Professional Documents
Culture Documents
Required
Which of the above items is a cost that is eligible for capitalization as an intangible asset?
Solution
(a) The legal cost of acquiring the copyright can be capitalized.
(b) Operational costs during the start-up period are not allowed to be capitalized.
(c) Massive advertising campaign to launch the artist is not allowed to be capitalized.
Required
What is the proper accounting treatment for the various costs incurred during 20X5?
Solution
Treatment of various costs incurred during 20X5 depends on whether these costs can be capitalized or
expensed as per IAS 38. Although IAS 38 is clear that expenses incurred during the research phase
should be expensed, it is important to note that not all development costs can be capitalized. In order
to be able to capitalize costs, strict criteria established by IAS 38 should be met. Based on the criteria
prescribed by IAS 38, these conclusions can be drawn:
(1) It could be argued that the technical feasibility criterion was established at the end of August
20X5, when the first prototype was produced.
(2) The intention to sell or use criterion was met at the end of August 20X5, when the sample was
tested with the air-conditioning component to ensure it functions. But it was not until October
20X5 that the products marketability was established. The reason is attributable to the fact that
the entity had doubts about the new models being compatible with the air conditioners and that
the sample would need further testing, had it not functioned.
(3) In October 20X5, the existence of a market was clearly established.
(4) The financial feasibility and funding criterion was also clearly met because Extreme Inc. has
obtained a loan from venture capitalists and it had the necessary raw materials.
(5) Extreme Inc. was able to measure its cost reliably, although this point was not addressed
thoroughly in the question. Extreme Inc. can easily allocate labor, material, and overhead costs
reliably.
Therefore, the costs that were incurred before October 20X5 should be expensed. The total costs that
should be expensed = $175,000 + $250,000 + $300,000 + $80,000 = $805,000.
The costs eligible for capitalization are those incurred after October 20X5. However, conference costs
of $50,000 would need to be expensed because they are independent from the development process.
Thus there are no total costs to be capitalized in terms of IAS 38.
Case Study 3
Facts
Costs generally incurred by a newly established entity include
(a) Preopening costs of a business facility
(b) Recipes, secret formulas, models and designs, prototype
(c) Training, customer loyalty, and market share
(d) An in-housegenerated accounting software
(e) The design of a pilot plan
(f) Licensing, royalty, and stand-still agreements
(g) Operating and broadcast rights
(h) Goodwill purchased in a business combination
(i) A company-developed patented drug approved for medical use
(j) A license to manufacture a steroid by means of a government grant
(k) Cost of courses taken by management in quality engineering management
(l) A television advertisement that will stimulate the sales in the technology industry
Required
Which of the above-mentioned costs are eligible for capitalization according to IAS 38, and which of
them should be expensed when they are incurred?
Solution
Costs that are eligible for capitalization include items (b), (e), (f), (g), and (h); for item (j), after initial
recognition at cost, both the asset and the grant can be recognized at fair value.
These costs are eligible for capitalization under IAS 38 because
They meet the criteria of identifiability (i.e., they are separable or they arise from contractual
rights).
It is probable that future economic benefits will flow to the entity.
These costs can be measured reliably.
Costs that should be expensed because they do not meet the criteria under IAS 38 include items
(a), (c), and (d). Item (i) is a case of an internally generated intangible asset that can be capitalized
only provided it meets the development criterion. The main issue with item (k) is that the entity does
not have control over its workforce. Despite the obvious benefit of item (l) to the business, such
expenditure on advertisement does not meet the criterion of control.
Case Study 4
Active Asset Inc. owns a freely transferable taxi operators license, which it acquired on January 1,
20X1, at an initial cost of $10,000. The useful life of the license is five years (based on the date it is
valid for). The entity uses the straight-line method to amortize the intangible.
Such licenses are frequently traded either between existing operators or with aspiring operators. At the
balance sheet date, on December 31, 20X2, due to a government-permitted increase in fixed taxi fares,
the traded values of such a license was $12,000. The accumulated amortization on December 31,
20X2, amounted to $4,000.
Required
What journal entries are required at December 31, 20X2, to reflect the increase/decrease in carrying
value (cost or revalued amount less accumulated depreciation) on the revaluation of the operating
license based on the traded values of similar license? Also, what would be the resultant carrying value
of the intangible asset after the revaluation?
Solution
The journal entries to be recorded in the books of account are
Dr Intangible assetaccumulated amortization $4,000
Cr Intangible assetcost $4,000
(Being elimination of accumulated depreciation against the cost of the asset)
Dr Intangible assetcost $6,000
Cr Revaluation reserve $6,000
(Being uplift of net book value to revalued amount)
The net result is that the asset has a revised carrying amount of $12,000 ( $10,000 $4,000 + $6,000).