EBITDA and Other Scary Words: Scary Words No. 7 - 'Intangible' Assets
Intangible assets. Now those are some scary words. What is an intangible and how should I record it on my books?
Intangible Assets – the Basics
An intangible asset is an asset that is not physical in nature. Examples include non-compete agreements, customer lists, goodwill, and corporate intellectual property such as patents, trademarks, copyrights, trade secrets and domain names. These all could be considered scary words –and what can be even scarier is how to account for these assets.
Generally, corporate intellectual property that is internally developed is expensed. Non-compete agreements, customer lists, and other intangibles that occur internally during your course of business may not have a cost when the non-compete is signed or as customers are added, but costs incurred in generating these would be expensed as well.
Acquired intangibles fall under purchase price accounting (more scary words) under generally accepted accounting principles, which require that all assets and liabilities be measured at their acquisition date’s fair value and, also, require that all identifiable assets acquired, including identifiable intangible assets, be assigned a portion of the purchase price based on their fair values. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
What You Need to Know About Intangible Assets
We hope you haven’t fallen asleep already. There is still more.
In keeping with our prior example – the bar scenario – let’s discuss purchasing a bar for $10 million. It seems like a very steep price for a bar, but there is a domain name of beer.com that comes with it. And, if you are wondering why that would have such a big difference in the price of the bar, in 2004, beer.com was purchased for $7 million.
(Getting off topic for a second, imagine creating the domain name fb.com before Facebook came out. Facebook bought that domain name for $8.5 million in 2010.)
Ok, so you buy the bar and you received the land and building worth $1 million, inventory of $220,000, domain name of $8 million, copyright for How To Pour the Perfect Beer (which is in Oprah’s Book Club) for $120,000, and a design patent for beer glasses that prevent spills and do not break for $360,000. Wait, that’s only $9.7 million? The remaining $300,000 is goodwill.
Intangible Assets: Domain Name, Copyright, Patent and Goodwill
Domain names are used to identify particular web pages. Each page has its own unique web address. This is how your computer locates the web page that you are trying to find. The domain name value would remain on the balance sheet and be analyzed yearly for any impairment (another scary word; this article is like Freddy vs. Jason). If the value of the domain name decreased, you would need to write down the intangible asset. However, if the value of the domain name increased, you would not increase the asset. Crazy as this is, insurance.com sold for $35.6 million in 2010. And we wonder why our insurance increases so much each year.
A copyright gives exclusive rights to reproduce, publish, or sell an original work of authorship. Protection in the United States generally extends 70 years after the creator’s death. (There are some interesting developments in this area, supposedly due to the Mickey Mouse copyright, which runs out in 2023. We may see some additional changes in the next five to seven years. We digress.) If the copyright has 10 years left, then you would amortize the copyright over the 10 years or $1,000 per month.
A patent grants exclusive rights for a certain number of years, usually 20, for an invention, product or process that provides a new way of doing something, or that offers a new technical solution to a problem. If the patent rights you acquired are up in six years, then you would amortize the patent over six years or $5,000 a month.
Goodwill is an intangible asset that may arise when a buyer acquires an existing business and represents assets that are not separately identifiable. Private business can either keep the asset on its books and analyze the goodwill for impairment (as discussed above) or adopt ASU 2014-02, accounting for goodwill for private companies. This ASU gives the private company an alternative accounting method for amortizing goodwill on a straight-line basis over 10 years, or less than 10 years if another useful life is more appropriate. Goodwill must be tested for impairment when a triggering event occurs that indicates that the fair value may be below its carrying amount.
If you adopted the accounting method to amortize goodwill over 10 years, then you would record amortization of goodwill for $2,500 a month.
Well, that wasn’t so scary. But wait, what about the tax ramifications? Ahhhhh. This can depend on how the agreement is written. You should speak with your tax accountants before finalizing any purchase or sale. If you have questions, please feel free to contact us.
"This article originally appeared on Financial Poise and is reprinted here with permission."
- EBITDA and Other Scary Words: What Did They Just Say?
- Scary Word No. 1 – GAAP
- Scary Word No. 2 – Financial Statements
- Scary Word No. 3 – Cash
- Scary Word No. 4 – Accounts Receivable
- Scary Word No. 5 – Inventory
- Scary Word No. 6 – PP&E
- Scary Word No. 7 - 'Intangible' Assets
- Scary Word No. 8 - Accounts Payable
- Scary Word No. 9 - Accrued Expenses
- Scary Word No. 10 - Commitments and Contingencies
- Scary Word No. 11 - Debt, Collateral, Covenants, Guarantees and More
- Scary Word No. 12 - "The Deferreds"
- Scary Word No. 13 - "Equity"