Accounting Theory

CASE STUDY

Prepared by
Lutfiana Hermawati
023091076

Excellent Class Program

Faculty of Economy
Trisakti University
May 2012
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Case 7.2

Theory In Action
Explain what is represented by the items shown in the biological asset table
At 1 January 2004, 95% of the Group’s biological assets were in Sweden, however these were
divested in March when the Group’s recently created forest holding company, Bergvik Skog AB, was
divested to institutional investors. Stora Enso retained a minority shareholding of 43.3% and has
signed longterm supply agreements with its new Associate at market rates. The divestment value of
Bergvik Skog’s free standing trees was EUR 1 524.6 (SEK 13 753) million, other disposed fi xed
assets of EUR 89.9 (SEK 811) million representing the land under the trees, the roads thereon and
sundry forestry equipment. Prior to the divestment in March, the change in the value of the Swedish
biological assets had generated income of EUR 6.2 million, however after March, the Group’s 43.3%
share of this income is aggregated with the normal trading result of Bergvik Skog and reported as an
Associated Company result.

(a) Asset reclassified from fixed asset, €705.9 m

The new accounting standard IAS 41, Agriculture, under which Stora Enso’s biological assets in
the form of standing trees are fair market valued, came into effect on 1 January 2003. The value
of Group forests was thus increased from a previous book value of EUR 705.9 million to a fair
value of EUR 1 561.3 million.

(b) Fair valuation surplus €855.8 m

The revaluation reserve amounted to EUR 855.8 million, which resulted in an increase in equity
of EUR 615.4 million after the deduction of deferred tax; in accordance with IAS 8, this was
credited directly to Retained Earnings as non-distributable equity. Periodic future changes
resulting from growth, price and other factors will be entered in the Income Statement so that
operating profit includes an adjustment for the change in value of the standing forest during the
year. This change in value is made up of growth, harvesting and price fluctuations. The result for
2003 includes EUR 116.2 million in respect of the change in fair value, being the growth and
price effect, less EUR 104.6 million for harvesting, resulting in the net gain of EUR 11.6 million
shown in the Income Statement.

(c) Carrying value at 31 December 2003, €1,587.8 m

At 31 December 2004 Stora Enso’s remaining biological assets had a fair value of EUR 64.6
Accounting Theory : Case Study
(EUR 1 587.8) million and were located by value in Portugal (83%), Canada (3%) and China
(14%). In addition, the Group now has three Associated Companies where IAS 41 is taken into
account in computing their results:
 Bergvik Skog AB, the new 43.3% owned Swedish associate, had biological assets at a fair
value of EUR 2 622.6 (SEK 23 657) million.
 Tornator Timberland Oy, a 41% owned associate which acquired the Group’s Finnish
forest interests in 2002, had biological assets at a fair value of EUR 614.9 (EUR 628.9)
million.
 Veracel, a 50% owned associate in Brazil, also has substantial forest plantations fair
valued at EUR 70.0 (EUR 67.4) million, though with a growing cycle of only seven years.

(d) Additions €4.5 – and disposals, €-1,541.2 m

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Following the divestment of the Swedish forests in 2004, future biological income will not be
material. Nevertheless, the periodic future changes resulting from growth, price and other factors
will be entered in the Income Statement so that operating profit includes an adjustment for the
change in value of the standing forest during the year. This change in value is made up of growth,
harvesting and price fluctuations
.
(e) Change in fair value, €37.5 m
The periodic future changes resulting from growth, price and other factors will be entered in the
Income Statement so that operating profit includes an adjustment for the change in value of the
standing forest during the year. This change in value is made up of growth, harvesting and price
fluctuations. The result for 2004 includes EUR 37.5 (EUR 116.2) million in respect of the change
in fair value, being the growth and price effect.

(f) Decrease due to harvest, €-30.4

The periodic future changes resulting from growth, price and other factors will be entered in the
Income Statement so that operating profit includes an adjustment for the change in value of the
standing forest during the year. This change in value is made up of growth, harvesting and price
fluctuations. The result for 2004 includes EUR 30.4 (EUR 104.6) million for harvesting, resulting
in the net gain of EUR 7.1 (EUR 11.6 million) shown in the Income Statement; all but EUR 0.9
million came from Bergvik Skog prior to its divestment.

Accounting Theory : Case Study

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Case 7.2
Intangible Asset
Consider the following four valuation methodologies
1. Cost approach : the after tax cost which be incurred in reproducing the asset.
2. Market transaction : actual transaction value for identical or similar asset based on an arm’s
length market transaction.
3. Income method : excess earnings transaction value of future earnings generated by the
intangible asset net of a reasonable return on other assets contributing
to the stream of earnings.
4. Income method : relief from royalty approach the present value of the likely future
royalty stream which be earned from licensing out the intangible asset
to third party.
Which of the above approaches are appropriate for each intangible asset listed below?
Give the explanations.
a) Brands and Trade Marks
the most common general approaches to brand valuation is cost approach. The cost approach
method is based on the putative cost of creating the brand, for example the amount spent on
marketing and advertising it. It is considered to be the most conservative method in terms of the
value which results. Not surprisingly, it is sometimes deployed in trade mark cases, when the issue
of damages is at stake. When applied to an acquired brand, it will assume that the value of the
asset will decline from the time of acquisition. It has been argued that this fails to take account of
the fact that brand values may increase over time. Another commonly adopted approach is the
market value or comparables approach, which bases the value of the brand on what it might bring
in the open market. The obvious bench mark for such an approach would be to compare the brand
with other similar brands in the market which have been sold. Clearly problems would arise if
there were no other brands available for comparison.

b) Patents
Patent valuations are needed for a variety of matters including to support the transfer of
ownership (licensing or assignment) of the business or patent, collateralized financing, financial
reporting and taxation matters. A valuation of patents may also be needed to support litigation

Accounting Theory : Case Study

matters, such as quantifying patent infringement damages. The most common approach to
valuation of patents is the income approach. In this approach, an appraiser identifies the profit
attributed to a patent by calculating the premium pricing associated with the sale or the patented
products and/or the money savings associated with the use of the patent. Alternatively, an
appraiser may examine the projected income stream derived from the royalties earned under
licensing. Or the appraiser may calculate the net present value of the income stream with the
patented technology and without, and then compare the two as another means of valuation. The
income based approach is perhaps the most commonly deployed method of brand valuation. This
approach is designed to arrive at the value that the brand produces in after tax income Its
attraction no doubt lies in the fact that it combines several different indicators of brand value.
These may include the relief from royalty measures, as well as market and cost based assumptions
of brand value.

c) Customer Contract
Income approach. Customer contract can refer to a base contract to share the terms and
conditions from the base contract. Income approaches are based around the concept that an
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asset's worth is equal to the present value of the future returns the asset is expected to generate.
This involves forecasting the entity or asset's ability to generate cash and adjusting the future
income streams to today's value by discounting for risk. Successful businesses are skilled at
managing their customers profitably. After all, customers are the reason for the businesses'
existence.

d) Internally Generated Computer Software

One or a combination of three main approaches are normally used in order to calculate the market
value of software – the Income Approach, the Market Approach and the Cost Approach:
 The Income Approach indicates the market value of the software based on the value of the
cash flows that the software might reasonably be expected to generate.
 The Market Approach indicates the market value of the software based on a comparison of
the software to comparable software transactions in the market.
 The Cost Approach indicates the market value of the software based on the concept of
replacement cost. The premise of the Cost Approach is that a prudent investor would pay no
more for the software than the amount for which he could replace the software with a new
one having the same utility to the investor as the existing software.
The Market Approach is typically difficult to apply to software since rarely are transactions of
truly comparable assets readily available. In addition, the Cost Approach is inappropriate for most
software as it fails to capture expected returns on the asset. However, it may be appropriate for
certain software packages for internal use.
The Income Approach is the most common technique used to value software, because it both
captures expected future returns to the owner and it is able to estimate value for unique assets
when market transaction data is not available. Market data may often be obtained to estimate the
income stream that might reasonably be expected to be generated from a particular software asset.
Broadly speaking, there are two main categories into which the Income Approach can be
classified; namely, Direct and Indirect methods:
 Direct Income Approach: the cash flows, or earnings, generated by a technology or brands,
or expenses saved through the ownership of the asset, are estimated directly by reference to
market benchmarks.
 Indirect Income Approach: the value is estimated from the residual earnings after fair returns
on all other assets employed have been deducted from the business’s after-tax operating

Accounting Theory : Case Study

earnings.
Our preferred approach, where possible, is to have primary reference to the relief from royalty
method (a Direct Income Approach) for software market value determinations. This method
measures the after-tax royalties or licence fees saved by owning the asset.
However, in other circumstances the multi-period excess earnings methodology, or another
valuation technique, may prove more appropriate, depending on the specific circumstances of the
case.
Key stages to a valuation employing the relief from royalty methodology are:
 Isolating forecast sales that are associated with the software
 Determining an appropriate arm’s length royalty rate, based on comparable market data
 Cross-checking the affordability of the selected royalty rate
 Determining an appropriate discount rate that reflects the risk of the software