Intangible assets: A comprehensive guide for accountants

Intangible assets such as patents, copyrights, trademarks, and intellectual property are increasingly critical for a company's success. However, accounting for these assets can be challenging, impacting financial statements and investor trust. This article delves into the intricacies of recognizing, measuring, and disclosing intangible assets, addressing potential pitfalls accountants may face, and offering practical solutions.

What are intangible assets?

Intangible assets are assets that lack a tangible presence but hold significant value for businesses. These assets are often intellectual or legal rights and include items such as patents, copyrights, trademarks, goodwill, and proprietary knowledge. 

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Why are intangible assets important?

Intangible assets are crucial for companies looking to gain a competitive edge, protect their innovations, and establish brand recognition. Intangible assets may also affect a company's financial health, influencing its valuation, revenue streams, and market positioning.¹ Understanding and managing these assets effectively can be the key to long-term success.

How do intangible assets work?

Intangible assets work by providing businesses with exclusive rights, competitive advantages, and revenue-generating opportunities. For example, a patent grants the owner a monopoly on a particular invention, allowing them to profit from its use or licensing. Trademarks and copyrights protect brand identity and creative works, respectively, safeguarding a company's reputation and revenue streams. Goodwill represents the intangible value associated with customer loyalty and brand recognition, often resulting in increased sales and market share.

Benefits of intangible assets

Intangible assets offer several benefits to businesses, contributing to their competitive advantage, growth, and long-term success. 

• Competitive advantage: Intangible assets can set a company apart from competitors by providing unique products, services, or brand recognition.
• Revenue generation: Licensing and royalties from intangible assets can create additional revenue streams.
• Enhanced valuation: Intangible assets may significantly increase a company's overall value, attracting investors and stakeholders.
• Longevity:  Some intangible assets, like brand reputation, can endure for years, contributing to a company's sustainability.²

Downsides to intangible assets

While intangible assets offer numerous advantages, they come with certain challenges and potential disadvantages.

• Valuation complexity: Determining the accurate value of intangible assets can be complex and subjective.
• Risk of obsolescence: Rapid technological advancements can lead to the obsolescence of certain intangible assets.³
• Dependence on talent: Some intangible assets, like proprietary knowledge, depend on specific individuals, posing a risk if they leave the organization.

Examples of intangible assets

When it comes to intangible assets, there's an array of examples.

Intellectual property

• Patents: Exclusive rights to an invention.
• Trademarks: Distinctive symbols or logos.
• Copyrights: Protection for creative works like books, music, and software.

Brand-related assets

• Goodwill: The reputation and customer loyalty a company has built over time.
• Trade Secrets: Proprietary information, like recipes or manufacturing processes.

Customer-related assets

• Customer lists: Databases of customer information.
• Customer contracts: Agreements that guarantee future revenue.

How to value intangible assets

Valuing intangible assets is essential, yet challenging, given their lack of physical attributes and market prices. Various methods are commonly employed for this purpose. 

• ‍Cost-based approach: This approach involves assessing historical or replacement costs, though it may not consider changes in asset value. ‍
• Market-based methods: These rely on comparable sales or royalty rates, particularly relevant for assets with established marketplaces. ‍
• Income-based approaches: Like discounted cash flow analysis or earnings multiplier methods, these are favored for assets generating future cash flows, necessitating assumptions about revenue, expenses, and discount rates. 

Differences between tangible and intangible assets

Tangible and intangible assets are two distinct categories of assets that businesses own, each with its own characteristics.

Tangible assets

• Physical nature: Tangible assets are physical and have a tangible presence. They can be seen, touched, and felt.
• Measurability: The value of tangible assets can often be easily measured and assessed, as they have a market value or a cost associated with their acquisition and maintenance.
• Depreciation: Tangible assets typically depreciate over time, which means they lose value as they age or wear out. Depreciation expenses are recorded on a company's financial statements to account for this decline in value.
• Examples: Tangible assets include real estate, buildings, machinery, vehicles, inventory, equipment, cash, and physical investments, like stocks and bonds.

Intangible assets

• Lack of physical presence: Intangible assets lack physical substance. They cannot be seen or touched and exist as legal or intellectual rights.
• Measurability: Valuing intangible assets can be challenging because they often lack a market price. Their value is typically based on estimates, projections, or historical costs.
• Amortization: Intangible assets are amortized rather than depreciated. Amortization is the process of allocating the cost of an intangible asset over its useful life, reflecting its diminishing value.
• Examples: Intangible assets encompass intellectual property like patents, trademarks, copyrights, trade secrets, brand recognition, customer relationships, goodwill, software, licenses, and proprietary processes.

How can businesses protect their intangible assets?

Businesses can protect their intangible assets by implementing a combination of legal, technological, and operational strategies, such as the following below:

• Implementing legal protections: Businesses can safeguard their intangible assets by obtaining patents, trademarks, or copyrights. These legal protections prevent others from using or reproducing their intellectual property.
• Non-disclosure agreements (NDAs): Utilizing NDAs when sharing sensitive information can further protect intangible assets by legally binding parties to confidentiality.
• Internal security measures: Internally, businesses can establish robust data security protocols to protect digital intangible assets from cyber threats.

Frequently asked questions 

Are intangible assets valuable to investors?

Intangible assets often hold immense value for investors. While tangible assets like property and equipment are easily quantifiable, intangible assets can be the real game-changers for a business. They encompass items such as patents, trademarks, copyrights, and goodwill. Understanding their value is vital for investors to assess a company's potential and competitiveness.

Are intangible assets subject to depreciation?

No, but intangible assets can be subject to amortization, which is the process of allocating their cost over their useful life. The specific amortization period depends on the type of intangible asset.

Can intangible assets be transferred or sold?

Yes, intangible assets can be transferred or sold, often through licensing agreements or outright sales. Legal documentation is crucial in such transactions to ensure the proper transfer of rights.

How do intangible assets affect financial statements?

Intangible assets are typically reported on a company's balance sheet and may affect its overall valuation. Amortization expenses related to intangible assets also affect the income statement.

Can intangible assets be impaired, and how is impairment assessed?

Yes, intangible assets can be impaired if their carrying value exceeds their recoverable amount. Impairment is assessed by comparing the asset's carrying amount to its recoverable amount, with the lower value being recognized.

How do intangible assets impact financial ratios and performance metrics?

Intangible assets can affect financial ratios and metrics like return on assets (ROA) and return on equity (ROE) by influencing the denominator (total assets or equity) without directly affecting revenue or profit.

Are there industry-specific nuances in accounting for intangible assets?

Yes, certain industries, such as pharmaceuticals and technology, have unique accounting considerations for intangible assets due to their reliance on patents, research and development, and intellectual property.

Sources:

1. Rindu Rika Gamayuni. (2015). The Effect Of Intangible Asset, Financial Performance And Financial Policies On The Firm Value. International Journal of Scientific & Technology Research, 4. http://www.ijstr.org/final-print/jan2015/The-Effect-Of-Intangible-Asset-Financial-Performance-And-Financial-Policies-On-The-Firm-Value.pdf
2. FreshBooks. (n.d.). What Is an Intangible Asset? A Simple Definition for Small Business (With Examples). FreshBooks. https://www.freshbooks.com/hub/accounting/what-is-an-intangible-asset
3. How To Calculate And Extend Useful Life Of Asset. (2021, May 25). Limble. https://limblecmms.com/blog/useful-life-of-asset/