There’s more to your business’s value than the numbers on your balance sheet.
Today, I’m here to walk you through the types of intangible assets. We will explore what intangible assets are, how to account for them, and why these assets are frequently underrepresented in financial statements.
Let’s broaden your perspective on your company’s tangible and intangible assets because you need to know your assets before you know your value.
Intangible assets are non-physical assets that are pivotal in a business’s operations and growth.
Identifiable intangible assets are unique because, unlike tangible assets, they don’t have physical substance, making it difficult to pin down their fair value. Examples of intangible assets include intellectual property and proprietary software, as well as the following items:
- Patents
- Trademarks
- Computer software
- Copyrights
- Industry reputation
- Brand recognition
- Company culture
- Trade secrets
- In-house research and development
Unlike tangible assets, which are straightforward to value and account for, most internally generated intangible assets present unique challenges and opportunities in accounting.
The key to accounting for these assets is a three-step process: identification, valuation, and amortization.
First, let’s identify what makes an asset intangible.
To qualify as “intangible,” an asset must be
- identifiable;
- of economic benefit; and
- owned or controlled by your business.
This clarity is the first step in harnessing their value on your balance sheet.
Now, let’s determine the asset’s future value.
Valuation methods reflect the future economic potential of an intangible asset.
- The cost method values an asset based on the cost to recreate or replace it.
- The income method values an asset based on its future cash return.
- The market method values an asset by comparing its value to similar assets in the marketplace.
Then, we can use amortization to deduct expenses throughout the useful life of an asset.
Amortization is an accounting technique that spreads the cost of an intangible asset over its useful life.
Here’s where the deductions come from: when amortization is applied to an intangible asset, the expenses related to that asset appear on your income statement periodically. Let’s pick a number: $5,000. So, the first expense for the asset is $5,000. As an amortized asset ages, its value decreases.
Now, the asset is worth $3,000, but your income statement shows an expense of $5,000. The difference between the two—$2,000—is deducted from your gross taxable income.
Some intangible assets cannot be amortized. For example, an intangible asset classified as having an “indefinite useful life” is presumed to generate a consistent amount of income indefinitely. The asset retains its original value, so the expenses associated with it stay the same—no difference, no deduction.
Be aware of some basic but important do’s and don’ts when assessing a company’s value.
Do:
- Classify and assign appropriate value to intangible assets.
- Amortize intangible assets over their useful life to accurately reflect their contribution to revenue.
Don’t
- Forget to review and adjust amortization periods regularly.
- Underestimate the complexity of valuing intangible assets—you’ll need professional help.
Too many business owners overlook their company’s intangible assets.
The carrying value of an intangible asset is difficult to recognize, value, and quantify. Traditional accounting practices have struggled to keep pace with the evolving business landscape, particularly in the age of digital media, where a significant portion of a company’s value is tied to intangible assets.
Intangible assets are critical in determining the value of your business.
Accurately accounting for intangible assets is essential for displaying financial standing and growth potential. By embracing a broader perspective on asset value, businesses stand to increase their valuation.
Remember, intangible assets drive innovation and profitability.
Does your balance sheet fully reflect the present value of your business?
Let’s ensure it does. Schedule a discovery call today.
Talk soon,
Jeremy A. Johnson, CPA