What are Intangible Assets: A Definitive Guide
Intangible assets - As the word means, intangible assets denote the goods, properties, and reserves that are not in physical form. Assets are indispensable to increasing the value of a company’s worth, revenue, and reputation. Though it can be difficult to value, we still cannot deny the contribution of intangible assets to a company.
Just like a company can invest in tangible assets like physical properties, they can create or acquire intangible assets too. Some common intangible assets include patents, goodwill, trademarks, trade secrets, etc.
Does that mean my brand name has value too? How exactly do tangible assets differ from intangible ones? Can this value be monetized? This guide will do its utmost to clarify this concept and solve your queries about intangible assets standards and value.
What is an intangible asset?
In simple terms, an intangible asset is something that lacks physical attributes and substance. You cannot see them, yet they are a valuable resource to your organization.
It can be both definite and indefinite. Definite as in a license acquired, patent, copyrights, etc. These have a definite value that can be recorded in bookkeeping and documents that can be printed and stored.
Indefinite assets are the ones that don’t have a monetary value yet hold greater importance. Some examples are brand name and recognition, goodwill, etc.
Although these assets cannot be touched, they can contribute to the long-term existence and prosperity of a business. It’s important to estimate the value of the intangible assets because the company's total worth includes this as well, considering from an accounting point of view.
What is the difference between intangible asset and tangible asset?
Standard definition
● Tangible assets are properties owned by a company that physically exists and can be valued as per market standards.
● Intangible assets are untouchable, meaning they are physically unexisting assets owned by a company which are hard to be valued but play a crucial role in the company’s long-term growth and valuation.
Common examples
● Tangible assets include machinery, factories, real estate properties, vehicles, inventory, etc.
● Intangible assets include trademarks, franchises, tradenames, software, brand recognition, copyrights, etc.
Companies & their assets
● Tangible assets - Google’s data center.
● Intangible assets - Google’s brand recognition all over the world.
Liquidity
● Tangible assets can be sold and converted into cash.
● Intangible assets cannot be sold. But can be licensed for a specific period of time.
How does their value reduce over a period of time?
● In the case of tangible assets, their value depreciates.
● While, tangible assets’ value gets amortized.
Value estimation
● Tangible assets price can be accurately estimated.
● Hard to uncover the valuation of intangible fixed assets.
Is it possible to insure them?
● Tangible assets can be lost or destroyed. Hence it’s insurable.
● In the case of intangible assets, it’s not possible to get insurance
Acceptable as collateral for financing purposes
● Tangible assets are accepted commonly.
● Intangible assets cannot be kept as collateral. Because of their fluctuating, intangible values, banks don’t accept them.
Types of intangible assets
1. Goodwill
Goodwill is the brand name or reputation a business holds that favors it while buying another asset and earning more profit than usual.
Unlike other brand factors like customer loyalty or brand recognition, goodwill can be recorded in books too and it doesn’t depreciate over time. It is required when one firm buys another or goes through a merger.
Here is an example. Company A has an asset worth $10 million but company B has bought it for $14 million. Any additional amount that has been paid more than the actual value of the company going to be sold, accounts as goodwill and is recorded so in the balance sheets of the acquirer.
This additional amount paid by company B is considered a premium (also goodwill) to buy the intangible assets of company A, like its brand name, reach, and other immeasurable assets like this.
2. Brand recognition
If not for brand recognition, any brand could have easily replaced another existing brand. Brand recognition is what keeps a brand remembered for a long time among its customers.
Brands indeed make use of this as a part of their marketing and sales strategy to sell more and gain more. They create logos, advertisements, banners, slogans, and of late social media templates to ensure that their recognition will not be diminished.
That being said, brand recognition can depreciate over time unlike goodwill or tangible assets. Your brand recognition decides the preference your product/service is going to gain from your competitors’.
Though brand recognition can sound like it’s meant for big and well-established brands, smaller brands can work on their brand too through effective promotion, and marketing and creating an unparalleled customer experience.
3. Intellectual property
It refers to the intangible value that the human mind and intellect give life to. Some examples can be trademarks or copyrights for designs, artwork, logos, etc.
To be declared as intellectual property, this must have been a unique work that doesn’t replicate any other existed and existing. To protect intellectual property, a company can formulate legal measures.
If their registered intellectual property is misused without credits, the company can sue those who use it underhandedly. Any kind of intellectual property is recorded as intangible fixed assets in the accounting books.
Following are the type of intellectual properties.
Trademarks
A trademark can be a symbol, logo, phrase, or expression that is unique to a brand and is specifically used to spot a brand among its competitors. One good example of a trademark is the half-bitten apple logo of the Apple brand.
Trademarks exist to protect the goods/services it represents from known or unknown infringement from other companies. To obtain a trademark, one can do a basic trademark search and register their design by submitting a TEAS application.
Copyright
Copyright provides authors and creators of digital work the right to protect their work and solely use that without anyone being able to duplicate or copy the content.
Think of a music album that is released by a music production company. For others to use the album in their work, they must have obtained permission or license from the owner.
Licensing
Licensing is when the licenser of any of the above intellectual property decides to let others use the licensed goods/services. One such example has been explained already in the above section.
Licensing is also an intangible asset that can be depreciated because the licensee decides how long a business can use the license. Licensing cost is a fixed amount received by the licenser in specific intervals.
4. Customer lists
Customer list is an intangible asset that is obtained from one company when another company acquires it.
Since it has a monetary value that the acquirer would pay to obtain it, it also gets its place in financial statements and books as a ‘customer list’. The customers' list contains the list of buyers from a specific company who have had valuable relationships with them.
5. Client relationships
Last but not least, client relationships. We cannot ignore the intangible value clients bring in, while we discuss the untouchable and abstract resources that bring value to a business.
Client relationships fall under intangible assets if there is a contractual-based agreement between the supplier and the client. This is considered so because a fair share of the profit would usually be from the recurring clients.
When the same company gets sold, this is considered as customer lists for intangibles accounting and bookkeeping purposes.
How to value intangible assets?
Identifying intangible assets possessed by the company and their value is still a challenge for many business owners. Intangibles accounting is tough because these assets don’t hold a physical value. And there are no standard calculations to estimate the intangible assets’ value.
With the following approaches, you can get a step closer to determining intangible assets' value. If an intangible asset produces an economic benefit to its owner, then its value can be identified for sure.
Also, remember that it is not possible to deduce the value of an intangible asset in certain cases. If it’s undeterminable, you cannot report it in any way in the balance sheet as well.
Market approach
Market approach is when you find out, analyze and compare similar assets that have been valued already. It can be hard to find precise data as most of them are not available to the public. This can suit a few categories like brand name, software, and license.
Cost approach
When you can identify the cost associated with an intangible asset, you can figure out the actual value too. That is, subtracting the cost required to build/create the asset from the total returns that it helps to generate will reveal the intangible asset value.
If this asset is a license obtained for design, then identifying the total costs spent on developing the design should be the way to proceed.
Income approach
This suits well for assets like patents or copyrights which bring in an income of some sort. If this is going to generate monthly-based income, add them up and predict the overall value. With the help of methods like excess earning accounting, the value of the assets can be concluded here.
Example of intangible asset
Intangible items are recorded in a balance sheet only when a merger or acquisition happens. Here is an example of how an intangible asset is treated over one such occurrence and how it’s accounted for in the balance sheet.
How patent is purchased or leased out?
A fabrication company that is known for its unique designs owns a patent for one of its hot-selling designs. This fabrication company is going to be purchased by another well-known metal industry.
Now the actual value of tangible assets of the former company is only $100 million. But the metal industry pays $150 million including the value of the intangible assets owned by the former. And this additional $50 million is written as intangible assets.
Now regarding the patent, the fabrication company decides to lease out the patent for 3 years to use by the metal industry for another price. This cost is recorded as an intangible asset in their balance sheet records.
Limited life vs unlimited life intangible assets
Based on the lifetime and usage of these intangible assets, they can be put under two categories.
Limited life intangible assets
Like the name suggests, this specific type of intangible asset’s value will expire over a period of time. Exactly how a patent or license becomes invalid after some years of use.
The value of this asset is amortized over the due course of time when it’s useful. Amortization is how the value of the intangible asset is spread over the active duration of the asset which in turn gets recorded in accounting books.
Unlimited life intangible assets
These intangible assets don’t die over a period of time but continue to remain and contribute as long as they exist. Brand recognition or customer loyalty is an unlimited life intangible asset that cannot be associated directly with monetary value yet magnify the marketing efforts and boost sales if used correctly.
Contrary to limited life assets, unlimited lifetime assets cannot be amortized as their value is enjoyed by the business till it ceases to exist.
Just like tangible assets, intangible assets are equally valuable and important for the success and longevity of a business. Valuation of intangible assets will not be smooth sailing. Nevertheless, intangible assets are indispensable to computing the actual worth of a company.