Accounting Theory CASE STUDY
Prepared by Lutfiana Hermawati 023091076
Excellent Class Program Faculty of Economy Trisakti University May 2012
Page 2 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 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 c hange 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 gai n 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 (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 i n 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.
– and disposals, € -1,541.2 m (d) Additions €4.5 – and
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Page 3 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 and price fl uctuations. uctuations. 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 and price fl uctuations. uctuations. 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.
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Page 4 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 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 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 brands in the market which have been sold. Clearly problems would would arise if there were no other brands available for comparison. b) Patents 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 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 designed to arrive at at the value that the 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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Page 5 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 d) Internally Generated Computer 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 Approach is that a prudent investor 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. 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 t echnology 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 after fair returns on all other assets employed have been deducted from the business’s after -tax -tax operating 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 f ees 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 m ethodology are: Isolating forecast sales that that are associated with the software software Determining an appropriate appropriate arm’s length royalty royalty rate, based on comparable market data Cross-checking the affordability of the selected royalty rate Determining an appropriate discount discount rate that reflects the risk of the software
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