💰Intermediate Financial Accounting I Unit 9 – Intangible Assets

What Are Intangible Assets?

• Intangible assets are non-physical assets that provide long-term economic benefits to a company
• Lack physical substance but still hold value and can be bought, sold, or licensed (patents, trademarks, copyrights)
• Represent exclusive rights, privileges, or competitive advantages that contribute to a company's profitability
• Differ from tangible assets (property, plant, and equipment) in their nature and accounting treatment
• Recognized on the balance sheet when acquired from external sources or through business combinations
• Internally generated intangible assets are generally not recognized due to the difficulty in reliably measuring their cost and future economic benefits
• Key characteristics include identifiability, control, and future economic benefits
  • Identifiability distinguishes intangible assets from goodwill
  • Control ensures the company has the power to obtain benefits from the asset
  • Future economic benefits may include revenue from the sale of products or services, cost savings, or other benefits

Types of Intangible Assets

• Patents grant exclusive rights to manufacture, use, or sell an invention for a specified period (20 years from filing date in the US)
• Trademarks are distinctive signs, designs, or expressions that identify and distinguish a company's products or services (Nike swoosh, Apple logo)
• Copyrights protect original works of authorship, such as literary, musical, artistic, or software creations
• Licenses and franchises grant rights to use intellectual property, resources, or business models in exchange for fees or royalties
• Customer lists and relationships represent the value of a company's established customer base and the expected future benefits from these relationships
• Brand names and reputations are valuable intangible assets that can significantly influence consumer behavior and company performance (Coca-Cola, Disney)
• Goodwill arises when a company acquires another business and pays more than the fair value of its net identifiable assets
  • Represents the value of unidentifiable intangible assets, such as synergies, market position, or assembled workforce
• Domain names are internet addresses that can be valuable for companies operating in the digital space (amazon.com, google.com)

Initial Recognition and Measurement

• Intangible assets are initially recognized at cost when acquired separately or through a business combination
• Cost includes the purchase price and any directly attributable costs of preparing the asset for its intended use (legal fees, registration costs)
• Intangible assets acquired through a business combination are measured at fair value on the acquisition date
  • Fair value reflects the price that would be received to sell the asset in an orderly transaction between market participants
• Internally generated intangible assets are generally not recognized due to the difficulty in reliably measuring their cost and future economic benefits
  • Exceptions include certain development costs that meet strict criteria for capitalization
• Intangible assets acquired through government grants are initially measured at fair value or a nominal amount
• Exchanges of intangible assets are measured at fair value unless the transaction lacks commercial substance or the fair value cannot be reliably measured
• Grouped acquisitions of intangible assets are allocated cost based on their relative fair values
• Subsequent expenditures on intangible assets are capitalized only if they increase the asset's future economic benefits beyond its originally assessed standard of performance

Amortization vs. Indefinite Life

• Intangible assets with finite useful lives are amortized over their expected period of benefit
  • Amortization allocates the cost of the asset to the periods in which it generates economic benefits
• The amortization method should reflect the pattern of economic benefits consumption (straight-line, units of production)
• Factors influencing the useful life include legal, regulatory, or contractual provisions, as well as the effects of obsolescence, demand, or competition
• Residual value is generally assumed to be zero unless there is a commitment by a third party to purchase the asset or an active market exists
• Amortization period and method are reviewed at least annually and adjusted if expectations change significantly
• Intangible assets with indefinite useful lives are not amortized but are tested for impairment at least annually
  • Examples include certain trademarks, licenses, or broadcasting rights that have no foreseeable limit to their cash flow generation
• The indefinite life assessment is reviewed each reporting period to determine if events and circumstances continue to support an indefinite useful life
• If an intangible asset's useful life changes from indefinite to finite, it is accounted for as a change in accounting estimate and amortization begins

Impairment of Intangible Assets

• Intangible assets are tested for impairment when events or changes in circumstances indicate that their carrying amount may not be recoverable
  • Indicators include a significant decline in market value, adverse changes in the business environment, or plans to discontinue or restructure operations
• Impairment testing compares the asset's carrying amount to its recoverable amount, which is the higher of its fair value less costs of disposal and its value in use
  • Fair value less costs of disposal is the price that would be received in an orderly transaction between market participants, less incremental costs directly attributable to disposal
  • Value in use is the present value of future cash flows expected to be derived from the asset's continued use and ultimate disposal
• If the recoverable amount is less than the carrying amount, an impairment loss is recognized for the difference
• Impairment losses are recognized in profit or loss and cannot be reversed for goodwill
• For other intangible assets, impairment losses can be reversed if there has been a change in the estimates used to determine the recoverable amount
  • The increased carrying amount cannot exceed what would have been the carrying amount (net of amortization) had no impairment loss been recognized

Accounting for Research and Development

• Research and development (R&D) activities aim to develop new products, services, or processes, or improve existing ones
• Research costs are expensed as incurred because future economic benefits are uncertain and cannot be measured reliably
  • Includes activities aimed at obtaining new knowledge, searching for applications of research findings, or formulating and designing possible product or process alternatives
• Development costs are capitalized as intangible assets only if strict criteria are met:
  • Technical feasibility of completing the asset for use or sale
  • Intention to complete the asset and use or sell it
  • Ability to use or sell the asset
  • Demonstration of how the asset will generate probable future economic benefits
  • Availability of adequate technical, financial, and other resources to complete the development and use or sell the asset
  • Ability to measure reliably the expenditure attributable to the asset during its development
• Capitalized development costs are amortized over the period of expected future benefits
• If capitalization criteria are no longer met, capitalization ceases and any unamortized costs are expensed immediately

Disclosure Requirements

• Financial statements should disclose information that enables users to understand the nature, amount, timing, and uncertainty of intangible assets and their related cash flows
• For each class of intangible assets, companies should disclose:
  • Useful lives or amortization rates used
  • Amortization methods used
  • Gross carrying amount and accumulated amortization (including impairment losses) at the beginning and end of the period
  • A reconciliation of the carrying amount at the beginning and end of the period, showing additions, disposals, impairments, amortization, and other changes
• Intangible assets with indefinite useful lives should be disclosed separately, along with the reasons supporting the indefinite life assessment
• R&D expenditures recognized as expenses during the period should be disclosed
• Other relevant information may include restrictions on title, pledges as security for liabilities, or contractual commitments for the acquisition of intangible assets

Real-World Examples and Applications

• Microsoft's acquisition of LinkedIn in 2016 for $26.2 billion resulted in the recognition of significant intangible assets, including customer relationships, trade names, and developed technology
• Pharmaceutical companies heavily invest in R&D to develop new drugs and treatments, capitalizing development costs once regulatory approval is probable (Pfizer, Johnson & Johnson)
• Technology companies often hold valuable patent portfolios that protect their innovations and provide competitive advantages (IBM, Samsung, Canon)
• Luxury brands derive substantial value from their trademarks and brand reputation, which influence consumer perceptions and command premium prices (Louis Vuitton, Hermès, Gucci)
• Media and entertainment companies rely on copyrights to protect and monetize their content across various platforms (Disney, Netflix, Universal Music Group)
• Franchising allows companies to expand their business models and brand presence while collecting royalties from franchisees (McDonald's, 7-Eleven, Marriott)
• Wireless spectrum licenses are essential intangible assets for telecommunications companies, enabling them to provide mobile services to customers (Verizon, AT&T, T-Mobile)
• E-commerce companies benefit from strong domain names and customer data that facilitate online transactions and personalized marketing (Amazon, Alibaba, eBay)