An intangible asset is a long-term asset or resource (greater than one year) of a company, which is not physical in nature and, in general, is very difficult to evaluate. Goodwill, brand recognition, and intellectual property, such as patents, franchises, software, trademarks, and copyrights, are all intangible assets.
Intangible assets exist as opposed to tangible assets, which include land, vehicles, equipment, and inventory. Additionally, financial assets such as stocks and bonds that derive their value from contractual requirements are also considered tangible assets.
Unlike tangible assets, intangible assets cannot be destroyed by fires, hurricanes, or other accidents or disasters, and can help rebuild destroyed tangible assets.
However, they cannot normally be used as collateral to obtain loans, and some intangible assets, such as goodwill, can be destroyed inadvertently or as a side effect of business failure.
Characteristics
The lack of physical substance seems to be a defining characteristic of an intangible asset. The definition of intangible assets specifically excludes monetary assets.
This is necessary in order to avoid classifying items such as accounts receivable and cash in the bank as intangible assets. While tangible assets add to an entity's current market value, intangible assets add to its future value.
The approximate monetary value of a company's intangible assets can be calculated by deducting the net value of its tangible assets from the company's market value.
While intangible assets do not have the obvious physical value of a factory or equipment, they can be valuable to a business and critical to its long-term success or failure.
Intangible assets can represent a significant percentage of a company's total assets and therefore have a large impact on a company's book value.
In some cases (such as the Coca-Cola trademark), the value of a company's intangible assets far exceeds the value of its tangible assets.
Classification
An intangible asset can be classified as indefinite or permanent. A company's brand is considered an indefinite intangible asset because it remains with the company as long as it continues its operations.
An example of a defined intangible asset would be a legal agreement to operate under another company's patent, with no plans to extend the agreement. Therefore, the arrangement has a limited life and is classified as a defined asset.
Accounting record of intangible assets
Accounting for intangible assets has some unique requirements. Intangible assets are recorded in the balance sheet. An intangible asset is only recorded if the company buys or acquires it.
In addition, intangible assets must have an identifiable value and a long-term useful life. Intangible assets that are created within the business are not recorded.
For example, the logo is an intangible asset that has value. However, the logo was created within the company. The rights to another company's logo were not purchased. Therefore, the logo will not be recorded on the balance sheet.
In most cases, an analyst calculating book value will only include intangible assets that can be separated from the business and sold.
Goodwill cannot be separated from the business, so it is generally not included in book value calculations. A valuable patent can be sold and would be included in the book value.
Valuation of intangible assets
Companies can create or acquire intangible assets. For example, a company can create a customer mailing list or establish a patent. A company could also choose to acquire intangibles.
If a company creates an intangible asset, it can pay the expenses of the process, such as filing the patent application, hiring a lawyer and other related costs. In addition, all expenses to create intangible assets are charged to income.
However, intangible assets created by a company do not appear on the balance sheet and do not have a book value.
Because of this, when a company is purchased, the purchase price is often above the book value of the assets on the balance sheet. The purchasing company records the premium paid as intangible assets (goodwill) on its balance sheet.
Methods for valuing intangible assets
If it is planned to sell a company, its intangible assets should be included in the valuation of the company. In addition to consulting a business advisor to help value assets, the following methods can be used to understand the value of intangible assets.
Cost method
The cost that it would take another company to duplicate intangible assets is calculated. For this method, the actual costs required to recreate the asset can be estimated.
Or, the present value of all original costs that entered intangible assets could be calculated.
Market method
You can find the brand or other intangible assets of another company that is compared with the company to be sold. The value of the intangibles of that company is used as a benchmark to value its intangibles.
Entry method
The future benefits that intangible assets will bring to another business are measured. For this method you need to use cash flow projections.
Examples
A business like Coca-Cola wouldn't be as successful if it weren't for the money made through brand recognition. While brand recognition is not a physical asset that can be seen or touched, it can have a significant impact on generating sales.
Intangible assets related to trading
- Trademarks.
- Internet domain names.
- Non-competition agreements.
Intangible assets related to the client
- Customer lists.
- Order-book.
- Customer relations.
- Artistic intangible assets.
- Performance events.
- Literary works.
- Images.
- Musical works.
- Movies and television shows.
Intangible assets based on contracts
- License agreements.
- Service contracts.
- Franchise agreements.
- Leasing contracts.
- Transmission rights.
- Employment contracts.
- Rights of use (such as drilling rights or water rights).
Intangible assets based on technology
- Patented technology.
- Computer software.
- Trade secrets (such as secret formulas and recipes).
