Question

What are the different types of intangible assets? So, what is the accounting procedure for patents and how does the amortization works for these type of assets...

Answer 1

Intangible Assets:

According to the IFRS, intangible assets are identifiable, non-monetary assets without physical substance. Like all assets, intangible assets are those that are expected to generate economic returns for the company in the future. As a long-term asset, this expectation extends for more than one year or one Operating Cycle.

Intangible assets lack a physical substance like other assets such as inventory and equipment. They form the other largest category of long-term assets, other than Property, Plant and Equipment. They can be separated into two classes. They are identifiable and non-identifiable.

Identifiable and Unidentifiable Intangible Assets

Identifiable intangible assets are those that can be separated from other assets and can even be sold by the company. These are such assets as intellectual property, patents, copyrights, trademarks, and trade names. Software and other computer-related assets outside of hardware also classify as identifiable intangible assets.

Unidentifiable intangible assets are those that cannot be physically separated from the company. The most predominant unidentifiable intangible asset is goodwill. Internally generated goodwill is expensed as a loss, but externally generated goodwill when a company acquires or merges with another company is capitalized as an asset. This means that when a company pays above the fair value of another company to acquire it, the difference is goodwill. This asset is not depreciated like PP&E but is instead tested for impairment regularly. A company will take on an impairment loss if it deems the goodwill’s value is not as high as its book value.

Another key unidentifiable asset is branding and reputation. While a company can sell its trademark, logos and such, it can be very difficult to separate good branding and reputation from a strong company. This branding is expected to generate good economic returns for the company in the future.

How to account for a patent

A patent is considered an Intangible Asset; this is because a patent does not have physical substance, and provides long-term value to the owning entity. As such, the accounting for a patent is the same as for any other intangible fixed asset, which is:

• Initial recordation. Record the cost to acquire the patent as the initial asset cost. If a company files for a patent application, this cost will include the registration, documentation, and other legal fees associated with the application. If the company instead bought a patent from another party, the purchase price is the initial asset cost.
• Amortization. The owner of the patent gradually charges the cost of the patent to expense over the useful life of the patent, usually using the straight-line amortization method.
• Impairment. If a patent no longer provides value, or a reduced level of value, recognize an impairment to reduce or eliminate the carrying amount of the asset.
• Derecognition. Once the company is no longer making use of the patented idea, the asset can be derecognized by crediting the balance in the patent asset account and debiting the balance in the accumulated amortization account. If the asset has not been fully amortized at the time of derecognition, then any remaining unamortized balance must be recorded as a loss.

Consider the following additional points when accounting for patents:

• R&D expenditures. Note that the research and development (R&D) costs required to develop the idea being patented cannot be included in the capitalized cost of a patent. These R&D costs are instead charged to expense as incurred; the basis for this treatment is that R&D is inherently risky, without assurance of future benefits, so it should not be considered an asset.
• Useful life. A patent asset should not be amortized for longer than the lifespan of the protection afforded by the patent. If the expected useful life of the patent is even shorter, use the useful life for amortization purposes. Thus, the shorter of a patent's useful life and its legal life should be used for the amortization period.
• Capitalization limit. In practice, the costs of obtaining a patent may be so small that they do not meet or exceed a company's capitalization limit. If so, charge these costs to expense as incurred. In many larger companies with higher capitalization limits, this means that patents are rarely recorded as assets unless they have been purchased from other entities.

Amortization expense:

While PP&E is depreciated, intangible assets are amortized (except for goodwill). These assets are amortized over the useful life of the asset. Generally, intangible assets are simply amortized using Straight-Line Expense.

If an intangible asset has a perpetual life, it is not amortized. Consequently, if an intangible asset has a useful life but can be renewed easily and without substantial costs, it is considered perpetual and is also not amortized.

Example

McRoonald’s has two intangible assets. The first is a patent worth $25,000,000 and with a useful life of 50 years. The patent expires and cannot be renewed. The second is a trademark worth $1,000,000 and with a useful life of 10 years, upon which it expires. However, the trademark can be renewed at marginal costs. What is McRoonald’s amortization expense per year?

The trademark is not amortized, as it virtually has a perpetual life. The patent, however, is amortized with straight-line over its 50-year life. Amortization expense is $25,000,000 / 50 = $500,000. Thus, the yearly amortization expense for McRoonald’s is $500,000.