Accountants, investors, lawyers, and other professionals often must address what are intangible assets and how to handle them.
From a legal perspective, many intangible assets represent legal rights to the fruits of creativity, inventions and expertise and public popularity cultivated by companies. Accountants, investors, and lenders seek to value these legal rights, along with other seemingly unseen assets of the company.
Those who rely on the valuation of assets need to understand the nature of what are intangible assets and the challenges in reporting their value.
The Concept of an Intangible Asset
Assets fall into two broad categories. Tangible assets consist of those you can touch, feel and see. Land, buildings, inventory, and equipment are common tangible assets. Within the realm of tangible assets lie subcategories of fixed assets and current, or short-term assets. The former include items such as land, buildings, and equipment and are held on a long-term basis. Cash and inventory are examples of current assets.
Invisibility describes the essence of what are intangible assets. These non-physical assets include the following.
- customer lists
- franchise agreements
- rights to broadcast events or programs
- internal operations.
Contracts and statutes often create many of these intangible assets. Also, much of what are intangible assets come from companies’ own processes, employees, and management.
Treatment of intangible assets has generated much debate among the accounting community. Traditionally, accounting principles and standards eschew the reporting of speculative values for assets. In many cases, copyrights, trademarks, licenses, and programming rights are subject to buying, selling, and assigning. As to these assets, the accountant can record the acquisition costs by resorting to a contract or receipt.
However, internal intangibles offer significant valuation challenges. Without a purchase price, accountants and investors predict or anticipate the future benefits (or lack thereof) of intangibles. This introduces considerable speculation and subjectivity into valuation and reporting of asset values.
Goodwill is a common intangible created internally. The quality of a company’s employees, processes, management and perception in the public often shapes goodwill. Other sources of goodwill include geographic advantages.
However, the reluctance to record intangibles may cause undervaluation of companies. For example, Businessjournalism.org notes that Alphabet, Inc. reported $29 billion in tangible assets and only $3.8 billion in intangible assets. The company’s value existed mostly in the Google search engine and user base rather than any physical assets.
Advantages and Disadvantages of Intangible Assets
Companies rely on assets to produce income, generate cash when necessary, and finance operations. Whether intangible (and other) assets can help a company depends on several factors. Examples include liquidity, the ability to serve as collateral for loans and the effect of assets to handle competition.
With statute or contract often creating intangibles, holders of these assets can leverage various benefits against competitors. However, the invisible, speculative, and internal nature of what are intangible assets can impede effective and reliable valuation. These features may complicate the financing and operation of enterprises.
Advantages of Intangible Assets
Competitive Advantage. Intellectual property rights can help companies obtain strongholds in various markets and take on competitors. Common intellectual properties include:
Patents. The holder of a patent from the federal government enjoys the exclusive right to manufacture, sell, market, and use an invention or process. This lasts 20 years from when the patent is filed. With a patent, a company can differentiate features of its products and claim them solely as its own.
Trademarks. Trademarks represent the exclusive right to control and use logos, symbols, words, and other representations of a brand or company. Instant recognition by the public of the brand and its perceived quality are hallmarks of what are intangible assets with significant potential value.
Copyrights. Creators or owners of literary, artistic, musical, film and similar works can claim an exclusive right to display, distribute, sell or control these activities concerning the works. The copyright lasts for the author or creator’s life plus 70 years.
While statutes give birth to intellectual properties, other intangibles arise via agreements. For instance:
Franchise Agreements. In a franchise arrangement, a business such as a restaurant or a vehicle maintenance service operates under a brand name. Franchises offer standardized products or services and operate establishments within specifications and requirements set by the parent company. Therefore, the proprietors gain a valuable asset in being able to associate themselves with a popular and lucrative brand.
Broadcast rights. Sports leagues and teams grant television networks and other media outlets the right to cover their games. The popularity of these events can generate considerable value for entities that broadcast them. For instance, Sports Illustrated reports that television rights to the NCAA Men’s Basketball Tournament carry an annual value of at least $1 billion.
Liquidity and Ease of Transfer. Certain intangibles such as intellectual property and customer lists can be readily transferred and create cash for the holder. By contrast, the sale or transfer of physical assets, especially land or buildings, involve significant periods of marketing, inspection and checking title or ownership.
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Disadvantages of Intangible Assets
Often Limited to a Single Company. Goodwill, operational advantages and other internal intangibles are tied principally to the company. As a result, these assets do not exist as separately transferable commodities. Instead, companies realize the value of internal assets as “premiums” for the acquisition of the company overall.
Rights Open to Disputes. Many intangible assets, such as franchises, licenses, and non-competition agreements, are the creatures of agreements. Lack of careful drafting of these documents could create ambiguities. As a result, intangible assets with the promise of value become costly and time-consuming legal disputes about the nature, scope, and enforceability of intangible assets. For example, courts have struck non-competition agreements that contain excessively broad geographic and time restrictions on a person’s ability to work in a particular trade or business.
Intellectual properties in particular foster imitators and others seeking to profit from the popularity of the works, products or brands. As a result, companies may need to take continuous legal actions to protect them against infringement.
Questionable Source of Collateral. Companies who rely heavily on intangibles may find difficulty getting loans. The approval and underwriting of loans often turn on the value of assets being used to secure the loans. Assigning values to intangible assets create challenges because of their indefinite and speculative nature. Further, intangibles such as goodwill, employee expertise, and operational advantages are often company-specific. Such do not have the resale capability or ease of transfer lenders seek from collateral.
What are intangible assets? They are legal rights that offer their holders protections for competitive advantages. Intangibles also afford opportunities for companies to capitalize on brand popularity and the superiority of their employees and opportunities. In an economy that relies on information and technology, their valuation may afford a truer account of an entities’ value than brick, mortar, land and other physical assets.
Yet, valuation of intangible assets is fraught with uncertainty. Companies create many of their intangibles internally and, as a result, accountants may lack a concrete basis for their value.
If you deal with intangibles in investing or your business, please share your thoughts and questions about how you handle these issues.