Brand valuation and impairment

When are brands recognised on the balance sheet?

A brand bought in a business combination is recognised separately from goodwill at its fair value under IFRS 3, because trademarks arise from legal rights. A brand bought on its own is recognised at cost. A brand built internally is never recognised: IAS 38 prohibits recognising internally generated brands, mastheads, publishing titles and customer lists, and later spending to maintain or strengthen a brand, including on acquired brands, is expensed. So a consumer goods group's balance sheet shows the brands it has bought, but not the ones it created, however valuable. See IAS 38 intangibles and purchase price allocation.

How is a brand valued?

The most common method is relief from royalty. It assumes that, without the brand, the owner would have to license it from someone else, so the brand is worth the present value of the royalties it saves. The model forecasts revenue under the brand, applies a royalty rate based on comparable licence agreements and adjusted for the brand's strength and profitability, deducts tax, and discounts the result at a rate that reflects the brand's risk, often slightly above the business's cost of capital, with a terminal value for the years beyond the forecast. When measuring fair value at acquisition, valuers often add the tax benefit a buyer would get from amortising the brand for tax purposes, where tax rules allow it. Other methods, such as comparing the price premium the brand commands, are used less often. Because the inputs are unobservable, brand values are Level 3 fair value measurements.

Is a brand's useful life indefinite or finite?

IAS 38 treats a brand as having an indefinite useful life when, based on all relevant factors, there is no foreseeable limit to the period over which it is expected to generate cash flows. Factors include the brand's history and market position, how stable the category is, likely action by competitors and retailers, and the spending needed to maintain it. Indefinite does not mean infinite: it means the end of the brand's life cannot be foreseen. The assessment is reviewed every period. If a group decides to retire a brand, for example by moving its products to a master brand, the life becomes finite, the brand is tested for impairment and then amortised over the remaining period of use.

How is brand impairment tested?

Under IAS 36, a brand with an indefinite life is tested at least once a year, at the same time each year, and also whenever there is an indication of impairment, such as a lost listing, falling market share or higher interest rates. Its carrying amount is compared with its recoverable amount, the higher of fair value less costs of disposal and value in use. Because a brand rarely generates cash on its own, it can be tested individually only if its fair value less costs of disposal is above its carrying amount, or its value in use can be estimated to be close to that fair value; otherwise it is tested as part of the cash-generating unit that sells its products. Consumer goods groups commonly estimate both values with relief-from-royalty models, using market participants' assumptions for fair value and their own forecasts for value in use. Brands tested on their own are tested before the units that contain goodwill. See IAS 36 impairment.

Brand impairment: a snacks brand after a lost listing

A group carries an acquired snacks brand at US$ 45 million, with an indefinite life. Last year, its relief-from-royalty model assumed brand revenue of 100 million, a royalty rate of 5%, tax of 25%, a discount rate of 9.5% and long-term growth of 2%, giving a value of 50.0 million and headroom of 5.0 million. This year, the brand lost a major supermarket listing to a retailer's own label, so expected revenue falls to 88 million, and higher interest rates lift the discount rate to 10.25%. The group's own forecasts and a market participant's are similar, so value in use is close to fair value and the brand is tested on its own.

The brand's recoverable amount is now 88 × 5% × (1 - 25%) ÷ (10.25% - 2%) = 40.0 million, below its carrying amount of 45 million, so the group recognises an impairment loss of 5.0 million in profit or loss and carries the brand at 40.0 million. Costs of disposal are small and are ignored here for simplicity.

Which assumptions need sensitivity disclosures?

For each cash-generating unit with significant goodwill or brands with indefinite lives, IAS 36 requires the key assumptions, the approach used to set them, and, where a reasonably possible change in a key assumption would cause an impairment, the effect of that change. After the write-down, the brand has no headroom, so every assumption matters:

The royalty rate is often the most sensitive input, because it scales every year's cash flow. Auditors usually compare it with published licensing data and the brand's own profit margin, since a brand cannot sensibly pay away more in royalties than it earns.

Can a brand impairment be reversed?

Under IAS 36, yes. If the estimates used to measure the recoverable amount change, for example the brand regains its listing, the impairment is reversed, but only up to the carrying amount the brand would have had without the impairment, here 45 million because an indefinite-life brand is not amortised. Impairments of goodwill are never reversed. See reversing impairment losses.

How does US GAAP differ?

Under ASC 350, indefinite-lived intangible assets such as brands are also tested at least annually and when events indicate impairment, with an option to start with a qualitative assessment. The test compares the carrying amount with fair value only, so there is no value in use, and the loss is the excess of carrying amount over fair value. Brands that are operated as a single asset can sometimes be combined for the test. Impairment losses are never reversed. See ASC 350 impairment and FMCG accounting.

This guide is general information. It is not tax or legal advice for your situation.