Assets are resources owned to produce economic benefits in the future and are classified into tangible and intangible assets. Valuation of tangible and intangible assets determines their true worth or value. The tangible and intangible assets valuation is important for tax & financial reporting, litigation support, analysis of merger & acquisition transactions, and bankruptcy filing. Let’s understand tangible and intangible assets in more detail below:
Tangible assetsA tangible asset possesses physical substance and can be seen and touched. Buildings, machinery, and land are examples of tangible assets. Also referred to as real assets or hard assets.
ClassificationThe following are the classification of Tangible assets: Fixed assets are long-term assets that cannot easily be converted into cash for more than one year. Example: Property, plant, and equipment. Current assets are liquid assets that can easily be converted into cash within a year.
Valuation of Tangible AssetsValuation of Tangible assets involves the following methods:
- Appraisal method: Fair market value of assets is estimated by considering the current state of assets including depreciation and obsolescence.
- Liquidation method: Fair market value of assets is determined at liquidation, sale, or closure.
- Reproduction cost method: The cost to reproduce an identical asset at current costs.
- Replacement cost method: The cost of creating the assets with similar characteristics at current costs.
Intangible assetsAn intangible asset lacks physical substance and is difficult to quantify or recognize. Types of intangible assets are artistic, consumer, technology, contract, and market-related. Examples include goodwill, patents, trademarks, software, and customer relationships.
ClassificationThe following are the classification of Intangible assets: Definite life or Indefinite-life Definite intangible assets have an expected economic life and may cease in some time. These assets are amortized over their useful life, using a straight-line method. Patents and copyrights are examples of limited-life intangible assets. Indefinite-life intangibles have an unlimited useful life and have perpetual existence. There are no legal, regulatory, contractual or economic limiting factors. Indefinite-life intangibles are not amortized and tested for impairment annually. Examples include trademarks and perpetual franchise agreements. Purchased or internally created intangibles Purchased intangibles are recorded at cost, which includes the acquisition costs as well as expenses incurred to bring the asset in a ready state. Internally created intangibles are costs incurred internally to create intangibles that are generally expensed as incurred and only direct costs are capitalized and not recorded on the balance sheet. Examples include research & development cost and legal costs.
Valuation of Intangible AssetsValuation of Intangible assets involves the following methods: Income approach: Cash flows and earnings of intangible assets are discounted to the present value by discounted cash flow or capitalization of cash flow method.
- Excess earnings method: Excess earnings are calculated by subtracting the earnings of net tangible assets from total earnings. The capitalized excess earnings value is obtained by dividing excess earnings by capitalization rate. The capitalized excess earnings value is added to the value of tangible assets to calculate total business value. It is generally used to determine the value of business goodwill.
- Relief from royalty method: Value is based on saving the payment of license fees to third parties as employing an intangible asset.
Differences Between Tangible and Intangible Assets
|Physical form||Abstract form|
|Easily liquidated||Not easily liquidated|
|Cost can be easily determined||Harder to evaluate|
|Salvage value exists||No salvage value|
|Used as collateral to obtain loans||Not used as collateral to obtain loans|
|Reported on the balance sheet||Not reported on the balance sheet|
|Managed by control||Managed by alignment|
|Easily duplicated||Difficult to duplicate|
|Limited application||Multiple applications|