IAS 38 Non-contractual customer relationships

IAS 38 Non-contractual customer relationships, in Business Combinations, this is a intangible asset and is therefore recognised separately from goodwill, provided that its fair value can be measured reliably. This customer-related intangible asset does not arise from contractual or other legal rights, but meets the definition of an intangible asset because it is separable. IAS 38 Non-contractual customer relationships

IAS 38 Non-contractual customer relationships

If a customer relationship acquired in a business combination does not arise from a contract, the relationship is an intangible asset if it meets the separability criterion. Exchange transactions for the same asset or a similar asset provide evidence of separability of a non-contractual customer relationship and might also provide information about exchange prices that should be considered when estimating fair value. IAS 38 Non-contractual customer relationships

There are valuation models to value customer contracts and the related customer relationship and the non-contractual customer relationships, as per IFRS 3 Business Combinations. IAS 38 Non-contractual customer relationships

What are the inputs? IAS 38 Non-contractual customer relationships

Revenue – represents revenue from existing customer relationships for existing products. Includes contractual and non-contractual relationships (even those without current backlog or commitments). Separate valuation of a backlog revenue intangible asset can be considered if and when such backlog exists.

The model assumes a “market participant” point of view, therefore revenue/earnings assumptions should not include the impact of synergies specific to Acquirer Co., rather only those synergies that would be realized by any market participant.

Revenue growth on a stand-alone basis, i.e. without Acquirer Co.-specific Synergies

Turnover/Attrition IAS 38 Non-contractual customer relationships

The expected attrition rate is used in valuing customer-related assets using the Multi-period excess earnings method (MPEEM), a discounted cash flow model, the valuation expert should identify the portion of revenue expected to be generated through repeat customers existing as of the valuation date. The estimated future revenue is derived from the revenue per customer and the number of retained customers. Because customer relationship assets derive value within a finite period, the number of customers providing repeat business is expected to decrease over time. For example an attrition rate of 20% leads to the following phase out of turnover of an existing customer portfolio (year zero is 100%): IAS 38 Non-contractual customer relationships

1

2

3

4

5

6

7

8

9

10

80%

64%

51%

41%

33%

26%

21%

17%

13%

11%

(just for the sake of it, period 1: 100% x 80% = 80%, period 2 80% x 80% = 64%) IAS 38 Non-contractual customer relationships

Terminal value IAS 38 Non-contractual customer relationships

Terminal value (TV) is the value of a business or project beyond the forecast period when future cash flows can be estimated. Terminal value assumes a business will grow at a set growth rate forever after the forecast period. Terminal value often comprises a large percentage of the total assessed value. Therefore more conservative calculation model use a limited period to calculate the terminal value over. IAS 38 Non-contractual customer relationships

Net margin IAS 38 Non-contractual customer relationships

The net profit margin is equal to how much net income or profit is generated as a percentage of revenue. Net profit margin is the ratio of net profits to revenues for a company or business segment. Net profit margin is typically expressed as a percentage but can also be represented in decimal form. The net profit margin illustrates how much of each dollar in revenue collected by a company translates into profit. IAS 38 Non-contractual customer relationships

Inventory write-up – represents purchase accounting write-up of Inventory, if any. Amount should be deducted herein to avoid overvaluing the customer intangible asset. It is deducted completely in year 1 as cost of sales. IAS 38 Non-contractual customer relationships

Contributory asset charge IAS 38 Non-contractual customer relationships

Contributory assets are those tangible or intangible assets used in the generation of the cash flows associated with the subject intangible asset that is being valued. A contributory asset charge is a charge against revenues to reflect a fair return on or return of contributory assets used in the generation of the cash flows associated with the intangible asset being valued. Once determined, contributory asset charges are typically allocated based on revenues. In this model the following contributory assets are included:

  • Charge for trade namesTrade names can be valued using a benchmarked revenue stream from a tradename branded product. Revenue and growth rates should only be reflective of “market participant” synergies, not synergies specific only to Acquirer Co. The royalty tradename rate should correspond to the estimated rate that would be required by a 3rd party to utilize the subject tradename. IAS 38 Non-contractual customer relationships
  • Charge for other technology – Represents revenue relating to patented/unpatented proprietary technology. It may be a subset of total business revenue. Revenue and growth rates should only be reflective of “market participant” synergies, not synergies specific only to Acquirer Co. The royalty technology rate should correspond to the estimated rate that would be required by a 3rd party to utilize the subject technology.If and when other technology items are separately valued as intangible assets, this income stream has to be eliminated from the customer relationships valuation component by using this line as costs in this part of the model. IAS 38 Non-contractual customer relationships

Income tax rate – this should reflect the estimated effective tax rate for the acquired business (the rate would not be revised for any benefits that would be specific to Acquirer Co.).

Unit of measurement – the functional currency of the acquired business in units or ‘000 units, so for example EUR ‘000 or USD ‘000.

Partial first year factor – when the first year is not a full year, the factor has to be for example 10/12 if first time inclusion is beginning March of the year under review. Here the first year is a full year or 12/12 = 1.

Present Value Factor/Discount Rate – takes into consideration the Weighted Average Cost of Capital (WACC), Internal Rate of Return (IRR), and the Weighted Average Return on Assets (WARA). Note that the discount rate used for the intangible asset valuations should generally reflect a premium of 100 to 300 basis points over the WACC determined for the overall acquisition.

The present value factor is then calculated as follows: 1 / ((1 + i%)^n), i is the discount factor, 14.0% and n is year 1, year 2, …….. year 16, so year 1 = 1 / ((1.14)^1) = 0.8772 and year 16 = 1 / ((1.14^16) = 0.1229.

Here is the model in Customer relationships valuation

IAS 38 Non-contractual customer relationships

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