Accounting for Intellectual Property: Valuation and Recognition of Intangible
Assets such as Patents and Trademarks
Introduction
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
Intellectual property refers to creations of the mind like inventions, literary and artistic works,
designs, and symbols, names and images used in commerce. Intangible assets are non-
physical assets like patents, copyrights, trademarks, trade secrets and brand names. As
businesses increasingly invest in developing intellectual property, the accounting for these
intangible assets has become an important issue.
The objective of this report is to discuss the accounting treatment and valuation methods for
recognizing intangible assets in the financial statements. Specifically, it will cover the
following key aspects:
- Defining intellectual property and different types of intangible assets
- Recognition criteria for intangible assets as per accounting standards
- Initial measurement and valuation of intangible assets
- Subsequent measurement and amortization of intangible assets
- Impairment testing of indefinite-lived intangible assets
- Disclosure requirements as per accounting standards
This report analyzes the concepts based on the International Financial Reporting Standards
(IFRS) and the accounting principles generally accepted in the United States (US GAAP).
Appropriate examples are provided to illustrate the accounting treatment.
Defining Intellectual Property and Intangible Assets
Intellectual property refers to creations of the mind or intellect that have commercial value,
are protected in law by copyright, patents, trademarks, and trade secrets. The main categories
of intellectual property include:
- Copyright - Protects original works of authorship including books, music, articles, films,
broadcasts and software.
- Patents - Protect new and useful inventions through exclusive rights granted for a limited
period. Patents protect tangible research results.
- Trademarks - Protect words, phrases, symbols or designs identifying the source of the goods
or services.
- Trade Secrets - Protect confidential business information and formulas.
Intangible assets are non-physical assets without physical substance, such as patents,
copyrights, trademarks, logos, intellectual property, goodwill. They have a useful economic
life beyond one year. Some common types of intangible assets include:
- Patents and copyrights
- Trademarks and trade names
- Franchises
- Licenses and rights
- Goodwill
- Customer lists
- Non-compete agreements
- Software
Intangible assets meet the definition of assets as per accounting standards if it is identifiable,
controlled by the entity as a result of past events, and if future economic benefits are
expected.
Recognition Criteria for Intangible Assets
For an intangible asset to be recognized in the balance sheet, IFRS and US GAAP have
similar initial recognition criteria as below:
- It is probable that future economic benefits will flow to the entity.
- The cost of the intangible asset can be reliably measured.
- The intangible asset must be identifiable i.e. separable or arises from contractual or legal
rights.
- The asset is controlled by the entity through custody or legal rights.
Intangible assets acquired separately are initially measured at cost comprising purchase price
and any directly attributable expenditure. Internally generated intangible assets from
development are not recognized if they cannot be distinguished between research and
development phase.
Initial Measurement and Valuation of Intangible Assets
There are generally three accepted valuation methods for intangible assets:
1. Cost Approach
It estimates the cost required to replace the service capacity of the intangible asset. Useful for
valuing separate acquisitions of intangible assets like patents. Does not capture going concern
value or synergies from the asset.
2. Market Approach
Values the asset by comparing it to transactions involving similar assets. Usually based on
prices of comparable assets in the market or the income generated from the asset. Difficult to
find comparable transactions.
3. Income Approach
Measures the present value of future economic benefits expected to be derived from
ownership of the asset based on future net cash flows. Useful for valuing trademarks,
customer lists, franchise agreements etc. Includes relief-from-royalty, multi-period excess
earnings, and discounted cash flow methods. Most widely used for valuing IP.
The specific method used depends on availability of data and the nature of intangible asset.
The purchase price allocates to various tangible and intangible assets acquired. Goodwill
arises when purchase price exceeds value of net identifiable assets.
Subsequent Measurement and Amortization of Intangible Assets
Intangible assets are either amortized over their useful life or not amortized if life is
indefinite. Useful life is the period over which economic benefits are consumed. It is
reviewed annually and assets with finite lives are amortized as below:
Finite-lived Intangible Assets
- Amortized on a systematic basis over estimated useful life in a rational and systematic
manner.
- Reviewed annually for any changes in useful life estimate.
- Tested annually for impairment if indicators exist.
- Charge to profit and loss account over estimated life.
Indefinite-lived Intangible Assets
- Not amortized but tested annually for impairment.
- Useful life re-assessed if changes and any change accounted prospectively as change in
accounting estimate.
Amortization methods commonly used include straight line as it allocates costs evenly over
years. Others like double declining balance provides larger amortization in early years. The
method reflects consumption pattern if not straight line.
Impairment Testing of Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets and goodwill are subject to annual impairment test to assess
if carrying amount exceeds recoverable amount. This is done at same time each year.
Recoverable amount is higher of value in use or fair value less costs of disposal.
Value in use is the present value of estimated future cash flows from the asset. Fair value less
costs of disposal is market value of similar assets or estimated amount realizable from sale in
arm's length transaction between knowledgeable parties less any incremental direct selling
costs.
Impairment loss is immediate expense in profit and loss. It cannot be reversed in future even
if recoverable amount increases. Carrying value is reduced to recoverable amount. Disclosure
of methodology, key assumptions and results is required. CGU is level at which assets
monitored for impairment.
Disclosure Requirements for Intangible Assets
Accounting standards mandate certain specific disclosures in the financial statements for
intangible assets:
- Accounting policies adopted for measurement and recognition
- Carrying amount and remaining amortization period of intangible assets
- Assets measured after recognition using revaluation method
- Assets with indefinite useful lives
- Reconciliation of changes in intangible assets
- Amount of commitments for acquisition of assets
- Amount of contractual commitments for development
- Amount and remaining period of amortization for major intangible asset classes
- Impairment losses recognized or reversed
- Methods and significant assumptions for impairment test
- Description if assets pledged as security for liabilities
Adequate disclosures provide transparency to users about significant accounting estimates
and judgments for intangible assets.
Patents as Intangible Assets
Patents are a legally enforceable right granted to an inventor for a new and useful invention
providing exclusive right to prevent others from commercially exploiting the patented
invention without consent.
Patents meet the definition of intangible asset and can be recognized at cost if they meet the
recognition criteria. Costs include legal and registration fees. Useful life is normally the
remaining legal life of patent which ranges between 10-20 years depending on jurisdiction.
Subsequent to initial recognition, patents are carried at cost less accumulated amortization
and impairment losses, if any. Amortization is done over estimated remaining useful life on
straight line basis. Residual value is assumed nil.
At each reporting date, patents are reviewed for indicators of impairment. If any such
indicator exists, the recoverable amount is estimated and compared with carrying amount.
Impairment loss is charged if carrying amount exceeds recoverable amount.
Additionally, patents are tested annually for impairment if indefinite life assessment is
involved. Disclosure requirements as per standards are duly followed in notes. Patents
contribute significantly to intellectual property portfolio of many companies.
Trademarks as Intangible Assets
Trademarks are words, phrases, symbols or designs used in trade to identify goods or services
produced or provided by an individual or organization. Trademarks provide exclusive right to
exploit the mark in commerce.
Trademarks can be registered for limited statutory periods which can be renewed indefinitely
as long as they remain in use. Some trademarks have indefinite useful lives due to strong
brand recognition and intention/ability to renew them indefinitely.
Trademarks are initially recognized at historical cost and subsequently carried at cost less
accumulated amortization and impairment losses. Finite-lived trademarks are amortized over
estimated useful life on straight line basis with residual value nil.
Trademarks with indefinite useful lives based on strong brand recognition and intention to
renew are not amortized but tested annually for impairment. Indefinite life assessment is
reviewed annually. Recoverable amount is estimated for impairment testing.
Disclosures around accounting policies, carrying amount, useful lives and basis of
amortization are provided. Many companies hold valuable trademarks as part of their
intellectual property portfolio providing sustainable competitive advantage.
Recognition and Valuation of Internally Generated Intangible Assets
Internally generated intangible assets from development activities are capitalized when it
meets the definition of an asset and recognition criteria are met. It should be identifiable,
control over resource is demonstrated and benefits probable. Development costs incurred are:
Research Phase:
Expensed as incurred since future economic benefits cannot be reliably measured. Activities
seeking technical, commercial and financial feasibility.
Development Phase:
Capitalized if meet criteria, otherwise expensed. Activities applying research findings to
devise a plan/design for production of new materials, products etc before commercial
production.
Initial measurement of internally developed intangible asset is cost which includes material,
employee and overhead costs directly attributable to readying asset for intended use.
Subsequent to recognition, same accounting model is followed as purchased intangible assets.
Case Study: Accounting for Patents at Tech Giant
Tech Inc. is a large technology company that makes significant investments in R&D to
develop new products and services. In the current year, it incurred the following costs relating
to development of a new smartphone technology:
Research costs $5 million
Development costs $12 million
Patent registration costs $0.5 million
Tech Inc. believes the new technology meets the criteria for capitalization since future
economic benefits are probable and costs reliably measurable.
The patent was registered for 10 years. Useful life estimated at 8 years based on technology
life cycle. Patent will be amortized over 8 years on straight line basis.
In the balance sheet, a patent intangible asset of $12.5 million ($12m development costs +
$0.5m registration costs) will be recognized. Amortization expense of $1.56 million
(=$12.5m/8 years) will be charged each year to P&L. Research costs of $5m remain as
expense.
At each reporting date, patent is reviewed for any impairment indicators. Also, tested
annually for impairment regardless of indicators. Recoverable amount estimated if
impairment exists.
Conclusion
In conclusion, this report discussed the accounting treatment, recognition criteria, valuation
and subsequent measurement principles for intellectual property and intangible assets as per
accounting standards. Valuation methods like income, cost and market approach help
estimate recoverable amounts.
Key aspects like amortization of finite-lived intangibles, impairment testing of indefinite-
lived intangibles, capitalization of internally developed intangibles were analyzed. Adequate
disclosure mandated by standards provide transparency.
Intellectual property represents a major investment area for many organizations in current
knowledge based economy. Therefore, proper accounting recognition and presentation of
intangible assets is critical for financial reporting and decision making.
