How are intangible assets valued and impaired (Goodwill, Patents)?

Intangible Assets

How are intangible assets valued and impaired (Goodwill, Patents)?
Intangible assets are initially valued at cost and subsequently amortized (finite life) or tested for impairment (indefinite life). Goodwill and intangible assets with indefinite lives are tested annually for impairment.

Intangible Assets: Definition and Recognition

According to IAS 38 Intangible Assets, an intangible asset is an identifiable non-monetary asset without physical substance.

Key Characteristics:

  • Identifiability: Can be separated from entity or arises from contractual/legal rights
  • Control: Power to obtain future economic benefits
  • Future Economic Benefits: Expected to flow to entity
  • No Physical Substance: Cannot be touched or seen physically

Recognition Criteria:

An intangible asset should be recognized if, and only if:

  1. It is probable that future economic benefits will flow to entity
  2. The cost can be measured reliably

Initial Measurement:

  • Acquired Separately: Cost = purchase price + directly attributable costs
  • Acquired in Business Combination: Fair value at acquisition date
  • Internally Generated:
    • Research Phase: Expense all costs
    • Development Phase: Capitalize if strict criteria met
    • Internally generated brands, mastheads, publishing titles: Never capitalize

Subsequent Measurement: Amortization vs Impairment

1. Intangible Assets with Finite Useful Lives

Amortization: Systematic allocation of depreciable amount over useful life.

  • Amortization Method: Reflect pattern of consumption (usually straight-line)
  • Useful Life: Period asset is expected to generate benefits
  • Residual Value: Usually zero unless third party commitment to purchase
  • Review: Review amortization period/method at each reporting date

2. Intangible Assets with Indefinite Useful Lives

No Amortization: Not amortized but tested for impairment annually.

  • Indefinite Life: No foreseeable limit to period over which asset will generate cash flows
  • Examples: Some trademarks, perpetual licenses
  • Review: Review useful life assessment annually

Common Intangible Assets:

Asset TypeTypical LifeAmortizationImpairment Test
PatentsLegal life (e.g., 20 years)YesWhen indicators exist
CopyrightsLegal life + economic lifeYesWhen indicators exist
TrademarksIndefinite or finiteDepends on lifeAnnual if indefinite
GoodwillIndefiniteNoAnnual (mandatory)
Software3-5 years typicallyYesWhen indicators exist

Impairment Testing for Intangible Assets

When to Test for Impairment:

  • Intangible assets with indefinite lives: Test annually (mandatory)
  • Intangible assets with finite lives: Test when impairment indicators exist
  • Goodwill: Test annually at Cash Generating Unit (CGU) level

Impairment Indicators:

  • External Indicators:
    • Significant decline in market value
    • Significant adverse changes in technology, markets, economy, or laws
    • Increase in market interest rates affecting discount rate
  • Internal Indicators:
    • Evidence of obsolescence or physical damage
    • Asset part of restructuring or held for disposal
    • Worse economic performance than expected
    • Significant changes in use of asset

Impairment Test Process (IAS 36):

  1. Determine Recoverable Amount: Higher of:
    • Fair Value Less Costs of Disposal (FVLCD)
    • Value in Use (VIU) - present value of future cash flows
  2. Compare to Carrying Amount: Book value of asset
  3. Recognize Impairment Loss: If Carrying Amount > Recoverable Amount
  4. Journal Entry: Dr Impairment Loss (P&L), Cr Accumulated Impairment (B/S)

Goodwill Impairment Testing (Special Rules):

  • Tested at Cash Generating Unit (CGU) level
  • Two-step process under US GAAP (one-step under IFRS)
  • Cannot reverse goodwill impairment losses (under IFRS)
  • Significant judgment required in cash flow projections

Example: Patent Impairment

Situation: Patent with carrying amount $500,000. New technology makes patent obsolete.

  • Fair Value: Estimated at $200,000 (from potential buyer)
  • Costs to Sell: $20,000
  • FVLCD: $200,000 - $20,000 = $180,000
  • Value in Use: $150,000 (discounted future cash flows)
  • Recoverable Amount: Higher of $180,000 and $150,000 = $180,000
  • Impairment Loss: $500,000 - $180,000 = $320,000
  • Journal Entry: Dr Impairment Loss $320,000, Cr Accumulated Impairment - Patent $320,000

Reversal of Impairment Losses:

  • Allowed for: Tangible assets and intangible assets (except goodwill)
  • Conditions: Change in estimates used to determine recoverable amount
  • Limit: Cannot increase carrying amount above what it would have been without impairment
  • Journal Entry: Dr Asset, Cr Impairment Loss Reversal (P&L)
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