What are Intangible Assets?
According to the IFRS, intangible assets are identifiable, non-monetary assets without physical substance. Like all assets, intangible assets are expected to generate economic returns for the company in the future. As a long-term asset, this expectation extends for more than one year or one operating cycle.
Intangible assets lack a physical substance like other assets such as inventory and equipment. They form the second largest category of long-term assets, behind number one – PP&E. They can be separated into two classes: identifiable and non-identifiable.
Identifiable and Unidentifiable Intangible Assets
Identifiable intangible assets are those that can be separated from other assets and can even be sold by the company. These are assets such as intellectual property, patents, copyrights, trademarks, and trade names. Software and other computer-related assets outside of hardware also classify as identifiable intangible assets.
Unidentifiable intangible assets are those that cannot be physically separated from the company. The most commonplace unidentifiable intangible asset is goodwill. Internally generated goodwill is expensed as a loss, but externally generated goodwill when a company acquires or merges with another company is capitalized as an asset. This means that when a company pays above the fair value of another company to acquire it, the difference is goodwill. This asset is not depreciated like PP&E. However, it is instead tested for impairment regularly. A company will record an impairment loss if it deems the goodwill’s value has decreased from its recorded book value.
Another key unidentifiable asset is branding and reputation. While a company can sell its trademark, logos, and such, it can be very difficult to separate good branding and reputation from a strong company. Nonetheless, brand recognition and reputation are expected to generate good economic returns for the company in the future.
While PP&E is depreciated, intangible assets are amortized (except for goodwill). These assets are amortized over the useful life of the asset. Generally, intangible assets are simply amortized using the straight-line expense method.
If an intangible asset has a perpetual life, it is not amortized. Consequently, if an intangible asset has a useful life but can be renewed easily and without substantial cost, it is considered perpetual and is not amortized.
McRonald’s has two intangible assets. The first is a patent worth $25,000,000 and with a useful life of 50 years. The patent expires and cannot be renewed. The second is a trademark worth $1,000,000 and with a useful life of 10 years, after which it expires. However, the trademark can be renewed at a marginal cost. What is McRonald’s amortization expense per year?
The trademark is not amortized, as it virtually has a perpetual life. The patent, however, is amortized on the straight-line scale over its 50-year life. The amortization expense is $25,000,000 / 50 = $500,000. Thus, the yearly amortization expense for McRonald’s is $500,000.
Referring to the identifiable intangible asset definition mentioned earlier, goodwill does not meet the IFRS definition, as it is not identifiable/not separable. However, goodwill is still an intangible asset, treated as a separate class. The main difference concerning goodwill, as compared to other intangibles, is that goodwill is never amortized. In accounting, goodwill represents the difference between the purchase price of a business and the fair value of its assets, net of liabilities.
What this essentially means is the difference represents how much the buyer is willing to pay for the business as a whole, over and above the value of its individual assets alone. For example, if XYZ Company paid $50 million to acquire a sporting goods business and $10 million was the value of its assets net of liabilities, then $40 million would be goodwill. Companies can only have goodwill on their balance sheets if they have acquired another business.
Finally, another type of intangible asset is government grants. For several reasons, governments at all levels may choose to provide financial assistance to companies that engage in certain activities. The accounting treatment for grants involves two methods: the net method and the gross method. The net method deducts the grant to arrive at the carrying amount of the asset, while the gross method sets up the grant as deferred income.
Government grants may be in the form of a specific grant that includes specific requirements/stipulations such as employment levels or pollution control levels. If these stipulations are not met, then the grants may need to be refunded by the company. Government grants may also include forgivable loans in situations where companies meet certain conditions. As the name implies, the loan does not need to be repaid. In terms of recognition, government grants should be recognized only if:
- The entity will comply with the stipulations/requirements attached to them; and
- The grants will actually be received.
Thank you for reading CFI’s explanation of intangible assets. To further your financial education, CFI suggests the following resources: