AGENDA ITEM 12 IVSC PROFESSIONAL BOARD MEETING 3 NOVEMBER 2011 The Board is invited to approve that attached for

publication, subject to any final editorial changes. The Board also needs to confirm that this proposed TIP does not need to go through the normal process of issuing as an exposure draft for consultation. The reason for this is that this TIP is mainly a minor updating and reformatting of the material that is in GN4 that was published in March 2010 following a 3 year consultation process. The updating and reformatting are to bring the guidance in the TIP into line with the new IVS, in particular the new IVS 210 Intangible Assets, which was also the subject of extensive consultation. 1 Copyright IVSC Draft Proposed Technical Information Paper 3 INTANGIBLE ASSETS Technical Information Papers An IVSC Technical Information Paper (TIP) provides guidance on different valuation topics and is designed to be of assistance to valuation professionals and informed users of valuations alike. A TIP may: provide information that is helpful to valuation professionals in exercising the judgements they are required to make during the valuation process, give indications and examples of generally accepted best practice, including appropriate valuation methods and criteria for their use and provide additional information to assist in the application of an International Valuation Standard (IVS). A TIP does not: provide valuation training or instruction or

 direct that a particular approach or method should or should not be used in any specific situation. The contents of a TIP are not intended to be mandatory. Responsibility for choosing the most appropriate valuation methods is the responsibility of the valuer based on the facts of each valuation task. The guidance in this paper presumes that the reader is familiar with the International Valuation Standards (IVS). Of particular relevance are the concepts and principles discussed the IVS Framework and IVS 210 Intangible Assets. 2 Copyright IVSC Contents Paragraphs Page 1 Introduction # 2 Definitions # 3 Identifying the Asset # 4 Valuation Approaches and Methods # 5 The Market Approach # 6 The Income Approach # Prospective Financial Information 6.2 6.11 # Valuation Methods 6.12 - 15 # Relief from Royalty Method 6.16 6.24 # Premium Profits Method 6.25 6.31 # Excess Earnings Method 6.32 6.44 # Greenfield Method 6.45 6.46 # 7 The Cost Approach # 8 Other Considerations #

Discount Rates 8.1 # Remaining Useful Life 8.4 # Illustrative Example # 3 Copyright IVSC 1 Introduction 1.1 The objective of this TIP is to provide guidance on the principal recognised approaches and methods that are used for valuing intangible assets of different types of assets. The guidance in this TIP should be read in conjunction with the International Valuation Standards. IVS 210 Intangible Assets sets out: matters that must be considered when developing a scope of work for a valuation of intangible assets and matters that are to be considered when reporting a valuation of intangible assets. 1.2 The Commentary to IVS 210 provides a high level overview of different types of intangible assets and the principle valuation approaches and methods that are used. This TIP examines the matters discussed in the Commentary in greater detail and gives examples of how these are applied in practice. 1.3 Valuations of intangible assets are required for different purposes including, but not limited to: acquisitions, mergers and sales of businesses or parts of businesses; purchases and sales of intangible assets; reporting to tax authorities; litigation and insolvency proceedings; and financial reporting. 1.4 This TIP provides guidance on appropriate valuation procedures, approaches and methods for the valuation of intangible assets generally. It does not examine any specific statutory or

regulatory requirements that may apply to the valuation of intangible for particular purposes in specific jurisdictions, eg for taxation or financial reporting. Where a valuation is required for inclusion in a financial statement the provisions of IVS 300 Valuations for Financial Reporting apply. IVS 300 also contains guidance on the principal valuation requirements under the International Financial Reporting Standards (IFRS). 4 Copyright IVSC 2 Definitions 2.1 The following defined words and terms have particular relevance to the valuation of intangible assets and appear in this TIP. Other words and terms that are also defined in the IVS Glossary may be used but are not listed below in the interests of brevity. Contributory Assets Any tangible or intangible assets used in the generation of the cash flows associated with the intangible asset being valued Contributory Asset Charges A charge to reflect a fair return on Contributory Assets used in the generation of the cash flows associated with the intangible asset being valued. Cost approach A valuation approach based on the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction. Discounted Cash Flow Method A method within the income approach in which a discount rate is applied to future expected income streams. Excess Earnings That amount of anticipated economic benefits that exceeds an

appropriate rate of return on the value of a selected asset base (often net tangible assets) used to generate those anticipated economic benefits Excess Earnings Method A method of estimating the economic benefits of an intangible asset by identifying the cash flows associated with the use of the asset and deducting a charge reflecting a fair return for the use of contributory assets. Going Concern A business enterprise that is expected to continue operations for the foreseeable future. Goodwill Any future economic benefit arising from a business, an interest in a business or from the use of a group of assets which is not separable. Greenfield Method A method of valuing an intangible asset that deducts the cost of buying or creating contributory assets from the cash flows associated with the use of that asset. Income Approach A valuation approach that provides an indication of value by converting future cash flows to a single current capital value. Intangible Asset A non-monetary asset that manifests itself by its economic properties. It does not have physical substance but grants rights and economic benefits to its owner. Market Approach A valuation approach which provides an indication of value by comparing the subject asset with identical or similar assets for which price information is available. 5 Copyright IVSC Multi Period Excess Earnings Method

A method of estimating the economic benefits of an intangible asset over multiple time periods by identifying the cash flows associated with the use of the asset and deducting a periodic charge reflecting a fair return for the use of contributory assets. Premium Profits Method A method that indicates the value of an intangible asset by comparing an estimate of the profits or cash flows that would be earned by a business using the asset with those that would be earned by a business that does not use the asset. Prospective Financial Information Forecast financial data used to estimate cash flows in a discounted cash flow model. Relief from Royalty Method A method that estimates the value of an intangible asset by reference to the value of the hypothetical royalty payments that are saved through owning the asset, as compared with licensing it from a third party. Royalty A payment made for the use of an asset, especially an Intangible Asset or a natural resource. Tax Amortisation Benefit Tax relief available on amortisation of the capitalised asset. Weighted Average Cost of Capital A discount rate determined by the weighted average, at market value, of the cost of all financing sources in a business enterprises capital

structure. 6 Copyright IVSC 3 Identifying the Asset 3.1 IVS 210 requires the intangible asset being valued to be identified by reference to its type and the nature of the right or interest in that asset. The Commentary to IVS 210 explains the distinction between intangible assets that are identifiable and goodwill, which is an unidentifiable intangible asset. In summary, an intangible asset is identifiable if it is separable from the entity or if it arises from a contractual or other legal right. 3.2 The Commentary to IVS 210 describes four principal classes of identifiable intangible asset to assist in compliance with the requirement to clearly define the asset to be valued and the nature of the right or interest being valued. These are marketing related customer or supplier related technology related and artistic related A more comprehensive discussion of each of these classes of assets and the type of right or interest typically found is provided below: 3.3 Marketing related intangible assets are used primarily in the marketing or promotion of products or services. Examples include, but are not limited to: trademarks, trade names, service marks, collective marks and certification marks; trade dress (unique colour, shape or package design); newspaper mastheads; internet domain names; or non-compete agreements. The word brand is often used to describe marketing related assets. It is a generic

description that typically refers to a group of complimentary assets that can be separately identified and therefore distinguished from goodwill. The rights to marketing related assets such as trademarks, trade names or trade dress often are protected by registration under statute. 3.4 Customer or supplier-related intangible assets arise from relationships with or knowledge of customers or suppliers. Examples include, but are not limited to: advertising, construction, management, service or supply agreements, licensing and royalty agreements, servicing contracts, order books, employment contracts, 7 Copyright IVSC use rights, such as drilling, water, air, timber cutting and airport landing slots, franchise agreements, customer relationships or customer lists. As can be seen from this list, the rights to assets arising from customer or supplier relationships often arise from contracts, although considerable value can attach to non contractual assets such as customer relationships and customer lists. 3.5 Technology-related intangible assets arise from contractual or non-contractual rights to use a specific technology or formula, such as: patents and design patents, a distinct design of machine or tool used for a specific process, a formula or recipe used in the making a product, computer software or

a design or distinct type of product. The rights to technology related intangible assets are often legally protected, but may also be granted by contract or be implicitly protected by proprietary know-how (trade secrets). 3.6 Artistic-related intangible assets arise from the right to benefits such as royalties from artistic works such as: plays and other performed works, books, newspapers and other literary works, films, television and other visual media music, including lyrics, and either published or performed or photographs, illustrations, drawings and paintings Frequently the rights to artistic related intangible assets are the subject of statutory protection (copyright laws) but can also be granted by contract. 3.7 Statutory protection of intangible assets through rights such as trademarks, copyright and patents, collectively known as intellectual property, is primarily under the laws of the specific country or state where the intellectual property has been protected. However, protection is often extended by various international treaties in which participating states agree to mutually recognise intellectual property rights. The foremost of these is the World Trade Organisation (WTO) Agreement on Trade Related Property Rights which aims to harmonise the intellectual property laws of member states. Compliance with this agreement is a requirement for any state wishing to join the WTO. There are, however, other treaties that are specific to certain types of asset that may differ from the WTO or involve different states. 8 Copyright IVSC 3.8 There are also differences between states in the way in which the treaties are applied or enforced. Where an intangible asset is international in its use, or potential use, and the

rights are dependent upon statutory protection, expert legal advice may be required on the effective geographic extent as well as on the fields of use of the rights in that asset. 3.9 Contractual ownership rights may be recorded in a formal legal agreement or recorded by an exchange of correspondence. Where rights are granted by a contract or agreement the terms of the agreement are essential to the definition of the rights to be valued. Some agreements may be of limited life contain a restriction on transfer which could have a fundamental effect on the value. 3.10 Some intangible assets grant privileges without the existence of actual ownership rights, eg customer relationships or trade secrets. These intangibles do not necessarily have an underlying contract, yet a company or individual can be the owner of such intangibles and derive economic benefit from them. 3.11 Although it may at times be appropriate and possible to value an identifiable intangible asset on a stand-alone basis, it may be either impossible or impractical in other cases to value an intangible asset other than assessing it in conjunction with other tangible or intangible assets. The valuer should document clearly in the valuation report whether an intangible asset has been valued on a stand-alone basis or in conjunction with other assets. If the latter is the case, the valuer should explain why it is necessary to aggregate the subject asset with other asset(s) for valuation purposes and describe clearly the asset(s) with which the subject asset has been aggregated. 3.12 Goodwill is an unidentifiable intangible asset because it is not separable from the business to which it relates. Although goodwill is not separable and is therefore unidentifiable in its entirety, some elements that contribute to goodwill can be identified. These include but are not limited to: company specific synergies arising from a combination of two or more businesses, eg reductions in operating costs, economies of scale or product mix dynamics,

opportunities to expand the business into different markets, the benefit of an assembled workforce, as distinct from any intellectual property developed by members of that workforce the benefit to be derived from future customers or the benefit of an established network. 3.13 In general terms, the value of goodwill is any residual amount remaining after the value of all identifiable tangible, intangible and monetary assets less liabilities and potential liabilities have been deducted from the total value of a business. 9 Copyright IVSC 4 Valuation Approaches and Methods 4.1 All three of the principal valuation approaches described in the IVS Framework, the market approach, the income approach and the cost approach, can be applied to the valuation of intangible assets. The main methods within each approach are discussed in this section. There are additional valuation methods such as real option theory, which are not discussed in this TIP as they are not widely used, although they may be appropriate for the valuation of certain types of intangible asset under certain circumstances. 4.2 Understanding the nature and attributes of the subject intangible asset and the nature and characteristics of the market for that asset is generally critical to determining the most appropriate valuation approach. Sufficient data may be available so that the required parameters to apply a secondary method can be deduced from the value for the intangible asset calculated under the primary method. This is sometimes called reverse engineering. For instance: if an intangible asset is valued using relief-from-royalty or premium profits as the primary method, the implied multiples of, say, revenues and contribution after marketing charges could be deduced and compared with those from identified

comparable market transactions; or if an intangible asset is valued using multi-period excess earnings or replacement cost as the primary method, implied royalty rates could be deduced that would have applied if relief-from-royalty were used; such rates could then be considered for reasonableness. 4.3 The Commentary to IVS 210 observes that the heterogeneous nature of many intangible assets means that there is often a greater need to consider the use of multiple methods and approaches than for other asset classes. 4.4 Regardless of the valuation method applied, a sensitivity analysis can be an important part of performing cross-checks or reasonableness checks on the value of the asset and its application should be considered if appropriate. 5 Market Approach 5.1 The market approach provides an indication of value by comparing the subject asset with identical or similar assets for which price information is available. 5.2 The required inputs for applying the market approach to intangible assets are: prices and/or valuation multiples in respect of identical or similar intangible assets; and adjustments as required to such transaction prices or valuation multiples, to reflect the differentiating characteristics or attributes of the subject asset and the assets involved in the transactions. 10 Copyright IVSC 5.3 A valuation multiple is often determined by dividing the transaction price of an asset by a financial parameter, such as historic or prospective revenue or profit at a given level. Valuation multiples may also be calculated by reference to a key non-financial operating parameter eg to establish a price per unit of sale 5.4 Because most intangible assets are heterogeneous it is rarely possible to find transactional

data for an identical asset that can be used as a benchmark for the value of the subject asset. It is more likely that any market evidence will be in respect of similar rather than identical assets. Where transactional evidence is available an exercise should be undertaken to identify any differences between the subject asset and the asset that is being used as a benchmark and how these affect the relative values. Differences can include: geographical coverage, functionality, market share, markets accessed (for example one asset may be in the business-to-business market and the other in the business-to-consumer market) or the date of the benchmark transaction and the valuation date. 5.5 The objective of this exercise should be to determine whether the identified factors would result in the price in the benchmark transaction being higher or lower than the price in a hypothetical transaction involving the subject asset. If possible, any increase or decrease should be quantified if this is not possible, as much qualitative information as available should be documented, such as whether the factor is likely to significantly or slightly increase value as compared with the asset transacted. 5.6 Care should also be taken to establish the circumstances of the transaction that is being considered as a benchmark. The price paid may have been with a related party, the seller may have been under pressure to sell or the buyer motivated to pay a high price because of synergies that only it could exploit. 5.7 It is often the case that full information on a transaction may not be in the public domain, is difficult or impossible to obtain or may be subject to confidentiality. The valuer may not know the detailed terms, for example whether warranties and indemnities were given by the seller, whether incentives were involved, or the impact of tax planning on the transaction.

Caution is required before relying on transactions where full information is not available. 5.8 Even where transactions can be identified and information regarding prices paid is available, it can be difficult to determine the appropriate adjustments to the prices or the valuation multiples necessary to reflect the differentiating characteristics or attributes of the subject intangible asset as compared to those of the assets involved in the transactions. Because the difficulties described may restrict the appropriateness of the market approach this method is often only used as a cross check. 11 Copyright IVSC 6 Income Approach 6.1 Valuation methods under the income approach determine the value of an intangible asset, by reference to the present value of future income, cash flows or cost savings that could be reasonably expected to be achieved by a market participant owning the asset. Prospective Financial Information 6.2 All the intangible asset valuation methods under the income approach require prospective financial information (PFI) for some of their inputs. The income stream will relate to financial parameters such as revenues, operating profit, cash flow or some other measure. Estimates of these financial parameters are critical to derive a credible valuation. 6.3 PFI should be estimated with respect to factors, such as: revenues anticipated through use of the asset or asset group and the forecast share of the market; historic profit margins achieved and any variations from those margins anticipated taking account of market expectations; tax charges on income derived from the asset or asset group; working capital, capital expenditure requirements or replenishment costs of the business using the asset; and

growth rates after the explicit forecast period appropriate to the assets expected life reflecting the industry involved, the economies involved and market expectations. 6.4 The assumptions behind these inputs should be documented in the valuation report together with their source. 6.5 The forecast period needs to be assessed consistently with the expected remaining useful life of the subject intangible asset. As the life of an intangible asset may be finite or assumed to be indefinite or even infinite, forecast cash flows may be for a finite period or may run into perpetuity. 6.6 PFI obtained from different sources should be benchmarked to assess its appropriateness for use in the valuation. Benchmarking is the process of performing consistency checks on the PFI assumptions. When performing valuations to establish market value this will include comparing the inputs with data derived from the market to assess and improve their accuracy and reliability. 6.7 For PFI being used to determine the market value of intangible assets, growth rates, margins, tax rates, working capital and capital expenditure, benchmarking should include a comparison with the corresponding data from market participants, where possible. 12 Copyright IVSC 6.8 Other factors affecting PFI inputs may include the economic and political outlook and related government policy. Matters such as currency exchange rates, inflation and interest rates may affect intangible assets that operate in different economic environments quite differently. Consideration should be given to how such factors affect the specific market and industry in which the subject asset is being valued. 6.9 When cash flows are forecast into perpetuity, specific consideration should be given to the growth rates used. These should not exceed the long-term average growth rates for the products, industries, country or countries involved, unless a higher growth rate can be

justified. 6.10 When using PFI to determine the value of an intangible asset, a sensitivity analysis of the resulting asset value should be performed to assess the impact of possible variations in the underlying assumptions. Those elements of PFI to which the resulting asset value is most sensitive, should be reviewed to ensure that the assumptions underlying them are as robust as possible with all available relevant factors being reflected. 6.11 Where the PFI is to be used as an input into a valuation method that uses discounting techniques, regard should be had as to whether a discount rate adjustment technique or an expected cash flow adjustment technique is being used, and to select a discount rate that is consistent with the cash flow forecasts.1 Valuation Methods 6.12 There are various methods used for valuing intangible asset that fall under the income approach. The most common are discussed in this paper, ie: relief-from-royalty method, sometimes known as royalty savings method, premium profits method, sometimes known as the incremental income method, excess earnings method and greenfield method. 6.13 Each of these methods involve the discounting of forecast cash flows attributable to the subject asset based on PFI using either discounted cash flow techniques or, in certain limited cases, the application of a valuation multiple. 6.14 In addition to capitalising the future expected income flows, or alternatively cost savings that may be derived from use of the asset, it may be appropriate to take account of any tax relief that would be available on amortisation of the capitalised asset in a transaction. Such an adjustment, known as the tax amortisation benefit (TAB), reflects the fact that the income derivable from an asset includes not only the income directly achievable from its use but

also the reduction in tax payable by purchaser of the asset. The benefit is highly dependent on the ability to amortize the intangible asset in the relevant tax jurisdiction, thereby 1 See IVSC TIP No 1 Discounted Cash Flow 13 Copyright IVSC providing a tax shield, as well as the assumptions for relevant tax rates and amortization conventions. 6.15 If estimating the market value, an adjustment to the cash flows for tax amortisation should be made only if this benefit would be available to a purchaser of the asset in the market under the relevant tax regime. When performing a valuation of an asset on a basis other than market value, a TAB adjustment should be made if amortisation would be consistent with the basis of valuation and the approach adopted. Thus, if an entity-specific valuation is being performed, a TAB adjustment should be included only if tax amortisation is available to the specific entity concerned under the application of an income approach. Relief-from-royalty 6.16 The relief-from-royalty, or royalty savings, method estimates the value of an intangible asset by reference to the value of the hypothetical royalty payments that would be saved through owning the asset, as compared with licensing the asset from a third party. It involves estimating the total royalty payments that would need to be made over the assets useful life, by a hypothetical licensee to a hypothetical licensor. Where appropriate, the royalty payments over the life of the asset are adjusted for tax and discounted to present value. 6.17 Some or all of the following valuation inputs are required in the relief-from-royalty method: an estimate of the hypothetical royalty rate that would be paid if the asset were licenced from a third party, projections for the financial parameter, eg revenues that the royalty rate would be

applied to over the life of the intangible asset together with an estimate of the life of the intangible asset, rate at which tax relief would be obtainable on hypothetical royalty payments, the cost of marketing and any other costs that would be borne by a licensee in utilising the asset and an appropriate discount rate or capitalisation rate to convert the assets hypothetical royalty payments to a present value. 6.18 Royalty rates are typically applied as a percentage of the revenues expected to be generated when using the asset. In some cases, royalty payments may include an upfront lump sum in addition to periodic amounts based on revenues or some other financial parameter. 6.19 Two methods can be used to derive the hypothetical royalty rate. The first is based on market royalty rates for identical or similar assets. Royalty rates may be obtained by reference to any existing or previous arrangements in which the subject asset was licensed or by reference to licensing arrangements for other identical or similar assets. A prerequisite for this method is the existence of comparable intangible assets that are licensed at arms length on a regular basis. 14 Copyright IVSC 6.20 The second method used in the absence of market royalty rates for identical or similar assets is based on a split of profits that would hypothetically be paid in an arms length transaction by a willing licensee to a willing licensor for the rights to use the subject intangible asset. A reasonable percentage split is determined having regard to the facts of the case, eg the respective investment that would be required by the licensor and licensee in order for the asset to generate the anticipated profit. A cross check can be made by reference to royalty rates for any broadly analogous asset.

6.21 Any royalty information obtained should be adjusted to reflect the differences between the comparable royalty arrangement and the subject asset. Factors to benchmark when comparing the subject asset and other royalty agreements include: specific licensor or licensee factors that might impact the royalty rate such as their being related parties; exclusivity terms; whether the licensor or licensee has responsibility for certain costs, such as marketing and advertising; licence inception date and period of effect; duration of licence; or differentiating characteristics such as market position, geographical coverage, functionality, whether they are used in connection with B2B or B2C products etc. 6.22 When performing royalty cash flow calculations, maintenance and other support expenditure must be treated consistently. Thus, if the licensor would be responsible for maintenance expenditure, for example advertising or maintenance research and development, the royalty rate should reflect this as should the royalty cash flows. Alternatively, if maintenance expenditure is not included in the royalty rate, it should also be excluded from the royalty cash flows. Similarly, taxes must be treated consistently in the royalty cash flows. 6.23 Reasonableness checks should also be performed in respect of the selected royalty rate. One such check compares the total profit at a particular level, such as gross or operating profit, and how much of that profit would accrue to each of licensee and licensor if a selected royalty rate were used in determination of the licence fee. The reasonableness of such a profit split can then be reviewed. 6.24 If the resulting profit splits are significantly different from the ranges indicated by market

observation then: this may be explicable by reference to specific factors for instance, the subject asset may be especially complex and, hence, expected to earn a higher than normal return for the licensor, it may be necessary to reconsider whether the selected royalty rate is appropriate or 15 Copyright IVSC depending on the basis of valuation being adopted, a royalty rate might be appropriate that is different from that adopted by market participants. The above are indications of potential shortcomings. There may be other reasons for deviations and respective adjustments require professional judgement. Premium profits method 6.25 The premium profits, or incremental income, method indicates the value of an intangible asset by comparing an estimate of the profits or cash flows that would be earned by a business using the asset with those that would be earned by a business that does not use the asset. The forecast incremental profits or cash flows achievable through use of the asset are then computed. Forecast periodic amounts are brought to a present value through use of either a suitable discount factor or suitable capitalisation multiple. 6.26 The key inputs in the premium profits method of valuation are: forecast periodic profit, cost savings or cash flows expected to be generated by a market participant using the intangible asset, forecast periodic profit, cost savings or cash flows expected to be generated by a market participant not using the intangible asset and an appropriate capitalisation multiple or discount rate to capitalise forecast periodic profit or cash flows. 6.27 Forecasts of the cash flows achievable both with and without the subject intangible asset

should be made by reference to: activities of the owning entity, any entities using similar or identical intangible assets for which information is available publicly, any proprietary databases of the valuer and other research as available. 6.28 Where the PFI is obtained from the owning entity it should be tested or benchmarked against other data in the market. Depending on the basis of valuation required, adjustments may be required in respect of entity-specific factors in the forecasts. 6.29 The method can be used to value both intangible assets whose use will save costs and those whose use will generate additional profit. Examples of where different profits may be generated with or without an asset include: a beverage being sold by the same entity under both a branded and non-branded label and a non-compete agreement creating different projected cash flows. 16 Copyright IVSC 6.30 The application of this approach should reflect the extent to which the profit or cash flow forecast excluding the use of the intangible asset is unrepresentative because of its reliance on another intangible asset. This could happen, for instance, through the comparable profits being reliant on an own-name brand rather than no brand. In such cases, the identified premium profit and resulting value attributable to the intangible subject asset would be understated. 6.31 Account also needs to be taken of any differences in the level of investment that may exist between an apparently comparable brand and the subject. A branded product may produce higher gross profits than an unbranded product due to higher selling price. However, sales

of the branded product may require advertising and marketing expenses that the unbranded product does not. Similarly, a new manufacturing technology may reduce manufacturing costs, but require the purchase of additional machinery. The return on and of the additional machinery needs to be considered in the valuation of the technology. Excess earnings method 6.32 The excess earnings method determines the value of an intangible asset as the present value of the cash flows attributable to the subject intangible asset after excluding the proportion of the cash flows that are attributable to other assets. It is a method that is often used for valuations used in financial reporting when there is a requirement for the acquirer to allocate the overall price paid for a business between tangible assets, identifiable intangible assets and goodwill. 6.33 The excess earnings method can either be applied using several periods of forecast cash flows the multi-period excess earnings method or using a single period of forecast cash flows the single-period excess earnings method. In practice, because an intangible asset will normally bring monetary benefits over an extended period, the multi-period excess earnings method is more commonly used. 6.34 The inputs that should be considered when applying the excess earnings method include, but are not limited to: forecast cash flows obtainable from the business to which the subject intangible asset contributes to cash flows this will involve allocating both income and expenses appropriately to the pertinent business or group of assets of the entity that includes all the income derivable from the subject intangible asset, contributory asset charges in respect of all other assets in such business(es), including other intangible assets, an appropriate discount rate to enable expected cash flows attributable to the subject

intangible asset alone to be brought to a present value and if appropriate and applicable,TAB. 17 Copyright IVSC 6.35 The method is frequently used in practice to value in-process research and development, or IPR&D, projects which are difficult to value by other methods. As each IPR&D project is likely to be unique, it is unlikely that there will be data available from market transactions of similar assets so a comparison approach is unlikely to be possible. The nature of an IPR&D project is that additional development time and costs are anticipated prior to the asset generating cash flows (or cost savings). A discounted cash flow exercise, such as multi-period excess earnings, can be adapted to reflect these costs prior to the asset generating cash flows (or cost savings), whereas such adaptation is difficult with either the relief-from-royalty or premium profits methods. 6.36 The method is also frequently used in practice to value customer relationships or customer contracts. Again, there are rarely market transactions in similar assets for which price information is available so a comparison valuation method is unlikely to be possible. Also, it is difficult to apply relief-from-royalty to such assets as these assets are not leased in the market and so there is no data available on which to base royalty rates. Similarly, it is not possible to apply the premium profits method as it would be difficult to find a comparable business that did not have customer relationships. 6.37 Typically, the types of intangible assets that are valued using the excess earnings method are those that contribute to cash flows in combination with other assets in a group. While it is important to assess the cash flows in the context of the business, the excess earnings method is generally applied at a level of cash flows below that of the business. The method first involves forecasting the total cash flows expected to arise from the business or group of assets that use the subject intangible asset. From this forecast of cash flows, a deduction

is made in respect of the contributions to the cash flows that are made by assets, tangible, intangible and financial, other than the subject intangible asset. This is referred to as the application of contributory asset charges (CACs) or economic rent. 6.38 When calculating the intangible asset value it is important to ensure that the forecast cash flows are reflected in the projection only to the extent that it is expected to arise from the asset being valued in existence at the valuation date. 6.39 The forecast cash flows are brought to a present value by application of a suitable discount rate or, in simple case with infinite or indefinite RUL, a capitalisation rate. 6.40 The underlying principles of the CAC calculation are that: CACs should be made for all the tangible, intangible and financial assets that contribute to the generation of the cash flow and if an asset for which a CAC is required is involved in more than one line of business, its CAC should be allocated to the different lines of business involved. 6.41 CACs are generally computed as a fair return on and of the value of the contributory asset. 18 Copyright IVSC The appropriate return on a contributory asset is the investment return a typical prudent investor would require on the asset. This return that an investor would require is computed with respect to the Market Value of the asset. The return of a contributory asset is a recovery of the original investment in respect of assets that deteriorate over time. Thus, in the case of a tangible fixed asset, the return of such asset could be represented by its depreciation charge. 6.42 If cash flows are forecast on a post-tax basis, CACs should be determined on a post-tax basis. if cash flows are forecast on a pre-tax basis, CACs should be determined on a pretax basis. In practice, it is more common to value intangible assets on a post-tax basis. 6.43 Assets for which CACs are typically assessed include working capital, fixed assets, intangible assets other than the subject intangible asset, and any workforce in place.

Precautions should be taken to ensure that there is no double counting between charges in the profit and loss account and the CACs, and similarly that no CACs are omitted. 6.44 For more guidance on CACs specifically for valuations for financial reporting see the Exposure Draft TIP## The Calculation of Contributory Assets and Economic Rents. Greenfield method 6.45 The greenfield method is conceptually similar to the excess earnings method in that it identifies the incremental or excess cash flow associated with the subject asset. However instead of subtracting a CAC from the cash flow to reflect the contribution of contributory assets, the greenfield method assumes that the owner of the subject asset would have to build or buy the contributory assets. An amount representing that initial investment is therefore deducted from the cash flow. 6.46 Because the cash flows used in the greenfield method can be used to explicitly model the initial start-up costs of buying or creating the contributory assets, it can it can be a useful indicator of the value of the going concern in cases where the PFI reflects an established business. A greenfield approach is most commonly used as one of the methods to estimate the value of licence based intangible assets. 7 Cost approach 7.1 The cost approach is based on the economic principle that a buyer will pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase or by construction. Due to most intangible assets being heterogeneous there will rarely be any transactions involving identical or even similar assets (see para 4.8) and therefore the cost approach considers the cost that a buyer would incur in constructing or creating an equivalent asset. 19 Copyright IVSC 7.2 The cost approach, determines the value of an intangible asset by comparing it with the

cost of creating an asset of equal utility or service capacity. Often a newly created intangible asset will have a greater utility than the subject asset. Where this is the case an adjustment is required to the cost of creating the new asset to reflect the inferior utility of the subject asset. This adjustment is generally known as an obsolescence or depreciation adjustment. 7.3 The cost approach can only be applied to the valuation of intangible assets when it is possible to reasonably estimate either the reproduction or replacement cost of the subject asset. In this context; The reproduction cost is the cost that would be incurred in replicating the asset. It would reflect the time, investment and processes involved in creating the subject asset, at costs prevailing at the valuation date. It is most appropriate for recently created intangible assets. The replacement cost is the cost of creating an modern equivalent asset that offers the same utility or functionality as the subject asset. Due to changes that have occurred in the market, eg because of changing consumer tastes or technological changes, the processes involved in creating the subject asset may no longer be appropriate. Replacement cost is most appropriate for well established assets where a potential buyer may have options for creating an equivalent alternative that do not involve replicating the processes involved in creating the subject asset. 7.4 The cost approach is mainly used for those intangible assets that have no identifiable income streams or other economic benefits. Examples of intangible asset the cost approach is applied include: self-developed (proprietary) software, web sites, and the benefit of an assembled workforce (see 6.43) .

7.5 The costs that should be considered in applying the cost approach to value an intangible asset include: the labour costs and any material costs involved in creating the asset, the cost of any advertising or other promotion required to create an asset of equivalent utility, the cost of any management time involved in project oversight, legal, licensing and patent registration fees and the opportunity cost, ie the cost of any opportunities for alternative investment that would be foregone in order to develop an equivalent asset. 20 Copyright IVSC 7.6 It may also be appropriate to consider the impact of tax deductibility for the costs incurred in researching or developing an intangible asset 7.7 Obsolescence adjustments may be needed to the costs of replacing an intangible asset if the subject asset would be less valuable than its replacement. This could arise where: the a new equivalent would be developed using technology or know how that was not available when the subject asset was created or if the subject asset would have a shorter remaining useful life than a new equivalent 8 Other Considerations Discount rates 8.1 The various methods that fall under the Income Approach described in Section 6 of this TIP involve the use of discounting techniques. The heterogeneous character of most intangible assets means that it will seldom be possible to obtain reliable market data on discount rates for comparable individual assets. However, it may be possible to use rates from the market as reasonableness cross-checks of results from application of the build-up method. 8.2 If the subject intangible asset is the principal asset of the business it is common practice to

estimate the discount rate for an intangible asset by reference to to the weighted average cost of capital (WACC ) applicable to that business. However, the WACC rate may not be appropriate if the subject intangible asset has a distinct risk profile from the rest of the assets and liabilities utilised in the business or if there is other evidence that indicates an alternative discount rate. 8.3 Because of the limitations on deriving an appropriate discount rate from market data the build-up technique described in TIP1 Discounted Cash Flow is commonly used for valuing intangible assets. Remaining Useful Life 8.4 An important consideration in the valuation of an intangible asset is the remaining useful life of the asset. This may be a finite period limited by either contract or typical life cycles in the sector; other assets may effectively have an indefinite or even infinite life. Estimating the remaining useful life of an asset will include consideration of legal, technological or functional and economic factors. For example, an asset comprising a drug patent may have a remaining legal life of five years before expiry of the patent, but a competitor drug with improved efficacy may be expected to reach the market in three years. This might cause the remaining useful life of the patent to be assessed as only three years, although consideration should be given as to whether the know how would have value beyond that date for production of a generic drug. 21 Copyright IVSC ILLUSTRATIVE EXAMPLE The following example illustrates how various methods referred to in this TIP can be applied. The valuer has been engaged to perform a purchase price allocation under IFRS 3 for the clients acquisition of a company that distributes food products. The required valuation basis is therefore fair value as defined in IFRS. Revenue is forecast to grow at 4% per annum for 4 years. The

company expects revenue of CU200m in the first year and to maintain a constant EBITDA margin of 20% each year. Depreciation is estimated at 2.5% of revenue. A long term tax rate assumption of 23% has been assumed over the forecast period. As at the valuation date, the valuer determines an appropriate post-tax discount rate to be 8.5%. The valuer has identified the following intangible assets in the company as at the Valuation Date: 1. A registered patent applied on all food products the company distributes which will generate economic benefits for 4 years. 2. A non-compete agreement with the founder of the company which disallows his establishment of a rival company after the sale of the company to the acquirer. 3. A four year distribution agreement with a key customer representing 10% of the companys annual turnover at the same overall margin. The valuer uses different methods to value the above intangible assets based on the nature of the intangible assets: 1. Relief from royalty method is used to value the registered patent. 2. Premium profits method is used to value the non-compete agreement. 3. Multi-period excess earning method (MPEEM) is used to value the distribution agreement. The valuer has added risk premia on top of the base discount rate to the company as appropriate for the respective intangible asset. A total pre-tax contributory asset charge of 11% is applied to the pre-tax earnings in using the MPEEM on the distribution agreement. 22 Copyright IVSC Method 1 - Relief from royalty m Year 1 2 3 4 Revenue 200.0 208.0 216.3 225.0

Pre-tax royalty payment 10.0 10.4 10.8 11.2 Tax -2.3 -2.4 -2.5 -2.6 Relief from royalty 7.7 8.0 8.3 8.7 Discount period 1.0 2.0 3.0 4.0 Discount factor 0.913 0.834 0.762 0.695 Present value 7.0 6.7 6.3 6.0 Fair value before TAB 26.1 Key assumptions WACC 8.5% Risk premia 1.0% Discount rate 9.5% Comparable royalty rate (pre-tax) 5.0% Tax 23.0% Method 2 - Premium profits m Year 1 2 3 4 EBIT with non-compete agreement 35.0 36.4 37.9 39.4 EBIT without non-compete agreement 28.0 30.9 34.1 37.4 Premium pre-tax profit 7.0 5.5 3.8 2.0 Discount period 1.0 2.0 3.0 4.0 Discount factor 0.905 0.819 0.741 0.671 Present value 6.3 4.5 2.8 1.3 Sum of present value before TAB 14.9 Probability of competition and success 75.0% Fair value before TAB 11.2

Key assumptions WACC 8.5% Risk premia 2.0% Discount rate 10.5% 23 Copyright IVSC Method 3 - Multi-period excess earning method m Year 1 2 3 4 EBIT 3.5 3.6 3.8 3.9 Pre-tax CAC -0.4 -0.4 -0.4 -0.4 Pre-tax profit after CAC 3.1 3.2 3.4 3.5 Tax -0.7 -0.7 -0.8 -0.8 Excess earnings 2.4 2.5 2.6 2.7 Discount period 1.0 2.0 3.0 4.0 Discount factor 0.913 0.834 0.762 0.695 Present value 2.2 2.1 2.0 1.9 Fair value before TAB 8.1 Key assumptions WACC 8.5% Risk premia 1.0% Discount rate 9.5% % of total sale and EBIT attributed 10.0% Pre-tax contributory asset charges (CAC) 11.0% Tax 23.0% ( Additional text required to reconcile different methods and confirm valuation conclusion )