This topic discusses the identification, measurement, and disposition of intangible assets. These assets provide the entity that owns them with some kind of preferred position because of certain rights or special privileges they are allowed. Intangible assets are valued at their cost and generally are adjusted downward to reflect their future benefit to the entity as of the end of each fiscal period.
Characteristics and Classification of Intangible Assets
The characteristics of an intangible asset are:
- They lack physical existence,
- They are not a financial instrument, and
- They are long-term in nature and subject to amortization.
Classification of Intangible Assets
- Separately identifiable intangible assets:
Patents, Copyrights, Trademarks and Trade names, Franchises and Licenses
- Non-separately identifiable intangible assets:
Accounting for Acquisition of Intangible Assets
- Cost is the appropriate basis for recording purchased intangible assets.
- Like tangible assets, cost includes acquisition price and all other expenditures necessary in making the asset ready for its intended use.
- When intangibles are acquired for consideration other than cash, the cost of the intangible is the fair market value of the consideration given or the intangible asset received, whichever is more clearly evident.
- Costs incurred to create internally-created intangibles are generally expensed as incurred.
Amortization of Intangible Assets
Amortization is the process of systematically charging the cost of intangible assets to expenses.
Factors to be considered for amortization:
- Amortizable cost: Cost minus estimated residual value which usually is zero.
- Estimated useful life: Choose the shortest of (1) legal life (if applicable); (2) economic life (which can be much shorter than its legal life; or (3) 40 years.
- Amortization method: Usually the “straight-line method.” (This method is required for income tax purposes).
- Entries to record the amortization
Dr. Amortization expense A/c
Cr. Intangible assets/Accumulated amortization A/c
- Impairments of intangibles: When an intangible asset ceases to provide future service potential to an enterprise, its cost should be removed from the accounting records.
- Intangible assets are normally shown in financial statements at cost less total amortization taken to date. The financial statements should disclose the method of amortization, but a separate Accumulated Amortization Account needs not be presented.
Description of Several Intangible Assets
- A patent gives the holder an exclusive right to use, manufacture and sell a product or process for a period of 20 years.
– Product patents, which cover actual physical products.
– Process patents, which relate to the process which products are made.
- Amortization is recorded over the legal life or useful life, whichever is shorter.
- Any legal costs incurred to successfully defend a patent suit may be charged to the Patents Account and amortized over the remaining useful life.
- Research and development costs related to the development of a product, process, or idea that is subsequently patented must be expensed as incurred.
- A copyright is a federally granted right that authors and other artists have in their creations.
- A copyright is granted for the life of the creator plus 50 years. During this time the owner or heirs have the exclusive right to reproduce and sell an artistic or published work.
- Normally, the useful life of a copyright is less than its legal life, but, in any case, amortization should not exceed 40 years.
Trademarks or Trade Names
- A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a particular enterprise’s product. A company that registers a trademark or trade name with the U.S. Patent Office may renew it for an unlimited number of 20 year periods. Thus, a company establishing a trademark or trade name can consider it to have an unlimited life. The cost to be capitalized for a trademark or trade name is the acquisition cost if purchased, or all associated expenditures (other than research and development costs) if the item is developed the company.
- Even though the life of a trademark or trade name may be unlimited, its cost must be amortized over the periods benefited or 40 years, whichever is shorter.
Franchises and Licenses
- A franchise provides an entity with the right to conduct a particular business or sell a particular product, usually in a designated geographical area.
- A license is granted a government entity for the use of public property or a service.
- Franchises and licenses may be for a definite period of time, for an indefinite period of time, or perpetual.
- Franchise or license costs that benefit future periods should be recorded in a Franchise or License account. These costs are amortized over the life of the franchise or license or 40 years, whichever is less.
- Continuing periodic franchise and license payments are expenses of the period and do not represent assets associated with future periods.
- Goodwill is recorded only when an entire business is purchased because goodwill is a “going concern” valuation and cannot be separated from the business as a whole.
- Goodwill is measured in a business purchase computing the difference between acquisition cost of the investment and the fair market value of the net assets of the acquired company.
- Goodwill is not amortized. However, periodic valuation should be taken to see if the value of goodwill is impaired. A loss must be recorded to write down goodwill if it is impaired.
Valuing Goodwill and Determining Purchase Price
- Goodwill can be measured in a business purchase discounting the extra earning potential of an enterprise and determining the present value of this extra inflow.
- The factors necessary to compute goodwill under this approach are: (a) the normal rate of return for the enterprise, (b) an estimate of the future earnings of the enterprise, (c) the discount rate that should be applied to excess profits, and (d) the number of periods over which excess profits should be discounted.
Research and Development
- The expenditure for research and development is designed to develop new products or processes, improve existing processes, and discover new knowledge.
- FASB Statement No. 2 requires that all research and development (R&D) costs be charged to expense when incurred.
- The reasons for this treatment include problems associated with (a) identifying the costs associated with particular activities, projects, or achievements and (b) determining the magnitude of future benefits and length of time over which such benefits may be realized.
- The following is a description of the recommended treatment of the costs associated with R&D activities:
- Materials, Equipment, and Facilities. Expense the entire costs, unless the items have alternative future uses (in other R&D projects or otherwise), then carry as inventory and allocate as consumed or capitalize and depreciate as used.
- Personnel. Salaries, wages, and other related costs of personnel engaged in R&D should be expensed as incurred.
- Purchased Intangibles. Expense the entire cost, unless the items have alternative future uses (in other R&D projects or otherwise), then capitalize and amortize.
- Contract Services. The costs of services performed others in connection with the reporting company’s R&D should be expensed as incurred.
- Indirect Costs. A reasonable allocation of indirect costs should be included in R&D costs, except for general and administrative cost, which must be clearly related to be included and expensed.