Intangible assets have a long term nature as opposed to non-physical assets.
They are assets that are used in the operation of the business i.e. they contribute to the production or operating cycle of a business. While, non-physical assets are not used in the operation of the business.
For example, Accounts Receivable or Prepayments have no physical attributes but they are current assets, not intangible ones.
It is the systematic write-off to expenses of the cost of an intangible asset over its useful life, since it is not indefinite.
It is the parallel of depreciation. The straight line method is most commonly used.
The accounting entry to record amortization is:
Intangible Asset Account………….X
It is difficult to estimate the useful life of some intangible assets like that of a trademark. Amortization should be carried out over the shorter of the two: legal or economic life. So amortization is carried over the useful life only.
They will not benefit the firm forever.
Intangible assets can be amortized for a maximum period of 40 years.
Purchased Goodwill: It arises on the acquisition of one business by another. It is defined as the excess of the purchase price of the acquired business over the fair value of its net tangible and identifiable intangible assets.
Value the business as a whole and then subtract the current market value of the net identifiable assets. The current market value is determined from the p/e ratio.
Example: XYZ Company sells for 5 times annual earnings. The yearly income is $2 million. The value of the business is $10 million. Net identifiable assets are $8 million, so goodwill is $10-$8=$2million.
Capitalize the amount by which earnings exceed normal amounts. Capitalizing an earnings stream is done by dividing those earnings by the investor’s rate of return.
Goodwill in financial statements arises when a company is purchased for more than the book value of the company. It is the difference between the purchase price and the sum of the fair value of the net assets.
Impairment involves a comparison of the book value of the asset with its estimated recoverable amount.
The recoverable amount is defined as the value of an asset, either the price it would fetch if sold, or its value to the company when used, whichever is the larger figure .
If the recoverable amount is less than carrying value, the cash generating unit is said to be impaired. In this case the goodwill value needs to be reduced so that the recoverable amount of the cash generating unit is equal to its carrying value.
The impairment loss is reported as a separate line item on the income statement, and new adjusted value of goodwill is reported in the balance sheet.
A copyright is an intangible asset that gives its owner an exclusive legal right to the reproduction and sale of a literary or artistic work. It is granted by the federal government and lasts for the life of the creator plus 50 years.
Their legal life is very small but the economic life is limited to the period for which a commercial market exists for the publication. Copyrights are amortized over a short period of time.
Accounting for this is a controversial issue because:
Generally, they provide the firm with benefits but not always. It is not clear whether research would be successful or not so all these expenses are not capitalized and expensed out.
The costs may be incurred in 2008, for a product that will be nonexistent till 2010.
In today’s highly competitive economy, where all firms strive to secure their position through innovation, the period for which the benefits will last is virtually impossible to measure. E.g. the failure of IBM’s PC Junior in the mid-1980s.
Intangible assets such as moving costs, plant rearrangement costs, name lists and film rights, are grouped under deferred Charges.
Deferred charges are expenditures that will provide benefits beyond the current year and will be written off to expense over their useful economic lives.
For example, the costs incurred in issuing bonds for funds and those incurred for machinery rearrangement, both generate revenue, so the costs should be allocated to revenue over a reasonable number of years.