Valuation of Intangible Assets

Valuation of Intangible Assets: An Accounting Guide

Intangible assets, unlike physical resources, represent non-material value for a business, such as brand reputation, patents, or proprietary processes. The valuation of these assets plays a key role in financial reporting and requires specific approaches to ensure accurate representation on the balance sheet. This guide covers the primary approaches to valuing intangible assets, focusing on purchased intangibles and internally developed intangibles.

Purchased Intangibles

Purchased intangible assets are those acquired from an external entity. Their valuation involves specific costs and methods to ensure they are recorded accurately.

Initial Valuation at Cost
Purchased intangibles are recorded at acquisition cost. This includes:
- Purchase price paid to the seller
- Additional costs, like legal fees and setup expenses, to make the intangible asset usable for the company’s purposes.
Valuation in Non-Cash Exchanges
Sometimes companies acquire intangibles by trading stock or other assets instead of paying cash. In these cases:
- The intangible’s value is the fair market value of the asset exchanged or the intangible received, depending on which is more observable.
- For example, if a company acquires a patent by issuing shares, the patent’s value would be based on the share value if that is more evident.
Basket Purchases
When multiple intangibles are acquired in one transaction, a method known as a “basket purchase” is used.
- The total cost is divided among each intangible asset based on their fair market values.
- This approach ensures that each intangible asset reflects its proportionate share of the total cost.

Internally Created Intangibles

Companies often invest in developing their own intangible assets, such as new technologies or customer databases. The accounting treatment of internally generated intangibles differs significantly from purchased ones.

Expensing Development Costs
Generally, costs incurred internally for creating intangible assets are expensed as they are incurred. Common examples include:
- Research and development expenses for new product development
- Marketing costs related to building brand identity.
Capitalizing Certain Direct Costs
Only specific costs associated with developing an intangible asset are capitalized. These typically include:
- Direct legal fees for securing a patent or trademark
- Other directly attributable expenses required to establish ownership or usage rights.
Rationale Behind Expensing
Internally created intangibles are often expensed rather than capitalized due to:
- The difficulty in accurately associating internal costs with the asset’s final value.
- Concerns that the internally recorded value might not reflect actual market value.
Conservative Accounting Approach
Due to the uncertainties surrounding valuation, a conservative approach is recommended. This involves:
- Expensing most costs as incurred, ensuring that only direct and verifiable costs are capitalized.
- This conservative stance protects the integrity of financial statements by avoiding overvaluation.

Key Takeaways

Purchased Intangibles are recorded at acquisition cost, which includes purchase price and additional setup costs. Non-cash acquisitions rely on fair value assessments, and basket purchases allocate costs proportionately.
Internally Created Intangibles are generally expensed, with limited direct costs capitalized. This approach reflects the difficulty in linking internal costs with final intangible value, ensuring a conservative accounting stance.

Proper valuation of intangible assets ensures that companies accurately represent these critical resources on their financial statements, supporting transparent and reliable financial reporting.