Intangible asset

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An intangible asset is an asset that lacks physical substance; in contrast to physical assets, such as machinery and buildings, and financial assets such as government securities. An intangible asset is usually very hard to evaluate. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names. The general interpretation also includes software and other intangible computer based assets; these are all examples of intangible assets. Intangible assets generally—though not necessarily—suffer from typical market failures of non-rivalry and non-excludability. [1]

Asset economic resource, from which future economic benefits are expected

In financial accounting, an asset is any resource owned by the business. Anything tangible or intangible that can be owned or controlled to produce value and that is held by a company to produce positive economic value is an asset. Simply stated, assets represent value of ownership that can be converted into cash. The balance sheet of a firm records the monetary value of the assets owned by that firm. It covers money and other valuables belonging to an individual or to a business.

Valuation (finance) process of estimating what something is worth, used in the finance industry

In finance, valuation is the process of determining the present value (PV) of an asset. Valuations can be done on assets or on liabilities. Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and in litigation.

Patent Intellectual property conferring a monopoly on a new invention

A patent is a form of intellectual property that gives its owner the legal right to exclude others from making, using, selling, and importing an invention for a limited period of years, in exchange for publishing an enabling public disclosure of the invention. In most countries patent rights fall under civil law and the patent holder needs to sue someone infringing the patent in order to enforce his or her rights. In some industries patents are an essential form of competitive advantage; in others they are irrelevant.

Contents

Definition

Intangible assets may be one possible contributor to the disparity between "company value as per their accounting records", as well as "company value as per their market capitalization". [2] Considering this argument, it is important to understand what an intangible asset truly is in the eyes of an accountant. A number of attempts have been made to define intangible assets:

The Australian Accounting Standards Board (AASB) is an Australian Government agency that develops and maintains financial reporting standards applicable to entities in the private and public sectors of the Australian economy. Also, the AASB contributes to the development of global financial reporting standards and facilitates the participation of the Australian community in global standard setting. The AASB's functions and powers are set out in the Australian Securities and Investments Commission Act 2001.

The International Accounting Standards Board (IASB) is the independent, accounting standard-setting body of the IFRS Foundation.

Financial Accounting Standards Board

The Financial Accounting Standards Board (FASB) is a private, non-profit organization standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the US. The FASB replaced the American Institute of Certified Public Accountants' (AICPA) Accounting Principles Board (APB) on July 1, 1973.

The lack of physical substance would therefore seem to be a defining characteristic of an intangible asset. Both the IASB and FASB definitions specifically preclude monetary assets in their definition of an intangible asset. This is necessary in order to avoid the classification of items such as accounts receivable, derivatives and cash in the bank as an intangible asset. IAS 38 contains examples of intangible assets, including: computer software, copyright and patents.

Research and development

Research and Development (known also as R&D) is considered to be an intangible asset (about 16 percent of all intangible assets in the US) [5] ), even though most countries treat R&D as current expenses for both legal and tax purposes. Most countries report some intangibles in their National Income and Product Accounts (NIPA), yet no country has included a comprehensive measure of intangible assets. The contribution of intangible assets in long-term GDP growth has been recognized by economists. [6]

IAS 38 requires any project that results in the generation of a resource to the entity be classified into two phases: a research phase, and a development phase.

The classification of research and development expenditure can be highly subjective, and it is important to note that organisations may have an ulterior motive in its classification of research and development expenditure. Less scrupulous directors may manipulate financial statements through their classification of research and development expenditure.[ citation needed ]

An example of research (as defined as "the original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding"): a company can carry a research on one of its products which it will use in the entity of which results in future economic income.[ clarification needed ][ gobbledegook ]

Development is defined as "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."

Accounting treatment of expenses depends on whether they are classified as research or development. Where the distinction cannot be made, IAS 38 requires that the entire project be treated as research and expensed through the Statement of Comprehensive Income.

Research expenditure is highly speculative. There is no certainty that future economic benefits will flow to the entity. Prudence dictates that research expenditure be expensed through the Statement of Comprehensive Income. Development expenditure, however, is less speculative and it becomes possible to predict the future economic benefits that will flow to the entity. The matching principle dictates that development expenditure be capitalised, as the expenditure is expected to generate future economic benefit to the entity.

Financial accounting

General standards

The International Accounting Standards Board (IASB) offers some guidance (IAS 38) as to how intangible assets should be accounted for in financial statements. In general, legal intangibles that are developed internally are not recognized and legal intangibles that are purchased from third parties are recognized. Wordings are similar to IAS 9.

Under US GAAP, intangible assets are classified into: Purchased vs. internally created intangibles, and Limited-life vs. indefinite-life intangibles. [ citation needed ]

Expense allocation

Intangible assets are typically expensed according to their respective life expectancy. [4] Intangible assets have either an identifiable or an indefinite useful life. Intangible assets with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, [7] whichever is shorter. Examples of intangible assets with identifiable useful lives are 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/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.

Taxation

For personal income tax purposes, some costs with respect to intangible assets must be capitalized rather than treated as deductible expenses. Treasury regulations in the USA generally require capitalization of costs associated with acquiring, creating, or enhancing intangible assets. [8] 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. [9]

Given the growing importance of intangible assets as a source of economic growth and tax revenue, [6] and because their non-physical nature makes it easier for taxpayers to engage in tax strategies such as income-shifting or transfer pricing, [10] tax authorities and international organizations have been designing ways to link intangible assets to the place where they were created, hence defining nexus. Intangibles for corporations are amortized over a 15-year period, equivalent to 180 months.

Definition of "intangibles" differs from standard accounting, in some US state governments. These governments may refer to stocks and bonds as "intangibles". [11]

See also

Related Research Articles

International Financial Reporting Standards Technical standard

International Financial Reporting Standards, usually called IFRS, are standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB) to provide a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particularly important for companies that have dealings in several countries. They are progressively replacing the many different national accounting standards. They are the rules to be followed by accountants to maintain books of accounts which are comparable, understandable, reliable and relevant as per the users internal or external.

In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be "tangible book value".

Tax deduction is a reduction of income that is able to be taxed and is commonly a result of expenses, particularly those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and credits. The difference between deductions, exemptions and credits is that deductions and exemptions both reduce taxable income, while credits reduce tax.

Income statement

An income statement or profit and loss account is one of the financial statements of a company and shows the company’s revenues and expenses during a particular period.

Earnings before interest, taxes, depreciation, and amortization accounting measure: net earnings, before interest expenses, taxes, depreciation, and amortization are subtracted

A company's earnings before interest, taxes, depreciation, and amortization is an accounting measure calculated using a company's earnings, before interest expenses, taxes, depreciation, and amortization are subtracted, as a proxy for a company's current operating profitability.

Financial accounting field of accounting

Financial accounting is the field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of financial statements available for public use. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stakeholders are examples of people interested in receiving such information for decision making purposes.

Cash flow statement financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities

In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7, is the International Accounting Standard that deals with cash flow statements.

Capital expenditure

Capital expenditure or capital expense is the money a company spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered a capital expenditure when the asset is newly purchased or when money is used towards extending the useful life of an existing asset, such as repairing the roof.

A capital asset is defined to include property of any kind held by an assessee, whether connected with their business or profession or not connected with their business or profession. It includes all kinds of property, movable or immovable, tangible or intangible, fixed or circulating. Thus, land and building, plant and machinery, motorcar, furniture, jewellery, route permits, goodwill, tenancy rights, patents, trademarks, shares, debentures, securities, units, mutual funds, zero-coupon bonds etc. are capital assets.

Chart of accounts

A chart of accounts (COA) is a created list of the accounts used by an organization to define each class of items for which money or its equivalent is spent or received. It is used to organize the entity’s finances and segregate expenditures, revenue, assets and liabilities in order to give interested parties a better understanding of the entity’s financial health.

Amortization (business) spreading payments over multiple periods; the term is used for two separate processes: amortization of loans and amortization of assets. In the latter case it refers to allocating the cost of an intangible asset over a period of time

In business, amortization refers to spreading payments over multiple periods. The term is used for two separate processes: amortization of loans and amortization of assets. In the latter case it refers to allocating the cost of an intangible asset over a period of time.

Consolidation (business) Merger and acquisition of many smaller companies into much larger ones

In business, consolidation or amalgamation is the merger and acquisition of many smaller companies into a few much larger ones. In the context of financial accounting, consolidation refers to the aggregation of financial statements of a group company as consolidated financial statements. The taxation term of consolidation refers to the treatment of a group of companies and other entities as one entity for tax purposes. Under the Halsbury's Laws of England, 'amalgamation' is defined as "a blending together of two or more undertakings into one undertaking, the shareholders of each blending company, becoming, substantially, the shareholders of the blended undertakings. There may be amalgamations, either by transfer of two or more undertakings to a new company, or to the transfer of one or more companies to an existing company".

Goodwill (accounting) accounting

Goodwill in accounting is an intangible asset that arises when a buyer acquires an existing business. Goodwill represents assets that are not separately identifiable. Goodwill does not include identifiable assets that are capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability regardless of whether the entity intends to do so. Goodwill also include contractual or other legal rights regardless of whether those are transferable or separable from the entity or other rights and obligations. Examples of identifiable assets that are goodwill include a company’s brand name, customer relationships, artistic intangible assets, and any patents or proprietary technology. The goodwill amounts to the excess of the "purchase consideration" over the total value of the assets and liabilities. It is classified as an intangible asset on the balance sheet, since it can neither be seen nor touched. Under US GAAP and IFRS, goodwill is never amortized. Instead, management is responsible for valuing goodwill every year and to determine if an impairment is required. If the fair market value goes below historical cost, an impairment must be recorded to bring it down to its fair market value. However, an increase in the fair market value would not be accounted for in the financial statements. Private companies in the United States, however, may elect to amortize goodwill over a period of ten years or less under an accounting alternative from the Private Company Council of the FASB.

Provision (accounting) account which records a present liability of an entity

In financial accounting, a provision is an account which records a present liability of an entity. The recording of the liability in the entity's balance sheet is matched to an appropriate expense account in the entity's income statement. The preceding is correct in IFRS. In U.S. GAAP, a provision is an expense. Thus, "Provision for Income Taxes" is an expense in U.S. GAAP but a liability in IFRS. 

In tax law, amortization refers to the cost recovery system for intangible property. Although the theory behind cost recovery deductions of amortization is to deduct from basis in a systematic manner over an asset's estimated useful economic life so as to reflect its consumption, expiration, obsolescence or other decline in value as a result of use or the passage of time, many times a perfect match of income and deductions does not occur for policy reasons.

International Financial Reporting Standards requirements

This article lists some of the important requirements of International Financial Reporting Standards (IFRS).

IAS 16

International Accounting Standard 16 Property, Plant and Equipment or IAS 16 is an international financial reporting standard adopted by the International Accounting Standards Board (IASB). It concerns accounting for property, plant and equipment, including recognition, determination of their carrying amounts, and the depreciation charges and impairment losses to be recognised in relation to them.

In accounting, tax amortization benefit refers to the present value of income tax savings resulting from the tax deduction generated by the amortization of an intangible asset.

Nepal Financial Reporting Standards

Nepal Financial Reporting Standards ('NFRS') are designed as a common global language for business affairs so that company accounts are understandable and comparable within Nepal. The rules to be followed by accountants to maintain books of accounts which is comparable, understandable, reliable and relevant as per the users internal or external.

References

  1. Webster, Elisabeth; Jensen, Paul H. (2006). Investment in Intangible Capital: An Enterprise Perspective. The Economic Record, Vol. 82, No. 256, March, 82-96.
  2. Lev, Baruch; Daum, Juergen (2004). "The dominance of intangible assets: consequences for enterprise management and corporate reporting" (PDF). Measuring Business Excellence. 8 (1): 6–17. doi:10.1108/13683040410524694.
  3. "SAC 4: Definition and Recognition of the Elements of Financial Statements" (PDF). Australian Accounting Standards Board. Retrieved 19 December 2012.
  4. 1 2 "IAS 38". International Accounting Standards Board. Retrieved 19 December 2012.
  5. Bureau of Economic Analysis (2013). Preview of the 2013 Comprehensive Revision of the National Income and Product Accounts. https://www.bea.gov/scb/pdf/2013/03%20March/0313_nipa_comprehensive_revision_preview.pdf
  6. 1 2 Corrado, Carol. Charles Hulten, and Daniel Sichel (2006). Intangible Capital and Economic Growth. Federal Reserve Board Discussion Paper N. 2006-24. April. http://www.federalreserve.gov/pubs/feds/2006/200624/200624pap.pdf
  7. For international legal lives by class of intangible asset, see the table in Tax amortization lives of intangible assets
  8. Treas. Reg. § 1.263(a)-4.
  9. Donaldson, Samuel A. Federal Income Taxation Of Individuals: Cases, Problems and Materials (2nd ed.). St. Paul: Thomson West, 2007. pg. 200.
  10. "Action Plan on Base Erosion and Profit Shifting." (2013) Organisation for Economic Co-operation and Development (OECD). http://www.oecd.org/sti/inno/46349020.pdf
  11. Florida Intangible Tax