This article is in continuation to the earlier article on ‘Valuation of Intangible Assets’ published in the January 2011 issue of the Journal. In the January 2011 article we discussed about the five categories under which generally accepted intangible assets fall and got a brief background on the various methodologies that are often used to value these intangible assets. In this article, we will discuss exhaustively the customer-related category of intangible assets. I have selected this category to start with, because the results of various surveys (whether formally published or otherwise) carried out globally, show that customer-related intangible assets are the most often recognised intangible assets which get reported, by way of a purchase price allocation process and one of the primary value drivers for an acquisition.
The article is divided as follows:
Identification of customer-related intangible
assets
- Examples
- Definition
- Basis of identification
- Additional highlights
Valuation of customer-related intangible
assets
Comparison with Ind-AS
Conclusion
Identification:
Examples
FASB ASC 805 under US GAAP and IFRS-3 (January 2008) under IFRS, give the following examples of customer-related intangible assets:
Before we start, it is imperative to know that selfgenerated intangibles (including goodwill) are not allowed to be recognised under any accounting guidance. The identification and the valuation of these intangibles would arise only in the case of an acquisition, resulting in a business combination where the acquirer would be required to allocate the value paid for the target to, inter alia, intangible assets by way of a purchase price allocation process. Hence, in the discussion below we would constantly talk about an acquirer-target relationship.
Definitions:
Customer contracts and the related customer relationships:
Standard: When an entity establishes relationships with its customers through contracts, customer relationships arise from these contractual rights. Customer contracts refer to signed contracts as at the date of the valuation.
Customer contracts are signed contracts by the target as at the valuation date. On account of the acquisition, the acquirer will get the benefit of these contracts and hence it is an intangible for the acquirer. Related to these contracts would be their associated relationships and the acquirer will also get the benefit of these contractual relationships. ?
Non-contractual customer relationships:
Standard: A customer relationship acquired in a business combination that does not arise from a contract may nevertheless be identifiable because the relationship is separable.
There would be few instances in practical life where relationships are contractual. Most of the times relationships are non-contractual and though the benefits are not guaranteed, a trend can be observed wherein the same customers continue to give business repeatedly. This recall value is what is measured and termed as no contractual customer relationships.
Customer lists:
Standard: A customer list consists of information about customers, such as their names and contact information. A customer list also may be in the form of a database that includes other information about the customers, such as their order histories and demographic information. Databases are collections of information, often stored in electronic form. A database that includes original works of authorship may be entitled to copyright protection.
Customer lists (all type of information) depending on the industry can open more avenues for business by adding new customers and hence would add value to the acquirer.
Order or production backlog:
Standard: An order or a production backlog arises from contracts such as purchase or sales orders and therefore is considered a contractual right.
Order or production backlog refers to the unexecuted orders as at the valuation date. The only difference between customer contracts and order or production backlog is that in customer contracts the work on the contracts has not started, while in order or production backlog, the work on the contracts has not been completed.
Basis of identification:
Additional highlights: Customer contracts and the related customer relationships:
(i) It is an intangible and will meet the contractuallegal criterion even if confidentiality or other contractual terms prohibit the sale or transfer of a contract separately from the acquiree.
(ii) A customer contract and the related customer relationship may represent two distinct intangible assets.
(iii) Both the useful lives and the pattern in which the economic benefits of the two assets are consumed may differ.
(iv) A customer relationship related to the customer contract exists between an entity and its customer if
(a) the entity has information about the customer and has regular contact with the customer, and
(b) the customer has the ability to make direct contact with the entity.
(v) Customer relationships related to the customer contracts meet the contractual-legal criterion if an entity has a practice of establishing contracts with its customers, regardless of whether a contract exists at the acquisition date.
(vi) Customer relationships related to the customer contracts also may arise through means other than contracts, such as through regular contact by sales or service representatives. Consequently, if an entity has relationships with its customers through these types of contracts, these customer relationships also arise from contractual rights and therefore meet the contractual-legal criterion.
(vii) Customer contracts can also be a contract-based intangible asset. If the terms of a contract give rise to a liability (for example, if the terms of an operating lease or customer contract are unfavourable relative to market terms), the acquirer recognises it as a liability assumed in the business combination.
Non-contractual customer relationships:
Exchange transactions for the same asset or a similar asset that indicate that other entities have sold or otherwise transferred a particular type of no contractual customer relationship would provide evidence that the no contractual customer relationship is separable. For example, relationships with depositors are frequently exchanged with the related deposits and therefore meet the criteria for recognition as an intangible asset separately from goodwill.
Customer lists:
(i) A customer list generally does not arise from contractual or other legal rights. However, customer lists are frequently leased or exchanged. Therefore, a customer list acquired in a business combination normally meets the separability criterion. For example, customer and subscriber lists are frequently licensed and thus meet the separability criterion.
(ii) Whether customer lists have characteristics different from other customer lists, the fact that customer lists are frequently licensed generally means that the acquired customer lists meet the separability criterion.
(iii) However, a customer list acquired in a business combination would not meet the separability criterion if the terms of confidentiality or other agreements prohibit an entity from selling, leasing, or otherwise exchanging information about its customers.
(iv) A database acqui
