Contract-based intangible assets – In a Business Combinations, contract-based intangible assets –by definition– are intangible assets and are therefore recognised separately from goodwill, provided that their fair values can be measured reliably. These intangible assets meet the definition of an intangible asset because they again –by definition– arise from contractual or other legal rights and are not tangible/visible/instantly recognisable.
Self explanatory examples are:
- Licensing, royalty and standstill agreements
- Advertising, construction, management, service or supply contracts
- Lease agreements Contract-based intangible assets
- Construction permits Contract-based intangible assets
- Franchise agreements
- Operating and broadcasting rights Contract-based intangible assets
- Use rights such as drilling, water, air, mineral, timber-cutting and route authorities
- Servicing contracts such as mortgage servicing contracts Contract-based intangible assets
Contracts to service financial assets are one particular type of contract-based intangible asset. While servicing is inherent in all financial assets, it becomes a distinct asset (or liability):
- when contractually separated from the underlying financial asset by sale or securitisation of the assets with servicing retained; or
- through the separate purchase and assumption of the servicing.If mortgage loans, credit card receivables or other financial assets are acquired in a business combination with servicing retained, the inherent servicing rights are not a separate intangible asset because the fair value of those servicing rights is included in the measurement of the fair value of the acquired financial asset.
- Employment contracts that are beneficial contracts from the perspective of the employer because the pricing of those contracts is below their current market value
A contract is an enforceable agreement between two or more parties to either do a thing (or a set of things) or to not do a thing (or a set of things). The rights and duties encompassed in the contract can have a intangible value in a business combination. The contract document (or the oral agreement) itself is not the intangible asset. The legal rights and duties of the contract are the intangible asset. Before any valuation can be performed, there should be an enforceable contract. In order for the contract to be enforceable, it should meet certain (standard) legal requirements.
Contract valuation: Contract-based intangible assets
All intangible asset valuation approaches may be applicable to most contract valuations. These are:
An intangible asset is a non-physical asset having a useful life greater than one year. These assets are generally recognized as part of an acquisition, where the acquirer is allowed to assign some portion of the purchase price to acquired intangible assets. Few internally-generated intangible assets can be recognized on an entity’s balance sheet.
Factors Commonly Considered in the Contract Intangible Asset Valuation
- The degree of legal enforceability of the contract or agreement
- The state law under which the contract is binding
- The specific terms of the agreement, including the rights, duties, and obligations of each of the parties
- The expected amount of time required to negotiate a new contract (or to obtain a new license or permit)
- The degree to which the contract is transferable
- The degree to which the contract is assignable
- The party’s ability to create or support subcontractors or sublicenses
- The legal term of the agreement (the contract start date and termination date)
- The provisions (if any) for a renewal or extension of the agreement
- The schedule of any payments associated with the contract
- Whether the determination of contract payments is fixed or variable
- Does the contract specify that it contains all of the agreements between the parties?
- Does the contract refer to (and does it depend on) any other contract or agreement between the parties?
- Is this type of contract between the parties common or unique? (Do all company customers, suppliers, or employees have similar contracts?)
- Has the contract or agreement ever been tested in court?
- Does the contract mention (or quantify) liquidation damages?
- Does the contract describe what happens in the case of a contract dispute (mediation, arbitration, and litigation)?
- What is the degree of standardization (for example, a standard real estate lease) or uniqueness (a celebrity performance agreement) of the contract?
- How comparable is the contract to other contracts (of the parties or in the industry)?
- What did the parties do before the contract? What would the parties do without the contract?
Contract-based intangible assets
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