Intangible assets can come in many different forms, although they all lack physical substance without being financial in nature. Intangible assets can still be used for the purpose of creating profit, however, which is often the reason these assets have value in the first place.
That said, it can be difficult to come up with a valuation for intangible assets since they are non-physical and may not have been bought or sold in the past. This article will cover the definition of intangible assets, examples, valuation methods, and how intangible assets appear on balance sheets.
- Intangible assets are assets that do not have a physical form, which means you cannot touch or see them.
- Meanwhile, tangible assets are assets you can touch and see, such as real estate, inventory, machinery, or office equipment.
- Intellectual property, brand recognition, copyrights, mineral rights, and water rights are common examples of intangible assets.
- A business’s intangible assets have value that varies based on their importance, but determining this value is more complicated than determining the value of tangible assets.
What Are Intangible Assets?
Intangible assets are a type of resource that has value and can be utilized in some way. Other criteria that applies to intangible assets includes the following:
- No physical form: Intangible assets lack a physical form, so you cannot see them or touch them.
- Non-monetary in nature: Intangible assets are not financial in nature, yet they can be utilized to build wealth or earn income.
- Long lasting: Intangible assets have a useful life of more than two years.
- Separate in nature: An intangible asset should be identifiable as a separate asset from the entity that owns and controls it.
- Has value: Intangible assets are typically held or acquired to pursue future economic benefits or services.
Types of Intangible Assets
Intangible assets can come in many different forms, and they can be treated differently for business and tax purposes as a result. Here's a rundown of the types of intangible assets you can find and acquire.
- Created intangible assets: Created intangible assets are ones created by a company or organization, and they are often artistic-related or technology-based. These assets do not have a recorded value thus far because they have not been bought or sold, so they are not included on a company's balance sheet.
- Acquired intangible assets: Acquired intangible assets are ones a business has purchased or negotiated. These assets are listed on a company's balance sheet as a result.
- Definite-life intangible assets: Definite-life intangible assets are not made to last forever, and may only have value for a short duration of a few years. This type of intangible asset is typically amortized as a result.
- Indefinite-life intangible assets: Indefinite-life intangible assets can have value and be used to build wealth indefinitely, so this type of intangible asset is not amortized. On the flipside, indefinite-life intangible assets can be subject to goodwill impairment accounting.
- Goodwill: In terms of intangible assets, the term "goodwill" is defined as the positive reputation of a business or the favoritism acquired when a company takes over another for more than the fair market value of its assets and liabilities.
Intangible vs. Tangible Assets: What is the Difference?
Businesses may rely on a range of assets to produce goods, fund operations, and drive long-term growth. These assets can include tangible assets and intangible assets that serve different purposes.
- Tangible assets have a physical form, whereas intangible assets do not. Tangible assets can include things like inventory, business equipment, real estate, and more.
- Both types of assets have value. The fact you cannot touch or see an intangible asset doesn't mean it is automatically less valuable.
Examples of Intangible Assets
If you're curious which assets typically count as intangible, here's an overview of common intangible assets, how they work, and what makes them unique.
- Brand equity: Equity created by building a brand from scratch is considered an intangible asset that has value but no physical form.
- Intellectual property: This type of asset is considered intangible because intellectual property has value without being physical in nature.
- Licensing agreements: Patented technology and licensing agreements are intangible since they are valuable but you cannot see or touch them.
- Water rights: Water rights can be valuable and used for monetization, but these rights obviously do not have a physical form.
- Mineral rights: The same is true for mineral rights, which are the legal ownership to mineral rights beneath a property.
Amortization of Intangible Assets
Amortization is an accounting technique that lets businesses deplete the value of certain intangible assets over time. When it comes to assets, this accounting technique can also be referred to as depreciation.
- Most amortization of intangible assets is straight-line. This amortization method helps businesses determine the cost of an intangible asset to expense for depreciation purposes at a predictable rate over time.
- Intangible assets with an indefinite lifespan are not amortized. Instead, businesses perform annual impairment tests to determine the assets value and any changes.
- Created intangible assets are not amortized. As we mentioned, created intangible assets are not listed on a company's balance sheet at all.
How to Value Intangible Assets
There are several reasons businesses may ultimately need to set values for their intangible assets, including tax and financial reporting purposes. Here's an overview of the most common intangible assets formulas for determining value.
The cost approach for determining the value of intangible assets is based on the idea that an investor would not pay more for something than required to make their own.
- This approach values intangible assets on the cost involved for someone to create or reproduce their own equivalent asset.
- Analysis is required to determine this value, which must include costs for time and labor involved.
- Opportunity cost is also taken into account, especially when creating a similar asset would require a lot of time and effort.
The cost approach for determining the value of intangible assets is based on how much income a buyer could earn from them. This type of valuation is most commonly used for intangible assets that are generating cash flow, such as licensing agreements, mineral rights, and software licenses.
- Income-based methods used include Relief from Royalty, the Multi-Period Excess Earnings, Greenfield, and Avoided Loss of Income methods.
- The Relief from Royalty method uses the hypothetical income from royalties to determine value, whereas the Multi-Period Excess Earnings looks at earnings from the asset but deducts expenses that can be associated with other assets to determine value.
- Meanwhile, the Greenfield method bases value of an intangible asset on the discounted cash flows of a hypothetical start-up business, and the Avoided Loss of Income method compares two business scenarios to determine value.
Finally, the market approach for valuing intangible assets is used when similar assets are frequently bought and sold and those sales can be used for the purpose of comparison.
- For example, it may be possible to place a value on intangible assets like liquor licenses and water rights since plenty of information on them can be found in public records.
- This method cannot always be used since the necessary data may not be available.
- Often, a market approach is combined with an income approach to determine the worth of an intangible asset.
Intangible Assets on Balance Sheets
According to the U.S. Small Business Administration (SBA), a business balance sheet is "a statement of a business’s assets, liabilities, and owner’s equity as of any given date." The SBA also notes that balance sheets are typically prepared once per quarter or annually, depending on the business.
- Intangible assets are listed on balance sheets in three different scenarios. This occurs when an intangible asset is acquired, has an identifiable value, or has a useful lifespan.
- Intangible assets on balance sheets can be amortized. For example, this can be the case for an acquired patent or licensing agreement that has an expiration date.
Intangible assets cannot be physically held or seen, but they can still be an important element of a business’s overall value. That said, determining the value of intangible assets in business can be difficult since these assets are often created or come with a complex set of potential uses and limitations.
Fortunately, a range of methods can help businesses determine the value of all the assets they own — seen and unseen.