An asset that is not
physical in nature. Corporate intellectual property (items such as
patents, trademarks, copyrights, business methodologies), goodwill
and brand recognition are all common intangible assets in today's
marketplace. An intangible asset can be classified as either
indefinite or definite depending on the specifics of that asset. A
company brand name is considered to be an indefinite asset, as it
stays with the company as long as the company continues operations.
However, if a company enters a legal agreement to operate under
another company's patent, with no plans of extending the agreement,
it would have a limited life and would be classified as a definite
asset.
While intangible assets
don't have the obvious physical value of a factory or equipment, they
can prove very valuable for a firm and can be critical to its
long-term success or failure. For example, a company such as
Coca-Cola wouldn't be nearly as successful were it not for the high
value obtained through its brand-name recognition. Although brand
recognition is not a physical asset you can see or touch, its
positive effects on bottom-line profits can prove extremely valuable
to firms such as Coca-Cola, whose brand strength drives global sales
year after year.
Why are they shown in
the Balance Sheet ?
The balance sheet
aggregates all of a company's assets, liabilities, and shareholders'
equity. Since an intangible asset is classified as an "asset,"
it should appear in the balance sheet. However, this is not always
the case.
The reason for the variable treatment of intangible
assets is that the accounting standards mandate that a business
cannot recognise any internally-generated intangible assets (with
some exceptions), only acquired intangible assets. This means that
any intangible assets listed on a balance sheet were most likely
gained as part of the acquisition of another business, or they were
purchased outright as individual assets.For example, if a company conducts expensive research for many years and eventually creates a valuable patent from this research, all of the associated cost is charged to expense as incurred - no intangible asset can be capitalised. However, if the same organisation were to buy the patent from another company, it could recognise the fair value of the patent in its balance sheet, because it bought the patent.
One effect of this accounting treatment is that many corporations that have spent inordinate amounts of cash over the years to develop valuable brands and patents have not capitalised any of the associated costs; their balance sheets do not reflect the real value of their intangible assets. This can be misleading when an outsider is trying to gain an understanding of the value of a business by perusing its financial statements.
Though intangibles do not appear on the balance sheet in many instances, this can also work in favour of a company. First, the entity does not have to absorb an ongoing amortisation charge to reflect the ongoing consumption of the value of these assets, since the entire cost was charged to expense up front. Also, the accounting standards state that a sudden loss in the value of an asset can trigger an impairment charge, which can adversely impact profits. Again, since the cost of these assets was written off up front, the organisation has no intangible assets that could be subject to such a charge.
What is meant by
amortisation of intangible assets?
The amortisation of
intangibles involves the consistent reduction in the recorded value
of an intangible asset over time. Amortisation refers to the
write-off of an asset over its expected period of use (useful life).
KEY POINTS[edit]
- Intangible assets are amortised using the
straight line amortization method.
- Goodwills an intangible asset that is not
amortised, but is instead tested for impairment on an annual basis.
- The economic or useful life of an intangible
asset is based on an estimate made
- by management and is subject to change under certain market conditions.
For example, ABC
International acquires another company, and as a result recognises a
customer list asset in the amount of $1,000,000. ABC elects to
amortise this intangible asset over the next five years at a rate of
$200,000 per year. After one year, the carrying amount of the asset
has been reduced to $800,000, but ABC now estimates that the asset
has a market value of only $300,000 and a remaining useful life of
just two years. Accordingly, ABC incurs a $500,000 impairment charge
to write down the value of the asset to $300,000, and then re-sets
the associated amortisation to be $150,000 in each of the next two
years. After that time, the customer list asset will have a carrying
amount of zero in the accounting records of ABC.
Reasons for
amortisation
If an intangible asset has
a finite useful life, you should amortise it over that useful life.
The amount to be amortised is its recorded cost, less any residual
value. However, intangible assets are usually not considered to have
any residual value, so the full amount of the asset is usually
amortised. If there is any pattern of economic benefits to be gained
from the intangible asset, then you should adopt an amortisation
method that approximates that pattern. If not, the customary approach
is to amortise it using the straight-line method.
