INSIGHT - Who really values your brands?

As intangible assets become more important to companies, balance sheets begin to show their current values and they become of greater interest to shareholders. As a result, the valuation of intangibles is growing into a major issue for companies and their advisers. FRS10: Accounting for goodwill and intangibles is now in force. According to research by specialist consultancy Brand Finance, 44% of the FTSE-350 are accounting for intangibles under FRS10. But of those 151 companies, only nine are now separately identifying brands from general goodwill, to a tune of £8.9bn. Within this total Diageo’s capitalised brands come to £4.7bn, Cadbury’s to £1.6bn and Reckitt & Colman’s to £1.2bn. According to David Haigh, Brand Finance’s managing director and a chartered accountant, these figures beg one question that FDs as a group have so far ignored: how will such valuations be regulated? Haigh says: “The size of the assets in question and their materiality to the accounts of the companies putting them into their balance sheets is unquestionable. If intangibles in general, and brands in particular, are incorrectly valued there could be significant write-offs leading to irate and litigious creditors and shareholders.” Haigh’s argument is that auditors are stretching the current ethical rules because many initial brand valuations are being conducted by directors after seeking assistance from the auditors. He adds: “Annual impairment reviews are being conducted in the same way. In reality, few company directors have any idea how to value complex intangible assets and advice is usually sought on an informal basis from the auditors to complete the ‘director’s valuations.’ The resulting figures are included in the accounts, which are then reviewed at the year-end by the very same auditors who were consulted about the valuation exercise in the first place.” Such aspersions are flatly denied by the Big Five. One technical manager told Financial Director: “Our auditors don’t do brand valuations for our clients.” However, where the professional services firms do become heavily involved is on mergers and acquisitions. For instance, PwC has a team of around 20 professionals working full-time on brand valuation, mostly in transaction-based assignments. Ian Wright, technical partner with PricewaterhouseCoopers, says that PwC carries out valuations when companies are looking to buy other companies or when organisations are selling their brands. “Companies don’t have to resort to the auditors to give them a helping hand on valuation, but management want an independent view, and they are looking for any information that might help. But that’s not part of audit,” he says. Wright agrees with Brand Finance’s figures that show brand valuation as a minority sport. “In the main, companies are not attempting to value their brands even with the arrival of FRS10,” he says. Brand valuations are most common in three industries: pharmaceuticals, drinks and newspapers. But, Wright insists, directors of most of the companies in these sectors hardly need the auditor’s help to know what their brands are worth. Brand valuation is still an emerging issue. The debate could really take off if, or when, companies are allowed to value internally generated brands. FRS10 prohibits the placing of these on the balance sheet, but this is arguably illogical, and national and international standard setters have the subject on their agendas. But finding valuation methods for home-grown brands promises to be a nightmare – and auditors will not be keen to give work into the arms of their competitors. It is clear that Brand Finance’s Haigh is pointing to an area of difficulty, however. One auditor told Financial Director: “There is a self-review threat. You might be asked to perform a piece of work that management will want to incorporate into the financial statement. What tends to happen is that we produce a range, explain our methodology and the way we have looked at the problem. We don’t just say the answer is X.” Wright believes that the dangers are minimal: “We continue to look carefully at this and we have detailed discussions of what we are permitted to do. There are pieces of work that we turn down. But is there widespread flouting of the ethical rules? Then my answer is, ‘Good Lord, no.'” Yet Haigh doesn’t take such a relaxed view. In his view, the Institute’s ethical rules are being broken by default. “There have been no high-profile write-offs to bring this abuse into the open. However, it is only a matter of time before this happens, and when it does, the directors will, no doubt, seek to blame the auditors, equating ‘advice’ on valuation methods with a valuation ‘opinion’.” – See cover story, page 28. WHAT THE ETHICAL RULES SAY The relevant guidance is section 1.201 of the ICAEW’s Professional Ethics. It states: “The provision for an audit client of expert services, by an audit firm or an associated firm or organisation in the same country or overseas, which directly affects amounts and disclosures in the financial statements of an audit client gives rise to a clear self-review threat to objectivity. These services may include reports, opinions, valuations or statements by an expert.” The guidance goes on to state that an auditor should consider whether the threat is so great that the firm should either not audit the financial statements or advise the client to seek an alternative source of advice. But there is no blanket prohibition. The guidance adds: “In cases where the firm decides to accept such an engagement, the auditor should determine what the appropriate safeguards should be to address the threat. To ensure that careful consideration has been given to the key aspects of the threat the auditor should record the basis of its decisions and document the safeguards.” John Denney, director of IMACE, the ICAEW’s Industrial Members’ Advisory Committee on Ethics, says: “The big firms have separate divisions to handle brand valuations and even then there are obvious dangers. I don’t say it is impossible for an auditor to value a brand, but it is difficult. Doubtless this question will arise in the future.”