Intangible Assets are crucial to business, though you can’t touch it, it is very important for business owners. Let’s dive into what intangible assets are, how to calculate their fair value and how you can account for them in books.
What Intangible Assets Are?
Unlike tangible assets, intangible assets are owned by your business but they don’t have a physical presence or take up space.
Have you ever wondered what makes coca-cola famous? It is not only about the liquid inside the bottle, a huge chunk of their value comes from their name, logo, design of bottle and secret ingredient to make that liquid which is known as “brand value.”
According to IFRS, “An intangible asset is an identifiable non-monetary asset without physical substance. Such an asset is identifiable when it is separable, or when it arises from contractual or other legal rights.”
You can define intangible assets as “valuable resources of your business that don’t have any physical form but any assets that contribute to the value of your business and its success.”
What are the Types of Intangible Assets?
As these assets are absent physically, they come in two categories:
Identifiable Intangible Assets
Assets which have no physical presence in your business, but it provides a long-term value and can be acquired or separated from the company are known as Identifiable Intangible Assets. Usually these kinds of assets are generated from contractual agreements with other companies, or governments.
Examples of Identifiable Intangible Assets are:
Patent:
Imagine you invent a technology, then A patent grants you exclusive right to use, sell or manufacture it for a specific period of time. Patents prevent others from copying your technology which ultimately gives you a unique advantage. Example: A pharmaceutical company holding a patent of a life-saving drug.Trademarks:
Your company’s logo, brand name or even that catchy slogan is known as a trademark. Trademarks can be anything, a symbol, design or a phrase which is legally registered to represent your brand, products or services. Trademarks help your customers to easily identify your products or services and trust your products. Example: The logo of Apple, Google or Nike’s “Just Do It” slogan.Copyrights:
When your company creates some original artistic or literary works (like content of website, codes for the software, music, or write & published a book). Copyrights help you to protect these things from getting copied or distributed without your authorization. Example: Micorosoft having a copyright of Windows Software.Other examples of identifiable intangible assets are:
- Non-monetary government grants
- Airport landing rights
- Broadcasting licenses
- Proprietary data and algorithms
Unidentifiable Intangible Assets
Unidentifiable Intangible Assets can’t be sold, or separated from your business. They can only exist as a part of your business strategy like your goodwill with customers can be changed as you shift your business focus.
Examples of unidentifiable intangible assets are:
Goodwill:
When a company acquires another company at a higher price than its fair market value because of its identifiable intangible assets, then it is recognized as Goodwill. Example: If an established local bakery with a loyal customer base is acquired by a larger national chain, the premium price paid by larger national chain is for the bakery’s reputation and customer loyalty in the neighborhood, which will be recorded as goodwill. Check our guide on Goodwill here.Customer Relationship:
When your business has a strong relationship with your customer which is not based on any contractual agreement. The value of customer relationships lies in positive word-of-mouth and continued business.
While intangible assets lack physical form, tangible assets like Property, Plant and Equipment (PPE) are also important for businesses. So, understanding both types of assets can provide you a clear picture of a company’s resources.
Accounting for Intangible Assets
As intangible assets are classified as noncurrent assets (which provides benefit for more than a year) unlike current assets, it is also important to remember that some intangible assets can directly impact day-to-day business operations. Like, a strong brand reputation of a business can directly impact sales. Here’s is how we can account for these assets:
Initial Measurement of Intangible Assets
Not every intangible item is recognized as intangible assets. So, any expenditure made for intangible items, we can’t book them as assets, until those items meet the definition provided by IFRS (International Financial Reporting Standard) for intangible assets, which are:
- It is probable that in future items should provide economic benefits.
- The cost of those items can be reliably measured.
Once, we understood what we can book as intangible assets, It’s important to know that when a business initially acquires an intangible asset (either by purchasing it or developing it), it is always recorded on the balance sheet at cost.
Cost includes:
- Purchase price,
- Legal fees,
- Or any other expenses which are directly related to getting the asset ready for its use.
However, if intangible assets are generated internally, like a self-developed brand, these are not generally recorded in the balance sheet (while there are some exceptions like certain development costs).
Amortization of Intangible Assets
Just like tangible assets (except for land) which depreciate over a period of time, some intangible assets which have definite useful life will gradually lose their value. The process of allocating those costs over its useful life is called amortization.
Similar to methods of depreciation for tangible assets, there are different methods of amortization like:
- Straight-line method,
- Diminishing balance method,
- Units of production method.
To learn more, check out our article on Amortization.
Though, it is important to understand that not every intangible asset is amortized. For example, goodwill and trademarks with indefinite lives are not systematically amortized, instead they are tested for impairment.
Impairment of Intangible Assets
When a recoverable amount of an asset falls below its book value in the balance sheet, impairment occurs. If impairment occurs, the asset’s value should be written down, and impairment loss should be recognized in the income statement. It is important to regularly test the impairment and update the balance sheet so that it can accurately reflect their current economic worth.
Research and Development Costs of Intangible Assets
In business, Research and Development takes a huge amount of money, as it helps businesses to create new products, processes or knowledge which leads to generating valuable intangible assets. Generally, the costs which are incurred during the research phase are expenses immediately because the economic benefits from the future are uncertain. However, we can capitalize the cost incurred during the development phase if certain criteria are met, such as the technical feasibility of completing the asset and the intention or ability to use or sell can be shown.
Real World Examples of Intangible Assets
Here are some examples on how intangible assets play out in the real world of business:
| Intangible Asset Type | Example Scenario | Value / Benefit |
|---|---|---|
| Branding | A small local coffee shop has built a strong reputation among customers for its high-quality coffee and service. | This positive brand image (intangible asset) allows them to charge premium prices compared to competitors. |
| Technology | A small tech startup has developed a unique and efficient algorithm for data analysis. | The patent protecting this algorithm can become a valuable intangible asset, giving them an important competitive advantage in the market. |
| Customer Relationships | A consulting firm invests heavily in building strong relationships with its clients. | These relationships (often linked to goodwill) are intangible assets that lead to repeat business and get referrals from customers. |
How to Calculate Amortization of Intangible Assets on Patent?
Case 1
Tech Solutions Inc., a small software development company successfully applied and received a patent for a new algorithm on January 1, 2024. The directly attributable cost to obtain patent were:
- Legal Fees: $5000
- Government filing fees: $1000
Now, Tech Solutions estimates that the patent will give them an exclusive competitive advantage for the next 10 years. Assuming they are using the straight-line method for amortization.
Let’s calculate,
- What will be the carrying amount of the patent on December 31, 2024.
- What is the amortization expense for the year ended December 31, 2024.
- Show it in the Financial Statement of December 31, 2024.
Solutions
It is necessary to find the initial cost of obtaining a patent to find out the amortization expenses and carrying value, so let’s find out the initial cost by adding directly attributable cost.
Initial Cost = Legal Fees ($5000) + Government filing fees ($1000)
So, the initial cost of obtaining a patent is $6000.
Now, let’s find out amortization expense:
As we know Tech Solutions has estimated that the patent will give them an exclusive competitive advantage for next 10 years, so the patent’s useful life is 10 years, and suppose if they are using straight-line method:
Amortization expense = Initial Cost ($6000) / Useful life (10 Years)
So, the amortization expense of the patent is $600 per year.
As we already know the initial cost and amortization expense, let’s find out the carrying amount of the Patent.
Carrying Amount = initial Cost ($6000) – Accumulated Amortization ($600)
For the year ended December 31, 2024 the carrying amount of the Patent is $5400.
Now, let’s put them in the Financial Statement of Tech Solutions Inc.
| Items | Amount ($) |
|---|---|
| Income | |
| Sales | 5,000 |
| Total Income | 5,000 |
| Direct Expenses | |
| Amortization of Patent | 600 |
| Total Operating Expenses | 600 |
| Items | Amount ($) |
|---|---|
| Assets | |
| Noncurrent assets | |
| Intangible assets: | |
| Patent (Gross) | 6,000 |
| Less: Accumulated Amortization | (600) |
| Patent (Net) | 5,400 |
How to Calculate Impairment of Goodwill?
Case 2
Tech Solutions Inc, acquired a local marketing company (ABC Co.) on January 1, 2023. As part of the acquisition, they recorded goodwill of $20000. On December 31, 2024, due to increased competition and a decline in ABC Co.’s profitability, Tech Solutions Inc, performed an impairment test on the goodwill. The recoverable amount of goodwill was determined to be $15000.
Let’s find out:
- What is the impairment loss on goodwill that should be recognized for the year ended December 31, 2024?
- What will be the carrying amount of goodwill on December 31, 2024?
- Show it in the Financial Statement of Tech Solutions Inc.
Solutions
From the case given, we know that there was no other directly attributable cost on acquiring Goodwill, so the initial cost is $20000.
Also, the carrying amount of goodwill on December 31, 2024, before considering any impatient is still the initial cost recognized $20000 (as Goodwill is not amortized).
From the case above given, we also know that the recoverable amount of Goodwill is $15000. So, let’s find out;
Impairment Loss of Goodwill (as impairment loss is only recognized when the carrying amount of an asset exceeds its recoverable amount).
Impairment Loss = Carrying Amount ($20000) – Recoverable Amount ($15000)
So, the impairment loss of Goodwill is $5000.
Now, we know the impairment loss of goodwill, let’s find out the carrying amount of Goodwill after impairment (carrying amount of goodwill is reduced to its recoverable amount after recognizing the impairment loss).
Carrying amount after impairment = recoverable amount ($15000)
| Items | Amount ($) |
|---|---|
| Income | |
| Sales | 15,000 |
| Total Income | 15,000 |
| Direct Expenses | |
| Impairment of Loss on Goodwill | 5,000 |
| Total Operating Expenses | 5,000 |
| Items | Amount ($) |
|---|---|
| Assets | |
| Noncurrent assets | |
| Intangible assets: | |
| Goodwill | 15,000 |