Identifiable intangibles are intangible assets that are separately identified and linked with specific rights or privileges having limited benefit periods. Candidates are patents, trademarks, copyrights, and franchises. Companies record them at cost and amortize them over their benefit periods. The writing off to expense of the entire cost of identifiable intangibles at acquisition is prohibited.
Unidentifiable Intangibles
Unidentifiable intangibles are assets that are either developed internally or purchased but are not identifiable and often possess indefinite benefit periods. An example is goodwill. When one company acquires another company or segment, it needs to allocate the amount paid to all identifiable assets (including identifiable intangible assets) and liabilities according to their fair market values. Any excess remaining after this allocation is allocated to an unidentifiable intangible asset called goodwill. Goodwill can be a sizable asset, but it is recorded only upon purchase of another entity or segment (internally developed goodwill is not recorded on the balance sheet). Its makeup varies considerably it can refer to an ability to attract and retain customers or to qualities inherent in business activities such as organization, efficiency, and effectiveness. Goodwill implies earning power. Stated differently, goodwill translates into future excess earnings, where this excess is the amount above normal earnings.
Amortization of Intangibles
When costs are capitalized for identifiable tangible and intangible assets, they must be subsequently amortized over the benefit periods for these assets. The length of a benefit period depends on the type of intangible, demand conditions, competitive circumstances, and any other legal, contractual, regulatory, or economic limitations. For example, patents are exclusive rights conveyed by governments to inventors for a specific period. Similarly, copyrights and trademarks convey exclusive rights for specific periods. Leaseholds and leasehold improvements are benefits of occupancy that are contractually set by the lease. Also, if an intangible materially declines in value (applying the recoverability test), it is written down.
Analyzing Intangibles
Analysts often treat intangibles with suspicion when analyzing financial statements. Many analysts associate intangibles with riskiness. We encourage caution and understanding when evaluating intangibles. Intangibles often are one of the more valuable assets a company owns, and they can be seriously misvalued. Analysis of goodwill reveals some interesting cases. Since goodwill is recorded only when acquired, most goodwill likely exists off the balance sheet. Yet we know that goodwill is eventually reflected in superearnings. If superearnings are not evident, then goodwill, whether purchased or not, is of little or no value. To illustrate this point, consider the write-off of goodwill reported by Viacom.
Our analysis of intangibles other than goodwill also must be alert to management’s latitude in amortization. Since less amortization increases reported earnings, management might amortize intangibles over periods exceeding their benefit periods. We are probably confident in assuming any bias is in the direction of a lower rate of amortization. We can adjust these rates if armed with reliable information on intangibles’ benefit periods.
In analyzing intangibles, we must be prepared to form our own estimates regarding their valuation. We must also remember that goodwill does not require amortization and that auditors have a difficult time with intangibles, especially goodwill. They particularly find it difficult to assess the continuing value of unamortized intangibles. Our analysis must be alert to the composition, valuation, and disposition of goodwill. Goodwill is written off when the superior earning power justifying its existence disappears. Disposition, or write-off, of goodwill is frequently timed by management for a period when it has the least impact on the market.
Unidentifiable intangibles are assets that are either developed internally or purchased but are not identifiable and often possess indefinite benefit periods. An example is goodwill. When one company acquires another company or segment, it needs to allocate the amount paid to all identifiable assets (including identifiable intangible assets) and liabilities according to their fair market values. Any excess remaining after this allocation is allocated to an unidentifiable intangible asset called goodwill. Goodwill can be a sizable asset, but it is recorded only upon purchase of another entity or segment (internally developed goodwill is not recorded on the balance sheet). Its makeup varies considerably it can refer to an ability to attract and retain customers or to qualities inherent in business activities such as organization, efficiency, and effectiveness. Goodwill implies earning power. Stated differently, goodwill translates into future excess earnings, where this excess is the amount above normal earnings.
Amortization of Intangibles
When costs are capitalized for identifiable tangible and intangible assets, they must be subsequently amortized over the benefit periods for these assets. The length of a benefit period depends on the type of intangible, demand conditions, competitive circumstances, and any other legal, contractual, regulatory, or economic limitations. For example, patents are exclusive rights conveyed by governments to inventors for a specific period. Similarly, copyrights and trademarks convey exclusive rights for specific periods. Leaseholds and leasehold improvements are benefits of occupancy that are contractually set by the lease. Also, if an intangible materially declines in value (applying the recoverability test), it is written down.
Analyzing Intangibles
Analysts often treat intangibles with suspicion when analyzing financial statements. Many analysts associate intangibles with riskiness. We encourage caution and understanding when evaluating intangibles. Intangibles often are one of the more valuable assets a company owns, and they can be seriously misvalued. Analysis of goodwill reveals some interesting cases. Since goodwill is recorded only when acquired, most goodwill likely exists off the balance sheet. Yet we know that goodwill is eventually reflected in superearnings. If superearnings are not evident, then goodwill, whether purchased or not, is of little or no value. To illustrate this point, consider the write-off of goodwill reported by Viacom.
Our analysis of intangibles other than goodwill also must be alert to management’s latitude in amortization. Since less amortization increases reported earnings, management might amortize intangibles over periods exceeding their benefit periods. We are probably confident in assuming any bias is in the direction of a lower rate of amortization. We can adjust these rates if armed with reliable information on intangibles’ benefit periods.
In analyzing intangibles, we must be prepared to form our own estimates regarding their valuation. We must also remember that goodwill does not require amortization and that auditors have a difficult time with intangibles, especially goodwill. They particularly find it difficult to assess the continuing value of unamortized intangibles. Our analysis must be alert to the composition, valuation, and disposition of goodwill. Goodwill is written off when the superior earning power justifying its existence disappears. Disposition, or write-off, of goodwill is frequently timed by management for a period when it has the least impact on the market.
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