Intangible assets are identifiable non-monetary assets of an entity which do not have physical substance or existence. Here the word identifiable needs further elaboration. An asset would be identifiable if it falls in any of the following two categories:
- It is capable of being sold separately from the rest of the assets or business, i.e. it has its individual worth and can be sold independently, OR
- It arises as a result of a business combination or acquisition (for e.g. Goodwill recognized at the time of acquisition of a subsidiary)
The above definition should be read with the basic definition of asset in mind, because an intangible asset is one that meets the basic definition of asset along with satisfying the above criteria. Let’s recall the basic definition of asset. Asset is a resource controlled by an entity from which the entity expects to obtain economic benefits in future.
Some common examples of intangible assets are given below:
- Intellectual property such as patents and copyrights
- Brands
- Trademarks
- Licenses
- Goodwill
Recognition criteria of intangible assets
Intangible assets are recognized initially at their cost if the following criteria is met:
- The asset meets the definition of intangible assets;
- It is probable that the entity will get the economic benefits associated with the intangible asset; and
- Cost of the intangible asset can be reliably measured.
It is important to note that an intangible asset will be recognized only if all the three above-mentioned conditions are fulfilled. For instance, a lot of internally generated intangible assets are not recognized in the books of account of entities, as their cost cannot be ascertained reliably, even though they meet the other two conditions.
Accounting of internally generated intangible assets
Most of the internally generated intangible assets cannot be capitalized as their cost cannot be measured reliably. For instance, a restaurant business is operating at its very best for the past ten years and has developed an excellent reputation in the market. Generally speaking, it has developed a goodwill which will definitely be beneficial for the business in future. But can we separate the cost of operations from the cost of developing the goodwill? No, it is impossible to identify the cost of creating that goodwill as it was being silently developed over the past ten years of good work. As the cost cannot be measured reliably, therefore internally generated goodwill cannot be recognized as an intangible asset. Similarly, following are some other examples of internally generated intangible assets which fail to meet the recognition criteria of intangible assets as their costs cannot be measured reliably:
- Internally generated brands
- Internally generated publishing titles
- Internally generated logos etc.
But it’s not all dark for internally generated intangibles! There are some internally generated intangible assets (development expenditure) that can be recognized, although there are some conditions that must be met. These are discussed in our chapter research and development expenditure.
Accounting of purchased intangibles
Intangible assets that are acquired or purchased are initially recorded at their cost. Subsequently, one of the following two models is adopted for their accounting.
- Cost model
- Revaluation model
Let’s discuss both models for subsequent accounting of intangible assets.
Cost model
Under the cost model, intangible assets are carried in the books of account at cost less accumulated amortization and accumulated impairment losses, if any.
Intangible asset = Cost – accumulated amortization – accumulated impairment losses
Intangibles are amortized over their useful lives and by doing so, the cost of the intangible assets is transferred to income statement spreading over a number of years, as the economic benefits associated with intangibles are also obtained over those years. Intangibles with indefinite useful lives are not amortized but are tested for impairment at each reporting date. In addition, such intangible assets are also tested for impairment during the accounting period whenever there is an indication that the asset might be impaired.
Amortization of intangible assets and impairment of intangible assets are explained in dedicated chapters.
Revaluation model
Under the revaluation model, intangible assets are carried in the books of account at cost or revalued amount less accumulated amortization and accumulated impairment losses, if any.
Intangible asset = Cost or revalued amount – accumulated amortization – accumulated impairment losses
Under revaluation model, an entity is required to revalue its intangible asset regularly so that its carrying amount is not materially different from its fair value. For this model, there must be an active market for the intangibles as the fair value is determined by reference to that active market.
What is an active market of an intangible? It is a market where sufficient volume of transactions of that intangible asset are being carried out with sufficient frequency so that information about the pricing of that intangible can be obtained. This is only possible if the intangible is not unique, and is a homogenous type of item, for example, government quotas or licenses for doing a particular business, taxi driving licenses etc. However, most of the intangible assets are unique and do not have an active market, therefore for such intangibles, cost model is followed.
Revaluation surplus on intangible assets is accounted for exactly in the same way as revaluation surplus of property, plant and equipment. Gain on revaluation is recorded in the statement of comprehensive income and then accumulated in a reserve under equity called revaluation surplus. If revaluation results in a loss, it is recorded in the income statement, however, if there is any balance in the revaluation surplus reserve pertaining to previous revaluations, that balance is first adjusted. It means that revaluation loss to the extent of previous revaluation surplus is recorded in statement of comprehensive income and any excess revaluation loss is recorded in income statement.
Intangibles under revaluation model are also amortized over their useful lives and by doing so, the cost or the revalued amount of the intangible assets is transferred to profit or loss spreading over a number of years, as the economic benefits associated with intangibles are also obtained over those years. Intangibles with indefinite useful lives are not amortized but are tested for impairment at each reporting date. In addition, such intangibles are also tested for impairment during the accounting period whenever there is an indication that the asset might be impaired.
