Intangible Assets Valuation

Intangible Assets Valuation

Executive Summary

Following the controversy behind the financial accounting recordings of Mags Limited, the analysis of some of their intangible assets recordings concerning the AASB138/IAS 38 standards was conducted. The following was deduced;

• The decision of Mags Limited to capitalize mailings cost of $4.2 million as of June 30, 2018, was justified according to the AASB 138/IAS 38 standards (IAS 38.29a). This is because mailing costs are direct costs related to the deployment of an intangible asset- mail according to the company’s highly subjective nature.
• The action of Mags Limited buying a customer list from a competitor for $800,000 is within the confines of the law. The list is useful for 18 months (3 years) according to the company’s valuation. However, the potential decision of the company to add names from recent research to the list to increase its usefulness time span is not supported as per the AASB 138/IAS 38 standards. The regulations stipulate that no value-added benefit of an intangible asset should be recorded as the commercial return of that asset (IAS 38.47).
• The action of Mags Limited to list their marketing costs of $7.5 million as non-current assets, thus, in effect adding their net income to $12 million from $10 million, is not supported according to the IAS 38 framework. Some of the costs inclusive of the marketing costs are not fit to be cost as intangible assets (IAS 38.28b) while some fit the criteria. The marketing cost decision should be, therefore, revisited.

Mailing Costs

According to the information given, Mags Limited’s direct mailing costs were capitalized at $ 4.2 million as of June 30, 2018. The payback was set on a straight-line basis over 3 years. These are the conditions set according to the management of the Limited company.

In contrast, the AASB138/IAS 38 sets some standards and requirements under which intangible assets should be treated. The decision of the company to treat the mailing costs as such is subject to those rules and regulations, as described below.

• First and Foremost, the AASB188/IAS 38 states clearly that all costs incurred on research and innovations, training, advertising, start-ups,  and development programs are applicable under this standard. This is because those activities almost every time result in assets with substance. The standard stipulates that the assets derived from those activities are subject to their parent intangible component, which is the knowledge contained in it.
• Mailing costs, therefore, fall under the regulation of this standard. These are costs incurred in direct advertising and communication with potential consumers or the company’s consumers on their daily activities of selling goods through the mail. From the company’s point of view, those costs arise from the activity of advertising their goods to generate sales. In the mail-order business, the mailing costs are, in effect, directly proportionate to the sales volume of the business (Pfeifer & Perticucci 2017). In the real sense, the mailing costs are professional fees accrued by repairing the assets to its stable working (IAS 38.28b).
• The standard, in IAS 38.69, requires that the advertisement or promotional costs be charged as expenses when they are realized. This, in effect, means when the company receives the particular benefits of the incurred costs as described. The company was therefore lawfully right to recognize the mailing costs as a component on their accounts since the mailing was already done, and the promotional and advertisement benefits were already starting to be realized.

However, the decision of the company to capitalize on the costs is highly subjective and fully relies on the nature of the mail-order business. The mailing costs are considered as an asset in the mail order industry because they have a direct positive relationship with the sales of the company. In layman language, the more catalogs you mail, the more sales you stand a chance to get.

The costs that were incurred in mailing the catalogs have not been fully exhausted, as more and more customers could buy from the company with the catalogs sent by those mailing costs. The benefits, however, have an indefinite life period as their use cannot be measured (Lustosa 2017). These catalogs are likely to be obsolete within a period that is hard to measure. As such, the relevancy of these benefits derived from these marketing costs decreases sharply after the 2018 financial year. This also explains why the company has to incur other mailing costs in the next financial year. On that note, the basis for the amortization of these mailing costs is wrong.

The author believes that the costs of this asset should only be paid within the same year and in full amount. This is from the basis that intangible assets that have unforeseeable life their use should not be amortized (IAS 38.107).  By amortizing the mailing costs over three years, the company spreads its operation costs within those years, a cost that should be paid within one year. In doing so, they increase their financial viability (Lev et al. 2016).

Mailing and Customer Lists

The company owns an in-house mailing list compiled by the employees of the company. In addition to that, they purchased another customer list for the price of $800,000 on July 4, 2019. As described above, the AASB188/IAS 38 states clearly that all costs incurred on advertising, training, start-up, research, and development activities are applicable under this standard. This is because those activities almost every time result in assets with substance. The standard stipulates that the assets derived from those activities are subject to their parent intangible component, which is the knowledge contained in it.

Mailing and customer lists are an intangible asset. This is because those lists are separate in their rights as they can be sold and bought and are protected by other legal laws(Lim et al. 2019) The decision of the company to buy a customer list is therefore legal. According to the company’s estimation, the acquired customer list is going to benefit the company for a maximum period of 3 years. However, the company plans on adding more names to the customer list that are going to prolong the life of the asset by a year. This is not allowed according to the IAS 38 standard. The accounting standard (IAS 38) requires the commercial charge of an asset to be measured by an entity by examining the scope to which its potential cash flows are predictable to change as an end result of the transaction (IAS 38.47). This, in effect, means that the acquired asset’s modification to extend its commercial viability should not be treated as the asset’s doing. The exact contents of the asset are the ones to be measured in terms of increasing commercial viability to the entity.

In our case, this effectively means that the benefits expected to be derived from the customer list have a fixed relation to the customer names only on that list. The addition of other names on the list to increase its benefit by a year is not related to the costs of buying the list. Therefore, when calculating the cost of the customer list against the returns, the list will be expected to only have a useful life period of 18 months, which is 3 years. The asset’s cost should also be calculated over the above stipulated years. The asset should also be subjected to an impairment test.

Additionally, the mailing list that is created by the company’s employees is considered an internally generated intangible asset since it has already passed the research phase and is on the development phase, and it demonstrates all the set standards of accounting for the intangible asset (IAS 38). The price of acquiring such an asset is, in effect, regarded as the cost incurred in its research and development. An example of these costs may be labor costs (IAS, 38.62).

Under IAS 38 standards, the asset value throughout the stipulated time frame will be as follows;

Marketing Costs

According to the provided information, the company decided to list marketing costs of $7.5 million in the non-current asset section at an accelerated amortization rate of 55% in the first year, 29% in the second year, and 16% in the third year. This decision increased its net income from $10 million to $12 million. It is important to note that in the company’s vantage point, the marketing costs are a very broad cost category (Kimouche & Rouabhi, 2016).  The category is inclusive of various costs incurred in the advertising and promotion of the products of the company. There is a possibility that an array of costs that generated an asset of commercial value to the company. There are also some costs inclusive in the marketing costs that did not create or generate an asset of commercial value.

The IAS 38 standard denotes that some expenditure does not form part of the price of an intangible asset. These include administration and overhead costs, cost of relocation or staff training, and, most importantly, in our case, costs of promotional and advertising activities (IAS 38.29a). The company has some of these costs in the umbrella marketing costs, which were charged in the non-current asset section as described. This discredits the whole process of recording the entity as required by IAS 38 standards.  The company should, therefore, review its marketing costs and zoom on each cost to differentiate the costs linked with intangible assets, as in the case of a mail-order industry like Mags Limited. The costs associated with the labor of the strive for value creation of an intangible asset, professional fees for modifying the asset to condition, and expenses of fixing the functionality are, in effect, supposed to be included in the non-current assets section.

Other costs that do not meet the above-stated criteria such as the introductory costs inclusive of advertisement and promotion activities, costs of market orientation or relocation, and costs of administration and other overhead costs should be removed from this section and treated as expenses in the liability sections of the Mags limited. The amortization of the amount is, however, correct. This correction will ultimately affect the net income section of Mags Limited, and the increase of $2 million on their income could be proved null and void. This can also be used to nullify the suggested higher growth rate since financial recording is not done according to the IAS 38 standards and related criteria. (Bryan et al. 2017).

Conclusion

After the analysis of Mags Limited financial recording criteria, some of their accounting practices were found not to comply with the IAS 38 standards. Their financial information disclosures are subject to thorough auditing before any further decisions are made concerning their quantitative figures. This method brings about accurate financial reports as compared to other approaches. This reality can be achieved in financial reports as the approach uses the present values an assets and liabilities. On that note, Maggs Limited can report all variations related to assets and liabilities, as well as the financial reports. In accordance with Accounting Standards, Intangible assets valuation will also enable the company to make wise moves regarding the future of operations in the business since their decision is based on the real value of their assets and liabilities. This approach will also be of benefit to the company since it presents actual values of assets and liabilities.

On the occasion where a shareholder wants to invest in the company, they will have a clear understanding of the business’s financial position. However, it is important to comprehend the market effect of this approach on assets. Assets valuation may deprive hence attracting investors. Furthermore, the approach does not consider current marketing hence forth revaluing the assets. It, in turn, increases the potentiality of selling this asset, henceforth reducing the price even further. In this case, there is no need for Mags Limited to sell its assets.