What are intangible assets?

1. Definition and classification of intangible assets

Intangible assets are assets that lack physical existence and are not financial instruments.

Intangible assets are usually classified as noncurrent (long-term) assets because they produce benefits over several years. They are valuable because they provide rights and privileges to their owners. Examples of intangible assets are: trademarks, copyrights, patents, franchises, customer lists, and goodwill.

Intangible assets have the following classifications:

  1. Purchased vs. internally created intangibles
  2. Limited-life vs. indefinite-life intangibles

Purchased intangibles are recorded at the cost incurred to purchase an intangible asset from another entity, which includes the acquisition costs as well as expenditures made to get the asset ready for its intended use (e.g. legal fees).

Internally created intangibles are often not recorded on the balance sheet: most costs incurred to internally develop an intangible asset have to be expensed (including Research and Development costs), and only certain costs (e.g. legal costs) might be capitalized (e.g. debit Patent for the cost of defending the patent).

Limited-life intangibles are intangible assets with a limited useful life (e.g. copyrights, patents). Limited-life intangibles are systemically amortized throughout the useful life of the intangible asset using either units of activity method or straight-line method. The amortization amount equals the different between the intangible asset cost and the asset residual value. The owner of the intangible asset, in this case, either credits the appropriate intangible asset account or the appropriate accumulated amortization account.

On the other hand, indefinite-life intangibles are not amortized because there is no foreseeable limit to the cash flows generated by the intangible asset. Such intangible assets have no legal, contractual, regulatory, economic, or competitive limiting factors. Indefinite-life intangibles, nevertheless, are subject to an impairment test that should be performed at least annually. Examples of indefinite-life intangibles are: goodwill, trademarks, perpetual franchises, etc.

Types of intangible assets:

  1. Artistic-related: copyrights (photos, videos, audio materials)
  2. Consumer-related: customer lists, contractual customer relationships, etc.
  3. Contract-related: franchises, licensing agreements, broadcast rights, construction permits, exploration permits, import and export permits, service contracts, etc.
  4. Goodwill (identified only with a business as a whole)
  5. Market-related: trademarks, brand names, internet domain names, magazine mastheads, etc.
  6. Technology-related: patents, trade secrets, computer programs, product formulas, etc.

Intangible assets (other than goodwill) are reported similarly to property, plant, and equipment (PP&E) assets on the balance sheet. Goodwill is reported separately. The notes to financial statements should include information about purchased intangible assets (e.g. amortization expense for the next five years; changes in the carrying value of goodwill; accumulated depreciation if separate accumulated amortization accounts are not used).

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