What Is an Intangible Asset?

What Is an Intangible Asset?

Intangible assets differ from tangible assets, which have physical forms such as buildings or office furniture. For businesses, an intangible asset includes patents, goodwill, and intellectual property.

Types of Intangible Assets

Intangible assets are generally considered long-term and their value can increase over time. An intangible asset like a brand name can be critical to a company's long-term success. Businesses can create or acquire intangible assets. For example, a company may create a mailing list of clients or establish a patent. It can write off the expenses from the process, such as filing the patent application, hiring a lawyer, and paying other related costs.

An indefinite intangible asset stays with the holder as long as it continues to operate, such as a brand name. A definite intangible asset is restricted to a limited timeframe such as a legal agreement to operate under another company's patent. Types of intangible assets include:

• Brand: A brand sets a business apart from its competition and is commonly represented by a logo, symbol, or name. Companies use marketing, design techniques, and advertising to create their brand. The Nike swoosh or the red Coca-Cola label are two easily recognized branding techniques. Brands contribute to a company's brand equity and help keep customers loyal.
• Goodwill: When one company purchases another, the intangible assets associated with that transaction are considered goodwill. When a company acquires another business, any amount that exceeds the fair value of the target's net assets represents its goodwill. The amount above the target's book value results in positive goodwill. Anything below book value is negative goodwill or badwill.
• Intellectual Property: A type of intangible asset that is legally protected and cannot be used by another business or individual unless authorized by the owner. Common forms of intellectual property include copyrights, digital assets, franchises, patents, trademarks, and trade secrets.
  

How to Value Intangible Assets 

A business like Coca-Cola (KO) can contribute much of its success to brand recognition. Although brand recognition is not a physical asset that can be seen or touched, it can have a meaningful impact on generating sales.

Intangible assets have no recorded book value. Because of this, when a company is purchased, the purchase price is above the book value of assets on the balance sheet. The purchasing company records the premium paid as an intangible asset on its balance sheet.There are three common ways that businesses can value their intangible assets, according to the American Institute of Certified Public Accountants (AICPA):

• Market Approach: This valuation compares similar intangible assets in the marketplace. It may prove difficult because of the limited details available about assets held by other companies.
• Income Approach: Companies can use this method when their intangible assets have a cash flow stream. Some income approaches include the relief from royalty method, which estimates possible royalty payments derived from the use of the asset or the avoided loss of income.
• Cost Approach: This method relies on substitution and doesn't account for future benefits based on time or amount.
  

Intangible vs. Tangible Assets

Tangible assets can be current or fixed. Current assets can be easily used and converted to cash such as inventory. Fixed assets are tangible assets with a lifespan of one year or more. Plant, property, and equipment (PP&E) are considered fixed.

Common tangible assets include property, equipment, furniture, inventory, and vehicles. Financial securities, such as stocks and bonds, are also considered tangible assets because they derive value from contractual claims.

Unlike intangible assets, the value of tangible assets is easier to determine. The owner may choose to hire an appraiser who determines the fair market value (FMV) of the asset or they may decide to sell the asset for cash. Another common form of valuation is comparing it to the cost of a replacement.

The Bottom Line

Businesses can have both tangible and intangible assets. Even though intangible assets can't be seen and held, they provide value for companies as brand names, logos, or mailing lists. Intangible assets can be difficult to value.