Intangible assets and investments
Some of a company's most valuable assets cannot be touched: patents, brands, software, and goodwill. Accounting for them involves special rules.
Intangible assets
Intangible assets lack physical substance but provide future benefits: patents, copyrights, trademarks, franchises, licences, software, and customer lists. For many technology and consumer companies, intangibles far exceed physical assets in value, though much of their value, such as internally built brands, is not recorded on the balance sheet.
Recording intangibles
Purchased intangibles are recorded at cost. Under US GAAP, most internally generated intangibles, such as research costs and brand-building advertising, are expensed rather than capitalised. Under IFRS, development costs meeting certain criteria can be capitalised, one of several differences between the frameworks.
Amortisation
Intangibles with finite useful lives, such as patents (legal life about 20 years from filing in the US), are amortised, usually straight-line, over the shorter of their legal or useful life. Intangibles with indefinite lives, such as some trademarks that can be renewed indefinitely, are not amortised but are tested for impairment.
Goodwill
Goodwill arises only when one company acquires another and pays more than the fair value of its identifiable net assets, reflecting things like reputation, customer relationships, and expected synergies. Goodwill is not amortised under US GAAP for public companies or IFRS; instead, it is tested for impairment at least annually.
Impairment
An asset is impaired when its carrying amount exceeds the amount recoverable from using or selling it. The asset is written down, and an impairment loss is recognised. Large goodwill impairments often signal that an acquisition did not deliver expected value, as with several big write-downs by technology and media firms.
Investments in other companies
Companies invest in other firms' shares and bonds. Accounting depends on influence: small passive holdings are usually measured at fair value; holdings giving significant influence (often 20-50% of voting shares) use the equity method, recording a share of the investee's profits; control (usually over 50%) requires consolidation, combining the subsidiary's statements with the parent's.
Natural resources
Natural resources, such as oil reserves, timber, and mineral deposits, are recorded at cost and depleted as they are extracted, similar to units-of-production depreciation: depletion per unit = (cost - residual value) / estimated total units, times units extracted.
Worked example
Company A buys Company B for 50 million dollars. B's identifiable assets have a fair value of 60 million and its liabilities 25 million, so net identifiable assets are 35 million. Goodwill = 50 - 35 = 15 million. If, two years later, B's business performs poorly and the recoverable amount falls, A must recognise an impairment loss on the goodwill.
Key takeaways
Intangibles lack physical form but can be very valuable; many internally created intangibles are not recorded. Purchased intangibles are recorded at cost; US GAAP expenses most internal R&D, while IFRS can capitalise some development costs. Finite-life intangibles are amortised; indefinite-life ones and goodwill are tested for impairment. Goodwill arises only in acquisitions. Investment accounting depends on influence: fair value, equity method, or consolidation. Natural resources are depleted as extracted.
Flashcard
Non-physical assets with future benefits
Check your understanding
A company pays 30 million dollars to acquire a business whose net identifiable assets are worth 22 million. How much goodwill is recorded?