Intangible assets are non-monetary assets lacking physical substance.
Intangible assets include items that involve exclusive rights, such as patents, copyrights, trademarks, and franchises. Under IFRS, identifiable intangible assets must meet three definitional criteria. They must be
- (1) identifiable (either capable of being separated from the entity or arising from contractual or legal rights),
- (2) under the control of the company, and
- (3) expected to generate future economic benefits.
In addition, two recognition criteria must be met:
- (1) It is probable that the expected future economic benefits of the asset will flow to the company, and
- (2) the cost of the asset can be reliably measured.
Goodwill, which is not considered an identifiable intangible asset, arises when one company purchases another and the acquisition price exceeds the fair value of the net identifiable assets (both the tangible assets and the identifiable intangible assets, minus liabilities) acquired.
Intangible Assets Purchased in Situations Other Than Business Combinations
Intangible assets purchased in situations other than business combinations, such as buying a patent, are treated at acquisition the same as long-lived tangible assets; they are recorded at their fair value when acquired, which is assumed to be equivalent to the purchase price. If several intangible assets are acquired as part of a group, the purchase price is allocated to each asset on the basis of its fair value.
In deciding how to treat individual intangible assets for analytical purposes, analysts are particularly aware that companies must use a substantial amount of judgment and numerous assumptions to determine the fair value of individual intangible assets. For analysis, therefore, understanding the types of intangible assets acquired can often be more useful than focusing on the values assigned to the individual assets. In other words, an analyst would typically be more interested in understanding what assets a company acquired (e.g., franchise rights) than in the precise portion of the purchase price a company allocated to each asset. Understanding the types of assets a company acquires can offer insights into the company’s strategic direction and future operating potential.
Intangible Assets Developed Internally
The general requirement that costs to internally develop intangible assets be expensed should be compared with capitalising the cost of acquiring intangible assets in situations other than business combinations. Because costs associated with internally developing intangible assets are usually expensed, a company that has internally developed intangible assets, such as patents, copyrights, or brands through expenditures on R&D or advertising, will recognise a lower amount of assets than a company that has obtained intangible assets through external purchase. In addition, on the statement of cash flows, costs of internally developing intangible assets are classified as operating cash outflows whereas costs of acquiring intangible assets are classified as investing cash outflows. Differences in strategy (developing versus acquiring intangible assets) can thus impact financial ratios.
Intangible Assets Acquired in a Business Combination
When one company acquires another company, the transaction is accounted for using the acquisition method of accounting.
Under the acquisition method, the company identified as the acquirer allocates the purchase price to each asset acquired (and each liability assumed) on the basis of its fair value. If the purchase price exceeds the sum of the amounts that can be allocated to individual identifiable assets and liabilities, the excess is recorded as goodwill. Goodwill cannot be identified separately from the business as a whole.
