Lesson 1 of 8 · All lessons in this module
- Intangible assets: definition, purchase and business combinations
- Internally developed intangibles and capitalising versus expensingVideo lesson
- Impairment of PPE and intangiblesVideo lesson
- Assets held for sale and impairment reversals
- Derecognition: sale, abandonment, exchange and spin-offVideo lesson
- Disclosures for PPE and intangible assets
- Fixed asset turnover, asset age and reinvestmentVideo lesson
- Integrated cases: a purchase price allocation and the PPE note
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Lesson 1 of 8 · 13 min
Intangible assets: definition, purchase and business combinations
An intangible asset is recorded at what was paid for it when it is bought on its own or with a whole company, and whatever part of a takeover price cannot be pinned to identifiable assets becomes goodwill.
In short
- Intangible assets are non-monetary assets without physical substance, such as patents, copyrights, trademarks, franchises and licences.
- Under IFRS an identifiable intangible must be identifiable, controlled by the company and expected to bring future economic benefits; it is recognised if those benefits are probable and its cost can be reliably measured.
- Bought on its own (outside a business combination), an intangible is recorded at fair value, assumed equal to the price paid; a group purchase is split by each asset's fair value.
- In a business combination, the acquisition method assigns the price to every identifiable asset and liability at fair value; the excess is goodwill.
- Finite-life intangibles are amortised; indefinite-life intangibles (and goodwill) are not amortised but tested for impairment at least annually.
What counts as an intangible asset
An intangible asset is a non-monetary asset that you cannot touch. Typical examples give the owner an exclusive right: patents, copyrights, trademarks, franchises and licences.
IFRS sets three definitional criteria for an identifiable intangible. It must be identifiable, meaning it could be separated from the company or it arises from contractual or legal rights. It must be under the company's control. And it must be expected to produce future economic benefits.
Two recognition criteria must also hold before it goes on the balance sheet: it is probable that the benefits will flow to the company, and the cost can be measured reliably. A trained workforce or a strong reputation may be valuable economically, but it fails these tests and stays off the accounting balance sheet.
Goodwill is a special case. It arises only when one company buys another for more than the fair value of the net identifiable assets, and it cannot be separated from the business as a whole. IFRS therefore does not call it an identifiable intangible; US GAAP's broader definition of intangibles includes it.
The accounting balance sheet is much narrower than the 'economic' one. Many of a company's most valuable resources, such as know-how built over years, never appear as assets unless someone pays for them.
Buying an intangible on its own
When a company buys an intangible outside a business combination, for example a patent from an inventor, it treats it like a purchase of equipment. The asset is recorded at its fair value, which is assumed to equal the purchase price.
If several intangibles are bought together for one price, the price is allocated to each asset on the basis of its fair value.
Fair values of individual intangibles rest on heavy judgement and many assumptions. For analysis, it is usually more useful to know what kind of assets were bought (franchise rights, customer lists, technology) than exactly how the price was split. The type of assets acquired says a lot about strategy and future operating potential.
Intangibles acquired in a business combination
Both IFRS and US GAAP account for takeovers with the acquisition method. The acquirer assigns the purchase price to each asset acquired and each liability assumed at its fair value, including identifiable intangibles that the target never recorded itself (for example, its home-grown brands).
Any excess of the price over the fair value of the net identifiable assets (tangible assets plus identifiable intangibles minus liabilities) is recorded as goodwill. Goodwill typically reflects things like an assembled workforce and expected synergies.
Under IFRS, an acquired item is recognised separately if it meets the definitional and recognition criteria; anything that cannot be recognised as a tangible or identifiable intangible asset is folded into goodwill. Under US GAAP, an acquired intangible is recognised apart from goodwill if it arises from contractual or legal rights or can be separated from the acquired company. Patents, copyrights, franchises, licences, internet domain names and video or audiovisual material all qualify.
| How obtained | Initial treatment | Cash flow statement |
|---|---|---|
| Purchased on its own | Capitalised at fair value (= price paid); group price split by fair values | Investing outflow |
| Developed internally | Generally expensed; some development costs capitalised (next lesson) | Operating outflow |
| Acquired in a business combination | Capitalised at fair value; residual price = goodwill | Part of the acquisition (investing) |
Finite versus indefinite useful lives
After recognition, what matters is the useful life. An intangible with a finite useful life, such as a patent that expires, is amortised over that life: its carrying amount falls each year, and it is tested for impairment only when events suggest it may be impaired.
An intangible with an indefinite useful life, such as a trademark or copyright that can be renewed without limit, is not amortised. It stays at historical cost and is tested for impairment at least annually. Goodwill is treated the same way.
| Asset | Amortised? | Impairment testing |
|---|---|---|
| Finite-life intangible (e.g. patent expiring in 12 years) | Yes, over its useful life | When indicators of impairment exist |
| Indefinite-life intangible (e.g. renewable trademark) | No | At least annually |
| Goodwill | No | At least annually |
Formula
- Goodwill
Identifiable assets include tangible assets and identifiable intangibles, all at fair value at the acquisition date.
Worked examples
Example 1 Splitting a takeover price
Kestrel Group pays SEK 900 million for all of Tindra AB. At fair value, Tindra has PPE of 300, a customer list of 120, a brand Tindra built itself (never on its books) of 80, patents of 100, other assets of 150 and liabilities of 250 (SEK millions). Kestrel also estimates Tindra's skilled workforce is worth 30. How much goodwill does Kestrel record?
Example 2 Classifying four intangibles
Arnhem Media NV (IFRS) owns: (1) a patent bought last year with 12 years of legal protection left; (2) a trademark bought with a radio station, renewable every ten years at negligible cost, which management plans to keep indefinitely; (3) goodwill from that radio station purchase; (4) a podcast brand it built itself through advertising. How is each treated after recognition?
On the exam
Expect concept questions: the IFRS criteria for an intangible, how goodwill arises, which acquired items US GAAP recognises apart from goodwill, and which intangibles are amortised; sometimes a goodwill calculation from fair values.
- Computing goodwill against book values instead of fair values of the target's net identifiable assets.
- Forgetting that the target's own internally built brands and customer lists are recognised by the acquirer.
- Amortising goodwill or an indefinite-life trademark. Neither is amortised; both are tested at least annually.
- Thinking an assembled workforce is a separate intangible. It cannot be separated and ends up in goodwill.
Check yourself
Q1Under IFRS, which of the following is not one of the definitional criteria for an identifiable intangible asset?
Q2An acquirer pays CHF 750 million for a company whose identifiable assets have a fair value of CHF 900 million, including CHF 200 million of identifiable intangibles, and whose liabilities are CHF 350 million. Goodwill is closest to:
Q3Under US GAAP, an intangible acquired in a business combination is recognised separately from goodwill if it:
Q4A copyright that can be renewed indefinitely at little cost is most likely:
Q5A company buys three patents together for EUR 6 million outside a business combination. The price is most likely allocated to the patents:
Answer the 5 questions: +10 XP for each one you get right first time.
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