According to fundamental accounting principles, assets are anything you own that has value. The difference between intangible assets and tangible assets is that you cannot touch intangible assets. Like tangible assets, intangible assets also increase their value.
Because intangible assets provide long-term value to a business and cannot be converted quickly into cash, they are considered long-term assets. Intangible assets include intellectual property, such as patents and copyrights, and goodwill, such as a company's reputation and brand recognition. Keep reading to learn more about what is an intangible asset, its types and how to value such assets.
Did you know that Microsoft has the highest intangible assets (goodwill) level globally compared to all other companies.
What is an Intangible Asset?
Intangible assets are non-physical assets that are valued over time by a company. An intangible asset is not a physical object. A tangible asset can be touched or seen, whereas an intangible asset cannot. It is interesting to note that intangible assets also increase the value of tangible assets.
As well as being accounted for as a long-term asset, an intangible asset is subject to periodic impairment assessments and amortisation over its useful life. As well as this, intangible assets can either be definite or indefinite.
Also Read: What Is Caro 2016, Caro 2020 Applicability Explained With Reporting Requirements
Types of Intangible Assets
There are four common types of Intangible assets which are in use by many successful businesses. Listed below are four common intangible assets.
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Definite Intangible Assets
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Indefinite Intangible Assets
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Goodwill
Definite Intangible Assets
There is a set time limit on the value of a definite intangible asset. Definite intangible assets lose value when they expire. Using another company's patent without planning to extend the agreement would be an example of a definite intangible asset. Another example is a three-year contract for using another company's patent is a definite intangible asset since it loses value when it passes.
Indefinite Intangible Assets
Brand names are considered intangible assets because they stay with the company for as long as it continues to operate and will remain an asset indefinitely. A company's or brand's value stays indefinitely throughout its existence. Example: An intangible asset such as customer loyalty remains valuable to a business for the rest of its existence.
Goodwill
Intangible assets such as goodwill refer to the following,
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The success of a brand,
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The quality of service provided to customers, and
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The relationships between employees and management.
Business and accounting terms for goodwill include the ability to transfer, exchange, license, rent, or sell them separately from the company at any time. Examples: Brand recognition, consumer loyalty, company strategies, and employee relationships are unquantifiable assets. You cannot remove these items from the firm because they add value.
Intellectual Property
These intangible assets are the works you produce with your thoughts, such as inventions, names, images, designs, and literary works.
In India, there are seven types of intellectual property assets, namely.
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Copyright,
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Patents,
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Geographical indications,
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Plant varieties,
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Industrial designs and
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Semiconductor integrated circuit layout designs.
Examples: You can use a licence agreement, a copyright, a trademark, and a patent to protect your intellectual property. Further, these safeguards prevent other businesses from copying your work by accounting for intangible assets.
Also Read: Accrued Expenses Meaning Explained With Examples of Accrued Expenses & Importance
Importance of Intangible Assets in Business
A firm's ability to account for intangible assets is one of its most critical values. Here are some examples of intangible components:
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The reputation of a brand
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Relationship with customers
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Satisfaction of customers
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product or process that is patented
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Loyalty of customers
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Process quality in business
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People's quality
Why are Intangible Assets Important to Businesses?
In general, a strong brand and brand recognition influence customers. Consequently, these elements could determine whether your business succeeds or fails. Further, consumers prefer to do business with companies they know in various ways.
As well as establishing a reputation for quality and dependability, a strong brand can also select an image of reliability. In some cases, it also promotes social prestige. For example, a company that provides excellent customer service will be higher than the value of one that treats its customers poorly. Brand recognition and a unique patent enable businesses to charge higher prices for the items they sell. The performance of the stock market can be affected by intangible assets.
How to Manage Intangible Assets?
The management of tangible assets is relatively straightforward, such as machinery, equipment, furniture, and buildings. They are generally seen and touched because they are tangible. You can manage the intangible assets in the following ways:
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When accurately managing intangible assets, you will quickly find yourself in unfamiliar territory. It can sometimes take work to follow the same process.
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Your company gains much value from these assets. In addition, internal management of them is much more challenging, especially during decision-making. The reason is that they are not always reported on your balance sheet.
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Although valuing intangible assets is challenging, it is possible. Examples include the brand, the company name, and customer relationships.
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A termination date is not set for the accounting of intangible assets. However, that does not mean you cannot eliminate them. For example, a business can quickly lose value if it misuses social media platforms.
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Instead of reacting professionally to a negative internet review, one of your employees replies with insults. A viral message spreads quickly through social media, gaining access to millions of people. Due to this, your company's reputation has been damaged, and its value has diminished.
Valuing Intangible Assets
In most cases, tangible assets can be valued as a definite number. You calculate the total value by adding up the values of each actual item. However, it is essential to note that the value of tangible assets differs from the value of your business. Identifying the value of your intangible assets is more challenging than finding the value of tangible assets. You may need help to quantify your intangibles directly.
Your small business valuation must include your intangible assets if you plan to sell your company. To value assets, you should consult a business advisor. You can also use the methods listed below to determine the value of your intangible assets.
Cost method
You calculate the cost of duplicating your intangible asset by another business. Using this method, you can estimate how much it would cost to recreate the investment in today's market. All the costs that went into creating the support could be calculated and added to determine the present-day value.
Market method
Identify an intangible asset that compares with yours, such as another company's brand. When valuing your intangibles, use their intangibles as a reference point.
Income method
This method measures the future benefit that an intangible asset will bring to another business. For this method, you will need to use cash flow projections.
How to Calculate Intangible Assets?
You can use the below formula to determine the intangible assets' value:
Net Tangible Assets Value - Market Value of Business = Intangible Assets Value
Please note that the formula above only gives a rough estimate. The market value of your company is the highest price a purchaser is willing to pay for it (and the highest price you are ready to accept) as the owner.
Items Considered as Tangible Assets
The first step to finding net tangible assets is to list all your tangible assets. The following items are considered tangible assets:
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Inventories
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Your business's bank account balance
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A building
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The land
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The machinery
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Furniture
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Postage metres and other office supplies
Recording Intangible Assets in the Balance Sheet
A balance sheet does not include anything developed internally because it cannot be valued at fair market value. Intangible assets purchased by your company can be amortised and listed under tangible assets on your balance sheet.
For example, Meta (formerly Facebook) cannot list its Like button on its balance sheet since it is an intangible asset. Nevertheless, Instagram's "double tap" feature could theoretically be listed, given that it is valuable intellectual property acquired when it purchased Instagram.
Also Read: Know All About GAAP (Generally Accepted Accounting Principles)
Examples of Recording Intangible Assets
Companies only record intangible assets on their balance sheets when they purchase or acquire them. The following methods are some examples of how to record intangible assets:
Example #1: Acquisition of a Company
Imagine ABC is a health food company with strong brand recognition and a large following. Fresh Food Markets agrees to pay ABC company.
Due to ABC's excellent brand recognition and loyal client base, the company's actual fair market value is higher than the company's tangible assets.
Intangible assets are eventually classified as part of Fresh Food Markets' balance sheet.
Example #2: Purchase from another Enterprise
ABC has created strong brand awareness in the health foods sector and a considerable following thanks to its secret cupcake recipe. Patent protection is also granted to the recipe.
Additionally, they purchased the use of their patent and obtained access to their secret recipe from Fresh Food Markets for five years. As a result, Fresh Food Markets accounted for the cost of purchasing the patent as an intangible asset.
Conclusion
A tangible asset is in physical form but has a higher value than an intangible asset. A company's fair value should be calculated for intangible assets, which are difficult to value. Companies create or acquire intangible assets. A balance sheet does not usually reflect the value of intangible assets. Nevertheless, intangible assets are recorded on the balance sheets of acquired companies when two or more companies merge or accept each other.
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