As the name suggests, intangible assets can be difficult to define. Yet all businesses have them, no matter the company’s size or which sector they work in. And for some companies, including many of the world’s best-known businesses, intangible assets are actually their most valuable assets.
What is an intangible asset?
Tangible assets are usually easily identifiable and quantifiable. Take a look around any business and you’d be able to point a few out. Depending upon the business sector, you might see premises, vehicles, equipment, machinery or inventory. These are objects that have at least some value and can be sold for cash.
Intangible assets though are harder to identify since they are not physical assets. They are non-monetary in nature, and are more difficult to value and sometimes have no finite worth. Instead, they often have potential value.
Examples of intangible assets
Goodwill is a prime example of an intangible asset with potential value. It is the outcome of a business acquisition, in circumstances when the purchasing company pays more than the market value (stock market value) for the target company’s assets. The difference between the price paid and the market value is termed goodwill.
Yet if there’s no acquisition or no overpayment, this type of intangible asset doesn’t come into existence at all.
This is why intangible assets can’t usually be used to secure a loan; lenders can’t easily turn them into cash if the loan isn’t repaid.
Other common examples of intangible assets include intellectual property like patents, trade secrets, copyrights and trademarks. These assets all distinguish the company that holds them from its competitors. The most obvious asset in this class is brand identity.
Now more than ever, a strong, instantly recognisable brand has immense value. Consumers are swayed by brands and will pay more for their products or services.
In the same way, customer lists, client relationships, lease agreements, import quotas and permits all give a company an advantage over rival companies that don’t hold them. Like a well-known brand identity, owning these intangible assets often contributes to higher sales for a business.
Infinite and finite assets
Intangible assets come in two forms: infinite and finite. In theory, infinite assets will last as long as the company does. Brand identity is one such asset.
Finite intangible assets, on the other hand, have a set lifespan. For instance, an agreement to use another company’s patent might have an expiry date. Unless the agreement is renewed, the company would then lose this asset.
Our two-day financial statement analysis course, which is taught virtually, covers the various types of assets and the distinctions between them.
Calculating intangible assets
The total value of a company’s intangible assets is sometimes calculated by subtracting the net tangible value of the business from the firm’s market value. This gives an approximate value.
Not all intangible assets are recorded on balance sheets – another factor hindering their valuation. This is especially true of assets developed internally, such as customer mailing lists, for instance.
Intangible assets purchased by a third party though, do feature on balance sheets, which give their purchase price. A useful example would be a trade secret. Once assigned a monetary value and purchased, the trade secret has gone from having theoretical worth to having a concrete value.
Amortisation vs impairment of intangible assets
Much as depreciation reduces the value of tangible assets throughout their lifetime, amortisation gradually brings down the cost of intangible assets. Unlike tangible assets, they cannot be revalued upwards.
Amortisation is conducted on a straight-line basis, meaning that the value is reduced consistently, until the asset has been completely consumed.
Of course, the nature of infinite intangible assets means that they’re never used up, so they’re not amortised. Instead, they’re revalued using a present value calculation and – if their value has dropped – impaired.
Businesses can discover if an infinite asset’s value has dropped by conducting an annual impairment test. The figure given for the asset on the balance sheet (the book value) should be compared with the asset’s ability to generate cash. Any difference should be reflected in a new value on the balance sheet and also recorded as an expense on the company’s income statement.