Intangible Assets
Intangible assets are nonphysical resources controlled by a company or individual that hold economic value. Defined by the International Accounting Standards Board (IASB), these assets include items like goodwill, software, licensing agreements, patents, and technological innovations. Unlike tangible assets, such as equipment or real estate, intangible assets do not have physical substance but can be identified and transferred, contributing to a company's future economic benefits. Their valuation is complex, often depending on whether they were purchased or internally generated, and whether they have a limited or indefinite useful life.
Accounting for intangible assets typically involves treating expenditures on them as capital investments, rather than deductible expenses. This is due to their role in generating revenue over multiple years. Intangible assets fall into various categories, including artistic, contract-based, technology-based, marketing-related, and customer-related assets. Each type has specific characteristics regarding ownership, legal rights, and potential for revenue generation, impacting how they are recorded and valued in financial statements. Overall, intangible assets play a crucial role in business operations, influencing sales, acquisitions, and overall company valuation.
Intangible Assets
In accounting, an asset is the term used for any financial resource controlled by a company or individual. A company’s assets fall into two broad categories, tangible and intangible assets. Tangible assets are physical properties, including real estate, equipment, monetary holdings, and staff. The International Accounting Standards Board (IASB) defines an intangible asset as "an identifiable nonmonetary asset without physical substance." Intangible assets include consumer reputation or goodwill, software, licensing agreements, technological concepts, and patents. A concept, idea, or nonphysical resource is only considered an asset when it can, in concept, be transferred to another individual or company.
Intangible assets are an important part of business accounting, in that the sale and transfer of businesses often depends on the ability to evaluate relevant intangible assets. In general, intangible assets are difficult to quantify because the monetary value of intangible assets can be difficult to assess. Accounting for intangible assets differs according to whether the asset was purchased or internally generated, and whether the asset has limited or indefinite value for the company.
Defining Intangible Assets
The IASB, founded in 2001, is an independent organization that generates and publishes information on accounting standards. The IASB defines intangible assets in their annual publication of national and international standards under International Accounting Standard (IAS) 38, which defines intangible assets as nonmonetary resources without physical substance.
In accounting, a resource must meet certain requirements to be considered an asset. Assets are resources that are "identifiable," meaning that they can be separated from other facets of the business. Assets must be transferrable such that they represent a part of the business that could, in theory, be sold to another party. Assets must also be controlled by the business or entity claiming the asset. For instance, a computer program used solely by one company or entity may be claimed as an asset, but a computer program used widely by a variety of different companies in the same industry may not qualify. In addition, a resource only qualifies as an asset if it implies future economic benefit, such as increased revenue or a reduction in costs.
Intangible assets may be tested through "recognition," meaning that the resource, whether created or purchased, must be reasonably expected to create economic benefits to the entity claiming ownership and that the cost of the resource can be measured. If a company cannot estimate the cost of a resource, or cannot specify how the resource can earn revenues for the company, the resource may not be recognized as an asset for the purpose of accounting.
All intangible assets have "conceptual" properties, meaning that they relate to the ownership of an idea, concept, or creative product seen as conferring financial advantage. Some intangible assets are linked to physical assets. For instance, ownership of music and films are considered intangible, though the physical media on which the film or musical program is stored is part of an entity’s tangible assets.
Taxation and Allocation
While expenditures on tangible assets may be deductible for the purposes of taxation, meaning that a person or company can subtract the amount spent on the asset before calculating income for a given period, spending on intangible assets is typically not deductible. Intangible assets are related to future revenue, and therefore contribute to the business’s capital investment. Therefore, accounting standards require that expenditures on intangible assets, whether on maintaining or developing assets, should be treated as capital expenditures. In general, expenditures on assets that will provide revenues for a period greater than one year are classified as capital rather than deductible expenditures.
Most types of intangible assets are also subject to amortization, which is a process of accounting for expenditures by spreading out the costs over a certain period. Trademarks, for instance, are amortized over a period of fifteen years. Some portion of an entity’s expenditures on intangible assets may be deductible. For instance, in starting a new company, organizational expenditures are made for initial legal documents, copyrights, and promotion. A portion of this cost can be deducted in the initial year, with the rest amortized over fifteen years.
Some intangible assets have an identifiable legal life, such as the legal period of a copyright or other intellectual property. Other assets, such as franchise rights, customer goodwill, and reputation, have indefinite life expectancies; meaning that it is unknown how long a company can earn revenues from control of the resource. In the case of indefinite assets, expenditures on the asset are reassessed each year rather than amortized over a specific period. If an asset is considered to have become a financial drain or liability, it is classified as an impairment for accounting purposes.
Artistic Assets
Intellectual property that results in nonphysical artistic products are generally classified as intangible assets, including films, television, literature, and music. Similarly, licensing and royalty rights to artistic materials are also qualified as intangible assets.
A copyright is a grant, issued through the federal government, giving the owner exclusive rights to publish, sell, or otherwise control literary or artistic products during the life of the creator, plus an additional seventy years. Companies can capitalize, rather than deduct, the cost needed to acquire or defend copyrights or intellectual property ownership.
Contract-Based Assets
Contract-based assets include resources that result from a contract that can be transferred. For instance, royalty agreements, which allow an entity to receive revenues from the sale of intellectual artistic property, and licensing agreements, which permit the distribution, reproduction, and sale of artistic properties, are contract-based assets. Another common type of contract-based asset is a franchise, in which a company sells the right to sell certain products or provide services using the company’s trademarked name, logos, and other representations. Franchises are locally owned and operated, but must pay a portion of their revenues to the franchise creator.
Other examples of contract-based assets include use rights and rental agreements. A rental property contract, for instance, may contribute to a company’s value by guaranteeing access, for a specified period, to a location or a customer population. Construction permits and local/federal permits are other types of contracts that can be listed among a company’s assets.
Technology-Based Assets
Technology-based assets include patents on inventions, computer software, databases, and intellectual technology. Recipes for food or chemical formulas, and instructions for physical processes can also be considered technology-based assets. To earn revenues from these assets, companies may acquire patents, which are permits issued by the government giving an entity exclusive right to manufacture, sell, or use a certain invention.
Patents are not renewable, and are generally considered to have a useful life of fifteen or twenty years. Patents can therefore be amortized over that same period. Companies can also capitalize on efforts to legally defend one of the company’s patents, or to guarantee exclusivity of manufacture or production.
Marketing-Related Assets
Marketing-related assets are resources that are used to promote a company. Company logos and trademarks are among the most common types of marketing-related assets. Trademarks are words, names, phrases, or symbols that identify a company. Logos are images, which may or may not contain text, used to advertise a business. Trademarks are registered with the US Patent and Trademark office and become part of a company’s intellectual property. Trademarks and logos must be renewed every ten years, but are indefinitely renewable so long as the trademark is continuously used.
Expenditures used to develop advertising strategies and Internet services are also intangible assets. Companies purchasing and maintaining web domains, domain names, and websites can count these expenditures among their intangible assets. As website ownership has become increasingly important in modern business, companies have invested considerably in purchasing domain names for specific websites. For instance, in 2010, the social media company Facebook paid $8.5 million to acquire control of the domain name FB.com.
Customer-Related Assets
Companies may also claim aspects of their business related to customer relations as part of the company’s intangible assets. One form of customer-related assets are customer lists or databases of customer identities and preferences purchased by some companies to help in building a customer base. The sale of customer lists is a standard practice in many industries, but is sometimes considered controversial as it may violate privacy.
Another type of customer-related asset is goodwill, which is an estimated measurement of company’s reputation and relationship with customers. If a company has a demonstrable reputation for good service, competitive pricing, or community involvement, these aspects of the company’s history can constitute goodwill between the company and its customer base. Goodwill is unidentifiable because it cannot be independently assessed, quantified, or transferred. Goodwill is tied to the company’s identity, and the sale of a company therefore necessarily affects goodwill in as far as customers are aware that there has been a management change. Measuring and accounting for goodwill is problematic and difficult, but many businesses calculate sale price or company value based in part on goodwill within a certain community or customer base.
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