Intangible assets are non-physical assets with monetary value but cannot be seen or touched. These assets are an important part of a company’s balance sheet and can greatly impact its financial performance. However, accounting for intangible assets can be tricky, and it is important to understand the proper accounting treatment to ensure accurate financial reporting. Examples of intangible assets include patents, trademarks, copyrights, trade secrets, goodwill, brand value, licenses, and franchises.
Difference between tangible and intangible assets
Tangible and intangible assets are assets that a company can own and use to generate income. However, there are several key differences between the two.
Tangible assets are physical assets that can be seen and touched, such as land, buildings, equipment, and inventory. They have a measurable value and can be easily quantified, and their market value or replacement cost can determine their value. They can be used to generate income through renting, leasing, or selling the asset. Examples of tangible assets include cash, land, buildings, vehicles, inventory, and equipment.
On the other hand, intangible assets are non-physical assets with monetary value but cannot be seen or touched. They are often the result of intellectual or creative efforts, such as patents, trademarks, copyrights, trade secrets, goodwill, brand value, licenses, and franchises. Their value is not always easy to quantify and is often based on the company’s reputation and the strength of its brand. Intangible assets can be used to generate income through licensing or using intellectual property to produce or sell goods or services.
In-house developed intangible assets and recording
In-house developed intangible assets are intangible assets developed internally by a company rather than acquired from an external source. Examples of in-house developed intangible assets include software, trademarks, and patents.
The accounting treatment for in-house developed intangible assets is similar to other intangible assets. According to IAS 38 Intangible Assets, development costs can be capitalised as an asset when certain conditions are met. These conditions include:
- The costs will probably result in future economic benefits
- The costs can be reliably measured
- The asset is available for use or sale
If these conditions are met, the development costs are capitalised as an asset on the balance sheet and are amortised over their useful life. The amortisation is recorded as an expense on the income statement, and the asset account is credited with the same amount.
For example, suppose a company incurs $100,000 in costs to develop new software. In that case, it is determined that the software will result in future economic benefits, and the costs can be reliably measured. The software can be capitalised as an asset. The annual amortisation expense would be $10,000 (100,000/10), assuming a useful life of 10 years. The entry would be:
Debit: Amortization Expense (Income Statement) $10,000
Credit: Software (Intangible Asset Account) $10,000
It’s worth noting that the capitalisation and amortisation of in-house developed intangible assets require careful judgment and estimation. Companies should consult an accountant to ensure compliance with accounting standards and accurate financial reporting.
Accounting for Intangible Assets
The accounting treatment for intangible assets varies depending on the type of asset and the accounting standard used. As per US GAAP and IFRS, intangible assets can be capitalised and amortised over their useful lives. Capitalisation means that the intangible asset’s cost is recorded as an asset on the balance sheet. At the same time, amortisation is spreading the asset’s cost over its useful life.
Impairment testing is also required for intangible assets. This evaluates whether the asset’s value has decreased and whether it needs to be written down. For example, if a patent loses its value due to changes in technology or market conditions, it may need to be written down.
Disclosure requirements for intangible assets also vary depending on the accounting standard used. Companies must disclose their intangible assets, such as their acquisition cost, useful life, and impairment charges.
General ledger entries of the intangible assets
General ledger entries for intangible assets involve several steps and account entries. Intangible assets are initially recorded as assets on the balance sheet and then amortised over their useful lives.
- Capitalisation of the intangible asset: When an intangible asset is acquired, it is recorded as an asset on the balance sheet. The intangible asset’s cost is debited to the intangible asset account and credited to the cash or accounts payable account, depending on the payment method.
For example, if a company purchases a patent for $50,000, the entry would be:
Debit: Patent (Intangible Asset Account) $50,000
Credit: Cash or Accounts Payable $50,000
- Amortisation of the intangible asset: The intangible asset’s cost is then amortised over its useful life. The amortisation is recorded as an expense on the income statement, and the same amount credits the intangible asset account. The amortisation expense is debited to the amortisation expense account. The amortisation expense is calculated by taking the intangible asset’s cost divided by its useful life in years.
For example, if the patent has a useful life of 10 years, the annual amortisation expense would be $5,000 (50,000/10). The entry would be:
Debit: Amortization Expense (Income Statement) $5,000
Credit: Patent (Intangible Asset Account) $5,000
- Impairment Testing: Impairment testing is performed to ensure that the value of the intangible asset is reflected accurately in the financial statements. If the value of the intangible asset has decreased, it may need to be written down. This is recorded as an impairment loss on the income statement, and the same amount is credited to the intangible asset account.
For example, if the value of the patent is determined to have decreased by $10,000, the entry would be:
Debit: Impairment Loss (Income Statement) $10,000
Credit: Patent (Intangible Asset Account) $10,000
It’s worth noting that the accounting treatment of intangible assets is complex and depends on the accounting standard being used. It’s always recommended to consult with an accountant to ensure compliance with the accounting rules and accurate financial reporting.
Accounting for R&D Costs on Intangible Assets
Companies incur research and Development (R&D) costs in researching and developing new products, processes, or technologies. These costs can include employee salaries, materials, and other expenses related to the R&D process.
The treatment of R&D costs under IAS 38 Intangible Assets is that research costs are expensed as incurred. This means they are recognised as an expense in the period they are incurred and are not capitalised as an asset. This is because research costs are considered exploratory and incurred in the search for new knowledge or capabilities without a specific plan to complete a tangible asset.
On the other hand, development costs are capitalised as an asset when certain conditions are met. According to IAS 38, development costs can be capitalised if it is probable that the costs will result in future economic benefits, the costs can be reliably measured, and the asset is available for use or sale. This means that if a company incurs costs in the process of developing a new product or technology that is expected to generate future economic benefits, and these costs can be reliably measured, then they can be capitalised as an asset.
Once capitalised, the development costs are amortised over the asset’s useful life. The amortisation is recorded as an expense on the income statement, and the asset account is credited with the same amount. The amortisation expense is calculated by taking the asset’s cost divided by its useful life in years.
It’s important to note that the capitalization of R&D costs is complex. Companies should consult with an accountant to ensure compliance with accounting standards and accurate financial reporting.
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Conclusion
Intangible assets play a crucial role in a company’s overall financial picture, and proper accounting for these assets is essential for accurate financial reporting. Companies need to understand the different types of intangible assets, accounting treatments, and disclosure requirements. This will ensure their compliance with accounting standards and provide stakeholders with transparent financial information.