Accounting for Goodwill and Other Intangible Assets

Ervin L. Black, Mark L. Zyla

• Publisher: Wiley
• Year: 2018
• ISBN:
  9781119157212
• Edition: 1
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

Concepts, methods, and issues in calculating the fair value of intangibles

Accounting for Goodwill and Other Intangible Assets is a guide to one of the most challenging aspects of business valuation. Not only must executives and valuation professionals understand the complicated set of rules and practices that pertain to intangibles, they must also be able to recognize when to apply them. Inside, readers will find these many complexities clarified. Additionally, this book assists professionals in overcoming the difficulties of intangible asset accounting, such as the lack of market quotes and the conflicts among various valuation methodologies.

Even the rarest and most problematic situations are treated in detail in Accounting for Goodwill and Other Intangible Assets. For example, the authors analyze principles for identifying finite intangible assets and appropriately accounting for amortization expenses or impairment losses. Using the information in this book, the results of these calculations can also be reported with precision on financial statements. These topics are especially important for ensuring the success of any asset acquisition or business combination. In these special cases, the utmost accuracy is essential. This book provides:

• Rules for identifying and recognizing intangible assets in business combinations and asset acquisitions
• Guidance on the accurate valuation and carrying amount calculation of acquired and self-created intangibles
• Tips for overcoming the challenges unique to intangible assets, including impairment testing
• Clear instructions for disclosing intangible assets, goodwill, and amortization expenses

Accounting for Goodwill and Other Intangible Assets is an indispensable reference for valuation students and specialists. Ervin L. Black and Mark L. Zyla provide thorough instructions for understanding, accounting for, and reporting this challenging asset class.

CHAPTER 1
Recognizing Intangible Assets

A. Introduction and Background

For financial reporting purposes, “intangible assets” consist of assets (not including financial assets) that lack physical substance.¹ Intangible assets are getting more and more important to companies and their owners as the economies of many developed countries have changed from industrial to knowledge-based. The manufacturing/industrial value chain is no longer the primary driver of value creation; it is innovation and constantly seeking new ways of meeting market demands. Companies seek to differentiate themselves through the creation or acquisition of intangible assets to create competitive advantages. With the increased importance of their intangible assets, the need for relevant and reliable financial information for their existence and valuation is increasing.

The necessity of valuing intangible assets as accurately as possible is tied to the growing significance of such assets.² The FASB put the situation more mildly: “At the inception of [FAS 142], the [FASB] observed that intangible assets make up an increasing proportion of the assets of many (if not most) entities.”³ With such a large percentage of total assets classified as intangible assets, it no longer takes an extremely large error to affect financial statements. Even small valuation errors, if made repeatedly, can mushroom into very large valuation errors on the financial statements.⁴

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Comment

The relevance of intangible assets has been well documented in the academic research literature. Firms can gain competitive advantage and achieve superior performance by holding, acquiring, and effectively using intangible assets. Intangible assets are valuable due in part because they tend to be more rare, nonsubstitutable, and hard to imitate. Studies have found a positive relationship between such intangible assets and firm performance measures. One study found a positive relationship between intellectual capital and firm performance measures.⁵ Another study examined several intangible assets (R&D, advertising, training, software acquisitions, and product quality) and found that these assets are positively associated with a firm's ability to generate future operating cash flows.⁶ In another study, a researcher found that firms capitalize intangible assets more aggressively when they are nearing failure. In addition, he finds that managers' propensity to capitalize intangible assets has a strong statistical association with earnings management. These findings suggest that capitalizing earnings aggressively is associated with distressed firms in which managers also likely may have incentives to aggressively manage earnings.⁷

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Increasingly, intangible assets come from unique entity organizational designs and business processes that companies use to outperform competitors. Tangible assets that in the past have allowed entities to gain a productive edge over competitors no longer allow the same advantage. Unless equipment is very expensive, the productive equipment that might have allowed a competitive advantage is now within the financial range of both large and small firms. The barriers to entry in many fields have fallen. Intangible assets can now form the competitive edge that tangible assets once formed. Examples include:

1. Dell allows built-to-order computers (customers design their own computers).
2. Wal-Mart has a supply chain that essentially shifts its inventory management to its suppliers. (Wal-Mart's smaller competitors cannot duplicate this supply chain.)
3. Benetton, an Italian apparel manufacturer, has a unique information system relaying real-time information about product colors between stores and manufacturing facilities.
4. Citibank has an online (internet-based) banking system that allows it to seek customers all over the world. Moreover, the synergy between different parts of the banking system, such as mortgages and credit cards, is high.⁸

These are but a few of the thousands of intangible assets that businesses use to gain a competitive edge on their competitors.

ASC 805-20-55 lists a number of intangible assets. Exhibit 1.1 presents these intangible assets.⁹

EXHIBIT 1.1 Intangible Assets

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Trademarks, trade names	Service marks, collective marks, certification marks
Trade dress (unique color, shapes, or package design)	Newspaper mastheads
Internet domain names	Not-to-compete agreements
Customer lists	Order or production backlog
Customer contracts and related customer relationships	Noncontractual customer relationships
Plays, operas, ballets	Musical works such as compositions, song lyrics, or advertising jingles
Pictures, photographs	Video and audiovisual material
Licensing, royalty, standstill agreements	Advertising, construction, management, service, or supply contracts
Lease agreements	Construction permits
Franchise agreements	Operating or broadcast rights