OBJECTIVE
To outline the accounting treatment for intangible assets that are not dealt with specifically in another standard.
EXCLUSIONS
IAS 38 does not apply to:
- Intangible assets that are within the scope of another standard
- Financial assets, as defined in IAS 39 Financial Instruments: Recognition and Measurement
- Mineral rights and expenditure on the exploration and extraction of oil, gas, minerals, etc.
DEFINITION
An intangible asset is an identifiable non-monetary asset without physical substance. Examples of such assets, which come within the scope of IAS 38 are:
- Brand Names
- Mastheads and Publishing Titles
- Computer Software
- Licences and Franchises
- Copyrights and Patents
To be considered identifiable, the intangible asset:
- Must be separable, i.e. it is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or
- Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations
In addition, the ability of the entity to control an asset is important in determining whether to recognise that asset in the accounts. An entity controls an asset if it has the power to obtain the future economic benefits flowing from that asset and also restrict the access of others to those benefits.
Usually, the ability to control these benefits derives from enforceable legal rights, but IAS 38 recognises that there are potentially other ways to control these benefits, though admittedly it is more difficult to demonstrate control in the absence of legal rights. An example given in the Framework for the Preparation and Presentation of Financial Statements of such a situation is know-how obtained from a development activity which may meet the definition of an asset when, by keeping that know-how secret, an entity controls the benefits that are expected to flow from it.
ACCOUNTING TREATMENT
IAS 38 requires that intangible assets be recognised at cost in the financial statements if:
- It is probable that future economic benefits attributable to the asset will flow to the organisation, and
- The cost of the asset can be measured reliably.
The cost of the asset refers to the amount of cash or cash equivalents paid or the fair value of other consideration given (e.g. equity shares) to acquire an asset at the time of its acquisition.
The cost of separately acquired intangible assets comprises:
- Purchase price (including irrecoverable taxes / duties less discounts and rebates) and
- Directly attributable costs of preparing the asset for use (these can include items such as professional fees, costs of testing and employees’ benefits)
However, the following costs cannot be included:
- Costs of introducing new products / services such as advertising
- Costs of conducting new business
- Administration costs
- Costs incurred while an asset that is ready for use is awaiting deployment
- Initial operating losses incurred from an operation.
[Note: if the intangible asset is acquired in an acquisition, then the fair value of the asset at the date of acquisition is used in accounting for the business combination.]
The fair value of an asset is the amount for which that asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction.
The fair value is easy to determine if there is an active market for the asset type. If an active market does not exist, then the fair value will have to be estimated. In determining this amount the entity should consider the outcome of recent transactions for similar assets. An active market is a market in which all the following conditions exist:
- The items traded in the market are homogenous
- Willing buyers and sellers can normally be found at any time
- Prices are available to the public
ACQUISITION BY GOVERNMENT GRANT
There may be situations where an intangible asset may be acquired free of charge through a government grant, e.g. licences for Radio/TV stations.
The entity may choose to recognise both the intangible asset and the grant initially at fair value. This would be in accordance with IAS 20.
Alternatively, the entity can recognise the asset initially at a nominal amount plus any expenditure that is directly attributable to preparing the asset for its intended use.
EXCHANGE OF ASSETS
An intangible asset may be acquired for a non-monetary asset or assets, or by way of a combination of monetary and non-monetary assets.
The cost of such an intangible asset is measured at fair value unless:
- The exchange lacks commercial substance, or
- The fair value of neither the asset given or received can be measured reliably
If the acquired asset is not measured at fair value, its cost is measured at the carrying amount of the asset given up.
INTERNALLY GENERATED GOODWILL
[There will be a fuller description of the treatment of goodwill elsewhere in this book.]
Internally generated goodwill should not be recognised in the financial statements.
This is because it is not an identifiable resource controlled by the company that can be measured reliably at cost.
INTERNALLY GENERATED INTANGIBLE ASSETS
IAS 38 points out that the recognition of internally generated intangible assets may be problematic because of difficulties in:
- Determining whether and when the asset will generate future economic benefits, and
- Determining the cost of the asset reliably
The standard does not prohibit, per se, the recognition of internally generated intangible assets but it does specifically mention that internally generated brands, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets.
This is because expenditure on these items cannot be distinguished from the cost of developing the business as a whole
To determine whether an internally generated intangible asset should be recognised, IAS 38 says that the entity should classify the generation of the asset into:
- A research phase, and
- A development phase.
Research and development activities are aimed at the development of knowledge. Therefore, although these activities may result in an asset with physical substance (e.g. a prototype), the physical element of the asset is secondary to its intangible component, i.e. the knowledge embodied in it.
RESEARCH
Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
Research expenditure must be recognised as an expense in the Statement of Comprehensive Income when it is incurred, i.e. it cannot be capitalised. This is because, in this phase of a project, it cannot be demonstrated that an intangible asset exists that will generate probable future economic benefits.
IAS 38 provides examples of research activities:
- Activities aimed at obtaining new knowledge
- The search for alternatives for materials, devices, products, processes, systems or services
- The design or evaluation of possible alternatives for new or improved materials, devices, products, processes, systems or services.
DEVELOPMENT
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 intangible asset arising from development shall be recognised if, and only if, an entity can demonstrate all of the following:
- Probable future economic benefits will be generated by the asset
- Intention to complete and use or sell the asset
- Resources exist to complete the development and to use/sell the asset
- Ability to use or sell the asset
- Technical feasibility of completing the asset so that it will be available for use or sale
- Expenditure attributable to the development of the asset can be measured reliable
The cost of an internally generated intangible asset is the total expenditure incurred from the date when the intangible asset first meets the recognition criteria.
This cost includes all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by management. For example:
- Costs of materials/services uses
- Fees to register a legal right
- Amortisation of patents and licences used to generate the intangible asset
Note that expenditure on an intangible item that was initially recognised as an expense cannot be recognised as part of the cost of an intangible asset at a later date, i.e. such an expense cannot be re-instated as an asset at a later date.
IAS 38 provides examples of development activities:
- Design, construction and testing of prototypes and models
- Design of tools, moulds and dies involving new technology
- Design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services.
If the two phases cannot be distinguished, then the entire expenditure is classified as research.
A project can very often commence with a research phase and subsequently evolve into a development phase. In this situation, it will be necessary to determine at what point in time the project has entered into this development stage. Expenditure incurred up to this point must be expensed in the Statement of Comprehensive Income and expenditure after this point can be capitalised as an intangible asset (assuming the afore-mentioned conditions apply).
Using hindsight to capitalise the entire expenditure in not allowed. Research expenditure must be expensed when incurred and IAS 38 does not allow the re-instatement of previously written off costs. In addition, it is not permissible to accumulate costs in an account and then consider the nature of the entire project only when preparing the year end financial statements.
MEASUREMENT OF INTANGIBLE ASSETS AFTER RECOGNITION
After initial recognition, an intangible asset should be valued using either: (a) Cost Model, or
Revaluation Model
COST MODEL
The intangible asset should be carried at:
Cost
Less Accumulated Amortisation
Less Accumulated Impairment Losses
REVALUATION MODEL
The intangible asset should be carried at:
Revalued Amount (i.e. fair value at date of revaluation)
Less Any Subsequent Accumulated Amortisation
Less Any Subsequent Accumulated Impairment Losses
The “fair value” should be determined by reference to an active market. If there is no active market for the asset, it cannot be revalued. Thus, the revaluation model would be inappropriate in this case.
An active market is one in which:
- The items traded are homogenous
- Willing buyers and sellers can be found at any time
- Prices are available to the public.
As a result of this definition of an active market, the revaluation model is not a realistically usable model. Intangible assets such as brands, trademarks, film titles, copyright etc. are unique and cannot be considered homogenous.
If a revaluation policy is used, the revaluation should be carried out regularly so that the fair value of the asset does not differ materially from its carrying amount at the Statement of Financial Position date.
This means that the frequency with which an intangible asset is revalued depends on the volatility of the fair values of the asset. Accordingly, some intangible assets will be revalued on an annual basis while others may show only insignificant movements in fair value, thereby necessitating less frequent revaluations.
If an intangible asset shows a revaluation gain, that gain should be credited to reserves. However, if the gain reverses a previous revaluation loss of the same asset, and that loss was recognised in the Statement of Comprehensive Income, then the present gain shall be credited to the Statement of Comprehensive Income, with any excess going to reserves.
If the intangible asset shows a revaluation loss, that loss shall be recognised in the Statement of Comprehensive Income. However, if the loss reverses a previous revaluation gain of the same asset, and that gain was credited to reserves, the loss should be debited to reserves to the extent of any credit balance in the revaluation surplus in respect of that asset.
[The cumulative revaluation surplus included in equity may be transferred directly to retained earnings on disposal or retirement of the asset. Alternatively, some of the surplus may be realised as the asset is used by the entity.
The transfer from revaluation surplus to retained earnings is not made through the Statement of Comprehensive Income but through the Statement of Changes in Equity.]
USEFUL LIFE
IAS 38 states that an entity should assess the useful life of an intangible asset. In particular, whether that useful life is:
- Finite, or
- Indefinite
All relevant factors must be considered in assessing the lifespan of an intangible asset, for example:
- Product life cycles
- Industry stability
- Likely actions by competitors
- Legal restrictions
- Whether the useful life is dependent on the useful life of other assets
Note that “indefinite” does not mean “infinite”.
An intangible asset with a finite life should be amortised over its estimated useful life. Such amortisation is usually on a straight-line basis and no residual value is provided for unless:
There is a commitment by a third party to purchase the asset at the end of its useful life, or
There is an active market for the asset and:
- The residual value can be determined by reference to that market and
- It is probable that such a market will exist at the end of the asset’s useful life.
Amortisation of an intangible asset with a finite life commences when the asset is available for use and will cease when the asset is derecognised or when the asset is classified as held for sale, whichever is earlier.
The amortisation of an intangible asset is usually recognised in the profit or loss for the period. The amortisation period and method should be reviewed on an annual basis, and changed if necessary.
If an intangible asset is deemed to have an indefinite life, that asset should not be amortised. However, it should be tested for impairment annually and whenever there is an indication that the asset may be impaired.
The asset is said to have an indefinite life if there is no foreseeable limit to the periods over which the asset is expected to generate net cash inflows.
If a change occurs, resulting in an intangible asset with a heretofore indefinite life becoming an asset with a finite life, such an alteration is considered to be a change in estimate (IAS 8) and thus does not require a prior year adjustment.
DISPOSALS AND RETIREMENTS
An intangible asset should be derecognised:
- On disposal, or
- When no future economic benefits are expected.
Any gain or loss on de-recognition should be calculated and included in the profit or loss for period.
DISCLOSURE REQUIREMENTS
The disclosure requirements for intangible assets are extensive.
The entity must disclose the following for each class of intangible assets, distinguishing between internally generated intangible assets and other intangible assets:
- Whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortisation rates used.
- The amortisation methods used for intangible assets with finite useful lives.
- The gross carrying amount and any accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period
- The line item(s) of the Statement of Comprehensive Income in which any amortisation of intangible assets is included
- A reconciliation of the carrying amount at the beginning and end of the period showing:
- Additions, indicating separately those from internal development, those acquired separately and those acquired through business combinations
- Assets classified as held for resale under IFRS 5
- Increases or decreases in the period arising from revaluations and impairment losses recognised or reversed directly in equity under IAS 36
- Impairment losses recognised in profit or loss during the period under IAS 36
- Impairment losses reversed in profit or loss during the period under IAS 36
- Any amortisation recognised in the period
- Exchange differences (net) arising on the translation of the financial statements of a foreign operation
- Other changes during the period An entity must also disclose:
- For an asset assessed as having an indefinite useful life, the carrying amount of that asset and reasons supporting the assessment of an indefinite useful life
- The amount of contractual commitments for the acquisition of intangible assets
- The aggregate amount of research and development expenditure recognised as an expense during the period
- Details of revaluations
- The existence and carrying amounts of assets whose title is restricted and the carrying amounts of assets pledged as security for liabilities
The entity is encouraged, but not required, to disclose:
- A description of any fully amortised intangible asset that is still in use, and
- A brief description of significant intangible assets controlled by the entity but not recognised as assets because they did not meet the recognition criteria in the standard or because they were acquired or generated before the version of IAS 38 issued in 1998 was effective.
ASSETS WITH BOTH TANGIBLE AND INTANGIBLE ELEMENTS
IAS 38 recognises that some intangible assets may be contained in or on a physical substance such as a compact disc (in the case of computer software), legal documentation (in the case of a licence or patent) or film.
It must then be determined whether an asset that incorporates both intangible and tangible elements should be treated under IAS 16 Property, Plant and Equipment or under IAS 38 Intangible Assets. In order to resolve this issue, the entity must use judgement to assess which element is more significant.
For example, computer software for a computer-controlled machine tool that cannot operate without that specific software is an integral part of the related hardware and it is treated as Property, Plant and Equipment. The same applies to the operating system of a computer.
But when the software is not an integral part of the related hardware, computer software is treated as an intangible asset.
WEBSITE DEVELOPMENT COSTS
In most modern business environments, websites now exist which introduce the products / services of the entity to the market. A website has many of the features of both a tangible and intangible asset and SIC 32 Intangible Assets – Website Costs was issued to deal with the accounting issues surrounding web site costs.
SIC 32 states that a website that has been developed for the purposes of promoting and advertising an entity’s products and services does not meet the criteria for the capitalisation of costs under IAS 38. Therefore, costs incurred in setting up such websites should be expensed.
