Intangible Assets & Goodwill

Intangible Assets

  • Definition: Intangible assets are non-physical acquired assets.

    • Typically include:

    • Customer lists

    • Franchises

    • Memberships

    • Licenses

    • Patents

    • Technology

    • Trademarks

    • Goodwill

  • Value: Intangible assets have value based on the rights associated with them.

Amortization of Intangible Assets

  • Amortization: Systematic allocation of the cost of intangible assets over their estimated useful life.

    • Functions similarly to depreciation of fixed assets (property, plant, and equipment).

  • Balance Sheet Impact: Intangible assets are reduced on the balance sheet due to amortization.

    • Accumulated amortization acts as a contra account, offsetting intangible asset values.

Example: Google’s Financials

  • Google’s balance sheet indicates intangible asset balance of:

    • $6,000,000,000 against total assets of $110,000,000.

  • Amortization expense associated with these intangible assets in 2013 was:

    • $1,100,000,000.

    • Amortization expense is included within cost of goods sold (COGS) and SG&A (Selling, General and Administrative Expenses).

Changes to Intangible Asset Balance During the Year

  • Starting with an intangible asset balance of $100.

  • If the company purchases $30,000,000 in intangible assets:

    • New balance = $130.

  • If amortization expense for the year is $15,000,000:

    • New balance = $115.

  • If the company sells $25,000,000 worth of intangible assets:

    • End balance = $90.

Goodwill

  • Definition: Goodwill represents the excess of the purchase price over the fair market value of the net assets acquired.

    • It accounts for intangible value such as:

    • Business name

    • Customer relations

    • Employee morale

  • Nature of Goodwill: Considered a unique type of intangible asset that most analysts should be familiar with.

Example of Goodwill Calculation

  • Suppose the fair market value of a furniture company, Johnny's Interiors, is $5,000,000 in 2014.

  • A national company, Big Time Furniture, acquires it for $8,000,000:

    • Excess payment = $3,000,000 (the goodwill recognized on the balance sheet).

Amortization and Impairment of Goodwill

  • Goodwill is unique as it:

    • Is not amortized like patents or other finite-life assets.

    • Considered to have an indefinite life due to intrinsic value factors like employee morale and management.

  • Annual Testing for Impairment:

    • Companies must test goodwill annually to check for decline in value.

    • If the acquired company's value decreases, goodwill must be reduced, affecting retained earnings.

  • Historical Context:

    • Prior to 2001, US GAAP required amortization of goodwill, which was seen as illogical for intangible assets.

    • Current accounting standards (FASB) provide no systematic amortization but require annual impairment tests.

Concept of Goodwill Write-downs

  • Goodwill cannot be increased; it can only be written down if impairment occurs.

  • Notable case: Time Warner's acquisition of AOL had significant goodwill impairments reflecting overpayment concerns.

Real-World Example: Huron Consulting Group

  • 2013 Financials:

    • Total assets: $885,000,000

    • Goodwill: $536,000,000 (largest asset on the balance sheet).

  • Historical goodwill impairments:

    • No impairment in 2013; however, $13,000,000 in 2012 and $22,000,000 in 2011 indicating overpayments for acquisitions.

  • Impairments recognized as expenses on the income statement:

    • Often aggregated into other operating expense categories based on significance.

Visualizing Goodwill Changes

  • Start the year with an initial goodwill balance (example: 100).

  • New acquisitions create an excess of purchase price, adding to goodwill (example: 30), raising the balance to 130.

  • Impairment recognized (example: 20) lowers balance to 110.

  • Year-end goodwill balance is straightforward since there is no systematic amortization.