Intangible Assets

This article is the sixth installment in an ongoing series focusing on accounting and financial matters for corporate counsel.

Domain names, customer lists, patents, trademarks, copyrights, trade secrets, franchises, licenses, contracts, business methods, and other forms of rights, relationships, and intellectual property have become the overwhelming items of value in many businesses today. They are a major focus area for the Business Valuation profession, but get disproportionately small attention in the accounting world.

Goodwill

Goodwill is probably the best-known intangible asset. Almost every business has goodwill, because without it, business does not exist for very long. Yet, goodwill does not appear as an asset on most company balance sheets. Remember some of the accountant's core principles ' historical cost, consistency, objectivity, and conservatism. These generally discourage the booking of self-created assets, especially assets whose value is so hard to measure. When you see goodwill on a balance sheet, that generally means that the company acquired another company and paid more than the sum of the value of identifiable assets. Goodwill is generally only recorded as a result of arm's-length transactions.

Perverse Results

The treatment (or non-treatment) of goodwill can lead to perverse results. Paying more than can be attributed to physical assets, in the accountant's world, is considered evidence of goodwill. In the real world, it is sometimes considered evidence of stupidity.

R & D Costs

Research and development costs are money that the company spends in the hopes of obtaining new business processes, patents, copyrights, or products. Since it is often difficult to assign specific costs to specific outcomes and there are uncertainties in identifying the extent and timing of the benefits received from these expenditures, the costs of research and development are generally expensed immediately as incurred, whether the research is successful or not.

Restrictions

Other intangible assets are subject to the same restrictions ' if they are internally created, they generally do not get recognized on the balance sheet. If they are purchased, they can get shown on the balance sheet as an identifiable asset. Thus, the billions of dollars that beer companies spend promoting their brand names during sporting events is considered to be an expense that gets written off each month, even though it is building value. Their carefully cultivated and developed brand names will never appear on their balance sheet. If, however, one beer company buys another, the acquiring company will be able to record the value of the acquired brand names on its balance sheet, even as its own internally developed and promoted brands appear nowhere on any of its financial statements .

Depreciation

Purchased goodwill was originally treated by accountants very similarly to fixed assets in that it was assumed that the asset would steadily lose value over time, and therefore needed to be written down each period. For fixed assets this is called “depreciation.” For intangible assets it is called “amortization.”

Eventually, it was accepted in the accounting world that if management is doing its job the value of the goodwill they acquired should be increasing, not decreasing. The value of goodwill could be seriously understated by amortizing it. This shift in perspective caused goodwill to be treated more like land (which is not depreciated) than like buildings (which are depreciated). The new accounting standard became not to amortize goodwill.

Other intangible assets are amortized or not based on whether they have an identifiable life. Examples of this are the length of a patent, the expiration of an agreement, or the life cycle of a product. If the life of the asset is identifiable, than the asset gets amortized over that life. The amortization is usually on a straight-line basis, assuming the intangible loses its value at a steady rate. If the life of the asset is not identifiable, then the asset value remains the same on the balance sheet unless it becomes impaired. Intangibles are tested for impairment every year and written down whenever impairment is identified. These write-downs are a one-way street ' assets are never written up for enhancements in value.

GAAP

To further delve into the realm of the surreal, GAAP (Generally Accepted Accounting Principles) for intangible assets is different than IRS regulations as to what gets expensed, capitalized and amortized. Different state laws may define and treat intangible assets differently from each other, both from a legal and tax perspective. Basically, what you need to know about the Intangible Asset number on the balance sheet you are looking at is that it is not comparable to any other company's Intangible Asset figure and that it is most likely understated and meaningless. In an attempt to adhere to their core principles, the accountants have missed the forest for the trees on this one. Intangible assets on a balance sheet are more of a plug to make debits equal credits than they are a true indication of value.

Business Valuation

A more specialized branch of the accounting profession, the Business Valuation community, has dealt extensively with valuation of intangible assets. Unlike GAAP accountants, business valuation analysts are not paralyzed by the uncertainty inherent in intangibility. While intangibles usually get no more than a single chapter in accounting texts, entire libraries of books have been written about them by and for the Valuation community.

Reasons to properly value intellectual property and other intangible assets include transaction sale support, solvency analysis, licensing, strategic alliances, infringement damages, taxation of intercompany transactions, collateral-based financing, regulatory requirements, and even for determining the loss due to attorney malpractice. Valuation methods of intangible assets will be the subject of a later installment in this series. For now, rest assured that there are professionally accepted methods of valuing intangible assets that are scientific, insightful, justifiable, and defensible.

Michael Goldman, MBA, CPA, CVA, CFE, CFF, is principal of Michael Goldman and Associates, LLC in Deerfield, IL. He may be reached at [email protected].

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This article is the sixth installment in an ongoing series focusing on accounting and financial matters for corporate counsel.

Domain names, customer lists, patents, trademarks, copyrights, trade secrets, franchises, licenses, contracts, business methods, and other forms of rights, relationships, and intellectual property have become the overwhelming items of value in many businesses today. They are a major focus area for the Business Valuation profession, but get disproportionately small attention in the accounting world.

Goodwill

Goodwill is probably the best-known intangible asset. Almost every business has goodwill, because without it, business does not exist for very long. Yet, goodwill does not appear as an asset on most company balance sheets. Remember some of the accountant's core principles ' historical cost, consistency, objectivity, and conservatism. These generally discourage the booking of self-created assets, especially assets whose value is so hard to measure. When you see goodwill on a balance sheet, that generally means that the company acquired another company and paid more than the sum of the value of identifiable assets. Goodwill is generally only recorded as a result of arm's-length transactions.

Perverse Results

The treatment (or non-treatment) of goodwill can lead to perverse results. Paying more than can be attributed to physical assets, in the accountant's world, is considered evidence of goodwill. In the real world, it is sometimes considered evidence of stupidity.

R & D Costs

Research and development costs are money that the company spends in the hopes of obtaining new business processes, patents, copyrights, or products. Since it is often difficult to assign specific costs to specific outcomes and there are uncertainties in identifying the extent and timing of the benefits received from these expenditures, the costs of research and development are generally expensed immediately as incurred, whether the research is successful or not.

Restrictions

Other intangible assets are subject to the same restrictions ' if they are internally created, they generally do not get recognized on the balance sheet. If they are purchased, they can get shown on the balance sheet as an identifiable asset. Thus, the billions of dollars that beer companies spend promoting their brand names during sporting events is considered to be an expense that gets written off each month, even though it is building value. Their carefully cultivated and developed brand names will never appear on their balance sheet. If, however, one beer company buys another, the acquiring company will be able to record the value of the acquired brand names on its balance sheet, even as its own internally developed and promoted brands appear nowhere on any of its financial statements .

Depreciation

Purchased goodwill was originally treated by accountants very similarly to fixed assets in that it was assumed that the asset would steadily lose value over time, and therefore needed to be written down each period. For fixed assets this is called “depreciation.” For intangible assets it is called “amortization.”

Eventually, it was accepted in the accounting world that if management is doing its job the value of the goodwill they acquired should be increasing, not decreasing. The value of goodwill could be seriously understated by amortizing it. This shift in perspective caused goodwill to be treated more like land (which is not depreciated) than like buildings (which are depreciated). The new accounting standard became not to amortize goodwill.

Other intangible assets are amortized or not based on whether they have an identifiable life. Examples of this are the length of a patent, the expiration of an agreement, or the life cycle of a product. If the life of the asset is identifiable, than the asset gets amortized over that life. The amortization is usually on a straight-line basis, assuming the intangible loses its value at a steady rate. If the life of the asset is not identifiable, then the asset value remains the same on the balance sheet unless it becomes impaired. Intangibles are tested for impairment every year and written down whenever impairment is identified. These write-downs are a one-way street ' assets are never written up for enhancements in value.

GAAP

To further delve into the realm of the surreal, GAAP (Generally Accepted Accounting Principles) for intangible assets is different than IRS regulations as to what gets expensed, capitalized and amortized. Different state laws may define and treat intangible assets differently from each other, both from a legal and tax perspective. Basically, what you need to know about the Intangible Asset number on the balance sheet you are looking at is that it is not comparable to any other company's Intangible Asset figure and that it is most likely understated and meaningless. In an attempt to adhere to their core principles, the accountants have missed the forest for the trees on this one. Intangible assets on a balance sheet are more of a plug to make debits equal credits than they are a true indication of value.

Business Valuation

A more specialized branch of the accounting profession, the Business Valuation community, has dealt extensively with valuation of intangible assets. Unlike GAAP accountants, business valuation analysts are not paralyzed by the uncertainty inherent in intangibility. While intangibles usually get no more than a single chapter in accounting texts, entire libraries of books have been written about them by and for the Valuation community.

Reasons to properly value intellectual property and other intangible assets include transaction sale support, solvency analysis, licensing, strategic alliances, infringement damages, taxation of intercompany transactions, collateral-based financing, regulatory requirements, and even for determining the loss due to attorney malpractice. Valuation methods of intangible assets will be the subject of a later installment in this series. For now, rest assured that there are professionally accepted methods of valuing intangible assets that are scientific, insightful, justifiable, and defensible.

Michael Goldman, MBA, CPA, CVA, CFE, CFF, is principal of Michael Goldman and Associates, LLC in Deerfield, IL. He may be reached at [email protected].

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