Accounting of Brand Equity Jamnalal Bajaj Institute ofManagement StudiesManagement Accounting, MMS I, Batch of 2014 Prepared and Submitted By : (In order of the presentation) Rajiv Parwani (98) Vibhuti Mhatre (93) Priyanka Pardeshi Amit Mutha (94) Vivek Metkar (92) Preethi Parthasarathy (100) Neha Dave (95) Rohan Pai (96)
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accounts (income statements), or they had to write off the amount to reserves and in many cases ended
up with a lower asset base than before the acquisition.
In countries such as the UK, France, Australia and New Zealand it was, and still is, possible to recognize
the value of acquired brands as identifiable intangible assets and to put these on the balance sheet of
the acquiring company. This helped to resolve the problem of goodwill. Then the recognition of brands
as intangible assets made use of a grey area of accounting, at least in the UK and France, whereby
companies were not encouraged to include brands on the balance sheet but nor were they prevented
from doing so. In the mid-1980s, Reckitt & Colman, a UK-based company, put a value on its balance
sheet for the Airwick brand that it had recently bought; Grand Metropolitan did the same with the
Smirnoff brand, which it had acquired as part of Heublein. At the same time, some newspaper groups
put the value of their acquired mastheads on their balance sheets.
By the late 1980s, the recognition of the value of acquired brands on the balance sheet prompted a
similar recognition of internally generated brands as valuable financial assets within a company.
In 1988, Rank Hovis McDougall (RHM), a leading UK food conglomerate, played heavily on the power of
its brands to successfully defend a hostile takeover bid by Goodman Fiel der Wattie (GFW). RHM’s
defence strategy involved carrying out an exercise that demonstrated the value of RHM’s brand
portfolio. This was the first independent brand valuation establishing that it was possible to value
brands not only when they had been acquired, but also when they had been created by the company
itself. After successfully fending off the GFWbid, RHM included in its 1988 financial accounts the value of both the internally generated and acquired brands under intangible assets on the balance sheet.
In 1989, the London Stock Exchange endorsed the concept of brand valuation as used by RHM by
allowing the inclusion of intangible assets in the class tests for shareholder approvals during takeovers.
This proved to be the impetus for a wave of major branded-goods companies to recognize the value of
brands as intangible assets on their balance sheets. In the UK, these included Cadbury Schweppes,
Grand Metropolitan (when it acquired Pillsbury for $5 billion), Guinness, Ladbrokes (when it acquired
Hilton) and United Biscuits (including the Smith’s brand).
Today, many companies including LVMH, L’Oréal, Gucci, Prada and PPR have recognized acquired brands
on their balance sheet. Some companies have used the balance-sheet recognition of their brands as an
investor-relations tool by providing historic brand values and using brand value as a financial
performance indicator. In terms of accounting standards, the UK, Australia and New Zealand have been
leading the way by allowing acquired brands to appear on the balance sheet and providing detailed
guidelines on how to deal with acquired goodwill. In 1999, the UK Accounting Standards Board
introduced FRS 10and 11 on the treatment of acquired goodwill on the balance sheet. The International
Accounting Standards Board followed suit with IAS 38.
And in spring 2002, the US Accounting Standards Board introduced FASB 141 and 142, abandoning
pooling accounting and laying out detailed rules about recognizing acquired goodwill on the balance
sheet. There are indications that most accounting standards, including international and UK standards,
will eventually convert to the US model. This is because most international companies that wish to raise
funds in the US capital markets or have operations in the United States will be required to adhere to US
Generally Accepted Accounting Principles (GAAP).
The principal stipulations of all these accounting standards are that acquired goodwill needs to be
capitalized on the balance sheet and amortized according to its useful life. However, intangible assets
such as brands that can claim infinite life do not have to be subjected to amortization. Instead,companies need to perform annual impairment tests. If the value is the same or higher than the initial
valuation, the asset value on the balance sheet remains the same. If the impairment value is lower, the
asset needs to be written down to the lower value. Recommended valuation methods are discounted
cash flow (DCF) and market value approaches. The valuations need to be performed on the business unit
(or subsidiary) that generates the revenues and profit.
The accounting treatment of goodwill upon acquisition is an important step in improving the financial
reporting of intangibles such as brands. It is still insufficient, as only acquired goodwill is recognized and
the detail of the reporting is reduced to a minor footnote in the accounts. This leads to the distortion
that the McDonald’s brand does not appear on the company’s balance sheet, even though it is
estimated to account for about 70 per cent of the firm’s stock market value, yet the Burger King brand is
recognized on the balance sheet. There is also still a problem with the quality of brand valuations for
balance-sheet recognition. Although some companies use a brand-specific valuation approach, others
use less sophisticated valuation techniques that often produce questionable values. The debate about
bringing financial reporting more in line with the reality of long-term corporate value is likely to
continue, but if there is greater consistency in brand-valuation approaches and greater reporting of
brand values, corporate asset values will become much more transparent.
Brand Valuation Methods:
A number of methods have been proposed to define the value posted in the balance sheet when a
brand is part of the assets of an acquired company, or any other instance when this valuation is needed.
They can be positioned on a two-dimensional mapping.
The horizontal axis refers to time (but do we base the analysis on the past, the present or the future?).
This axis discriminates between valuations based on historical costs (those that helped build the brand),
valuations based on present earnings, on market price, and those which rely on a business plan: that is
to say, a forecast. The vertical axis is a real/virtual dimension. Some analysts rely on hard facts (historical
accounts are facts, as well as present earnings).
The brand valuation methods can be broadly classified into 3 types
• Cost based
• Income based
• Market based
Cost Based Methods:
The cost approach measures the value of a brand based on the costs invested in building it, or
duplicating or replacing it. The premise is that a prudent investor would not pay more for a brand than
the cost to replace or reproduce it. The actual amount invested encompasses all expenses to build andsupport it up to the valuation date. Replacement costs include those to create, at current prices, a
similar brand of equivalent utility. Duplication costs represent the expenses needed to recreate an
identical brand, adjusted for any potential losses of awareness and strength.
When adopting the cost approach, a comparison must be performed between past expenditures and
awareness of the brand generated by them. It should not be automatically assumed that there is a link
between money spent and value created. The cost approach is often based on retrospective data and
does not consider a company’s future earnings potential. It may be used when other valuation
approaches cannot be implemented and there is no other reliable data. It is sometimes used to
ascertain the consistency and reasonableness of values obtained through other approaches.
Creation costs method: this brand valuation methodology estimates the amount that has beeninvested in creating the brand. In this all the assets are taken at a current value and summed to
arrive at a value. This includes tangible assets, intangible assets, investments and stocks.
Replacement value method: this brand valuation method estimates the investment required to
build a brand with a similar market position and share.
Even assuming that historical cost data of the brand is available and/or the replacement cost can be
estimated with a reasonable degree of reliability and confidence, these approaches are generally
inappropriate. The reason is that cost is not relevant for determining the value of a brand, which, is
derived from future economic benefits. There is no direct correlation between expenditure on an asset
and its value. Probably one of the few occasions where cost can be a relevant benchmark is one where
the brand has been recently acquired.
Income Based Methods:
In general this involves estimating the expected after-tax cash flows attributable to the brand over its
remaining useful economic life, and present valuing them at an appropriate discount rate. The cash
flows (or another measure of brand earnings) used shall be those reasonably attributable to the brand.
Various methods are available to determine the cash flows to be calculated after tax.
• Valuation by royalty method: This is often chosen to determine the cash flow generated by a
brand. It measures the present value of expected future royalty payments, assuming that the
brand is not owned but licensed. The royalty rate selected shall be determined after an in-depth
analysis of available data from licensing arrangements for comparable brands and an
appropriate split of brand earnings between licensor and licensee. It should be as close aspossible to those for brands with the same characteristics and size.
• Valuation by Earnings Multiple method: The cash profit is multiplied by what is known as
earnings multiple which in turn is estimated on the basis of various attributes of Brand such as
Leadership, Stability, Market position, Internationality, Support and Protection
Out of the above two approaches, the earnings multiple approach is easy to use, but it is not based on strong
conceptual underpinning. Generally DCF approach is considered as the conceptually superior method of
Brand Valuation.
Market based Method:
A measure of value may be based on what other purchasers have paid for reasonably similar assets. The
market approach should result in an estimate of the price reasonably expected to be realized if the
brand were to be sold. Data on the prices paid for reasonably comparable brands shall be collected and
adjustments made for differences between them and the subject brand. For selected comparables,
multiples are calculated on the basis of their acquisition price and then applied to the aggregates of the
subject.
When applying this approach, comparables should have similar characteristics to the subject, such as
brand strength, goods or services, economic and legal situation, as well as a transaction reasonably closein time to the valuation date. The valuator shall take into account the fact that the actual prices
negotiated by independent parties in transactions may reflect strategic values and synergies that cannot
be realized by the present owner. The number of transactions relating to brands as isolated assets is
very small. In addition, when the data is known, the characteristics of the subject may differ significantly
from those of the few examples of brands sold.
Apparently the methodology sounds simple, attractive, and objective. But the methodology is frequently
impractical due to lack of market information. Arm’s length transactions involving similar brands in
similar industries are infrequent, given the uniqueness of individual brands. In addition, for transactions
that are comparable, it is likely that market and financial information concerning the asset will not bepublicly available. However this method can be used as a counter check.
How to Calculate Brand Value
To capture the complex value creation of a brand, take the following five steps: