Decades ago, the majority of assets were either buildings and machinery – often referred to as plant, property and equipment (PPE) – or financial assets such as cash or securities. These are known as tangible assets. However, over time intangibles have grown to become a greater proportion of assets for many firms.
In some sectors, intangible assets may now be a far more significant part of a company’s value than tangible assets, even though much of this may not be fully reflected in its accounts. Valuable (and sellable) intangible assets include intellectual property, such as patents, copyrights and trademarked brands. Since the money that a firm spends on creating and maintaining these assets is usually classed as an expense for accounting purposes, these cumulative value of these outgoings is generally not recorded in the balance sheet (let alone any additional value created over and above the initial outlay). This differs from capital expenditure on physical assets, which will be recorded.
Often, the only time most intangibles will be measured is as goodwill in an acquisition. When one company buys another, it will typically pay a premium to the estimated fair value of its target (fair value will be an adjusted version of the value of a company’s assets minus its liabilities). Goodwill is the difference between the acquired company’s fair value and the price paid. In theory, this is the estimated value of intellectual property, as well as any value placed on a skilled workforce or loyal customers.
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The real value of these intangibles may be difficult to measure (and buyers often pay too much). So goodwill may be a bad guide to what the assets are actually worth. The value of goodwill must be reviewed each year and reduced if necessary. It is not increased even if the assets are now worth more.
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