When a business sells, the owners are supposed to allocate the purchase price across all tangible and intangible assets. The overage is then deemed to be due to goodwill.
In the past, it mattered little if some of the important intangible assets were lumped together with business goodwill. The reason? There used to be little difference in how business intangible assets, such as intellectual property or customer contracts, were handled in the company’s financial records.
Business goodwill impairment
Along come the SFAS 141 an 142 published by the Financial Accounting Standards Board (FASB), and everything changes. No longer is business goodwill amortized. Rather, companies must conduct the goodwill impairment test and adjust their income statements accordingly. In addition, the Generally Accepted Accounting Principles (GAAP) now require that all intangible assets be amortized. In other words, such assets as software, technology, customer and vendor contracts, patents, copyrights and trademarks, all are expected to be gradually used up in business operations.
With these new financial reporting rules, companies have an incentive to put high values on goodwill and reduce the values of other intangible assets. The benefit of this strategy is that you can increase the reported earnings without any effect on the business cash flow. Earnings per share go up, so the company stock value increases.
According to the US Securities and Exchange Commission (SEC), there are several types of business intangible assets that must be valued:
- Customer related intangibles
- Creative intangibles
- Marketing oriented intangible assets
- Technology specific intangibles
- Contractual intangible assets
All these assets must be recognized as distinct from business goodwill. Contract specific assets do not need to be actually separable. However, all other intangible assets must be capable of being sold on their own.
This sounds a bit tricky. The plain English meaning is that an intangible asset must be either based on a legally enforceable right, such as a customer contract, or be sellable by itself, such as a license to use a patented invention.
To see the difference, imagine the problems with trying to transfer a trained and assembled workforce to another company. You are unlikely to have this valuable asset preserved intact, in contrast to the licensing of a trademark.