Fair Value Measurement: Practical Guidance and Implementation, 2nd Edition

CHAPTER EIGHT

The Income Approach

The income approach to fair value measurement estimates the fair value of an entity, intangible assets, or other assets and liabilities by calculating the present value of future cash flows that the entity or asset is expected to generate over its lifetime. The cash flows are discounted to the measurement date at a rate of return that is required to compensate for the risk associated with receipt of the future cash flows.

The income approach is one of the three basic valuation techniques to measure fair value described in the Financial Accounting Standards Board's Accounting Standards Codification 820, Fair Value Measurements and Disclosures (ASC 820). This chapter presents various methods used to estimate the fair value under the income approach. Although the income approach can be used to measure the fair value of entities, tangible assets, intangible assets, and liabilities, the focus of the chapter is on measuring the fair value of intangible assets that are recognized through business combinations. The chapter also includes a section on determining appropriate rates of return (discount rates) for those intangible assets.

The Financial Accounting Standards Board's (FASB) Master Glossary defines the income approach as “the use of valuation techniques to convert future amounts (cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts.” ...