Intangible Assets

ACTG 6580

Chapter 13

Objectives

1. Understand the key characteristics of an intangible asset

2. Recognition and initial measurement

3. Measurement subsequent to initial recognition

4. Retirement and disposal of intangible assets

Objectives

5. Disclosure requirements of IAS 38

6. Proposals for changes in accounting for intangible assets

7. Innovative measures for improving the reporting of intangible assets

The Nature of Intangible Assets

IAS 38 para 8 defines intangibles: “An identifiable non-monetary asset without physical

substance”

Three key characteristics of intangibles:

1.Non monetary 2.Identifiable

3.They lack physical substance

The Nature of Intangible Assets: Identifiability

For an intangible to be identifiable, one of the following two criteria must be met:

1. It is separable from the entity, capable of being transferredCustomers listsNon-contractual customer relationships

2. It arises from a contractual or some other legal rightTrademarksFranchise agreements

The Nature of Intangible Assets:

Lack of Physical Substance

When they should be recognized: Should one wait for a point of discovery? Does an asset exist when the investment is made? Is there an asset at the point employee training occurs?

How they should be measured: Where is the market? Can the specific benefits be isolated? Are the property rights over the expected benefits

fuzzy?

Why are Intangibles Important?

Intangibles have been increasing in importance due to: Intensified business competition The advent of information technologies

The above factors have resulted in a fundamental corporate change

Significant increase in: Innovation related intangibles Human Resource related intangibles Organizational intangibles

Identifying Intangible Assets

An asset is defined in the Conceptual Framework as a resource controlled by the entity

Control usually stems from legal or other rights and can be difficult to establish

Highly trained staff do not qualify as intangibles due to the lack of control the entity has over the staff If at all, such benefits may be recognized as part

of goodwill

Recognition & Initial Measurement

Once it has been determined that an item meets the definition of an intangible, it must then meet the following recognition criteria before it can be recognized as an asset: It is probable that future economic benefits attributable

to the asset will flow to the entity The cost of the asset can be measured reliably.

Intangibles that fail the recognition criteria must be expensed

Intangibles are required to be initially measured at cost (purchase price + directly attributable costs)

Recognition & Initial Measurement

Intangibles may be acquired in the following ways: By separate acquisition As part of a business combination By way of a government grant By exchanges with another intangible They may be internally generated

Recognition & Initial Measurement:

Separate Acquisition

IAS 38 considers that the probability recognition criteria is always considered to be satisfied for separately acquired intangibles

Cost can usually be measured reliably, although there may be issues where the acquirer is giving up non-monetary assets rather than cash

Recognition & Initial Measurement: Acquisition as Part of Business Combination

Intangibles acquired as part of a business combination are not initially measured at cost but at fair value in accordance with IFRS 3

Fair value measures used may include: Quoted market prices in an active market Recent transactions in the same or similar items Using other measurement techniques

Internally Generated Intangible Assets

Research is defined as "original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding".

Development is defined as "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".

Internal generation of an intangible asset is split into a research phase and a development phase.

IAS38 Treatment of Research and Development

costs All research expenditures must be written off

as an expense when it is incurred. An intangible asset which arises from the

development phase of an internal project must be recognized if certain criteria are satisfied:technical feasibility of completionavailability of resources to completeintention to complete and ability to use/sell

the assetprobability of future economic benefitsability to measure expenditure reliably.

Research and Development Example

Example 1 – Internet Imaging Inc. (Triple I), is working on a project to create a database of picture images which it intends to sell over the internet. Triple I has identified the following stages and costs incurred in its project:

Research stageThis stage included identifying the system requirements, searching for an appropriate database and other system materials and images to purchase, gaining the technical knowledge necessary to collect and transfer the images and overall project feasibility. Costs incurred were $50,000 during the period of January 1, 2010 through March 31, 2010. On April 1, 2010, Triple I determined that it would complete the intended project. Additional research costs of $75,000 were incurred during the period of April 1, 2010 through June 30, 2010.

R & D Example Continued

Example 1 Continued:

Development stageThis stage included performing market analysis to identify potential demand, acquiring system materials and images to populate the database; designing the website; and testing a system prototype. During the period of May 1, 2010 through August 31, 2010, Triple I incurred development costs of $100,000. On August 31, 2010, Triple I determined that its project was technically feasible. During the period of September 1, 2010 through October 31, 2010, Triple I incurred development costs of $50,000. On October 31, 2010, Triple I received its results from its market study and determined that the project was economically feasible. Additional development costs of $200,000 were incurred during the period of November 1, 2010 through December 31, 2010.

Production stageTriple I will launch its imaging database on the internet on January 1, 2011.

R & D Example Continued

Example 1 continued:

• Complete the diagram below by inputting the research and development costs for 2010 in the appropriate periods based on the information above.

• Based on the diagram, determine which research and development costs Triple I can

capitalize related to this project during 2010 using US GAAP and IFRS? Research phase

Development phase

$ $

$ $ $

Jan. 1, 2010

March 31,

2010

April 1, 2010

May 1, 2010

June 30, 2010

August 31,

2010

Sept. 1, 2010

October 31, 2010

November 1, 2010

December 31, 2010

Research Initiated

Decision to complete

the project

Develop-ment

initiated

Research completed

Technical feasibility reached

Economic feasibility reached

Development completed

R & D Example Continued

Example 1 solution:Using US GAAP, Triple I cannot capitalize any research and development costs. Using IFRS, Triple I cannot capitalize any research costs, similar to US GAAP; however, Triple I may capitalize development costs when technical and economic feasibility of a project can be demonstrated in accordance with specific criteria. Some of the stated criteria include: demonstrating technical feasibility, intent to complete the asset and ability to sell the asset in the future, as well as others. As shown in the diagram below, Triple I met these criteria on October 31, 2010; therefore, the $200,000 incurred from November 1, 2010 through December 31, 2010, prior to the product launch on January 1, 2011, may be capitalized.

Research phase

Development phase

$50,000 $75,000

$100,000 $50,000 $200,000

January 1, 2010

Research started

March 31,

2010

April 1, 2010

May 1, 2010 June 30, 2010

August 31, 2010

Sept. 1, 2010

October 31, 2010

Nov. 1, 2010

December 31, 2010

Decision to

complete the

project

Development initiated

Research completed

Technical feasibility reached

Economic feasibility reached

Development completed

The following internally generated assets are specifically excluded from recognition per IAS 38:

GoodwillInternally generated brandsMastheads Publishing titlesCustomer lists

These intangibles can only be recognized at their FV when acquired as part of a business combination

Recognition & Initial Measurement:Internally Generated Intangibles

Measurement Subsequent to Initial Recognition

Choice of cost or revaluation models available just as with property, plant and equipment

Where the revaluation model is applied, the FV must be determined by reference to an active market

If there is no active market for unique assets (which includes most intangibles), such items must be measured under the cost model

Subsequent expenditure on intangibles are required to be expensed

Amortization of Intangible Assets

Need to assess whether the useful life is finite or indefinite

Finite Amortization principles are the same as for depreciating

PP&E Straight-line method most commonly used Residual value assumed to be zero in most cases Amortization period generally over life of contract

Indefinite No amortization charge Subject to annual impairment tests

Review of Residual Value, Useful

Life and Amortization Method The residual value and useful life of an intangible asset

should be reviewed at least at the end of each financial year.

If expectations differ from previous estimates, these should be accounted for as a change in an accounting estimate in accordance with IAS8.

Similarly, the amortization method used in relation to an intangible asset should be reviewed at least at the end of each financial year. Any change in method should be accounted for as a change in an accounting estimate in accordance with IAS8.

Retirements & Disposals

Accounting for retirements and disposals of intangible assets Treatment identical to IAS 16 Derecognized on disposal Amortization calculated up to point of sale

Main Disclosure Requirements of IAS38

whether the useful lives are indefinite or finite if finite, the useful lives or amortization rates used the amortization methods used the gross carrying amount and accumulated amortization

at the beginning and end of the accounting period the line item in the statement of comprehensive income in

which amortization is included a reconciliation of the carrying amount at the beginning

and end of the period, showing additions, disposals, revaluation increases and decreases, amortization, impairment losses and any other movements.

For each class of intangible asset, distinguishing between internally generated assets and others:

Proposals for Changes in Accounting for Intangible

Assets

In 2008, the AASB published a Discussion Paper (DP) entitled Initial Accounting for Internally Generated Intangible Assets

Proposals for change include: Recognition of internally generated intangibles Measurement of fair value A disclosure only reporting approach

Innovative Measures of Intangibles

Homework

Exercises 13.12, 13.14DUE THURSDAY, OCTOBER 2