TYPES OF INTANGIBLE ASSETS

There are 5 major types of intangible assets that need to be accounted for. The accounting for intangible assets is governed by the international accounting standards and local standards of the country in which the business operates.

ACCOUNTING ENTRIES FOR INTANGIBLE ARE ALSO EXPLAINED 

As indicated, the accounting for intangible assets depends on whether the intangible has a limited or an indefinite life. There are many different types of intangibles, and they are often classified into the following six major categories.

 Marketing-related intangible assets.

Marketing-Related Intangible Assets Marketing-related intangible assets are those assets primarily used in the marketing or promotion of products or services. Examples are trademarks or trade names, newspaper mastheads, Internet domain names, and noncompetition agreements. A very common form of a marketing-related intangible asset is a trademark or trade name. A trademark or trade name is a word, phrase, or symbol that distinguishes or identifies a particular enterprise or product. The right to use a trademark or trade name under common law, whether it is registered or not, rests exclusively with the original user as long as the original user continues to use it. Registration with the U.S. Patent and Trademark Office provides legal protection for an indefinite number of renewals for periods of 10 years each, so a business that uses an established trademark or trade name may properly consider it to have an indefinite life. Trade names like Kleenex, Pepsi-Cola, Oldsmobile, Excedrin, Wheaties, and Sunkist create immediate product identification in our minds, thereby enhancing marketability. If a trademark or trade name is acquired, its capitalizable cost is the purchase price. If a trademark or trade name is developed by the enterprise itself, the capitalizable cost includes attorney fees, registration fees, design costs, consulting fees, successful legal defense costs, and other expenditures directly related to securing it (excluding research and development costs). When the total cost of a trademark or trade name is insignificant, it can be expensed rather than capitalized. In most cases, the life of a trademark or trade name is indefinite and therefore its cost is not amortized. The value of a marketing-related intangible can be substantial. Consider Internet domain names as an example. The name Drugs.com recently sold for $800,000, and the bidding for the name Loans.com approached $500,000.

Company names themselves identify qualities and characteristics that the companies have worked hard and spent much to develop. In a recent year an estimated 1,230 companies took on new names in an attempt to forge new identities and paid over $250 million to corporate-identity consultants. Among these were Primerica (formerly American Can), Navistar (formerly International Harvester), Nissan (formerly Datsun), and USX (U.S. Steel).

Customer-related intangible assets.

Customer-related intangible assets occur as a result of interactions with outside parties. Examples are customer lists, order or production backlogs, and both contractual and noncontractual customer relationships. To illustrate, assume that We-Market Inc. acquired the customer list of a large newspaper for $6,000,000 on January 1, 2003. The customer list is a database that includes name, contact information, order history, and demographic information for a list of customers. We-Market expects to benefit from the information on the acquired list for 3 years, and it believes that these benefits will be spread evenly over the 3 years. In this case, the customer list is a limited-life intangible that should be amortized on a straight-line basis over the 3-year period. The entry to record the purchase of the customer list and the amortization of the customer list at the end of each year is as follows:

January 1, 2003 Customer List 6,000,000

Cash 6,000,000 (To record purchase of customer list)

December 31, 2003, 2004, 2005 Customer List Amortization Expense 2,000,000 Customer List (or Accumulated Customer List Amortization) 2,000,000 (To record amortization expense)

In the preceding example it was assumed that the customer list had no residual value. If We-Market determined that it could sell the list for $60,000 to another company at the end of 3 years, this residual value should be subtracted from the cost in order to determine the proper amortization expense for each year. Amortization expense would therefore be $1,980,000 as shown below

Artistic-related intangible assets.

Artistic-related intangible assets involve ownership rights to plays, literary works, musical works, pictures, photographs, and video and audiovisual material. These ownership rights are protected by copyrights. A copyright is a federally granted right that all authors, painters, musicians, sculptors, and other artists have in their creations and expressions. A copyright is granted for the life of the creator plus 50 years. It gives the owner, or heirs, the exclusive right to reproduce and sell an artistic or published work. Copyrights are not renewable. The costs of acquiring and defending a copyright may be capitalized, but the research and development costs involved must be expensed as incurred. Generally, the useful life of the copyright is less than its legal life (life in being plus 50 years). The costs of the copyright should be allocated to the years in which the benefits are expected to be received. The difficulty of determining the number of years over which benefits will be received normally encourages the company to write these costs off over a fairly short period of time. Copyrights can be valuable. Really Useful Group is a company that consists of copyrights on the musicals of Andrew Lloyd Webber—Cats, Phantom of the Opera, Jesus Christ-Superstar, and others. It has little in the way of hard assets, yet it has been valued at $300 million.

 Contract-related intangible assets.

Contract-related intangible assets represent the value of rights that arise from contractual arrangements. Examples are franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts. A very common form of contract-based intangible asset is a franchise. A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell certain products or services, to use certain trademarks or trade names, or to perform certain functions, usually within a designated geographical area. For example, when you drive down the street in an automobile purchased from a Toyota dealer, fill your tank at the corner Texaco station, eat lunch at McDonald’s, cool off with one of Baskin-Robbins’ 31 flavors, work at a Coca-Cola bottling plant, live in a home purchased through a Century 21 real estate broker, or vacation at a Holiday Inn resort, you are dealing with franchises. The franchisor, having developed a unique concept or product, protects its concept or product through a patent, copyright, or trademark or trade name. The franchisee acquires the right to exploit the franchisor’s idea or product by signing a franchise agreement. Another type of franchise is the arrangement commonly entered into by a municipality (or other governmental body) and a business enterprise that uses public property. In such cases, a privately owned enterprise is permitted to use public property in performing its services. Examples are the use of public waterways for a ferry service, the use of public land for telephone or electric lines, the use of phone lines for cable TV, the use of city streets for a bus line, or the use of the airwaves for radio or TV broadcasting. Such operating rights, obtained through agreements with governmental units or agencies, are frequently referred to as licenses or permits. Franchises and licenses may be for a definite period of time, for an indefinite period of time, or perpetual. The enterprise securing the franchise or license carries an intangible asset account entitled Franchise or License on its books only when there are costs (such as a lump sum payment in advance or legal fees and other expenditures) that are identified with the acquisition of the operating right. The cost of a franchise (or license) with a limited life should be amortized as operating expense over the life of the franchise. A franchise with an indefinite life, or a perpetual franchise, should be carried at cost and not be amortized. Annual payments made under a franchise agreement should be entered as operating expenses in the period in which they are incurred. They do not represent an asset to the concern since they do not relate to future rights to use public property.

Technology-related intangible assets.

Technology-related intangible assets relate to innovations or technological advances. Examples are patented technology and trade secrets. To illustrate, patents are granted by the U.S. Patent and Trademark Office. The two principal kinds of patents are product patents, which cover actual physical products, and process patents, which govern the process by which products are made. A patent gives the holder exclusive right to use, manufacture, and sell a product or process for a period of 20 years without interference or infringement by others. With this exclusive right, fortunes can be made. For example, companies such as Merck, Polaroid, and Xerox were founded on patents.9 If a patent is purchased from an inventor (or other owner), the purchase price represents its cost. Other costs incurred in connection with securing a patent, as well as attorneys’ fees and other unrecovered costs of a successful legal suit to protect the patent, can be capitalized as part of the patent cost. Research and development costs related to the development of the product, process, or idea that is subsequently patented must be expensed as incurred, however. See pages 15–19 for a more complete presentation of accounting for research and development costs. The cost of a patent should be amortized over its legal life or its useful life (the period benefits are received), whichever is shorter. If a patent is owned from the date it is granted, and it is expected to be useful during its entire legal life, it should be amortized over 20 years. If it appears that the patent will be useful for a shorter period of time, say, for 5 years, its cost should be amortized to expense over 5 years. Changing demand, new inventions superseding old ones, inadequacy, and other factors often limit the useful life of a patent to less than the legal life. For example, the useful life of patents in the pharmaceutical and drug industry is frequently less than the legal life because of the testing and approval period that follows their issuance. A typical drug patent has 5 to 11 years knocked off its 20-year legal life because 1 to 4 years must be spent on tests on animals, 4 to 6 years on human tests, and 2 to 3 years for the Food and Drug Administration to review the tests—all after the patent is issued but before the product goes on a pharmacist’s shelves. From bioengineering to software design to the Internet,10 battles over patents are heating up as global competition intensifies. For example, Priceline.com filed suit against Microsoft for launching Hotel Price Matcher, a service that operates pretty much like the name-your-own-price-system pioneered by Priceline. And Amazon.com filed a complaint against Barnesandnoble.com, its bitter rival in the Web-retailing wars. The suit alleges that Barnesandnoble.com is infringing on Amazon.com’s patent for oneclick shopping and asks the court to stop Barnesandnoble.com from using its own quickcheckout system, called ExpressLane. Legal fees and other costs incurred in successfully defending a patent suit are debited to Patents, an asset account, because such a suit establishes the legal rights of the holder of the patent. Such costs should be amortized along with acquisition cost over the remaining useful life of the patent. Amortization expense should reflect the pattern in which the patent is used up, if that pattern can be reliably determined. Amortization of patents may be credited directly to the Patent account, or it may be credited to an Accumulated Patent Amortization account. To illustrate, assume that Harcott Co. incurs $180,000 in legal costs on January 1, 2003, to successfully defend a patent. The patent has a useful life of 20 years, and is amortized on a straight-line basis. The entries to record the legal fees and the amortization at the end of each year are as follows:

 Goodwill.

Although companies are permitted to capitalize certain costs to develop specifically identifiable assets such as patents and copyrights, the amounts capitalized are generally not significant. Material amounts of intangible assets are recorded when companies purchase intangible assets, particularly in situations involving the purchase of another business (often referred to as a business combination). In a business combination, the cost (purchase price) is assigned where possible to the identifiable tangible and intangible net assets, and the remainder is recorded in an intangible asset account called Goodwill. Goodwill is often referred to as the most intangible of the intangibles because it can only be identified with the business as a whole. The only way it can be sold is to sell the business. The problem of determining the proper cost to allocate to intangible assets in a business combination is complex because of the many different types of intangibles that might be considered. Many of these types of intangibles have been discussed earlier. It is extremely difficult not only to identify certain types of intangibles but also to assign a value to them in a business combination. As a result, the approach followed is to record identifiable intangible assets that can be reliably measured. Other intangible assets that are difficult to identify or measure are recorded as goodwill.12 Recording Goodwill Internally Created Goodwill. Goodwill generated internally should not be capitalized in the accounts, because measuring the components of goodwill is simply too complex and associating any costs with future benefits too difficult. The future benefits of goodwill may have no relationship to the costs incurred in the development of that goodwill. To add to the mystery, goodwill may even exist in the absence of specific costs to develop it. In addition, because no objective transaction with outside parties has taken place, a great deal of subjectivity—even misrepresentation—might be involved.