Objective To explain the accounting rules for intangible

Objective To explain the accounting rules for intangible non-current assets.

Scope The standard applies to all intangibles except: those covered specifically by other standards (IAS 2, IAS 11, IAS 12, IAS 19, IAS 32, IAS 39, IFRS 3, IFRS 4, IFRS 5 and IFRS 6); and: expenditure on the development and extraction of minerals, etc.

Definitions Definitions Intangible assets are identifiable non-monetary assets without physical substance. Commentary Some intangibles may be contained in or on a physical medium (e.g. software on a floppy disk or embedded within the hardware). Judgement has to be used to determine which element is more significant, i.e. the intangible or the tangible asset.

Activity 1 Classify each of the following assets as either tangible or intangible: the operating system of a personal computer an off-the-shelf integrated publishing software package specialised software embedded in computer controlled machine tools a "firewall" controlling access to restricted sections of an Internet website.

Solution Tangible: the operating system (e.g. DOS or Windows) of a personal computer is an integral part of the related hardware and should be accounted for under IAS 16 Property, Plant and Equipment. Intangible: such computer software (e.g. QuarkXpress) is not an integral part of the hardware on which it is used.

Solution Tangible: specialised software integrated into production line "robots" is similar in nature to (1). Intangible: companies developing "firewall" software to protect their own websites may also sell the technology to other companies.

Definitions 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 intangibles include: Patents; Intellectual property (e.g. technical knowledge obtained from development activity)

Examples of intangibles include: Patents; Intellectual property (e.g. technical knowledge obtained from development activity) Trade marks including brand names and publishing titles; Motion picture films and video recordings.

Definition criteria "Identifiability" An intangible asset, whether generated internally or acquired in a business combination, is identifiable when it: is separable; or Commentary So it 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, asset or liability.

arises from contractual or other legal rights. Commentary These rights are regardless of whether they are transferable or separable from the entity or from other rights and obligations. These criteria distinguish intangible assets from goodwill acquired in a business combination.

"Control“ Control means: the power to obtain the future economic benefits from the underlying resource; and the ability to restrict the access of others to those benefits.

"Control“ Control normally stems from a legal right that is enforceable in a court of law. However, legal enforceability is not a prerequisite for control as the entity may be able to control the future economic benefits in some other way.

"Control“ Expenditure incurred in obtaining market and technical knowledge, increasing staff skills and building customer loyalty may be expected to generate future economic benefits. However, control over the actions of employees and customers is unlikely to be sufficient to meet the definition criterion especially where there are non-contractual rights.

Commentary An entity may seek to protect the technical talent or knowledge of certain skilled staff by including a "поп-compete" or "restraint of trade" clause into their contracts of employment. The entity may be able to secure the future economic benefits of such staff during a notice period and restrict the access of others for a period after they have left ("gardening leave ").

"Future economic benefits" "Future economic benefits" These are net cash inflows and may include increased revenues and/or cost savings. Commentary The use of intellectual property in a production process may reduce future production costs rather than increase future revenues.

Recognition and initial measurement An intangible asset should be recognised when it: complies with the definition of an intangible asset (see above); and meets the recognition criteria set out in the standard. The recognition criteria are that: it is probable that future economic benefits specifically attributable to the asset will flow to the entity; and the cost of the asset can be measured reliably

Recognition and initial measurement Further, the probability of future economic benefits must be assessed using reasonable and supportable assumptions, with greater weight being given to external evidence. Commentary The criteria for recognition as an intangible asset are therefore, in summary -identifiability, control, probable future economic benefits and reliable cost measurement.

Initial measurement-cost Intangible assets should be measured initially at cost. An intangible asset may be acquired: separately; as part of a business combination; by way of a government grant; by an exchange of assets.

Separate acquisition ■The cost of the intangible asset can usually be measured reliably when it has been separately acquired (e.g. purchase of computer software). Commentary As the price paid will normally reflect expectations of future economic benefits, the probability recognition criteria is always considered to be satisfied for separately acquired intangible assets.

"Cost" "Cost" is determined according to the same principles applied in accounting for other assets. For example: Purchase price + import duties + non-refundable purchase tax. Deferred payments are included at the cash price equivalent and the difference between this amount and the payments made are treated as interest.

As with other assets, expenditure that would not be classified as "cost" include those associated with: Introducing a new product or service (including advertising and promotion); Conducting business in a new location or with a new class of customer; Administration and other general overheads; Initial operating costs and losses; Costs incurred while an asset capable of operating in the manner intended has not yet been brought into use; Costs incurred in redeploying the asset.

Worked example 1 Kirk is an incorporated entity. On 31 December it acquired the exclusive rights to a patent that had been developed by another entity. The amount payable for the rights was $600,000 immediately and $400,000 in one year's time. Kirk has incurred legal fees of $87,000 in respect of the bid. Kirk operates in a jurisdiction where the government charges a flat rate fee (a "stamp duty") of $1,000 for the registration of patent rights. Kirk's cost of capital is 10%. Required: Calculate the cost of the patent rights on initial recognition.

Worked solution 1 Cash paid 600,000 Deferred consideration ($400,000 x 1/1,1) 363,636 Legal fees 87,000 Stamp duty 1,000 Cost on initial recognition 1,051,636

Worked example 3 A water extraction company was obtained as part of a business combination for a cost of $1,000,000. The fair value of the net assets at the date of acquisition was $750,000. A licence for the extraction of the water had been granted to the company prior to the acquisition by the local authority for an administration fee of $1,000. Whilst extremely valuable to the company (as without the licence the business could not operate), the licence cannot be sold other than as part of the sale of the business as a whole. The fair value of the licence on acquisition was identified as $20,000. Required: Calculate goodwill arising on acquisition.

Worked solution 3 The water extraction rights were obtained as part of a business combination. Without these rights, the acquiree cannot extract water and therefore could not operate as a business. The rights cannot be sold separately without the business but the licence can be separately identified and therefore should be included in the consolidated financial statements at its fair value.

Worked solution 3 $000 Cost 1000 Net assets recognised in (750) statement of financial position Licence (20) Goodwill on acquisition 230

Exchanges of assets The cost of an intangible asset acquired in exchange for non-monetary asset (or a combination of monetary and non-monetary assets) is measured at fair value unless: The exchange of transaction lacks commercial substance; or The fair value of neither the asset received no the asset given up is reliably measurable.

Subsequent expenditure In most cases, there are no additions to an intangible asset, nor the replacement of parts of such assets. Most subsequent expenditures maintain the expected future economic benefits embodied in an existing intangible asset and do not meet the definition of an intangible asset and IAS 38 recognition criteria.

Subsequent expenditure Also, it is often difficult to attribute subsequent expenditure directly to a particular intangible asset rather than to the business as a whole. Therefore, only rarely will subsequent expenditure be recognised in the carrying amount of an asset. Normally, such expenditure must be written off through profit or loss.

Subsequent expenditure Subsequent expenditure on an acquired in-process research and development project is accounted for like any cost incurred in the research of development phase of internally generated intangible asset (see next section). Research expenditure - expense when incurred. Development expenditure - expense when incurred if it does not satisfy the asset recognition criteria. Development expenditure that satisfies the recognition criteria - add to the carrying amount of the acquired in-process research or development project.

Internally generated goodwill Internally generated goodwill should not be recognised as an asset. Although goodwill may exist in any business its recognition as an asset is precluded because it is not an identifiable resource (i.e. it is not separable nor does it arise from contractual or other legal rights) controlled by the entity that can be measured reliably at cost. Commentary When goodwill is "crystallised" by a business acquisition it is recognised as an asset and accounted for in accordance with IFRS 3.

Other internally generated assets It is sometimes difficult to assess whether an internally generated intangible asset qualifies for recognition. Specifically it is often difficult to: identify whether there is an identifiable asset that will generate probable future economic benefits; and determine the cost of the asset reliably.

Other internally generated assets Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance are not recognised as intangible assets. Commentary Such expenditures cannot be distinguished from the cost of developing the business as a whole.

Recognition of expenses and costs Expenditure on an intangible item shall be recognised as an expense when it is incurred unless: it forms part of the cost of an intangible asset that meets the recognition criteria; or the item is acquired in a business combination and cannot be recognised as an intangible asset.

Recognition of expenses and costs The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Examples include: costs of materials and services used; salaries, wages and other employment related costs; fees to register a legal right.

Recognition of expenses and costs Costs that are not components of the cost of an internally generated intangible asset include: selling, administration and other general overhead costs; identified inefficiencies and initial operating losses incurred before the asset achieves planned performance; costs that have previously been expensed (e.g. during a research phase) must not be reinstated; training expenditure.

Measurement after recognition An entity can choose either a cost or revaluation model. Cost model Cost less any accumulated amortisation and any accumulated impairment losses. Revaluation model Revalued amount, being fair value at the date of the revaluation less any subsequent accumulated amortisation and any accumulated impairment losses.

Measurement after recognition The revaluation model does not allow: the revaluation of intangible assets that have not previously been recognised as assets; the initial recognition of intangible assets at amounts other than their cost.

Useful life The useful life of an intangible asset should be assessed as finite or indefinite. Commentary A finite useful life is assessed as a period of time or number of production or similar units. An intangible asset with a finite life is amortised. "Indefinite " does not mean "infinite ".

Useful life Factors to be considered in determining useful life include: expected usage of the asset by the entity; typical product life cycles for the asset; public information on estimates of useful lives of similar types of assets that are similarly used; technical, technological, commercial or other obsolescence; expected actions by competitors or potential competitors.

Amortisation The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. Amortisation begins when the asset is available for use. Commentary When it is in the location and condition necessary for it to be capable of operating as intended.

Amortisation Amortisation ceases at the earlier of the date that the asset is: classified as held for sale; or derecognised. The amortisation method used should reflect the pattern in which the asset's economic benefits are consumed by the entity (e.g. unit of production method). If that pattern cannot be determined reliably, the straight-line method should be adopted.

Residual value The residual value of an intangible asset is assumed to be zero unless there is a commitment to purchase by a third party and there is an active market for that particular asset.

Indefinite useful lives An intangible asset with an indefinite useful life is: not amortised; but tested for impairment: — annually; and - whenever there is an indication of impairment.

Impairment losses IAS 36 Impairment of Assets contains provisions regarding: when and how carrying amounts are reviewed; how recoverable amount is determined; and when an impairment loss is recognised or reversed.

Retirements and disposals An intangible asset should be derecognised (i.e. eliminated from the statement of financial position): on disposal; or when no future economic benefits are expected from its use or disposal. Gains or losses arising are determined as the difference between: the net disposal proceeds; and the carrying amount of the asset.

Disclosure The financial statements should disclose the accounting policies adopted for intangible assets and, in respect of each class of intangible assets: whether useful lives are indefinite or finite and, if finite: the useful lives or the amortisation rates used; the amortisation methods used;

Disclosure the gross carrying amount and any accumulated amortisation (including accumulated impairment losses) at the beginning and end of the period; the line item of the statement of comprehensive income in which any amortisation is included; a reconciliation of the carrying amount at the beginning and end of the period showing all movements that have arisen in the period analysed by type.

Disclosure Disclose the nature, carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial statements as a whole; Indefinite useful life Disclose the carrying amount and reasons supporting the assessment of an indefinite useful life (this includes describing the factors that played a significant role in determining that the asset has an indefinite useful life).

Other disclosures The existence and carrying amounts of intangible assets whose title is restricted and the carrying amounts of intangible assets pledged as security for liabilities. The amount of contractual commitments for the acquisition of intangible assets.

Revaluations The following should be disclosed when assets are carried at revalued amounts: the effective date of the revaluation (by class); the carrying amount of the revalued intangible assets (by class); the carrying amount that would have been recognised using the cost model (by class);

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