8. Intangible Non-Current Assets Flashcards
What are licences?
How do licences appear in the financial statements? Why?
What treatment should be applied throughout their lifetime?
Licences are purchased by companies to allow them to operate in a particular area, for example, a bus company may be granted a licence to allow it to operate in certain areas in the country.
The cost of licences can be capitalised as intangible assets as the grant of the licence meets the definition of an intangible asset - that is, the licence is controlled by the entity as a result of past events and economic benefits are expected to flow from the licence.
Licences have a finite life as they are granted for a set period. They should therefore be amortised over their finite life.
What are patents?
How do patents appear in the financial statements? Why?
What treatment should be applied throughout their lifetime?
Patents on ides are designs that the business has developed or bought. Patents are legally controlled by the entity and are expected to generate income over many reporting periods.
They are initially capitalised at cost and are subject to amortisation over the period that they are expected to generate benefits.
What are brands?
How do brands appear in the financial statements? Why?
What treatment should be applied throughout their lifetime?
Brands are important for many businesses as they help to distinguish that business’s products or services from those of other businesses.
The cost of developing internally generated brands cannot be capitalised as the cost cannot be separated from the other general costs of developing the business.
The cost of purchases brands (those purchased from other businesses) can, however, be capitalised.
Brands are likely to have an indefinite useful life and therefore should not be amortised and should instead be tested annually for impairment.
What is the journal entry when an intangible asset is purchased?
How is the cost on intangible non-current assets allocated to the statement of profit and loss?
Debit - Intangible non-current assets
Credit - Cash/payables
The cost of this intangible asset will need to be allocated to the statement of profit or loss as it is matched against the income it helps to generate. This process is essentially the same as depreciation for non-current assets, but it is called amortisation.
What is the journal entry to recognise amortisation?
Debit - Amortisation expense (P&L)
Credit - Accumulated amortisation
How are intangible assets with an indefinite life amortised?
They are not amortised. Intangible assets with an indefinite useful life are required to be tested for impairment on an annual basis.
Where indicators of impairment exist, the approach to calculating and accounting for any impairment loss is the same as for tangible assets (PPE).
What is the accounting problem related to how to treat the debit balance on the development cost account at the date of the statement of financial position?
Large companies spend significant amounts of money on development activities from which they hope to generate revenues in future periods. These amounts are credited to cash or payables and debited to an account for development expenditure.
In terms of how to treat the debit balance on the development cost account, there are two possibilities:
1. The debit balance may be classified as an expense and transferred to the statement of profit or loss. This is referred to as ‘writing off’ the expenditure. The argument here is that it is an expense just like rent or wages and its accounting treatment should be the same.
2. The debit balance may be classified as an asset and included in the statement of financial position. This is referred to as ‘capitalising’ or ‘carrying forward’ or ‘deferring’ the expenditure. This argument is based on the accrual principle. If development activity eventually leads to new or improved products which generate income, the costs should be carried forward to be matched against that income in future reporting periods.
What determines whether intangible assets should be capitalised?
IAS 38, Intangible Assets, sets out the criteria that must be satisfied in order to recognise development expenditure as an asset. Knowledge of the criteria falls outside the scope of ‘Accounting’, but you should be aware that a company does not have a choice as to whether to expense or capitalise the expenditure - if the criteria are satisfied, the development expenditure must be capitalised.
What is the journal entry for development expenditure which is capitalised?
What is the accounting treatment for internally generated intangible assets?
When development expenditure is to be recognised as an asset, the accounting entries are:
Debit - Intangible non-current assets
Credit - cash/payables
Internally generated intangible assets should be amortised and tested for impairment.
What is the accounting treatment for internally generated brands?
There are some internally generated intangibles that cannot be recognised as assets as they do not meet the definition of an asset.
Whilst you are not expected to be aware of the criteria in ‘Accounting’, you should be aware that internally generated brands cannot be capitalised as an intangible asset whereas purchased brands can be capitalised.
What is goodwill?
If a business has goodwill it means that the market value of the business as a going concern is greater than the carrying amount of its assets less its liabilities in its accounting records.
How is goodwill created? (3)
Goodwill is create by good relationships between a business and its customers, for example:
1. By building up a reputation (by word of mouth perhaps) for high quality products or high standards of service.
2. By responding promptly and helpfully to queries and complaints from customers.
3. Through personality of the staff, their attitudes to customers and their skills.
How is goodwill recorded in the financial statements?
Although the value of goodwill to a business might be extremely significant, it is not usually included in the financial statements.
For example, the welcoming smiles of shop staff and its reputation for good customer service may contribute more to a supermarket’s profit than the fact that a new electronic cash register has recently been acquired; even so, whereas the cash register will be recorded in the ledger accounts as a non-current asset, the value of the staff and the supermarket’s reputation would be ignored for accounting purposes.
Why is goodwill generally not included in the financial statements? (2)
What about internally generated goodwill?
- Goodwill is inherent in the business but it has not been directly paid for, so valuation is subjective.
- Goodwill changes from day to day. One act of a bad customer relations might damage goodwill and one act of good relations might improve it. Staff with a favourable personality might retire or leave, to be replaced by staff who need time to become established.
Internally generated goodwill is not identifiable as it is not separable from the business, doesn’t arise from legal rights and is not controlled by the entity.
Internally generated goodwill cannot be recognised as an asset.
What is the exception to the general rule that goodwill is not usually included in the financial statements?
The exception to the general rule that goodwill is not usually included in the financial statements arises when an existing business is purchased.
The buyer has to pay for not only its non-current assets and inventories (and perhaps take over its payables and receivables too) but also for its goodwill.
This is why the purchase consideration for most businesses is more than the value of their net assets (the total of a business’s assets less its liabilities).
