What Is an Intangible Asset?
Intangible assets differ from tangible assets, which have physical forms such as buildings or office furniture. For businesses, an intangible asset includes patents, goodwill, and intellectual property.
Key Takeaways
- An intangible asset is a non-physical asset such as a patent, brand, trademark, or copyright.
- Businesses can create or acquire intangible assets.
- An intangible asset like a brand name is considered indefinite.
- A legal contract or agreement is a definite intangible asset.
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Types of Intangible Assets
Intangible assets are generally considered long-term and their value can increase over time. An intangible asset like a brand name can be critical to a company's long-term success. Businesses can create or acquire intangible assets. For example, a company may create a mailing list of clients or establisha patent. It can write off the expenses from the process, such as filing the patent application, hiring a lawyer, and paying other related costs.
An indefinite intangible asset stays with the holder as long as it continues to operate, such as a brand name. A definite intangible asset is restricted to a limited timeframe such as a legal agreement to operate under another company's patent. Types of intangible assets include:
- Brand: A brand sets a business apart from its competition and is commonly represented by a logo, symbol, or name. Companies use marketing, design techniques, and advertising to create their brand. The Nike swoosh or the red Coca-Cola label are two easily recognized branding techniques. Brands contribute to a company's brand equity and help keep customers loyal.
- Goodwill: When one company purchases another, the intangible assets associated with that transaction are considered goodwill. When a company acquires another business, any amount that exceeds the fair value of the target's net assets represents its goodwill. The amount above the target's book value results in positive goodwill. Anything below book value is negative goodwill or badwill.
- Intellectual Property: A type of intangible asset that is legally protected and cannot be used by another business or individual unless authorized by the owner. Common forms of intellectual property include copyrights, digital assets, franchises, patents, trademarks, and trade secrets.
Any unauthorized use of intellectual property is called infringement. This includes using, mimicking, or copying another entity's brand name, logo, or other intangible assets.
How to Value Intangible Assets
A business like Coca-Cola (KO) can contribute much of its success to brand recognition. Although brand recognition is not a physical asset that can be seen or touched, it can have a meaningful impact on generating sales.
Intangible assets have no recorded book value. Because of this, when a company is purchased, the purchase price is above the book valueof assets on the balance sheet. The purchasing company records thepremium paid as an intangible asset on its balance sheet.There are three common ways that businesses can value their intangible assets, according to the American Institute of Certified Public Accountants (AICPA):
- Market Approach: This valuation compares similar intangible assets in the marketplace. It may prove difficult because of the limited details available about assets held by other companies.
- Income Approach: Companies can use this method when their intangible assets have a cash flow stream. Some income approaches include the relief from royalty method, which estimates possible royalty payments derived from the use of the asset or the avoided loss of income.
- CostApproach: This method relies on substitution and doesn't account for future benefits based on time or amount.
Intangible vs. Tangible Assets
Tangible assets can be current or fixed. Current assets can be easily used and converted to cash such as inventory. Fixed assets are tangible assets with a lifespan of one year or more. are considered fixed.
Common tangible assets include property, equipment, furniture, inventory, and vehicles. Financial securities, such as stocks and bonds, are also considered tangible assets because they derive value from contractual claims.
Unlike intangible assets, the value of tangible assets is easier to determine. The owner may choose to hire an appraiser who determines the fair market value (FMV) of the asset or they may decide to sell the asset for cash. Another common form of valuation is comparing it to the cost of a replacement.
Why Is It Difficult to Value Intangible Assets?
It is often difficult to determine an intangible asset's future benefits and lifespan or the costs associated with maintaining it.The useful life of an intangible asset can be either identifiable or non-identifiable. Most intangible assets are considered long-term assets with a useful life of more than one year.
What Is Brand Equity?
Brand equity is an intangible asset and refers to a value premium that a company generates from a recognized product instead of its generic equivalent. Companies create brand equity for their products through massmarketing campaigns.
How Are Intangible Assets Disclosed on a Company's Balance Sheet?
Internally developed intangible assets do not appearon a company's balance sheet. When intangible assets have an identifiable value and lifespan,they appear on a company's balance sheet aslong-term assetsvalued according to their price andamortization schedules.
The Bottom Line
Businesses can have both tangible and intangible assets. Even though intangible assets can't be seen and held, they provide value for companies as brand names, logos, or mailing lists. Intangible assets can be difficult to value.
