ACCA F7 (INT) Financial Reporting - Study text - 2010

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Chapter 8: Intangible assets

1.2 Definition of an intangible asset

An intangible asset is ‘an identifiable, non-monetary asset without physical

substance’. This definition does not therefore apply to:

 items of property, plant and equipment, which physically exist, or

 assets such as receivables and cash, which are monetary assets.

Control

An asset is a resource controlled by the entity as a result of past events and from

which future economic benefits are expected to flow. This definition is useful in

deciding whether an intangible item meets the criteria for treatment as an intangible

asset.

 For tangible assets such as property, plant and equipment the asset physically

exists and the entity controls it.

 However, in the case of an intangible asset, control may be harder to achieve or

prove.

Control would usually arise where there are legal rights, for example legal rights

over the use of patents or copyrights. Ownership of legal rights would indicate

control over them. However, some entities have tried to capitalise ‘intangibles’ such

as the costs of staff training or customer lists. These would fail the control test

because an entity does not control them.

 Staff training. Staff training creates skills that could be seen as an asset for the

employer. However, staff could leave their employment at any time, taking with

them the skills they have acquired through training.

 Customer lists. Similarly, control is not achieved by the acquisition of a

customer list, since most customers have no obligation to make future

purchases.

Need to be identifiable

An intangible asset must also be ‘identifiable’. Intangibles, by their very nature, do

not physically exist. It is therefore important that this ‘identifiability test’ is satisfied.

IAS38 states that to be identifiable an intangible asset:

 must be separable, or

 must arise from contractual or other legal rights.

To be separable, the intangible must be capable of being separated or divided from

the entity, and sold, transferred, licensed, rented or exchanged.

Many typical intangibles such as patent rights, copyrights and purchased brands

would meet this test, (although they might fail other recognition criteria for an

intangible asset).

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1.3 Recognition criteria for intangible assets

If an item meets the definitions of being an asset, and being intangible, certain

recognition criteria must be applied to decide whether the item should be

recognised as an intangible asset.

These recognition criteria are broadly the same as those specified in IAS16 for

tangible non-current assets. IAS38 states that an intangible asset should be

recognised in the financial statements of an entity only when:

 it is probable that expected future economic benefits arising from the asset will

flow to the entity, and

 the cost of the intangible asset can be measured reliably.

Economic benefits can arise in the form of sales revenue from products or services,

cost savings, or other benefits.

1.4 Internally-generated intangibles

An internally-generated intangible asset is an asset created by an entity through its

own efforts. (An internally-generated asset differs from an acquired asset that has

been purchased from an external seller.) For example, a publishing company may

build up legal copyrights by publishing books.

It can sometimes be difficult for an entity to assess whether an internally-generated

asset qualifies for recognition as an asset in the financial statements. This is likely to

be because:

 it fails the ‘identifiability test’, or

 its cost cannot be determined reliably.

Although IAS38 does not ban completely the recognition of internally-generated

intangibles, it does prohibit the recognition as non-current assets of the following

internally-generated intangible items:

 goodwill

 brands

 mastheads (Note: a masthead is a recognisable title, usually in a distinctive

typographical form, appearing at the top of an item. An example is a newspaper

masthead on the front page of a daily newspaper)

 publishing titles

 customer lists.

IAS38 prohibits the recognition of these items as intangible assets because the

internal costs of producing these items cannot be distinguished separately from the

costs of developing and operating the business as a whole.

If some of the items in the above list of intangibles are purchased from another

business entity, then they might be recognised as intangible assets. This is because

the fact of the purchase means that the asset must exist separate from the business

Chapter 8: Intangible assets

as a whole and there is a cost attached to it that can be measured reliably (which is

the purchase cost of the item).

IAS38 does not prohibit the recognition of all internally-generated intangibles as

intangible assets in the financial statements. The main internally-generated

intangible considered by IAS38 is research and development expenditure, and if

certain criteria are met, IAS38 requires development expenditure to be ‘capitalised’

and treated as an intangible asset.

1.5 Research and development expenditure

Definitions

The term ‘research and development’ is commonly used to describe work on the

innovation, design, development and testing of new products, processes and

systems. IAS38 makes a clear distinction between ‘research’ and ‘development’.

 Research is defined as original and planned investigation undertaken to gain

new scientific or technical knowledge and understanding.

 Development is the application of research findings or other knowledge to a

plan or design for the production of new or substantially improved products,

processes, systems or services before the start of commercial production or use.

Examples of research activities include:

 Activities aimed at obtaining new knowledge

 The search for and evaluation of applications of knowledge obtained from

research

 The search for alternative materials, products or processes

 The formulation and testing of possible alternatives for new materials, products

or processes.

Examples of development activities include:

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

 The design of tolls involving new technology

 The construction and operation of a pilot plant that is not large enough for

economic commercial production

 The design, construction and testing of new materials, products or processes.

Accounting treatment of research costs

Expenditure on research should be recognised as an expense as it is incurred and

included in profit or loss for the period. Research costs cannot be an intangible asset.

(Any property, plant and equipment used in research or on a research phase, such

as laboratory equipment, could be capitalised in accordance with IAS16 and

depreciated. The depreciation charge is a revenue expense.)

IAS38 states: ‘No intangible asset arising from research … shall be recognised.

Expenditure on research … shall be recognised as an expense when it is incurred.’

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Accounting treatment of development costs

Development costs must be recognised as an intangible asset, but only if all the

following conditions can be demonstrated.

 It is technically feasible to complete the development project.

 The entity intends to complete the development of the asset and then use or sell

it.

 The asset that is being developed is capable of being used or sold.

 Future economic benefits can be generated. This might be proved by the

existence of a market for the asset’s output or the usefulness of the asset within

the entity itself.

 Resources are available to complete the development project.

 The development expenditure can be measured reliably (for example, via costing

records).

If any of these conditions is not met, the development expenditure should be

treated in the same way as research costs and recognised in full as an expense when

it is incurred, and cannot be treated as an intangible asset.

Once such expenditure has been written off as an expense, it cannot subsequently be

reinstated as an intangible asset. Expenditure on development may only be

capitalised and treated as an intangible asset if it is incurred after all the conditions

for recognition of the development costs as an intangible asset have been met.

Example

Entity Q has undertaken the following activities during Year 1.

(1) Training of sales staff at a cost of $50,000. Additional revenue as a result of

training the staff to a higher level of skill is expected to be in the region of

$500,000.

(2) Development of a new product. Total expenditure on development of the

product has been $800,000. All of the conditions for recognising the

development costs as an intangible asset have now been met. However,

$200,000 of the $800,000 was spent before it became clear that the project was

technically feasible, could be resourced and the developed product would be

saleable and profitable.

Required

Consider how the above amounts will be dealt with in the financial statements of

Entity Q for Year 1.

Answer

Training costs. These must be written off as an expense in full when they are

incurred. The ‘asset’ (the training costs) is not controlled by Entity Q. The cost is

controlled by the staff who could leave at any time.

Chapter 8: Intangible assets

Development costs. The $200,000 incurred before all of the conditions for

recognising the development costs as an intangible asset were met must be written

off as an expense. The remaining $600,000 should be capitalised and recognised as

an intangible asset (development costs).

1.6 Measurement of intangibles

Initial measurement

Intangible assets should be measured initially at their cost.

The cost of a purchased intangible asset is its purchase price.

The cost of an internally-generated intangible asset (such as development

expenditure) is the expenditure incurred from the date when the asset first meets

the recognition criteria. It should not include:

 selling, administrative and other general overheads

 training costs

 advertising expenditure.

Measurement of intangible assets after initial recognition

As with IAS16 and tangible non-current assets, having recognised an intangible

asset, the entity should then choose between:

 the cost model, or

 the revaluation model.

This is an accounting policy choice and the selected policy must be applied

consistently across each class of intangible assets.

Under the cost model, assets are carried at cost minus any accumulated

amortisation and any accumulated impairment losses. (Amortisation is the

intangible asset equivalent to depreciation.)

Under the revaluation model, assets are carried at fair value, minus any

accumulated amortisation and any accumulated impairment losses. Fair value must

be determined by reference to an active market. Revaluations must be carried out

regularly, so that at the end of any reporting period, the carrying amount of the

asset in the statement of financial position is not materially different from its fair

value.

An active market is defined as one where:

 the items traded are ‘homogenous’ (all the same)

 willing buyers and sellers can be found at any time, and

 market prices are available to the public.

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If no such market exists for the asset (and in practice, due to the unique nature of

intangibles, such a rarely will exist for intangible items) then the cost model must be

adopted.

1.7 Amortisation and impairment of intangible assets

The useful life of an intangible should be assessed as being either:

 finite, or

 indefinite.

A finite useful life is a useful life that will come to an end, within a foreseeable

time. An indefinite useful life is one where there is no foreseeable limit to the

asset’s useful life.

Intangibles with a finite useful life

Where the useful life is assessed as finite:

 the intangible should be amortised over its estimated useful life

 its residual value is usually assumed to be zero

 amortisation charges should be charged as an expense in each period over the

useful life of the asset

 if there are any indications of impairment, then an (IAS36) impairment review

should be carried out.

Intangibles with an indefinite useful life

Where the useful life is assessed as indefinite:

 the intangible asset should not be amortised

 impairment reviews should be carried out annually (and even more frequently

if there are any indications of impairment).

1.8 Disposals of intangible assets

The rules for de-recognition of intangible assets (accounting for their ‘disposal’) are

the same as for property, plant and equipment under IAS16. There is a gain or loss

on disposal equal to the difference between the net disposal proceeds and the

carrying value of the asset at the time of disposal.

1.9 Disclosure requirements

In the financial statements, disclosures should be made separately for each class of

intangible asset. (Within each class, disclosures must also be made by internally-

generated intangibles and other intangibles, where both are recognised.)

Most of the disclosure requirements are the same as for tangible non-current assets

in IAS16. The only additional disclosure requirements are set out below.

Chapter 8: Intangible assets

 Whether the useful lives of the assets are finite or indefinite.

 If the useful lives are finite, the useful lives or amortisation rates used.

 If the useful lives are indefinite, the carrying amount of the asset and the reasons

supporting the assessment that the asset has an indefinite useful life.

Example

An example is shown below of a note to the financial statement with disclosures

about intangible assets



Internally‐

generated

developmentcosts

Software

licences



Goodwill



Total

 $m$m$m$m

Cost

    

Atthestartoftheyear 290 649001,254

Additions 60 14 ‐74

Additionsthroughbusiness

combinations

‐  ‐  20 20

Disposals (30) (4) ‐(34)



–

––

–

––

–

––

–

––––

Attheendoftheyear 320 749201,314



–

––

–

––

–

––

–

––––

Accumulateddepreciation

andimpairmentlosses

    

Atthestartoftheyear 140 31120291

Amortisationexpense 25 10 ‐35

Impairmentlosses‐‐15 15

Accumulatedamortisationondisposals 10 2 ‐12



–

––

–

––

–

–––

–

–––

Attheendoftheyear 175 43135353



–

––

–

––

–

–––

–

–––

Netcarryingamount

    

Atthestartoftheyear 150 33780963



–

––

–

––

–

–––

–

–––

Attheendoftheyear 145 31785961



–

––

–

––

–

–––

–

–––

 For any intangible asset that is individually material to the financial statements,

the following disclosure is required:

− a description

− its carrying amount

− the remaining amortisation period.

 The total amount of research and development expenditure written off (as an

expense) during the period must also be disclosed.

Paper F7: Financial reporting (International)

Goodwill: IAS38 and IFRS3

 Purchased goodwill: IAS38 AND ifrs3

 Non-purchased goodwill

 Negative goodwill: IFRS3

2 Goodwill: IAS38 and IFRS3

2.1 Purchased goodwill: IAS38 and IFRS3

Purchased goodwill arises when one business buys another. It is calculated as the

difference between the purchase cost of the acquisition and the fair value of the (net)

assets acquired:

Cost of acquisition X

Minus: Fair value of the net assets acquired

(at the date of the acquisition)

(X)

–

–––

Purchased goodwill X

–

–––

A purchaser is usually willing to pay more than the fair value of the net assets

acquired because almost all businesses have some goodwill. Goodwill may exist for

a number of reasons: the reputation of the business, a good list of customers or a

good geographical location. Purchased goodwill is recognised in the financial

statements.

In contrast, the goodwill that a business generates itself as it operates over time

(internally-generated goodwill) is not recognised in the financial statements as an

intangible asset.

Purchased goodwill is recognised because it has a measurable value, and arises as a

result of a business transaction at a point in time. The transaction is the acquisition

of the other business, and the goodwill is measurable (as shown above). The fact

that the buyer of the business sis willing to pay a price in excess of the value of net

assets acquired indicates a probability that future economic benefits will flow to the

buyer; therefore the goodwill also meets the definition of asset in this sense.

Goodwill is defined by IFRS3 as an asset representing future economic benefits

arising from other assets acquired in a business combination that are not capable of

being individually identified and separately recognised.

An essential difference between goodwill and other intangible assets is that

goodwill is not separable (it cannot be sold separately) from the other assets of the

business.

Chapter 8: Intangible assets

Purchased goodwill is the difference between the purchase price for a business and

the fair value of the net assets acquired. In order to calculate the purchased

goodwill, the fair value of the net assets acquired must include all other separately

identifiable assets, including any separately-identifiable intangible assets. Otherwise

goodwill itself will be overstated.

The separately-identifiable intangible assets of the purchased business cannot

include any goodwill in the statement of financial position of the business being

acquired. This is because any such goodwill cannot be sold separately, without the

business as a whole.

Example

Entity R buys the business of S, a sole trader, and pays $350,000 as the purchase cost.

At the date of acquisition, the fair value of the assets of S was $420,000 and the fair

value of its liabilities was £90,000.

Required

Calculate the goodwill arising on the acquisition of S in the books of Entity R.

Answer

Cost of acquisition 350,000

Minus: Fair value of net assets acquired (420 – 90) (330,000)

–

–––––––

Purchased goodwill 20,000

–

–––––––

This purchased goodwill will be recognised in the financial statements of Entity R at

its cost of $20,000.

Where goodwill arises on the acquisition of a subsidiary or associated company it is

covered by IFRS3 Business combinations. This goodwill in business combination is

not covered by IAS38).

Brief summary of purchased goodwill and IFRS3

The main provisions of IFRS3 are described in later chapters on consolidated

accounts, which is where this type of purchased goodwill appears. However, the

main provisions in IFRS3 about the treatment of goodwill arising on an acquisition

of a subsidiary can be summarised as follows.

 Goodwill arising on acquisition is recognised in the statement of financial

position as an intangible non-current asset.

 Purchased goodwill arising on acquisition is not amortised, but reviewed for

impairment annually.

Paper F7: Financial reporting (International)

2.2 Non-purchased goodwill

Non-purchased goodwill does not meet the recognition criteria for an intangible

asset, so it is not recognised in the financial statements.

2.3 Negative goodwill: IFRS3

In very unusual circumstances, purchased goodwill might be ‘negative’. This will

happen if the price paid to acquire another business is less than the fair value of the

net assets acquired. IFRS3 refers to this as a ‘bargain purchase’, which might occur

for example when a seller is forced into a sale of its business at a knock-down price.

In this situation:

 the calculation of goodwill should be checked carefully (because negative

goodwill is very unusual and should arise only rarely)

 any negative goodwill should be taken as a gain to the consolidated statement of

comprehensive income for the period in which the acquisition or purchase

occurs, as an addition to the profit for the period.

Negative goodwill is not recognised in the statement of financial position.

ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing

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