Intangible Assets

IAS - 38
Definition of Intangible Asset
An intangible asset is defined as:
An identifiable, non-monetary asset without physical substance
1. An asset is identifiable when it
◦ It is separable; in other words it can be sold as a single item, or
◦ It is not separable, but arises from contractual rights.

2. A non-monetary asset is any asset other than cash or an asset to be settled in a fixed
amount of cash (such as a receivable)
3. An asset is a resource:
◦ Controlled by an entity as a result of past events, and
◦ From which future economic benefits are expected to flow to the entity
Examples of intangible assets
Intangible assets include:
◦ goodwill acquired in a business combination
◦ computer software
◦ patents
◦ copyrights
◦ motion picture films
◦ customer list
◦ mortgage servicing rights
◦ licences
◦ import quotas franchises
◦ customer and supplier relationships
◦ marketing rights.
Recognition criteria for an intangible Asset
IAS 38 requires that an intangible asset meeting the definition above is recognised only
where:
◦ 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.
Initial Measurement
Intangible assets which are recognised in the financial statements are measured initially at
cost.
Where they are acquired as part of a business combination, they are initially measured at
fair value. Where fair value cannot be established, the intangible is not recognised
separately and its value is subsumed within goodwill.
Measurement after initial recognition
There is a choice between:
◦ the cost model
◦ the revaluation model.
The cost model
The intangible asset should be carried at cost less amortisation and any impairment losses.
This model is more commonly used in practice.
Amortisation works the same as depreciation. The intangible asset is amortised over the
useful economic life, with the annual expense being shown in the statement of profit or loss
each year.
An intangible asset with a finite useful life must be amortised over that life, normally using
the straightline method with a zero residual value.
An intangible asset with an indefinite useful life:
◦ should not be amortised
◦ should be tested for impairment annually, and more often if there is an actual indication of
possible impairment.
The revaluation model
The intangible asset may be revalued to a carrying amount of fair value less subsequent
amortisation and impairment losses.
Fair value should be determined by reference to an active market.
Features of an active market are that:
◦ the items traded within the market are homogeneous (identical)
◦ willing buyers and sellers can normally be found at any time
◦ prices are available to the public.
Internally generated Intangibles
Generally, internally generated intangibles cannot be capitalised, as the costs associated
with these cannot be separated from the costs associated with running the business.
The following internally generated items may never be recognised:
◦ goodwill ("inherent goodwill")
◦ brands
◦ mastheads
◦ publishing titles
◦ customer lists.
Brands
The accounting treatment of brands has been a matter of controversy for some years. IAS
38 Intangible Assets has now ended the controversy by stating that internally generated
brands and similar assets may never be recognised.
Expenditure on internally generated brands cannot be distinguished from the cost of
developing the business as a whole, so should be written off as incurred.
Where a brand name is separately acquired and can be measured reliably, then it should be
separately recognised as an intangible noncurrent asset, and accounted for in accordance
with the general rules of IAS 38.
Goodwill
The nature of goodwill
◦ Goodwill is the difference between the value of a business as a whole and the aggregate of the fair
values of its separable net assets.

Separable net assets are those assets (and liabilities) which can be identified and sold off
separately without necessarily disposing of the business as a whole. They include
identifiable intangibles such as patents, licences and trademarks.
Fair value is defined in IFRS 13 as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the
measurement date (i.e. an exit price).
Goodwill may exist because of any combination of a number of possible factors:
◦ reputation for quality or service
◦ technical expertise
◦ possession of favourable contracts
◦ good management and staff
Purchased and non-purchased Goodwill
Purchased goodwill
◦ arises when one business acquires another as a going concern
◦ includes goodwill arising on the consolidation of a subsidiary
◦ will be recognised in the financial statements as its value at a particular point in time is certain.

Non-purchased goodwill
◦ is also known as inherent goodwill
◦ has no identifiable value
◦ is not recognised in the financial statements.
IFRS 3 revised Business combinations
IFRS 3 revised governs accounting for all business combinations and deals with the
accounting treatment of goodwill.
Goodwill is defined in IFRS 3 as an asset representing the future economic benefits arising
from assets acquired in a business combination that are not individually identified and
separately recognised. Negative goodwill (gain on a bargain purchase) is treated as income,
as a company has paid less than the fair value of the identifiable net assets.
Exchanges of assets
If one intangible asset is exchanged for another, the cost of the intangible asset is measured
at fair value unless:
a) The exchange transaction lacks commercial substance, or
b) The fair value of neither the asset received nor the asset given up can be measured reliably.

Otherwise, its cost is measured at the carrying amount of the asset given up.
Amortisation
Where an intangible asset has a finite useful life, it is amortised over that useful life,
beginning when the asset is available for use.
Amortisation should reflect the pattern in which the asset’s benefits arise, or where this
cannot be established, should be on a straight line basis.
The residual value of an intangible asset is taken to be nil unless:
◦ There is a commitment by a third party to purchase the asset at the end of its life
◦ There is an active market for the asset which is likely to exist at the end of its useful life.

Where an intangible asset has an indefinite useful life, then it is not amortised, but is tested
for impairment annually, and in between if there are indications of impairment.
The useful life should also be assessed each period and if it is no longer indefinite, then it
must be amortised.
This represents a change in accounting policy in accordance with IAS 8
Impairment
Intangible assets with a finite life are tested for impairment where indications of an
impairment are evident.
Intangible assets with an indefinite life are tested for impairment annually and where there
are indications of an impairment.
Impairments are accounted for in line with IAS 36.
Revaluation
The revaluation model may be adopted for intangible assets only where a fair value can be
established by reference to an active market.
In practice examples of assets which are part of an active market are:
◦ Taxi cab licenses
◦ Airport landing rights
◦ Fishing and milk quotas

By definition, however,most intangible assets are unique and therefore do not qualify as
belonging to an active market and so cannot be revalued.
Where revaluations are allowed, they should be made sufficiently regularly that the carrying
value of the asset is not materially different from its fair value.
Research and Development
Definitions
Research is original and planned investigation undertaken with the prospect of gaining new
scientific knowledge and understanding.
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.
Accounting treatment
Research expenditure: write off as incurred to the statement of profit or loss.
Development expenditure: recognise as an intangible asset if, and only if, an entity can
demonstrate all of the following:
◦ Probable future economic benefits from the asset, whether through sale or internal cost savings.
◦ Intention to complete the intangible asset and use or sell it.
◦ Resources available to complete the development and to use or sell the intangible asset.
◦ Ability to use or sell the intangible asset.
◦ Technical feasibility of completing the intangible asset so that it will be available for use or sale.
◦ Expenses attributable to the intangible asset during its development can be measured.

(It is only expenditure incurred after the recognition criteria have been met which should
be recognised as an asset. Development expenditure recognised as an expense in profit or
loss cannot subsequently be reinstated as an asset.)
Example
An entity has incurred the following expenditure during the current year:
$100,000 spent on the initial design work of a new product – it is anticipated that this
design will be taken forward over the next two year period to be developed and tested with
a view to production in three years-time.
$500,000 spent on the testing of a new production system which has been designed
internally and which will be in operation during the following accounting year. This new
system should reduce the costs of production by 20%.
How should each of these costs be treated in the financial statements of
the entity?
Solution
a) These are research costs as they are only in the early design stage and therefore should
be written off as part of profit and loss for the period.
b) These would appear to be development stage costs as the new production system is due
to be in place fairly soon and will produce economic benefits in the shape of reduced
costs. Therefore these should be capitalised as development costs.
Example
An entity has incurred the following expenditure during the current year:
i. A brand name relating to a specific range of chocolate bars, purchased for $200,000. By
the year end, a brand specialist had valued this at $250,000.
ii. $500,000 spent on developing a new line of confectionary. $150,000 was spent on
researching the product, before management gave approval to fully fund the project.
iii. Training costs for staff to use a new manufacturing process. The total training costs
amounted to $100,000 and staff are expected to remain for an average of 5 years.
 Solution
i. The brand name is a purchased intangible asset, so can be capitalised at the cost of
$200,000.
Intangible assets can only be revalued if an active market exists. This is unlikely here, as
the brand name will not be a homogenous item. Therefore the item should be held
under the cost model.
The brand should be written off over its expected useful life. If this has an indefinite
useful life, then no amortisation is charged. However, an annual impairment review
would be required.
ii. The $500,000 relates to research and development. Of the total, $150,000 should be
expensed to the statement of profit or loss, as management had not displayed either
the intention to complete, or the release of the resources to complete.
Therefore $350,000 can be capitalised as an intangible asset as development costs.
iii. The training costs must be expensed in the statement of profit or loss. The movement
of staff cannot be controlled, and therefore there is no way of restricting the economic
benefits. If the staff leave, the company gets no benefit.
Example
Improve has deferred development expenditure of $600,000 relating to the development of
New Miracle Brand X. It is expected that the demand for the product will stay at a high level
for the next three years. Annual sales of 400,000, 300,000 and 200,000 units respectively
are expected over this period. Brand X sells for $10.
◦ How should the development expenditure be amortised?

Solution
There are two possibilities for writing off the development expenditure:
◦ Write off in equal instalments over the threeyear period, i.e. $200,000 pa.
◦ Write off in relation to total sales expected (900,000 units).

Year 1 (400,000/900,000) × $600,000 = 266,667

$m
Research into materials 0.5
Market research 0.4
Employee training 0.2
Development activities 0.9

The expenditure on development activities was incurred evenly over the year. It was not
until 1 May 20X1 that market research indicated that the product was likely to be profitable.
At the reporting date, the product development was not yet complete.
Required:
◦ Discuss the correct accounting treatment of the research and development expenditure in the
year ended 31 December 20X1.
Solution
Expenditure on research, market research and employee training cannot be capitalised and
so must be written off to profit or loss.
In relation to development activities, $0.3 million (4/12 × $0.9m) was incurred before the
product was known to be commercially viable. This amount must also be written off to
profit or loss.
In total, $1.4 million ($0.5m + $0.4m + $0.2m + $0.3m) must be written off from intangible
assets to profit or loss:
Dr Profit or loss $1.4m
Cr Intangible assets $1.4m
The intangible asset recognised on the statement of financial position will be $0.6 million
($2m – $1.4m). No amortisation will be charged because the product is not yet complete.
Example
Ten years ago, Innovate developed a new game called ‘Our Sports’. This game sold over 10
million copies around the world and was extremely profitable. Due to its popularity, Innovate
release a new game in the Our Sports series every year. The games continue to be best-
sellers.
The directors have produced cash flow projections for the Our Sports series over the next five
years. Based on these projections, they have prudently valued the Our Sports brand at $20
million and wish to recognise this in the statement of financial position as at 30 September
20X3.
On 30 September 20X3, Innovate also paid $1 million for the rights to the
‘Pets & Me’ videogame series after the original developer went into administration.
Required:
◦ Discuss the accounting treatment of the above in the financial statements of Innovate for the year
ended 30 September 20X3.
Solution
According to IAS 38, an intangible asset can be recognised if:
◦ it is probable that expected future economic benefits attributable to the asset will flow to the entity
◦ the cost of the asset can be measured reliably.

Cash flow projections suggest that the Our Sports brand will lead to future economic benefits.
However, the asset has been internally generated and therefore the cost of the asset cannot
be measured reliably. This means that the Our Sports brand cannot be recognised in the
financial statements.
The Pets & Me brand has been purchased for $1 million. Therefore, its cost can be measured
reliably. An intangible asset should be recognised in respect of the Pets & Me brand at its cost
of $1 million.
In subsequent periods, the Pets & Me brand will be amortised over its expected useful
economic life.
Example
Kalesh is preparing its financial statements for the year to 31 March 20X2. Kalesh is engaged
in a research and development project which it hopes will generate a new product. In the
year to 31 March 20X1 the company spent $120,000 on research that concluded there were
sufficient grounds to carry the project on to its development stage and a further $75,000
was spent on development. At 31 March 20X1, management had decided that they were
not sufficiently confident in the ultimate profitability of the project and wrote off all the
expenditure to date to the statement of profit or loss. In the current year further
development costs have been incurred of $80,000 and it is estimated than an additional
$10,000 of development costs will be incurred in the future. Production is expected to
commence within the next few months. Unfortunately the total trading profit from sales of
the new product is not expected to be as good as market research data originally forecast
and is estimated at only $150,000. As the future benefits are greater than the remaining
future costs, the project will be completed but, due to the overall deficit expected, the
directors have again decided to write off all the development expenditure.
Required
Explain how Kalesh should treat the above transaction in its financial statements for the
year to 31 March 20X2.
Solution
The treatment of the research and development costs in the year to 31 March 20X1 was
correct due to the element of uncertainty at the date. The development costs of $75,000
written off in that same period should not be capitalised at a later date even if the
uncertainties leading to its original write off are favourably resolved. The treatment of the
development costs in the year to 31 March 20X2 is incorrect. The directors' decision to
continue the development is logical as (at the time of the decision) the future costs are
estimated at only $10,000 and the future revenues are expected to be $150,000. However, at
31 March 20X2 the unexpensed development costs of $80,000 are expected to be recovered.
Provided the other criteria in IAS 38 Intangible Assets are met, these costs of $80,000 should
be recognised as an asset in the statement of financial position and amortised across the
expected life of the product in order to 'match' the development costs to the future earnings
of the new product. Thus the directors' logic of writing off the $80,000 development cost at
31 March 20X2 because of an expected overall loss is flawed. The directors do not have the
choice to write off the development expenditure.
Recognition of an expense
All expenditure related to an intangible which does not meet the criteria for recognition
either as an identifiable intangible asset or as goodwill arising on an acquisition should be
expensed as incurred. The IAS gives examples of such expenditure:
◦ Start up costs
◦ Advertising costs
◦ Training costs
◦ Business relocation costs

Prepaid costs for services, for example advertising or marketing costs for campaigns that
have been prepared but not launched, can still be recognised as a prepayment.
Disposals/retirements of intangible assets
An intangible asset should be eliminated from the statement of financial position when it is
disposed of or when there is no further expected economic benefit from its future use. On
disposal the gain or loss arising from the difference between the net disposal proceeds and
the carrying amount of the asset should be taken to profit or loss as a gain or loss on
disposal (ie treated as income or expense).
Disclosures
IAS 38 states that an entity must disclose:
◦ The amount of research and development expenditure expensed in the period
◦ The amortisation methods used
◦ For intangible assets assessed as having an indefinite useful life, the reasons supporting that
assessment
◦ The date of any revaluations, if applicable, as well as the methods and assumptions used
◦ A reconciliation of the carrying amount of intangibles at the beginning and end of the reporting
period.