Asset Analysis

Vishwanath
 Assets are resources owned by a firm that are likely to produce
future economic benefits and that are measurable with a
reasonable degree of certainty.
 Cash, marketable securities, receivables from customers,
inventory, fixed assets, long-term investments in other
companies, and intangibles.
 Key principles used to identify and value assets are historical
cost and conservatism.
Historical cost and
conservatism
 Historical costs are easily verifiable than
replacement or fair values or value in use
 Distorts the true value as well as constrains
managers from presenting a favorable view
 Conservatism requires that assets be written
down when they are impaired
 Some financial instruments are required to be
reported at fair value in the US; other classes
of tangible and intangible assets are
permitted to be reported at fair value in the
UK, Australia
Asset reporting challenges
1) Resources are owned by the company
2) Resources are expected to provide future
economic benefits sufficient to cover costs
3) Future benefits are measurable with a
reasonable degree of certainty
 Challenges arise when ownership is
uncertain, future benefits from outlays are
uncertain or difficult to measure, resource
values have changed
1) Ownership of resources is
uncertain
 Leased resources, training programs
 American Airlines leases 42% of its
fleet; pays $14b p.a. in lease rentals;
there’s a provision that American
airlines can purchase the aircraft at or
near the lease period at market values
 Who is the effective owner? Is it a
purchase or a rental arrangement?
 A lease transaction is equal to purchase if:
 Ownership of the asset is transferred to the
lessee at the end
 Lessee has the option to purchase
 Lease term is 75% or more of the useful life
of the asset
 PV of lease payments is 90% or more of the
fair value
 Such leases are treated as capital leases and
recorded at PV of lease payments
 The same amount is shown as liability
 The leased equipment is depreciated over the
life of the lease; lease payments are treated
as interest and principal payments
 Other leases are operating leases
 Reports only rental expense
 The value of training programs
 US spends close to $150b p.a.
 Owned by the firm or the employee?
 Can be substantial for professional
service firms
2) Economic benefits are uncertain or are
difficult to measure
 E.g. does the change in price of oil make the drilling equipment
less valuable?
 Good will:
 In 1996, Disney acquired Capital Cities (ABC TV Network,
newspapers etc) for $19b; majority is intangible- revenue from
advertising
 Value of tangible assets is only $4b
 Should the difference be written off? Capitalized?
 Prior to the acquisition, the market had valued Cap Cities at
$9b; Disney paid more than 100% premium
 The remaining is treated as goodwill based on the premise that
Disney has not overpaid; destroyed value of its stockholders
 Amortized over a maximum of 40 years in the US
 Brands:
 Coca Cola had a book value of equity of
8.4b and a market value of 165b
 Brands create value by:
a) Permitting lower levels of marketing than
competition
b) Creating leverage with distributors and
retailers
c) Enabling higher pricing
 No limits like patents
 Acquired brands are recorded as part of
intangible assets
 Brands can be recorded as assets in the
UK and Australia
Valuing Brands
 Cost Based the value of a brand is the present value of all
expenditure incurred on the brand till date; difficult to trace all
brand related costs throughout the life of the brand
 Market Based The amount for which a brand can be sold
which is simply the present value of the benefits from owning
the brand.
 Income Based This involves determining future revenues
directly attributable to the brand and then discounting them to
the present at a suitable rate. In order to estimate net revenues
the brand’s price premium and volume are compared to those
of generic product
 Interbrand Approach
Interbrand methodology
 A brand’s value is the product of:
1) Average annual after-tax profits of the
brand adjusted for earnings of an
equivalent unbranded product and
2) A multiple reflecting the brand’s
strength
 Leadership A brand which has the ability influence the market
in setting price points and commanding distribution gets a
higher score (Max 25)
 Stability Those brands which enjoy a strong consumer
franchise are considered stable and awarded a higher score
(Max 15)
 Market Brands in markets such as foods and soft drinks are
less vulnerable to shifts in fashion and technology (max 15)
 Geographic Spread Brands that have an international appeal
are stronger then regional brands ( Max : 25 )
 Trend The long term appeal to consumers (Max 10)
 Support Consistency in investment and strength of
communication (Max 10)
 Protection Legal protection available to the brand owner
 Collect most recent profit data (3 years)
 Restate the prior period (year –2, year-1) profits to present day
values by inflating at a suitable rate
 Attach a weighting factor to the restated profit figures. Usually,
a simple weighting of three times the current year, twice the
previous year and once before is used. These aggregate
earnings are divided by the sum of the weighting factors
(3+2+1 = 6)
 Deduct operating income of an equivalent unbranded product
 Deduct taxes at the medium –term effective tax rate
 Apply a suitable multiple depending on the brand strength
Dr Reddy’s Brand name in
2000
 TN-1
Deferred tax assets
 Tax laws permit loss carry forwards
 In 1998 Amazon had losses of 207m, equivalent to
73.1m of future tax savings since inception
 These begin to expire in 2011
 Firms are required to show deferred tax asset for the
value of operating loss carry forwards, net of a
valuation allowance for the portion of the asset that
is unlikely to be realized
 Deferred tax assets with more than a 50 percent
probability of being unrealized should be included in
the valuation allowance.
 Can also arise due to temporary
differences between tax and financial
reporting methods of recognizing
income.
3) Changes in Future
economic benefits
 What types of assets, if any, should be
marked up or down to their fair values?
 Accounts receivables, loan portfolios have
loss provisions; nothing is marked up in the
US
 U.K. and Australian standards, for example,
permit managers to revalue fixed assets and
intangibles if they have appreciated in value
 Changes in the value of financial
instruments:
 Not recorded at fair values if held for
control reasons; Equity method is used
if owns 20-50% i.e. initial investment +
accumulated earnings is the value of
the stake
 Consolidate if more than 50%
Changes in Values of Foreign
Subsidiaries
 Many companies have foreign subsidiaries that
subject their assets to exchange rate fluctuations.
 How are these fluctuations recognized? Are assets of
foreign subsidiaries translated into local currency at
the historical rates when the assets were acquired?
 Alternatively, are they translated at current rates?
 Accounting Standards for translation, transaction
exposure
Misconceptions about asset
accounting
 If a firm paid for a resource, it must be an
asset (e.g. acquisitions)
 If you can’t kick a resource, it really isn’t an
asset (e.g. Merck’s research capabilities and
sales force)
 If you bought a resource, it must be an asset;
if you developed it, it must not be (e.g. R&D)
 Market values are only relevant if you intend to
sell an asset (e.g. marketable securities)