Can intangible assets be created based on a valuation report?
December 11, 2014
The amount of intangible assets in financial statements within software, pharmaceutical, sport and other industries has grown significantly in recent years making capitalization and valuation of intangible assets a topical issue. The article below deals with recognition, measurement and valuation of intangible assets.
An intangible asset is an asset (excluding financial assets) that lack physical substance.
Criteria for recognition in the financial statements include:
- Arising from contractual/legal right;
- Sold/transferred with a related contract.
The standards require intangible assets to be measured at historical cost less accumulated amortization and impairments, while no revaluation of intangible assets is permitted under US GAAP.
US GAAP states that internal costs for developing, maintaining, or restoring intangible assets (including goodwill) shall be recognized as an expense when incurred. Thus, generally research and development costs are fully expensed when incurred.
However, as an exception the following costs may be capitalized:
- The creation of computer software intended to be sold,
- Web-site design and construction, and
- Computer software for internal use.
For example, if a company has created a web-site for trading gadgets, it may not need any valuation report to capitalize the asset, instead the entity will capitalize the costs directly linked to the creation of the web-site (for example, the web-site designer’s fee and the IT specialist salary for the period of the project duration). So, in this case, the historical cost principle is applied. On the other hand, if the entity wishes to sell the web-site, it may refer to an independent appraiser to determine the value of the web-site based on valuation techniques. However, the appraised value cannot be recorded on the company’s books; instead, only the cost of web-site creation can be capitalized.
Intangible assets acquired individually or with a group of assets should be recognized on the balance sheet of the acquirer. This is in line with purchase accounting. When such recognition of intangible assets takes place, they are recorded at their fair values.
How are fair values determined? There is a high degree of subjectivity involved in the process.
Generally, there are three approaches to intangible asset valuation:
- Cost approach (not considered appropriate for valuation of intangibles in most cases);
- Income approach (valuation based on expected cash flows the subject under valuation is expected to generate);
- Market approach (comparing the relevant asset parameters with those of similar asset).
Although valuation techniques may provide fair values of intangible assets, the accounting treatment is not to capitalize them in financial statements. Capitalization of intangible assets may take place only in case of mergers and acquisitions (i.e., purchase accounting).
Suggest a Topic
Suggest it to be answered on Simplestudies.com: