Intangible assets are non-physical assets that contribute to the earning capacity of a business. They typically have a useful life of more than one year and are usually derived from legal rights or intellectual property. Intangible assets can include things like patents, copyrights, trademarks, brand recognition, proprietary technology, customer lists, and business methodologies, among others.
These assets can be classified into two main categories:
- Identifiable Intangible Assets: These are assets that can be separated from the company and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract. They also include assets that arise from contractual or other legal rights, regardless of whether those rights are transferable or separable from the company or from other rights and obligations. Examples include patents, trademarks, and customer lists.
- Unidentifiable Intangible Assets (or Goodwill) : Goodwill typically arises from business combinations (like mergers and acquisitions) and represents the excess of the purchase price over the fair value of identifiable net assets (which includes identifiable intangible assets) of the acquired company. Goodwill can be thought of as the value of a company’s reputation, its relationships with customers and suppliers, and other factors that make the company’s operations more profitable than would be suggested by the value of its tangible and identifiable intangible assets alone.
Although intangible assets do not have a physical presence, they can be extremely valuable and can contribute significantly to a company’s success. For example, a company’s brand name recognition can drive customer loyalty and sales, while patents can give a company exclusive rights to produce a unique product, protecting its market share.
From an accounting perspective, intangible assets are usually initially recorded on the balance sheet at their acquisition or development cost. They are then amortized over their useful life, except for assets with an indefinite useful life (like goodwill) which are instead tested annually for impairment.
Example of Intangible Assets
Let’s consider a real-world example of an intangible asset: the Coca-Cola brand.
Coca-Cola is one of the most recognized brands globally. This recognition doesn’t come from the physical product (i.e., the actual soda), or the machinery used to produce it, or the buildings where the company operates. Instead, it comes from the Coca-Cola logo, the trademarked name, and the goodwill the company has built up over the years through its marketing efforts, customer relationships, and consistent product quality.
These intangible assets are extremely valuable. They contribute to the company’s profitability by driving customer loyalty and enabling the company to charge higher prices than it could if it were selling a generic soda.
In financial terms, these intangible assets appear on Coca-Cola’s balance sheet. As of the end of 2020, for example, Coca-Cola reported $21.8 billion in goodwill and $13.9 billion in other intangible assets.
This example illustrates the value and importance of intangible assets. Even though you can’t physically touch or see these assets, they’re a crucial part of the company’s identity and success.