Solutions to GAAP : Graded Questions Intangible assets

Solution 9.1

a. (b)

An intangible asset does not need to be separable. It needs to be identifiable. Being separable
is one of two ways in which we can prove ‘identifiability’: if an asset is not separable, it can
still be ‘identifiable’ if it arises from contractual or other legal rights. See IAS 38.12

An intangible asset is defined as :

x an asset that is
x identifiable;
x non-monetary; and
x without physical substance. See IAS 38.8

b. (d)

(b) and (c) are incorrect because control exists only if the entity has both:
x the ability to restrict access to the asset and its related future economic benefits; and
x the power to obtain the related future economic benefits, (generally, but not always,
through legally enforceable rights e.g. copyright). See IAS 38.13

(a) is incorrect and (d) is correct because an entity does not need to have legally
enforceable rights over an item's expected future economic benefits in order to conclude
that the entity has control over the asset’s related economic benefits. The lack of legally
enforceable rights simply makes it more difficult to prove that control exists.

c. (d)

An intangible item that does not meet the ‘identifiability’ criterion (part of the definition of
an intangible asset) may not be recognised as a separate intangible asset in the books of the
acquirer. However, this does not always mean that it will be expensed. Instead, if it was
acquired through a business combination, it would be included in the calculation of
purchased goodwill, whether this be positive or negative goodwill. Positive goodwill is
recognised as an asset and negative goodwill, referred to as a ‘gain on a bargain purchase’,
is recognised as income. Thus, an intangible item that is acquired by way of a business
combination and which may not be recognised because it is not identifiable, will either be
recognised as part of the goodwill asset or be recognised as a reduction of the goodwill
income (i.e. gain on bargain purchase).

d. (c)

Intangible assets may be subsequently measured using either the:

x Cost model: cost less accumulated depreciation and accumulated impairment losses;
x Revaluation model: fair value less accumulated depreciation and accumulated
impairment losses. See IAS 38.72

This revaluation model may only be used if the fair value is reliably measurable in terms
of an active market. An active market is defined in IFRS 13 as ‘a market in which
transactions for the asset or liability take place with sufficient frequency and volume to
provide pricing information on an ongoing basis’.

The fair value model is a model that applies to investment property – not intangible assets
and is a model that is significantly different to the revaluation model in that there is no
depreciation or impairment testing of the asset.

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Solutions to GAAP : Graded Questions Intangible assets

Solution 9.1 continued …

e. (a)

Not all intangible assets are amortised: only intangible assets with finite lives are amortised.
Intangible assets with indefinite useful lives are not amortised but their impairment testing
is more stringent in that we must calculate the recoverable amount every year (not
necessarily at the end of the year), even if there is no indication of an impairment.

f. (a)

Training costs and research costs are always expensed. It is clear that the ‘product costs’
are still all ‘research costs’ because we are told that development of the prototype would
only begin in the next year if this phase (research) is successful.

g. (d)

The statements (a, b and c) are incorrect because amortisation of an intangible asset
begins from the date it is first available for use.

h. (c)

An intangible asset's useful life is measured as the shorter of:

x its economic useful life; and
x its legal life. See IAS 38.94

i. (d)

When calculating the useful life of an intangible asset that has a limited legal life, we
include the optional renewal periods only if there is evidence that the entity intends to
renew and if the renewal would be at insignificant cost. See IAS 38.94

j. (d)

All statements were false because the residual value of an intangible asset is zero unless:
x a third party has committed to purchase the intangible asset at the end of its useful
life; or
x an active market exists for the intangible asset and the residual value can be measured
in terms of this active market and it is probable that the active market will exist at the
end of intangible asset’s useful life. See IAS 38.100

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Solution 9.2

An intangible asset is defined as:

x an identifiable,
x non-monetary asset,
x without physical substance.

An asset is defined as:

x a resource,
x controlled by the entity,
x as a result of a past event,
x from which an inflow of future economic benefits is expected.

The market share is without physical substance and is non-monetary, and thus would appear
to be an intangible asset, but the market share fails the intangible asset definition because it is
not identifiable and because it fails the asset definition. The reasoning is explained below.

Discussion of asset definition:

x The market share is a resource in that it generates sales for the company.
x The event was the creation of the customer loyalty that constitutes the market share (e.g.
through advertising and high quality products). This event is a past event if the creation
occurred before year-end. In this regard, the advertising campaigns and high
manufacturing standards have occurred over a few years and thus we are dealing with a
past event.
x Future economic benefits can be expected from the market through sales made to
customers that form part of the market.
x There is, however, little or no control over the company’s market-share since it can be
easily usurped by another company offering better products, service, advertising etc.

Therefore, the market share does not meet the definition of an asset.

Discussion of identifiability criterion:

An asset meets the identifiability criterion in the definition of an intangible asset when it:
x is separable, or
x arises from contractual or other legal rights. See IAS 38.12

An asset is separable if it:

x ‘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, identifiable
asset or liability,
x regardless of whether the entity intends to do so’. See IAS 38.12

The market share is clearly not able to be separated or divided from the business and is thus
not separable. Similarly, it does not arise from contractual or other legal rights. It therefore
fails the identifiability criterion. Since it fails the identifiability criterion, it does not meet the
definition of an ‘intangible asset’.

Therefore, the market share does not meet the definition of an asset (not controllable) or the
definition of an intangible asset (not an asset and not identifiable) and must thus be expensed.

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Solution 9.3
Memorandum
TO : Bob
FROM : IFRS Consultant
DATE : 11 November 20X2
SUBJECT: Recognition of research and development costs

IAS 38 Intangible assets defines research and development as follows:

x Research is original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.
x Development involves the application of these research findings or other knowledge to a
plan or design for production of new or substantially improved materials, devices, products,
processes, systems or services before the start of commercial production or use. IAS 38.8

The question is whether the costs should be recognised as an expense or capitalised as an asset.

For an item to be recognised as an asset, it must meet the definition of an asset and also meet the
recognition criteria (both of which are based on the 2010 Conceptual Framework):
x Asset definition:
 A resource, controlled by an entity, as a result of past events
 From which future economic benefits are expected to flow to the entity. IAS 38.8
x Recognition criteria:
 the cost or value must be reliably measurable; and
 the inflow of expected future economic benefits must be probable. IAS 38.21

If the costs do not qualify to be recognised as an asset, they must be expensed instead.

By the very nature of research, the inflow of future economic benefits (although perhaps
possible) cannot be said to be probable since the investigation is in its infancy. For this reason,
IAS 38 requires that research costs always be expensed. IAS 38.54

Development costs, on the other hand, may result in a resource where the expected inflow of
future economic benefits is probable. Development costs must be capitalised if the six
recognition criteria stipulated in IAS 38 are met (these criteria are based on the basic two
recognition criteria referred to above):
x the cost or value is reliably measurable; and
x the inflow of expected future economic benefits are probable. The inflow of future economic
benefits is considered probable when all the following can be demonstrated:
- the technical feasibility of completing the asset;
- the intention to complete the asset and to either use or sell it;
- the ability to use or sell the asset;
- how the asset will generate future economic benefits, through, for example,
proving that there is a market to sell to, or if the asset is to be used internally, then
the usefulness thereof; and
- the adequate availability of necessary resources (technical, financial or otherwise)
to complete the development and to sell or use the asset. IAS 38.57

It is important to note that if these criteria are met, then the development costs must be capitalised,
but if any one of the criteria are not met, then the development costs must be expensed.

Once the development costs are capitalised and the intangible asset is available for use,
amortisation and impairment testing must begin. It is also interesting to note that if costs
incurred do not meet the criteria initially and are expensed as a result, these costs may not be
capitalised at a later date if and when the criteria are subsequently met.

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Solutions to GAAP : Graded Questions Intangible assets

Solution 9.4

a) Purchased brand

x An intangible asset is defined as an identifiable, non-monetary asset, without physical

substance.
x The fact that the brand is purchased, makes it identifiable.
x The brand is controlled by Eat Limited through legal ownership.

x Recognition criteria (probable inflow of future economic benefits and cost measured
reliably) are assumed to be satisfied. The price an entity pays to acquire separately an
intangible asset normally reflects its expectations about the probability that the expected
future economic benefits associated with the intangible asset will flow to the entity:
- probability criterion is always considered to be satisfied for separately acquired
intangible assets (Eat Limited is unlikely to have purchased the brand if it wouldn’t
receive future economic benefits from it). See IAS 38.25
- cost can be reliably measured at the C2 000 000 paid for it.

x Residual value is assumed to be zero, because there is neither:

- a commitment by a third party to purchase the brand at the end of its useful life, nor
- an active market for the brand. See IAS 38.100 & .78

x Amortise over estimated useful life of 20 years.

x Amortisation is thus C100 000 for the current year [(C2 000 000 – 0)/ 20yrs].

x The brand must be measured under the cost model. This is because:
- When using the revaluation model, the fair value must be determined with reference
to an active market, See IAS 38.75
- IAS 38 clarifies that it would not be possible for a brand to have an ‘active market’ as
defined, See IAS 38.78
- Since the revaluation model requires that the fair value be determined in accordance
with an active market, and since the brand does not have an active market, it is not
possible to use the revaluation model for the brand, with the result that the only other
option is to use the cost model.

x When using the cost model, the carrying amount is calculated as: cost less accumulated
amortisation and accumulated impairment losses.
- Thus, the carrying amount of the brand on the statement of financial position at
31/12/20X3 is C1 600 000 [Cost 2 000 000 – Accumulated amortisation (100 000 X
4yrs) – Accumulated impairments 0].

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Solution 9.4 continued . . .

b) R&D programme

x ‘Research’ is original and planned investigation undertaken with the prospect of gaining
new scientific knowledge and understanding. There is a low level of certainty that future
benefits will flow to the entity from a research project.

x Research costs of C300 000 must therefore be expensed in the current year
- Expenditure on research shall be recognised as an expense when it is incurred. IAS 38.54

x ‘Development’ is the application of research findings or other knowledge to a plan or

design for the production of new or substantially improved items prior to commencement
of commercial production.

Since development is the second, and thus more advanced stage of creation, it may be
possible to anticipate the generation of future economic benefits.

x Development costs are recognised as an asset if six specific criteria are all met.

All six criteria for capitalisation of these costs were satisfied on 1 May 20X3, thus the
development costs must be capitalised as an intangible asset from this date.

The development costs incurred prior to this date must be expensed.

Thus, assuming that the development costs were incurred evenly between 1 March 20X3
and 31 December 20X3,
- C1 600 000 of the development costs must be recognised as an intangible asset
(C1 800 000 / 9 months x 8 months)
- C200 000 of the development costs must be recognised as an intangible asset
(C1 800 000 / 9 months x 1 month)

x There will be no amortisation of the development costs during the 20X3 year as the Super
Tin Project has an indefinite useful life.

x As the development cost intangible asset has an indefinite useful life, it must be tested for
impairment annually, and whenever there is an indication of impairment:
When testing this asset for impairment at 31/12/20X3, we find that it is not impaired
because its recoverable amount (C2 000 000) exceeds its carrying amount (C1 600 000).

x Thus, the carrying amount of the ‘development asset’ that will be presented on the
statement of financial position at 31/12/20X3 is C1 600 000 (Cost: 1 600 000 – Acc
amortisation: 0 – Acc impairments: 0).

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Solution 9.4 continued . . .

c) Fishing quota

x An intangible asset is an identifiable, non-monetary asset, without physical substance.

x The fishing quota is without physical substance as it is the ‘ability to fish’ that is more
significant than the ‘physical paper licence’.

x The cost of the fishing quota must be recognised as an intangible asset. This is because
both the recognition criteria are met:
- The probability criterion is always considered to be satisfied for separately acquired
intangible assets (Eat Limited is unlikely to have purchased the quota if it didn’t
expect to receive future economic benefit from it). IAS 38.25
- The cost can be reliably measured at the C1 000 000 paid for it.

x Amortisation of the portion used in the current period is C100 000 (C1 000 000 x 50/ 500)
- The amortisation method shall reflect the pattern that best reflects the usage of the
asset.
- Since the asset is a ‘fishing quota’ in tonnes, the tonnes fished during the period/ total
tonnes allowed to be fished in terms of the quota best reflects the usage of the quota.

x As there is an active market for fishing quotas, the revaluation model can be used.
- The quota is revalued, in accordance with the entity’s accounting policy, to its fair
value of C1 350 000
- The carrying amount (CA) on 31/12/20X3, before the revaluation, is C900 000 (Cost:
1 000 000 – Amortisation: 100 000)
- The revaluation on 31/12/20X3 entails increasing the asset’s carrying amount by
C450 000 (FV: 1 350 000 – CA: 900 000) and crediting C450 000 to the revaluation
surplus account.

x The carrying amount presented on the statement of financial position at 31/12/20X3 will
be its fair value of C1 350 000.

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Solutions to GAAP : Graded Questions Intangible assets

Solution 9.4 continued . . .

d) Advertising promotion

x The costs of the advertising of C220 000 must be recognised as an expense during the
current year.

x IAS 38 prohibits the recognition of advertising costs as an asset See IAS 38.68 & .69
This is because costs incurred on advertising, and the future economic benefits that may
flow from these costs, cannot be reliably distinguished from the costs of developing the
business as a whole.
x
Although the advertising costs may not be recognised as an intangible asset, and are thus
expensed, the prepaid advertising expense of C25 000 is recognised as a current asset at
31/12/X3. This is because a prepayment meets the definition of an asset: it is a resource
controlled by the entity (the airtime slot that it has bought for its radio advertisement),
from a past event (paid in cash). See IAS 38.70

e) Masthead

x This is an internally generated masthead.

Mastheads may never be recognised as intangible assets (IAS 38.63 states that internally
generated brands, mastheads, publishing titles, customer lists and items similar in
substance shall not be recognised as intangible assets).
This is because costs incurred on the masthead cannot be distinguished from the costs of
developing the business a whole.

x The C270 000 incurred in previous years and the C30 000 incurred in the current year
must be expensed.

x As the masthead is not recognised as an asset, it cannot be revalued.

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Solutions to GAAP : Graded Questions Intangible assets

Solution 9.5

a) Capitalisation of a trademark
A trademark would be capitalised if it met the intangible asset definition and the recognition
criteria provided in IAS 38 Intangible assets.

An item meets the intangible asset definition if it is an:

x identifiable
x non-monetary
x asset (which IAS 38 defines as a resource from which an inflow of future economic
benefits is expected, and which is controlled by the entity as a result of a past event).
x without physical substance.
An item that meets the intangible asset definition should be recognised as an asset only if it
meets the recognition criteria provided in IAS 38, which are as follows:
x it is probable that the future benefits that are attributable to the asset will flow to the entity
x the cost can be measured reliably.
b) Measurement of the trademark
The trademark, which is an intangible asset, should initially be measured in the financial
statements at its cost of C150 000.
Since the trademark has an indefinite useful life:
x it must not be amortised; but
x must be tested every year for impairment.

When testing the trademark for impairment, its carrying amount must be compared to its
recoverable amount. If the recoverable amount is less than its carrying amount, it must be
written down to the lower recoverable amount and the difference recorded as an impairment
loss expense.

Since this particular trademark is not amortised, its recoverable amount must be calculated
annually (at the same time every year) irrespective of whether or not the indicator review
suggests an impairment.

A recent detailed calculation of this intangible asset’s recoverable amount may be used
instead of recalculating the recoverable amount if:
x the intangible asset is part of a cash generating unit, where the change in the values of the
assets and liabilities within the cash generating unit are insignificant;
x the recent detailed estimate of the recoverable amount was substantially greater than the
carrying amount at the time; and
x events and circumstances subsequent to the calculation of the previous recoverable
amount suggest that there is only a remote chance that the current recoverable amount
would now be less than the carrying amount.

The assessment of its useful life as ‘indefinite’ must be reviewed each year and if
circumstances have changed such that the useful life is now considered to be finite, then:
x the amortisation must be adjusted as a change in estimate (IAS 8);
x check for a possible impairment and record an impairment loss if necessary (IAS 36).

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Solution 9.5 continued …

c) Disclosure of the trademark

The following information relating to this trademark must be disclosed separately from any
internally generated intangible asset:
x the fact that the trademark is considered to have an indefinite useful life, the reasons (and
significant factors supporting these reasons) for assessing the life as indefinite and the
carrying amount of the trademark;
x the ‘gross carrying amount’ and ‘accumulated depreciation and impairment losses’ at the
beginning and end of each period and a reconciliation between these carrying amounts
(the reconciling items would probably include only the acquisition and any impairment
loss or impairment loss reversed unless the indefinite useful life is reassessed as finite, in
which case amortisation will also be processed).
The following information must also be disclosed:
x restrictions on title to the trademark, if applicable;
x the carrying amounts of the trademark pledged as security for a liability, if applicable.
x if the trademark is considered to be material to Radiance Ltd’s financial statements, the
nature, carrying amount and the remaining amortisation period (indefinite) thereof.

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Solutions to GAAP : Graded Questions Intangible assets

Solution 9.6

Recognition of a fishing licence

The issue here is whether the cost of the fishing licence should have been expensed or
recognised as an intangible asset.

To be recognised as an intangible asset, the item must meet the definition of an intangible
asset and the recognition criteria.

An intangible asset is defined as an identifiable non-monetary asset without physical

substance:
x The fishing licence is identifiable as it arises from a legal right to fish in the demarcated
area.
x As an asset, the intangible asset must be a resource controlled by the entity, from a past
event and must result in an expected inflow of future economic benefits
x Marlin Limited does have control over the fishing licence as no other company may
fish in the specific area during the term of the licence.
x The past event is the acquisition of the license before year-end.
x Future economic benefits should flow through increased revenue from the sale of fish.
x The fishing licence (although the related documentation has physical form), does not have
physical substance as the most significant aspect is the licensed ability to fish.

The licence therefore meets the definition of an intangible asset.

This intangible asset may only be recognised as an asset (capitalised) if it meets the
recognition criteria:
x As the fishing license is a separately acquired intangible asset, the probability of future
economic benefits is satisfied (IAS 38 assumes this criterion is met when the asset is
separately acquired). See IAS 38.25
x The cost of the fishing license is reliably measured at the amount paid for it: C500 000.

The licence therefore meets the recognition criteria necessary for it to be recognised as an
intangible asset.

Marlin Limited should therefore reverse the expense initially recorded on acquisition of the
licence. The licence should be capitalised as an intangible asset since it meets the relevant
definition and recognition criteria.

Measurement of a fishing licence

x The fishing licence has a finite life and must be amortised.
x The useful life is determined as the shorter of the actual life and legal life.
x In this scenario, there is no actual life outside of the legal life so we need focus only
the legal life. In this regard, the licence provides Marlin with legal rights for four
years. Thus, the useful life is four years.
x The residual value is zero.
x The pattern of future economic benefits is not apparent and therefore the straight-line
basis may be used as the default method of amortisation. See IAS 38.97
x Amortisation of C100 000 must be expensed in 20X4 [(C400 000 – 0) / 4 years x 1 year]

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Solution 9.6 continued …

x An impairment indicator test must be performed. If no indication of impairment is found,

the recoverable amount need not be calculated. No evidence of impairment was given in
the question.
x The carrying amount of the licence at 31 December 20X4 will be measured at C300 000
(Cost: 400 000 – Accumulated amortisation: 100 000 - Accumulated impairments: 0).

Disclosure of a fishing licence

x The carrying amount of the licence would be included in the ‘intangible assets’ line item
on the face of the statement of financial position. This would be referenced to the
intangible asset note.
 The intangible asset note should detail the opening and closing carrying amount of
the licence, as well as the reconciliation between these two carrying amounts.
 The reconciliation will show the purchase of the licence (2 January 20X4) as an
addition.
 Other items that would be included in the reconciliation would include amortisation
during the year, any impairments, purchases of other intangible assets and/or
disposals thereof.
x The amortisation expense would be included in the calculation of the profit before tax line
item in the statement of comprehensive income. This line-item would be referenced to the
profit before tax note.
 The amortisation must be disclosed in the profit before tax note.
x Accounting policies relating to intangible assets would need to be disclosed.

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