Accounting for Intangible Assets

Valuation of Intangible Assets

Generally, the value of a purchased intangible asset is equal to the amount paid to acquire it. Costs incurred in internally developing intangible assets are usually expensed as incurred, except for certain development costs that meet specific criteria.

Example:

• Purchased Brand: If a company buys a brand for ₹10 crore, the brand's value is recorded at ₹10 crore.
• Internally Developed Brand: If a company spends ₹5 crore building a brand, this amount is expensed each year as it is spent, not capitalized as an asset.

Amortization of Intangible Assets

Amortization is the process of allocating the cost of an intangible asset over its useful life. This is similar to depreciation for tangible assets.

• Limited Life Intangible Assets: These are amortized over their useful life or legal life, whichever is shorter.
  • Patent: A patent has a legal life of 20 years. However, if its useful life is estimated to be only 6 years, it is amortized over 6 years.
• Indefinite Life Intangible Assets: These are not amortized. Instead, they are tested for impairment annually or more frequently if events indicate a potential decline in value.
  • Brands: Brands with indefinite lives are not amortized but are subject to impairment testing.
  • Goodwill: Goodwill, arising from the acquisition of another company where the purchase price exceeds the fair value of net identifiable assets, is not amortized but is subject to impairment testing.

Leasehold Improvements

When a company leases an asset and makes improvements to it, these improvements are capitalized and amortized over the shorter of the lease term or the useful life of the improvement.

Example:

• Lease Term: 20 years
• Cost of Building on Leased Land: ₹50 crore
• Useful Life of Building: 50 years

The building is amortized over 20 years (the lease term), resulting in an annual amortization expense of ₹2.5 crore (₹50 crore / 20 years).

Research and Development (R&D) Costs

Accounting for R&D costs varies:

• Research Costs: Generally expensed as incurred.
• Development Costs: May be capitalized if certain criteria are met:
  • Technical feasibility of completing the intangible asset for use or sale.
  • Intention to complete the intangible asset and use or sell it.
  • Ability to use or sell the intangible asset.
  • How the intangible asset will generate probable future economic benefits.
  • Availability of adequate technical, financial, and other resources to complete the development and to use or sell the intangible asset.
  • Ability to reliably measure the expenditure attributable to the intangible asset during its development.

Software Development Costs: These are often capitalized after technological feasibility has been established (usually when a working prototype is available).

Summary Table

Intangible Asset Type	Amortization/Impairment	Valuation
Patent	Amortized over useful/legal life (whichever is shorter)	Acquisition cost
Brand (Indefinite)	Impairment testing	Acquisition cost
Goodwill	Impairment testing	Excess of purchase price over fair value of net identifiable assets
Leasehold Improvements	Amortized over shorter of lease term or useful life	Improvement cost
Research Costs	Expensed as incurred	N/A
Development Costs	Capitalized if criteria met, otherwise expensed	Development costs meeting capitalization criteria
Software Development	Capitalized after technological feasibility, otherwise expensed	Development costs meeting capitalization criteria after technological feasibility