Reporting and Analyzing Intangibles



Reporting Intangibles

Intangible assets are either recorded at cost or expensed as they are created.

Learning Objectives

Explain how to value an intangible asset for reporting purposes

Key Takeaways

Key Points

  • The most common types of intangibles are patents, copyrights, franchises or licenses, trademarks or trade names, and goodwill.
  • In most cases, intangible assets provide services over a period of years.
  • Intangibles purchased from another party are recorded at cost.
  • The cost of created intangibles is generally expensed as incurred.
  • Intangible assets derive their value from the rights and privileges granted to the company using them.

Key Terms

  • Intangibles: Things that are recognized but not easily quantified.
  • Capitalized: To capitalize is to treat costs as capital not an expense. The capital expenditure costs are then amortized or depreciated over the life of the asset.

Intangibles

Intangible assets lack physical existence. Unlike tangible assets such as property, plant, and equipment, intangible assets derive their value from the rights and privileges granted to the company using them.

They are not financial instruments. Assets such as bank deposits, accounts receivable, and long-term investments in bonds and stocks lack physical substance, but are not classified as intangible assets. These assets are financial instruments and derive their value from the right or claim to receive cash or cash equivalents in the future.

In most cases, intangible assets provide services over a period of years. As a result, they are normally classified as long-term assets. The most common types of intangibles are patents, copyrights, franchises or licenses, trademarks or trade names, and goodwill.

Valuation and Accounting

Intangibles purchased from another party are recorded at cost. Cost includes all costs of acquisition and expenditures necessary to make the intangible asset ready for its intended use—for example, purchase price, legal fees, and other incidental expenses.

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Reporting Intangibles: Valuation and Accounting

If intangibles are acquired for stock or in exchange for other assets, the cost of the intangible is the fair value of the consideration given or the fair value of the intangible received, whichever is more clearly evident.

The accounting treatment for purchased intangibles closely parallels that followed for purchased tangible assets. The cost of created intangibles is generally expensed as incurred. Therefore, even though a company may incur substantial research and development costs to create an intangible, these costs are expensed.

Various reasons are given for this approach. Some argue that the costs incurred internally to create intangibles bear no relationship to their real value. Therefore, expensing these costs is appropriate. Others note that with a purchased intangible, a reliable number for the cost of the intangible can be determined. With internally developed intangibles, it is difficult to associate costs with specific intangible assets. And others argue that due to the underlying subjectivity related to intangibles, a conservative approach should be followed—that is, expense as incurred.

The accounting for intangible assets depends on whether the intangible has a limited or an indefinite life. The costs of acquiring and defending a copyright may be capitalized, but the research and development costs involved must be expensed as incurred. Generally, the useful life of the copyright is less than its legal life. The costs of the copyright should be allocated to the years in which the benefits are expected to be received. The difficulty of determining the number of years over which benefits will be received normally encourages the company to write these costs off over a fairly short period of time.

Reporting R&D Cost

Expense R&D, unless items have alternative future uses, then allocate as consumed, or capitalize and depreciate as used.

Learning Objectives

Summarize how to report research and development costs on the financials statements

Key Takeaways

Key Points

  • R&D costs may be expensed. A cost which cannot be deducted in the year in which it is paid or incurred must be capitalized.
  • If the acquired property’s useful life is longer than the taxable year, then the cost must be capitalized. The capital expenditure costs are then amortized or depreciated over the life of the asset.
  • Choice of the appropriate accounting treatment should be guided by the degree of certainty of future benefits and the principle of matching revenues and expenses.

Key Terms

  • research: Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
  • development: Development is the application of research findings to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services, before the start of commercial production or use.

Research and Development Defined

Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.

Development is the application of research findings to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services, before the start of commercial production or use.

Reporting R&D Costs

R&D costs may be expensed. A cost which cannot be deducted in the year in which it is paid or incurred must be capitalized. The general rule is that if the acquired property’s useful life is longer than the taxable year, then the cost must be capitalized. The capital expenditure costs are then amortized or depreciated over the life of the asset. Choice of the appropriate accounting treatment for such costs should be guided by the degree of certainty of future benefits and the principle of matching revenues and expenses.

Some companies conduct R&D activities for other entities under a contractual arrangement. In this case, the contract usually specifies that all direct costs, certain specific indirect costs, plus a profit element, should be reimbursed to the enterprise performing the R&D work. Because reimbursement is expected, such R&D costs should be recorded as a receivable. It is the company for whom the work has been performed that reports these costs as R&D and expenses them as incurred.

It should be emphasized that R&D activities do not include routine or periodic alternatives to existing products, production lines, manufacturing processes, and other ongoing operations even though these alterations may represent improvements. For example, routine ongoing efforts to refine, enrich, or improve the qualities of an existing product are not considered R&D activities.

Reporting R&D Activities

The costs associated with R&D activities and the accounting treatment accorded them are as follows: expense the entire costs, unless the items have alternative future uses (in other R&D projects or otherwise), then carry as inventory and allocate as consumed, or capitalize and depreciate as used.

Analyzing Intangible Assets

Intangibles with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, whichever is shorter.

Learning Objectives

Explain how to report intangible assets on the financial statements

Key Takeaways

Key Points

  • Intangible assets are typically expensed according to their respective life expectancy. Intangible assets have either an identifiable or indefinite useful life.
  • Examples of intangible assets with identifiable useful lives include copyrights and patents.
  • Intangible assets with indefinite useful lives are reassessed each year for impairment. If an impairment has occurred, then a loss must be recognized.
  • Some costs with respect to intangible assets must be capitalized rather than treated as deductible expenses.

Key Terms

  • goodwill: The value of an asset that is considered intangible but has a quantifiable “value” in a business. For example, a reputation the firm enjoys with its clients.
  • impairment: When the carrying value exceeds the fair value.
  • Amortized: Refers to expensing the acquisition cost in a systematic manner over economic or legal lives so as to reflect their consumption, expiry, obsolescence or other decline in value as a result of use or the passage of time.

Analyzing Intangible Assets

Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured. Intangible assets are created through time and effort, and are identifiable as a separate asset.

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Analyzing Intangibles: How to Analyze Intangible Assets

Intangible assets are typically expensed according to their respective life expectancy. Intangible assets have either an identifiable or indefinite useful life. Those with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, whichever one is shorter. Examples of intangible assets with identifiable useful lives include copyrights and patents.

Intangible assets with indefinite useful lives are reassessed each year for impairment. If an impairment has occurred, then a loss must be recognized. An impairment loss is determined by subtracting the asset’s fair value from the asset’s book or carrying value. Trademarks and goodwill are examples of intangible assets with indefinite useful lives. Goodwill has to be tested for impairment rather than amortized. If impaired, goodwill is reduced and loss is recognized in the Income statement.

Capitalization

Some costs with respect to intangible assets must be capitalized rather than treated as deductible expenses. Treasury regulations generally require capitalization of costs associated with acquiring, creating, or enhancing intangible assets. For example, an amount paid to obtain a trademark must be capitalized. Certain amounts paid to facilitate these transactions are also capitalized. Some types of intangible assets are categorized based on whether the asset is acquired from another party or created by the taxpayer. The regulations contain many provisions intended to make it easier to determine when capitalization is required.

Research and Development

Research and development (R&D) costs are not in and of themselves intangible assets. R&D activities frequently result in the development of something that is patented or copyrighted (such as a new product, process, idea, formula, composition, or literary work). Many businesses spend considerable sums of money on research and development to create new products or processes, improve present products, and discover new knowledge that may be valuable.