Intangible Assets

An intangible asset is an asset that lacks physical substance. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names, as well as software. This is in contrast to physical assets (machinery, buildings, etc.) and financial assets (government securities, etc.). An intangible asset is usually very difficult to evaluate. They suffer from typical market failures of non-rivalry and non-excludability.

Intangibles can be acquired:

• By separate purchase
• As part of a business combination
• By a government grant
• By exchange of assets
• By self-creation (internal generation)

Financial accounting

General standards

The International Accounting Standards Board (IASB) offers some guidance (IAS 38) as to how intangible assets should be accounted for in financial statements. In general, legal intangibles that are developed internally are not recognized and legal intangibles that are purchased from third parties are recognized. Wordings are similar to IAS 9.

Under US GAAP, intangible assets are classified into: Purchased vs. internally created intangibles, and Limited-life vs. indefinite-life intangibles.

Expense allocation

Intangible assets are typically expensed according to their respective life expectancy. Intangible assets have either an identifiable or an indefinite useful life. Intangible assets with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, whichever is shorter. Examples of intangible assets with identifiable useful lives are copyrights and patents. Intangible assets with indefinite useful lives are reassessed each year for impairment. If an impairment has occurred, then a loss must be recognized. An impairment loss is determined by subtracting the asset’s fair value from the asset’s book/carrying value. Trademarks and goodwill are examples of intangible assets with indefinite useful lives. Goodwill has to be tested for impairment rather than amortized. If impaired, goodwill is reduced and loss is recognized in the Income statement.

Intangible asset: an identifiable non-monetary asset without physical substance. An asset is a resource that is controlled by the entity as a result of past events (for example, purchase or self-creation) and from which future economic benefits (inflows of cash or other assets) are expected. Thus, the three critical attributes of an intangible asset are:

Identifiability control (power to obtain benefits from the asset) future economic benefits (such as revenues or reduced future costs)

Identifiability: an intangible asset is identifiable when it:

• Is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract).
• Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

Recognition

Recognition criteria. IAS 38 requires an entity to recognise an intangible asset, whether purchased or self-created (at cost) if, and only if:

• It is probable that the future economic benefits that are attributable to the asset will flow to the entity.
• The cost of the asset can be measured reliably.

Types

Businesses have many different types of intangible assets. Many of these can be unique to a specific business, making it very hard to compile a comprehensive list of intangible assets. However, some of the more common types include:

• Patents, copyrights and licenses
• Customer lists and relationships
• Non-compete agreements
• Favorable financing
• Software
• Trained and assembled workforces
• Contracts
• Leasehold interests
• Unpatented proprietary technology
• Trademarks/Trade names

Research and Development

Research is a planned and detailed investigation into a product or service for gaining scientific or technical know-how. Development is the application of such researches to develop new and better products and service than the current portfolio a company has.

R&D is a part of internally generated intangible assets of a company. Companies spend millions of dollars on R&D and hence, it is a valuable intangible asset capable of taking a company to new heights.

Franchise Agreements

Franchise agreements are another type of intangible asset that grants the legal right to a business to operate using the name of another company or sell a product or service developed by another company. These are classified as assets because the business owners reap monetary gains with the help of these intangible assets.

For example, many fast food restaurants like KFC, McDonald’s, Subway, Dominos, etc. operate using a franchise system. Here the franchisor grants varying amount of autonomy to the franchisees to use the brand name and benefit from franchisor’s extensive marketing.

Licenses

A licensor can permit a licensee to use a trademark, patent, or copyright through a license in exchange for a fee or a charge. Such licenses usually have fixed time validity, and may even set geographical validity or restrictions. Intellectual property licensing, such as transfer of technology, franchising, and publication rights, are very important in present-day business. Violation of the license terms by the licensee or a third-party is also a punishable offense under the law.

Trademarks

A trademark is an intangible asset which legally prevents others from using a business’s name, logo or other branding items. It is a design, symbol or a logo used in connection with a particular product or a business.

Copyrights

Copyright grants an extensive right to the business to reproduce and sell a software, book, journal, magazine, etc. It is an intangible asset used to secure legal protection by preventing others from reproducing or publishing a work of authorship.

Patents

A patent is a type of intangible asset that grants a business the exclusive right to manufacture, sell or use a specific invention. A company can purchase the patent from another company or it can invent a new product and receive a patent for it.