What is an intangible asset?
An intangible asset is an asset that lacks a physical presence or form. These assets cannot be touched, held, or physically manipulated due to their abstract nature. Common examples of intangible assets include items like brand recognition and reputation, relationships, intellectual property and goodwill.
Valuing intangible assets poses challenges because they lack a tangible form, unlike physical assets that can be seen and touched.
In contrast, tangible assets are those with a physical form and can be physically held or managed. Intangible assets derive their value from qualities such as reputation, ideas, or legal rights rather than from a physical substance or structure.
Criteria for recognising intangible assets
According to AASB 138, intangible assets must meet specific criteria to be recognised:
Identifiable: The asset must be distinguishable or separable from the entity’s business. Alternatively, it can result from a legal right or document.
Non Monetary: Intangible assets cannot be assigned a specific monetary value. For instance, it’s challenging to assign a dollar value to a trademark when it has been internally generated and not acquired from another entity.
Lack of Physical Substance: Intangible assets do not possess physical attributes; they cannot be touched or physically held.
Control: The entity must have control over the intangible asset, meaning it has the authority to determine its use and can prevent others from using it. For example, if an entity holds a trademark for its business name, it can dictate how the name is employed and prevent unauthorised use by others.
Future Economic Benefit: Intangible assets should offer the potential for future economic benefits. This can include selling the asset itself or generating revenue by selling products and services that rely on the asset, such as selling patented products.
These criteria help entities determine whether an intangible asset qualifies for recognition in their financial statements, ensuring that only relevant and economically significant intangible assets are included in their financial reporting.
Types of intangible assets
There are two primary categories of intangible assets: identifiable intangible assets and unidentifiable intangible assets.
Identifiable intangible assets
Identifiable intangible assets are assets that can be acquired or separated from the entity, meaning they can be bought and sold. These assets lack physical form but hold economic value.
Examples of identifiable intangible assets include intellectual property, such as patents, trademarks, copyrights, and even non monetary government grants like airport landing rights or broadcasting licences.
Identifiable intangible assets are often considered indefinite, meaning they remain with the entity as long as it exists. Proprietary data and algorithms fall into this category. For instance, the algorithm governing a social media platform’s feed is an indefinite intangible asset as long as the entity exists and can even be sold separately to another entity.
Unidentifiable intangible assets
Unidentifiable intangible assets are a type of intangible asset that cannot be bought or sold because they are intrinsically linked to the entity itself. These assets only exist in relation to the entity.
Examples of unidentifiable intangible assets are reputation, goodwill, brand recognition and client relationships. These assets are challenging, if not impossible, to quantify in monetary terms but significantly contribute to the entity’s overall value.
Unidentifiable intangible assets are typically considered definite intangible assets, meaning they have a limited lifespan. For example, a client relationship is only considered an asset for as long as it is actively maintained by the entity.
These two categories of intangible assets, identifiable and unidentifiable, each play unique roles in assessing the overall worth and value of an entity.
Recognition and measurement of intangible Assets
Entities should recognise and account for intangible assets, whether acquired separately or as part of a business combination, considering factors:
Separate acquisition of intangible assets
When an entity acquires an intangible asset separately, it recognises it as an asset based on the expectation of future economic benefits, even if the exact timing or amount of these benefits is uncertain.
The cost of a separately acquired intangible asset includes the purchase price and directly attributable costs related to preparing the asset for its intended use.
Costs associated with using or redeploying an intangible asset are not considered part of its carrying amount.
Incidental operations during intangible asset development, which aren’t necessary for the asset’s intended use, result in immediate recognition of income and expenses in profit or loss.
Acquisition as part of a business combination
In business combinations (e.g., mergers and acquisitions), the cost of an acquired intangible asset is its fair value at the acquisition date. This fair value accounts for expected future economic benefits, even if their timing or amount is uncertain.
Intangible assets acquired in business combinations are recognised separately from goodwill.
If an in process research and development project of the acquiree meets the definition of an asset and is identifiable, the acquirer recognises it as an intangible asset.
When estimating the fair value of intangible assets, any uncertainty due to a range of possible outcomes with different probabilities is taken into account.
In some cases, an intangible asset acquired in a business combination may only be separable when combined with a related contract, asset, or liability. The acquirer recognises it separately from goodwill but together with the related item.
Complementary intangible assets with similar useful lives may be recognised as a single asset. For instance, terms like ‘brand’ and ‘brand name’ can encompass a group of complementary assets, such as trademarks, trade names, formulae, recipes, and technological expertise.
How to determine the value of intangible assets
Determining the value of intangible assets can be somewhat challenging, as their contributions to an entity are not always immediately apparent. Calculating their value for financial reporting purposes can vary depending on the type of intangible asset.
Here’s a general formula to estimate the value of intangible assets:
Intangible Assets Value = Market Value of the Entity – Net Tangible Assets Value
This formula essentially involves subtracting the net tangible assets value from the market value of the entity.
First, calculate the net tangible assets value by deducting total liabilities from total assets. Then, subtract this net tangible assets value from the overall market value of the entity to estimate the value of its intangible assets.
Additionally, when it comes to calculating the value of goodwill, use the following formula:
Goodwill = Purchase Price – (Fair Market Value of Assets – Liabilities)
In this case, knowledge of the purchase price of the entity is necessary. Subtract the difference between the fair market value of the entity’s assets and its liabilities from the purchase price to calculate the value of goodwill.
It’s important to note that these calculations are generally relevant when an entity is being bought or sold, as they rely on specific transaction data.
Identification of intangible assets
Identifying intangible assets in the context of business combinations, such as acquisitions and mergers, can be a complex task with specific considerations.
The detection of identifiable intangible assets depends on various factors, and useful sources to identify them include:
Acquiree’s financial statements and reports:
Some intangible assets may have been recognised in the acquiree’s financial statements. Other financial data may indirectly indicate the presence of intangible assets, like significant marketing expenditures indicating the importance of brands and trademarks.
Purchase agreement and documentation:
These documents may reference specific trademarks, patents, or other intangible assets established through contracts or legal rights. Non compete provisions in agreements can also give rise to potential intangible assets.
Due diligence reports:
Reports generated during due diligence may provide valuable information about the acquired business, its resources, and how it generates revenue.
Materials on websites, press releases, and investor relations communications:
These sources may contain discussions, from both the acquiree and acquirer, about unique business characteristics that could translate into potential intangible assets.
Industry practises:
Past business combinations within the same industry can offer insights into the types of intangible assets typically recognised in such situations.
In light of these complexities, entities engaged in acquisitions or contemplating such actions should carefully consider these factors to ensure the identification of all assets being acquired. Accurate reporting of intangible assets and goodwill is essential, as these figures are closely scrutinised by investors, analysts, and regulatory bodies.
Amortisation of intangible assets
Amortisation is the process of gradually writing off the initial cost of an asset over a specific period. This concept is similar to depreciation, which applies to tangible assets and reflects their decline in value over time. However, amortisation is specifically applied to intangible assets rather than physical ones.
Not all intangible assets can be subject to amortisation; it applies only to those with a finite useful life, which is the predetermined period an entity owns the intangible asset. For example, if an entity obtains a patent, it typically has a finite useful life, often around 20 years before it expires.
On the other hand, certain intangible assets, like brand recognition, may have what’s known as a perpetual life because their value continues indefinitely. Such assets cannot be amortised.
To calculate the amortisation of intangible assets, the straight line method is commonly used. The calculation involves:
Amortisation Expense = (Initial Value – Residual Value) / Lifespan
The Residual Value represents the asset’s value once it has been fully utilised or is no longer beneficial. However, intangible assets typically do not have a residual value because they often become worthless once they are no longer owned. Therefore, for most intangible assets, the calculation simplifies to:
Amortisation Expense = Initial Value / Lifespan
This formula helps entities account for the gradual reduction in the value of intangible assets over their finite useful life.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.