Hello I'm Professor Brian Bushee. Welcome back. In this video, we're going to talk about intangible assets, including what determines what types of things can be recognized as intangible assets on the balance sheet, and what the heck is this thing called goodwill. And what does it mean if we have an impairment of goodwill. Hope you enjoy the video. So recall that intangible assets are assets that do not have a physical form. You can't load them in the back of a truck and move them from one place to another. In general, US GAAP and IFRS require that internally-developed intangibles be expensed immediately. Internally-developed means that, you spend money to develop these benefits internally, but have never acquired them in a market transaction. So common things you see in this category would be R&D, Advertising, Employee Training. These are all expensed when the cost is incurred. There's a little bit of difference internationally. Some types of R&D can be capitalized. Under US GAAP, Software Development R&D can be capitalized. After the point that the software project reaches technological feasibility, and under IFRS, any kind of development expense could be capitalized. So when you're trying to come up with a new product your doing research, that gets expensed immediately. Once the project reaches this technological feasibility point, then the cost after that when you're developing it could be capitalized and then amortized over time. Both sets of accounting standards require that purchased intangibles be capitalized as an asset, so if you buy patents, you purchase trademarks, you purchase customer lists, you get goodwill from an acquisition which we'll talk about later. All of those show up as assets rather than immediate expenses. Let me get this straight. If a company spent money to develop a customer list, it would not be an asset. But, if a company bought a customer list from another company, it would be an asset. Do you accounting types just arbitrarily make this stuff up? Is it so you can feel like you actually have an important role in the business world? Hey, accounts do have an important role in the business world. Don't we? Don't we? But, but anyway, getting back to the first part of your question. yes, if you spent money to internally develop the customer list, it's not an asset. Whereas, if you get the customer listed in acquisition. It is an asset, and this goes back to what we talked about way at the beginning of the course, that accountants erra on the side of reliability. So we don't want to record something as an asset, unless we're pretty sure we can estimate the value of that asset. If we're spending the money internally and managers have to come up with a value, it's not reliable so we don't record the asset, whereas if we acquire an acquisition, we pay a market price. It's more reliability. We're more willing to call that an asset. So now we're going to talk in more detail about the Purchased Intangibles, since those are the ones that show up as Long-Lived assets. You generally get Purchased Intangibles when you do an acquisition. You go out and buy another company. You pay a market price for that company. Part of what you're buying is to acquire these intangibles. And so they're going to end up showing up on the balance sheet. And the rule is that intangible assets and liabilities must be separately recognized if it comes from a transferable contract or it's separable. Which sounds like a bunch of gobbledygook. But, essentially what it means is, if you get to clearly identify an intangible asset that you're getting. And, you can put a value on it, it should be a separate asset. So, for instance, if in part of the acquisition what you get the acquired company is their list of customers. And then, you can use that list of customers to now sell the product of your combined company. That's a separable intangible, and we can probably put a value on having that list of customers. Or maybe the company you acquired had a contract to run a restaurant in an airport. Gave them exclusive rights. When you acquire them, you get that contract, and so we value that contract as an intangible asset. It's the right to operate those restaurants. So basically anything that you acquire that you could separately identify as yes, this intangible asset represents this right or this, benefit that we go from the other company. We create a separate asset or liability for it. Non-separable intangibles are included in Goodwill. So anything that you can't separately identify, you just put in this plug number Goodwill and we'll talk more about what that represents a little bit later in the video. Intangibles that have a definite life must be amortized over that life. So for instance if we buy out a company and we decide to book an asset for the pattens for the pattens we acquire, well pattens have an expiration date so generally their about 17 years. And if you got a patent that had ten years left to go, you would amortize it over ten years. Same thing with copyrights, those have a definite legal life, you'd amortize it over the remaining life. Customer lists, this requires a little bit more judgment, so if you got a customer list, you would think well, we're going to be able to benefit from this for about three years, and then it won't be useful anymore, then you would take that customer list asset and amortize it over three years. Intangibles with an indefinite life don't have to be amortized. So brand name, is assumed to have an indefinite life. It's not going to be used up in five years or ten years, and so you never have to amortize it. Same thing with Goodwill. Goodwill and again we'll talk about what's in this later. It's assumed that whatever you're buying doesn't have a finite life. So, it will just sit there as an asset forever without being amortized. But, the intangibles are still subject to these asset impairment tests. Which means that even though you don't amortize brand name, or goodwill. If they become impaired, which means the, say the fair value of the brand name drops below what it is on your financial statements, then you would have to write it down at that point. So you don't have to systematically amortize it. But you still have to test whether the market value is dropped and, if so, write it down, because it'll be lower of cost or market, just like we're curing the tangible assets we talked about in the prior videos. >> [FOREIGN]. >> Excuse me! Is the the part of the course when we will finally learn about Goodwill Amortization? >> Yes, as the professor just said, Goodwill is not amortized. >> Hey, it's the virtual people from the intro video for the course! Yeah, so if you watched the intro video that I posted as a teaser for the course earlier in the year. And you were dying to find out what why Goodwill was not advertised or even what Goodwill meant. This is the video for you. We're finally going to talk about Goodwill. Okay, so let's talk in more detail about Goodwill. So when an acquirer purchases a target firm, purchases another company, that firm's individual assets are first adjusted to reflect their current market values. So as we've talked about inventory is lower of cost or market, property, plant, equipment is lower, cost or market. Which means that they're generally valued below market value. Usually market value's higher. In an acquisition, it's assumed that when we buy the inventory, when we buy the property equipment of the other company, we're paying market value. So what we do is we write those assets up to what their market value would be. Then, we record any separable or transferable intangible assets. So if we're getting a brand name, or a customer list, or patents or trademarks, we create assets for those, trying to value them at the fair market value. Goodwill is going to be what's ever left over. It's the difference between the purchase price in the acquisition, and the fair market value of all the net identifiable assets. So that includes all the assets that were on the balance sheet, now written up to market value. Plus, all of these separable, or transferable intangible assets that we acquire. So, Goodwill is basically the difference between the purchase price and the fair value of all the assets we could identify. I always believed that Goodwill represented the brand name, trademarks, customer lists, trade secrets, and so forth. Are you saying that is not the case? >> I believe the professor is saying that because they are separable or transferable assets. So, what types of things are included in Goodwill? >> So, anytime I've taught Goodwill in an on-campus course, early in the class session, I'll ask my students, what's included in the Goodwill asset? And they'll always list things like brand name, or trademarks, or copy rights, or trade secrets, or customer lists cognents. All of which are not included in the Goodwill asset because they're broken out as separate intangible assets, they're either separable or transferable. So what's left in Goodwill is the real fuzzy stuff. Things like, synergies, the idea that you put two companies together and the whole is greater than the sum of the parts, you know, two plus two equals five. Things like potential future growth opportunities, human capital. And overpayment. So if you had two firms, firm A and firm B, are trying to acquire firm C. They get into a bidding war. Firm A wins the bidding war. They probably have suffered the winner's curse. Which says, if you win a bidding war, you're probably cursed by overpaying to acquire the company. Well, we have to account for that difference between purchase price, and the fair value of all the net assets, somewhere. And so, if we overpay, that over payment goes into the Goodwill asset, making it Goodwill in the sense of a good will towards your fellow company you acquire in that you were willing to overpay for it. So let's take a look at an example. So, KP goes out and acquires the TK company for $2 million cash. TK's balance sheet is shown on the right. So this is what TK looked like when we go out and buy them as KP. First thing KP has to do is estimate fair values for all of TK's asset and liabilities. As you see cash and accounts receivable are [INAUDIBLE] basically carried at fair value. But inventory, property plant equipment, those are carried at lower of cost or market, and so we have to write them up to fair value. So inventory goes from 68 up to 78, PP&E up from 850 to 900. The liabilities were carried basically at fair value, so we don't have to make any adjustment. And we'll talk more about acquisitions a little bit later, but note that in an acquisition you're buying the assets and liabilities of the other company, the other companies stock holder equity goes away. Basically doesn't exist anymore because these were shares that the owner of TK had in TK, TK's going to disappear, so the stock holders equity disappears as well. KP also estimates that it acquired a customer list worth $200,000 and a proprietary technology worth $500,000. So those are going to be additional assets that we're going to have to add, now they weren't on TK's balance because they were internally developed. TK internally developed the customer list, and the proprietary technology. They can't claim them as assets. But now there's been a market transaction. KP has paid to buy TK. Part of what they're buying is the customer list and the proprietary technology. So we can create these as separable, intangible assets. KP must record the acquisition using these fair values and then adding the intangibles required. So let's look at the journal entry to do this. So first of all KP is paying $2 million in cash, so their crediting cash two million. Their acquiring a couple thousand of cash from TK, so we get that cash back, we also get the 80,000 of accounts receivable, 78,000 of inventory. And note again this is not the book value on TK's books, but this is the fair value of that inventory. [SOUND] We get the net property, plant and equipment of 900,000. Again, this is the fair value of the property, plant and equipment. We ass the customer list of 200. That was not on TK's balance sheet. But it's something that we bought the company to get, so we add it as an intangible asset. We try to value the fair value and come up with 200,000. We add the proprietary technology at $500,000. Same story, not on the balance sheet originally. Gets added as part of the acquisition. We assume all of the payables, accounts payable, salary payable of TK, and we take on all their other liabilities. Again, at fair value, which in this case, was the same as book value. And it's hard to see here, but our debits don't equal our credits because we paid more, $2 million, than the net fair value of of the assets and liabilities we acquired. And so, the plug that makes this balance is Goodwill. So we must have paid 440,000 for all of those intangibles that are not separable. So the things like synergies and growth opportunities and human capital, and, as we talked about, maybe even overpayment. Those go into the Goodwill asset which is essentially applied. What happens if KP's fair values are incorrect? And how does KP value the Goodwill asset? It surely is not just a plugged value to make the debits equal the credits! >> As the professor said, Goodwill is a plug. It is the difference between the purchase price, and the fair value of all of the assets. That is why you may have a good will impairment if a company overpays for an acquisition. >> So there are two issues here. The first the good will is a plug, so if you estimate those fair values of the net assets incorrectly, it directly affects your good will asset. So if you overestimate the fair value of the customer list, you will under state goodwill, or if you under state the fair value of that customer list, you'll over state goodwill. The second issue is, if you do anything to over state the value of the goodwill asset, including over paying an acquisition, you're susceptible to a goodwill impairment. So just like we talked about with long lived assets, where if the value of the long lived asset, the market value of the long lived asset drops below what it, is carried on the books, you have to write it down, if the market value of the goodwill, drops below its book value, then you have to write it down. Now its really hard to figure out the market value of goodwill. Basically, you try to do a valuation of all the business segments, add it up to get the value of the company. And, see if it's dropped below the book value, which would mean the Goodwill's been impaired. So, good example of this, was back in the height of the internet bubble AOL, America Online, acquired Time Warner. Then in 2002, they had to take what was at the time the biggest loss in U.S. history by taking a goodwill impairment of $44.9 billion, basically writing down their goodwill asset by $44.9 billion. What happened is the synergies that AOL expected between their internet business, and the magazine and media business of Time Warner,. Never materialize, the company hadn't performed well, it was clear they overpaid, and so they take had to take that goodwill impairment charge, write down that goodwill asset. We're going to talk more about goodwill impairment and the effect that it has on financial statements in the next video. Are there any other questions out there about how this works? [FOREIGN]. >> Okay. I think they're talking about smorgasbords, so there must be no more questions on good will in this video. What we will do in the next video, is take a look at a firm's disclosure of their long live assets, both tangible, and intangible. And see what things we can learn from the disclosure. I'll see you next time. [FOREIGN]
