What Are Intangible Assets?
Under IAS 38.8, an intangible asset is defined as,
It is an identifiable non-monetary asset that has no physical existence. It is a resource held by a company due to a past event(patent creation by research), and an economic benefit in the future is expected from it.
The same standard has identified three attributes of an intangible asset:
Under IAS 38.12, an asset will meet the criterion of identifiability when:
- It is separable, which means it can be separated from the entity. Besides, the asset can be transferred, licensed, rented, or exchanged against a contract. For example, a business name is an intangible asset that cannot be separated from a company until it continues its operation.
- The asset is created from any legal or contractual rights. Irrespective of whether the rights can be transferred or separated from the entity.
- Controlled by the company(It can be controlled by an entity for benefits)
- Future economic benefits(revenues can be generated or future costs can be reduced)
What are the most common examples of an entity’s intangible assets?
Following are examples of these non-physical assets:
- Patents, Trademark, Copyrights,
- Computer software, registered domains, trade dress, databases, trade secrets
- Customer mailing lists
- Import quotas
- Marketing Rights
- Customer And Supplier Relationship
- Licensing, royalty
- Video, and audiovisual material, etc.
Classification Of Intangible Assets
Although intangible assets are generally long-term assets, their economic benefits are extended to more than one operating cycle.
However, under the IAS 38.88 of International Accounting Standards, an entity’s non-physical and non-monetary assets are classified according to useful life. These assets are classified as having:
Finite life: The assets having finite life provide economic benefit to a company for a limited time.
Indefinite life: These assets have no defined limit of time over which it can be said with the probability that the asset will generate net cash inflows for the entity.
Recognition In Balance Sheet
The recognition criteria for intangible assets are the same as for other types of assets. Under the IAS 38.21, the company will recognize its intangible assets(internally generated and acquired from external organizations) as part of the balance sheet only if:
- An asset is expected to provide economic benefit to the company in future
- An entity can measure the asset’s cost with reliability.
In most cases, the internally generated assets are not shown on the balance sheet. The internally generated items include brands, titles, customer lists, etc.
A company can acquire the non-physical assets as a result of different events, which includes:
- Purchase of an intangible asset
- Acquired as a part of the business combination
- Acquired by a government grant
- Received in assets exchange
- Internally generated.
Any intangible asset acquired by an enterprise as a result of a business combination can be valued reliably. Therefore, it is recorded as an asset in the balance sheet.
If a research-in-progress is also acquired in a business combination, it will be recorded as an asset. The future progress in research will be considered as development cost and charged to an expense account.
Research And Development Costs
Under IAS 38.54 and 38.57, the treatment of research & development costs is defined. It says that:
Any research and development cost incurred by an entity to generate an intangible asset will be charged to an expense account.
The costs will be recorded as capital expenditure only after the project has been completed and there is a feasibility that asset will bring economic benefits to the company.
If a company has acquired computer software from external organizations, it will be capitalized and recorded as an intangible asset. However, if the software is developed internally, it cannot be charged to assets unless:
- There are probable future-benefits
- The company has the intention and ability to sell software
- The cost of software can be measured reliably
- There is technological feasibility of software
Other Defined Types Of Costs
There is often confusion about the many costs of a company to be recorded as an asset. However, there are defined rules about the capitalization of costs. Following costs can not be capitalized and must be charged to the expense account:
- Internally generated goodwill: A company will never record its internal goodwill on the balance sheet unless liquidating its assets. Therefore, the goodwill we see in the balance sheets of many organizations is externally acquired due to any business combination, joint venture, take over, etc.
- The startup and pre-operating costs are the company’s capital expenditures, and they are not recorded as the company’s intangible assets on the balance sheet. However, suppose a company’s balance sheet has preliminary expenses as deferred assets. In that case, the auditor’s responsibility is to verify that the useful life of the pre-operating costs is appropriately estimated by management.
- Training costs, advertising, and promotional costs.
- Relocation costs
The initial measurement of an intangible asset will be made on its cost.
Cost models and revaluation models can be used for the subsequent measurement of intangible assets.
The cost model implies that the value of an asset will be calculated by subtracting accumulated amortization and any impairment losses from historical cost. Whereas, revaluation model emphasizes the asset’s fair value less than any recent amortization or impairment losses.
The subsequent measurement of an intangible asset differs based on the classification under the useful life of an asset.
Measurement Of Intangible Assets With Finite Life
It works like the depreciation model. The cost of an intangible asset less its salvage value is periodically allocated as amortization of the investment.
The pattern of amortization should be self-explanatory of how a company gets to benefit from the item. If a reliable amortization method cannot be determined, the straight-line method will be used to amortize the asset.
Measurement Of Intangible Assets With Indefinite Life
The asset having no definite life will not be amortized as described under IAS 38.107. However, the management will be responsible for reviewing its useful life in every accounting period.
This analysis enables the company to keep on recording assets with indefinite life or to change the standard. Management is also responsible for the assessment of all intangibles for any deterioration or impairment.
The proper valuation and accounting treatment of intangible assets are very complex and difficult. Due to uncertainty about the future benefits of non-physical assets, the classification of useful life is made.
Intangible assets with indefinite value are not amortized and are also not recorded on the balance sheet. It is the reason why the goodwill of the company is not amortized.
Amortization is defined as the systematic allocation of an intangible over its useful life or projected life. An enterprise might amortize its non-physical assets for accounting purposes or tax purposes. The amortization method is different for both purposes.
Amortization of an intangible for tax purposes implies that it will be amortized over a specific number of years irrespective of actual useful life.
In tax law, amortization is defined as a cost-recovery system. When amortizing for tax purposes, business entities pro-rate the amortization monthly for the year of acquisition or selling.
However, the accounting purpose of amortization is compliance with the matching principle of accounting. It states that every expense should be recorded in the accounting period when it was incurred to generate revenues.
Therefore, business entities write off a part of intangible as annual amortization and charge it to an expense account.
What are the amortization method that are popularly use?
The amortization method is a way of spreading out the cost of an asset or a loan over a period of time. There are several popularly used methods of amortization, including:
- Straight-line amortization: This is the simplest method of amortization. The cost of the asset is divided equally over its useful life. For example, if a $10,000 asset has a useful life of 10 years, the straight-line amortization expense would be $1,000 per year.
- Declining balance amortization: This method involves applying a fixed percentage rate to the remaining balance of the asset or loan each period. This results in higher amortization expenses in the earlier years of the asset’s life and lower expenses in the later years.
- Sum-of-the-years-digits (SYD) amortization: This method involves adding up the digits of the years of the asset’s useful life to determine a denominator. Each year, the numerator is the number of years remaining in the asset’s useful life. This results in higher amortization expenses in the earlier years of the asset’s life and lower expenses in the later years.
- Units-of-production amortization: This method involves calculating amortization expense based on the asset’s usage. For example, if a machine has a useful life of 10,000 hours and is expected to produce 100,000 units, the amortization expense per unit would be determined by dividing the total cost of the asset by the expected number of units produced, and then multiplying that result by the number of units produced in the period.
Company A has acquired patents from company B that authorize company A to have exclusive right over intellectual property for the next 35 years. The cost of the patent was $350000. Now, company A will amortize its cost over 35 years with the amount of $10,000 annually.
Another example of an intangible asset is an internally generated patent after rigorous research and development. The cost of research and development will not be capitalized. Instead, it will be recorded as an expense.
The patent will be an intangible asset, but it will not appear on the business’s balance sheet.
What are the different between Intangible Assets and tangible assets?
The main difference between intangible assets and tangible assets is that tangible assets have physical substance and can be touched, while intangible assets do not have physical substance and cannot be touched. Here are some other differences between the two types of assets:
- Nature: Tangible assets are physical assets that can be seen and touched, such as buildings, land, vehicles, and equipment. Intangible assets, on the other hand, are non-physical assets that are derived from intellectual or legal rights, such as patents, copyrights, trademarks, and goodwill.
- Valuation: Tangible assets are typically valued based on their fair market value, which is the price that a willing buyer would pay for the asset in an arm’s length transaction. Intangible assets, however, can be more difficult to value, as their worth is often based on subjective factors such as customer loyalty or brand recognition.
- Depreciation: Tangible assets are subject to depreciation, which is the gradual decrease in value over time due to wear and tear or obsolescence. Intangible assets, on the other hand, are subject to amortization, which is the gradual decrease in value over time due to the expiration of legal or intellectual rights.
- Physical risk: Tangible assets are subject to physical risks such as damage from natural disasters, theft, and accidents. Intangible assets are not subject to physical risks, but may be subject to legal risks such as infringement of intellectual property rights.
- Transferability: Tangible assets are generally more easily transferable than intangible assets, as they can be physically moved from one location to another. Intangible assets, however, may require legal or regulatory approval to transfer ownership.
Overall, both tangible and intangible assets are important components of a company’s balance sheet, and their value contributes to the overall net worth of the company.
Intangible assets are vital for the business, and in some cases, they are the fuel of the business engine. The best example to prove this point is the Walt Disney Company.
The balance sheet of the company reports $103.5 billion in intangible assets and goodwill. So, even the assets are non-monetary, but they are way more valuable than any company’s monetary assets.