IAS 38 – INTANGIBLE ASSETS
The objective of this IAS is to prescribe accounting treatment for intangible assets.
INTANGIBLE ASSET – DEFINITION
An intangible asset is an identifiable non-monetary asset without physical substance held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
Thus, the three critical attributes of an intangible asset are:
- control (power to obtain benefits from the asset)
- future economic benefits (such as revenues or reduced future costs)
Intangible assets are business assets that have no physical form. Unlike a tangible asset, such as a computer, you can‘t see or touch an intangible asset.
An intangible asset can be termed identifiable if it:
- is separable or
- arises from contractual or other legal rights
An intangible asset needs to be identifiable to be recorded in financial statements. To be separable, the asset should be capable of being disposed of on its own, with the remainder of the business being retained.
Goodwill can only be disposed of as part of the sale of a business, so is not separable. The lack of identifiability prevents internally generated goodwill from being recognized.
Examples of intangible assets include:
o Computer software o Patents o Copyrights o Motion picture films o Mortgage servicing rights o Licenses o Important quotes o Franchises o Marketing rights
Level of control
Another aspect of the definition of an intangible asset is that it must be under the control of the entity as a consequence of a past event. The entity must be able to enjoy the future benefits from the asset and deter external parties from access to those benefits. A legally enforceable right is an example of such control but isn‘t a necessary prerequisite for determining control.
Some notable points to consider are:
- Control over technical knowledge only exists if it is protected by a legal right
- The skill of employees, arising out of the benefits of training costs, are unlikely to be considered as intangible assets because of the relative uncertainty over the future actions of staff. The problem from a control point of view is that the staff can leave at any point in time, taking their new skills with them.
- Market share and customer loyalty are also fickle by nature and cannot be considered as intangible assets.
RECOGNITION AND MEASUREMENT
The recognition of an intangible asset requires an entity to demonstrate that the item meets:-
- The definition of an intangible asset
- The recognition criterion that:-
- It is probable that the expected economic benefits that are attributable to the asset will flow to the entity; and
- The cost of the asset can be measured reliably
An intangible asset shall be measured initially at cost.
There are two types of intangible assets: those that are purchased and those that are internally generated. The accounting treatment of purchased intangibles is relatively straightforward in that the purchase price is capitalised in the same way as for a tangible asset. Accounting for internally-generated assets, however, requires more thought.
Research & Development costs fall into the category of internally-generated intangible assets, and are therefore subject to specific recognition (Discussed later).
Separate rules for recognition and initial measurement exist for intangible assets depending on whether they were:
- Acquired separately: At cost
- Acquired as part of a business combination: At fair value
- Acquired by way of a government grant: As per IAS 20
- Obtained in an exchange of assets: At fair value Generated internally (Discussed later)
The cost of a separately acquired intangible asset can be measured reliably when purchase consideration is in the form of cash or other monetary assets. The cost comprises:-
- Its purchase price, including import duties and non-refundable purchase taxes after deducting trade discounts and rebates; and
- Professional fees arising directly from bringing the asset to its working condition; and
- Costs of testing whether the asset is functioning properly
Examples of expenditures that are NOT part of cost of an intangible asset are:-
- Costs of introducing a new product or service (advertising cost)
- Costs of conducting business in a new location or with a new class of customers (training cost of staff)
- Pre-operating losses, Administration and other general overheads
The capitalization of expenses ceases when the asset is ready for its intended use therefore; the expenditures incurred afterwards are not capitalized.
If the payment for an intangible asset is deferred beyond normal credit terms, its cost will be the cash price equivalent. The difference between this amount and the total payments will be recognized as interest expense or will be capitalized if meets the requirements of IAS-23.
Acquisition as part of business combination
An acquirer recognizes an intangible asset, distinct from goodwill, on the acquisition date if the asset‘s fair value can be measured reliably, irrespective of whether the asset had been recognized by the acquiree before the business combination (Research and development).
The circumstances when an entity cannot measure the fair value are when the intangible asset arises from legal or other contractual rights and either:-
- Is not separable; or
- Is separable, but there is no history or evidence of exchange transactions for the same or similar assets, and otherwise estimating fair value would be depended on immeasurable variables.
Acquisition by way of Government Grant
If an intangible asset is acquired through a government grant then the related asset and government grant will be recognized as per the requirements of IAS-20.
Exchanges of asset
An asset may be acquired in exchange or part exchange for a non-monetary asset or assets, or a combination of monetary and non-monetary assets.
The cost of such an item is the fair value unless the exchange transaction lacks commercial substance or the fair value of the asset given up/ acquired is not reliably measureable, in which case the cost of the asset acquired will be the carrying value of the asset given up.
The entity determines whether the exchange transaction has the commercial substance by considering the extent to which its cash flows differ as a result of the transaction.
A transaction has commercial substance if:-
- The risk, timing and amount of cash flows of the asset acquired differ from the asset transferred.
- The entity specific value of the portion of the entity‗s operations affected by the transaction changes as a result of the exchange (post tax cash flows).
- The difference in above two is significant relative to the fair value of the assets exchanged.
If the entity is able to measure the fair value of any of the asset given up/acquired then the cost of the new asset is the fair value of the asset given up unless the fair value of the asset acquired is more reliable.
INTERNALLY GENERATED INTANGIBLE ASSETS
To assess whether an internally generated intangible assets meets the criteria for recognition, an enterprise classifies the generation of the asset into RESEARCH and DEVELOPMENT.
Reason for spending money on R&D
Many businesses in the commercial world spend vast amounts of money, on an annual basis, on the research and development of products and services. These entities do this with the intention of developing a product or service that will, in future periods, provide significant amounts of income for years to come.
Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
An example of research could be a company in the pharmaceuticals industry undertaking activities or tests aimed at obtaining new knowledge to develop a new vaccine. The company is researching the unknown, and therefore, at this early stage, no future economic benefit can be expected to flow to the entity.
Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use.
An example of development is a car manufacturer undertaking the design, construction, and testing of a pre-production model.
It is impossible to demonstrate whether or not a product or service at the research stage will generate any probable future economic benefit. As a result, IAS 38 states that all expenditure incurred at the research stage should be written off to the statement of profit or loss as an expense when incurred, and will never be capitalised as an intangible asset.
An intangible asset arising from development (or from the development phase of an internal project) should be recognized as asset (capitalized) if, and only if, an enterprise can demonstrate all of the following:
- The technical feasibility of completing the intangible asset so that it will be available for use or sale;
- Its intention to complete the intangible asset and use or sell it;
- Its ability to use or sell the intangible asset;
- How the intangible asset will generate probable future economic benefits. Among other things, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
- The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
- Its ability to measure the expenditure attributable to the intangible asset during its development reliably.
If any of the recognition criteria are not met then the expenditure must be charged to the statement of profit or loss as incurred. Note that if the recognition criteria have been met, capitalisation must take place.
Internally generated brands, mastheads, publishing titles, customer lists and similar items should not be recognised as intangible assets.
Treatment of capitalised development costs
Once development costs have been capitalised, the asset should be amortised in accordance with the accruals concept over its finite life. Amortisation must only begin when commercial production has commenced (hence matching the income and expenditure to the period in which it relates).
Each development project must be reviewed at the end of each accounting period to ensure that the recognition criteria are still met. If the criteria are no longer met, then the previously capitalised costs must be written off to the statement of profit or loss immediately.
Past expense not be recognized as an asset
Expenditure on an intangible asset that was initially recognized as an expense shall not be recognized as part of the cost of an intangible asset.
Cost of an internally generated intangible asset
The cost comprises all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by the management.
- Costs, of materials and services used or consumed in generating the intangible asset;
- Costs of employee benefits arising from the generation of intangible assets
- Fees to register a legal right; and
- Amortization of patents and licenses that are used to generate the intangible asset
The following are NOT components of the cost of an internally generated intangible asset:
- Selling, administrative and other general overhead expenditure unless this expenditure can be directly attributed to preparing the asset for use;
- Clearly identified inefficiencies and initial operating losses incurred before an asset achieves planned performance; and
- Expenditure on training staff to operate the asset.
SUBSEQUENT MEASUREMENT OF INTANGIBLE ASSETS
After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortization and any accumulated impairment loss.
After initial recognition an intangible asset whose fair value can be determined with reference to the active market shall be carried at revalued amount, less subsequent accumulated amortization and subsequent accumulated impairment losses.
Classification of intangible assets based on useful life Intangible assets are classified as having:
- Indefinite life: no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.
- Finite life: a limited period of benefit to the entity.
An entity shall assess whether the useful life of an intangible asset is finite or indefinite and if finite, the length of, or number of production or similar units constituting, that useful life.
An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity
The useful life of an intangible asset that is not being amortized shall be reviewed in each period to determine whether events and circumstances continue to support an indefinite useful life assessment for that asset. If they do not, the change in the useful life assessment from indefinite to finite shall be accounted for as change in an accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Amortisation and Impairment
- The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life.
- The amortization method should reflect the pattern of benefits
- Amortise when commercial production begins
- The amortization period and the amortization method for an intangible asset with a finite useful life shall be reviewed at least at each financial year end.
- An intangible asset with an indefinite useful life shall not be amortized but will be tested for impairment at every reporting date.
- The recoverable amount of the asset should be determined at least at each financial year end and any impairment loss should be accounted for in accordance with IAS 36.
Remove from statement of financial position when disposed of or abandoned. Recognize any gain or loss in the statement of profit or loss.
Goodwill is not normally recognised in the accounts of a business at all. The reason for this is that goodwill is considered inherent in a business and it does not have any objective value.
There is one exception to the principle that goodwill has no objective value, this is when a business is sold.
Purchased goodwill is shown in the statement of financial position because it has been paid for. It has no tangible substance, and so it is an intangible non-current asset. It is dealt with under IFRS 3 Business Combinations
Due to the nature of intangible assets, subsequent expenditure will only rarely meet the criteria for being recognised in the carrying amount of an asset. Subsequent expenditure on brands, mastheads, publishing titles, customer lists and similar items must always be recognised in profit or loss as incurred.