If an intangible asset is revalued upwards, the increase in value should be credited…
IAS® 38 Intangible Assets is one of the key standards in the Financial Reporting (FR) exam, covering how companies should account for intangible assets. This standard can be examined in all sections of the exam. A well-prepared candidate needs to be able to understand and explain the key principles of the standard, in addition to preparing calculations. These calculations mainly relate to the initial recognition or subsequent measurement of the asset. Show 1. Definition of an intangible assetAn intangible asset is defined under International Financial Reporting Standards (IFRS®) as ‘an identifiable, non-monetary asset without physical substance’. This definition is already a little unhelpful for students, and this article will break it down more. (a) Identifiable Separable intangible assets will be items that can be separated from the entity as a whole, meaning that they could be acquired from the entity without having to acquire the entire company. Items which may be categorised as separable intangible assets are commonly items such as licences or patents, where one entity can acquire the rights from another. In addition to this, brand names are also likely to be separable. A company may operate many different product lines and may be willing to sell one of those brands, which could be done without selling the entire company. It is important to note that internally generated brands cannot be capitalised (ie recognised on the statement of financial position), which will be covered later in the article. Legal/contractual rights often arise in consolidated accounts. For example, if an entity wanted to buy a controlling share in a company with many long-term contracts with major customers, these contracts would be recognised at fair value in the consolidated financial statements as key assets acquired with the subsidiary. In an entity’s individual accounts, legal/contractual rights might relate to something like a franchise agreement which the entity is not permitted to sell on to a third party. A franchise agreement such as this would still be identifiable for the purposes of the entity’s individual financial statements because it arose from legal/contractual rights, even though it cannot be sold separately. (b) Non-monetary
asset (c) Without physical substance EXAMPLE: In 20X3, Entertain Co entered into negotiations to acquire the Gadgetworks brand from Gadget Co for $1.2 million. This would give Entertain Co the ability to sell products under the Gadgetworks brand and give access to the Gadgetworks web domain name. Entertain Co did not wish to acquire any other assets of the Gadget Co business, such as the other brands or properties so therefore had no interest in acquiring the Gadget Co business as a whole. In this example, the Gadgetworks brand is clearly separable as negotiations are underway to acquire it separately from the rest of the Gadget Co business. It is a non-monetary asset and it has no physical substance. Therefore, assuming the recognition criteria discussed later in this article are met, it would be recognised as an intangible asset in the individual statement of financial position of Entertain Co at the cost of $1.2m (Dr Intangible Asset, Cr Cash). Financial Reporting exam focus: 2. Initial recognition of intangible assetsOnce it has been determined that an item meets the definition of an intangible asset, the entity must determine whether it meets the recognition criteria. An intangible asset can only be recognised if it is probable that the expected future economic benefits (eg revenue from the sale of products or services) that are attributable to the asset will flow to the entity and the cost of the asset can be measured reliably. (a) Purchased intangible assets (b) Internally generated intangible assets Common misconceptions include the belief that training costs can be capitalised. Even though these may bring future benefit to the business, these costs cannot be separated from the entity and the company retains no legal or contractual right to these. This is because staff have a right to leave the company at any point, subject to their notice period, so the company cannot restrict the access of this economic benefit to others. In addition to this, internally generated brands are specifically prohibited from being recognised. This has created a problem where some of the major assets in modern businesses can go unrecognised. (c) Research and development costs Probable economic benefits Intention to complete the project Resources available to complete the project Ability to use or sell the item Technologically feasible Expenses on the project can be identified In practice, an auditor will look at these criteria and determine if these have been met on the project. The principle of the six criteria is that an asset can only be recognised when a project has cleared hurdles such as regulatory testing, and the entity can demonstrate a willingness and ability to complete the project. If the six criteria are met, then the entity can recognise an asset at cost. A key principle here is that costs can only be recognised as an asset from the point all six are met, up to the date that the project is complete. Any costs incurred before the criteria are met are expensed to the statement of profit or loss as they are incurred. Similarly, any costs associated with research into a new product will be incurred much earlier than the six criteria being met, so these would also be expensed. Even though assets can be recognised for development costs, this is another area of criticism from the financial reporting community. These assets can only be recognised towards the end of the process, when the six criteria are met. This means that any asset recognised is still likely to be at a significantly lower value than the actual expected economic benefit to be realised from the asset itself. (d) Consolidated financial statements EXAMPLE: Res Co are developing a new line of pharmaceuticals and have spent $2m up to 1 January 20X5. On 1 January 20X5 the board gave approval to fully fund the rest of the project following promising results and spent a further $1m to 1 April 20X5. On 1 April 20X5 problems were discovered in the trials and approval was not given from the medical regulator for use of the pharmaceuticals. Res Co spent a further $1m to 1 July 20X5, at which point approval was given. From 1 July 20X5 to 1 October 20X5 Res Co spent $1.5m putting the product into the final finished stage of development. The new pharmaceuticals are expected to generate revenues in excess of $20m and have a useful life of five years. In the financial statements of Res Co, only $1.5m of expenditure could be capitalised, as it is only from 1 July 20X5 that all of the development criteria are met. Even though the asset is likely to generate significant benefit and a total of $5.5m of costs have been incurred as part of research and development, the previously expensed costs cannot be recognised as assets. Financial Reporting exam focus: The recognition of internally generated intangible assets within the consolidated financial statements is regularly examined within section C of the exam. Candidates may be asked to produce calculations based on this fair value but may also be asked to explain why they are recognised in the group but not in individual company financial statements. 3. Subsequent measurement of intangible assetsSimilar to the principles of IAS 16 Property, Plant and Equipment there are two major models for accounting for intangible assets. These are the cost model and the revaluation model, and the methods used in the application are very much in line with the IAS 16 methodology. (a) Cost model (b) Revaluation model The main problem with revaluations under IAS 38 is that an item can only be revalued if there is an active market in place. This means that transactions would be taking place with sufficient regularity and volume to provide pricing information on an ongoing basis. This is unrealistic in practice as intangibles tend to be unique by their very nature. The examples quoted by the standard involve items such as fishing quotas and taxi licences, which goes some way to show that the standard itself is a little dated. Financial Reporting exam focus: EXAMPLES: From the earlier examples of Entertain Co and Res Co, both of these would be held under the cost model. The useful life of the Gadgetworks brand would need to be established. If there is a finite life, it would be amortised over this. If not, it would have to have an annual impairment review. The development costs of the pharmaceuticals would be amortised over the useful life of five years. Neither asset would qualify for being held under the revaluation model. Both are specific to the companies so would not have identical items regularly traded in order to assess a true market price. ConclusionThe principles of intangible assets are key to both the FR and Strategic Business Reporting (SBR) exams. You should be aware of the general principles of how to account for them in addition to the necessary calculations. While IAS 38 is a key standard, there is an argument to be made that IAS 38 was not written with modern technological companies in mind. The standard was written in 1998, the same year as the first MP3 player which cost $200 and could hold a total of 1 hour’s music. It is fair to say that the rules of the standard may fail to capture some of the key value in modern entities. This means that many modern technology firms have brands that are unrecognised on the statement of financial position, causing large discrepancies between a company’s market value and the value of the assets recorded in its financial statements. The International Accounting Standards Board (IASB) have acknowledged this problem, and it may well be that it is added to its standard-setting agenda in future periods. Written by a member of the FR examining team Can intangible assets be revalued upwards?Revaluation model.
Intangible assets may be carried at a revalued amount (based on fair value) less any subsequent amortisation and impairment losses only if fair value can be determined by reference to an active market.
Can you increase the value of an intangible asset?Develop Your Intangibles Depending on the timing of your sale, it may be possible to create new intangible assets as well as increase the value of intangible assets that already exist. You can also make intangible assets more tangible.
When an intangible asset is sold the gain or loss is Recognised?An intangible asset with a finite useful life is amortised and is subject to impairment testing. An intangible asset with an indefinite useful life is not amortised, but is tested annually for impairment. When an intangible asset is disposed of, the gain or loss on disposal is included in profit or loss.
What are the two conditions that must be present for the recognition of an intangible asset?An intangible asset shall be recognised if, and only if: (a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and (b) the cost of the asset can be measured reliably.
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