However, in a world where knowledge is the basis of competitive advantage and business value, the worth of an organization cannot be determined only through tangible items such as buildings, equipment, inventory, and cash holdings. Intellectual property rights, computer software, patents, trademarks, and copyrights among others play an important role in business expansion. The comprehension of intangible assets in accounting is critical because it enables one to present the value of the company accurately.
With businesses investing more in technology, innovations, research, and brand development, there is need for one to be able to identify and record the intangible assets that a company holds. Knowledge about when the intangible assets should be recognized, the way their values should be quantified and the way their cost should be allocated over time is crucial for businesses.
What Are Intangible Assets?
An intangible asset is one of the assets that does not have physical form but can be identified as a non-monetary asset and is capable of yielding economic value for an entity.
The main difference between intangible assets and tangible assets such as land, buildings and equipment lies in the fact that intangibles generate their value from intellectual property, contracts, technology or any other non-physical resource.
Examples include patents, copyrights, trademarks, computer software, licenses, and customer related contracts. In the first case, a software firm will have a patented product that it can use to come up with new products, whereas in the second case, a manufacturing company will use a trademarked name for its products differentiating them from those of its competitors.
Nevertheless, all valuable resources cannot be treated as intangible assets in the accounting books since accountants should consider if they meet the criteria for recognition.
Types of Intangible Assets in Business
Intangible assets may be categorized into various types based on the type of activities conducted by a business.
Patents offer legal protection to qualifying inventions and entitle the owner to certain rights that are exclusive to the patent holder for a specific period. The benefits of a patent can be realized by the business through manufacturing, licensing, and technology development.
The use of trademarks and branding rights helps a business identify its products and services. Registered trademarks protect the identity of a brand name; however, internally created brand value is not considered an intangible asset under Ind AS 38/IAS 38.
Creative works, such as publications, music, and software, are protected by copyright and generate income through licensing or distribution of the work.
Software and licences have become important elements in today’s businesses. Certain software programs and licenses related to enterprise resources planning and accounting systems might qualify as intangible assets depending on the accounting requirements.
Another element linked with intangibles relates to goodwill, which may be significant in cases of business acquisitions. However, goodwill arising in a business combination differs from other identifiable intangible assets and is not subject to amortization under Ind AS 103 or IFRS 3.
Recognition of Intangible Assets
Recognition is what enables the inclusion of intangible resources in accounting statements as assets. According to Ind AS 38 and IAS 38, the intangible asset is recognized provided that it is identifiable, the entity controls the resource, the future economic benefits will flow to the entity, and the cost of the asset is reliably measurable.
Identifiability is one of the main requirements. An asset is identifiable if it can be separated from the entity and be sold, transferred, licensed, rented or exchanged, or if it is derived from contractual or other legal rights.
Control refers to the possibility of the business deriving benefits from the resource and preventing other entities from using the benefits of the resource. In case a business has enforceable rights to use certain patented technologies, it is likely that it has control over such technologies.
Expectation of future economic benefits is another requirement. Such benefits could arise through higher revenue, lower costs of production, higher productivity, and any other commercial benefits. The accountants need to consider the evidence for the satisfaction of recognition criteria.
It is also necessary to differentiate between externally acquired intangible assets and internally generated assets. Externally acquired intangible assets would normally be initially measured at cost in accordance with the relevant standard. But internally generated goodwill, internally generated brands, customer lists, and other such intangibles are usually not recognized as assets as it is difficult to separate their costs from the cost of building up the business.
Research and Development Costs
Research and development operations need to be accounted for prudently because some costs incurred in connection with innovation do not meet the criteria for recognition as an asset.
Research refers to activities carried out with a view to acquiring new scientific or technological information. It includes such things as the investigation of new technology, exploration of alternative materials and the evaluation of product ideas. Research costs are recognized as an expense since there has not been sufficient evidence of future economic benefits.
Development refers to the use of research findings or other knowledge to develop or enhance products, processes, systems, or services ready for commercial use or sale.
Under Ind AS 38/IAS 38, development costs can be capitalized only where all the criteria are met by the organization. Such criteria include technical feasibility, intent and ability to complete the development and utilize or sell the asset, probable future economic benefits, available technical and financial resources and reliability of the measurement of attributable costs.
As an illustration, a technology firm developing a new business software would capitalize expenses related to the project once it is demonstrated that the project meets the criteria for recognition.
Correctly distinguishing between research and development expenditure prevents inappropriate asset recognition and improves the reliability of financial reporting.
Valuation of Intangible Assets
After recognition of the intangible asset, its measurement and subsequent accounting have to be established.
Cost approach is usually used after the initial recognition. This means that the intangible asset will be measured based on its cost, reduced by amortization and accumulated impairment losses, if any. Original cost might include the purchase price and other expenditures incurred in order to get the asset ready for using it in its intended purpose.
For instance, in case the company acquires software license for ₹5,00,000 and has additional ₹50,000 worth of expenditure on implementing the asset that are allowed to be capitalized, the initial value of the asset might be ₹5,50,000.
Revaluation might be acceptable according to IAS 38 and Ind AS 38, if the fair value of the asset can be estimated based on an active market. However, such markets are not common for many intangible assets, since these assets are often unique or regulated by separate contractual and legal relations.
Finally, companies should determine whether the intangible asset has been impaired. In case the recoverable amount of the asset is lower than the carrying amount, there might be a necessity to recognize an impairment loss.
Amortisation of Intangible Assets
Amortization is the process of allocating the depreciable amount of an intangible asset over its useful life. Like the depreciation process of tangible assets, amortization involves recognizing the cost of the asset as an expense during the accounting periods in which the asset’s economic benefit is derived.
Intangible asset accounting requires that intangible assets having finite useful lives be amortized over the useful lives of such assets. Amortization periods and methods should match the pattern of consumption of economic benefits of the asset. In the event that such pattern is not determinable, the straight line method shall be adopted.
Take for example a company that has purchased software for ₹6,00,000 and will use it over a five-year period without any residual value. The annual amortization expense in such case will be ₹1,20,000.
Calculation:
Annual amortisation = (Cost − Residual value) ÷ Useful life
Annual amortisation = (₹6,00,000 − ₹0) ÷ 5
Annual amortisation = ₹1,20,000
The accounting entry would be:
Amortisation Expense A/c Dr. ₹1,20,000
To Accumulated Amortisation A/c ₹1,20,000
This accounting entry captures the part of the software cost that relates to the accounting period. It leads to a reduction in profit, and amortisation expense results in the reduction in the value of the asset on the statement of financial position.
Amortization normally commences when the asset is put into use. The review of useful life and the method of amortization is undertaken at least once a year end, with any change in estimate being handled accordingly.
The intangible assets with indefinite useful lives are not subject to amortization. However, such assets require annual impairment tests as well as those conducted when there is an indicator of impairment. Indefinite useful life does not necessarily mean that the asset has an infinite life; it simply means there is no foreseeable finite life to the asset that generates cash flows.
Importance of Accurate Intangible Asset Accounting
The proper accounting of the intangible assets enables companies to provide an accurate representation of their financial position. Misstatement of recognition and measurement of the intangible assets would misrepresent the total assets, expenses incurred, and profitability of the company, which would affect the decision-making of stakeholders such as the investor, lender, and the management.
Proper accounting will ensure compliance of the financial reporting standard while improving transparency in auditing, business acquisition, merger, and business valuation. Management can use the accounting information to understand the value and life of the intangible asset to facilitate budgeting, technological investments, and intellectual property protection among others.
The company that capitalizes its development expenditure needs to identify the useful life of the asset and impair the asset if necessary. Failure to adopt the above processes makes the carrying amount not representative of the economic value of the asset anymore
Developing Practical Skills in Intangible Asset Accounting
The knowledge of accounting standards demands not only memorisation of definitions but also the ability to apply recognition criteria, identify capital expenditure and revenue expenditure, perform amortisation calculations, make entries into the journal, and interpret the impact of accounting adjustments in financial statements.
For those who are interested in advanced education in accounting, practical tasks associated with the purchase of software and patents, development expenditures, calculations of amortisation, and impairments can be very helpful. Performing such tasks will help the learner gain practice in accounting in real life situations.
Such practical experience will be useful for the future work of accounting executives, financial analysts, auditors and other specialists involved in financial accounting because it will allow understanding how intangible assets are presented in financial statements and how accounting decisions are justified in audits.
Conclusion
The growing significance of intangible assets for innovative firms which rely heavily on technology, intellectual property and specialised knowledge makes the treatment of such assets in the financial statements an issue requiring considerable attention.
The consistent application of the necessary accounting standards allows businesses to achieve a high level of precision in their financial reporting and provides valuable information to stakeholders. For those wishing to become professional accountants, this is an essential stage in building competence.
Frequently Asked Questions (FAQs)
1. Explain intangible assets in accounting terms.
Intangible assets are identifiable, non-monetary assets which lack physical substance but are capable of providing economic benefit to a business. Some common examples of intangible assets include patents, copyrights, licenses for software, and trademark registration.
2. State the general conditions necessary to recognize an intangible asset.
Intangible assets will be generally recognized if the asset is identifiable, under control of the entity, capable of producing future economic benefits and its cost can be reliably measured.
3. Distinguish between amortization and depreciation.
The term amortization is used in accounting context to describe the systematic allocation of the cost of intangible assets over their useful lives while depreciation relates to tangible assets such as machinery, furniture, and building
4. How is amortization of intangible assets calculated?
The straight-line method is used to calculate amortization of intangible assets by dividing the depreciable amount of the asset by its useful life. For instance, software with a cost of ₹5,00,000 having zero residual value and a useful life of five years will have an amortization expense of ₹1,00,000 per annum.
5. Are all intangible assets amortized?
No. Finite life intangible assets are amortized over their useful lives whereas indefinite life intangible assets are not amortized but tested for impairment annually and whenever there are impairment indicators
8. What ways exist for accounting specialists to expand their understanding of intangible assets?
Accounting specialists may enhance their understanding by means of practical exercises related to the process of recognizing assets, determining their value, performing calculations of amortization, making journal entries, and conducting impairment tests. Advanced accounting training may be helpful to learners as well.