Accounting for Intangibles

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Now that we know what intangibles are from a practical and economic standpoint, let’s look at how the accountants require us to deal with them.  Warning: it can be confusing and sometimes doesn’t make much sense, and it’s going to have a lot to do with: (a) GAAP vs. IFRS, and (b) whether that asset was internally developed or acquired.  


For financial reporting under US GAAP, Intangibles are defined as assets (not including financial assets, but otherwise meeting the basic criteria to be an asset – future benefits, etc.) that lack physical substance.  

Internally Developed

Costs of internally developed intangible assets (i.e., people at the company made it) are expensed (i.e., no balance sheet entry) when one or more of the following is true about the intangible asset:

As such the recognition of internally developed assets on the balance sheet is rare under GAAP and usually only seen for patents and trademarks, as they are “identifiable.” 

So internally developed (aside from the special type of software described above) catches all the stuff we discussed in the previous post, e.g., employee knowledge and processes, training programs/manuals, advertising investments that build brand value, firm relationships with customers, suppliers, governments, etc.  While it could be argued that much of this requires investment, can be as valuable as a new manufacturing plant (that would be on the balance sheet), and will provide value and revenue for many years into the future, it is still expensed in the income statement, has no place on the balance sheet, and that’s that. 

R&D expenditures are expensed in the income statement – no capitalization on the balance sheet, unless they are related to internal computer software development or acquisition of software that is in the “application development phase” – a good explanation of this can be found here.

Acquired Intangibles

To land on the balance sheet via acquisition accounting, an intangible asset acquired in a business combination must meet the general definition of an asset, must be separately identifiable, and must be part of what the acquirer and the acquiree exchanged in the business combination, rather than the result of separate transactions. 

An asset is separately identifiable if it meets either one of two criteria:

If one of these tests is met, the intangible asset must be measured at fair value at the time of the acquisition, included in the acquirer’s balance sheet, and then subject to amortization or periodic impairment testing. This applies to intangible assets that were valued by the target company on its balance sheet, but also those that weren’t.  For the latter, the acquirer has to go through an often tedious intangible asset valuation process, even though it did/does not do it for its own intangible assets. 

Here’s a good article on the above from the CPA Journal and here is a useful link to a page on the web that summarizes the above.

Right off the bat, you can see the arbitrariness of this approach: if an intangible asset is developed by a company’s personnel it has zero presence on the balance sheet and is expensed, but if the same asset comes to the company through an acquisition (developed by someone else’s personnel…) it is recognized on the balance sheet and amortized on the income statement prospectively.

Of course, this has implications for the denominator (invested capital/asset base) and the numerator (income/amortization expense) in measuring ROIC and comparing ROIC among companies, assuming one is not looking at just return on tangible capital.


Under IFRS an intangible asset is also defined as an identifiable non-monetary asset without physical substance. Expenditure for an intangible item is recognized as an expense unless the item meets the definition of an intangible asset, and:

If these criteria are met, the asset is carried on the balance sheet and amortized over its useful life and is also subject to impairment testing.  These assets can also be revalued to fair value, but this is rare.  Under IFRS, some R&D – notably the development part – can be capitalized on the balance sheet, if it meets the criteria listed here.  This note is also a good resource for much of what is discussed above.  In short, internally developed intangible assets are more likely to be on the balance sheet of companies using IFRS accounting standards. 

Accounting Goodwill

Accounting goodwill is a specific kind/subset of intangible asset that arises from acquisitions, making it an “acquisition intangible.” Per GAAP and IFRS, it is created only when one business acquires another. So when you see it on a company’s balance sheet, you know that they have done at least one acquisition. 

In simple terms, it is an asset that represents the difference between the acquisition price of a business and the sum of the fair values of the identifiable assets of the acquired business – both tangible and intangible. Once the acquirer has determined the value of intangibles that were not carried by the target (see above) they have everything they need to calculate goodwill: it’s what’s left when the net asset value plus newly valued and recognized intangible assets of the target are subtracted from the acquisition price. 

This goodwill amount is the accountant’s attempt to try to approximate that special, ethereal something that the acquirer paid above and beyond net asset value to get the target. Or put another way, it represents assets that are not separable or identifiable. Prior to 2001, goodwill was amortized, but now it is just tested for impairment periodically.  

So, in an acquisition, the acquirer will often have two new intangible assets on its balance sheet related to the target: (1) identifiable intangibles, and (2) goodwill.  Below is my attempt to bring this all together in a table:

A table showing identifiable intangibles and goodwill similarly to how one might find them on an acquirer's balance sheet related to the target.

In summary, what we have so far regarding intangibles:

We are finally ready to talk about goodwill in the context of ROIC, which will be the subject of the next post

Please email me with questions/comments/errors related to this post!