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4 Intangible asset: expected future economic benefits

4 Intangible asset: expected future economic benefits

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(b)



When an intangible asset is acquired as part of a business combination (ie an acquisition or

takeover), the cost of the intangible asset is its fair value at the date of the acquisition.



IFRS 3 explains that the fair value of intangible assets acquired in business combinations can normally be

measured with sufficient reliability to be recognised separately from goodwill.

Quoted market prices in an active market provide the most reliable measurement of the fair value of an

intangible asset. If no active market exists for an intangible asset, its fair value is the amount that the entity

would have paid for the asset, at the acquisition date, in an orderly transaction between market

participants, on the basis of the best information available. In determining this amount, an entity should

consider the outcome of recent transactions for similar assets. There are techniques for estimating the fair

values of unique intangible assets (such as brand names) and these may be used to measure an intangible

asset acquired in a business combination.



In accordance with IAS 20, intangible assets acquired by way of government grant and the grant itself may

be recorded initially either at cost (which may be zero) or fair value.



5.5 Exchanges of assets

If one intangible asset is exchanged for another, the cost of the intangible asset is measured at fair value

unless:

(a)

(b)



The exchange transaction lacks commercial substance, or

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.



5.6 Internally generated goodwill

Rule to learn



Internally generated goodwill may not be recognised as an asset.

The standard deliberately precludes recognition of internally generated goodwill because it requires that,

for initial recognition, the cost of the asset rather than its fair value should be capable of being measured

reliably and that it should be identifiable and controlled. Therefore, you do not recognise an asset which is

subjective and cannot be measured reliably.



5.7 Research and development costs

5.7.1 Research

Research activities by definition do not meet the criteria for recognition under IAS 38. This is because, at

the research stage of a project, it cannot be certain that future economic benefits will probably flow to the

entity from the project. There is too much uncertainty about the likely success or otherwise of the project.

Research costs should therefore be written off as an expense as they are incurred.

Examples of research costs



(a)



Activities aimed at obtaining new knowledge



(b)



The search for, evaluation and final selection of, applications of research findings or other

knowledge



(c)



The search for alternatives for materials, devices, products, processes, systems or services



(d)



The formulation, design evaluation and final selection of possible alternatives for new or improved

materials, devices, products, systems or services



5.7.2 Development

Development costs may qualify for recognition as intangible assets provided that the following strict

criteria are met.



Part B Accounting standards  3: Non-current assets



101



(a)



The technical feasibility of completing the intangible asset so that it will be available for use or sale.



(b)



Its intention to complete the intangible asset and use or sell it.



(c)



Its ability to use or sell the intangible asset.



(d)



How the intangible asset will generate probable future economic benefits. Among other things, the

entity should demonstrate the existence of a market for the output of the intangible asset or the

intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.



(e)



Its ability to measure the expenditure attributable to the intangible asset during its development

reliably.



In contrast with research costs development costs are incurred at a later stage in a project, and the

probability of success should be more apparent. Examples of development costs include the following:

(a)



The design, construction and testing of pre-production or pre-use prototypes and models



(b)



The design of tools, jigs, moulds and dies involving new technology



(c)



The design, construction and operation of a pilot plant that is not of a scale economically feasible

for commercial production



(d)



The design, construction and testing of a chosen alternative for new or improved materials,

devices, products, processes, systems or services



5.7.3 Other internally generated intangible assets

The standard prohibits the recognition of internally generated brands, mastheads, publishing titles and

customer lists and similar items as intangible assets. These all fail to meet one or more (in some cases

all) the definition and recognition criteria and in some cases are probably indistinguishable from internally

generated goodwill.



5.7.4 Cost of an internally generated intangible asset

The costs allocated to an internally generated intangible asset should be only costs that can be directly

attributed or allocated on a reasonable and consistent basis to creating, producing or preparing the asset

for its intended use. The principles underlying the costs which may or may not be included are similar to

those for other than non-current assets and inventory.

The cost of an internally operated intangible asset is the sum of the expenditure incurred from the date

when the intangible asset first meets the recognition criteria. If, as often happens, considerable costs

have already been recognised as expenses before management could demonstrate that the criteria have

been met, this earlier expenditure should not be retrospectively recognised at a later date as part of the

cost of an intangible asset.



5.7.5 Example: Computer software and hardware

The treatments can be illustrated by reference to computer software and hardware. The treatment depends

on the nature of the asset and its origin.



102



Asset



Origin



Treatment



Computer software



Purchased



Capitalise



Operating system for hardware



Purchased



Include in hardware cost



Computer software

Operating system for hardware

(For use or sale)



Internally

developed



Charge to expense until 'Development criteria' (Para

5.7.2) are met. Amortise over useful life, based on

pattern of benefits. Straight line is default).



3: Non-current assets  Part B Accounting standards



Question



Recognition criteria



Doug Co is developing a new production process. During 20X3, expenditure incurred was $100,000, of

which $90,000 was incurred before 1 December 20X3 and $10,000 between 1 December 20X3 and

31 December 20X3. Doug Co can demonstrate that, at 1 December 20X3, the production process met the

criteria for recognition as an intangible asset. The recoverable amount of the know-how embodied in the

process is estimated to be $50,000.

How should the expenditure be treated?



Answer

At the end of 20X3, the production process is recognised as an intangible asset at a cost of $10,000. This

is the expenditure incurred since the date when the recognition criteria were met, that is 1 December

20X3. The $90,000 expenditure incurred before 1 December 20X3 is expensed, because the recognition

criteria were not met. It will never form part of the cost of the production process recognised in the

statement of financial position.



5.8 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

Training costs

Advertising 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.



If tangible asset costs have been expensed in previous financial statements, they may not be recognised

as part of the cost of the asset.



5.9 Measurement of intangible assets subsequent to initial recognition

FAST FORWARD



Intangible assets should initially be measured at cost, but subsequently they can be carried at cost or at a

fair value.

The standard allows two methods of valuation for intangible assets after they have been first recognised.

Applying the cost model, an intangible asset should be carried at its cost, less any accumulated

depreciation and less any accumulated impairment losses.

The revaluation model allows an intangible asset to be carried at a revalued amount, which is its fair

value at the date of revaluation, less any subsequent accumulated amortisation and any subsequent

accumulated impairment losses.

(a)



The fair value must be able to be measured reliably with reference to an active market in that type

of asset.



(b)



The entire class of intangible assets of that type must be revalued at the same time (to prevent

selective revaluations).



(c)



If an intangible asset in a class of revalued intangible assets cannot be revalued because there is no

active market for this asset, the asset should be carried at its cost less any accumulated

amortisation and impairment losses.



Part B Accounting standards  3: Non-current assets



103



(d)



Point to note



Revaluations should be made with such regularity that the carrying amount does not differ from

that which would be determined using fair value at the year end.



This treatment is not available for the initial recognition of intangible assets. This is because the cost of

the asset must be reliably measured.

The guidelines state that there will not usually be an active market in an intangible asset; therefore the

revaluation model will usually not be available. For example, although copyrights, publishing rights and

film rights can be sold, each has a unique sale value. In such cases, revaluation to fair value would be

inappropriate. A fair value might be obtainable however for assets such as fishing rights or quotas or taxi

cab licences.

Where an intangible asset is revalued upwards to a fair value, the amount of the revaluation should be

credited directly to equity under the heading of a revaluation surplus.

However, if a revaluation surplus is a reversal of a revaluation decrease that was previously charged

against income, the increase can be recognised as income.

Where the carrying amount of an intangible asset is revalued downwards, the amount of the downward

revaluation should be charged as an expense against income, unless the asset has previously been

revalued upwards. A revaluation decrease should be first charged against any previous revaluation surplus

in respect of that asset.



Question



Downward valuation



An intangible asset is measured by a company at fair value. The asset was revalued by $400 in 20X3, and

there is a revaluation surplus of $400 in the statement of financial position. At the end of 20X4, the asset

is valued again, and a downward valuation of $500 is required.

Required



State the accounting treatment for the downward revaluation.



Answer

In this example, the downward valuation of $500 can first be set against the revaluation surplus of $400.

The revaluation surplus will be reduced to 0 and a charge of $100 made as an expense in 20X4.

When the revaluation model is used, and an intangible asset is revalued upwards, the cumulative

revaluation surplus may be transferred to retained earnings when the surplus is eventually realised. The

surplus would be realised when the asset is disposed of. However, the surplus may also be realised over

time as the asset is used by the entity. The amount of the surplus realised each year is the difference

between the amortisation charge for the asset based on the revalued amount of the asset, and the

amortisation that would be charged on the basis of the asset's historical cost. The realised surplus in such

case should be transferred from revaluation surplus directly to retained earnings, and should not be taken

through profit or loss for the year.



5.10 Useful life

An entity should assess the useful life of an intangible asset, which may be finite or infinite. An intangible

asset has an indefinite useful life when there is no foreseeable limit to the period over which the asset is

expected to generate net cash inflows for the entity.

Many factors are considered in determining the useful life of an intangible asset, including: expected

usage; typical product life cycles; technical, technological, commercial or other types of obsolescence; the

stability of the industry; expected actions by competitors; the level of maintenance expenditure required;

and legal or similar limits on the use of the asset, such as the expiry dates of related leases. Computer

software and many other intangible assets normally have short lives because they are susceptible to



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3: Non-current assets  Part B Accounting standards



technological obsolescence. However, uncertainty does not justify choosing a life that is unrealistically

short.

The useful life of an intangible asset that arises from contractual or other legal rights should not exceed

the period of the rights, but may be shorter depending on the period over which the entity expects to use

the asset.



5.10.1 2014 Amendments to IAS 38

In 2014, the IASB published amendments to IAS 16 and IAS 38 in a document Clarification of acceptable

methods of depreciation and amortisation.

Technical or commercial obsolescence



The first of these amendments concerned technical or commercial obsolescence, clarifying that expected

future reductions in the selling price of an item that was produced using an asset could indicate the

expectation of technical or commercial obsolescence of the asset, which, in turn, might reflect a

reduction of the future economic benefits embodied in the asset.

Amortisation method



The second amendment to IAS 38 concerned the depreciation method, which must reflect the pattern in

which the asset’s future economic benefits are expected to be consumed by the entity. The 2014

amendment states that there is a rebuttable presumption that amortisation methods that are based on

revenue generated by an activity that includes the use of an intangible asset are inappropriate. The

revenue generated by an activity that includes the use of an asset generally reflects factors other than the

consumption of the economic benefits of the intangible asset. For example, revenue is affected by other

inputs and processes, selling activities and changes in sales volumes and prices. The price component of

revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed.

The presumption may be rebutted under the following conditions.

(a)



Where the intangible asset is expressed as a measure of revenue, that is the predominant limiting

factor that is inherent in an intangible asset is the achievement of a revenue threshold, or



(b)



When it can be demonstrated that revenue and the consumption of the economic benefits of the

intangible asset are highly correlated.



An example of (a) might be the right to operate a toll road, if this right were based on a fixed total amount

of revenue to be generated from cumulative tolls charged. A contract could, for example allow operation of

the toll road until the cumulative amount of tolls generated from operating the road reaches $100 million.

Revenue would in this case be established as the predominant limiting factor in the contract for the use of

the intangible asset, so the revenue that is to be generated might be an appropriate basis for amortising

the intangible asset, provided that the contract specifies a fixed total amount of revenue to be generated

on which amortisation is to be determined.



5.11 Amortisation period and amortisation method

An intangible asset with a finite useful life should be amortised over its expected useful life.

(a)



Amortisation should start when the asset is available for use.



(b)



Amortisation should cease at the earlier of the date that the asset is classified as held for sale in

accordance with IFRS 5 Non-current assets held for sale and discontinued operations and the date

that the asset is derecognised.



(c)



The amortisation method used should reflect the pattern in which the asset's future economic

benefits are consumed. If such a pattern cannot be predicted reliably, the straight-line method

should be used.



(d)



The amortisation charge for each period should normally be recognised in profit or loss.



The residual value of an intangible asset with a finite useful life is assumed to be zero unless a third party

is committed to buying the intangible asset at the end of its useful life or unless there is an active market



Part B Accounting standards  3: Non-current assets



105



for that type of asset (so that its expected residual value can be measured) and it is probable that there will

be a market for the asset at the end of its useful life.

The amortisation period and the amortisation method used for an intangible asset with a finite useful life

should be reviewed at each financial year-end.



5.12 Intangible assets with indefinite useful lives

An intangible asset with an indefinite useful life should not be amortised. (IAS 36 requires that such an

asset is tested for impairment at least annually.)

The useful life of an intangible asset that is not being amortised should be reviewed each year to

determine whether it is still appropriate to assess its useful life as indefinite. Reassessing the useful life of

an intangible asset as finite rather than indefinite is an indicator that the asset may be impaired and

therefore it should be tested for impairment.



Question



Useful life



It may be difficult to establish the useful life of an intangible asset, and judgement will be needed.

Consider how to determine the useful life of a purchased brand name and how to provide evidence that its

useful life might in fact exceed 20 years.



Answer

Factors to consider would include the following:

(a)



Legal protection of the brand name and the control of the entity over the (illegal) use by others of

the brand name (ie control over pirating)



(b)



Age of the brand name



(c)



Status or position of the brand in its particular market



(d)



Ability of the management of the entity to manage the brand name and to measure activities that

support the brand name (eg advertising and PR activities)



(e)



Stability and geographical spread of the market in which the branded products are sold



(f)



Pattern of benefits that the brand name is expected to generate over time



(g)



Intention of the entity to use and promote the brand name over time (as evidenced perhaps by a

business plan in which there will be substantial expenditure to promote the brand name)



5.13 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 the profit or loss for the year as a gain or loss on disposal (ie treated as income or

expense).



5.14 Disclosure requirements

The standard has fairly extensive disclosure requirements for intangible assets. The financial statements

should disclose the accounting policies for intangible assets that have been adopted.



106



3: Non-current assets  Part B Accounting standards



For each class of intangible assets, disclosure is required of the following:





The method of amortisation used







The useful life of the assets or the amortisation rate used







The gross carrying amount, the accumulated amortisation and the accumulated impairment losses

as at the beginning and the end of the period







A reconciliation of the carrying amount as at the beginning and at the end of the period (additions,

retirements/disposals, revaluations, impairment losses, impairment losses reversed, amortisation

charge for the period, net exchange differences, other movements)







The carrying amount of internally-generated intangible assets



The financial statements should also disclose the following:





In the case of intangible assets that are assessed as having a indefinite useful life, the carrying

amounts and the reasons supporting that assessment







For intangible assets acquired by way of a government grant and initially recognised at fair value,

the fair value initially recognised, the carrying amount, and whether they are carried under the

benchmark or the allowed alternative treatment for subsequent remeasurements







The carrying amount, nature and remaining amortisation period of any intangible asset that is

material to the financial statements of the entity as a whole







The existence (if any) and amounts of intangible assets whose title is restricted and of intangible

assets that have been pledged as security for liabilities







The amount of any commitments for the future acquisition of intangible assets



Where intangible assets are accounted for at revalued amounts, disclosure is required of the following:





The effective date of the revaluation (by class of intangible assets)







The carrying amount of revalued intangible assets







The carrying amount that would have been shown (by class of assets) if the cost model had been

used, and the amount of amortisation that would have been charged







The amount of any revaluation surplus on intangible assets, as at the beginning and end of the

period, and movements in the surplus during the year (and any restrictions on the distribution of

the balance to shareholders)



The financial statements should also disclose the amount of research and development expenditure that

have been charged as expenses of the period.



5.15 Section summary





An intangible asset should be recognised if, and only if, it is probable that future economic benefits

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







An asset is initially recognised at cost and subsequently carried either at cost or revalued amount.







Costs that do not meet the recognition criteria should be expensed as incurred.







An intangible asset with a finite useful life should be amortised over its useful life. An intangible

asset with an indefinite useful life should not be amortised.



Question



List



As an aid to your revision, list the examples given in IAS 38 of activities that might be included in either

research or development.



Part B Accounting standards  3: Non-current assets



107



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