9.1 Types of intangible assets
7 min read•august 20, 2024
Intangible assets are non-physical resources that provide long-term value to companies. These assets, like , , and , lack physical form but play a crucial role in a business's success and financial reporting.
Understanding intangible assets is essential for grasping their impact on financial statements. This topic covers the definition, characteristics, and types of intangible assets, as well as their accounting treatment, valuation methods, and disclosure requirements.
Definition of intangible assets
- Intangible assets are non-physical assets that provide long-term economic benefits to a company
- These assets lack physical substance but hold significant value for the business
- Examples of intangible assets include patents, trademarks, copyrights, and
Characteristics of intangible assets
Identifiability
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- An intangible asset must be identifiable and distinguishable from other assets
- It should be capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged
- Identifiability helps in the recognition and measurement of intangible assets
Control
- The company must have control over the intangible asset to recognize it on the balance sheet
- Control implies the ability to obtain future economic benefits from the asset and restrict others' access to those benefits
- Legal rights, such as patents or trademarks, often establish control over intangible assets
Future economic benefits
- Intangible assets should generate future economic benefits for the company
- These benefits can include increased revenues, cost savings, or other advantages that contribute to the company's profitability
- The expected future benefits should be probable and measurable
Common types of intangible assets
Patents
- Patents grant exclusive rights to an invention or process for a specified period
- They protect the company's innovative products or technologies from being copied by competitors
- Examples include pharmaceutical patents and technology patents (smartphone designs)
Copyrights
- Copyrights protect original works of authorship, such as literary, musical, or artistic creations
- They give the owner exclusive rights to reproduce, distribute, and adapt the work
- Examples include software code, books, and musical compositions
Trademarks
- Trademarks are distinctive signs or symbols that identify a company's products or services
- They help establish brand recognition and differentiate the company from its competitors
- Examples include logos (Nike swoosh) and slogans (McDonald's "I'm lovin' it")
Franchises
- are agreements that allow a franchisee to operate under the franchisor's brand name and business model
- The franchisor grants the right to use its intellectual property, such as trademarks and operating procedures
- Examples include fast-food chains (Subway) and hotel chains (Hilton)
Licenses
- grant the right to use, produce, or sell a patented invention, copyrighted work, or trademark
- They allow companies to generate revenue from their intellectual property without directly using it themselves
- Examples include software licenses (Microsoft Office) and character licenses (Disney characters)
Goodwill
- Goodwill represents the excess of the purchase price over the of net assets acquired in a business combination
- It reflects the value of intangible elements, such as reputation, customer loyalty, and synergies
- Goodwill is not amortized but is tested for impairment annually
Accounting for intangible assets
Initial recognition and measurement
- Intangible assets are initially recorded at their acquisition cost or fair value if acquired in a business combination
- The cost includes the purchase price and any directly attributable costs necessary to bring the asset to its intended use
- Internally generated intangible assets are generally not recognized unless they meet specific criteria
Amortization of intangible assets
- Intangible assets with finite useful lives are amortized over their expected period of benefit
- The expense is allocated systematically over the asset's useful life using a rational and consistent method
- The most common amortization methods are the straight-line method and the units-of-production method
Impairment of intangible assets
- Intangible assets are tested for impairment when events or changes in circumstances indicate that their carrying amount may not be recoverable
- An impairment loss is recognized if the asset's carrying amount exceeds its fair value or future discounted cash flows
- Goodwill is tested for impairment annually or more frequently if impairment indicators are present
Disclosure requirements for intangible assets
Notes to financial statements
- Companies must disclose information about their intangible assets in the notes to the financial statements
- Disclosures include the types of intangible assets, useful lives, amortization methods, and accumulated amortization
- Any significant changes in the carrying amount of intangible assets during the period should be explained
Supplementary information
- Companies may provide additional information about their intangible assets in supplementary schedules or reports
- This information can include details about specific intangible assets, such as patent expiration dates or trademark registrations
- Supplementary information helps users better understand the nature and value of the company's intangible assets
Comparison of intangible assets vs tangible assets
Similarities
- Both intangible and tangible assets provide economic benefits to the company over multiple periods
- They are both recorded on the balance sheet and are subject to impairment testing
- The acquisition cost of both types of assets is capitalized and depreciated or amortized over their useful lives
Differences
- Intangible assets lack physical substance, while tangible assets have a physical form
- Intangible assets are often more difficult to value and have a higher degree of uncertainty in their future economic benefits
- The useful lives of intangible assets are generally longer and more subjective compared to tangible assets
Tax implications of intangible assets
Amortization for tax purposes
- The amortization of intangible assets is generally tax-deductible, similar to the depreciation of tangible assets
- The tax treatment of intangible assets may differ from the accounting treatment, resulting in temporary differences and deferred taxes
- Tax authorities may specify different amortization periods or methods for certain types of intangible assets
Tax deductibility of intangible assets
- The cost of acquiring or developing intangible assets is typically tax-deductible
- However, the deductibility may be subject to certain limitations or restrictions depending on the nature of the asset and the jurisdiction
- Research and development costs may be expensed or capitalized for tax purposes based on specific criteria
Valuation methods for intangible assets
Cost approach
- The cost approach estimates the value of an intangible asset based on the cost to recreate or replace it
- It considers the current cost of acquiring or developing a similar asset with equivalent utility
- The cost approach is often used for internally generated intangible assets or when market comparables are not available
Market approach
- The market approach determines the value of an intangible asset based on the prices paid for similar assets in actual market transactions
- It relies on the principle of substitution, assuming that a buyer would not pay more for an asset than the cost of acquiring a comparable substitute
- The market approach is suitable when there is an active market for similar intangible assets
Income approach
- The income approach estimates the value of an intangible asset based on the present value of future economic benefits it is expected to generate
- It involves forecasting the cash flows attributable to the asset and discounting them to their present value using an appropriate discount rate
- The income approach is commonly used for intangible assets with identifiable cash flows, such as licenses or customer relationships
Intangible assets in business combinations
Identification and valuation
- In a business combination, the acquirer must identify and recognize all intangible assets that meet the recognition criteria
- The fair value of each identifiable intangible asset is determined using appropriate valuation techniques
- Intangible assets acquired in a business combination are initially measured at their acquisition-date fair values
Allocation of purchase price
- The purchase price in a business combination is allocated to the identifiable assets acquired and liabilities assumed based on their fair values
- Any excess of the purchase price over the net identifiable assets acquired is recognized as goodwill
- The allocation of the purchase price to intangible assets can have a significant impact on the acquirer's financial statements
Research and development costs
Accounting treatment
- Research costs are expensed as incurred because they do not meet the recognition criteria for intangible assets
- Development costs are capitalized as intangible assets only if they meet specific criteria, such as technical feasibility and probable future economic benefits
- Capitalized development costs are amortized over their useful lives once the related asset is available for use
Capitalization criteria
- To qualify for , development costs must meet all of the following criteria:
- Technical feasibility of completing the intangible asset
- Intention and ability to complete and use or sell the asset
- Probable future economic benefits
- Availability of resources to complete the asset
- Ability to measure the expenditure reliably
Internally generated intangible assets
Recognition criteria
- Internally generated intangible assets, such as internally developed software or patents, are recognized only if they meet certain criteria
- The criteria include the ability to demonstrate the technical feasibility, intention and ability to complete and use the asset, and probable future economic benefits
- The costs incurred in the research phase are expensed, while costs in the development phase may be capitalized if the criteria are met
Measurement and amortization
- Internally generated intangible assets are initially measured at the sum of the expenditure incurred from the date when the recognition criteria are met
- Subsequent expenditure on an internally generated intangible asset after its purchase or completion is usually recognized as an expense
- The useful life of an internally generated intangible asset is determined based on the period over which it is expected to generate net cash inflows for the entity
Key Terms to Review (20)
Amortization: Amortization is the process of gradually reducing a financial obligation or intangible asset's value over time through scheduled payments or expense recognition. It plays a crucial role in accounting as it affects operating activities, impacts cash flows, and reflects the cost allocation of intangible assets and long-term liabilities.
ASC 350: ASC 350, or Accounting Standards Codification Topic 350, provides guidance on the accounting for intangible assets and goodwill. This standard outlines how to recognize, measure, and disclose intangible assets acquired in business combinations and addresses the impairment testing process for both intangible assets with finite lives and indefinite lives, including goodwill. It plays a crucial role in determining how companies report these assets on their financial statements.
Capitalization: Capitalization refers to the accounting practice of recognizing and recording an expenditure as an asset rather than an expense. This process allows costs associated with acquiring assets to be spread out over time, reflecting their ongoing utility and value. By capitalizing costs, businesses can better match expenses with revenues, especially in relation to acquiring tangible and intangible assets, and managing research and development investments.
Copyrights: Copyrights are legal protections granted to the creators of original works, such as literature, music, and art, giving them exclusive rights to use and distribute their creations. This concept is essential for recognizing and safeguarding intellectual property rights, which can be classified as intangible assets. Copyrights allow creators to control how their work is used, ensuring they receive recognition and financial benefits from their intellectual contributions.
Cost method: The cost method is an accounting approach used to record and report investments in securities or assets at their original purchase price, without adjusting for market fluctuations. This method is especially relevant when discussing intangible assets, trading securities, equity investments, and the repurchase of stock. Under this method, the initial cost remains the basis for valuation until the investment is sold or disposed of, emphasizing a conservative approach to financial reporting.
Definite-lived intangible assets: Definite-lived intangible assets are non-physical assets that have a limited useful life, meaning they are expected to provide economic benefits for a specific period. Unlike indefinite-lived intangible assets, which do not have a foreseeable end to their economic usefulness, definite-lived assets are amortized over their useful life, reflecting their gradual consumption or expiration. This category of intangible assets includes items such as patents, copyrights, and trademarks with finite durations, which require systematic allocation of their cost over time.
Fair Value: Fair value is the estimated price at which an asset or liability could be bought or sold in a current transaction between willing parties, reflecting current market conditions. It connects to the valuation of both long-term and intangible assets, as well as the recognition of changes in value due to impairment or disposition. Understanding fair value is essential for accurate financial reporting, as it affects the presentation of various assets and liabilities on financial statements.
FASB: The Financial Accounting Standards Board (FASB) is an independent organization responsible for establishing accounting and financial reporting standards in the United States. FASB's standards provide a framework for how financial statements should be prepared and presented, ensuring transparency, consistency, and comparability in financial reporting across different organizations. Their guidelines impact various accounting principles, such as revenue recognition, the presentation of financial statements, and the treatment of assets and liabilities.
Franchises: Franchises are a type of intangible asset that grants an individual or group the right to operate a business under the established brand of a franchisor, along with access to its business model, marketing strategies, and support systems. This arrangement allows franchisees to leverage the reputation and success of the franchisor while operating their own business, often in exchange for fees and royalties. Franchises play a significant role in various industries, offering a structured method for expansion and brand consistency.
Goodwill: Goodwill is an intangible asset that represents the excess value of a business beyond its identifiable net assets at the time of acquisition. It often reflects factors such as brand reputation, customer relationships, and employee relations that contribute to future earnings. Goodwill is important in understanding types of intangible assets and plays a role in amortization, impairment assessments, and consolidation processes.
IASB: The International Accounting Standards Board (IASB) is an independent body that develops and approves International Financial Reporting Standards (IFRS) to improve the consistency and transparency of financial reporting globally. It plays a vital role in shaping the way companies recognize revenue, measure depreciation, and account for intangible assets, ensuring that financial statements provide a true and fair view of a company's financial position.
IFRS 38: IFRS 38 is an international financial reporting standard that provides guidelines for the recognition, measurement, and disclosure of intangible assets. It emphasizes that intangible assets should be identified separately from tangible assets and sets out specific criteria for their recognition, including the requirement that the asset is identifiable, controlled by the entity, and expected to provide future economic benefits.
Impairment test: An impairment test is an accounting procedure used to determine whether the carrying amount of an asset exceeds its recoverable amount, indicating that the asset may be impaired. This test is especially important for intangible assets, as it helps ensure that their reported values on the balance sheet reflect their actual economic benefits. The impairment test involves comparing the asset’s carrying value to the estimated future cash flows or fair value, ensuring that losses are recognized in a timely manner.
Income method: The income method is a valuation technique used to determine the value of intangible assets based on the income they generate over time. This approach takes into account the present value of expected future cash flows that an asset is likely to produce, which is crucial in recognizing the financial significance of intangible assets like patents or trademarks.
Indefinite-lived intangible assets: Indefinite-lived intangible assets are non-physical assets that do not have a finite useful life and are not subject to amortization. These assets, such as trademarks or certain brand names, can provide value to a company indefinitely, as long as they continue to be used and maintained. Understanding these assets is crucial when considering their classification, valuation, and the implications of impairment assessments.
Licenses: Licenses are legal permissions granted by a licensor to a licensee, allowing the use of an intangible asset, such as technology, trademarks, or patents, under specific terms and conditions. This concept is crucial in recognizing how businesses can monetize their intellectual property while maintaining ownership rights, often leading to revenue streams through royalties or fees.
Patents: Patents are exclusive rights granted by a government to an inventor or assignee for a limited period of time, typically 20 years, allowing them to exclude others from making, using, selling, or distributing their invention without permission. This legal protection encourages innovation by ensuring that inventors can reap the financial benefits of their creations, linking patents closely to long-term assets as they can represent significant value on a company's balance sheet.
Recoverable amount: Recoverable amount is the higher of an asset's fair value less costs to sell and its value in use, representing the maximum value that can be obtained from an asset. This concept is crucial in determining whether an asset is impaired, as it helps to assess if the carrying amount exceeds the amount that can be recovered through either its sale or continued use.
Trademarks: Trademarks are distinctive signs or symbols, such as words, phrases, logos, or designs, that identify and distinguish the source of goods or services of one entity from those of others. They play a crucial role in protecting a company's brand and reputation, making them a significant aspect of long-term assets, particularly intangible assets. Proper management and accounting for trademarks can involve aspects such as amortization and assessing impairment, ensuring that their value is accurately reflected in financial statements.
Write-off: A write-off is an accounting term that refers to the removal of an uncollectible asset from the financial records of a business. This typically happens when it becomes clear that a debt or asset will not be paid or recovered, leading to a reduction in the company's net income and total assets. Understanding how write-offs work is crucial in managing financial statements and assessing the value of both receivables and intangible assets.