Accounting for intangible assets
/What is an Intangible Asset?
An intangible asset is a non-physical asset that has a useful life of greater than one year. It can be difficult to account for these items, since they have no physical substance. Despite this concern, intangible assets can be quite valuable, and may even provide the bulk of the value of many large corporations. Examples of intangible assets are trademarks, customer lists, motion pictures, franchise agreements, and computer software. More extensive examples of intangible assets are noted below:
Artistic assets. Artistic assets can include photos, videos, paintings, movies, and audio recordings. This may be the main source of value for a movie studio.
Defensive assets. You may acquire an intangible asset so that others may not use it. Its useful life is the period over which it is of value in being withheld from the competition. For example, a provider of downloadable graphics development software might buy a competitor whose offering is provided as an on-line service, with the intent of shutting down the acquiree in order to stymie this form of competition.
Leasehold improvements. Leasehold improvements are improvements to a leaseholding, where the landlord takes ownership of the improvements. You amortize these improvements over the shorter of their useful lives or the lease term. Leasehold improvements can be substantial, especially when the landlord is only providing a “bare bones” facility, and the tenant has to finish the accommodations.
Software developed for internal use. Software developed for internal use is the cost of software developed for internal use, with no plan to market it externally. You amortize these costs over the useful life of the asset.
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Accounting for Intangible Assets
The proper accounting for an intangible asset depends on the circumstances, as described below:
Internally developed and not specifically identifiable. If there is not a specifically identifiable intangible asset, then charge its cost to expense in the period incurred.
Goodwill. When an entity acquires another entity, goodwill is the difference between the purchase price and the amount of the price not assigned to assets and liabilities acquired in the acquisition that are specifically identified. Goodwill does not independently generate cash flows.
Initial recognition of intangible assets. A business should initially recognize acquired intangibles at their fair values. You should initially recognize the cost of software developed internally and leasehold improvements at their cost. The cost of all other intangible assets developed internally should be charged to expense in the period incurred.
Amortization of intangible assets. If an intangible asset has a finite useful life, then amortize it over that useful life. The amount to be amortized is its recorded cost, less any residual value. However, intangible assets are usually not considered to have any residual value, so the full amount of the asset is typically amortized. If there is any pattern of economic benefits to be gained from the intangible asset, then adopt an amortization method that approximates that pattern. If not, the customary approach is to amortize it using the straight-line method.
If an intangible asset is subsequently impaired (see below), you will likely have to adjust the amortization level to take into account the reduced carrying amount of the asset, and possibly a reduced useful life. For example, if the carrying amount of an asset is reduced through impairment recognition from $1,000,000 to $100,000 and its useful life is compressed from 5 years to two years, then the annual rate of amortization would change from $200,000 per year to $50,000 per year.
If the useful life of the asset is instead indefinite, then it cannot be amortized. Instead, periodically evaluate the asset to see if it now has a determinable useful life. If so, begin amortizing it over that period. Alternatively, if the asset continues to have an indefinite useful life, periodically evaluate it to see if its value has become impaired.
Impairment testing for intangible assets. You should test for an impairment loss whenever circumstances indicate that an intangible asset’s carrying amount may not be recoverable, or at least once a year. Examples of such instances are:
Significant decrease in the asset’s market price
Significant adverse change in the asset’s manner of use
Significant adverse change in legal factors or the business climate that could affect the asset’s value
Excessive costs incurred to acquire or construct the asset
Historical and projected operating or cash flow losses associated with the asset
The asset is more than 50% likely to be sold or otherwise disposed of significantly before the end of its previously estimated useful life
If there is an impairment of intangible assets, you must recognize an impairment loss. This will be a debit to an impairment loss account and a credit to the intangible assets account.
The new carrying amount of the intangible asset is its former carrying amount, less the impairment loss. This means that you should alter the amortization of that asset to factor in its now-reduced carrying amount. It may also be necessary to adjust the remaining useful life of the asset, based on the information obtained during the testing process.
A previously-recognized impairment loss cannot be reversed.