Intangible Assets explained

What is in the asset category of intangible assets on the balance sheet? This video provides you with the big picture on intangible assets. We start off with the definition of intangible assets, review examples of companies with a significant amount of intangible assets on their balance sheet, walk through an example including journal entries for acquired intangibles, discuss internally created intangibles, and end with intangible assets amortization and impairment.

⏱️TIMESTAMPS⏱️
00:00 Introduction to intangible assets
00:29 Intangible asset definition
01:12 Intangible assets in annual reports
01:59 Intangible asset example
02:37 Acquired intangible assets
03:04 Intangible asset journal entry
03:45 Internally created intangible assets
04:49 Amortization of intangible assets

In the International Financial Reporting Standards or IFRS, an intangible asset is defined as an identifiable non-monetary asset without physical substance. In US GAAP, an intangible asset is defined as an asset, other than a financial asset, that lacks physical substance. The first common factor is the lack of physical substance. An intangible asset does not physically exist, unlike a tangible asset such as a factory or a machine which would be in property, plant and equipment. Second common factor: an intangible asset is not a financial asset. Examples of monetary or financial assets are cash and cash equivalents, marketable securities, and accounts receivable.

When reviewing annual reports, you will find that companies have various ways of grouping intangible assets. Some use the term “intangible assets” as a category label, with items such as goodwill, computer software and patents as line items inside it. Others simply list goodwill and intangible assets as separate line items, where they really mean (here comes the language purist!) goodwill on one hand and other intangible assets on the other. When reviewing intangible assets in an annual report, check carefully whether you are looking at the category as a whole, or a subset. Many companies have a substantial amount of goodwill on their balance sheet, if they have done acquisitions at some point in their history. Far fewer companies have a significant amount in “other intangible assets”.

Intangible assets can be either acquired, or internally created. An example of acquired intangibles is the acquisition of LinkedIn by Microsoft. In the valuation of the acquisition, and subsequent consolidation of the accounts in Microsoft’s books, the intangible assets of LinkedIn were valued at $7.9 billion. On average, these intangible assets were deemed to have a useful economic life of 9 years. Let’s review the (simplified) high-level journal entry for the acquisition of LinkedIn by Microsoft. Five main categories of accounts were impacted. $27 billion was the purchase price, this is a credit to cash. Tangible assets acquired are $5.7 billion, debit to assets. Liabilities assumed are $3.4 billion, a credit to liabilities. Intangible assets are valued at $7.9 billion, debit to assets. The remainder is goodwill, the excess of the purchase price paid for an acquired firm, over the fair value of its separately identifiable net assets, for $16.8 billion, debit to goodwill.

An example of internally created intangible assets can be found in the annual report of Rolls-Royce, an engineering company focused on power and propulsion systems (such as aircraft engines), headquartered in the UK. Total net book value of intangible assets at the end of 2016 was £5.1 billion, of which goodwill was the largest item at £1.5 billion, and capitalized development expenditure second largest at £1.1 billion. In the notes to the financial statements, the treatment of R&D costs at Rolls-Royce is explained. All research phase expenditure is charged to the income statement. Development expenditure is capitalised as an internally generated intangible asset only if it meets strict criteria, relating in particular to technical feasibility and generation of future economic benefits. Expenditure capitalised is amortised over its useful economic life on a straight-line basis, up to a maximum of 15 years from the entry into service of the product.

Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investment decisions. Philip delivers training in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!