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When Intangible Assets Show Up on Balance Sheets

December 01, 2009

Intellectual property and - more broadly - all intangible assets have become a growing part of many companies' balance sheets. The valuation and financial treatment of these assets has become of increasing interest to boards and executives of companies across industries.

Let's start with some definitions. Intellectual property is a subset of the broader category of intangible assets. Intangible assets are defined as nonphysical assets that generate rights, privileges, and have economic benefits for the owner. Some examples of intangible assets include:

  • Marketing-Related Intangibles: Trademarks, trade names, service marks, Internet domain names, and non-competition agreements.
     
  • Customer-Related Intangibles: Customer lists, order backlog, customer contracts/relationships.
     
  • Artistic-Related Intangibles: Literary or artistic works.
     
  • Contract-Based Intangibles: Licensing, royalty, advertising, and service agreements. Also, lease agreements, franchise agreements, use rights, employment contracts.
     
  • Technology-Based Intangibles: Patents, software, unpatented technology, data bases, trade secrets.

Not surprisingly, most companies have significant intangible assets, though not all intangible assets are reflected on a company's financial statements. The most common reason for a company to have considerable balances for identified intangibles on its financial statements is a recent business combination or acquisition. Earlier this decade, the increase in merger and acquisition activity - coupled with changes to Generally Accepted Accounting Principles (GAAP) - resulted in an increase in the number companies with intangible assets on their balance sheets.

Under GAAP, when business combine or one acquires another, identifiable intangible assets are assessed at the fair value as of the acquisition date. 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 (Statement of Financial Accounting Standards, SFAS 157). It is typically determined by an expert at the time of the acquisition. If applicable, those intangible assets with a finite useful life are then amortized over that useful life.

If certain events or changes in circumstances occur ("trigger events"), the company must determine if the value of amortizing intangible assets is impaired. Non-amortizing intangibles - such as goodwill - fall under different rules not discussed in this article. The rules surrounding trigger events are defined in SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Some examples include:

  • A significant decrease in the market price of an intangible asset.
  • A significant adverse change in the extent or manner in which an intangible asset is being used or in its physical condition.
  • A current expectation that, more likely than not, an intangible asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

In the recent economic downturn, it is quite possible that many companies with intangible assets on their financial statements may have experienced a trigger event. In fact, over the past year, many companies have been grappling with the issue of possible impairment of identified intangible assets on their books.

If a trigger event occurs, the company must determine if the carrying amount of an intangible is recoverable. If not, impairment may exist and the asset may have to be written down or written off completely.

The rules for measuring impairment are complex. But, under these rules, the fair value being lower than what was originally recorded is not enough for impairment to exist. Presumably, since the time the company originally booked the intangible asset, it has been reducing (or amortizing) its value over its remaining useful life. Additionally, standards dictate that an amortizing intangible asset is only impaired if its value is not recoverable. Recoverability is defined as the value of undiscounted future benefits being greater than the current carrying value, an easier standard to meet.

It has become increasingly common for companies to take write-downs on intangible assets. In many cases, anticipated future benefits of intangible assets are lower than the expectations of the recent past. For businesses with identified intangible assets currently on their books, it is important to recognize that impairment may exist and to be proactive in approaching this issue.

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