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@@TheFinanceStoryteller Oh right, in my second statement I mistyped. I meant "cash decreases and R&D (so I guess intangible assets) would increase?" Right, so the journal entry would be a debit of intangible assets and a credit of cash. Thanks a lot for the response. I appreciate it. Obviously, since capitalizing R&D would benefit a company's income statement, I assume that companies would try to get away with capitalizing R&D / capitalizing expenses as an intangible asset as much as possible - so there must be pretty strict requirements for doing so, correct? It seems like all R&D could technically be capitalized on the balance sheet as an intangible asset but of course a lot (or most?) R&D is still expensed on the income statement. What factors would allow a company to capitalize R&D as an intangible asset? EDIT: just rewatched the video. I see this is explained at 4:47. So this is true - to an extent - for any company I guess. And the useful economic life is just determined by the overseeing accounting authority? Great video. I subscribed to your channel.
Hello Mingdian! Lots of good thinking in your reply! Yes, R&D capitalization is certainly a topic that a company's external accountant (KPMG, PWC, etc.) will review in detail versus what the accounting standards say about it, and something that regulatory agencies like the SEC as well as accounting standards boards (FASB, IASB) will focus on as well. A company itself will take the initiative to "build a case" (based on its interpretation of generic accounting standards) on how much to capitalize, and when/how to amortize. This is then reviewed, and either approved or challenged. If you are interested in the specific rules, take a look at some of the whitepapers from the big accounting offices, those can be helpful in understanding the specific criteria. US GAAP and IFRS have different levels of "strictness" for R&D capitalization, see my case study (even though n=1 here, so difficult to generalize) ruclips.net/video/7B96MhOGaqE/видео.html In general, it is hard or even impossible to argue that the R in R&D can be capitalized and then amortized, due to its extremely unsure outcomes. For the D in R&D, there might be ways to justify it, once you for example have a working prototype and a launch plan for the product or technology. If you think about it "big picture", then the argument for capitalization is always the matching principle. In the case of Rolls-Royce (aircraft engines) in the video, most of the development cost of the engine (which gets capitalized) will be matched to the actual production of the engine over the years. The risk of R&D capitalization is that you might get stuck with an impairment, if the product/technology fails, and you cannot therefore amortize on a regular basis over the years! Another big element of R&D spending is government funded or NGO funded research, as well as partnerships. That's a way for a company to share the load with external parties, and not have all R&D spending end up in its income statement. If you capitalize now, you will need to amortize in the future. Sharing with external parties is a different structure. I have a video on R&D spending for companies in the Dow Jones index, that might give you an idea of companies to review (I personally learn the most from reading specific sections of annual reports dealing with a specific topic): ruclips.net/video/EEOYQmKkIk4/видео.html Something similar to R&D capitalization happens at Netflix, where "streaming content assets" go onto the balance sheet, and are then amortized: ruclips.net/video/ikizI8dX1SA/видео.html
If you were to guess: What % of intangible assets are internally generated vs the % that are not internally generated (via an acquisition or merger) To Clarify: If we summed up all intangible assets for all US companies then what would be the % that are internally generated vs non-internally generated. I would imagine it would be over 95% are not internally generated but I may be wrong. Thx!
Hi Scott! I agree with you, but haven't done the research to get to a specific percentage either. The criteria to be able to capitalize "internally generated" intangible assets (such as software development) are very strict under US GAAP.
So a tangible asset (eg yellow plant) acquired through a business loan over a period of say five years would not have the loan and interest payments included in the Amortisation figure but only reflected in the depreciation amount?
That depends on whether you are looking at that situation from the accounting (journal entries) side, or the investment analysis (payback period, net present value) side.
Excellent question. The vast majority of intangible assets that I come across on balance sheets are generated from acquisitions, where purchase price of the acquired company gets recorded as (split between) net tangible assets + intangible assets + goodwill. Internally generated intangible assets need to meet very stringent criteria to be eligible for capitalization on the balance sheet (and subsequent amortization). I don't know off the top of my head, as I haven't read Facebook's annual report in detail recently, but I don't think their AI algorithm is even on the balance sheet as an intangible asset. Yes, the AI algorithm obviously has economic value, but not necessarily accounting value. Hope this helps!
I do a live stream every Sat @ 6pm my time or Sun 3:34am your time. I always have a guest host usually another Finance RUclips Channel. Would you consider being a guest host? I can change the time to make it more convenient for you.
Thanks for the invitation, Scott! I am really swamped at the moment with a consulting assignment and caring for my family. Maybe in the medium to long term future we will do something together.
Hi Krishan. This is putting part of the R&D spending on the balance sheet as an asset, and then amortizing it over the years. A bit like buying a machine, capitalizing that on the balance sheet as a fixed asset, and then depreciating it. However, the criteria for capitalization of intangible assets are much stricter.
@@TheFinanceStoryteller So, does it mean that the r&d expense which is capitalized will not flow through the income statement (Or it will only pass through income statement only during amortization)?
@@KrishanSingh-gz9op Correct. In the year of capitalization, the R&D expense does not flow into the income statement, but it does flow through the income statement during subsequent years when the amortization takes place.
Great question, Colin, to which I don't know the answer. I'm more of a Formula 1 fan than a football fan. ;-) But I am sure you can easily find it out from the notes to the financial statements in the annual report of one of the big football teams.
Enjoyed this video? Then subscribe to the channel right now, and let's explore the related topic of asset impairment: ruclips.net/video/lWMDdtHF4ZU/видео.html
Best explanation of intangible assets I have ever heard. I am officially a subscriber
Awesome, thank you! Please spread the word.
This was very helpful and insightful, thank you!
You're so welcome! Have a look at the related video on goodwill as well: ruclips.net/video/yq9qjCmUfS4/видео.html&pp=gAQBiAQB
very interesting, i have it more clear now, thanks for sharing!
Great to hear that! You're welcome. :-)
An excellent explanation. Thank you very much.
Happy to hear that, Joshua! :-) Thank you for watching, and please spread the word about the Finance Storyteller channel.
So are internally generated intangible assets basically just capitalized R&D? Cash decreases and R&D increases?
Yes for the 1st question. Second one: debit intangible assets (B/S), credit cash (B/S).
@@TheFinanceStoryteller Oh right, in my second statement I mistyped. I meant "cash decreases and R&D (so I guess intangible assets) would increase?"
Right, so the journal entry would be a debit of intangible assets and a credit of cash. Thanks a lot for the response. I appreciate it.
Obviously, since capitalizing R&D would benefit a company's income statement, I assume that companies would try to get away with capitalizing R&D / capitalizing expenses as an intangible asset as much as possible - so there must be pretty strict requirements for doing so, correct? It seems like all R&D could technically be capitalized on the balance sheet as an intangible asset but of course a lot (or most?) R&D is still expensed on the income statement. What factors would allow a company to capitalize R&D as an intangible asset?
EDIT: just rewatched the video. I see this is explained at 4:47. So this is true - to an extent - for any company I guess. And the useful economic life is just determined by the overseeing accounting authority?
Great video. I subscribed to your channel.
Hello Mingdian! Lots of good thinking in your reply!
Yes, R&D capitalization is certainly a topic that a company's external accountant (KPMG, PWC, etc.) will review in detail versus what the accounting standards say about it, and something that regulatory agencies like the SEC as well as accounting standards boards (FASB, IASB) will focus on as well. A company itself will take the initiative to "build a case" (based on its interpretation of generic accounting standards) on how much to capitalize, and when/how to amortize. This is then reviewed, and either approved or challenged. If you are interested in the specific rules, take a look at some of the whitepapers from the big accounting offices, those can be helpful in understanding the specific criteria.
US GAAP and IFRS have different levels of "strictness" for R&D capitalization, see my case study (even though n=1 here, so difficult to generalize) ruclips.net/video/7B96MhOGaqE/видео.html
In general, it is hard or even impossible to argue that the R in R&D can be capitalized and then amortized, due to its extremely unsure outcomes. For the D in R&D, there might be ways to justify it, once you for example have a working prototype and a launch plan for the product or technology. If you think about it "big picture", then the argument for capitalization is always the matching principle. In the case of Rolls-Royce (aircraft engines) in the video, most of the development cost of the engine (which gets capitalized) will be matched to the actual production of the engine over the years.
The risk of R&D capitalization is that you might get stuck with an impairment, if the product/technology fails, and you cannot therefore amortize on a regular basis over the years!
Another big element of R&D spending is government funded or NGO funded research, as well as partnerships. That's a way for a company to share the load with external parties, and not have all R&D spending end up in its income statement. If you capitalize now, you will need to amortize in the future. Sharing with external parties is a different structure.
I have a video on R&D spending for companies in the Dow Jones index, that might give you an idea of companies to review (I personally learn the most from reading specific sections of annual reports dealing with a specific topic): ruclips.net/video/EEOYQmKkIk4/видео.html
Something similar to R&D capitalization happens at Netflix, where "streaming content assets" go onto the balance sheet, and are then amortized: ruclips.net/video/ikizI8dX1SA/видео.html
Excellent explanation! Thanks
You're welcome! Nice to hear that.
If you were to guess:
What % of intangible assets are internally generated vs
the % that are not internally generated (via an acquisition or merger)
To Clarify: If we summed up all intangible assets for all US companies then what would be the % that are internally generated vs non-internally generated.
I would imagine it would be over 95% are not internally generated but I may be wrong.
Thx!
Hi Scott! I agree with you, but haven't done the research to get to a specific percentage either. The criteria to be able to capitalize "internally generated" intangible assets (such as software development) are very strict under US GAAP.
So a tangible asset (eg yellow plant) acquired through a business loan over a period of say five years would not have the loan and interest payments included in the Amortisation figure but only reflected in the depreciation amount?
That depends on whether you are looking at that situation from the accounting (journal entries) side, or the investment analysis (payback period, net present value) side.
How would tech companies like FB amortize their intangible asset such as AI algorithm?
Excellent question. The vast majority of intangible assets that I come across on balance sheets are generated from acquisitions, where purchase price of the acquired company gets recorded as (split between) net tangible assets + intangible assets + goodwill. Internally generated intangible assets need to meet very stringent criteria to be eligible for capitalization on the balance sheet (and subsequent amortization). I don't know off the top of my head, as I haven't read Facebook's annual report in detail recently, but I don't think their AI algorithm is even on the balance sheet as an intangible asset. Yes, the AI algorithm obviously has economic value, but not necessarily accounting value. Hope this helps!
I do a live stream every Sat @ 6pm my time or Sun 3:34am your time. I always have a guest host usually another Finance RUclips Channel. Would you consider being a guest host? I can change the time to make it more convenient for you.
Thanks for the invitation, Scott! I am really swamped at the moment with a consulting assignment and caring for my family. Maybe in the medium to long term future we will do something together.
Simple
... yet effective. :-)
@@TheFinanceStoryteller Really awesome how you kept it simple for us all to understand. Subscribed!!!
Please share the video and/or link to the channel with friends and colleagues! 😊
What is capitalization of R&D expenses?
Hi Krishan. This is putting part of the R&D spending on the balance sheet as an asset, and then amortizing it over the years. A bit like buying a machine, capitalizing that on the balance sheet as a fixed asset, and then depreciating it. However, the criteria for capitalization of intangible assets are much stricter.
@@TheFinanceStoryteller So, does it mean that the r&d expense which is capitalized will not flow through the income statement (Or it will only pass through income statement only during amortization)?
@@KrishanSingh-gz9op Correct. In the year of capitalization, the R&D expense does not flow into the income statement, but it does flow through the income statement during subsequent years when the amortization takes place.
Are football payers intangible
Great question, Colin, to which I don't know the answer. I'm more of a Formula 1 fan than a football fan. ;-) But I am sure you can easily find it out from the notes to the financial statements in the annual report of one of the big football teams.
no they are not, because you can not control the players as much as the is a legal contract. i read about it on grapping gaap textbook
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