Understanding Intangible Assets and Amortization Expense

After investments and other assets (covered in the next section), the company lists goodwill and then other intangibles, net of amortization. In addition to providing benefits, a franchise usually places certain restrictions on the franchisee.

• The person or company obtaining rights to possess and use the property is the lessee.
• In accounting, goodwill is an intangible value attached to a company resulting mainly from the company’s management skill or know-how and a favorable reputation with customers.
• Intangible assets are non-physical resources that hold measurable value for businesses and organizations.
• Intangible assets are generally both nonphysical and noncurrent; they appear in a separate long-term section of the balance sheet entitled “Intangible assets”.
• When purchasing a patent, a company records it in the Patents account at cost.

Intangible assets are generally both nonphysical and noncurrent; they appear in a separate long-term section of the balance sheet entitled “Intangible assets”. For example, an individual who wishes to open a hamburger restaurant may purchase a McDonald’s franchise; the two parties involved are the individual business owner and McDonald’s Corporation. This franchise would allow the business owner to use the McDonald’s name and golden arch, and would provide the owner with advertising and many other benefits. A copyright is an exclusive right granted by the federal government giving protection against the illegal reproduction by others of the creator’s written works, designs, and literary productions.

Unit 11: Plant Assets and Intangible Assets

• Understanding the difference is crucial for accounting and business valuation.
• However, something like goodwill that is purchased when a company buys another company has an undefined useful life.
• This is similar to fixed assets, except the allocation of the cost is called amortization instead of depreciation, and it is usually calculated using the straight-line method.
• A portion of an intangible asset’s cost is allocated to each accounting period in the economic (useful) life of the asset.
• Amortization is the systematic write-off of the cost of an intangible asset to expense.

However, computing an intangible asset’s acquisition cost differs from computing a plant asset’s acquisition cost. Firms may include only outright purchase costs in the acquisition cost of an intangible asset; the acquisition cost does not include cost of internal development or self-creation of the asset. If an intangible asset is internally generated in its entirety, none of its costs are capitalized. Therefore, some companies have extremely valuable assets that may not even be recorded in their asset accounts.

The finite useful life for a copyright extends to the life of the creator plus 50 years. Straight-line amortization is calculated the same was as straight-line depreciation for plant assets. Generally, we record amortization by debiting Amortization Expense and crediting the intangible asset account. An accumulated amortization account could be used to record amortization. However, the information gained from such accounting would not be significant because normally intangibles do not account for as many total asset dollars as do plant assets. When purchasing a patent, a company records it in the Patents account at cost.

The finite useful life of such an asset is considered to be the length of time it is expected to contribute to the cash flows of the reporting entity. (Pertinent factors that should be considered in estimating useful life include legal, regulatory, or contractual provisions that may limit the useful life). The method of amortization should be based upon the pattern in which the economic benefits are used up or consumed. If no pattern is apparent, the straight-line method of amortization should be used by the reporting entity. Tangible assets are physical assets like property, plant, and equipment.

The firm also debits the Patents account for the cost of the first successful defense of the patent in lawsuits (assuming an outside law firm was hired rather than using internal legal staff). Such a lawsuit establishes the validity of the patent and thereby increases its service potential. In addition, the firm debits the cost of any competing patents purchased to ensure the revenue-generating capability of its own patent to the Patents account. This exclusive right enables the owner to manufacture, sell, lease, or otherwise benefit from an invention for a limited period. Protection for the patent owner begins at the time of patent application and lasts for 17 years from the date the patent is granted. Intangible assets are mainly classified as identifiable or unidentifiable based on whether they can be separated and sold.

What you will learn to do: Account for intangibles

Correct presentation of intangible assets demonstrates an organization’s true financial strength. The accounting treatment for intangible assets involves recognizing them at cost, then amortizing them over their useful life (except for goodwill, which is tested for impairment). This is guided by accounting standards like IAS 38 and AS 26 and requires careful consideration of their nature and useful economic lives. Understanding intangible assets is required for analyzing company accounts, preparing for commerce exams, and making informed business choices. Concepts like goodwill, amortization, and impairment are frequently asked in financial statements and accounting standards exam questions. Initially, firms record intangible assets at cost like most other assets.

Amortization and Impairment of Intangible Assets

Understanding these distinctions helps in proper accounting and reporting for exams and real-world financial analysis. The property owner is the grantor of the lease and is the lessor. The person or company obtaining rights to possess and use the property is the lessee.

Building up a good reputation with customers or establishing a well-known brand is not recorded as an intangible asset. Intangible assets are reported on the balance sheet, typically under non-current assets. This section lists long-term assets providing future economic benefits. The specific presentation depends on accounting standards (e.g., IAS 38, AS 26). Amortization systematically allocates the cost of an intangible asset over its useful life.

Mastering the concept of intangible assets is essential for students appearing in accountancy exams, as well as for anyone interested in finance or understanding real-world business valuation. This topic is commonly examined in school and competitive exams and is crucial for analyzing company balance sheets. Intangible assets are typically expensed according to their respective life expectancy. This is similar to fixed assets, except the allocation of the cost is called amortization instead of depreciation, and it is usually calculated using the straight-line method. Those with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, whichever one is shorter. Recognized intangible assets deemed to have indefinite useful lives are not to be amortized.

Understanding Intangible Assets and Amortization Expense

A company’s value may be greater than the total of the fair market value of its tangible and identifiable intangible assets. This greater value means that the company generates an above-average income on each dollar invested in the business. Thus, proof of a company’s goodwill is its ability to generate superior earnings or income. Intangible means without physical existence, in contrast to buildings, vehicles, and computers. Amortization refers to the allocation of the cost of an intangible asset over its estimated economic life. Intangible assets are non-physical resources that hold measurable value for businesses and organizations.

Use this knowledge to master exam questions, confidently analyze accounts, and better understand real-world business strategies. Only intangible assets that are purchased are recorded by a business. A business must expend cash, or take on debt, or issue owners’ equity shares for an intangible asset in order to record the asset on its books.

FAQs on Intangible Assets in Accounting: Meaning, Examples, and Reporting

A goodwill account appears in the accounting records only if goodwill has been purchased. A company cannot purchase goodwill by itself; it must buy an entire business or a part of a business to obtain the accompanying intangible asset, goodwill. Since these positive factors are not individually quantifiable, when grouped together they constitute goodwill.

The amount of any goodwill impairment loss is to be recognized in the income statement as a separate line before the subtotal income from continuing operations (or similar caption). Amortization is the systematic write-off of the cost of an intangible asset to expense. A portion of an intangible asset’s cost is allocated to each accounting period in the economic (useful) life of the asset. Only recognized intangible assets with finite useful lives are amortized.

Tangible assets are physical and touchable (e.g., buildings, machinery), while intangible assets lack physical form but hold economic value (e.g., patents, brand reputation). Both are reported on the balance sheet but have different accounting treatments; tangible assets are depreciated while intangible assets are typically amortized. Intangible assets with identifiable value and finite useful lives are reported on the balance sheet as non-current assets. They are initially recorded at cost and then amortized over their useful life. Goodwill, however, is not amortized but tested for impairment annually. In accounting, goodwill is an intangible value attached to a company resulting mainly from the company’s management skill or know-how and a favorable reputation with customers.

Amortization will however begin when it is determined that the useful life is no longer indefinite. The method of amortization would follow the same rules as intangible assets with finite useful lives. Impairment of intangible assets reduces their carrying value on the balance sheet, signaling a decrease in future economic benefits. This can negatively impact company valuation as it suggests lower profitability and reduced future cash flows, affecting investor confidence the expensing of intangible assets is called and potentially loan agreements. Unlike tangible assets that are depreciated, intangible assets (except goodwill) are amortized.

Intangible assets are non-physical assets such as patents, copyrights, and brand recognition that provide future economic benefits. Understanding the difference is crucial for accounting and business valuation. Intangible assets appear under non-current assets on a company’s balance sheet. Their valuation follows accounting standards such as AS 26 and IAS 38. Most identifiable intangibles are amortized over their useful life, while goodwill is tested annually for impairment.