Comment 19 (a) IACVA
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International Association of Consultants, Valuators and Analysts 707 Eglinton Avenue West, Suite 501 Toronto, Ontario M5N 1C8, Canada October 4, 2007 International Valuation Standards Committee 12 Great George Street Parliament Square London SWIP 3AD United Kingdom, European Union Attention: Shan Kennedy, Adviser Dear Madam, The International Association of Consultants, Valuators and Analysts ("IACVA") is the largest valuation training and accreditation organization in the world, with over 8,000 members in seven charters, located in China, Germany, Ghana, Lebanon, South Korea, Taiwan and the United States. As you are no doubt aware, IACVA applied to join the International Valuation Standards Committee ("IVSC") in October 2006 and hopes to be accepted at the annual meeting in November, 2007. Representing valuators in many countries of varying degrees of sophistication IACVA wishes to congratulate IVSC on its excellent Discussion Paper "Determination of Fair Value of Intangible Assets for IFRS Reporting Purposes". However, in a number of ways we believe it can be improved and therefore have prepared the attached detailed comments. Yours Very Truly, James P. Catty, MA, CA•CBV, CPA/ABV, CFA, CFE, CVA Chairman Enclosure IACVA.021 thAdministrative Office – 1411 4 Avenue – Suite 410 – Seattle, Washington – 98101 Telephone (206) 623-3200 – Fax (206) 623-3222 COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER ...
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International Association of Consultants, Valuators and Analysts 707 Eglinton Avenue West, Suite 501 Toronto, Ontario M5N 1C8, Canada
October 4, 2007 International Valuation Standards Committee 12 Great George Street Parliament Square London SWIP 3AD United Kingdom, European Union Attention: Shan Kennedy, Adviser Dear Madam, The International Association of Consultants, Valuators and Analysts ("IACVA") is the largest valuation training and accreditation organization in the world, with over 8,000 members in seven charters, located in China, Germany, Ghana, Lebanon, South Korea, Taiwan and the United States. As you are no doubt aware, IACVA applied to join the International Valuation Standards Committee ("IVSC") in October 2006 and hopes to be accepted at the annual meeting in November, 2007. Representing valuators in many countries of varying degrees of sophistication IACVA wishes to congratulate IVSC on its excellent Discussion Paper "Determination of Fair Value of Intangible Assets for IFRS Reporting Purposes". However, in a number of ways we believe it can be improved and therefore have prepared the attached detailed comments. Yours Very Truly, James P. Catty, MA, CA•CBV, CPA/ABV, CFA, CFE, CVA Chairman Enclosure IACVA.021
Administrative Office – 1411 4 th Avenue – Suite 410 – Seattle, Washington – 98101 Telephone (206) 623-3200 – Fax (206) 623-3222
COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER COMMENTS ON IVSC DISCUSSION PAPER ENTITLED "DETERMINATION OF FAIR VALUE OF INTANGIBLE ASSETS FOR IFRS REPORTING PURPOSES" Section II of the Discussion Paper (the "Paper") requests responses to questions relating to various topics. IACVA has answered all of these and then appended further comments on areas where we believe either that expansion is necessary or required material has been omitted. 2.1.1 "Do you consider that there is a need for guidance in respect of the valuation of intangible assets for IFRS purposes?" IACVA strongly believes that the balkanization of valuation standards and methodologies is highly undesirable. Therefore, we believe that there is a need for uniform, worldwide guidance concerning the valuation of Intangible Assets (as defined in IAS [International Accounting Standards] 38 and SFAS [Statement of Financial Accounting Standards] 141). This should be applicable not only to reporting under the pronouncements of the International Accounting Standards Board ("IASB"), but also to those of the (US) Financial Accounting Standards Board ("FASB"). 2.1.2 "Do you consider that the guidance given in this Paper is at the right level of detail or should there be additional or less detail?" IACVA considers that the group preparing the Paper has done an excellent job, but, as valuators in many of the countries adopting IFRS [International Financial Reporting Standards] are less sophisticated than the group's members, we believe that more rather than less guidance is desirable. IACVA – Fair Value Discussion Paper Comments of IVSC Page 1 of 21
COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER In particular, we would recommend further detail as well as the inclusion of numerous examples. 2.1.3 "Do you consider that the Paper achieves the intentions set out in paragraph 1.4?" Paragraph 1.4 states: "The IVSC hopes that the Degree of Guidance in this Discussion Paper will make a useful contribution to the IASB as it formulates its final views on Fair Value Measurements." Our members operate not only under IFRS, but also United States GAAP as well as certain local standards. We consider the Paper should be expanded to be useful to all users of accounting and valuation standards dealing with Fair Value. 2.1.4 "Do you agree that any future guidance issued by IVSC on this topic should be principles based, with detailed discussion of different methods and illustrative examples clearly distinguished in a Technical Paper?"
Knowledge of the valuation of business interests, much less Intangible Assets, is rudimentary among many of the mainly real estate oriented valuation professionals in a number of countries. Therefore IACVA believes that there should only be one set of worldwide guidance, which, while principles-based, should include detailed discussions of pros and cons of different methods for valuing various classes of Intangible Assets and include numerous illustrative examples. The concept of splitting guidance between several documents is likely to lead to items being inadvertently misinterpreted. As an example, The American Institute of Certified Public Accountants ("AICPA") Practice Aid on "In-process Research and Development" ("IPR&D Practice Aid") appears to deal successfully with this difficulty while avoiding the potential problem described in paragraph 2.1, that: IACVA – Fair Value Discussion Paper Comments of IVSC Page 2 of 21
COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER "Issuing prescriptive instructions on how to value any particular class of asset or liability removes the vital element of discretion from the individual valuers, who must be free to adopt techniques that most accurately reflect those of market participants at the valuation date." In our view, it is essential that there be sufficient guidance to assist a valuator, in any country in determining the appropriate approaches, methods and techniques. 2.8.1 "Do you agree with the approach taken as regards each of the issues set out in paragraphs 2.6 - 2.8 above?" IACVA agrees in principle with the Paper's view that "the guidance in SFAS 157 is more appropriate for the valuation of financial than intangible assets". However, that document forms part of US GAAP and, as we believe that valuation standards should be globally uniform, IACVA is concerned that all the issues raised in SFAS 157 were not taken into account. Our comments on each of the four items, referred to in paragraphs 2.6 to 2.8, are set out below: 2.8.1 "2.6.1 - the difference between the 'principal' and 'most advantageous' market". Even for Intangible Assets, there can be different 'principal' and 'most advantageous markets'. As an example for the 2007 sale of the Chinese "Five Star Appliances" retail chain, the principal market for the brand was in that country, while the 'most advantageous' was among international buyers. The ultimate purchaser, the US firm "Best Buy", intends to run two sets of stores, under both the Five Star and Best Buy brands in competition, sharing a warehouse and back office. IACVA – Fair Value Discussion Paper Comments of IVSC Page 3 of 21
COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER 2.8.1 "2.6.2 - the highest and best use of an asset and whether this is 'in use' or 'in exchange'." The difference between the four premises of value: "in use", "in place", "in exchange" and "in liquidation" can have a significant value on many types of Intangible Assets. This is particularly true of artistic-related items, such as music and film copyrights, which may be used as collateral by their creators or the production companies involved. For example, the capitalization or discount rates and renewal assumptions used in applying an income capitalization or a Discounted Cash Flows ("DCF") method will vary significantly, depending on the premise adopted. 2.8.1 "2.6.3 - the difference between 'observable' and 'unobservable' inputs." While we concur that the documented benchmarking process described in Section VI of the Paper is a useful tool, which in most cases should form an important part of the Intangible Asset valuation process, the independence of the underlying data (the separation of 'observable' and 'unobservable') is also important and should be discussed in detail and not merely ignored. 2.8.1 "2.6.4 - a three level hierarchy of reliability for valuation inputs." The Paper's proposed hierarchy for the selection of valuation methods for Intangible Assets, set out in Sections 7.21 to 7.30, in effect is a series of subdivisions of the Level 3 inputs described in SFAS 157. IACVA believes that an explanation of the classifications, based on this concept, is more suitable than ignoring FASB's position. IACVA – Fair Value Discussion Paper Comments of IVSC
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COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER 2.8.2 "In particular, do you consider that 'inactive market' is a suitable term? If not, which other term would you use for an 'inactive market'?" The markets for Intangible Assets do not fit the definition of "active market", as set out in paragraph 8 of IAS 38, with the possible exception of "taxi licenses" in major centres. This appears to exclude many dealer and auction markets, such as a) those for websites, which are active in the sense that "willing buyers and sellers can normally be found at any time", but do not qualify under the first criteria in that the items are individual, not homogenous and prices are not generally available; and b) auctions, such as those for patents and copyrights that have taken place in the United States and the UK. A comparison would be many national "fine art" dealer or auction markets, such as those in New York, London or Paris. Therefore, we recommend that there should be a hierarchy of market activity, ranging from "hyper-active", such as those for "gilts", US Treasures and shares forming part of the FTSE 100 or S&P 500, to those that exist almost "by appointment". Suggested rankings are: (a) hyper-active auction/dealer (b) specialist auction/dealer (c) periodic auction/dealer (d) broker (e) by appointment IACVA – Fair Value Discussion Paper Comments of IVSC
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COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER We also recommend the elimination of the criterion "prices are available to the public", if they can be obtained, for a fee, from a proprietary data base, such as those available for fine art. 2.8.3 "Do you agree with the guidance in respect of entity-specific factors in paragraphs 4.25 et seq.? Do you consider that any additional guidance is required in respect of entity-specific factors?" The guidance on "entity-specific factors" in paragraphs 4.25 to 4.31 in our view is inadequate, as: (a) there is no discussion of the different effects of those "entity-specific factors" that would be inherited by a "marketplace participant" from those that would not; and (b) No examples are given to help a valuator trying to apply the guidance of paragraph 4.31: "4.31 It can be a difficult and judgmental area determining which attributes to retain and which to exclude when adjusting for entity-specific factors. It is an issue that regularly needs to be addressed when performing intangible asset valuations under IFRS 3 following a business combination".
2.8 4 "Do you agree with the approach taken in the Paper, paragraph 4.32 with regard to the . aggregation of identical and similar assets that form a portfolio?" Again, IACVA believes the guidance in paragraphs 4.32 to 4.45 is inadequate; 4.32 merely states: "Some intangible assets can be valued on a stand-alone basis. For other intangible assets, however, it may be either impossible or impractical to value them other than in conjunction with other tangible or intangible assets." IACVA – Fair Value Discussion Paper Comments of IVSC
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COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER No examples are offered. One point, raised in paragraph 4.38, may be misleading. Intangible Assets referred to in paragraphs 36 and 37 of IAS 38 do not lose their "individual identities" when "combined to form a different intangible asset from the underlying assets...." if they are Intellectual Properties (Intangible Assets such as patents, trademarks and copyrights protected by law). A combination will normally add to their usefulness and enhance their value but does not in any way legally create a "new asset". 2.17.1 "Do you agree that these are the five most regularly used methods for valuing intangible assets? " Section V lists the following valuation approaches and methods: 1) Sales Comparison (more commonly called Transaction Based or Market) Approach. (a) "5.10 Market Transactions method". 2) Income Capitalization Approach (b) "5.24.1 relief-from-royalty method, (sometimes known as the royalty savings method"; (c) "5.24.2 premium profits methods, (sometimes known as incremental income method)"; (d) "5.24.3 multi-priced excess earnings method". In paragraph 5.22 there seems to be some confusion. The capitalization of income, cash flows or cost savings implies the Intangible Asset has an infinite life; discounting of such items (normally IACVA – Fair Value Discussion Paper Comments of IVSC Page 7 of 21
COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER other than income) annually deals with an expected economic useful life. 3) Cost Approach (e) "5.61 Replacement cost is the principal method within the cost approach". Those three Approaches and five methods, (a) to (e), are indeed commonly applied, but there is no discussion at all of the Formula Approach (using option pricing models such as Black-Scholes) or explanations of many problems that often arise in implementation. 2.17.2 "Do you think that there are any other valuation methods that should be covered?" In addition to the Formula Approach referred to above, a number of variants of the Discounted Cash Flows ("DCF") method, such as "expected cash flows" and "probability based decision trees", are commonly used in valuing Intangible Assets, as are Real Options. All of those should be covered, as should comparative rankings by legal, commercial and financial criteria for patents. 2.17.3 "Do you think that the description of each method is sufficient or do you think that further details are required for any of the methods?" Once again we wish to point out IACVA represents members in seven countries (as of this response) with varying degrees of financial sophistication. In our view, there should be an example of the implementation of every method discussed together with some guidance as to when it might be suitable and when better avoided. 2.17.4 "Some simple examples regarding the intangible asset valuation methods are included. Do IACVA – Fair Value Discussion Paper Comments of IVSC Page 8 of 21
COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER you consider that these examples are sufficient or do you think that more detailed examples should be included?" As set out in the answer to the previous question (2.17.3), IACVA believes that many more examples are required, while the existing ones would be improved through additional detail. 2.17.5 "Do you agree with the approach taken in this Paper with regard to the tax amortization benefit, as set out in paragraphs 5.25 to 5.28?" The concept (not Approach, which, with respect to valuation, is a "term-of-art") of including tax amortization appears to be based on the recommendation of the IPR&D Practice Aid, which resulted from SFAS 109. In the US, all intangible assets may be amortized for tax purposes; this is not true in all IACVA member countries, and to an even lesser extent of those adopting IFRS. In our view, this concept means that, regrettably, Fair Value will vary across national borders, even within the European Union, and that for a multinational, the Fair Value of its Intangible Assets will in part be dependent as to where they are owned; we consider this to be undesirable. Paragraph 5.25 states: In addition to capitalising the income, cash-flows or cost savings that may be derived from " use of the asset, it is sometimes appropriate to adjust the resulting value to take account of the fact that, for certain an asset in certain jurisdictions, tax relief is available on amortisation of the capitalised asset. Such an adjustment is known as the 'tax amortisation benefit' or 'TAB'."
IACVA – Fair Value Discussion Paper Comments of IVSC
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COMMENTS ON IVSC INTANGIBLE ASSETS DISCUSSION PAPER This suggests that a TAB is not required when a DCF method is used, which conflicts with US practice, as set out in the IPR&D Practice Aid. In addition, there is no explanation of the phrase "sometimes appropriate" relating to when a TAB should be added to the calculated value and when not. 2.17.6 "Section V includes an assessment of the possible ways in which reliability might be restricted for each of the valuation methods. Do you agree with this assessment? Do you think that any other factors should be included in this assessment?" The reliability of the conclusion of any valuation method depends on its appropriateness and the quality of the available data used in its development. Paragraphs 5.5 to 5.8 deal with the issue of reliability using the IASB Framework. The following quotation from paragraphs 5.6 and 5.7 cover its main points:
"5.6 The Framework, paragraph 31, explains that information is reliable 'when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent' " .
"5.7 The Framework further clarifies that to be reliable, information must: 5.7.1 ‘represent faithfully the transactions and other events it purports to represent or could reasonably be expected to represent';
5.7.2 be such that 'transactions and other events that it purports to represent.... are IACVA – Fair Value Discussion Paper Comments of IVSC Page 10 of 21
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