An element or resource that is not physical but assigns a considerable value to a company is called an intangible asset.
Besides this definition, this post offers insights in:
- Description of Intangible asset
- Difference between Tangible and Intangible assets
- Types of Intangible assets
- Characteristics of Intangible assets
- How to value intangible assets
- Amortization of intangible assets
- Identifying intangible assets
What are Intangible Assets?
A non-physical asset that has a continuing and long-lasting value for a business is an intangible asset. Companies can either create or acquire them. The intangible assets do not have a recorded book value, nor do they appear on the balance sheet.
IFRS defines intangible assets as identifiable and non-financial assets that do not have a physical form. Just as other assets, intangible assets are set to create avenues for better economic returns in the future. An e.g would be brand awareness.
Intangible assets can be considered long-term assets and expected to generate returns for over a year or over multiple accounting cycles. Intangible assets are the second-largest type of long-term assets, the largest being PP&E (Property, Plant, and Equipment).
Difference Between Tangible and Intangible Assets
In contrast to the concept of intangible assets seen in the previous section, tangible assets have a physical presence. They can be measured and used in the company’s operations. The PP&E is a type of tangible asset, more specifically a fixed asset.
There are two types of tangible assets:
- Current assets: These types of assets can be sold off in times of emergencies to raise cash. Examples include marketable securities, cash, and inventory.
- Fixed assets: These are the non-current assets that have been in use for over a year by the company. The amount produced using tangible assets is listed as revenue on the income statement. Machinery, office furniture are some of the examples under this category.
Here’s a table to understand the differences better:
The examples of the two types can be segregated as shown in the following table:
What are the Types of Intangible Assets?
This section elucidates the types of intangible assets. They can be broadly classified as Identifiable and Unidentifiable.
- Identifiable intangible assets: These are the assets that can be physically separated from the other assets. A company can even sell them to other businesses or customers.
Examples: Trademarks, copyrights, patents, trade names are examples of identifiable intangible assets.
- Unidentifiable intangible assets: These assets cannot be physically identified or cannot be physically separated from the organization.
Examples: A company’s goodwill is a common example under this category. It may not be considered an asset within the company, but its goodwill provides it with a significant value if the company opts for a merger or acquisition. Another important example is the branding and reputation of a company.
Here is a table that comprehensively summarizes all the different types of intangible assets:
What are the Characteristics of Intangible Assets?
The intangible assets have been attributed certain features by the IAS 38. Some major characteristics of intangible assets are as follows:
- Identification or identifiability: An intangible asset can be termed identifiable when it can be separated for selling, renting, or licensing. It can also be called identifiable when it emanates from contractual or legal rights irrespective of the entity’s conditions of transferability or separability.
- Control: The company controls the intangible assets. This is to say that the company should have the authority to achieve the future flow of economic benefits.
- Acquisition: The intangible assets can either be internally created or acquired by the company.
- Economic benefits in the future: An asset must bring future economic benefits in several ways, including selling, costing, etc.
How do you Value Intangible Assets?
The value of intangible assignments, volatility, ongoing development, and protection and enforcement problems have to be evaluated. Knowledgeable business analysts have independently assessed intangible assets for years.
It is vital to get the answers to these questions before the valuation of the intangible assets:
- What would a ready buyer pay to use the inventory?
- What is this asset's useful life?
- How much of this asset generates operating income?
That said, there could be various methods to carry out the valuation. While one method might be good to value one kind of intangible asset, the same method may not work for the other asset. However, there are common elements that work for all valuation assignments. These are:
- Understanding the intangible assets: Intellectual property, brand names, client lists, and sometimes non-compete agreements are the principal intangible assets of an enterprise. These assets can sometimes be grouped under "goodwill", but in fact, they are distinct. Usually, when a company acquires another company or when a specific intangible asset is purchased separately, they appear on the balance sheet.
- Getting an expert on board: It is always wise to get an expert to review and establish the enterprise’s value. With their insights, you could help avoid disputes in the future. So, a credible professional with enough experience could pave the way forward for valuation.
- Get a grip of the process: While selling, the evaluator has to establish a value for the entire organization including the intangible assets. EBITDA - Earnings Before Interests, Tax, Depreciation, Amortization is a commonly used technique for assessing a company’s proficiency to create income. The net assets are subtracted from the total business value on the balance sheet to establish a value. What remains is the goodwill that could is fragmented into other elements such as intellectual property, customer list, etc.
Fundamentally, this means that it is essential to understand the process.
- Specific Valuation: This could be done through any of the methods here:
- Excess earnings method: Valuators predict the after-tax cash flow expected from the company. This is the most rigorous but also the most accurate method.
- Relief from Royalty method: In this method, the valuator assesses the expected revenue from the company and then applies the royalty rate and subtracts taxes.
- Cost method: This method requires the valuators to estimate the cost to develop the asset and the ROI. It is usually used when the other two are not applicable.
Why are Intangible Assets Hard to Value?
It can be difficult to price intangible assets. The technology to properly assess the value may not be adept enough. It becomes tough to gauge the revenue it can make or the competitive advantages it can offer to its owners in such a case. An expert can step in to ease and expedite the matter. Although there are no fixed procedures to evaluate the assets, these are certain factors worthy of attention:
- The relevance the intangible asset holds in the company.
- The amount of revenue, net sales or cost savings derived from the asset.
- The economic value of the asset.
- Competitive alternatives they provide.
The organizations must assess these factors which help them determine the value of the assets. The IRS and the valuation experts have to focus on these factors to adopt a method to evaluate the assets confidently.
Apart from this, an intangible asset that may seem to generate a lower value may come as a surprise when appropriately appraised by a valuation expert. Otherwise, underestimating their value could prove to be an expensive error. Patents and trademarks are examples that represent an unestablished source of income. Underestimating their price could affect the entire system of the business.
Therefore, the valuation of intangible assets requires a careful and systematic mechanism.
How do you Amortize Intangible Assets?
Patents, trademarks, and other intangible assets are amortized into an expense account whereas the tangible assets are depreciated. To understand the process of amortization of intangible assets, let’s look at the definition of Amortization.
What is Amortization?
The process of disbursing the cost of an intangible asset for its estimated or expected life for the accounting purpose is called Amortization.
The cost of an intangible asset, irrespective of its actual lifetime, is amortized for tax purposes over a specific number of years. The amortization deductible for tax purposes is calculated every month for the years in which the property is either acquired or sold. The amortization is to be reported through IRS Form 4562.
Find out the details of Form 4562 here.
How do you Amortize?
This section brings forth the methods to carry out amortization.
IAS 38 lays out the rules to amortize intangible assets. These are:
- Despite acquiring the requisite intangible asset, the amortization should begin only when the asset is brought into actual use and not before that.
- The level amortization should be suitable to get the correct book value of the asset.
The amortization method used should be proportionate to the use of the asset. In the case where no method can be determined, the asset shall be amortized directly through the straight-line method.
After glancing through the guidelines, let’s take a look at the amortization methods.
Revenue-based Amortization: The purpose of revenue-based amortization is to amortize the intangible assets in keeping with its revenue contributions, which results in a variable amortization schedule. The IAS 38 maintains that it is difficult to measure the revenue contribution of an intangible. Therefore, it recommends the straight-line method instead.
Indefinite Life Assets: Assets with indefinite life need to be amortized differently from the finite ones. They are evaluated for their deterioration each year. If deterioration is observed, then its usefulness is estimated and it is amortized for the remainder of its utility.
Straight-Line Method: This method amortizes the asset value to zero or the residual value. Its formula is:
How can you Identify an Intangible Asset?
When you proceed towards potential buyers, you also want to know the value your company holds for them. You need to identify the specific features that could add a sizable value beyond the company’s economic value. Identifying these would be synonymous with identifying the intangible assets of your company.
IAS 38 sets the guidelines for measuring and identifying intangible assets. According to these guidelines, an asset that is an identifiable non-monetary asset without a physical presence is an intangible asset. This sort of asset is identifiable when it can be separated or when it arises from legal rights. A company can sell off the separable assets. They can also be licensed and transferred.
Let’s look at how we could proceed with identifying the intangible assets.
Dividing the intangible assets into 6 classes as :
- Marketing and
Technology: If an enterprise buys a patent from the creator, we know that capitalized cost includes the purchase price along with any other fees or charges incurred in its acquisition. Patents make up a huge chunk of technology as an intangible asset. The cost for the internally developed patents is not capitalized but is reported as expenses in the statement.
Artistic-related intangibles: This includes copyrights of the original work by an author, artist, musician. The original composer or author can protect his rights to his poems, books, music, lyrics, or any recorded work. No other person or company can claim or use this original piece.
Companies capitalize the price for a copyright acquisition plus the cost to protect it from plagiarism. These costs are allocated to the useful life of the copyrights.
Contract-based intangibles: Licenses, permits, and franchise agreements come under this category of contract-related assets. Permits and licenses are often obtained from government bodies. The companies get these licenses for accessing the rights to operate. When the company is capable of paying the minimum guarantee for these rights or permits, this amount becomes an intangible asset. It is then placed in the balance sheet till the permit period lasts.
An example could be securing rights for the use of an area as a cab stand.
Customer-related intangibles: You must have received numerous calls for a credit card offer. This happens when your information, just like that of other customers, has been bought or sold by a company. Needless to say, customer information is a lucrative tangible asset for companies. That brings us to ask how the accounting is done for this asset. You can do this by figuring out the useful life of the customer list and if you’ll be able to sell it in the future. Simply put, you have to inspect if there is a residual value attached to the list.
Marketing: Anything that promotes the goods or services of a company is its marketing-related intangible asset. The logos, trademarks, signs, and symbols all come under this label. Companies capitalize the price of a trademark when they purchase it from another company. If they develop the trademark internally then all the costs related to its development and research are capitalized.
Goodwill: It can be defined as a company’s brand value, its good relations with its employees and customers, along with all the proprietary products. Goodwill is considered an intangible asset as it accounts for the purchase price of a company by the other. The organizations assess the value of goodwill each year on the financial statements. It differs from the other intangible assets in the way that it can have an indefinite useful life.
Dividing the assets into these categories will help you identify the intangible assets easily.
And that is a wrap. From this article, we can take away the following points:
- Intangible assets are assets without a physical nature but assign a considerable value to the enterprise.
- Tangible assets are the ones that have a physical form.
- Excess earnings method, Relief from Royalty method, and Cost Method are the methods through which valuation of the intangible assets is done.
- Tangible assets are depreciated whereas intangible assets are amortized.
- Revenue-based Amortization, Indefinite Life Assets, and Straight-Line Method are the amortization methods.
With Deskera, you can easily keep track of tangible and intangible assets, and manage fixed asset accounting to ensure your books are always in order.