OCW041: Types of Intangible Assets

Trademarks

A trademark is an intangible asset legally preventing others from using a business’s logo, name, or other branding.

Learning Objectives

Summarize how a company would value a trademark

Key Takeaways

Key Points

  • As a trademarks are used to identify a specific type of business or service, they are important for businesses that want to protect their branding.
  • A trademark’s value for accounting purposes equals what it cost to acquire.
  • Trademarks are not amortized, but if one loses its value, it can be impaired.

Key Terms

  • Trademark: A word, symbol, or phrase used to identify a particular company’s product and differentiate it from other companies’ products.
  • impairment: A downward revaluation, a write-down.

Trademarks

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Trademark Symbol: The following symbol is attached to images or text that have been trademarked with the federal government.

A trademark is an image, word, phrase, logo or combination of those elements used to identify a specific type of business or service. A trademark allows a customer to instantly identify a product and associate the item with a response regarding its quality and price. If developed properly, a trademark will allow customers to make a positive connection with the product to which it is attached. In short, a trademark is a visual representation of a business’s brand or logo.

To protect the work that it puts into developing its brand, a company will obtain a trademark. The legal protection of a trademark prevents other businesses from using the specific image and text associated with the brand. In some circumstances, a business may obtain a “common law” trademark. This offers the business some legal protection. Generally, American businesses will register their logo with the U.S. Patent and Trademark Office. This offers them more legal protection, but can also be more expensive to obtain.

A trademark is an intangible asset, as it’s a nonphysical item granting a business the legal right to exclusively use a logo or other item. This means it is reported on a business’s balance sheet.

Valuing Trademarks

Trademarks have enormous value to businesses, although that may not translate to a business’s financial report. A business can only value any intangible asset, including a trademark, based on what it cost to acquire. For example, if a business purchased a product line from another company, the trademark associated with that product could have a high value on the acquiring company’s books.

The value of a trademark can also be quite low. All costs associated with creating the logo or promoting its public awareness are not included in the trademark’s value if the business did all these tasks internally. As a result, some trademarks could have no value on a company’s books despite a significant investment by the business.

Annual Review of Trademarks

Some intangible assets are amortized over time. This means that the value decreases every year as an expense for using the item. The amount the value of the asset decreases also decreases the business’s income for that year. Trademarks are not amortized since each is considered to have an indefinite life, meaning a perception exists that a trademark can retain its value forever.

However, a business must reassess the value of its trademarks annually. If a business determines that one of its trademarks is worth less than it was a year ago, the value of the intangible asset must be impaired. When an impairment occurs, the value of the asset must be decreased to its current market value. The difference between the current value of the trademark and its former value must be recorded as a financial loss.

Copyrights

A copyright is an amortizable, intangible asset that is used to secure the legal right to publish a work of authorship.

Learning Objectives

Describe how to value a copyright

Key Takeaways

Key Points

  • A work of authorship can include poetry, novels, computer software, movies, plays, songs and architectural drawings.
  • Most copyrights last for the duration of an author’s life plus 70 years.
  • The value of a copyright equals the cost it took to secure the legal copyright on a work the business created, or the price the business paid to purchase the copyright from the original owner.
  • Every year, the company must amortize the value of the copyright by an amount equal to the original value of the copyright divided by the projected amount of time that the copyright will be able to generate revenue.

Key Terms

  • amortization: The cost distribution of an intangible asset, like an intellectual property right, over the projected useful life of the asset.
  • Copyright: the right by law to be the entity which determines who may publish, copy and distribute a piece of writing, music, picture or other work of authorship

Copyrights

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Copyright: This is the emblem attached to something that is copyrighted.

A copyright is a legal protection preventing others from publishing or reproducing works of authorship. A work of authorship can include poetry, novels, plays, computer software and architectural drawings. A person who creates a work of authorship has a copyright the moment the work is created and is fixed in a form that either a person or machine can read. As a result, an author does not have to register their work with the U.S. Copyright Office. Formally registering a work is generally recommend because it provides additional legal protection against those who would copy the work.

A copyright only lasts so long, but how long it lasts depends on several factors. Generally, most copyrights last for the duration of an author’s life plus 70 years. If it is an anonymous work or something done for hire, the copyright lasts for 95 years after it was published or 120 years from the year it was created.

While a copyright is associated with a tangible work, since it is a legal right it is also classified as an intangible asset and can be included on a business’s balance sheet.

Valuing a Copyright

The value a business attaches to a copyright depends on how it was acquired. If the business developed the work in question, the value of the copyright is equal to the cost the business incurred securing the copyright. This would include any legal or application fees it might have incurred to obtain the copyright.

If the business purchased the copyright from another company, the business will record the acquired asset at it acquisition cost.

Amortizing a Copyright

Since a copyright eventually terminates, it is amortized. This means that every year the value of the copyright on the company’s books will decrease. The business will record an amortization expense to reflect the decrease in the asset’s value. Generally, an intangible asset like a copyright is amortized via the straight-line method. This means that the book value of the copyright is divided by the useful life of the copyright to determine the amortization amount. The useful life determines how long the business expects the copyright to provide it revenue, and therefore may not equal the full term of the copyright.

Every year, the amortization amount is subtracted from the value of the copyright and is listed as an expense. This continues until the value of the copyright equals zero.

Patents

A patent is an amortizable, intangible asset that grants a business the sole right to manufacture and sell an invention.

Learning Objectives

Explain how a company values a patent

Key Takeaways

Key Points

  • There are three types of patents. A utility patent is for processes, machines, and articles of manufacture. A design patent is used for any new, original ornamental design that can be affixed to an item of manufacture. A plant patent is granted to anyone that has invented or created a new plant.
  • A U.S. patent lasts for 20 years.
  • The value of a patent depends on how it was acquired. If developed internally, the book value of the patent could be quite low since all R&D expenditures are listed as expenses when incurred. If the business purchased the patent, its value equals the acquisition cost.
  • The value of the patent must be amortized over its useful life, which can be no longer than 20 years.

Key Terms

  • book value: The value of an asset as reflected on an entity’s accounting books, net of depreciation, but without accounting for market value appreciation.
  • patent: A declaration issued by a government agency declaring someone the inventor of a new invention and having the privilege of stopping others from making, using, or selling the claimed invention.
  • incur: To render somebody liable or subject to.

Patents

A patent is a legal license granting its holder the exclusive right to make, use, or sell a specific invention. There are three types of patents. A utility patent is for processes, machines, and articles of manufacture. The light bulb and the Model T would have been utility patents. A design patent is used for any new, original ornamental design that can be affixed to an item of manufacture, such as a hood ornament for a Model T. A plant patent is granted to anyone that has invented or created a new plant, such as a unique strain of corn.

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A patent is an example of an intangible asset with a limited life.: A patent is an example of an intangible asset with a limited life.

A U.S. patent currently lasts 20 years. Despite the fact that a patent is connected to a specific type of item, a patent represents a legal right and not a tangible item. A patent is classified as an intangible asset and is listed on a company’s balance sheet.

Valuing a Patent

The value of a patent that a company would record on its books depends on how it acquired the patent. If the business developed the invention internally, all the research and development costs associated with that item would have been listed as an expense as those fees were incurred. Therefore, the initial value of an internally developed patent could be quite low.

If the business purchased the patent from the original holder, the value of the patent equals the acquisition cost.

The value of the patent may be increased if a patent holding company defends its rights to the invention in a lawsuit. If the company uses an outside law firm, all fees the business pays to the firm to defend the patent will be included as part of the patent’s book value.

Amortizing a Patent

Since a patent is only valid for a limited number of years, a business is required to amortize it. The process of amortization requires decreasing the value of the asset annually by an amount equal to the value of the asset divided by the number of years of the patent’s useful life. The useful life of the patent can be no longer than how much time is left on the patent’s term, but should reflect the period that the underlying invention can generate revenue for the business that owns it. Every year the business records a decrease in the patent’s value, it must also record a corresponding amortization expense equal to the decrease.

For example, assume a business acquires a patent that has 15 years left on its term for 1 million dollars. However, the invention the patent secures will only generate revenue for ten years. For the next ten years, the company must decrease the value of the asset by 100,000. To ensure the books are balanced, the business must also record a $100,000 amortization expense for the next ten years.

Goodwill

Goodwill is an intangible asset that equals an acquired company’s purchase price minus the value of its net assets when it was acquired.

Learning Objectives

Describe how a company values Goodwill

Key Takeaways

Key Points

  • A company may only record goodwill on its balance sheet in connection to a business or business segment it acquired.
  • Goodwill = acquisition price – net assets.
  • Goodwill is not amortized, but it can be impaired if the present value of the future revenues of the related business segment are less than the net assets (including goodwill) of the business segment.

Key Terms

  • net assets: The value of a business’s assets minus the value of its liabilities.
  • impair: To decrease the value of an intangible asset.
  • goodwill: Represents the difference between the firm’s total net assets and its market value; the amount is recorded at time of acquisition.

Goodwill

The value of a business is not always defined by what assets it owns and what it owes. A successful business will develop customer loyalty and an overall positive reputation in its community, which will cause its market value to be greater than its book value. A company may also generate a higher value if it proves over time that it can generate superior revenues than its competition through managerial expertise, its reputation within its business sector, and other company attributes.

The difference between the value of a company as reflected in its balance sheet and its market value is known as its goodwill. Accounting goodwill is the excess value of a firm’s net assets and is recorded at time of business acquisition or combination. Goodwill is not associated with a physical object that the business owns, so it is an intangible asset and is listed on a company’s balance sheet. In comparison, economic goodwill refers to company attributes that are hard to quantify, such as brand loyalty, brand recognition, company innovation, and executive talent.

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Apple is a successful company with considerable goodwill.: Apple is a successful company with considerable goodwill.

Valuing Goodwill

A company can list goodwill on its balance sheet when it acquires another business at a higher cost than what the assets and liabilities on the acquired company’s balance sheet dictate. In short, goodwill equals the acquisition price minus net assets.

Say a business was purchased for 100 million. Its assets were worth 80 million but it had 30 million in liabilities. The acquired business’ assets would be equal to 50 million, and the acquiring business would record 50 million worth of goodwill on its balance sheet.

However a business may not record goodwill that it generates for itself. Using the same example, assume the business was not acquired, but it was worth 100 million and still had 80 million of assets with 30 million in liabilities. The business would not be able to record the 50 million of goodwill on its own balance sheet. Goodwill can only be recorded when an entire business or an entire section of a business is purchased at a price greater than the value of its assets.

Annual Review of Goodwill

It used to be that goodwill was amortized. This meant that the value of goodwill was decreased annually, with the business recording a loss equal to the amount of the decrease in value. As of 2001, goodwill is no longer amortized.

Every year the value of goodwill must be evaluated by the business that owns it. The company must determine the present value of all of the future revenues of the business segment associated with the goodwill. If the present value of those revenues equal or exceed the value of the business segment’s carrying value, or its total assets (including goodwill) minus assets, the business does not have to make any changes.

If the present value of the future revenues is less than the business segment’s carrying value, the business must impair, or decrease the value, of the goodwill account. Goodwill must be decreased so that the segment’s carrying value equals the present value of its revenues. If the the total value of goodwill is not enough to make up the difference, the goodwill balance must be set to zero. A business cannot have a negative goodwill balance.

Any impairment of goodwill is recognized as a loss for year of the decrease and reported on the income statement.

Franchises and Licenses

Franchises and licenses are intangible assets that legally entitle a business to sell a product or service developed by another entity.

Learning Objectives

Explain how a company values a franchise or license

Key Takeaways

Key Points

  • If a franchisee makes periodic payments to the franchisor, it does not record a franchise asset. If the contract requires that a lump sum be paid up front to secure the franchise rights for several years, the franchisee would record a franchise asset on its balance sheet.
  • A business only records a license asset on its balance sheet if the term of the license ends after the date of the balance sheet.
  • Amortizing only applies if the business records an asset. The amortization rate is calculated by dividing the initial value of the asset by its useful life. Every accounting period, the business decreases the value of the asset by the amortization rate and records an expense equal to the rate.

Key Terms

  • license: the legal terms under which a person is allowed to use a product
  • franchise: The authorization granted by a company to sell or distribute its goods or services in a certain area.
  • franchisee: A holder of a franchise; a person who is granted a franchise.
  • franchisor: A company which or person who grants franchises.

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McDonald’s, Oldham Road, Manchester.: McDonald’s is one well known organization that operates using franchises.

A franchise is a contract that grants a business the right to operate using the name and products of an established brand. A franchisor will develop the brand, produce goods and develop marketing campaigns for its products. A franchisee will then purchase the rights to sell the franchisor’s products in a given area and benefit from the franchisor’s marketing efforts. The franchisor makes money by selling rights to franchisees, while the franchisee profits by selling directly to customers. A common industry that uses franchising is fast food.

A license is similar to a franchise, in that it grants someone the right to legally use someone else’s intellectual property or gooda. This license will contain terms that will define how the purchaser can use the product and whether she can share it. A common example of a license a business might purchase is for software.

Valuing Franchises and Licenses

How a franchise is recorded on a balance sheet depends on the conditions of the contract. If a franchisee makes periodic payments to the franchisor over the contract’s term, the franchisee does not record a franchise asset. Instead, the franchisee records a franchise expense when she pays the franchise fee.

If the contract requires that a lump sum be paid up front to secure the franchise rights for several years, the franchisee would record a franchise asset on its balance sheet. Therefore, the value of the franchise asset equals what it cost to acquire.

The same rules apply to a license. If a business must pay licensing fees on a monthly or on an annual basis that coincides with the end of the business’s fiscal year, the business does not record a license asset. The fees that the business paid for those licenses are included as an expense. If the license is for multiple years or accounting periods and is acquired by paying an initial fee, the license is recorded as an asset on the balance sheet and its value equals what it cost to acquire the license.

Amortizing Franchises and Licenses

Amortizing is a term that only applies if there is a franchise or license asset. Amortization is the process of writing off the cost of an asset over its useful life. Useful life is the amount of time that a business can generate revenues from the asset. For a franchise, the useful life is generally the length of the franchise contract. The useful life of a license is how long it grants the holder the exclusive right to use the underlying product.

The amortization rate is calculated by dividing the initial value of the asset by its useful life. Depending on when the balance sheet is issued, the useful life is presented as a number of months, quarters, or years. Every accounting period, the value of the asset is decreased by the amortization rate. The business also records an expense equal to the amortization rate every accounting period.


Source: Accounting