Mostly, intangible assets have a life of more than a year. So, these assets are not classified as current assets. Instead, these assets are classified as non-current assets and amortized over the useful life.
Examples of intangible assets include software, patents, and goodwill that do not seem to be depleted within twelve months. Hence, these are classified as non-current assets.
Let’s discuss detailed aspects of intangible assets in terms of definition, explanation, development, amortization, impairment, and classification, etc.
Intangible assets are business assets that do not have a physical existence, and the non-physical existence of these assets helps in the inflow of economic benefits.
The examples of these assets include copyrights, patents, licenses, goodwill, and trade-marks that help bring inflow of economic benefits in the business as we understand that the assets like goodwill, patents, and copyrights are expected to last for a longer period than a year. Hence, intangible assets are non-current assets.
Intangible assets are recorded in the business’s balance sheet, and these assets are stated at cost less accumulated amortization and impairment. To be recognized as an intangible asset, it must be separable, identifiable, non-monetary, and without physical existence.
Separable means an asset can be sold/transferred/licensed separately. Sometimes, an asset may not be separable but needs to arise from the contractual right.
For instance, internally generated goodwill cannot be separable. So, the business can not recognize it as an asset. However, if the business is sold to someone, the buyer can record the goodwill if the consideration paid to acquire the business is more than net assets acquired.
It’s important to note that goodwill is not separable for the business seller. So, they cannot recognize in the books of accounts. However, the purchasing party can prove legal right as they have paid more than net asset value. Hence, the excess amount paid must be due to goodwill acquisition.
Although goodwill cannot be internally developed, intangible assets like patents and software can be internally developed. However, the expense incurred on the development of intangible must comply with the following criteria,
- The cost incurred in the process of development can be reliably measured.
- The business needs to complete the project and raise cash flow.
- The business has sufficient resources to complete the project.
- The business can use/sell the intangible.
- The project is technically feasible.
- The expenses can be identified separately.
- It is probable that in the future, the economic benefits associated with an asset will flow in the business.
So, the expenses that do not qualify given criteria need to be classified as research expenses, and this expense is directly charged in the business’s income statement. On the other hand, the expenses that meet the given criteria are classified as an intangible assets.
Intangible assets are always non-monetary in nature. It means the business is not entitled to receive a fixed amount on the sale of the asset. So, it’s different from bank accounts and long-term investments where business is entitled to receive the fixed amount. So, intangible assets may have some market, but that cannot be financial market.
No physical substance
Intangible assets are mostly technology-based businesses and cannot be touched. For instance, software and patents are intangible that cannot be touched. However, these assets help the business in the efficient management of the activities.
Initially, intangible assets are recorded at cost. However, amortization is charged with the time, and assets are presented net of accumulated amortization and impairment. Further, the business can value the asset at fair market value, but there should be an active market for the assets to be recorded at fair value.
Impairment testing of intangible assets
If the life of intangibles is indefinite, no amortization is charged. However, annual testing for impairment needs to be performed to ensure the appropriate value of the assets is reflected in the financial statement. Similarly, impairment testing needs to be performed if there is any indication for the impairment in the value of assets.
To perform impairment testing, the asset’s carrying amount is compared with the recoverable amount; if the carrying value is greater than the recoverable amount, an impairment is charged in the income statement. On the other hand, no impairment is charged in the income statement if the carrying value is less than the recoverable amount.
Depreciation/amortization of the intangible asset
The intangible asset with a definite life is amortized over its life. Amortization reflects that benefit obtained with the use of an intangible asset. Accounting treatment and entry for amortization are similar to depreciation.
The expense is debited in the income statement, and the credit side is posted in the contra account; this account contains accumulated credit balance adjusted against the cost of an asset while reporting net book value.
Further, amortization has an inverse impact on profit. So, inputs to be used in the amortization like cost and useful life need to be calculated with due consideration.
However, sometimes the business is not able to determine the life of intangible. For instance, one cannot predict the life of a goodwill. Hence, it carried indefinite life, and amortization cannot be charged on it. However, impairment needs to be tested annually when an indication of impairment exists.
Disposal treatment of intangible assets
The disposal treatment of the intangible asset is the same as in the case of tangible assets. So, the net book value of intangibles is deducted from sale proceeds, any resulting gain/loss is recorded in the income statement.
Subsequent measurement of intangible asset
The subsequent measurement of intangible assets can be done using the cost model and revaluation model.
Under this model, the intangibles remain on cost and are not compared with the market value. These assets are stated at cost less accumulated depreciation in the financial statement.
Under the revaluation model, the asset’s market value is obtained and compared with the carrying value. If the market value of an asset exceeds, it’s considered to be an increase in the fair value and added in the cost of an asset. Similarly, the credit side is recorded in the comprehensive income.
However, the revaluation model can only be applied if there is an active market of intangibles that may not be available easily, especially in the case of internally developed intangibles its much difficult to find an active market. Hence, most businesses prefer to keep intangibles at cost model.
Intangible assets are separable, non-monetary, and without physical substance. These assets may be internally developed or acquired from other businesses. If the business internally develops the intangible asset, certain criteria need to be fulfilled. Otherwise, the cost incurred in developing an asset is charged in the incomes statement under the head of research expenses.
Initially, intangible is valued at the cost incurred in the case of development. Similarly, intangible purchases are valued at the price paid. Once intangibles are recognized in the books of accounts, amortization is charged. However, if the life of an asset cannot be estimated, no depreciation is charged, but impairment is assessed annually.
Frequently asked questions
Why are intangible assets non-current assets in nature?
Intangible assets usually have a life of more than one year. In other words, the business uses intangible assets for more than one year. Even some assets like goodwill have an indefinite life. However, in a normal business run, these assets have a life of more than a year. Hence, intangibles are classified as non-current assets.
Why is goodwill an example of an intangible asset?
Goodwill is an example of an intangible asset because it’s separable (only when acquired), non-monetary, and without physical substance. So, it’s classified as an example of an intangible asset.
Is goodwill a fictitious asset in the balance sheet of the business?
Goodwill is not a fictitious asset as it does have realizable value. On the other hand, the fictitious asset is merely an expenditure with no subsequent cash inflow. On the other hand, goodwill helps in the cash inflow of the business.