Slide 19.1

R&D; Goodwill; IntangibleAssets and Brands

Chapter 19

Slide 19.2

The main purpose of this chapter is considerthe accounting treatments of:

Research and development

Goodwill and intangible assets

Brands

Main purpose

Slide 19.3

ObjectivesBy the end of this chapter, you should be able to:define and explain how to account for research

and development (R&D), goodwill and other intangible assets;

comment critically on the IASB requirements in IAS 38 and IFRS 3;

account for development costs;account for impairment;prepare extract of the entries and disclosure of

these items in the statement of comprehensive income and statement of financial position.

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Intangibles

An intangible asset is defined under IAS 38, as: an identifiable non-monetary asset without physical

substance Intangibles include systems, licences,

intellectual property, market knowledge and trademarks (including brand names and publishing titles) – see p. 503 for more examples

An intangible asset must be identifiable (para 12 IAS 38), and there must be control (para 13), as well as the production of future economic benefits and its cost can be reliably measured (para 21) before it may be recognised

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Intangibles

Initial recognition is at cost (para 24)Two categories of intangible asset:

externally acquired or internally generated .

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Intangibles

Externally acquired: Purchased from another party either separately

or as part of a business combination. If purchased separately, eg. buying rights to a

book before making it into a film, cost can be established as the purchase price and any other expenses associated

with readying the asset for its intended use. plus any duties and non-refundable taxes less any trade discounts or rebates (para 27)

Slide 19.7

Intangibles

Buying the business of a competitor may include, for example, the rights to copyrights, patents or mastheads.

If these cannot be reliably measured or distinguished from other assets, they become part of purchased goodwill – the premium paid over and above the fair value of tangible and identifiable intangible assets (para 10).

Where the price paid for the intangible can be distinguished from goodwill and the future economic benefits that arise can be identified, the test of identifiability is met and it can be recorded as a separate asset (para 34) at fair value at the date of purchase (para 33).

This treatment differs from the separate purchase of an intangible, which is recorded at cost.

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Intangibles

Goodwill is recognised as a separate intangible asset, subject to an annual test for impairment.

A gain on bargain purchase – negative goodwill - (paid less than fair value) is taken to revenue.

Where an identifiable intangible asset exists but cannot be reliably measured, it is included as part of goodwill. In such a case, there is a requirement to describe each intangible asset acquired in a business combination, and explain why its fair value could not be reliably measured.

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Intangibles – internally generated

As the name suggests, these arise from the activities of the business.

Expenditure on internally developed brands, mastheads (newspaper and magazine titles), publishing titles, customer lists, and similar cannot be distinguished from the cost of developing the entity’s overall business.

Such intangibles (including internally generated goodwill) do not meet the definition of assets, and shall not be recognised as intangible assets (IAS 38, para 63).

Slide 19.10

Research defined

Research – original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding i.e.

Obtaining new knowledgeSearch for alternatives

Materials Products Processes

Evaluation of alternatives.

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IAS 38 – accounting treatment for R&DResearch:Expense in the year in which incurredNot to be carried forward in statement of

financial position i.e research is not capitalised or shown as an asset on the balance sheet

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IAS 38 intangible assets

Development defined Application of research findings to a plan for production

of new or substantially improved• Products• Processes• Systems

Prior to commencement of commercial production.

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Development costs compriseDirectly attributable costs

Materials Labour Fees such as patents

Allocatable on a reasonable and consistent basis Necessary and identifiable overheads

Depreciation Insurance premiums, rent.

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IAS 38 – development recognition criteriaTechnical feasibilityIntention to complete and use or sellGenerate future economic benefits

Existence of market for asset or output

Availability of adequate resources to complete Technical Financial Reliable measurement of costs possible

Expense if not recoverable from future revenue. Otherwise, capitalise and show on balance sheet.

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Activities that are neither researchor developmentActivities related to research and development, but cannot be classified for the purposes of the standard as R&D include: Engineering follow through in an early phase of

commercial production Quality control during commercial production, including routine testing Troubleshooting in connection with breakdowns during production Routine efforts to improve the qualities of an existing product.

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Goodwill and intangible assets

The main requirements of IFRS 3 Business Combinations and IAS 38 Intangible Assets are:

• Purchased goodwill and intangible assets should be capitalised as assets

• Internally generated goodwill should not be capitalised and

• Internally developed intangible assets should be capitalised only where it is probable that future economic benefits attributable to the asset will flow to the enterprise and the cost of the asset can be measured reliably

• Capitalised assets are subject to amortisation and/impairment review.

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Accounting for research & development Why does the accounting differ between research

and development? Research expenditure, whether pure or applied, cannot

meet the definition of assets. There is no probability of service potential or future

economic benefits arising as a direct result of the expenditure. Accordingly, it meets the definition of expense – consumption has occurred that has reduced assets (or increased liabilities) and it can be reliably measured.

Development expenditure, when it passes the test criteria, meets the definition of assets.

In meeting the test it is probable that service potential or future economic benefits will eventuate, and the cost or other value can be reliably measured.

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IFRS 3 business combinationsIFRS 3 Business Combinations states:Goodwill is the difference between the cost of

acquisition and the acquirer’s interest in the fair value of the identifiable assets, liabilities and contingent liabilities acquired at the date of the exchange transaction.

Purchased goodwill is based on Transaction with third party at arm’s length

Internally generated goodwill is based on Directors’ valuation of internal goodwill by valuing

Business as a whole Separable assets.

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Accounting treatment of goodwill

Purchased goodwill is recognised in the statement of financial position as an asset

Amortisation prohibited

Annual impairment reviews

Inherent goodwill not normally recognised in the accounts.

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Economic consequence of write-off/amortisationROCE

Write-off reduces shareholders’ reserves and capital employed

Gearing Write-off reduces shareholders’ reserves and so capital

employed How this affects investor decisions How this affects creditor decisions.

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Negative goodwill – related toexpectation of losses and expenses

Arises when the amount paid for the purchase is less than its fair value.

Credit income statement immediately.

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Intangible assets – purchased

Separately purchased, included in goodwill and with a finite life Capitalise as part of goodwill

Separately purchased and capable of reliable measurement Capitalise separately from goodwill and amortise.

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Intangible assets – internally developed

Capitalise – 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; 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 reliably the expenditure attributable to the intangible asset during its development. (para 57)

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Intangible assets – indefinite useful economic life Intangible assets with indefinite useful lives must, at each annual

balance date compare carrying value against recoverable amount. If the recoverable amount is less, then the impairment amount is written off first to any related asset revaluation reserve and then as an expense to the Income Statement.

Where impairment losses recognised in prior periods no longer exist or have decreased so that recoverable amount is now above carrying amount, the previous impairment loss is unwound – first to any amount expensed to the Income Statement and then to the revaluation reserve, if one exists. The reversal must not result in the asset’s carrying value exceeding that which would have resulted had

no prior impairment loss been recognised. Improve transparency Improve comparability.

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Brand accounting

Include in statement of financial position topre-empt equity depletion caused by goodwill write-offs or amortisation

Typically not amortised but subject to impairment review.

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Intellectual property – two categories

Industrial property Inventions Trademarks Designs

Copyright Literary and artistic works.

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OECD definition of intellectual capital

The economic value of two categories of intangible assets:

Organisational (structural) capital– Software systems– Supply chains

Human capital– Internally – staff– Externally – customers.

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Discussion

Explain how primary ratios were distorted by immediate write-off of goodwill against reserves

Explain the criteria for recognising internally generated intangible assets.

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Discussion (Continued)

Explain why companies began to recognise brands in their statement of financial positions

Explain the requirement at the year end with respect to intangible assets with an indefinite useful economic life

Why do you think companies were motivated to measure intellectual capital?

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Discussion (Continued)

What indications may there be that an impairment review of an intangible asset is necessary?

Explain the criteria to be satisfied for development costs to be capitalised

Discuss why intellectual property has become increasingly important.

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Review questions

7. The Chloride 2005 Annual Report included the following accounting policy for goodwill:Goodwill is subject to review at the end of the year of acquisition and at any other time when the directors believe that impairment may have occurred. Any impairment would be charged to the profit and loss account in the period in which the loss occurs(a) Explain the indications that a review for

impairment is required(b) Once there are indications of impairment,

how is impairment measured?

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10. IFRS 3 has introduced a new concept into accounting for purchased goodwill – annual impairment testing, rather than amortisation. Consider the effect of a change from amortisation of goodwill (in IAS 22) to impairment testing and no amortisation in IFRS 3, and in particular:

• The effect on the financial statements• The effect on financial performance ratios.

• Continued …

Review questions (Continued)

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Which method gives the fairest charge over time for the value of the goodwill when a business is acquired

Whether impairment testing with no amortisation complies with the IASC’s Framework for the Preparation and Presentation of Financial Statements

The effect on the annual impairment or amortisation charge and its timing

Why there has been a change from amortisation to impairment testing – is this pandering to pressure from the US FASB and/or listed companies?

Review questions (Continued)