Intangible Assets explained
What is in the asset category of intangible assets on the balance sheet? This video provides you with the big picture on intangible assets. We start off with the definition of intangible assets, review examples of companies with a significant amount of intangible assets on their balance sheet, walk through an example including journal entries for acquired intangibles, discuss internally created intangibles, and end with intangible assets amortization and impairment.
⏱️TIMESTAMPS⏱️
00:00 Introduction to intangible assets
00:29 Intangible asset definition
01:12 Intangible assets in annual reports
01:59 Intangible asset example
02:37 Acquired intangible assets
03:04 Intangible asset journal entry
03:45 Internally created intangible assets
04:49 Amortization of intangible assets
In the International Financial Reporting Standards or IFRS, an intangible asset is defined as an identifiable non-monetary asset without physical substance. In US GAAP, an intangible asset is defined as an asset, other than a financial asset, that lacks physical substance. The first common factor is the lack of physical substance. An intangible asset does not physically exist, unlike a tangible asset such as a factory or a machine which would be in property, plant and equipment. Second common factor: an intangible asset is not a financial asset. Examples of monetary or financial assets are cash and cash equivalents, marketable securities, and accounts receivable.
When reviewing annual reports, you will find that companies have various ways of grouping intangible assets. Some use the term “intangible assets” as a category label, with items such as goodwill, computer software and patents as line items inside it. Others simply list goodwill and intangible assets as separate line items, where they really mean (here comes the language purist!) goodwill on one hand and other intangible assets on the other. When reviewing intangible assets in an annual report, check carefully whether you are looking at the category as a whole, or a subset. Many companies have a substantial amount of goodwill on their balance sheet, if they have done acquisitions at some point in their history. Far fewer companies have a significant amount in “other intangible assets”.
Intangible assets can be either acquired, or internally created. An example of acquired intangibles is the acquisition of LinkedIn by Microsoft. In the valuation of the acquisition, and subsequent consolidation of the accounts in Microsoft’s books, the intangible assets of LinkedIn were valued at $7.9 billion. On average, these intangible assets were deemed to have a useful economic life of 9 years. Let’s review the (simplified) high-level journal entry for the acquisition of LinkedIn by Microsoft. Five main categories of accounts were impacted. $27 billion was the purchase price, this is a credit to cash. Tangible assets acquired are $5.7 billion, debit to assets. Liabilities assumed are $3.4 billion, a credit to liabilities. Intangible assets are valued at $7.9 billion, debit to assets. The remainder is goodwill, the excess of the purchase price paid for an acquired firm, over the fair value of its separately identifiable net assets, for $16.8 billion, debit to goodwill.
An example of internally created intangible assets can be found in the annual report of Rolls-Royce, an engineering company focused on power and propulsion systems (such as aircraft engines), headquartered in the UK. Total net book value of intangible assets at the end of 2016 was £5.1 billion, of which goodwill was the largest item at £1.5 billion, and capitalized development expenditure second largest at £1.1 billion. In the notes to the financial statements, the treatment of R&D costs at Rolls-Royce is explained. All research phase expenditure is charged to the income statement. Development expenditure is capitalised as an internally generated intangible asset only if it meets strict criteria, relating in particular to technical feasibility and generation of future economic benefits. Expenditure capitalised is amortised over its useful economic life on a straight-line basis, up to a maximum of 15 years from the entry into service of the product.
Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investment decisions. Philip delivers training in various formats: KZread videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!
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This was very helpful and insightful, thank you!
@TheFinanceStoryteller
2 ай бұрын
You're so welcome! Have a look at the related video on goodwill as well: kzread.info/dash/bejne/q6Vt08x8nbjMg5c.html&pp=gAQBiAQB
Best explanation of intangible assets I have ever heard. I am officially a subscriber
@TheFinanceStoryteller
3 жыл бұрын
Awesome, thank you! Please spread the word.
An excellent explanation. Thank you very much.
@TheFinanceStoryteller
5 жыл бұрын
Happy to hear that, Joshua! :-) Thank you for watching, and please spread the word about the Finance Storyteller channel.
very interesting, i have it more clear now, thanks for sharing!
@TheFinanceStoryteller
5 жыл бұрын
Great to hear that! You're welcome. :-)
Excellent explanation! Thanks
@TheFinanceStoryteller
4 жыл бұрын
You're welcome! Nice to hear that.
So a tangible asset (eg yellow plant) acquired through a business loan over a period of say five years would not have the loan and interest payments included in the Amortisation figure but only reflected in the depreciation amount?
@TheFinanceStoryteller
2 жыл бұрын
That depends on whether you are looking at that situation from the accounting (journal entries) side, or the investment analysis (payback period, net present value) side.
How would tech companies like FB amortize their intangible asset such as AI algorithm?
@TheFinanceStoryteller
2 жыл бұрын
Excellent question. The vast majority of intangible assets that I come across on balance sheets are generated from acquisitions, where purchase price of the acquired company gets recorded as (split between) net tangible assets + intangible assets + goodwill. Internally generated intangible assets need to meet very stringent criteria to be eligible for capitalization on the balance sheet (and subsequent amortization). I don't know off the top of my head, as I haven't read Facebook's annual report in detail recently, but I don't think their AI algorithm is even on the balance sheet as an intangible asset. Yes, the AI algorithm obviously has economic value, but not necessarily accounting value. Hope this helps!
If you were to guess: What % of intangible assets are internally generated vs the % that are not internally generated (via an acquisition or merger) To Clarify: If we summed up all intangible assets for all US companies then what would be the % that are internally generated vs non-internally generated. I would imagine it would be over 95% are not internally generated but I may be wrong. Thx!
@TheFinanceStoryteller
2 жыл бұрын
Hi Scott! I agree with you, but haven't done the research to get to a specific percentage either. The criteria to be able to capitalize "internally generated" intangible assets (such as software development) are very strict under US GAAP.
So are internally generated intangible assets basically just capitalized R&D? Cash decreases and R&D increases?
@TheFinanceStoryteller
Жыл бұрын
Yes for the 1st question. Second one: debit intangible assets (B/S), credit cash (B/S).
@mingdianli7802
Жыл бұрын
@@TheFinanceStoryteller Oh right, in my second statement I mistyped. I meant "cash decreases and R&D (so I guess intangible assets) would increase?" Right, so the journal entry would be a debit of intangible assets and a credit of cash. Thanks a lot for the response. I appreciate it. Obviously, since capitalizing R&D would benefit a company's income statement, I assume that companies would try to get away with capitalizing R&D / capitalizing expenses as an intangible asset as much as possible - so there must be pretty strict requirements for doing so, correct? It seems like all R&D could technically be capitalized on the balance sheet as an intangible asset but of course a lot (or most?) R&D is still expensed on the income statement. What factors would allow a company to capitalize R&D as an intangible asset? EDIT: just rewatched the video. I see this is explained at 4:47. So this is true - to an extent - for any company I guess. And the useful economic life is just determined by the overseeing accounting authority? Great video. I subscribed to your channel.
@TheFinanceStoryteller
Жыл бұрын
Hello Mingdian! Lots of good thinking in your reply! Yes, R&D capitalization is certainly a topic that a company's external accountant (KPMG, PWC, etc.) will review in detail versus what the accounting standards say about it, and something that regulatory agencies like the SEC as well as accounting standards boards (FASB, IASB) will focus on as well. A company itself will take the initiative to "build a case" (based on its interpretation of generic accounting standards) on how much to capitalize, and when/how to amortize. This is then reviewed, and either approved or challenged. If you are interested in the specific rules, take a look at some of the whitepapers from the big accounting offices, those can be helpful in understanding the specific criteria. US GAAP and IFRS have different levels of "strictness" for R&D capitalization, see my case study (even though n=1 here, so difficult to generalize) kzread.info/dash/bejne/aXZtmK-hf6rHoag.html In general, it is hard or even impossible to argue that the R in R&D can be capitalized and then amortized, due to its extremely unsure outcomes. For the D in R&D, there might be ways to justify it, once you for example have a working prototype and a launch plan for the product or technology. If you think about it "big picture", then the argument for capitalization is always the matching principle. In the case of Rolls-Royce (aircraft engines) in the video, most of the development cost of the engine (which gets capitalized) will be matched to the actual production of the engine over the years. The risk of R&D capitalization is that you might get stuck with an impairment, if the product/technology fails, and you cannot therefore amortize on a regular basis over the years! Another big element of R&D spending is government funded or NGO funded research, as well as partnerships. That's a way for a company to share the load with external parties, and not have all R&D spending end up in its income statement. If you capitalize now, you will need to amortize in the future. Sharing with external parties is a different structure. I have a video on R&D spending for companies in the Dow Jones index, that might give you an idea of companies to review (I personally learn the most from reading specific sections of annual reports dealing with a specific topic): kzread.info/dash/bejne/d3mDu7Ome86vm5c.html Something similar to R&D capitalization happens at Netflix, where "streaming content assets" go onto the balance sheet, and are then amortized: kzread.info/dash/bejne/m5-d3KtxlLuXg6Q.html
I do a live stream every Sat @ 6pm my time or Sun 3:34am your time. I always have a guest host usually another Finance KZread Channel. Would you consider being a guest host? I can change the time to make it more convenient for you.
@TheFinanceStoryteller
2 жыл бұрын
Thanks for the invitation, Scott! I am really swamped at the moment with a consulting assignment and caring for my family. Maybe in the medium to long term future we will do something together.
Simple
@TheFinanceStoryteller
Ай бұрын
... yet effective. :-)
@ismaelhall3990
Ай бұрын
@@TheFinanceStoryteller Really awesome how you kept it simple for us all to understand. Subscribed!!!
@TheFinanceStoryteller
Ай бұрын
Please share the video and/or link to the channel with friends and colleagues! 😊
What is capitalization of R&D expenses?
@TheFinanceStoryteller
3 жыл бұрын
Hi Krishan. This is putting part of the R&D spending on the balance sheet as an asset, and then amortizing it over the years. A bit like buying a machine, capitalizing that on the balance sheet as a fixed asset, and then depreciating it. However, the criteria for capitalization of intangible assets are much stricter.
@KrishanSingh-gz9op
3 жыл бұрын
@@TheFinanceStoryteller So, does it mean that the r&d expense which is capitalized will not flow through the income statement (Or it will only pass through income statement only during amortization)?
@TheFinanceStoryteller
3 жыл бұрын
@@KrishanSingh-gz9op Correct. In the year of capitalization, the R&D expense does not flow into the income statement, but it does flow through the income statement during subsequent years when the amortization takes place.
POR FAVOR , YO PREGUNTE EN ESPAÑOL.- NO HABLAMOS INGLES EN CHILE,.
Are football payers intangible
@TheFinanceStoryteller
4 жыл бұрын
Great question, Colin, to which I don't know the answer. I'm more of a Formula 1 fan than a football fan. ;-) But I am sure you can easily find it out from the notes to the financial statements in the annual report of one of the big football teams.
@rodneybaloyi1614
3 жыл бұрын
no they are not, because you can not control the players as much as the is a legal contract. i read about it on grapping gaap textbook
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