Learn what qualifies as an intangible asset, their valuation methods, and their impact on financial reporting.
Jun 27, 2024
Intangible assets may seem elusive, but understanding them is crucial for business owners. While you can’t touch these assets, their impact on your company’s value is real. Let’s explore intangible assets, how to calculate their fair value, and how to account for them in your financial documents.
An intangible asset is a nonphysical long-term asset that accrues value over time. These are not just theoretical concepts but real assets that can significantly impact your business. Examples include intellectual property, brand recognition, customer relationships, and goodwill.
In contrast, tangible assets are physical items you can touch, typically under the PPE (property, plant, and equipment) category.
Identifiable intangible assets can be acquired or separated from the company (bought and sold), but lack physical form. These often have an indefinite lifespan, lasting as long as a company exists.
Examples of other intangible assets include:
For instance, a social media platform’s feed algorithm is an indefinite intangible asset. It adds value over the long term and could potentially be sold to another company.
Unidentifiable intangible assets can’t be bought or sold separately because they only exist in relation to the company. These are often definite intangible assets with a limited lifespan.
Examples of unidentifiable intangible assets include:
While difficult to quantify, these assets significantly contribute to a company’s overall value. A client relationship, for example, is only an asset for as long as it’s maintained.
Companies can acquire intangible assets by creating them internally or purchasing them from another entity.
Companies often develop assets in-house. For example:
Companies can also acquire intangible assets from other businesses. For instance, when Meta (formerly Facebook) acquired Instagram and WhatsApp, it gained:
While many apps perform similar functions, Instagram’s and WhatsApp’s intangible assets contributed significantly to their high valuations.
Unlike tangible assets, quantifying the value of intangible assets can be challenging. Here’s a general formula to estimate their value:
Intangible Assets Value = Market Value of Business - Net Tangible Assets Value
To use this formula:
Goodwill, while abstract, can be calculated when a company is bought or sold. Subtract the difference between the fair market value of the business’s assets and liabilities from its purchase price:
Goodwill = Purchase Price - (Assets - Liabilities)
To determine the value of many intangible assets over time. This process gradually writes off an asset’s initial cost over a given period.
Amortization applies only to intangible assets with a finite useful life. Say your business gets a patent: that patent typically has a 20-year lifespan in the US. However, brand recognition resulting from that patent has no finite useful life and can’t be amortized.
To calculate amortization, use the straight-line method:
Amortization Expense = Initial Value / Lifespan
Note: Most intangible assets have no residual value, simplifying the calculation.
Only acquired intangible assets can be listed on a balance sheet under tangible assets. Internally developed assets can’t be assigned a fair market value and, therefore, are omitted.
For example, Meta couldn’t list its like button (developed in-house) on its balance sheet. However, it could list Instagram’s “double tap” feature, as it was acquired intellectual property with a market value.
To comply with International Financial Reporting Standards, intangible assets are measured and disclosed at cost. This means providing valuation and disclosures about your intangible assets when selling them. The purchaser can use these assets as a line item for expenses and amortization on their profit and loss statement.
For intangible assets with finite useful lives, amortization expenses are included in the income statement. Assets with indefinite useful lives aren’t amortized but are tested annually for impairment. If impaired, the asset’s carrying amount is reduced to its recoverable amount, and the impairment loss is recorded in the income statement.
To preserve the value of your intangible assets, it’s crucial to take steps for legal protection. Here are some common methods:
Examples of intangible assets include intellectual property, brand reputation, and customer relationships, which hold value despite not having a physical presence. Intellectual property encompasses patents, trademarks, and copyrights.
Tangible assets are physical items that can be touched or seen and have a finite monetary value, such as buildings, machinery, and inventory. Intangible assets, like patents, trademarks, goodwill, and brand recognition, lack physical form but still have value.
No, real estate, like buildings, offices, and land, is a tangible asset. While you can’t hold a building in your hand, it’s still a physical asset and, therefore, tangible.
