An intangible asset can be defined as an asset that is not physical in nature. However, it is treated as an asset because of the fact that having that on the financial statements of the company is resourceful on numerous different grounds. Organizations can either create intangible assets, or they can acquire those assets.
However, they cannot be arbitrarily purchased in order to inflate assets of the company. They are mainly assets that are created in order to facilitate better business practices, which can ensure sustainability for the company.
Intangible assets can broadly be categorized as either definite intangible assets, or indefinite intangible assets.
As far as definite intangible assets are concerned, they can be defined as assets that are meant to be kept intact on the balance sheet, because their valuation or their existence is not contingent on any other factor, other than the organization’s existence.
An example in this regard is that of the brand name. On the other hand, as far as definite intangible assets are concerned, these are those assets that have a finite and limited life.
They are not meant to exist across the lifespan of the company. Hence, the types of intangible assets are classified as definite intangible assets.
Regardless of the fact that intangible assets have no physical presence or no directly attributable benefit, yet it can be seen that they are an increasingly valuable resource for the company and is extremely critical for the long-term success or failure of the organization.
In the same manner, it can also be seen that intangible assets are important from the perspective of external investors, and users of the financial statements.
Therefore, companies prefer acquiring intangible assets in order to make their financial statements more attractive for their potential customers.
Accounting for Intangible Assets
Accounting for Intangible Assets has two broad categories: valuation, as well as accounting for those intangible assets once these assets have been subsequently acquired.
As far as valuation is concerned, it can be seen that intangible assets are only recorded on the financial statement of the company in the case where they are acquired externally.
For the intangible assets that are created internally, for example, patents, the accounting treatment is such that the processing costs associated with the patent creation are expensed, whereas the legal expenses that are associated with the patent registration are capitalized.
On the other hand, intangible assets are amortized. Amortization of intangible assets is similar in concept as depreciation of fixed assets.
However, they are treated differently. Intangible assets are mainly amortized across using their useful life, using straight line method. Given the fact that they have no salvage value, year on year amortization is calculated by dividing the total life of the asset over its useful life.
However, it must be noted that amortization of intangible assets only takes place in the case of definite intangible assets. Since indefinite intangible assets exist over a continuum, they don’t have a useful life to be amortized over.
Example of Intangible Assets:
Intangible assets are mentioned on the balance sheet in the case after they have been acquired. An example of a case and subsequent treatment of Intangible Assets is given below.
Let’s suppose, Company X purchases a patent from Company Y, for an agreed amount of $200 million, then the transaction would be reflected in the financial statements of Company X in the following manner.
|Dr. Intangible Asset – Patents Purchased from Company Y||200,000,000|
Types of Intangible Assets
There are numerous examples of intangible assets. Some of the major examples of intangible assets include:
- Copyrights: Although copyrights are in place in order to protect the organization’s products and services, yet they are considered intangible assets because of the fact that the copyrighting cost is spread across a multitude of years and expensing it one singular year is not the correct treatment.
- Patents: Registering patents is greatly helpful for the company in terms of ensuring that they are able to maintain their supremacy without any duplication of their ideas. Patents also stay with the organization for a considerable time period, and therefore, they are regarded as intangible assets.
- Trademarks: Trademarks are also maintained within the company for protective reasons. They are also declared as intangible assets on the balance sheet.
- Goodwill: Goodwill is perhaps the most important intangible asset. Goodwill is mostly acquired as a result of business combinations. Therefore, only that goodwill is included in the financial statements, which is externally acquired. Internally generated goodwill is not maintained in the balance sheet.