Lecture 1 - Intangible Assets

Question 1

Give examples of intangible assets?

Answer 1

Development costs
Software
Brands
Licences
Franchise fees
Customer lists
Industrial property (Inventions, Trademarks, Designs)
Copyright (Literary and artistic works)

Question 2

Why are advertising expenditure and goodwill not intangible assets?

Answer 2

Matching principle – cannot measure with reliability the future economic benefits of this asset. Goodwill is the reputation of the firm – relationship with banks, suppliers etc. It’s very hard to measure goodwill. Cannot measure the value of employees so it’s not an intangible asset.

Question 3

What is the definition of an intangible asset?

Answer 3

IAS 38 defines an intangible asset as “an identifiable, non-monetary asset without physical substance”.
An asset is identifiable when it arises from legal rights or when it is “separable”.
An asset is separable if it “is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged”.
Monetary assets are defined as “money held and assets to be received in fixed or determinable amounts of money”.

Question 4

How do you recognise an intangible asset?

Answer 4

According to the IFRS conceptual framework, 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 to the entity.
However, even if an item satisfies the definition of an asset, it should be shown on the statement of financial position of a firm, only if
a) it is probable that future economic benefits will flow to the enterprise and
b) the item has a cost or value that can be measured with reliability.

Question 5

How should the probability of expected future economic benefits be assessed?

Answer 5

The probability of expected future economic benefits should be assessed on the basis of reasonable and supportable assumptions about economic conditions affecting the asset.
– logically, they must be expected to yield future economic benefits or the buyer would not make the investment; and
– the fact that there is a transaction means that the cost can normally be ascertained reliably and without too much difficulty.

Question 6

Elements of Cost?

Answer 6

Purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and
Any directly attributable cost of preparing the asset for its intended use.
– “Directly attributable costs” include both employee costs and professional fees associated with bringing the asset to its working condition.
Eg projecter costs £100, £20 delivery and £30 installation – total cost will be £150, the sum of the projector. Just the projector would have no benefit, to make it work and to give benefits it needs to be delivered and installed.

Question 7

How do we treat goodwill?

Answer 7

Although it is traditionally considered as an intangible asset – because it is a non-identifiable intangible asset.

Question 8

How is goodwill recognised?

Answer 8

Goodwill is recognised only in a business combination.
It is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.
The future economic benefits may result from synergies between the identifiable assets acquired or from assets that, individually, do not qualify for recognition in the financial statements.

Question 9

Why can Goodwill not be treated as an asset?

Answer 9

Internally generated goodwill cannot be treated as an asset because it does not meet the criteria of being separable or arising from contractual or other legal rights. Internally generated/inherent/non-purchased goodwill is different than purchased goodwill as this type of goodwill has a convenient cost figure.

Question 10

How do we treat internally developed intangible assets?

Answer 10

Internally generated intangible assets are commonly expensed when they are incurred.
In particular, internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets.
Expenditure on these items cannot be distinguished from the cost of developing the business as a whole.
However, these items can be recognised as intangible assets when they are acquired in a business combination or as separate assets.
The cost of such an intangible asset is its fair value at the acquisition date and it reflects market participants’ expectations at the acquisition date (fair value is NOT the market value) about the probability that the expected future economic benefits embodied in the asset will flow to the entity.

Question 11

When are internally developed intangible assets capitalised?

Answer 11

Under certain circumstances, expenditure classified as development costs must be capitalised.
In particular, a company has to define the ‘research’ and the ‘development’ phase regarding the development of an asset/product/process.
In principle, research expenditure must be expensed as incurred while development expenditure must be capitalised (if certain criteria are met).
Certain Criteria:
1. Technical feasibility of completion
2. Availability of resources to complete
3. Intention to complete and ability to use/sell the asset
4. Probability of future economic benefits
5. Ability to measure expenditure reliably

Question 12

How do we define research expenditure?

Answer 12

Research is defined as “original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding”.
Search for alternatives
Materials
Products
Processes
Evaluation of alternatives
Under IAS 38, no intangible asset should be recognised resulting from research or from the search phase of an internal project. Expenditure on research should be recognised as an expense when incurred.

Question 13

How do we define development expenditure?

Answer 13

Development is “the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services before the start of commercial production”.
It includes activities such as:
(a) the design, construction, and testing of pre-production prototypes and models;
(b) the design of tools, molds, and dies involving new technology;
(c) the design, construction, and operation of a pilot plant that is not economically feasible for full commercial production; and
(d) the design, construction, and testing of a chosen alternative for new or improved material, devices, products, processes, systems, or services.
Development costs are recognised as an internally generated intangible assets, only when the technical, economic, and financial viability of the product or process being developed is assured.

Question 14

R&D Intensity Ratio

Answer 14

R&D Expense/Sales

Question 15

Knowledge Intensity Ratio

Answer 15

R&D Expense/ Number of Employees

Question 16

Annual Growth Rate of R&D

Answer 16

(R&D Expenses Y2- R&D Expenses Y1)/R&D Expenses Y1) X 100

Question 17

Potential other Intangible Assets

Answer 17

1.Start-up costs
E.g. incorporation fees, legal fees, underwriting fees, accounting and promotional fees. IAS 38 prohibits such capitalisation; they should be treated as expenses in the income statement in the period they incurred.
2.Advertising expenditure
IAS 38 requires expenditures on advertising costs to be expensed as incurred as its difficult to estimate the economic benefit coming in.
IAS 38 does not provide any exception to allow for the capitalisation of direct-response advertising as provided in US GAAP.
3.Software costs
Computer software for a computer-controlled machine tool that cannot operate without that specific software is an integral part of the related hardware and it is treated as PPE. The same applies to the operating system of a computer.
When the software is not an integral part of the related hardware, computer software is treated as an intangible asset.
With regard to the latter in particular, if it is purchased or it is developed internally and the amount is material, it is capitalised. Similar is the permitted practice under US GAAP.

Question 18

Subsequent measure of Intangible Assets

Answer 18

According to IAS 38, Intangible Assets may be measured using either:
a) the cost model, where items are carried at cost less any accumulated amortisation (i.e. depreciation) and less any accumulated impairment losses or
b) the revaluation model, where items are carried at fair value at the date of revaluation (sufficiently regular intervals), less any subsequent accumulated amortisation (i.e. depreciation) and less any subsequent accumulated impairment losses.
Notes
1. It is very rare a company to follow the revaluation model for measuring its intangible assets.
2. The revaluation model is not permitted under US GAAP and under the (converged with IFRS) Chinese GAAP.
Depreciation and amortization are the same- depreciation refers to plant, property and equipment etc whereas amortization is for intangible assets.

Question 19

Useful lives of intangible assets

Answer 19

UnlIke PPE (with the exception of land), an intangible asset may have an indefinite useful life or a finite—limited—useful life. 
If there is no foreseeable limit to the period the asset is expected to generate net cash inflows, it is identified as having an indefinite life and it is not amortised.
•	An intangible asset with indefinite useful life is tested for impairment annually and when there is any indication that it may be impaired. (This is also the case for goodwill.) 
•	The assumption of an indefinite useful life is reassessed annually. 
•	It is not uncommon firms to recognise intangible assets with indefinite useful lives (usually trademarks and brands).

Question 20

Intangible Assets with finite useful lives

Answer 20

IAS 38 requires that the depreciable amount of an intangible asset with a finite useful life should be amortised over that useful life.
Depreciable amount is “the cost of the asset, or other amount substituted for cost, less its residual value”.
The residual value of an intangible asset with a finite useful life is assumed to be zero, unless a third party is committed to buy the asset at the end of its useful life, or there is an active market for the asset and its residual value can be determined by reference to that market

Question 21

Amortisation of Intangible Assets

Answer 21

The amortisation method chosen in relation to an intangible asset should match the usage pattern of that asset.
Available amortisation methods include the same methods discussed regarding PPE
(i.e. the straight-line method, diminishing balance method etc.)
If the asset’s usage pattern cannot be estimated reliably, the straight-line method should be used.

Question 22

Intangible Assets: Mandatory Disclosures

Answer 22

As for PPE, companies are required to provide extensive disclosures regarding intangible assets. These included (but not limited to) the following:
For each class of intangible asset, distinguishing between internally generated assets and others:
• whether the useful lives are indefinite or finite
• if finite, the useful lives or amortisation rates used
• the amortisation methods used
• the gross carrying amount and accumulated amortisation at the beginning and end of the accounting period
• the line item in the statement of comprehensive income in which amortisation is included
• a reconciliation of the carrying amount at the beginning and end of the period, showing additions, disposals, revaluation increases and decreases, amortisation, impairment losses and any other movements.