Characteristics of Intangible Assets

Intangible Assets

Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, and are created through time and effort. Intangible assets are identified separately on a company's financial statements, and come in two primary forms: legal intangibles and competitive intangibles.

Legal intangibles are also known as intellectual property, and include trade secrets, copyrights, patents, and trademarks. An example would be Coca-Cola's drink formula which is a closely held trade secret that only a few employees know; this is an example of an internally developed intangible asset.

Coca-Cola

The year 1950 ushered in an era marked by the consolidation of large companies.

Competitive intangibles include collaboration, leverage, structural activities, and customer loyalty. Human capital is the primary source of competitive intangibles.

Goodwill

Goodwill is technically an intangible asset, but is usually listed separately on a company's balance sheet. Goodwill is only recognized through an acquisition of a company or business combination and is calculated as the difference between the amount of money paid to acquire a company and the fair or book value of the acquired company's net assets. Goodwill is a type of intangible asset that is acquired and recorded due to a business acquisition or combination rather unlike other intangible assets, which may be internally developed by the company.

Example

Company $X$ is a car dealership with assets consisting of 10 cars valued at $100,000, an office valued at $150,000, and long-term debt valued at $25,000. Company $X$'s net assets total $$100,000 + $150,000 - $25,000 = $225,000$. Company $X$ has a top-performing sales personnel who are loyal to the company and refuse to leave. Company $Y$ is a larger car dealership in the area and decides to purchase Company $X$ for $300,000 in order to capitalize on Company $X$'s sales force. The extra $$300,000 - $225,000 = $75,000$ that Company $Y$ paid above Company $X$'s net assets are recognized by Company $Y$ as Goodwill on their balance sheet.

Useful Lives

Intangible assets have a useful life that is either identifiable or indefinite. Intangible assets with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, which ever is shorter. Intangible assets with indefinite useful lives are assessed each year for impairment. Impairment losses are determined by subtracting the asset's market value from the asset's book/carrying value. If an impairment loss is found it is recognized on the income statement and the intangible asset value is reduced.

Under US GAAP, intangible assets are classified into: Purchased vs. Internally Created Intangibles, and Limited-Life vs. Indefinite-Life Intangibles.

Financial Statement Recognition

Firms initially record intangible assets at cost, however only costs associated with the outright purchase in the acquisition of an intangible asset. Research and development costs incurred during the internal development or self-creation of an intangible asset are not costs that can be capitalized. This then means that some companies have very valuable assets that they are not allowed to recognize on their balance sheets under US GAAP.