Income approach still preferred for valuing customer intangibles?

BVWireIssue #65-1
February 6, 2008

Valuing customer relationships has long been a controversial topic.  Starting in about 2005, statements from the FASB and the SEC generally indicated that the income approach was the most appropriate method for estimating the fair values of customer-related intangible assets.  But along came remarks by Joseph Ucuzoglu (SEC’s Office of Chief Accountant) before the AICPA ‘s 2006 national conference, that served as a “wake up call” to appraisers:

Some have suggested that the SEC staff always requires the use of an income approach to value customer relationship intangible assets. The staff has even heard some suggest that, as long as a registrant characterizes its valuation method as an income approach, the specific assumptions used or results obtained will not be challenged by the staff, because one has complied with a perceived bright line requirement to use an income approach.

“Let me assure you, these statements are simply false,” Ucuzoglu said.  “While an income approach often provides the most appropriate valuation of acquired customer relationship intangible assets, circumstances may certainly indicate that a different method provides a better estimate of fair value.”   Even when a registrant concludes that an income approach is the better approach, he added, “the staff may…question the result…when the underlying assumptions, such as contributory asset charges, do not appear reasonable in light of the circumstances.”  (Ucuzoglu’s full remarks—touching on purchase price allocations, employee stock-based compensation, and more—are worthwhile reading, available here.)

What is the current best practice?  “The general climate is one in which the customer relations are expected to be valued using the income approach,“ Bill Johnston told attendees at the ASA/BVR Fair Value Summit.  At the same time, he emphasized the same “facts and circumstances” caveat as the SEC.  For example, when customer relations are weak, of low value, and/or not the primary asset, Johnson believes that the cost approach makes sense.  "I start with the presumption that there is customer value to be valued using the income approach, and deviate from that only if I can build a convincing case," he said.  "If a client says their brand is strong and customer relations have no value, be suspicious."

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