Introduction
Branding is one of the core features of today’s companies as it is the brand which gives identity, look, and feel. As the saying goes, “People buy brands, not products”, it is the brand which leaves a footprint in the minds of consumers, and it is the very same brand which customers align with. Typically, people identify with the brand more than they identify with any individual driving the brand.
Whilst accounting convention has not itemised brand value annually in the balance sheet, another intangible asset known as goodwill is captured on the balance sheet. Goodwill is a sort of catch-all account for all value that an acquisition holds above and beyond its basic book value (of which brands may only be one part).
Goodwill shows up on a balance sheet when two companies complete a merger or acquisition. When a company buys another firm, anything it pays above and beyond the net value of the target’s identifiable assets becomes goodwill on the balance sheet.
The question arises, if goodwill is a catch-all, and incorporates brand value upon a merger and acquisition, what would the situation be in a Mudaraba-based enterprise? should this payment belong solely to the Rab al-Mal (Capital provider), or should it be shared between the Rab al-Mal and Mudarib (enterprise manager)?
Accounting for Brand Value
Before addressing the question on Mudaraba, brand value and its potential accounting treatment needs to be summarised. The money measurement principle of accounting suggests that only items that have a certain defined value are tracked in the balance sheet, which is why brands don’t appear[1].
On a company’s balance sheet, internally generated intangible assets do not actually show up as such. An intangible asset like the Apple logo, which has enormous name recognition value, is not recorded on the company’s balance sheet. Because the logo was created internally and does not have a price that can be used to determine fair market value, as would be the case had the logo been acquired as part of the acquisition of another company, it is not shown on the balance sheet[2].
Apple’s market value has previously fluctuated by 17% in a single year. If Apple kept track of this in their balance sheet, they would have to drastically adjust their equity as the value of their brand varied from year to year, which doesn’t produce very reliable or comparable accounting statements.
Measuring Brand Value
A brand is an intangible asset whose worth is frequently more vague, in contrast to fixed assets like inventories or PP&E. Market perception and customer loyalty are two examples of the value drivers of a brand that can be challenging to measure and much harder to translate into value. Market- and cost-based approaches are often less successful techniques for evaluating brands. A cost method (for instance, one applying replacement cost estimates) is subjective and may not accurately reflect the asset’s future worth because brand development is frequently unpredictable and hard to recreate. Due to the potential rarity of market transactions involving really comparable brands, precise comparable market measures on brands are typically inaccurate. As a result, an income- or cash-flow-based strategy is frequently the best for valuing brands.
A brand’s valuer must take into account a number of quantitative and qualitative factors. The value frequently reflects the present and/or potential future financial gains associated with brand ownership. The following important quantitative factors are typically considered:
- The historical and predicted growth rates;
- Profitability;
- Market Share;
- Brand-related premium pricing;
- Advertising and marketing costs necessary to sustain brand value.
The following qualitative factors are typically considered:
- Brand history, heritage, and longevity;
- Perceived quality;
- Brand recognition in the market;
- Possibility of expanding the brand into neighbouring regions;
- Capability to uphold brand integrity;
- Brand’s breadth of distribution
Brand valuations are therefore not included in the balance sheet. However, if a business is acquired, the acquiring entity may pay significantly more than the business’ accounting book value, in part to buy a highly prized brand. We can reasonably be sure that the valuation is accurate in this scenario because it won’t fluctuate from year to year and the acquiring company’s bottom line will suffer if they are wrong. Now that the value is known, it can be recorded on the balance sheet as part of the “goodwill” entry, which serves as a sort of catch-all account for all value that an acquisition possesses in addition to its fundamental book value (of which brands may be a part).
Goodwill as an Entry
If a ‘brand’ is a collection of IP assets, plus goodwill, then FRS 10 says that internally generated intangible assets may only be recognised in the financial statements if they have a readily ascertainable market value. This means the asset should be part of a homogeneous population and market value should be evidenced by frequent transactions.
Generally, there are two types of goodwill: internally generated goodwill and purchased goodwill. Internally generated goodwill relates to expenditure incurred to generate future economic benefits but does not result in the condition of an intangible asset). It may exist through its brand value or image, customer relationships and creditors trust of the entity.
Purchased goodwill is externally generated and arises when there is a business combination. This happens when the business is sold to another entity. Purchased goodwill is the excess amount that is paid by the acquirer after deducting the fair value of net identifiable assets in the seller’s business[3].
Goodwill according to FRS 10 is the difference between the fair value of the consideration paid/payable for a business or an enterprise and the fair value of the net assets acquired.
To be clear, brand and goodwill are not synonymous, but maximising brand value often results in long-term success, and goodwill provides a place to quantify that intangible value.
Sharia Considerations of Goodwill and Branding
There is a debate among Sharia scholars on the nature of goodwill and its components, and its recognition from a Sharia perspective. Some scholars do not accept the notion of goodwill and do not consider it as an asset at all. AAOIFI is not explicit on goodwill, whilst it explicitly approves other intangible assets. Some contemporary scholars such as Mufti Radha al-Haqq from South Africa have recognised goodwill as a valid entry. Of course, almost every major Islamic business and Islamic financial institution have goodwill on their financial statements and is clearly a business practice. The latter view seems to be more reasonable and in line with logic, industry, and practice.
The focus of our discussion is the brand itself. Brands have a tangible look and feel. Brand guidelines, kitemarks, patents and trademarks which all are components of a brand are stored as data. Of course, brand represents so much more than just some stored data; it is also about market perception, recognition, and customer satisfaction among other elements; All of this together formulates a brand. In marketing terminology, that is brand equity. So from the perspective of being considered a property (Māl) in Sharia, it can be argued that brand, which is data as a starting point, can be a valid asset class that is sold as part of a merger or acquisition. That is because Māl has two requirements:
- Anything which people seek due to the utility it has
- It is storable and retrievable
Brand – as data – most certainly fulfils the above two. The additional elements of market perception, satisfaction and so on, which cannot be defined, would all be considered Tābi’ (subsidiaries) from a Fiqh perspective. The ruling of something that is Tābi’ is that it is irrelevant and is simply an add-on to the primary feature. In our case study, the primary feature is the data, and everything else is an add-on.
Of course, a brand must have Taqawwum for it to be acceptable in Sharia. That means that the brand must be Halal in and of itself.
If an argument is raised that how can subsidiary and ancillary matters have a valuation in a transaction if they are irrelevant and overlooked, then there is an answer to that. From a valuation perspective, there are several formulae used to measure brand. Whichever formula is used, for Sharia compliance purposes, we can primarily assign the value to the data which is a valid asset, and that can incorporate and subsume the value that is derived from subsidiary matters of a brand too. Equating the entire price to the primary asset or component is perfectly acceptable for Islamic legal compliance. Importantly, the price can be whatever the parties agree on.
Acquisition of a Mudaraba-based Enterprise
Now that we have covered the basics on brand, valuation and Sharia, let us turn to Mudaraba. The principle in Mudaraba is that the assets in the Mudaraba pool or Mudaraba enterprise are owned by the Rab al-Mal, and the Mudarib only has a share in the profits from operational activities. That means that besides the profit, all the assets on a balance sheet in a Mudaraba enterprise are generally owned by the Rab al-Mal. And it follows that when a Mudaraba enterprise and its assets are sold, the Rab al-Mal usually is the recipient of the sale proceeds.
However, in a merger and acquisition, anything that is paid over and above the book value as part of goodwill and as consideration for the brand value, should that be transferred in full to the Rab al-Mal? An intuitive thought suggests that the Mudarib should also have a share in the proceeds from the brand value, in a scenario where the brand had little-to-no-worth and the Mudarib had laboured for several years in building the brand with his labour. A brand cannot grow from scratch with simply the capital of the Rab al-Mal, it needs the labour and expertise of the Mudarib also to grow.
Brand as an ‘asset’ is not like traditional assets; it grows in worth and substance over time. It is not a static item which depreciates like other fixed assets. Nor is it a typical current asset that is used in the operations like other assets which clearly belong to the Rab al-Mal. Brand is also not an intangible asset like other intangible assets, which are typically booked as non-current assets. These other intangibles have a market value and are priced and itemised according to convention. Hence, brand is clearly not the same as other assets, and the overall attribution to the Rab al-Mal and their ownership weakens as a result. When it has weakened, it is challenging to claim that the Rab al-Mal is due all the payment for the brand definitively.
All other current assets and potentially fixed assets are bought with the capital of the Rab al-Mal in a traditional Mudaraba and the Rab al-Mal owns them definitively, however, the brand value is not bought with the capital of the Rab al-Mal. Its value is grown due to the inputs of both parties. There may be an argument to suggest that such a dynamic and evolving asset like brand should be treated differently to all other assets in a Mudaraba pool. Perhaps there is resemblance with produce in a Muzara’a (sharecropping) and Musaqat (irrigation) partnerships.
In a Muzara’a partnership, land is injected by one party and labour by another. In other words, capital goods are supplied from one partner and the labour from another. The produce is shared between the parties according to their agreement, and they jointly own the produce.
In a Musaqat partnership, crops or trees belong to one partner and labour is delivered by
the other partner. A contract is formed between the owner of an orchard or its usufruct and a worker (irrigator) to share the produce according to specific ratios stipulated at the time of contract.
The above two structures are a precedent to show that assets which grow overtime due to the direct inputs of both parties will be co-owned by both parties.
If it is argued that the brand data is initially bought and acquired by the Rab al-Mal, that is a valid argument. However, the growth of the brand is not solely the input of the Rab al-Mal. What we mean by growth is not purely economic value, but everything that a brand represents as the business grows. Furthermore, in the above model of Musaqat, even though the trees or orchards are owned by one party, the produce is shared.
Based on the above reasoning, perhaps a Mudaraba enterprise that is acquired by another entity should consider splitting the proceeds for anything that is paid in relation to the brand as part of goodwill. Perhaps, this is closer to the manner in which Sharia analyses such dynamic assets.
[1] Harvard Business School (2016). What’s in a Brand? Accessible online: https://online.hbs.edu/blog/post/whats-in-a-brand-the-value-of-the-brand-and-how-to-record-it
[2] https://www.investopedia.com/ask/answers/013015/how-do-intangible-assets-appear-balance-sheet.asp
[3] Accounting for Islamic Finance (2020). Malaysian Institute of Accountants
