Measurement Subsequent To Initial Recognition Accounting Essay


Intangible Assets are identifiable nonmonetary long lived assets that dont have physical substance, which can be either acquired or developed internally by the company; contribute in the production of the goods and services. Under US Generally Accepted Accounting Principles (GAAP) intangible assets with definite life are amortized over their estimated useful life while as in the International Financial Reporting Standards (IFRS) indefinite lived intangible assets have to be impaired in any period by conducting an impairment test in order to account for the intangible assets.

Brand valuation originally started in the 1980s. The first brand valuation was done in 1988 by Rand Hovis McDougall(RHM) which thought that its brand was undervalued when Goodman Fielder Wattie(GFW) offered 600£ million to buy the company. So, the RHM 1988 Financial statements included brands in the intangible assets section with a value of 680£ millions [1] .

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Because of the increasing importance of brand names in the economic life of the business, the accounting treatment for brands has been a matter of discussion and debate. IFRS first addressed accounting for intangibles in the International Accounting Standard 38 (IAS 38) which established criteria for clarifying the recognition, measurement, amortization, disposal and disclosure of intangible assets, including brand names.

We will discuss the accounting treatment of brands under the following topics:

Why should a company value its brand?

Accounting for brands separate from goodwill

Recognition of brands as an asset.

Recognition of internally generated brand names.

Recognition of acquired brand names.

Initial measurement of brands.

Measurement subsequent to initial recognition.

Impairment tests under IFRS.

Intangible assets and brand names under GAAP according to FASB.

Retirement and Disposal.


Why should a company value its Brand?

Many reasons drive companies to value their brands, starting with determining price of brands in situations such as mergers, acquisitions, and joint venture, also determining the value that brands add to those transactions. Brand valuation is essential for making business and brand investment decisions. Assessing the value of brand means assessing brand performance to enhance the returns related to the brand. Establishing and communicating brand name as an intangible asset in the capital market is vital for supporting share price and obtaining funds. The company should value its brands for purposes such as legal transactions and licensing, and for cases of exposing the company into litigation for resolving disputes. Because brands are a valuable asset to any company; it can be the money maker that generates future cash flows if used wisely and reached its targeted groups. In other words, brands can change from just a sign into an asset worth millions even billions of dollars. In addition, recognizing the brand name today as an intangible asset is significant because of the highly increasing value of the intangible assets. Although highly valued it's the least fathomed. To conclude, brands today are the most valuable resources in business because they can impel demand, motivate personnel, and encourage financial markets, leading companies to recognize their need to realize and analyze brand equity and brand value when making strategic planning.

Accounting for brands separate from Goodwill

Goodwill is an intangible asset with the quantifiable value owned by the company. It reflects the business reputation and customers' loyalty. It is considered to be part of intangible assets on the balance sheet. According to the United States Financial Accounting Standards Board, Goodwill is the excess cost of the acquired company over the sum of the amounts assigned to identifiable assets acquired less liabilities. While the International Accounting Standards Committee defines goodwill as the excess of the cost of acquisition over the acquirer's interest in the fair value of the identifiable assets and liabilities acquired at the date of the exchange transactions. On the other hand, brand is a name, term, sign, symbol, or any other feature that identifies a company's goods or services and distinct them from those of competitors. In accounting, brands and goodwill share the same characteristics and they both contribute to enhance future cash flows. Therefore, brands are treated almost the same as goodwill. Many accountants use the same valuation methods such as the present value of future cash flows calculations for brands and goodwill. For that reason, companies may merge brands within goodwill and treat them as one. This is implemented even by large corporations such as Cadbury Schweppes. Brand names are classified by the accounting standards as intangible assets .In addition, brands are considered to be a legal property; they can be transferred, sold, licensed separately and legally protected. So, Brands proved to have a legally separate identity. Therefore, brands are recognized on the balance sheet as intangible assets separable from goodwill.

Recognition of brands as assets:

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Brand name can be recognized as an asset if it complies with the asset definition. Both GAAP and IFRS define intangible assets as "identifiable, nonmonetary assets without physical substance held for use in the production or supply of goods and services for rental to others, or for administrative purposes". To consider an item to be an asset, first it should result from past events, and in future economic benefits to the business.

US GAAP provides criteria for recognizing intangible assets similar to IFRS (IAS38) [2] :

If the asset can be identified separately from other aspects of the business entity

If the use of intangible asset is controlled by the entity as a result of its past actions and events.

Whether future economic benefits are expected to flow to the entity.

Whether the cost of the asset can be measured reliably.

According to the standards, intangible asset is identifiable if it is separable and can be distinguished from goodwill and if it arises from contractual or other legal rights. Brands are included in the definition of intangible assets that should be recognized and accounted for. Brand names are either internally developed or acquired in a business combination.

Internally generated brand names:

Accounting treatment for internally generated intangible assets differs from acquired intangibles. Both IFRS and GAAP prohibit the recognition of internally generated intangible assets including brand names.

Expenditures resulting from researches are expensed while costs resulting from development are capitalized if they meet certain criteria "IAS 38.57" [3] :

The technical feasibility of completing the asset so that it will be available for use or sale;

The intention to complete the asset and use or sell it;

The ability to use or sell the asset;

The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally;

The availability of adequate technical, financial and other resources to complete the development and to use or sell it; and

The ability to measure reliably the expenditure attributable to the intangible asset.

Companies may incur expenditures to improve brand names e.g. advertising campaigns. It's possible that these expenditures may be capitalized as part of brand names after deducting the costs related to research from the cost of creation, however it's argued which of these expenditures and how much can be capitalized. That's why IFRS prohibit the capitalization of internally generated brand names. In other words, the whole idea is based on management judgment of the amount to be capitalized regarding the brand name. When an internally generated brand name is recognized, the cost is determined using the acquisition principles.

Also, the guidelines prohibit the recognition of internally generated intangible assets even if the fair value can be measured reliably. Under US GAAP the standards prohibit the recognition and never capitalize brand names as an asset unless otherwise it was acquired.

The reason behind the non-recognition of internally generated brands is that we cannot distinguish the cost of these items from the cost of developing the business.

Acquired brand names:

The accounting authorities require that past events be reported at objective historical cost rather than the subjective fair value in order to make the financial statements more consistent, comparable and reliable. Purchased brands are initially recognized at cost (the sum of the purchase price plus any directly attributable costs), while acquired brands in a business combination can be recognized at their fair value at the acquisition date.

It's necessary that the acquirer of brand names in a business combination record them as intangible assets even though they were not recognized by the acquiree since they are internally generated.

Cost of acquired brands is determined based on conditions of the acquisition. This includes [4] :

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Its acquisition price, including legal and brokerage fees, import duties, value added and other nonrefundable purchase taxes, after excluding discounts.

Other direct costs in preparing the asset for the final use. For example, labor costs.

Initial Measurement of brand:

With the increased importance of brands, there has been increased creation of valuation methods and techniques, even establishment of entities that specialize in measuring brand value. Valuation methods vary in techniques, but the most and widely used is the present value technique.

However, here are five methods used for brand valuation [5] :

Historical cost method: this method considers the total cost of the brand. A problem arises when capitalizing the costs related to the brand that were expensed a long time ago and cannot appear on balance sheet which represents the aggregation of costs not yet charged to the profit and loss account rather than those that have already been expensed.

Market value Method: when the brand is being sold or acquired, the realizable value depends on conditions at that time such as the competitive situation in the market. The value of the brand then is equal to the replacement costs involved in creating brand loyalty, brand awareness and so on.

Price premium method: this method determines the excess or premium revenue of a brand by deducting the income of unbranded competing product from the income of a comparable branded product. The main purpose of many brands is to achieve highest level of future demand so the value of these brands lies in future demand rather than premium price. Under this method, the brand value is assessed by projecting the brand's future earnings and discounting them to the net present value at a discount rate. However, Many difficulties arising from this method:

Subjectivity in cash flows construction and in choosing the appropriate discount rate.

There is rarely unbranded product to compare with the branded product.

This method concentrates on price and ignores costs and other commercial factors such as manufacturing economies of scale from a high-volume brand.

Earnings Valuation method: this method applies price/earnings multiplier or another multiplier to a brand's profits. Profits arise after deducting the profits from any unbranded product competing with the branded product and eliminating profits from assets that are not necessary to the brand's strength. Difficulties arising from this method:

It's difficult to choose a baseline year for brand-related profits to apply a multiplier.

There's an unfair assumption that price/earnings multipliers of brand-related profits can be valued in the same way as the entire business.

Royalty payments method: it requires the determination royalty income from the licensing out of a brand. In other words, when a brand holding company license the brand to another operating company, the price paid by the operating company to the brand company is the royalty rate. The value of the brand to the business is then calculated as the net present value of all projected royalties. A major weakness is whether royalties are an effective substitute for brand-related premiums.

Measurement subsequent to initial recognition:

There are two alternative methods used to measure intangible assets after they have been initially measured:

Cost Model: intangible assets are carried at its cost less any accumulated amortization or impairment losses.

Revaluation Model: intangible assets are carried at fair value and are subject to amortization and impairment charges.

When using the revaluation model, the fair value is determined based on the active market of the intangible asset. There are three conditions for an active market: the items traded are homogenous, buyers and sellers are available anytime, and prices are available to the public. However, brand names and trademarks are not involved in an active market with such characteristics because they are unique. Therefore, they cannot be measured at fair value using the revaluation model; rather they can only be measured at cost, and are subject to impairment.

Impairment Tests under IFRS

Intangible assets may have finite or infinite useful lives. If finite, then the asset is amortized over its useful life. However, if the asset has infinite useful life then it's tested for impairment. The company should determine whether the intangible asset is expected to have finite or infinite useful life, based on analysis that the asset has or doesn't have foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.

Under the International Standards, classification of brand names as infinite-lived assets must have some conditions:

The position of the brand in the eyes of its customers globally in terms of market share and reputation.

Have projected future long term profits.

Its exposures to risk.

A main event affecting the future of the brand.

The age of the brand name.

Until the year of 2004, brand names under IFRS had been amortized and had been appointed for as definite intangible assets where the amortization was calculated retrospectively from the date of the acquisition. Updates that took place in 2004 started to consider brand names to have infinite life. Since then, trademarks and brand names acquired are considered to have infinite useful life because they are expected to generate cash inflows indefinitely. For that reason, the standards required brand names to be tested annually for impairment and whenever there's an indication that they may be impaired. The assumption that a brand name has indefinite life must be reviewed annually.

The impairment of intangible assets such as patents, copyrights and brand names is treated in the same way as long-lived tangible assets. According to IAS 36, impairment loss is the amount by which carrying value exceeds recoverable amount. Carrying value is compared to recoverable amount (the greater of fair value less costs to sell or value in use). The purpose of impairment test is to make sure that the carrying value of the asset does not exceed its recoverable amount. The company doesn't have to make the impairment tests annually, only when there's an indication or suspicion that a certain impairment of the asset occurred. However, IFRS emphasize that there are some assets that need to be tested annually on a regular basis. Those assets include infinite-lived intangible assets. The reason for impairment test is that the carrying value of these assets is uncertain because it's not subject to amortization. This leads us to conclude that brand names should be tested annually for impairment.

In contrast with US GAAP, retrieval of impairment loss under defined conditions is recognized under IFRS. The effects of impairment recognition and reversals will be reflected in profit or loss, if the intangible assets are being accounted for using the cost method.

Intangible Assets & Brand names under GAAP According to FASB:

Americans' or any other companies or corporations, who follow GAAP standards, in their accounting for brand names as part of an indefinite lived intangible asset must accomplish two types of assessments: Qualitative & Quantitative assessments. Those two types of tests are done to compute the impairment of the indefinite intangible asset in order to reflect its market value. Qualitative tests are judgmental tests conducted by professionals based on evidences and events and can be optional to determine whether it's important to conduct a quantitative assessment. In other words, the company can skip the qualitative assessment and perform the quantitative directly. Qualitative assessment also can help decay the cost and intricacy of the impairment test. To conduct a qualitative assessment companies evaluate and test events and conditions related to the market value of the intangible asset. Any decrease in value of the indefinite intangible asset must be recognized as an impairment loss and appear in the year end income statement, which is not allowed to be retrieved in following years if any increase in market value occurred. Examples of factors affecting the valuation & assessment of the fair value of the brand asset include: [6] 

Any changes of the costs of production as raw materials, labors, or any variable costs that have harmful effects on the future cash flows of the company.

Negative descent of financial performance due to a comparison between the actual and the projected cash flows that have effects on the major inputs used in determining the fair value.

Legal, contractual, political, business, or other factors, including asset-specific factors that could affect significant inputs used to determine the fair value of the indefinite-lived intangible asset.

Other related company-specific events such as alteration in management, key employees, plans, or clients; observation of bankruptcy; or lawsuits.

Business and market considerations such as a declining in the environment of the industry where the entity operates, an increased competition, obsolescence of the company's products and services, demand, or other economic factors or other factors such as technological advances.

A major deterioration of macroeconomic conditions such as limitations on having capital, fluctuations in foreign exchange rates, or any other improvements in equity and credit markets.

The quantitative impairment assessment should include a comparison of the fair value of the asset with its carrying amount. If the book value of an intangible asset exceeds its fair value, an entity should identify an impairment loss in an amount equal to that excess. As we mentioned above, the accounting standards "FASB 30-35-19" prohibit subsequent reversal of previously recognized impairment loss. Therefore the adjusted amount is the new value for the intangible asset.

For example; in 2012 annual testing of impairment for AT&T brand name, no impairment loss was recorded because through their calculations no change on brand names was recognized. Unlike 2011revaluation testing of brand names, the corporation recorded an impairment loss in the consolidated income statements of $165 in millions when the book value was $5,150 in millions compared to its fair value of $4,985 in millions computed through discounted future cash flows. Back to qualitative assessment an example of a factor that caused AT&T brand name to decrease is a sales decrease from 2011 to 2012 or if sales has grown in a small amount that's not attributable to brand name.

Retirement and Disposal:

GAAP and IFRS both have the same the accounting treatments for retirement and disposal of intangible assets including brand names. Procedures are the same as that for property, plant and equipment. Under those standards, brand names are retired when disposal or when they no longer generate future cash flows. Gains and losses on disposal are computed as the difference between the proceeds of disposal and the book value at the time of sale.


Disclosures are supplemental documents accompanied with the financial statements, providing a complete description and details about the financial information recorded. IFRS both require disclosures for intangible assets such as brand names, mastheads, software, copyrights and patents. These disclosures should include information regarding initially recognition method, increase or decrease in the brand value as result of impairment and the amount of impairment loss.

GAAP require a full disclosure when a brand name is acquired in a business combination. The disclosures must be done by writing the fair value and all the information about the brand name purchased. Under GAAP, The disclosures before was voluntary while after the financial accounting standard board meetings in 2002 to conduct an updated standards for disclosures of the intangible assets they worked ahead to make the disclosure required rather than voluntary. The board called for quantitative disclosures for the intangible assets as in our case the acquired brand name through two approaches; the fair-value-based and cost-based approaches. Those two approaches are used for disclosing quantitative information. Fair value information could be disclosed using several options as follows (board, 2012):

Pro forma Statement 142 accounting for unrecognized intangible assets. That might disclose values of newly generated assets, amortization, write-offs, and ending balance.

Values of unrecognized intangible assets at the end of the current year(s).

Values of all intangible assets at the end of the current year(s).

Values and changes in the values of all intangible assets, analyzed to distinguish assets added or disposed of from changes in values of assets retained.

While the cost-based approach has different options for disclosing the quantitative information such as (board, 2012): 

Pro forma successful efforts accounting, value-relevant costs that are spent during the year on the acquired intangible asset.

Pro forma retroactive successful efforts accounting, this method includes expensing the costs to develop the intangible asset and retroactively capitalize them

At the end, the board narrowed the use of one approach in disclosing the quantitative information. First, disclosing the fair values of all intangible assets at the end of the current year(s), or disclosing expenditures in the current year(s). 

Chapter Two: Case Study

AT&T Co. versus PALTEL Group

To complete our study we took two case studies to support our research and results; AT&T global company in USA and PALTEL group in Palestine. Although the two companies sit within two different markets; USA market which is considered one of the biggest economy in the world and the Palestinian market which is small relative to its opponent. We have chosen those two companies to study in our research because they're in the same industry, provide nearly the same services, and the ease of getting their financial information since they are publicly traded corporations. Also, we chose those two companies for an objective comparison.

In this chapter, we will bring the two companies into discussion, starting with a brief explanation and definition of each company and its history. We considered studying the brand names of those two companies from two points of view: marketing and accounting. On one hand, we will focus on brand equity, marketing strategies and the way they communicate their brand names to their customers. On the other hand, we will address the accounting treatments used by each company to account for their intangible assets and precisely their brand names. Then we will implement the premium price method discussed in the first chapter to calculate the value of their brands financially. The last part of this chapter includes a comparison between the two companies, clarifying the most important results and differences we came up with when studying AT&T and PALTEL group.