IAS 38 - Intangible Assets (detailed review)
This Standard deals with the accounting treatment of Intangible Assets, which are not covered by other accounting standards including the guidance for the main issues related to the recognition & measurement of intangible assets, including relevant disclosure requirements.
The requirements of this standard are applicable for the accounting treatment of intangible assets except for the following:
Financial assets, which are covered under IAS 32
Deferred tax assets, which are covered under IAS 12
Exploration and evaluation assets, which are covered under IFRS 6
Intangible assets which are held for sale and are covered under IAS 2
Goodwill acquired in a business combination which is under IFRS 3
Lease of intangible assets, which are covered under IAS 17
Long term intangible assets which are held for sale, and are covered under IFRS 5
It is the amount of cash or cash equivalents paid or the fair value of the consideration transferred to acquire, purchase or construct an asset.
It is the systematic allocation of the depreciable amount of an intangible asset over its related useful life.
It is the value at which an intangible asset will be presented in the statement of financial position, at the end of the reporting period, and it is determined as Cost less Accumulated Amortization and Accumulated Impairment Loss.
It is the amount of an asset, which will be depreciated over its useful and is determined as the cost of an asset less its residual value.
It is the period of time for which asset will be used by the management.
Itis amount that is expected to be received to sell an asset or required to be paid to transfer a liability, in an orderly transaction between market participants at the date of measurement (IFRS 13).
It is the estimated net disposal proceeds that an entity would currently obtain from disposal of the asset, if the asset were already in the condition and situation which is expected to be, at the end of its useful life.
It is the application of research findings or knowledge to produce new or significantly improved material, device, product, process, system or service before the start of commercial production or use.
It is the original and planned investigation undertaken for the purpose of gaining new scientific or technical information and understanding.
These are identifiable, non-monetary assets and do not have physical existence, controlled by entity from which future economic benefits are expected.
As per the definition of intangible asset under this standard, an intangible asset must be identifiable, to be distinguished from the goodwill, which is covered under IFRS 3. An asset will be identifiable if it meets any one of the following:
(a) It is separable, i.e. it is capable of being separated from the business entity and sold, transferred, licensed, rented or exchanged, either on individual basis or along with the related contractor
(b) It arises from a contractual legal right, irrespective of the fact whether those rights are transferable or separable from the business entity.
The definition of intangible asset requires that the intangible asset must be controlled by the entity, and an entity controls an intangible asset if it has ability to obtain economic benefits related to the asset and can restrict others from such benefits. Normally control arises through a legal contract or when an entity has absolute right of use of asset. For example:
Market share, customer loyalty and staff technical knowledge may give rise to future economic benefits. An entity controls those benefits if, these are protected by having customer contracts, trade agreements and legal contracts with employees. However, in the absence of legal contract entity has insufficient control over related future economic benefits and in such a case these will not qualify to be recognize as intangible assets.
Recognition and Measurement
An intangible asset may arise in following ways:
1. Intangible Assets Separately Acquired:
These are individually purchased from the external parties and these will be recognized, if following criteria is satisfied:
(a) It should meet the definition of intangible asset and
(b) The recognition criteria given in IASB’s framework i.e.
The future economic benefits are probable to flow to the entity and
The cost of the asset is reliably measurable.
These are initially measured at Cost, which comprises:
Less any Trade Discount or Rebate,
Plus any directly related cost which includes
Sales tax and Import duties (if non-refundable), Legal charges, Pre-production testing cost (Net expense) and any other cost which is essential in bringing the asset into its operating or intended use by the management.
The capitalization of cost will cease when the asset becomes available for operating or intended use by the management.
(a) Following elements of cost will not be added to the cost of asset rather these will be charged to statement of profit or loss as an expense:
Any general and administrative overheads
- Initial operating losses
2. Intangible Assets acquired as part of Business Combination:
If there is an intangible asset related to subsidiary at the date of business combination, the acquirer will recognize such intangible asset in the consolidated financial statements in accordance with IFRS 3, separately from the goodwill at Fair Value at the date of business combination, and it is irrelevant whether that asset has been recognized in the financial statements of subsidiary such as brand name, trademarks, customer relationships and market share.
3. Acquisition by way of Government Grant:
An entity may acquire an intangible asset free of cost, or for nominal consideration, as a result of a government grant. It may be the case when government transfers to the entity intangible assets such as airport landing rights, telecommunication license, or import license.
The entity will recognize such intangible assets either at Fair Value or at Nominal Cost including directly attributable expenditure in accordance with IAS 20.
4. Intangible Asset acquired in Exchange:
An entity may acquire an intangible asset in exchange for a non-monetary asset or combination of non-monetary and monetary assets, then the cost of the intangible asset acquired in exchange will be determined as follows:
(a) If Transaction of Exchange has Commercial Substance:
The transaction of exchange will be deemed to have commercial substance if:
The risk, timing and amount of cash flows related to the intangible asset acquired are different from the asset transferred;
The exchange has resulted in the change in the entity specific value of that operational portion of the entity
The change in (a) and (b) above is material.
In such circumstances the entity will determine the cost of the Intangible asset acquired in exchange as:
The fair value of asset transferred ± cash,
If the fair value of asset transferred is not determinable , then it will be recognized at the fair value of asset acquired,
Any gain or loss on the exchange transaction will be charge to statement of profit or loss.
(b) If Transaction of Exchange does not have Commercial Substance:
If the transaction of exchange does not have commercial substance or the fair value of asset transferred and the intangible asset acquired both are not determinable, then the intangible asset acquired will be recognize at the carrying value of asset transferred, which will result in no gain or loss on exchange.
5. Internally Generated intangible Assets:
These are generated by the entity using its own resources over the passage of time. These are accounted for as follows:i. Internally Generated Goodwill
Internally generated goodwill, brand name, customer loyalty, market share, labor skills or advance knowledge, mastheads, trademarks and advertisement costs are not allowed to be recognized as an intangible asset because:
These are not identifiable as per the definition of intangible asset i.e. (not separable from the business) and
- These do not have cost distinguished from the regular activities of the business.
Other internally generated intangible assets which are generated by the entity as part of research and development activities will be accounted for, by dividing these into following two phases:
(a) Research Phase
(b) Development Phase
(a) Research Phase
Research phase is the initial or inception stage of the project and the entity cannot demonstrate that an intangible asset exists which will generate economic benefits in future. Therefore, the whole of the cost incurred during the research phase will be charged to statement of profit or loss as an expense.
The research phase activities may include:
Activities undertaken by the entity for the purpose of obtaining new knowledge;
Activities undertaken to find out alternatives for material, device, product, or a processes.
(b) Development Phase
The development phase comes after the initial research phase and it may include the following activities:
The design, preparation, finalization and testing of prototypes or models before the start of commercial use
The designing and preparation of tools, jigs, structures and dies containing advance or new technology
The designing, preparation and testing of a final selected alternative for new or
advanced material, device, product, process, or a systems.
The cost incurred under the development phase will be capitalized as an intangible asset if the following capitalization is satisfied:
Ability to use and sell
Intention to complete the project
The completion of the project is technically feasible
The project is expected to generate economic benefits in future i.e. profitable
Availability of all the technical, human and financial resources
The cost of development is reliably measurable.
If the cost under development phase does not meet the above capitalization criteria, it will be charged to the statement of profit or loss as an expense.
The capitalization of development phase cost will commence right from the date, when the project meets the capitalization criteria as above.
- The costs under development phase that may be capitalized as an intangible asset include:
(a) Cost of material used for development
(b) Cost of employee services, which are engaged in the development of project
(c) Professional fee paid to get the legal title of asset (registration fee)
(d) Any depreciation or amortization of the assets that are used for the development of intangible asset.
(e) Cost of preparing the prototype, before the start of commercial production
(f) Any other cost which incurred for the development of the intangible asset.
(g) Any interest cost incurred under development phase, if it satisfies the criteria given in IAS 23.
- The capitalization of cost will cease when the asset becomes available for operating or intended use by the management.
- Following are the elements of cost under development phase which cannot be capitalized, and are charged to the statement of profit or loss as an expense:
(a) Any cost of administrative and selling overheads
(b) Cost of initial operating losses
(c) Cost of staff training to operate the asset
The development phase cost which is initially recognized as expense is allowed to be reinstated as intangible asset later on, in future.
If the entity is unable to differentiate between the research and development phase then all the cost incurred on the project will be charge to the statement of profit or loss as an expense.
- If the capitalized development cost as an intangible asset:
(a) Has limited life, then it will be amortized using appropriate method as per the pattern of economic benefits, if pattern of economic benefits is not identifiable, then use straight line method.
(b) Has unlimited useful life, then it will not be amortized and entity is required to apply annual impairment test as per IAS 36.
The amortization of intangible asset will start when it is available for commercial use by the entity.
In-Process Research and Development Project acquired Separately or in a Business Combination:
Any in-process research and development project acquired separately or as part of a business combination can be recognized as an intangible asset, if it meets the definition of intangible asset.
- Any expenditure on the in-process and development project incurred after the acquisition will be treated as follows:
(a) It will be recognized as an expense, if it is research expenditure
(b) It will be recognized as an expense, if it is development expenditure and does not satisfy the capitalization criteria
(c) It will be capitalized in the carrying value of the project, if it is development expenditure and satisfies the capitalization criteria
The entity has two options to account for the Intangible assets at reporting date as a choice of accounting policy;
1. Cost Model:
If an entity chooses to measure the intangible asset under Cost model at reporting date, then such intangible assets will be measured at Cost less accumulated amortization less accumulated impairment loss.
(a) It is the systematic allocation of the depreciable amount of an intangible asset over its related useful life.
(b)The amortization charge of the intangible asset for the accounting period will be charged to the statement of profit or loss as an expense. However, if the intangible asset is being used in the construction of another asset, then the amortization charge will be added to the cost of such asset under construction or being produced.
(c) The residual value of the intangible asset will assumed to be zero unless an active market exists, from which residual value can be determined or there is purchase commitment from the third party at the end of its useful life.
(d) The entity will continue to amortize the intangible asset which has limited useful life, even if the fair value of asset is higher than its carrying value. However, any amortization will not be charged if the residual value of the intangible asset exceeds its carrying value.
(e) The amortization charge will commence, when the intangible asset is available for operating use or intended use by the management.
(f) The entity will cease amortization charge when either, the intangible asset is classified as held for sale under IFRS 5, or the intangible asset is de-recognized from the statement of financial position.
(g) The intangible assets having indefinite life will not be amortized and will be tested for impairment annually as per IAS 36.
(a) The amortization method should reflect the pattern of economic benefits from the intangible asset. If the pattern of economic benefits is not determinable, then use straight line method.
(b) The entity should review the amortization method selected at each reporting date and if there is any change in the pattern of consumption of economic benefits related to the intangible asset, then the entity should change the amortization method in accordance with the new pattern of consumption of economic benefits and such change will be accounted for as change in accounting estimate, which will be applied prospectively from that date.
- The entity should consider the following aspects in determination of the useful life of the asset:
(a) The expected use of the intangible asset including its production capacity or output.
(b) The product life cycle related to the intangible asset.
(c) Any expected change in the demand of the product related to the intangible asset due to commercial or technical changes in the market.
(d) Any legal restriction on the asset in terms of its use.
(e) Future actions of competitors in the market.
(f) Any subsequent expense required on the intangible asset to obtain future economic benefits
- An intangible asset will be deemed to have an indefinite useful life if, based on an analysis of all of the relevant factors, there is no determinable time period over which the asset is expected to generate economic benefits for the entity.
- The entity should review the useful life the intangible asset at each reporting date, if it has changed as of the original estimate the entity should also revise the useful life accordingly following the change, it will be accounted for as change in accounting estimate, and it will have Prospective Application in accordance with IAS 8.
- The useful life of the asset is a matter of judgment, according to the expected use of the asset by management.
- The useful life of the asset which arises from a legal contract should not exceed its contractual life.
Any impairment will be determined as per the requirements of IAS 36.
2. Revaluation Model:
If an entity chooses to measure the intangible asset under Revaluation model at reporting date, then such assets will be measured at Revalued Amount less subsequent accumulated amortization less subsequent accumulated impairment loss.
The entity should consider the following points in revaluation:
(a) Normally the revalued amount of intangible asset is taken as fair value from the active market.
(b) The standard does not allow the revaluation for the intangible assets which are initially measured at other than the cost.
(c) The frequency of revaluation depends upon the volatility of the market related to the intangible asset.
(d) Revaluation should be performed regularly enough, so that the carrying value of intangible asset should not be materially different from its revalued amount.
(e) When the intangible asset is revalued, its accumulated amortization charge to the date of revaluation will be reset to zero, as it will be reflected in its revalued amount.
(f) Once an intangible asset is revalued, the whole class of such intangible asset has to be revalued, to avoid the presentation of assets in the same category at different cost and values with different valuation dates. However, if no active market exits for a particular intangible asset it will be measured at cost less accumulated amortization less accumulated impairment loss.
(g) Any increase in the carrying value of the intangible asset resulting from revaluation will be recognized in other comprehensive income and will be accumulated in a separate column of the statement of changes in equity until the disposal date. However first, it will reverse any loss related to the same intangible asset up to the extent it is recognized in the previous years.
(h) Any decrease in the carrying value of the intangible asset resulting from the revaluation will be recognized in statement of profit or loss as expense. However first, it will offset any revaluation surplus related to the same intangible asset up to the extent it is recognized in the previous years.
(i) If amortization charge on the basis of revalued amount of the intangible asset exceeds the original depreciation charge, then the excess will be transferred out of the revaluation surplus to the retained earnings as realization of the revaluation surplus. However, this transfer is optional and if opted by the entity then it will be applicable annually till the disposal of related intangible asset.
(j) Any remaining revaluation surplus in the statement of changes in equity will be transferred as whole to the retained earnings when the related intangible asset is de-recognized from the statement of financial position.
An entity will de-recognize the intangible asset from statement of financial position when:
(a) The intangible asset is disposed off or
(b) No economic benefits are expected either from use or from sale of the intangible asset
Any gain or loss on the disposal of intangible asset will be charged to the statement of profit or loss which will be the difference between carrying value of the intangible asset and its disposal proceeds.
If the intangible asset is sold on extended credit period or on deferred installment basis, then its disposal proceeds will be taken as cash price equivalent and any excess over the cash price will be treated as Interest Income which will be recognized over the period of credit.
The entity is required to disclose the following in respect of the intangible assets:
Intangible assets having indefinite useful life
Useful life of Intangible assets having limited useful life
Amortization method used for the intangible assets with limited useful life
Carrying value and accumulated amortization at the start of the year
The line item in the statement of profit or loss, in which amortization charge is included.
- A statement reconciling the carrying value at the start of the period to the carrying value at reporting date which includes:
(a) Any additions identifying the intangible assets separately purchase and internally developed along with any disposals during the year
(b) Any assets acquired as part of a business combination
(c) Any revaluation increase or decrease or impairment loss recognized in the current year
(d) Depreciation charge for the year
(e) Assets classified as held for sale under IFRS 5
(f) Any exchange differences arising on translation of foreign currency assets.
Any change in accounting estimate during the current year such as change in residual value, useful life or amortization method
For intangible assets having indefinite life, the factors supporting such assessment
- Intangible assets which are acquired by way of government grant and are recognized at fair value, the entity will disclose:
(a) Initial fair value
(b) Carrying value at year end
(c) Measurement model at reporting date
Intangible assets which are subject to pledge arrangements
Class of intangible assets which are revalued
Date of revaluation
Carrying value of such intangible assets
Carrying value that would have been if such assets have not been revalued
Amount of expenditure under research phase in the current year.
Intangible assets which are fully amortized but are still under use by the entity.
AB Ltd started a research and development project to develop a new production process on 1 January 2011. The research phase lasted on 30 April 2011 and incurred a cost of $500. The development phase started from 1 May 2011 and incurred atotal expenditureof $2,000 up to 31 December 2011, of which $1800 was incurred up to 1 December 2012, and $200 was incurred between 1 December 2011 and 31 December 2011.
The director of AB Ltd stated that, at 1 December 2011, the production process met the criteria for recognition as an intangible asset.
During 2012, further expenditure incurred was $4,000 and the project was completed successfully. However, At the end of 2012, the recoverable amount of this new production process is estimated to be $3800.
How this will be accounted for in the financial statements of AB Ltd for the year ended 31 December 2011 and 31 December 2012.
Year ended 31 December 2011:
Research expense of $500 up to 30 April 2011 and development expenditure of $1,800 from 1 May 2011 to 1 December 2011 will charge to statement of profit or loss as an expense.
As the capitalization criteria is met on 1 December 2011 therefore, development cost of $200 from 1 December 2011 to 31 December 2011 will be capitalized as intangible asset in the year ended 31 December 2011.
Year Ended 31December 2012:
The development cost of $4,000 will be added capitalized development expenditure recognized in the previous year. Hence total capitalized development expenditure as intangible asset is $$4,200.
However, this has a recoverable value of $3,800 in comparison with carrying value of $3800 which will result in impairment loss of $400 in the year ended 31 December 2012.
AB Ltd is a public listed company. It has asked for your opinion in respect of the accounting treatment of the following matter for the year to 31 December 2011.
On 1 December 2011 AB Ltd acquired Darby, a small pharmaceutical drug company that specializes in research and development. The purchase consideration was $70 million. The fair value of Darby's net assets was $30 million (excluding the items referred to below). Darby owns a patent for an established successful drug that has a remaining life of 8 years. A firm of experts has estimated the current value of this patentto be $20 million. Also included in Darby's statement of financial position is $4 million for medical research that has been conducted on behalf of a client.
Darby has developed and patented a new drug which has been approved for medical use. The costs of developing the drug were $24 million. Based on early assessments of future cash flows, it has an estimated market value at $40 million.
Darby's manufacturing process has recently received a favorable inspection by government officials. Consequently, the company has been allotted a license free of cost, for a period of 10 years to manufacture a new drug. The firm of experts has placed a value of $20 million on it.
Darby has spent $6 million sending its staff on specialist training courses, in the current year. These courses have been expensive, they have led to a marked improvement in production quality, increase in revenue and cost reductions. The directors of Darby believe these benefits will continue for at least two years and wish to treat the training costs as an intangible asset.
Explain how the above items will be treated in the financial statements of AB Ltd for the year to 31 December 2011.
Intangible assets may arise as a result of business combination and this standard requires intangible assets related to subsidiary which arises as part of business combination, to be recognized at fair value, separately from the goodwill. Therefore, the patents related to Darby will be recognized at fair value of $20 million.
As the research project is acquired as part of business combination and this is being conducted on behalf of a client not for the Darby’s own business, therefore, it will also be recognized as intangible asset.
Following assets will be recognized on the date of acquisition:
|Cost of Investment||70|
|- Fair value of Net Assets acquired:|
|In-Process Research for client||(4)|
The development phase cost of the internally generated intangible asset is capitalized as intangible asset if it satisfies the capitalization criteria given in IAS 38. As it is stated that the drug has been approved for clinical use, therefore it will be recognized as an intangible asset at its Cost of $24 million. The market value is irrelevant at initial recognition.
IAS 38 requires, intangible assets which arises as a result of government grant are recognized either at fair value or nominal cost. Therefore, the license received from government will be recognized at a fair value of $ 20 million.
IAS 38 does not allow the recognition of training cost as an intangible asset as the future actions of employees are not in the control of the entity. Therefore, such cost will be charged to the statement of profit or loss as expense.