Long-term assets that lack a physical substance
Long-term assets that lack a physical substance
According to the IFRS, intangible assets are identifiable, non-monetary assets without physical substance. Like all assets, intangible assets are those that are expected to generate economic returns for the company in the future. As a long-term asset, this expectation is supposed to last for more than one year or one operating cycle.
Intangible assets, however, lack a physical substance like other assets such as inventory and equipment. They form the other largest category of long-term assets, other than PP&E. They can be separated into two classes. They are identifiable and non-identifiable.
Identifiable, intangible assets are those that can be separated on its own and can even be sold by the company. These are such assets as intellectual property, patents, copyrights, trademarks, and trade names. Software and other computer-related assets outside of the hardware also classify as identifiable intangible assets.
Unidentifiable, intangible assets are those that cannot be physically separated from the company, or do not have physical substance. The most predominant unidentifiable, intangible assets are goodwill. Internally generated goodwill is expensed as a loss, but externally generated goodwill when a company acquires or merges 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 but is instead tested for impairment regularly. A company will take on an impairment loss if it deems the goodwill’s value is not as high as it’s 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. This branding is 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 straight-line expense.
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 costs, it is considered perpetual and is also not amortized.
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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, upon which it expires. However, the trademark can be renewed at marginal costs. 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 with straight-line over its 50-year life. Amortization expense is $25,000,000 / 50 = $500,000. Thus, the yearly amortization expense for McRonald’s is $500,000.
Referring to the 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 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 the 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, $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 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, these grants may need to be refunded by the company. Government grants also include forgivable loans in situations where companies meet certain conditions and the loan does not need to be repaid. In terms of recognition, government grants should be recognized only if: