Accounting for intangible assets is essentially the tracking of non physical assets, such as patents, copyrights, trademarks, software, and goodwill. These are valuable assets to companies, yet they have no physical existence. At bottom, they’re long-term assets that companies use to generate income. Physical assets such as land and equipment are relatively easy to track, but intangible assets are subject to different rules, standards and principles to properly handle their financial reporting. When it comes to accounting for intangible assets, companies must follow the GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards). Both frameworks provide guidelines on how to treat intangible assets on financial statements. The treatment and accounting entries for intangible assets can be complex due to their unique nature. Unlike physical assets, intangible assets don’t always have a clear market value, which makes their initial recognition and subsequent measurement tricky.

What are Intangible Assets?

Intangible assets are non-physical resources that aid in the operations of the business on a long-term basis. These are assets that you need to operate a business yet that are not in physical form. Some of the intangible assets are intellectual property, trademarks, patents, copyrights, software, goodwill.

Examples of Intangible Assets

• Patents: Exclusive rights to an invention or process.
• Trademarks: distinctive signs, such as symbols, words, or expressions, used to identify products.
• Goodwill: The amount paid for the value of a company’s reputation or brand.
• Copyrights: Exclusive rights granted by statute to an author or creator to print, reprint, publish, perform, film, or record literary, artistic, or musical material, and to authorize others to do so.
• Software: Programs or applications created for commercial use.

Intangible assets are very important in evaluating the market value of a company and typically represent the brand strength or unique products of the brand in the market. Because these assets are intangible in nature and do not exist in a physical sense, they cannot be felt or measured in the same manner as physical assets, complicating the asset’s accounting treatment and valuation.

Why We Need to Account for Intangible Assets?

Accounting for intangible assets is important since these assets can make a key difference to the value of a business. In the intellectual property and brand-driven economy of today, proper treatment of the intangibles is there to ensure the business conforms to its financial reporting obligations. This can have implications on investment decisions, corporate taxes and even mergers and acquisitions.

Process of Accounting for Intangible Assets

The accounting for intangible assets must follow the appropriate standards, either under GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards), as these frameworks guide the recognition, measurement, and reporting of intangible assets. Below, we will break down the steps and principles involved in the accounting for intangible assets.

Step 1: Recognition of Intangible Assets

Recognition is the first stage in intangible asset accounting. According to both GAAP and IFRS, an intangible asset is only recognized if it fulfils specific requirements. These are required to ascertain that the asset is valuable and will result in future economic benefits. An intangible asset is recognised if, it is:

1. Identifiability: The asset must be identifiable, meaning it can be separated from the business and sold, licensed, or transferred.
2. Control: The company must have control over the asset, meaning it has the ability to use the asset and restrict others from using it.
3. Future Economic Benefits: The property should be able to generate future cash flows or contribute to the company in some way, such as making the company more efficient in its operations or perhaps increasing brand value.
4. Measurability of Cost: The cost of the asset should be easily and accurately measurable. This means the company should be able to calculate what it spent to receive or develop the intangible asset.

Step 2: Measuring the Cost of the Intangible Resources

It should be borne in mind that when an intangible asset is recognised, the next thing is to decide its cost. The cost of an intangible asset comprises all directly attributable costs incurred to acquire, develop or produce the asset to the point at which it is available for use. This may comprise, for example:

1. Cost of Purchase: It’s a price buyer paid to purchase that intangible asset, may be bought through contracts or exchanges.
2. Legal and Registration Costs: Expenses are made to obtain the legal rights to an asset with fees for registration of patents or trademarks.
3. Development Costs: In the case of internally developed intangible assets, development costs, such as R&D (research and development) expenses, may be capitalized if the costs satisfy certain requirements under GAAP or IFRS.
4. Other applicable costs: These are costs that can be attributed directly to the acquisition or production of the intangible asset. So legal fees, advisory fees or the design and production costs to develop the software.

Brand development, or goodwill, which is an internal cost, is not capitalized under GAAP but rather expensed as incurred.

Step 3: Determining the Useful Life of Intangible Assets

Once the cost of the intangible asset is measured, the company must determine its useful life. The useful life refers to the period over which the asset is expected to generate economic benefits.

There are two main categories of intangible assets based on their useful life:

1. Definite Life Intangible Assets: These assets have a clear and determinable useful life. For example, a patent might last for 20 years, after which its legal protections expire, or software might have a useful life of 5 years. These assets are amortized over their useful life.
2. Indefinite Life Intangible Assets: These assets do not have a finite useful life. Goodwill is the most common example of an indefinite-life intangible asset. Goodwill arises during business acquisitions when the purchase price exceeds the fair value of the acquired company’s identifiable assets and liabilities. Since goodwill does not have an expiration period, it is not amortized but instead tested for impairment annually.

It is important to separate definite life intangibles from indefinite life intangibles since this distinction impacts the way the intangible asset will be amortized or tested for impairment. GAAP and IFRS provide pacing on its useful life; however, there could be nuances from practice of one to the other.

Step 4: Amortization of Intangible Assets

Amortization is the process of gradually expensing the cost of an intangible asset over its useful life. Intangible assets with a definite useful life must be amortized, while those with indefinite lives are not.

• Amortization under GAAP: Amortization under GAAP is the process of spreading out the cost of an intangible asset with a finite life over a number of years. The straight-line method is the most common, which allocates the deduction equally over the life of the asset. The amortization is charged to the income statement on an annual basis.

Example: A company acquires a patent at a cost of $100,000 with a useful life of 10 years. The annual charge to amortization would be $10,000 ($100,000 / 10 years). For each year, the company would book an amortization cost and decrease the patent balance sheet value.

• Amortization under IFRS: IFRS also requires the amortization of intangible assets with definite lives. However, IFRS allows for more flexibility in determining the amortization period and method. While the straight-line method is the most commonly used, companies can use other methods if they believe it better reflects the asset’s consumption of economic benefits.

Step 5: Impairment of Intangible Assets

While amortization accounts for the gradual expense of intangible assets with definite lives, the accounting treatment of intangible assets also requires an evaluation of impairment. Impairment occurs when an intangible asset’s carrying value exceeds its recoverable amount, i.e., when the asset’s future cash flows are expected to be lower than its current book value.

• Impairment Testing for Definite-Life Intangible Assets: If there are signs of impairment, companies must assess whether the carrying value of the asset exceeds its recoverable amount. Signs of impairment could include changes in market conditions, technological obsolescence, or a significant decline in revenue associated with the asset. If the asset is impaired, it is written down to its fair value, and an impairment loss is recorded.

• Impairment Testing for Indefinite-Life Intangible Assets (Goodwill): For indefinite-life intangible assets, such as goodwill, the impairment test is done annually, regardless of whether there is any indication that the asset has been impaired. The company must compare the carrying value of the asset with its fair value. If the fair value is less than the carrying value, an impairment loss is recognized.

The impairment of goodwill can have a significant impact on the company’s financial statements. Therefore, the company must follow the guidelines under both GAAP and IFRS to determine when impairment testing is necessary and how to account for any impairment losses.

Step 6: Treatment of Disposals of Intangible Assets

Ultimately, intangibles can be written off or divested. When that occurs, entities are required to recognize the gain or loss on disposal by comparing the carrying amount of the asset (after amortization and impairment) to the proceeds from selling it.

Example:

If a company sells a patent for $50,000 and its net book value (after amortization) is $40,000, it will report a gain of $10,000 on the sale.

Key Differences in Accounting for Intangible Assets: GAAP vs IFRS

While GAAP and IFRS have many similarities when it comes to accounting for intangible assets, there are some key differences:

1. Impairment Testing: IFRS requires annual impairment testing for indefinite-life intangible assets like goodwill, while GAAP only requires impairment testing if there is an indication that the asset may be impaired.
   
2. Internally Generated Intangible Assets:IFRS allows the capitalization of certain development costs for internally generated intangible assets, whereas GAAP generally requires such costs to be expensed as incurred.
   
3. Revaluation Model: IFRS allows for the revaluation of intangible assets, meaning companies can reassume the asset at fair value if an active market exists. GAAP, on the other hand, does not allow the revaluation of intangible assets.

Accounting Entries for Intangible Assets

Proper accounting entries for intangible assets are crucial for accurate financial reporting. The journal entries will depend on the nature of the asset, whether it is purchased or internally generated, and its expected useful life.

Journal Entry for Intangible Assets

1. When Acquiring Intangible Assets:

Intangible Asset A/c  Dr. Cash/Bank or Payable

2. Amortization of Intangible Assets:

Amortization Expense A/c Dr.   Intangible Asset (Accumulated Amortization)

3. Impairment of Intangible Assets:

Impairment Loss Dr.   Intangible Asset

Intangible Asset Accounting Challenges

Intangible Assets Accounting Although intangible assets accounting is crucial, it has certain limitations. These challenges include:

• Valuation: Intangible assets frequently have no readily ascertainable market value.
• Amortization: The useful life of intangible interest amortization can be subjective.
• Impairment Testing: Periodic impairment testing can be difficult and is judgmental

Relevance to ACCA Syllabus

Accounting for intangible assets” is directly related to Financial Reporting (FR) and Strategic Business Reporting (SBR) papers in ACCA. Understanding IFRS, particularly IAS 38 – Intangible Assets, is critical. Students are tested on recognition, measurement, amortization, and impairment of intangible assets in individual and consolidated financial statements.

Accounting for Intangible Assets ACCA Questions

Q1: Under IAS 38, which of the following conditions must be met to recognize an intangible asset?
A) Asset must have physical substance
B) Asset must arise from a business combination
C) Future economic benefits are probable and cost can be measured reliably
D) Asset must be a result of a government grant

Ans: C) Future economic benefits are probable and cost can be measured reliably

Q2: Which of the following is an example of an intangible asset under IAS 38?
A) Inventory
B) Leasehold land
C) Patent
D) Office furniture

Ans: C) Patent

Q3: What is the treatment of goodwill under IFRS in consolidated financial statements?
A) Amortized over 10 years
B) Tested for impairment annually
C) Expensed immediately
D) Revalued annually

Ans: B) Tested for impairment annually

Q4: Internally generated brands can be capitalized if:
A) Their market value is high
B) The brand is well-known
C) Development phase costs meet recognition criteria
D) They are developed before listing the company

Ans: C) Development phase costs meet recognition criteria

Relevance to US CMA Syllabus

In the Part 1: Financial Planning, Performance, and Analytics, the CMA syllabus tests candidates on the accounting treatment of intangible assets, including amortization, valuation, and reporting under US GAAP. Understanding how intangible assets impact the balance sheet and income statement is essential.

Accounting for Intangible Assets US CMA Questions

Q1: Under US GAAP, intangible assets with finite lives must be:
A) Expensed fully in the year of acquisition
B) Revalued annually
C) Amortized over their useful lives
D) Tested for impairment every 5 years

Ans: C) Amortized over their useful lives

Q2: Which of the following is not considered an intangible asset under US GAAP?
A) Customer lists
B) Brand recognition
C) Accounts receivable
D) Copyright

Ans: C) Accounts receivable

Q3: How is an intangible asset acquired in a business combination measured initially under GAAP?
A) At fair value on acquisition date
B) At book value of the acquiree
C) At cost of acquiring company
D) At amortized value

Ans: A) At fair value on acquisition date

Q4: What happens if the carrying amount of an intangible asset exceeds its fair value?
A) No adjustment is required
B) Amortization increases
C) An impairment loss is recognized
D) Depreciation is applied retroactively

Ans: C) An impairment loss is recognized

Relevance to US CPA Syllabus

In the FAR (Financial Accounting and Reporting) section of the CPA exam, candidates must understand the treatment of intangible assets under US GAAP and their presentation in financial statements. It includes both purchased and internally developed intangibles.

Accounting for Intangible Assets US CPA Questions

Q1: Goodwill under US GAAP is:
A) Amortized annually
B) Recorded only when internally generated
C) Tested for impairment annually
D) Revalued to market value

Ans: C) Tested for impairment annually

Q2: Which cost related to intangible assets must be capitalized under US GAAP?
A) Training costs
B) Research costs
C) Development costs meeting certain criteria
D) Advertising costs

Ans: C) Development costs meeting certain criteria

Q3: When should a company test intangible assets with indefinite lives for impairment under GAAP?
A) Every 3 years
B) Only upon disposal
C) When triggered by events
D) Annually or upon triggering events

Ans: D) Annually or upon triggering events

Q4: If a company writes off an intangible asset due to impairment, what journal entry is made?
A) Debit Intangible Asset, Credit Cash
B) Debit Impairment Loss, Credit Intangible Asset
C) Debit Amortization Expense, Credit Intangible Asset
D) Debit Retained Earnings, Credit Intangible Asset

Ans: B) Debit Impairment Loss, Credit Intangible Asset

Relevance to CFA Syllabus

Under the CFA Level I and Level II Financial Reporting and Analysis, candidates must understand how intangible assets affect a firm’s valuation, especially under IFRS and GAAP. This includes analysis of amortization, impairment, and the impact on cash flows and earnings quality.

Accounting for Intangible Assets CFA Questions

Q1: Why is goodwill not amortized under IFRS and US GAAP?
A) It increases income
B) It is expected to last forever
C) It is tested for impairment instead
D) It has no value

Ans: C) It is tested for impairment instead

Q2: Which of the following is most likely to be capitalized as an intangible asset under IFRS?
A) Advertising expense
B) Market research cost
C) Internally developed software (after feasibility)
D) Goodwill created by company reputation

Ans: C) Internally developed software (after feasibility)

Q3: What is the impact of impairment of intangible assets on financial ratios?
A) Increases ROA
B) Decreases profit margins
C) Increases total assets
D) Increases current ratio

Ans: B) Decreases profit margins

Q4: Under IFRS, when should an intangible asset be recognized in the balance sheet?
A) When it is internally developed
B) When it is likely to generate future economic benefits
C) When it has a physical form
D) Only when acquired in a merger

Ans: B) When it is likely to generate future economic benefits