The Impact of Intangible Assets

Numerous non-physical assets are considered intangible assets, which can essentially be categorized into three different types: intellectual property (patents, copyrights, trademarks, brand names, etc.), deferred charges (capitalized expenses) and purchased goodwill (the cost of an investment in excess of book value).

Unfortunately, there is little uniformity in balance sheet presentations for intangible assets or the terminology used in the account captions. Often, intangibles are buried in other assets and only disclosed in a note to the financials.

The dollars involved in intellectual property and deferred charges are generally not material and, in most cases, don't warrant much analytical scrutiny. However, investors are encouraged to take a careful look at the amount of purchased goodwill in a company's balance sheet because some investment professionals are uncomfortable with a large amount of purchased goodwill. Today's acquired "beauty" sometimes turns into tomorrow's "beast". Only time will tell if the acquisition price paid by the acquiring company was really fair value. The return to the acquiring company will be realized only if, in the future, it is able to turn the acquisition into positive earnings.

Conservative analysts will deduct the amount of purchased goodwill from shareholders equity to arrive at a company's tangible net worth. In the absence of any precise analytical measurement to make a judgment on the impact of this deduction, try using plain common sense. If the deduction of purchased goodwill has a material negative impact on a company's equity position, it should be a matter of concern to investors. For example, a moderately leveraged balance sheet might look really ugly if its debt liabilities are seriously in excess of its tangible equity position.

Companies acquire other companies, so purchased goodwill is a fact of life in financial accounting. Investors, however, need to look carefully at a relatively large amount of...