In August 2019, Financial Accounting Standards Board (FASB) member Gary Buesser issued a quarterly report on the status of reporting internally generated intangible assets. While change is unlikely anytime soon, the report did shine a light on the usefulness of including internally generated intangible asset disclosures. Buesser points out the challenges of enacting such a change and goes on to question its value to investors. However, the need to even release such a report signals to accountants and investors that the Board is listening.
On the side calling for change there is a common belief that internally generated intangible assets are the new drivers of economic activity. Therefore, they believe these assets should be required on company balance sheets. Proponents for change also argue that omitting intangibles from the balance sheet forces investors to rely more heavily on nonfinancial tools to assess a company’s value and sustainability.
Even with change unlikely any time in the near future, it is useful to understand where the standards are today and how tangible and intangible assets differ from one another.
What are the reporting intangible standards today?
According to Sarah Tomolonius, co-founder of the Sustainability Investment Leadership Council, the average company’s balance sheet understates its value by 80%. This is not an insignificant number by any means. So how does the value vary so greatly?
Under current Generally Accepted Accounting Principles in the United States (US GAAP), certain intangible assets are not recorded on the balance sheet. Acquired intangibles are the only intangibles presented on the balance sheet. Instead, GAAP demands that companies expense the costs associated with creating and maintaining those assets as they are incurred. These standards exist even though intangibles provide future economic benefits.
When intangible assets do have an identifiable value and lifespan, they are included on the company’s balance sheet as long-term assets valued according to their purchase prices and amortization schedules.
Due to the reporting variance, there is minimal uniformity in how intangible assets are represented on balance sheets and what terminology is used in the account captions. In fact, intangibles are often hidden in other assets and only disclosed in a note in the financials.
Tangible vs Intangible Assets: What are intangible assets?
An intangible asset is a non-physical asset with a useful lifespan of greater than one year. They are an entity’s long-term resources. Intangibles are either acquired from a third party or internally generated.
Examples of intangible assets are:
- Brands and trademarks
- Customer lists
- Proprietary software
- Trained and knowledgeable workforce
- Order backlogs
- Internet domain names
- Licensing or franchise agreements
- Use rights
Intangibles also include service contracts, blueprints, manuscripts, joint ventures, medical records and permits. Brand equity is itself an intangible asset, as the brand value is predicated on the perception of consumers.
Acquired intangible assets are reported at fair value. When the purchasing company overpays for the fair value of the acquired business’ identifiable tangible and intangible assets, the excess amount is reported as goodwill. Goodwill is listed as an intangible asset as it is not a physical asset.
GAAP standards require goodwill and other indefinite intangibles impairment tests at least once a year. However, private companies have the option to amortize those assets over a period of 10 years or less. Typically, major events trigger impairment testing. For example, testing may be warranted after the loss of a significant customer or the introduction of new technology which renders the company’s offerings obsolete.
Intangible Assets: Indefinite vs. Definite
There are two categories of intangible assets: indefinite and definite.
Indefinite intangible assets remain with the company as it continues operations. An example of an indefinite intangible is the company’s name.
On the other hand, definite intangible assets have a limited lifespan. An example of a definite intangible is a legal agreement to operate under another company’s patent, with no plans to extend the agreement.
Value of an Intangible Asset
Many companies rely on intangible assets to generate revenue. In addition, they also contribute substantial value to their parent company.
For instance, companies such as Apple or McDonald’s owe some of their success to brand recognition. Brand recognition is not a physical asset; however, it has a meaningful impact on generating sales.
Tangible vs Intangible Assets: What are tangible assets?
A tangible asset usually takes a physical form and carries a finite monetary value. Tangible assets maintain a real transactional value and typically account for the majority of a firm’s total assets. The income statement represents money generated from tangible assets as revenue.
Some examples of tangible assets are:
- Plant – physical space where the workers work or provide services
- Property – land, building, office furniture, etc.
- Inventory – including finished goods and raw materials
Like intangible assets, there are two categories of tangible assets: capital and current.
Tangible Assets: Capital/Fixed Assets
Capital assets, also known as fixed assets, are tangible physical assets which facilitate the business operations of a company and have a lifespan of longer than one year.
Common examples of fixed assets are:
- Computer hardware, cell phones, etc.
- Office furniture
Companies with a high ratio of capital costs to labor costs are known as capital intensive businesses. This means they require a significant financial investment in capital assets to produce goods or services. Examples of capital intensive industries are:
- Transportation (i.e. airlines, railroads, trucking, etc.)
- Oil and gas
Capital assets generate income for a company. However, they can also be sold in financial difficulty or used as collateral for business loans. In these cases, the lender normally issues a lien against the asset.
Capital assets decline in value over time; therefore, when it comes to the financial records, capital assets are typically presented as the cost of the asset minus depreciation. Depreciation rates vary depending on the asset class as defined by tax authorities. The annual depreciation qualifies as a tax write off.
On the other side, there are non-capital intensive companies that generate wealth through methods that do not require plants, machinery or expensive equipment. Instead, these companies rely on “intellectual capital.” Non-capital businesses, by nature, are easier to enter due to minimal startup costs. Some non-capital intensive businesses include:
- Software development firms
Tangible Assets: Current Assets
Current assets are the second form of tangible assets. These items are currently cash or expected to turn into cash within one year. Examples include:
- Accounts receivable
- Marketable securities
Tangible vs Intangible: How are tangible and intangible assets different?
Understanding tangible vs intangible assets makes the differences clearer. One common rule of thumb to follow: consider whether the asset can be touched or felt. Tangible assets have a physical presence, like a physical building or vehicle or piece of equipment. On the other hand, you cannot touch an intangible asset. It is impossible to touch brand equity or goodwill.
Furthermore, each asset is calculated differently on your financial records. The income statement lists income from tangible assets as revenue. Conversely, there are no easy calculations for intangible assets on the financial statements. Additionally, they are only included on the balance sheet if they are acquired or have a definite value and useful lifespan. Internally generated intangible assets do not appear on the balance sheet.
Below are the common distinctions between tangible and intangible assets.
If you have any additional questions about tangible vs intangible assets, feel free to contact us today!
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.