What Is an Intangible Asset?
An intangible object has no physical substance and can't be touched or seen. Similarly, intangible assets refer to a company's non-physical assets that might be difficult to describe and assign an exact value. Examples of intangible assets include copyrights and brand recognition.
Tangible assets are assets you can see and touch, such as equipment, real estate, and inventory. Compared to tangible assets with limited useful lives, intangible assets have long-term value for your business. Just like patents and trademarks, you can develop intangible assets internally and build them into your company's long-term growth.
Keep reading for more discussion on intangible assets. We'll also explore examples and types of intangible assets.
What Is an Intangible Asset?
In accounting, an intangible asset is described as a non-physical asset with a monetary value that a third party purchased. Goodwill and intellectual properties like patents, trademarks, and copyrights are all intangible assets, with financial value already attached to them.
Intangible assets developed internally, such as brand recognition and trade secrets, are undeniably valuable to a company. But they're not easy to monetize, and they aren't recognized on the balance sheet.
Examples of Intangible Assets
Intangible assets contribute as much to your company's growth and success as the tangible assets you use to produce your goods or services. For small business owners, reputation is everything. In fact, it's the most important intangible asset you can leverage to build and grow your company.
Below are items considered intangible assets:
- Customer lists: This is a list of your existing and potential customers. An example is your mailing or email list. Their contact information and your ability to tailor your marketing strategy to your customers are incredibly valuable for generating revenue for your business.
- Brand recognition: This refers to the reputation you build over time. Big brand names outsell smaller brands not because they're always the best option but because of consumers' familiarity with the brands.
- Domain names: The domain names you own are intangible assets because you can use them for marketing and creating brand recognition for your business. It might be difficult to assign a monetary value to a domain name until someone offers to buy it from you.
- Legal rights and permits: This refers to any license or legal right you own. For example, if you have a specialized license to manufacture a drug or chemical, it's an asset because you have the exclusive right to produce and sell a particular product.
- Licensing agreement: A licensing agreement is a legal contract between two parties where the licensor authorizes the licensee to produce and sell goods, use a brand name or trademark, or use patented technology owned by the licensor.
- Patents: A patent provides the inventor exclusive rights to the process, design, or product for a certain time frame in exchange for a complete disclosure of the invention. Patents provide an incentive for companies to develop innovative products and protect them from other companies wanting to copy and profit off their research, designs, and processes.
- Copyrights: A copyright protects the owner of an intellectual right, which means the creator of a product and anyone they give authorization to are the only ones who have the exclusive right to reproduce the work.
- Computer software: If you subscribe or pay for computer software, it's considered an intangible asset because it adds value to your business. If you were to sell your company now, you could add the software as part of the purchase.
- Goodwill: Goodwill refers to the value of a company's brand name, customer base, good customer relations, good employee relations, and proprietary technology.
- Franchises: A franchise is a method of delivering products or services with a franchisor and a franchisee. The franchisor establishes the brand's trademark, trade name, and business system. The franchisee then pays a royalty and an initial fee for the right to do business under the franchisor's name and structure. Both the franchisor and the franchisee will record a monetary value for the franchise as an intangible asset.
- Trade secrets: Trade secrets are one of the four main types of intellectual property. They're also one of the most challenging intangible assets to assign value to because of their ethereal existence.
Types of Intangible Assets
The main concern about intangible assets is that they can be difficult to value or monetize, though that's not always the case. Identifiable intangible assets, such as franchises and intellectual properties (e.g., patents, copyrights, and trademarks) can be separated and sold. The challenge arises when business owners try to attach a monetary value to intangible assets that can't be separated from a company's overall value.
These assets are called unidentifiable intangible assets. Examples of unidentifiable intangible assets are brand recognition and goodwill. Goodwill developed internally is not recorded in the balance sheet as an asset. But when a company is sold, any amount paid above its fair market value is recorded as goodwill.
In the following section, we'll define and discuss the valuation methods for two types of assets according to their useful lives.
Limited-Life Intangible Assets
A limited-life intangible asset is a resource that will generate cash flow only for a specific period of time. The most common example is a patent. In the United States, most patents issued by the U.S. Patent and Trademark Office (USPTO) are valid for 20 years from the date the application was filed.
The monetary value of your intangible asset will include all expenses you've incurred in the research, the process of creating it, and filing the necessary permits and applications. For instance, if you have a patent, your cost will include research and development, the patent application cost, lawyer fees, and other related expenses.
In accounting, amortization accounts for and expenses the value of intangible assets. Amortization is the equivalent of depreciation for fixed assets. It reduces the value of the intangible asset on the balance sheet over time and reports an expense on each accounting period's income statement to reflect the change.
Like depreciation, there are multiple methods a company can use to calculate an intangible asset's amortization, but the simplest is the straight-line method. To illustrate, let's assume the following figures for a patent:
- Total cost of patent: $13,500
- Patent application date: Jan. 1, 2018
- Patent issue date: Jan. 1, 2020, valid for 20 years
- Patent remaining useful life: 18 years (validity starting from the application filing date)
|Annual Amortization (Straight-line Method)|
For this patent, your annual amortization expense is $750.
Unlimited-Life Intangible Assets
Unlimited-life intangible assets are resources considered to have value forever. Trademarks, goodwill, and brand recognition are examples of assets with indefinite useful lives.
Intangible assets believed to have perpetual lives are not amortized. Similarly, an asset with a limited useful life that can easily be renewed without substantial cost is also treated as if it has perpetual life and is not amortized.
An intangible asset with perpetual life is not amortized in accounting but is subjected to a yearly impairment test. Impairment occurs when the assets can't deliver on the promised economic benefits expected of them at the time of purchase, or when their fair value drops below the previously recorded book value.
To illustrate, let's look at the annual goodwill and intangible assets of Coca-Cola.
Coca-Cola Annual Goodwill and Intangible Assets (in billions of U.S. dollars)
As you can see, there was a decline from 2015 to 2016 and again from 2016 to 2017, which means for 2016 and 2017, Coca-Cola recorded an expense of around $3 billion and $5 billion, respectively, for goodwill and intangible assets impairment.
Are Intangible Assets Listed on a Balance Sheet?
Although the value of brand recognition is undeniable to a company's ability to generate sales, intangible assets are only listed on the company's balance sheet when:
- They were obtained as part of the purchase of a business (e.g., goodwill)
- They were bought individually (e.g., franchises, license agreements)
- They have identifiable value and life span (e.g., patents)
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Notice to the Reader
The contents of this article are meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional accountant to ensure you're meeting accounting standards.