Significance of Intangible Assets and their Accounting treatment

Introduction and examples of intangible assets

Intangible assets are those assets which cannot be physically touched. This ‘intangibleness’ is because they do not have a physical presence. Instead, most of the intangible assets have a virtual presence, either in the form of software or something in the understanding of people’s mind.

For example, a movie recorded by a film producer is an intangible asset stored in the soft form in the camera. You may not touch that film physically, but that movie is produced after spending millions of dollars and may have a significant market value.

There are many other examples of intangible assets like:

  1. Registered trademark and logo: You would have seen many companies having a small ‘®’ in their trade name or their slogan. This sign represents a registered trademark. That company have spent money on designing, composing and registering this trademark. No other company can use the same trademark. This trademark is an asset which distinguishes this company’s products from other companies’. Therefore, this is an asset for this company and
  2. Examples of trademarks and logos are four circles in a row for Audi, five rings (three up and two down) for Olympics, the ‘just do it’ slogan for Nike, slightly eaten apple for Apple and the picture of the founder of KFC for KFC.
  3. A brand recognition A book: Yes, it seems that a book has a physical presence, but the value of the book written by a great author doesn’t lie in the physical appearance of the book. The value is in the story or script of that book, that is the intangible part of that asset. The actual price of the book may be a few dollars, but the copyright of publishing that book or the intellectual property of that book may have the value in millions.
  4. A software: A software doesn’t have a physical presence, although we can see it on computer screens, and we may purchase software for a few dollars as a retail customer, but having the right to sale that software is an intangible asset worth millions. Similarly, the person who produced that code for the creation of software possesses a significant value as an intangible asset in the form of programming of that software.
  5. A chemical formula: let’s say that a company devised a specific chemical formula which is helpful in producing any substance or medicine or product, then that chemical formula is also an intangible asset, i.e., the knowledge of that chemical formula is an intangible asset which can be capitalized (if conditions are met). For example, the recipe to prepare Coke drink is secret and is an intangible asset of Coca-Cola.
  6. A photograph taken from an ordinary mobile or camera may also be classified as an intangible asset if that photograph is hugely appreciated and liked. Now, the picture would be saved in the computer; thus, it is intangible, but due to its high likeness, it may be sold with copyrights. Many photographs are being sold on and similar websites. This is the trading of intangible assets.



Recognition of intangible assets


Can all intangible assets be recorded as assets in the balance sheet of a company?


No, both as per US GAAP and IFRS, there are certain conditions which need to be met for recognition of intangible assets. Once these conditions are met, then only an intangible asset can be recognized on the balance sheet of a company.


Conditions under IFRS are:

The first condition is that the cost of the asset should be measured reliably; this means that the cost incurred to create or prepare that intangible asset should be measured reliably. If it is not clear that which costs have incurred or if no expenses have incurred, the intangible asset cannot be recognized.

It is essential to reiterate the point that any internally generate asset can only be recognized at the cost. For example, if an asset is manufactured/designed/prepared for $1,000 then the asset would be recognized at the cost of $1,000 only. We cannot recognize an asset at a value higher than it’s original cost.

The cost would include direct labor and direct material etc. less any disposal value. For example, if in making a movie, actors were paid amount X and some furniture was purchased for amount Y, and this furniture was later sold at amount Z then in this case, the amount capitalized as an intangible asset would X + Y – Z.

The second condition is that it is probable that future economic benefits will flow to the entity. Now, the future economic benefits will flow to the entity only if that asset is technically feasible and commercially viable. This means that the asset should have technical feasibility, i.e., the product or item on which you are working to build, it should be technically feasible. You should not be investing in something which is not possible. IFRS doesn’t allow the recognition of such intangible assets. For example, if you are trying to build a formula to convert sand into gold and you are spending money on it, and you can measure the cost incurred, but this is something which is not technically feasible. So the investment on formula of converting sand into gold cannot be recognized as an intangible asset.

Further, as stated above, the product should be commercially viable. This means that there should be a market demand for this asset and it should be sold at a value which would be beneficial for the company. For example, customers should be willing to purchase this intangible asset (or any product made using this intangible asset) at a price which is beneficial for the company.

However, in exceptional circumstances, if the technical feasibility is established and there are successful results, then that formula can be recognized as an intangible asset.

Other than the regulations and rules, let’s talk about some practices about intangible assets. Do companies always want to recognize intangible assets? No, not necessarily. Especially if the amounts are small, companies and management would prefer to charge out this expenditure in profit and loss account. This accounting approach is adopted because recognition would lead to further requirements such as calculation of amortization in small amounts every year.

All intangible assets (other than goodwill) need to be amortized over their useful life. Amortization is simply another name for depreciation. However, the depreciation is for tangible assets, while amortization is for intangible assets. This is the difference between amortization and depreciation.

If it has been established that accounting entries need to be passed and asset needs to be recognized, then initial recognition of intangible assets should be recorded as Debit: intangible asset and Credit: Bank (for the amount spent on intangible asset).

Goodwill is the most famous example of intangible assets. However, it is a unique kind of intangible asset. Goodwill is the market value of the name of a brand. Let’s say that you purchase an iPhone just because of the goodwill of Apple. This is something other than all other tangible and intangible assets. Please read our detailed article on goodwill to understand it’s nature, calculation, impairment etc.

It is important to note that financial assets (stocks, shares, debentures, loans, receivables, etc.) are not generally classified as intangible assets. They are separately dealt with as financial assets and have their separate accounting treatments.

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