What Is an Intangible Asset?

An intangible asset is one that is not physical in nature. Since intangible assets have no shape or form, they cannot be held or manipulated. Common types of intangible assets include brands, goodwill, and intellectual property. Businesses have several ways to value these assets, which can be challenging because they have no shape or form. They are in contrast to tangible assets, which have physical forms and can be held.

Understanding Intangible Assets

As noted above, an intangible asset is one that has no physical form. As such, it cannot be handled. These assets are generally considered long-term whose value increases over time. Even though it doesn't have a physical form, an intangible asset can be very valuable for the owner and critical to their long-term success (or failure).1

Intangible assets are commonly held by businesses. They may include brand recognition, goodwill, and intellectual property like patents, trademarks, and copyrights. These assets can be divided into two categories:

• Indefinite: This type of intangible asset stays with the holder as long as it continues to operate, such as a brand name.
• Definite: This type is restricted to a limited time. A legal agreement to operate under another company's patent with no plans of extending the agreement is considered a definite intangible asset.2

Businesses can create or acquire intangible assets. For example, a business may create a mailing list of clients or establish a patent. If a business creates an intangible asset, it can write off the expenses from the process, such as filing the patent application, hiring a lawyer, and paying other related costs.3

Types of Intangible Assets

Let's look at some of the most common types of intangible assets—notably brands, goodwill, and intellectual property.

Brands

A brand is something that sets one business apart from another. This may come in the form of a logo, symbol, or brand name. Businesses commonly use marketing, design techniques, and advertising to come up with their brands. This allows consumers to easily identify a particular company. For instance, most people can easily identify Apple (AAPL) just by seeing its logo.

Brands are important because they contribute to a company's brand equity and help keep customers loyal. Some consumers may choose to ignore pricing and pay more for one company's product out of loyalty even if it is priced higher than a similar product offered by a competitor. Consider athletes who choose Nike over Adidas and vice versa.

Goodwill

When one company purchases another, the intangible assets associated with that transaction are considered goodwill. When a company acquires another business, any amount that exceeds the fair value of the target's net assets represents its goodwill. If the amount is above the target's book value, then it results in positive goodwill. Anything below book value is negative goodwill.

Intellectual Property

Intellectual property is a type of intangible asset that is legally protected. This means it cannot be used by another business or individual unless authorized by the owner. Common forms of intellectual property include:

• Copyrights
• Digital Assets
  
• Franchises
• Patents
• Trademarks
• Trade Secrets

Any unauthorized use of someone else's intellectual property is called infringement. This includes using (intentionally or unintentionally), mimicking, or copying another entity's brand name, logo, or other assets.

How to Value Intangible Assets 

A business like Coca-Cola (KO) wouldn't be nearly as successful if not for the money made through brand recognition. Although brand recognition is not a physical asset that can be seen or touched, it can have a meaningful impact on generating sales. So how does a company value intangible assets like this one?

There are generally three ways that businesses can value their intangible assets, according to the American Institute of Certified Public Accountants (AICPA). They are the:

• Market Approach: This valuation relies on an expected value based on a relative analysis. It focuses on placing a value on similar intangible assets. It may prove to be difficult because of the limited details available about similar assets held by other companies.
• Income Approach: Companies can use this method when their intangible assets have a cash flow stream. Some income approaches include the relief from royalty method, which estimates possible royalty payments derived from the use of the asset or the avoided loss of income.
• Cost Approach: This method relies on the idea of substitution and doesn't account for any future benefits based on time or amount.4

All the expenses of creating intangible assets are expensed. But intangible assets created by a company do not appear on the balance sheet and have no recorded book value. Because of this, when a company is purchased, often the purchase price is above the book value of assets on the balance sheet. The purchasing company records the premium paid as an intangible asset on its balance sheet.5

Intangible vs. Tangible Assets

As noted above, tangible assets are the opposite of intangible ones. They have a physical form, which means they can be held and manipulated. These are among the main assets that a company has in its portfolio.

Unlike intangible assets, the value of tangible assets may be easier to determine. The owner may choose to hire an appraiser who determines the fair market value (FMV) of the asset or they may decide to sell the asset for cash. Another common form of valuation is by comparing it to the cost of a replacement.

Some of the most common forms of tangible assets include:

• Equipment
• Furniture
• Inventory
  
• Land
• Property
• Vehicles

Financial securities, such as stocks and bonds, are also considered tangible assets even though they can't be held. That's because they derive their value from contractual claims.6

Tangible assets come in two categories: current and fixed. Current assets are those that can be easily used and converted to cash, such as inventory. Fixed assets, on the other hand, are tangible assets that have a lifespan of one year or more. Plant, property, and equipment (PP&E) is considered a fixed asset.

Example of Intangible Assets

Intangible assets only appear on the balance sheet if they have been acquired. If Company ABC purchases a patent from Company XYZ for an agreed-upon amount of $1 billion, then Company ABC would record a transaction for $1 billion in intangible assets that would appear under long-term assets.

The $1 billion asset would then be written off over a number of years via amortization. Indefinite life intangible assets, such as goodwill, are not amortized. Rather, these assets are assessed each year for impairment, which is when the carrying value exceeds the asset's fair value.2

The Bottom Line

Businesses can have both tangible and intangible assets. The former category consists of assets that can be physically handled while the latter is made up of assets that have no physical form. Even though intangible assets can't be seen and held, they provide a great deal of value for their owners. As such, businesses should take care to guard and protect them the same way they do with their tangible assets