Example of how intangible assets are accounted for using a patent as an example:

Scenario

A company purchases a patent for a new technology for $100,000. The patent has a useful life of 10
years.

1. Recognition : The company recognizes the patent as an intangible asset on its balance sheet because
it meets the criteria - it's identifiable, provides future economic benefits, and its cost can be reliably
measured.

Initial recognition:

Intangible Asset (Patent) $100,000

Cash or Accounts Payable $100,000

Date Account Debit Credit

XX/XX/XX Intangible assets $ 100,000

(patent)

Cash/accounts
payable $ 100,000

2. Valuation The patent is initially recorded at its cost, which is $100,000.

3. Amortization: Since the patent has a finite useful life of 10 years, the company will amortize it over
that period. Let's assume they use the straight-line method for simplicity:

Annual Amortization Expense = Cost / Useful Life

 Annual Amortization Expense = $100,000 / 10 = $10,000

Each year, the company records an amortization expense of $10,000 on their income statement:

Recording amortization expense

Date Account Note Debit Credit

Xx/XX/XXX Amortization $ 10,000

expense

Accumulated
amortization $ 10,000
(contra-asset)

Total $ 10,000 $ 10,000

4. Impairment. The company periodically assesses whether the patent's carrying value exceeds its
recoverable amount. If it does, an impairment loss is recognized. Suppose in year 5, the patent's value is
deemed to have decreased to $70,000 due to technological advancements. An impairment loss is
recognized:

Impairment loss=carrying value- recoverable amount

=100,000 - 70,000

=$ 30,000

Impairment Loss $30,000

Accumulated Amortization $30,000

Account Debit Credit

Amortization expense $ 30,000

Accumulated amortization $ 30,000

(loss)

Total $ 30,000 $ 30,000

5. Disclosure .In the company's financial statements, they would disclose information about the patent,
including its carrying amount, amortization method, and any impairment losses.

This example simplifies the accounting process for an intangible asset like a patent. In practice, more
complex scenarios, such as revaluations or changes in useful life, can arise, and accounting standards
may vary by jurisdiction. Companies should follow applicable accounting standards and consult with
accounting professionals when necessary.

Advantages and disadvantages /limitations of intangible assets

Advantages

 Competitive Advantage: A strong brand name, such as Coca-Cola, gives the company a
competitive advantage by creating brand loyalty among consumers. This can lead to higher sales
and market share compared to competitors.
 Long-Term Value: Pharmaceutical companies invest in research and development to develop
new drugs and obtain patents. These patents provide exclusive rights to produce and sell the
drugs, generating long-term value and revenue for the company.
 Revenue Generation: Microsoft's proprietary software, such as the Windows operating system,
generates significant revenue through licensing fees. Other companies pay to use Microsoft's
software, creating a recurring revenue stream for the company.
 Barriers to Entry: Google's search engine algorithm and complex algorithms provide a
competitive advantage by making it difficult for new search engines to replicate the accuracy
and relevance of search results. This creates barriers to entry and protects Google's market
position.
 Brand Recognition and Reputation: Nike's strong brand recognition and reputation for quality
and innovation attract customers and allow the company to charge premium prices for its
products. This enhances profitability and customer loyalty.
Limitations of Intangible Assets

Intangible assets have certain limitations that businesses should be aware of. Here are some limitations
of intangible assets, along with examples:
 Subjective Valuation: Valuing intangible assets can be subjective and challenging due to the lack
of a readily observable market price. For example, valuing a brand name or customer
relationships requires making assumptions and judgments about their future economic benefits.
 Uncertain Useful Life: Unlike tangible assets with a predictable physical deterioration, the useful
life of intangible assets can be uncertain. Changes in technology, market conditions, or
consumer preferences can render an intangible asset obsolete or less valuable. For instance,
advancements in digital technology can quickly make software applications outdated.
 Limited Legal Protection: Not all intangible assets receive strong legal protection. For example,
while copyrights and patents provide legal protection, trade secrets or know-how may have
limited legal remedies if misappropriated. This limitation exposes the business to risks of
unauthorized use or replication by competitors.
 Difficulty in Transferability: Transferring or selling intangible assets can be challenging
compared to tangible assets. Finding willing buyers, negotiating terms, and establishing fair
value can be complex due to the unique nature of intangibles. For instance, it can be j8j7 ok
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 High Development and Maintenance Costs: Developing and maintaining intangible assets can
be costly. For example, research and development expenses for new drugs in the
pharmaceutical industry can be substantial, including the costs of clinical trials and regulatory
approvals. These high costs impact profitability and cash flow.
 Limited Financing Options: Intangible assets may not be easily used as collateral for obtaining
financing. Lenders often prefer tangible assets, such as buildings or equipment, that can be
easily valued and sold in case of default. This limitation can make it challenging for businesses
heavily reliant on intangible assets to secure financing.
 Lack of Transparency: Intangible assets are not always disclosed in a company's financial
statements. Some valuable intangibles, such as internally developed software or certain
customer relationships, may not meet the recognition criteria or may be subsumed within other
asset categories, making it difficult for external stakeholders to assess their value.
Conclusion
Accounting for intangible assets requires careful consideration of their nature, useful life, and
value. Proper recognition, measurement, and disclosure of intangible assets are crucial for
providing users of financial statements with relevant and reliable information for decision-
making, risk assessment, and understanding a company's true value. As the business landscape
continues to evolve, the importance of effective accounting for intangible assets will only grow,
making it essential for companies to stay updated on relevant accounting .By following
accounting standards and guidelines, businesses can accurately reflect the value and impact of
their intangible assets on their financial position and performance.