“All arguments concerning existence are founded on the relation of cause and effect.” – David Hume
In the quote above, David Hume, a famous philosopher, says that the basis of existence is founded in cause and effect. Cause and effect is simple to picture for tangible objects – if I cause my finger to type a letter on the keyboard, that letter shows up on my computer screen. It becomes a little more difficult to picture cause and effect with intangible things – if I greet a stranger on the sidewalk as I walk past them, did that greeting have a positive or negative effect on them?
Similar to the example above, it is often much more difficult to determine the value of intangible assets in the acquisition of a company compared to determining the value of the company’s tangible assets. Intangible assets are just that – non-tangible, non-physical. This can make identifying and valuing such assets a difficult task, although it must be done to comply with Generally Accepted Accounting Principles related to business combinations and purchase accounting.
Let us begin with tangible assets, for which the cause and effect that identify their existence are easily perceived:
Cash – Cash is a tangible item, regardless of whether it is in the form of greenbacks or in a bank account. There are many causes for spending cash, the effect of which is often the receipt of goods or services.
Fixed Assets – By causing the fixed assets to operate, salable product is produced by manufacturing companies.
Accounts Payable – By causing the purchase of an item without making payment at the time the item is received, the effect is the creation of an accounts payable liability.
Things get a little more complicated when dealing with intangible assets. In an effort to help you identify intangible assets that may have been part of an acquisition, the list below presents the intangible assets most often recorded in business combinations:
Customer Relationships – Most companies have repeat customers that continue to return time and time again for goods or services. To the extent that these customers can be identified, the customer relationships have intangible value since the purchaser can expect the customers to continue to do business with the acquired company after the deal has closed.
Trademarks – Trademarks included registered trademarks, trade names and related items that identify a company. The existence of a well-known trademark may cause a person to purchase a particular item, the effect of which is cash flow to the company providing the good or service.
Noncompetition Agreements – A noncompetition agreement causes a key employee to refrain from competing against the newly purchased company, the effect of which is that the revenue and margins of the company are protected from the dilution that could have resulted from the competition of that key person.
Technology – While technology often results in the creation of tangible products, the general “know-how” behind a company’s technology is another commonly recorded intangible asset. Such technological know-how is the cause that allows a company to offer products or services which, as a related effect, meets needs that customers are willing to pay for.
There are numerous other types of intangible assets that exist and are recorded as a result of purchase accounting depending on the facts and characteristics of the acquired company. The list above should provide you with an idea of the “unseen” or intangible assets that are most often recorded in business combinations.
Do you struggle to identify intangible assets in the business world? Post a comment below or contact our financial reporting valuation group at 440-449-6800.