basu’s Arguments Against Recognition
of Intangible Assets (cont.)
6. Intangibles have a cumulative effect, continually
building upon themselves.
• Similar to Point 5: Why can we not capitalize
future developments?
7. Income earning potential matters rather than
their valuation on the balance sheet.
• Then why value anything using FASB standards?

16. Why Current Standards Aren’t Cutting It
• Current Standards Ignore Intangible Impact on
Business
• FASB S2 Requires R&D Expenditures to be
Expensed immediately during period incurred
• Shelf-Loading of Expenses is misrepresenting
Earned Revenue
• Treating as Investments with no future benefits
• Aggregated Allowed, No Meaningful Segregation
on individual expenditures
• Lev & Sougiannis, 1996: Individuals try to dissect
R&D Expenditures to find future value but FAIL

17. Why Current Standards Aren’t Cutting It
(cont.)
• FASB S142: Recognition, Impairment Testing,
and Useful-Life of Acquired Intangibles
• Segregation into Definite- & Indefinite-Life Assets
• Indefinite-Lived and Goodwill Impairment Test
Annually
• “Intangible assets are an increasingly important
economic resource for many entities”
• Still fails to recognize Internally Generated
Intangibles
• Kabir, 2008: Lack of Standards have hampered
development of Intangible Marketplace

18. Valuation Techniques
• Irrespective of claims, Intangibles have adequate
valuation techniques
• Most often employed are:
– Cost Method
– Market Method
– Income Method

19. Cost Method
 Intangible Asset is Valued at the Cost to
Replace.
 Replacement Cost = Reproduction Cost – Incurable
Functional & Technological Obsolescence
 Evaluate Impairment to Ascertain FMV
 Fair Market Value = Replacement Cost – External
Obsolescence – Curable Functional and Technological
Obsolescence (Pratt & Niculita, 2007).


20. Cost Method (cont.)
 In order to use, may have to expend resources
 Cost < Future Economic Benefit = Curable
 Cost > Future Economic Benefit = Incurable
 Replacement Cost = Amount to purchase Similar
Asset
 Reproduction Cost = Amount to imitate Asset
 4 Components of Reproduction and Replacement
 Direct costs
 Indirect costs
 Developer’s profit
 Entrepreneurial incentive

21. Income Approach
 Value established by the Present Value of Future
Income from three roles
 Lacks Structure as to what “Future Income” is
 Net Income Before Taxes
 Net Income After Taxes
 Operating Cash Flows
 Net Operating Income
 May Capitalize One Year of Income, Many Years
of Income, of an Average of Annual Income
Expected

22. Income Approach (cont.)
• Investor should review:
– Opportunity Cost Associated
– Time Value of Money
– Term of Investment
– Risk Associated
• Must Ensure not “double booking” between
various intangibles
• Prone to Use with Customer Lists, Favorable
Supply Contracts, and Proprietary Technologies

23. Income Approach (cont.)
• Approach is Cumbersome and Questionable
– Projecting Cash Flows is inherently risky
– Intangible coupling makes it much more difficult
• GAAP is not accustomed with utilizing Future
Economic Value
• Manufacturing Plant represented at net Historical
Value, not future cash flows from production

24. Market Approach
• Value is derived from similar transactions
regarding intangible assets.
• Must compare viability of asset and industry
• Pre-Disposed to use with Licenses, Permits, and
Technology such as Airline Reservation Systems
• Best and Most Simplistic Model
• Difficult to obtain information because Intangible
Asset transactions are rare and normally not
public knowledge.

25. Senkus’ (2005) Suggested Models
I. Accounting Approach : Amount Paid Less
Cost of Developing Asset
II. R&D Investments
III. Wages Paid to “Creative” Employees
IV. Operational Profit Margin: Sales Less COGS

26. Senkus’ Suggested Models (cont.)
V. Non-Fiscal Approach: Value is assigned
based on future potential wealth
• Similar to Income Approach
VI. Residual Value Method: Market Value of Entity
less Value of Net Assets.

27. Review of Financial Statements
Focused on 4 Companies 2002 and 2008 Financials

28. • 2003 10K Report Highlights
• Risks Associated with IP Rights
• Brand Awareness of 80-92% of Population
• Reach 2.7 B People Monthly
• IP Rights  Patents and TMs Held
• Product Formula not Patented to Protect Trade
Secret  Only known by a few internal
employees
• Employees Associated with R&D  5
• GW Impairment Changes  Saved $$$
• Intangibles broken out

29. • 2008 10K Report Highlights and Changes
• Increased Number of Patents and TMs
• Lists R&D Expense for 3 Previous Periods
• Increased Disclosures RE Risks Associated
• Complete Break Out of Intangibles, Useful Life,
Amortization Schedule for future 5 Years
• Disclosure of Method for Valuation 
– Income Approach with Appropriate Risk Discount
Rate
– Market Approach
• Show Payments for Intangibles in Cash Flows

30. • 2002 10K Report Highlights
– Licensing Agreements: % of
Revenue
– Amortization Schedules for GW and
Intangibles
– No Specific Record of Depreciation
or Amortization of Intangibles
– No Information Regarding R&D

31. • 2008 10K Report Highlights
– Break out Revenue from Licensing
Agreements Individually
– Include Sum of R&D Expenses
– “Inherent Risk Abroad Based on
Ability to Enforce IP Rights”
– Note #9: Breakout of Indefinite- and
Definite-Lived Intangibles and
Amortization Schedule for Future 5
Years

32. • 2002 10K Financial Statements
– FASB S142 in effect, but will not follow until 2003
– Instead, Goodwill and Intangibles Amortized over
Straight-Line Useful Life
– Values of Goodwill and Intangibles deduced from
Undiscounted Cash Flows and Future Projects
– Capitalize Internally Developed Software and
Amortize over 3 Years
– 2003 will result in Goodwill Recapture of $250M

33. • 2008 10K Financial Statements
– Following FASB S142, Previously used SL
Amortization
– Evaluate Value of Intangibles by Acquisition Price,
taking into account Business Use
• Based on FMV of Discount Cash Flows & Market
Approach
– Future Operations Risk Based on Intangibles
– No Breakout of R&D Expense or Amortization STILL

34. • 2002 Pepsi 10K Statements
– Definition of Intangible Lifespan
basis
• Significant Market Share
• Stable Macro Environment
• History of Strong Cash Flow
– Value using Undiscounted Cash
Flow Method
– Demonstrated Retroactive
Influence of S142

35. • 2008 Pepsi 10K Statements
– Break Out R&D Expenditures
– Capitalizing Software Development
– Provide 5 Year Amortization
Schedule
– Fair Value Analysis Based on:
• Market Participants
• Consumer Awareness
• Brand History
• Future Expansion
• Discounted Future Cash Flows

36. International Accounting Standards
• IAS 38: Intangible Assets
• Recognize Asset when purchased or self-created
– Probable that future economic benefits will occur
– Cost can be measured reliably
• If Fail To Meet These Requirements, Expense
• R&D
– Research is Expensed Immediately unless acquired
– Acquired Research is Capitalized
– Design Expenses may be Capitalized
• May Not Recognize Brands, Customer Lists

37. Conclusion
• While Principles Reflect Conservatism, Standards
are Out-dated
• Adequate Valuation Techniques Do Exist
• While Financial Statements are becoming more
transparent, It is still not enough.
• IAS 38 has established adequate principles far
beyond US GAAP