An intangible asset is one that is not physical in nature. Since intangible assets have no shape or form, they cannot be held or manipulated. Common types of intangible assets include brands, goodwill, and intellectual property. Businesses face challenges in valuing these assets, as they differ from tangible assets, which have physical forms and can be held.
Key Takeaways
- An intangible asset is an asset that is not physical in nature, such as a patent, brand, trademark, or copyright.
- Businesses can create or acquire intangible assets.
- Intangible assets can be considered indefinite (a brand name, for example) or definite, like a legal agreement or contract.
- Intangible assets created by a company do not appear on the balance sheet and have no recorded book value.
Why Intangible Assets are Critical to Business Value
Intangible assets are long-term assets whose value increases over time. Despite not having a physical form, they can be incredibly valuable and crucial to long-term business success. Intangible assets commonly include brand recognition, goodwill, and intellectual property like patents, trademarks, and copyrights.
Intangible assets can be divided into two categories:
- Indefinite: This type stays with the holder as long as it continues to operate, such as a brand name.
- Definite: This type is restricted to a limited time, for instance, a legal agreement that allows a company to use another company’s patent for a specified period.
Companies can either create or acquire intangible assets. For example, setting up a mailing list of clients or establishing a patent. Expenses incurred in creating intangible assets, such as filing a patent application or hiring a lawyer, can be written off but won’t appear as an asset on the balance sheet.
Intangible assets can lose their value if the owning company fails or goes bankrupt.
Key Types of Intangible Assets
Let’s explore some of the most common types of intangible assets: brands, goodwill, and intellectual property.
1. Brands
A brand differentiates one business from another through a logo, symbol, or brand name. Brands contribute to a company’s equity and drive customer loyalty. For instance, many people can instantly identify Apple just by seeing its logo and are willing to pay more for its products due to the brand’s influence.
2. Goodwill
When one company purchases another, the intangible assets acquired in this transaction are termed goodwill. Positive goodwill arises when a buying company pays more than the fair value of the collected net assets. On the other hand, negative goodwill arises if the purchase price is below the target’s book value.
3. Intellectual Property
Intellectual property (IP) is legally protected and cannot be used by another business or individual without authorization. Common forms of IP include:
- Copyrights
- Digital Assets
- Franchises
- Patents
- Trademarks
- Trade Secrets
Unauthorized use or infringement, whether intentional or unintentional, of someone else’s intellectual property results in legal consequences.
Valuing Intangible Assets: Techniques and Approaches
A business like Coca-Cola owes part of its success to brand recognition even though this intangible asset cannot be physically touched or seen. Here’s how a company can value such intangible assets:
1. Market Approach
This valuation method relies on an expected value based on a relative analysis, comparing similar intangible assets. Limited details about comparable assets might pose a challenge.
2. Income Approach
The income approach is useful for intangible assets with cash flow streams. The relief from royalty method, for example, estimates potential royalties or avoided loss of income from using the asset.
3. Cost Approach
This method is based on the substitution principle, considering the cost to recreate the intangible asset without any associated future benefits.
Expenses of creating intangible assets are expensed rather than added to the balance sheet. Thus, when a company is purchased, often the purchase price exceeds the book value, leading to a record of the premium paid as an intangible asset.
Tangible vs. Intangible Assets: Core Differences
Tangible assets contrast with intangible assets as they have a physical form. They are among a company’s principal portfolio assets and may be easier to value. Each tangible asset can undergo valuation through an appraiser or market comparisons.
Common Tangible Assets
- Equipment
- Furniture
- Inventory
- Land
- Property
- Vehicles
Financial securities such as stocks and bonds are also tangible, despite not being physically held, due to their value being derived from contractual claims.
Tangible assets come in two categories: current (convertible to cash within a year) and fixed (long-term assets like plant, property, and equipment or PPE).
Example of Intangible Assets in Practice
Intangible assets appear on a company’s balance sheet only if acquired. For instance, if Company ABC purchases a patent from Company XYZ for $1 billion, ABC records a $1 billion intangible asset under long-term assets. The asset undergoes amortization over several years, though indefinite life intangible assets like goodwill are not amortized but rather periodically assessed for impairment.
Main Types of Intangible Assets
Intangible assets can be definite, lasting a certain period, or indefinite, with an infinite lifespan. They include brands, goodwill, and intellectual property.
Differences Between Intangible and Tangible Assets
Intangible assets lack a physical form. Tangible assets can be handled and manipulated. Main categories of tangible assets like property, inventory, and equipment hold essential value for businesses.
How Intangible Assets Appear on a Balance Sheet
Intangible assets appear as long-term corporate balance sheet items. Their value is typically based on purchase or acquisition price along with amortization schedules. Some, such as goodwill, may not appear due to the complexity in value determination.
The Bottom Line: Valuing Invisible, Instrumental Assets
Businesses hold a mix of tangible and intangible assets. While tangible assets can be physically handled, intangible assets—though not visible or tactile—are extremely valuable and contribute significantly to overall business success. Therefore, businesses should aim to protect and manage these precious intangible assets diligently.
Related Terms: tangible assets, asset valuation, balance sheet, amortization, market approach, income approach, cost approach.
References
- PricewaterhouseCoopers. “Financial Reporting in the Power and Utilities Industry: International Financial Reporting Standards”, Page 25.
- The International Financial Reporting Standards Foundation. “IAS 38 Intangible Assets”.
- Internal Revenue Service. “Business Expenses: For Use in Preparing 2022 Returns”, Pages 32-33.
- AICPA & CIMA. “Three approaches to valuing intangible assets”.
- The University of Minnesota Libraries “Financial Accounting: 11.2 the Balance Sheet Reporting of Intangible Assets”.
- Shashin Shah, via Google Books. “Study Guide for 2019 CIMA Exam”, Page 87. John Wiley & Sons, 2019.
