Intangible Assets and Amortization - Online Tutor, Practice Problems & Exam Prep

Intangible assets are long-lived assets without physical form, categorized into limited and indefinite lives. Limited life assets, like patents and copyrights, are amortized using the straight-line method, while indefinite life assets, such as goodwill, are tested annually for impairment. Common intangible assets include patents (20 years), copyrights (70 years post-creator's life), trademarks (finite or indefinite), franchises, and research and development costs, which are expensed as incurred. Understanding these concepts is crucial for accurate financial reporting and compliance with accounting standards.

Intangible Assets and Amortization

Alright, so up to this point in this unit, we've been focused on fixed assets that have a physical form like machinery or land or buildings, things like that. Right? But now I want to think about a different type of long-term asset. This is an intangible asset. Let's talk about different types of those. So intangible assets, well, they're intangible. Right? They're going to be long-lived assets that they're going to help us for a long time, but they have no physical form. We can't just go into the factory and say, hey, there's our machine. No. It's there's no physical form, but they give special rights to the company and they are assets of the company. Okay? So, we're going to discuss what most of the common types of assets are. But there are two ways that we deal with intangible assets. The first type of intangible assets are going to be intangible assets, with limited lives. Okay? So these don't last forever. They're going to have some sort of useful life similar to when we were dealing with fixed assets. Okay? So these limited-lived intangible assets, what we're going to do is we're going to do amortization. We're going to amortize these intangible assets over their useful lives. Now, amortization is just another fancy word that we use for depreciation. Okay? So amortization is just the word we use when we're depreciating our intangible assets, okay? So when we have an intangible asset and we amortize them in a very similar way to depreciation, it's always going to be on a straight line basis. You're not going to see us using double declining balance or units of production. No. When we deal with it, it's just going to be on a straight line basis. So this actually ends up being super easy as long as you know what it is. The only difference is we're not going to have an accumulated Amortization account. Remember when we are dealing with depreciation expense, we always had this contra asset of accumulated depreciation. Well, in this case, there is no accumulated amortization account. There's no such thing, okay? What we do is we just directly credit the intangible asset itself, right? The asset is going to have some debit value just like all assets. And then as we amortize it, as we do amortization expense that goes to the income statement, well we're going to be debiting amortization expense and we're going to credit the asset itself, the intangible asset. So it is going to lower the value that way. Cool? So that is the first type of intangible asset and that's mostly what you're going to deal with in this class is just simple amortization problems where you're going to be calculating very similar to straight line they still like to, you know, test your vocabulary and test how you know about these unlimited life, intangible assets. But they are not amortized, right? Because they last forever. So there's no reason for us to be amortizing them over a certain time period if they are going to last forever. But what we are going to do with these is we're going to annually test them for impairment of value. Right? Because maybe they aren't worth what they are on our books. So we're going to have some special tests to impair them if we see that they've lost value. We're not going to talk about those in this lesson. We're going to focus on limited life assets and how we do amortization expense, as well as we're going to talk about the different types of intangible assets here. Okay? So there are going to be many different types of intangible assets. So why don't we start with the most common one and in this video, we'll go ahead and calculate an amortization expense, and then we'll pause and we'll talk about all the different types of assets, of intangible assets. Cool? So the first one here, that's one you're probably going to deal with the most, is patents. When the company patents an idea, something, some sort of special thing they came up with, well, it's the exclusive right to produce and sell an invention for and the US government gives you a patent for 20 years. Okay? So you get this special right to produce it and sell it for 20 years. However, the useful life might not be the same as the life that the government gives you this patent for, right? Maybe you've made this patent for 20 years, but competitors come to the market and start copying and selling similar assets to your similar ideas to your idea much faster. Think about, you know, when those first smartphones came out. Maybe, I'm not exactly sure, but I'm guessing the iPhone might have been the first one that came out, and it revolutionized the industry, and then all sorts of similar products came out and started eating up its profits as well, right? Even though they still had the market on the iPhone, well there were other similar products that maybe decreased the value of the iPhone patent. Since it wasn't the only one on the market anymore. So the useful life of a patent may be less than 20 years, okay? But they're going to have to tell you that in the problem. They'll say something like, the government granted a 20-year useful life, but the company only expects it to be useful for 15 years, for 10 years, for 8 years. Whatever it might be, they're going to have to give you that information in the problem. Alright? So let's check out this quick problem right here about amortization expense, And then we'll talk about the rest of the assets in the next video. Techno Corp purchased the patent from Invento Corp for 170,000 dollars on January first. So there we go. That's going to be the cost, right? That's going to be the cost of the patent and Techno Corp believes it will be able to produce the product for 5 years before competition renders the patent obsolete. Alright? So that's just what we were talking about. It's not going to get the full life of the patent, they are only going to get 5 years of value before competitors start figuring out what they are doing. So we want to journalize the purchase of the patent when we first bought it, and then amortization expense for the year. Alright. So let's go ahead. The first thing we want to do is the purchase. So let's do the purchase over here. And what do you guys think this journal entry is going to look like? It's much like many different journal entries that we've done in the past. We're purchasing something here, but we're purchasing a patent. So what do you think the debit is going to be in this transaction? Well, we're going to debit patents. Right? This intangible asset that we have, we're going to debit patents because we got a patent. And what do you think the debit is going to be for? It's going to be for that 170,000 dollars, right? We paid 170,000 dollars. And what do you think the credit is going to be in this transaction? Well, we paid for it with cash, right? We paid for this patent. So we're going to credit our cash for 170,000 dollars. Alright. So that's when we first purchased the asset, this intangible asset, and now it's time to amortize it. So when or how long are we going to amortize this asset for? Is it going to be the 20 years that the government gives us the patent? No. It's the 5-year useful life that we've determined. Right? So we're going to use our straight line method, and one thing to note is with these intangible assets, well if it's going to be obsolete after these 5 years, there's not going to be any salvage value. We generally don't talk about salvage value or residual value when we do intangible assets. We just take the whole amount and depreciate, excuse me, amortize the entire thing. 170,000 dollars divided by 5. So what's going to be our annual amortization expense? 170 divided by 5. Well, we're going to amortize 34,000 per year. That's going to be our amortization expense. So notice it's a straight line basis and it's actually really simple. So let's do that amortization entry. So that entry, well what's going to be our debit? Our expense, right? We're going to have amortization expense. And I'm going to shorten it to amort expense. Okay? Amort expense, this is going to the income statement and it's for 34,000 as a debit, right? So that's going to lower our income. Amortization expense has a debit. What about our credit? Is it accumulated amortization? No, right? We don't have an accumulated amortization account, we just directly lower the value of the patent. So we're going to credit patents here to lower the value of the patent by the 34,000. And it's as simple as that. That's all we have to do for amortization and we're going to make that same entry every year. Okay? So there's our amortization and there's our purchase entry. So what happened here? We purchased the patent for 170,000 dollars and cash we had go out for 170,000 dollars. So nothing really happened to our assets in that first situation. Right? We just paid for an asset, so we got rid of cash and we got an asset. So our assets stayed the same level, just changed what they were. And then in that second entry, well our patents went down, right? We took 34,000 out of our patents, so those went down by 34,000 and that amortization expense, well that lowers our equity. Right? Because it went to the income statement, and it was a decrease in our in our income. So the amortization, it's going to come out here in our equity for 34,000 and that keeps our equation balanced, right? Because we had a decrease in our assets of 34,000 after the amortization and our decrease in our equity. So everything stays balanced there. Alright? So let's pause here and then we'll talk about the remaining types of intangible assets that you're likely to come across. Alright? Let's do that now.

Common Intangible Assets

Alright. So let's go over the most common types of intangible assets. So we talked already about patents a little bit. Right? The exclusive right to produce and sell an invention for 20 years. And remember that that useful life could be less than the actual grant from the government. So the government tells you, hey, you're protected for 20 years, but maybe competitors figure out your product and start making similar products in less time than that. So you would only amortize it over that useful life, not the full life in that case. Alright? So those were patents. Let's continue on to the next one here with copyrights. So copyrights are similar to patents, but copyrights are dealing with more creative pursuits. So this is the exclusive right to sell some sort of work of art. Okay? And this includes all sorts of things. It will include books, music, movies that get made, and it will even include computer software. So the government looks at computer software as a work of art. Interesting enough. Cool. So these copyrights, well, they're going to last for a period of 70 years beyond its creator's life. So just like with patents, copyrights may be purchased by another company. So maybe the author of a book has the copyright when they made the book, they sent their copy to the government and they got a copyright. Well, they can sell that asset, that intangible asset, they can sell it to a publishing company for a price, and then the publishing company will then amortize it over its useful life. So that's usually how you're going to see it, is that there is going to be some purchase of this intangible asset and then we'll amortize it over the useful life. Cool? So the next one here is a trademark. Trademarks have to do more with like a symbol or something like that. So this has to do with a symbol or a brand name. So now we're protecting something a little different than an invention, a work of art. Right? It's a brand name or even a slogan. So now we're protecting something like that. And some of these trademarks have a finite life. There is going to be some sort of contracted finite life and then we are going to amortize it, right? If it's a finite life, they're going to tell you how long the life is and we amortize it over that life. While other ones will have an infinite life. An indefinite life, infinite, they're going to tell you that. They have to give you all this information in these problems. That's what ends up making these problems so easy. Even though we're talking about abstract things and intangible assets, in the end, when they give you an accounting problem, they have to be very concrete with the information they give you. Alright? So trademarks, you're going to see these types of symbols that I'm sure you're familiar with. The TM symbol, the R symbol, those are things that have been trademarked. Okay? Next, we have franchises and licenses. So these are privileges that are granted by a private business. So what a very common franchise we think about? Like a McDonald's, right? And McDonald's doesn't own every McDonald's restaurant around the country, around the world. No. People give money to McDonald's to say, hey, let me open a McDonald's. Well, this is an intangible asset. This franchise, this license that they get. So it's a privilege granted to sell its products, right? So I can't just sell a Big Mac without permission from McDonald's. Cool? So these McDonald's restaurants that are operated by what are called franchisees, the people who pay McDonald's to be able to operate 1. Well, they pay fees to operate a McDonald's. They pay advertising fees because McDonald's does these big advertising campaigns. They have to give a portion of their revenue to the McDonald's Corporation. Whatever it is. You're not going to have to deal with franchise accounting in this class. I'm just exposing you as a type of intangible asset, okay? So generally, these are going to have infinite lives, these franchises and licenses. Another important one here that's an interesting intangible asset is goodwill. Okay? So goodwill, this only occurs when you purchase other companies. Okay? Goodwill comes out of the purchase of another company. So this is the value above the market value that you pay for the purchase of another company. So let's say the market value, there's a company on the market that has a market value of $1,000,000 and you go in there and you pay the company and you say, hey, I'll pay you $1,200,000 for your company because we see the extra value that you bring to your customers. Customers have a certain loyalty to their brand, whatever it might be. You're willing to pay extra because this company has these intangible qualities that are not on the books. Right? So another example would be that customers are really happy with the company because of its green efforts. It has a lot of environmental persuasion and it's done all these great things with green marketing campaigns, and you're willing to pay a little extra because customers prefer your brand because it's a good brand. Okay? So that's what goodwill is. It's intangible in this sense, because you paid extra for these intangible qualities of the company. Alright? And goodwill is going to have an infinite life. Okay? And this is one that gets tested for impairment annually. Right? We have to test our goodwill when we've purchased other companies. We have to see, is it really worth what it was worth when we first purchased it? Maybe we paid $200,000 extra for the brand at that time. Is it still worth that extra $200,000? So we're going to have to test it for impairment, and we'll talk about that in another video, if you need to know it. And the last one is research and development cost. So you got to think about like a drug company that's constantly researching new drugs. Well, it's spending all this money on research and development, but it doesn't get to make it an intangible asset. This is a very specific one because it would have certain implications if you could start making assets out of your research and development. What if you're researching all these drugs, but then you can't actually end up selling the drug. So it would actually be pretty weird if you could make assets out of research and development costs. So this is the cost incurred in creating new products. And the way GAAP looks at it is like, hey, that's an operating cost of business, right? If you're in the business of creating and inventing new products, well, you're going to have to be researching and developing, right? So you don't get to make an asset out of it. When you get research and development costs, you must expense them as incurred. They must be expensed as incurred. They do not become intangible assets. Okay? There are specific cases that you talk about in high-level accounting courses with these research and development costs, but for all intents and purposes, most of the time, 99% of the time, you just have to expense them as they are incurred. So those are the most common types of intangible assets you might run across. That's about it for this video. Why don't we move on to the next topic?

Here’s what students ask on this topic:

What are intangible assets and how are they different from tangible assets?

Intangible assets are long-lived assets that lack physical form but provide value to a company through special rights or advantages. Examples include patents, copyrights, trademarks, and goodwill. Unlike tangible assets such as machinery, buildings, or land, intangible assets cannot be seen or touched. They are crucial for a company's operations and competitive edge but are accounted for differently. For instance, limited life intangible assets are amortized over their useful lives, while indefinite life intangible assets are tested annually for impairment. Understanding these differences is essential for accurate financial reporting and compliance with accounting standards.

How is amortization of intangible assets calculated?

Amortization of intangible assets is calculated using the straight-line method. This involves dividing the cost of the intangible asset by its useful life. For example, if a company purchases a patent for $170,000 and expects it to be useful for 5 years, the annual amortization expense would be calculated as follows:

$\frac{170000}{5}=34000$

Thus, the company would record an annual amortization expense of $34,000. This expense is debited to amortization expense and credited directly to the intangible asset account, reducing its book value.

What is the difference between amortization and depreciation?

Amortization and depreciation both refer to the process of allocating the cost of an asset over its useful life, but they apply to different types of assets. Depreciation is used for tangible assets like machinery, buildings, and vehicles, while amortization is used for intangible assets such as patents, copyrights, and trademarks. Another key difference is that depreciation can use various methods (e.g., straight-line, double-declining balance), whereas amortization typically uses the straight-line method. Additionally, depreciation involves an accumulated depreciation account, whereas amortization directly reduces the value of the intangible asset without an accumulated amortization account.

What are the common types of intangible assets?

Common types of intangible assets include:

• Patents: Exclusive rights to produce and sell an invention, typically granted for 20 years.
• Copyrights: Exclusive rights to sell a work of art, lasting 70 years beyond the creator's life.
• Trademarks: Protection for symbols, brand names, or slogans, which can have finite or indefinite lives.
• Franchises and Licenses: Privileges granted by a private business to sell its products, often with indefinite lives.
• Goodwill: Value paid above the market value during the purchase of another company, with an indefinite life and subject to annual impairment tests.
• Research and Development Costs: Costs incurred in creating new products, which are expensed as incurred and not capitalized as intangible assets.

How are intangible assets with indefinite lives treated in financial accounting?

Intangible assets with indefinite lives, such as goodwill and certain trademarks, are not amortized because they do not have a finite useful life. Instead, these assets are tested annually for impairment. Impairment testing involves evaluating whether the asset's carrying amount exceeds its recoverable amount. If an impairment is identified, the asset's carrying amount is reduced to its recoverable amount, and an impairment loss is recognized in the income statement. This process ensures that the asset's book value accurately reflects its current value and prevents overstatement of assets on the balance sheet.