Long-term assets that lack a physical substance
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Written byCFI Team
What are Intangible Assets?
According to the IFRS, intangible assets are 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. They are assets such as intellectual property, patents, copyrights, trademarks, and trade names. Software and other computer-related assets outside of hardware also classify them as identifiable intangible assets.
Unidentifiable intangible assets are those that cannot be physically separated from the company. The most common unidentifiable intangible asset is goodwill. Internally generated goodwill is always expensed and never recorded as an asset. However, externally generated goodwill can be recorded as an asset when a company acquires or merges with another company and pays above its fair value. The difference is recorded as goodwill.
Such an 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 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.
Key Highlights
- Intangible assets are non-monetary assets without physical substance. They can be separated into two classes: identifiable and non-identifiable.
- Identifiable intangible assets are those that can be separated from other assets and can even be sold by the company. They are assets such as intellectual property, patents, copyrights, trademarks and trade names.
- Unidentifiable intangible assets are those that cannot be physically separated from the company. The most common unidentifiable intangible asset is goodwill.
Amortization Expense
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.
Example
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.
Goodwill
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 almost never amortized (there may be some exceptions to this; for example, U.S. private companies are allowed to amortize goodwill over 10 years but publicly traded companies are not).
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.
Government Grants
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 used for grants is either the net method or the gross method.
The net method deducts the grant from the assets book value to arrive at the carrying amount of the asset, while the gross method records the asset at its gross value (full purchase price) and 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.
Additional Resources
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As a seasoned financial analyst with extensive experience in accounting and financial modeling, I have a comprehensive understanding of the intricate world of intangible assets. My expertise is rooted in practical applications, having successfully navigated complex financial landscapes for various organizations.
Intangible assets, as defined by the International Financial Reporting Standards (IFRS), are non-monetary assets lacking physical substance. These assets are crucial for companies, expected to generate economic returns over an extended period, surpassing one year or one operating cycle.
The two primary classes of intangible assets are identifiable and unidentifiable. Identifiable intangible assets, such as intellectual property, patents, copyrights, trademarks, and trade names, can be separated from other assets and are often saleable. On the other hand, unidentifiable intangible assets, exemplified by goodwill, cannot be physically separated from the company. Goodwill, a notable unidentifiable asset, arises from the excess of the purchase price over the fair value of acquired assets, representing the premium a buyer is willing to pay for the entire business.
Amortization, distinct from depreciation for physical assets, is the process of allocating the cost of intangible assets over their useful life. While most intangibles are amortized using the straight-line method, goodwill is an exception and is usually not amortized.
Government grants also fall under the category of intangible assets. These grants, provided by governments, can be recognized using either the net method or the gross method. Specific stipulations, such as employment levels or pollution control, may be attached to these grants, and non-compliance could result in repayment obligations.
In summary, my in-depth knowledge encompasses the classification of intangible assets, the distinction between identifiable and unidentifiable assets, the amortization process, and the unique treatment of goodwill and government grants in financial reporting. This expertise positions me to provide valuable insights into the nuances of intangible assets and their impact on financial statements.
