What is the Excess Earnings Method and how does it differ from MPEEM?

Full Explanation

The Excess Earnings Method and the Multi-Period Excess Earnings Method share the same conceptual foundation — isolating the earnings attributable to a specific intangible asset after deducting returns on all other contributing assets — but differ in their implementation. The single-period Excess Earnings Method (sometimes called the capitalisation of excess earnings or the Treasury Method, after Revenue Ruling 68-609) takes one year's earnings, deducts contributory asset charges, and capitalises the residual excess earnings using a single capitalisation rate. It is simpler but less precise because it assumes a stable, perpetual earnings stream from the intangible asset. MPEEM explicitly projects cash flows over multiple future periods, incorporating year-by-year changes in revenue (from attrition, growth, or both), margins, contributory asset charges, and tax. Each year's excess earnings are discounted individually, and the asset's value is the sum of discounted excess earnings over the projection period. MPEEM is preferred in modern PPA practice because it captures the reality that intangible assets (especially customer relationships) have declining cash flows over time due to attrition. The AICPA Practice Aid recommends MPEEM for the primary intangible asset in a business combination. The single-period approach may still be appropriate for assets with stable, perpetual characteristics (certain brands, perpetual licences) or for quick reasonableness checks. In practice, MPEEM has largely superseded the single-period method for formal valuations because auditors and regulators expect the granularity and transparency that multi-period projections provide.

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