Notes on Intangible Fixed Assets
Valuing and Amortizing Intangibles
The characteristics of intangible assets are: (1) they lack physical existence, and (2) they are not a financial instrument. The most common types of intangibles reported are patents, copyrights, franchises, licenses, trademarks, trade names, and goodwill.
Cost is the appropriate basis for recording purchased intangible assets. Like tangible assets, cost includes acquisition price and all other expenditures necessary in making the asset ready for its intended use—for example, purchase price, legal fees, and other incidental expenses. When intangibles are acquired for consideration other than cash, the cost of the intangible is the fair market value of the consideration given or the intangible asset received, whichever is more clearly evident. Costs incurred to create internally-created intangibles are generally expensed as incurred.
Amortization of Intangibles
Intangibles have either a limited (finite) useful life or an indefinite useful life. An intangible asset with a limited life is amortized; an intangible asset with an indefinite life is not amortized.
Limited-Life Intangibles
The expiration of intangible assets is called amortization. Limited-life intangibles should be amortized by systematic charges to expense over their useful life. The useful life should reflect the periods over which these assets will contribute to cash flows.
The amount of amortization expense for a limited-life intangible asset should reflect the pattern in which the asset is consumed or used up, if that pattern can be readily determined. If not, the straight-line method of amortization should be used. When intangible assets are amortized the charges should be shown as expenses, and the credits should be made either to the appropriate asset accounts or to separate accumulated amortization accounts. The amount of an intangible asset to be amortized should be its cost less residual value.
Indefinite-Life Intangibles
If no legal, regulatory, contractual, competitive, or other factors limit the useful life of an intangible asset, the useful life is considered indefinite. An intangible with an indefinite life is not amortized, instead it is tested for impairment.
Marketing-Related Intangible Assets
Marketing-related intangible assets are those assets primarily used in the marketing or promotion of products or services. Examples are trademarks or trade names, newspaper masthead, Internet domain names, and noncompetition agreements.
A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a particular enterprise or product. The right to use a trademark or trade name, whether it is registered or not, rests exclusively with the original user as long as the original user continues to use it. Registration with the U.S. Patent and Trademark Office provides legal protection for an indefinite number of renewals for a period of 10 years each. When the total cost of a trademark or trade name is insignificant, it can be expensed rather than capitalized. In most cases, the life of a trademark or trade name is indefinite, and therefore its cost is not amortized.
Customer-Related Intangible Assets
Customer-related intangible assets occur as a result of interactions with outside parties. Examples are customer lists, order or production backlogs, and both contractual and noncontractual customer relationships.
Artistic-Related Intangible Assets
Artistic-related intangible assets involve ownership rights to plays, literary works, musical works, pictures, photographs, and video and audiovisual material. These ownership rights are protected by copyrights. A copyright is a federally granted right that all authors, painters, musicians, sculptors, and other artists have in their creations and expressions.
A copyright is granted for the life of the creator plus 70 years. It gives the owner, or heirs, the exclusive right to reproduce and sell an artistic or published work. Copyrights are not renewable. Generally, the useful life of the copyright is less than its legal life (life in being plus 70 years). The costs of the copyright should be allocated to the years in which the benefits are expected to be received.
Contract-Related Intangible Assets
Contract-related intangible assets represent the value of rights that arise from contractual arrangements. Examples are franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts. A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products or services, to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area. A license or permit is the arrangement commonly entered into by a governmental body and a business enterprise that uses public property.
Franchises and licenses can have limited or indefinite lives. The cost of a franchise (or license) with a limited life should be amortized as operating expense over the life of the franchise; whereas those with an indefinite life should be carried at cost and not amortized.
Technology-Related Intangible Assets
Technology-related intangible assets relate to innovations or technological advances. Examples are patented technology and trade secrets. A patent gives the holder exclusive right to use, manufacture, and sell a product or a process for a period of 20 years without interference or infringement by others. If a patent is purchased from an inventor (or other owner), the purchase price represents its cost. Research and development costs related to the development of the product, process, or idea that is subsequently patented must be expensed as incurred. The costs of the patent should be amortized over its legal life or its useful life, whichever is shorter.
Goodwill
In a business combination, the cost (purchase price) is assigned where possible to the identifiable tangible and intangible net assets, and the remainder is recorded in an intangible asset account called goodwill. Goodwill generated internally should not be capitalized in the accountsit is recorded only when an entire business is purchased.
To record goodwill, the fair value of the net tangible and identifiable intangible assets are compared with the purchase price of the acquired business. The difference is goodwill.
Goodwill is considered to have an indefinite life and therefore should not be amortized. A bargain purchase results when the fair value of the net assets acquired is higher than the purchase price of the assets. The FASB requires that the excess be recognized as a gain and that the nature of the gain be disclosed.
Impairments
When the carrying amount of a long-lived asset (property, plant, and equipment or intangible assets) is not recoverable, a write-off of the impairment is needed. To determine if property, plant, or equipment has been impaired, a recoverability test is used. The first step of the test, an estimate of the future net cash flows expected from the use of that asset and its eventual disposition are determined. If the sum of the expected future net cash flows (undiscounted) is less than the carrying amount of the asset, an impairment has occurred. If an impairment loss has been incurred, it is the amount by which the carrying amount of the asset exceeds it fair value. The impairment loss is reported as part of income from continuing operations, generally in the “Other expenses and losses” section.
The rules that apply to impairments of property, plant, and equipment also apply to limited-life intangibles. Indefinite-life intangibles other than goodwill should be tested for impairment at least annually using the fair value test. This test compares the fair value of the intangible asset with the asset’s carrying amount. If the fair value of the intangible asset is less than the carrying amount, impairment is recognized.
The impairment rule for goodwill is a two-step process. First, the fair value of the reporting unit should be compared to its carrying amount including goodwill. If the fair value of the reporting unit is greater than the carrying amount, goodwill is considered not to be impaired, and the company does not have to do anything. However, if the fair value is less than the carrying amount of the net assets, then the second step compares the fair value of the goodwill to its carrying amount and the impairment is the difference between the carrying amount and the fair value.
Once an impairment loss is recorded, the reduced carrying amount of an asset held for use becomes its new cost basisand is not changed except for depreciation or amortization in future periods or for additional impairments. If the impaired asset is intended to be disposed of, the impaired asset is reported at the lower of cost or net realizable value. Assets that are being held for disposal are not depreciated or amortized during the period they are held.
Restoration of an impairment loss is not allowed on assets held for use. However, it is allowed on assets to be disposed of.
Research and Development Costs
Planned research or critical investigation aimed at discovery of new knowledge are research activities. Translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing or process whether intended for sale or use are development activities. In general, all research and development costs are to be charged to expense when incurred.
The costs associated with R&D activities and the accounting treatment accorded them are as follows:
a. Materials, Equipment, and Facilities. Expense the entire costs, unless the items have alternative future uses (in other R&D projects or otherwise), in which case carry as inventory and allocate as consumed; or capitalize and depreciate as used.
b. Personnel. Salaries, wages, and other related costs of personnel engaged in R&D should be expensed as incurred.
c. Purchased Intangibles. Recognize and measure at fair value. After initial recognition, account for in accordance with their nature (either limited-life or indefinite-life intangibles).
d. Contract Services. The costs of services performed by others in connection with the reporting company’s R&D should be expensed as incurred.
e. Indirect Costs. A reasonable allocation of indirect costs shall be included in R&D costs, except for general and administrative cost, which must be clearly related in order to be included and expensed.
Start-up costs, initial operating costs, and advertising costs are also expensed as incurred.
Presentation of Intangibles and Related Items
On the balance sheet, all intangible assets other than goodwill should be reported as a separate item. If goodwill is present, it also should be reported as a separate item.
On the income statement, amortization expense and impairment losses for intangible assets other than goodwill should be presented as part of continuing operations. Goodwill impairment losses should also be presented as a separate line item in the continuing operations section, unless the goodwill impairment is associated with a discontinued operation.
Companies should disclose, generally in the notes, the total R&D cost charged to expense during each period for which they present an income statement.
Accounting for Computer Software Costs
Costs incurred in creating a computer software product that is to be sold, leased, or otherwise marketed to third parties should be charged to research and development expense when incurred until technological feasibility has been established for the product.
Technological feasibility is established upon completion of a detailed program design or working model.
If software is purchased and it has alternative future uses, then it may be capitalized.
When software costs are capitalized companies are required to use the greater of (1) the ratio of current revenues to current and anticipated revenues (percent-of-revenue approach), or (2) the straight-line method over the remaining useful life of the asset (straight-line approach) as a basis for amortization.
Capitalized software costs should be valued at the lower of unamortized cost or net realizable value. If net realizable value is lower, then the capitalized software costs should be written down to this value. Once written down, they may not be written back up.