Posted: July 8th, 2015

The valuation of Intangible Assets in Technology Companies

Abstract

This research proposal will, investigate the valuation of intangible assets; Research and development (R&D), and patent count in technology-based companies. The paper proposes the use of non-financial information like backward citation and forward citation models of valuing intangible assets.

Introduction

Intangible assets valuations in technology-based companies have in the recent past raised concerns whether such assets are rationally valued. This has led to the questioning of the traditional asset valuation models’ validity in the present economy. Bearing in mind that technology-based companies have few tangible assets, this study will explore on the ability of non-financial information to value such companies’ intangible asset. Given the growing importance of technology-based companies, a study that aims at valuing any aspect of such companies would be of interest to stakeholders including investors and entrepreneurs planning in understanding the value drivers in such companies.

The objective of this study is to identify and prescribe an accounting treatment of intangible asset. The establishment of this standard requires the recognition of intangible asset, the standard will also specify how to measure such assets; this calls for a pecific disclosure of intangible assets

Research methodology

A patent refers to an exclusive governmental grant to a company (Mossof, 2008, p. 327). This study will use the number of grants controlled by technology-based companies as value indicator of their intangible assets; this is in line with Hall, Thoma and Torrisi (2008, p. 54) suggestion that, the number of patents in an organization is an indicator of value. Companies normally use intellectual property rights to bar entrance of competitors into their territory. Technology-based companies can use a combination of patents, trade secrets, trademark laws and copyrights to gain competitive advantage over their rivals.

Within any technology-based company, product development is driven by scientific research; therefore, the quality of the company’s research and scientific team is critical to the company’s product development, and investors’ evaluation of the company’s future prospects. However, measuring the quality of a research team is not easy. This study will employ citation statistics as an indicator of research quality. As pointed out by Adler, Ewing and Taylor (2009 p.14), citation statistic information can be used to judge the future earnings of a scientific discovery.

According to Duguet and MacGarvie,( 2008, p. 123 ), R&D output and citation weighted patterns (forward citation) have a direct relationship. This study will employ patent citations to validate the technological impact of innovations and their importance in particular areas. Citation patterns have been used in the assessments of the quality in scientific research.

In accordance with the aim of the study; to investigate the valuation of intangible assets in technology companies, representative companies will be chosen randomly. There are two research paradigms over which the study can employ; qualitative and quantitative paradigm. In quantitative paradigm, a researcher attempts to determine validity of existing theories or to understand relationships of existing phenomena. Since of the aims of this study is to determine how technology-based companies measure or value their intangible assets, quantitative paradigm will be used since it is appropriate for the study’s purpose. Qualitative paradigm orients the researcher to assume respondents’ frame of reference in understanding an existing phenomenon, additionally, findings are not represented numerically, but in actual words which contradict the aim of this study, hence the method will not be employed.

There are various strategies used to conduct a research, and they include action research, survey, ethnography and case studies. An appropriate research strategy is influenced by three main conditions; research question, and researcher’s control over event s under the study. With respect to this study’s objective, survey approach using questionnaires to collect data will be an economical way as it gives a representative sample thus achieving ‘generalizability’. Case study is an investigative approach focusing on detailed and in-depth analysis and description of one or few organizations. This implies that results obtained from case study approach cannot be generalized to a larger population due to the limited range of investigation. Considering the case study method limitation, the study will opted for survey method. Company representatives under the survey will be asked questions regarding their perception towards valuation of intangible assets. Documentation of secondary information will also used, but considerations will be taken as they can considerably affect findings validity and reliability. However, relying on secondary documentation is essential as it will strengthen the study’s findings.

To determine how companies value their intangible assets the study will employ a set of guided questions in preparing a questionnaire that can be completed within 30 minutes. The respondent could grade each statement of the survey questionnaire using Likert scale with five response choices. The responses will be analyzed statistically using SPSS to derive the significant p-value and regression weight. For secondary data, an evaluation will be drawn to identify factors influencing valuation of intangible assets.

Explain Intangible Assets

With the exception of good will, an intangible asset according to International Financial Reporting Standards (IFRS) is “an identifiable non-monetary asset without physical substance” Keong Choong, 2008, p. 13). The detection of intangible assets calls for a combination of entities and their future economic benefits at the time of their acquisition. Intangible assets can take the form of future additional income as a result of anticipated cost savings. With respect to technology-based companies, intangible assets may include: secrete formulas, trade secrets, and patented and unpatented technology.

An intangible asset can be recognized through its potential future economic benefits. . The future benefit of an asset is independent of the buyer’s intention of the asset’s future use. The fair value of the assets satisfies the considerations and uncertainties regarding the asset’s future economic benefits. The buyer’s considerations of the acquired assets do not affect the detection of an intangible asset; this also applies to the measurement of such asset.

It is a requirement of the IFRS that intangible assets acquired in a business combination be recorded at a fair value; however, IFRS and other accounting standards provide limited guidance on the determination of a fair value. Consequently, a number of approaches to measuring intangible assets have emerged; these approaches can be group into three: market approach, income valuation approach and cost approach.

The market approach provides a fair value indication by comparing an asset to other assets that were sold or acquired in a recent market transaction. A fair value can be estimated from similar assets transaction and observable market data. However, intangible assets form part of a sales or a licensing agreement; observable data is in most cases limited; available information may only relate to a similar asset thus calling for complex modifications to capture the characteristics of the assets in question. In that respect, market approach is not commonly used to estimate the fair value of intangible assets.

The fair value of an intangible asset can also be estimated using income valuation approach; this involves estimating the asset’s value based on its future expected income streams. This approach involves estimations of the present value and future economic benefits attached by the owner to the asset, as well as, observable market data. Income valuation approach heavily relies on discount rates and projected financial information. Income valuation approach is commonly preferred in measuring intangible assets’ fair value because it incorporates fair value management by referencing to the assets’ future benefits.

Cost approach estimates an asset’s fair value by computing the amount required to reproduce or repurchase the asset. The approach also takes into consideration depreciation (though not applicable in intangible assets), use and technology, as well as, economic relevance. Cost approach is less preferred in measuring the value of intangible assets because the replacement or reproduction of intangible assets can be difficult to measure particularly when such assets are unique. Additionally; this approach ignores the assets’ future economic benefits.

Explain and Evaluation Technology-based company

Technology based companies refer to companies that employ scientific knowledge to produce goods and services with an added value. Their scientific knowledge is derived through in-house R&D or close association with institutions of higher learning. Such companies operate at top strategic sectors like biotechnology, microelectronic and nanotechnology.

As industries move from manufacturing to service sector, companies are increasingly deriving their value from intangible assets. The last century saw a shift from manufacturing to service and technology industry with most changes happening in the US (Dicken, 2007, p. 106). As the business world continues to value pharmaceutical, service and technology companies, the global market is faced with two realities: first, most assets of such companies are intangible, and second, the way accounting deals with such assets have remained inconsistent, consequently, most valuation methods used; cash flows, return on capital and earnings, are inconsistent (Drucker, 2014, p. 43). In that respect, there is need for consistent and simple measure of how intangible assets are valued.

Assets are normally valued by referencing on the existing assets’ current earning; however, the accounting treatment of intangible assets renders such valuation unreliable since reported earnings of a technology-based company represent earnings after R&D reinvestment, as opposed to the book value, and true operating earnings (main assets are off the books).

It is a fact that growth is a function of a company’s reinvestment and reinvestment equity; however, accounting for expenditures on intangible assets is difficult since expenditure in reinvestment can be blurred by operating expenses and in most cases do not stand independently as capital expenditure; this makes it hard record the book value of an intangible asset which consequently makes it difficult to measure returns on equity and capital.

Analysis the importance of intangible assets

Traditional models of asset valuation include: discounted cash flow and relative valuation approach. Asset valuation takes the value of an asset as the present value of its expected returns, while relative valuation takes the value of an asset as the value of similar assets in the market. However, studies have shown that intangible assets can be valued using nonfinancial information e.g. the value of a biotechnology firm’s intangible assets are dependent on factors like location of the firm and its scientific team capabilities; therefore, an approach like citation analysis can effectively value the firm’s intangible asset (R&D).

Research ethical consideration

To ensure ethical research, human research ethics approval will be sought for this study. This will cover the use of questionnaires and semi-structured interviews. The main concern is the safety of the participants. Participant safety will be accomplished by assessing the risks and benefits of the research process and by using available information to monitor the progress of the project. The participants’ informed written consent will be sought; they will be informed that the information collected for the research project will not be used for any other purposes other than the study’s intent. Care will also be taken to protect sensitive information and participants will be notified of any unforeseen findings that may affect them.

Research Timescale

Conclusion and recommendation

Valuation of intangible assets in technology-based companies have in the recent past raised concerns on of whether such companies are rationally valued with respect to their accounting information. Following this concern, there is need for research studies inquiring on whether nonfinancial information approaches like citation patterns are effective than financial based information approaches like discounted cash flows.

References

Adler, R., Ewing, J., & Taylor, P. (2009). Citation statistics. Statistical Science,24(1), 1.

Drucker, P. (2014). Innovation and entrepreneurship. Routledge

Duguet, E., & MacGarvie, M. (2005). How well do patent citations measure flows of technology? Evidence from French innovation surveys. Economics of Innovation and New Technology, 14(5), 375-393.

Hall, B. H., Thoma, G., & Torrisi, S. (2007, August). THE MARKET VALUE OF PATENTS AND R&D: EVIDENCE FROM EUROPEAN FIRMS. In Academy of Management Proceedings (Vol. 2007, No. 1, pp. 1-6). Academy of Management.

Keong Choong, K. (2008). Intellectual capital: definitions, categorization and reporting models. Journal of intellectual capital, 9(4), 609-638.

Mossof, A. (2008). Exclusion and Exclusive Use in Patent Law. Harv. JL & Tech., 22, 321 book, 293