CHAPTER 31

INTANGIBLE ASSETS
Goodwill

TECHNICAL KNOWLEDGE

To know the criteria in defining an intangible asset.

To know the initial and subsequent measurement of an

intangible asset.

To understand amortization and impairment of intangible

assets.

To understand the nature of goodwill as an intangible

asset.

To know the residual approachof measuringgoodwill.

To know the direct approachof measuringgoodwill

 Definition

PAS 38, paragraph 8, simply defines an intangible asset as

an identifiable nonmonetary asset without physical substance.

Paragraph 8 further states that the intangible asset must

be controlled by the entity as a result of past event and from
which future economic benefits are expected to flow to the
entity.

Accordingly, there are three essential criteria in the

definition of an intangible asset, namely:

a. Identifiability
b. Control
0. Future economic benefits

Identifiability
The definition of an intangible asset requires that an
intangible asset must be identifiable in order to distinguish
it clearly from goodwill.

With nonphysical items, there may be a problem with

identifiability.

An asset is identifiable when:

a. It is separable.

This means that the asset is capable of being separated

from the entity and sold, transferred, licensed, rented
or exchanged, either individually or together with a
related asset or liability.

b. It arises from contractual or other legal rights.

This is regardless of whether these rights are

transferable or separable from the entity or from other
rights and obligations.
Control

Another element in the definition of an intangible asset is

that "it must be under the control of the entity as a result of
a past event."

Control is the power of the entity to obtain the. future

economic benefits flowing from the intangible asset and
_restrict the access of others to those benefits.

In othei' words, the entity must be able to enjoy the future

economw benefits from the asset and prevent others from
enjoying the same benefits.

The capacity of an entity to control the future economic

benefits from an intangible asset normally would stem from
legal rights that are enforceable in a court of law.

The capacity to control future economic benefits is much

pronounced in the case of trademark, copyright and patent.

In the absence of legal rights, it is more difficult to

demonstrate control.

However, legal enforceability of a right is not always a necessary

condition for control since an entity may be able to control the
future economic benefits in some other way.

For example,onemethodof centralis keepingsomething

secret
through employee confidentmlzty.

The skill of employees, arising out of the benehts of training

costs,cannot be recognized as intangible asset because the entity
does not control the future actions of the staff.

Similarly, market share and customer loyalty cannot normally

be recognized as intangible asset because an entity cannot
control the actions of the customers.

Customers cannot be forced to buy from the entity and can go

elsewhere.
Future economic benefits

Future economic benehts may include revenue from the sale of

products or services, cost savings or other benefits resulting
from the pse of the asset by the entity.
\

For example, the use of intellectual property in aproduction

process or the legal right to use a new technology, may reduce
future produCtion costs rather than increase future revenue.

Recognition of an intangible asset

An intangible asset shall be recognized if the following

conditions are present: -

a. It 1sprobable that future economicbenefits attributable to

the asset will flow to the entity.

b. The cost'of the intangible assetcan be measuredreliably.

Judgment is usually exercised in assessing the degree of certainty

of the future economic benefits.

The judgment is based on external evidence.

Initial measurement of intangible asset

PAS 38, paragraph 24, provides that an intangible asset shall

be measured initially at cost.

The cost of an intangible asset depends on the following:

Separate acquisition
Acquisition as part of a business combination

9997?Acquisition
Acquisition
Acquis'mon
by way of a government
by exchange
grant

by self-cre ation or internal generation

 Separate acquisition

If an intangible asset is acquired separately, the cost of the

intangible asset can be measured reliably, particularly so if
the purchase consideration is in the form of cash or other
monetary assets.

The cost of a separately acquired intangible asset comprises:

a. Purchase price
15. Import duties and nonrefundable purchase taxes,
c. Directly attributable costs of preparing the asset for the
intended use .

Directly attributable costs include the following:

a. Costs of employee benefits arising directly from bringing

the asset to its working condition.

b. Professional fees arising directly from bringing the asset

to its working condition.

c. Costs of testing whether the asset is functioning properly.

Costs which are not capitalizable

0

Examples of costs that are not included in the cost of an

intangible asset but expensed innnediately are:

a. Costs of introducing a new product or service, including

costs of advertising and promotional activities

b. Costs of conducting business in a new location or with a

new class of customer, including costs of staff training

0. Administration and other general overhead costs

(1. Costs incurred while an asset capable of Operating in a

manner intended by management has yet to be brought Into
use

8. Initial operating loss

////
Acquisition as part of business combination
If an intangible asset is acquired in a business combination, the
cost of the intangible asset is based on the fair value on the date
of acquisition.

Acquisition by government grant

An intangible asset may be acquired by way of a government

grant, free of charge or for nominal consideration.

This may occur when a government transfers or allocates to an

entity intangible assets such as:

a. Airport land rights

b. Licenses to operate radio or television stations
0. Import licenses or quotas or rights to access restricted
resources.

The intangible asset acquired by way of government grant may

be initially recorded at either:

Fair value

Nominal amount or zero, plus any expenditure that is

directly attributable to preparing the asset for its intended
use.

Acquisition by exchange

The cost of the intangible asset is measured at fair value of the

asset given up plus any cash payment, unless the exchange
transaction lacks commercial substance.

If the exchange transaction lacks commercial substance, the

intangible asset is measured at the carrying amount of the asset
given up plus any cash payment.

An exchange transaction lacks commercial substance when

the cash flows of the asset received do not diiTer signihcantly
from the cash flows of the asset transferred.

898
 Internally generated intangible asset
The cost of an internally generated intangible asset comprises
all directly attributable costs necessary to create, produce and
prepare the asset to be capable of operating it in the manner
intended by managemenh

Examples of directly attributable costs are:

a. Cost of materials and services used or consumed in

generating the intangible asset.

b. Costs of employee benehts arising from the generation of

the intangible asset.

C. Fees to register a legal right.

d. Amortization of patents and licenses that are used to
generate the intangible asset.

However, the following expenditures are not components of

the cost of an internally generated intangible asset:

a. Selling, administrative and other general overhead, unless

this expenditure can be directly attributed to preparing the
asset for use.

andinitial operating
Clearlyidentifiedrinefficieticies losses
incurred before an asset achieves planned performance.

Q. Expenditure on training staff to operate the asset.

PAS 38, paragraph 63, explicitly provides that "internally

generated brands, mastheads, publishing titles, customer lists
and items similar in substance shall not be recognized as
intangible assets".

Such items cahnot be identified separately from the cost of

developing the business as a whole.

Instead, such items are seen as being components of internally

generated goodwill.

Accordingly, such expenditures shall be expensed when

incurred.
*

899
 Recognition as an expense
An eXpenditure on an intangible item that does not meet the
recognition criteria for an intangible asset shall be expenaed
when incurred.

Examples of expenditures that are expensed when incurred

include:

a. Start up costs
Start up costs may consist of organization costssuch as legal
and secretarial costs incurred in establishing a legal entity.
Start up costs also include preopening costsor expenditures
to open a new facility or business, and preoperatmg costsor
expenditures for commencmg new operation or launching
new product.

b. Training costs
0. Advertising and promotional costs
(1. Business relocation or reorganization costs

Subsequent expenditure
As a rule, a subsequent onan intangibleassetshall
expenditure
be recognized as expense.
The reason is that most subsequent expenditures are likely to
maintain only the expected future economic benefits embodied
in the intangible asset.
However, the subsequent expenditure may be capitalized or
added to the cost of the intangible asset if the following
recognition criteria for an intangible asset are met:
a. It is probable that future economicbeneiits that are attributable
specifically to the subsequent expenditure will flow to the
entity.

b. The subsequentexpenditure can be measured reliably.

The nature of an intangible asset is such that, in many cases,
it is not possible to determine whether subsequent
expenditure is likely to enhance the economic benefits that
will flow to the entity from the intangible asset.
Therefore, only rarely will a subsequentexpenditure on an
intangible asset result to an addition to the cost of the
intangible asset.
900
 mentitiable intangible assets

PASo38 specifically pertains to identifiable intangible assets.

If the intangible asset is acquired through purchase, there is
a transfer of legal right that would make the asset
identifiable.
Moreover, if the asset could be sold, transferred, licensed,
rented or sold separately, the intangible asset is identifiable.

9'»
Examples of identifiable

es Patent
Copyright
Franchise
intangible assets are: I

W? Trademark
Customer
Computer
Broadcasting

Unidentifiable
or brandname
list
software
license,

intangible
airline right

asset
and fishing right

An intangible asset is unidentifiable if it cannot be sold,

'
transferred, licensed, rented or exchanged separately.

The intangible asset is inherent in a continuing business and

can only be identified with the entity as a whole.

This unidentifiable intangible asset squarely describes a

goodwill.

Classification of intangible assets

a. Intangible assets with definite life

Typical examples include patent, copyright, franchise

with fixed term, computer software, customer list and
license.

1). Intangible assets with indefinite life

Typical examples include goodwill, trademark and

Perpetual franchise.

901
Measurement after recognition

either thecostmodelor revaluation

Anentityehanchoose
model as an accounting policy.

1. Cost model An intangible asset shall be carried at cost,

less any accumulated amortization and any accumulated
. impairment loss.

2. Revaluation model - An intangible aeeet shall be carried

at a revalued amount, less any subsequent amortization
and any subsequent accumulated impairment loss.

The revalued amount is the fair value at the date of

revaluation and is determined by reference to an active
market.

Thus, an intangible asset can only be carried at revalued

amount if there is an active market for the asset.

Amortization and impairment of intangible assets

PAS 38, paragraph 97, states that intangible assets with

limited or finite life are amortized over their useful life.

Intangible assets with finite useful life are tested for

impairment whenever there is an indication of impairment at
the end of reporting period.

Paragraphs 107 and 108 state that intarigible assets with

indefinite life are not amortized but are tested for
impairment at least annually and whenever there is an
indication that the intangible asset may be impaired.

An impairment loss on an intangible asset is recognized if the

recoverable amount is less than the carrying amount.

The recoverable amount of the intangible asset is the higher

between fair value less cost of disposal and value in use.

902
Definition of amortization

Amortization is the systematic allocation of the amortizable

amount of an intangible asset over the useful life. The
amortizable amount is the coat of the intangible asset leu
residual value.

The amortization is recorded by debiting amortization expense

and crediting the intangible asset account.

Normally, the intangible asset accountis credited directly for

the periodic amortization but an accumulated amortization
account may be maintained.

Amortization period
The amortizable amount of an intangible asset shall be
amortized on a systematic basis over the useful life.

Amortization shall begin when the asset is available for use,

meaning, when the asset is in the location and condition for
the intended use.

Amortization shall cease when the intangible asset is

derecognized or when the asset is classiiied as "held for sale".
,

Useful life

The useful life of an intangible asset must be assessed as

either indefinite or finite.

If finite, the useful life may be expressed in terms of years

or the number of units to be produced.

The useful life of an intangible asset is indefinite when there

is no foreweable limit to the period over which the asset is
expected to generate net cash flows.

In other words. the useful life is indefinite when there are

no legal, contractual, competitive and other factors that
would limit the useful life of the intangible asset.

903
 Factors affecting useful life
a. Technical, technological, commercial or other type of
obsolescence
Expected action. by competitors or potential competitor.
Expected usage of the asset by the entity

resumes!"
F
. Typical product 1ife cycle ibr the asset
Stability of the industryin which the assetOperates
Level of maintenance expenditure required to obtain the
expected futUre economic benefits from the asset
The useful life of the asset may be dependent on the useful
life of other assets of the, entity
h. Period of control over the asset and legal or similar limits
on the use of the asset, such as expiry dates of related leases.

Amortization method
The method of amortization shall reflect the pattern in which
the future economic benefits from the asset are expected to be
consumed by the entity.

However, if such pattern cannot be determined reliably,

the straight line method of amortization shall be used.

Residual value

The residual value of an intangible asset shall be presumed to

be zero, except:

a. When a third party is committed to buy the intangible asset

at the end of the useful life.

b. When there is an active market for the intangible asset so

that the expected residual value can be measured and it is
probable that there will be a market for thé asset at the end
of the useful life.

The residual value is reviewed at each financial year-end.

A change in the residual value is accounted for as a change in
accounting estimate.
The residual value of an intangible asset may increase to amount
equal to or greater than the carrying amount.

904
Change in amortization method and useful life

The amortization method and the useful life of an intangible

asset shall be reviewed at each financial year-end.

If the expected useful life of the intangible asset is significantly

different from previous estimate, the amortization period shall
be changed accordingly.

If there has been a significant change in the expected pattern

of economic benefits from the asset, the amortization method
shall be changed to reflect the new pattern.

Such changes shall be accounted for as changes in accounting

estimates and therefore, shall be treated currently and
prospectively.

Derecognition of an intangible asset

An intangible asset shall be derecognized or eliminated from

the statement of financial position:

a. On disposal of the asset

b. When no future economic benefits are expected from use

and disposal of the asset

Gain and loss arising from the derecognition of an intangible

asset shall be determined as the difference between the net
disposal proceeds and the carrying amount of the asset.

905
Disclosures related to intangible assets

1. Whether useful lives are indefmite or hnite, ,and if hnite,

the useful lives or the amortization rate.

The amortization method.

The gross carrying amount and any accumulated

amortization at the beginning and end of the period.

The line item in the incomestatement'in which any

amortization of intangible asset is included.

Additions, separately showing those internally generated,

acquired separately and acquired through business
combination.

Intangible assets classif1ed as held for sale

Increases and decreases in intangible assets resulting

from revaluations.

8. Impairment losses and reversal of impairment losses.

9. Net exchange differences on translation.

10. The carrying amount of intangible asset with indefinite

life and the reason for the indefinite life.

11. The carrying amount and remaining amortization period

of intangible assets that are material

12. The carrying amount of intangible asset whose title is

restricted or pledged as collateral security.

13. Contractual commitments for intangible assets.

14. Intangible assets acquired by way of government grant

and initially recognized at fair value.

15. The amount of research and development expenditure

recognized as expense during the period.

906
GOODWILL
Goodwill is undeniably a unique asset presented in the humid
statements.

Goodwill is often referred to as the most intangible of all

intangible assets.

Goodwill is unique in the sense that goodwill standing alone

cannot be bought and sold.

The goodwill can only be identihed with the entity as a whole.

Goodwill is an intangible asset that is not specifically identifiable,

has an indeterminate life, is inherent in a continuing business
and relates to the entity as a whole.

What is goodwill?

Goodwill arises when earnings exceed'normal earnings by reason

of good name, capable staff and personnel, high credit standing,
reputation for fair dealings, reputation for superior products,
favorable location and a list of regular customers.

In other words, goodwill is created by a good relationship

between an entity and its customers:

a. By building up a reputation by word of mouth for high quality

products or high standard of service.
b. By responding promptly and helpfully to queries and
complaints of customers.
c. Through the personality of the staff and their attitude to
the customers.

Goodwill changes from day to day.

Goodwill is continually changing.

One act of bad customerrelationsmight damage goodwilland
one act of good relations might improve goodwill.

907
Recognition of goodwill

In recognizing goodwill, distinction should be made between

developedgoodwill and purchased goodwill.

Developed goodwill or internal goodwill is that goodwill which is

generated internally because of good name, capable staff and
personnel,superior quality of products,Eavorablelocation and high
credit standing.

Such homegrown" goodwill is not recorded.

The measurement of internal goodwill may prove to be

difficult and a great deal of subjectivity and
misrepresentation might occur.

PAS 38, paragraph 48, provides that internally generated

goodwill shall not be recognized as an asset.

Purchased goodwill is the goodwill that has been paid for.

Purchased goodwill arises when a business is purchased.

People wishing to set up a business either would start the

business from scratch or buy an existing business.

When an entity acquires an existing business, it Will have to

pay not only for the net tangible and identifiable intangible
assets but also the goodwill of the business.

Purchased goodwill is recognizedas an asset because it has

been paid for.

Measurement of goodwill

The measurement of goodwill is not really a problem for

accountants who will simply record the goodwill in the
accounts of the new business.

The value of goodwill is a matter for the purchaser and seller

to agree upon in fixing the purchase price of the business.

Two approaches may be followed in measuring goodwill,

namely residual approach and direct approach.

908
 RBSidual approach
Under.
this approach, is measured
goodwill the
purchasePrice for the bycomparing
entity
- with the net tangible
'
and
identifiable
. . , ,assets
g total
~ . meamn assets excludm g goodw111
minushabllltlesassumed.
The net assets
acquired must be measured at fair value.
thepurchase
9.350933.
0f priceoverthefairvalue
of net
tangible/
Th;
qn adenttftableassetsis consideredas gOOdLUill-

'fllhisis knowri
asthe"residual because
approach" is
goodwill
SlmP_1Y
the reSLdual
after deductingthefairvalueof net tangible
and identlfiable assets from the purchase price for the entity
a'greed upon between the buyer and the seller. I

Illustration - Residual
approach
An entity purchased an ongoing businessfer P9,000,000 cash.

The assets and liabilities of the acquired business measured

at fair value are as follows:

Assets

Cash 500,000
Accounts receivable 1,500,000
Inventory 2,500,000
Property, plant and equipment 4,000,000
Patent 1,300,000 9,800,000

Liabilities

Accountspayable 1,600,000
Notespayable 1,000,000
Accruedliabilities 200,000 2,800,000
Netassetsat fair value 7,000,000
' 9 . 000 . 000
r109
base
mhgaoqujred value
atfair 7,000,000
Goodwin W

909
 entry to record the purchase
cum

500,000
receivable
23mm 1,500000
Inventory . 2,500,000
plantandequipment
Property, 4,000,000
Patent 1,300,000
Goodwill 2,000,000
Accounts payable 1,600,000
Notes payable 1,000,000
Accrued liabilities 200,000
Cash . 9,000,000

Ditect approach
Under this approach, goodwill is measured on the basis of
the future earnings of the entity. An attempt is made to value
the anticipated excess earninés which are the essential
component of goodwill.

This approach seems to be a systematic and logical way of

measuring goodwill because if future earnings exceed normal
earnings, the excess earnings are indicative of the fact that
there is an unidentifiable intangible asset that is causing '
the excess earnings. Such unidentifiable intangible asset is
called goodwill.

A sophisticated application of this approach requires the

following information:

a. A normal rate of return for representative entities in the

industry. The normal rate of return is that rate of return
which usually attracts investors in a particular industry.

b. The fair value of tangible assets and any identifiable

intangible assets.

c. The estimated future normal earnings of the entity.

d. The probable duration of any excess earnings

attributable to goodwill.

910
 Illustration Direct approach
The fOHOWing
data are availablein relationto the computation
of goodwill:

Net assets. 7, 500,000

excluding goodwill
Normal rate of return in the 12%
industry
Past earnings for 5 years
precedingthe sale:
2016 950,000'
2017 975,000
2018 950,000
2019 1,075,000
2020 1,050,000 -

5,000,000

Average earnings of the 5-year period (5,000,000/ 5) 1,000,000

Method 1 Purchase of average excess earnings

The goodwill is measured at average excessearnings for 5 years.

Average earnings 1,000,000

Normal earnings (12% x 7,500,000) 900,000

Average excess earnings 100,000

Goodwill (100,000 x 5) 500,000

Note that the normal rate of 12%is appliedonnet assets,excluding

minusliabilities).
goodwill(totalassetsbeforegoodwill
Method 2 Capitalizationof average excessearnings»

The goodwillis measuredat the averageexcessearnings

capitalizedat 25%.
excess
Average earnings 100,000
mm rate
bycapitalization 25%

Goodwnn 400,000

911
Method 3 - Capitalization of average earnings

The goodwillis measured at average earnings capitalizea nt

10%.

Average earnings ~ 1,000,000

Divide by capitalization rate 10%
Net assets,including goodwill or purchase price 10,000,000
Less: Net assets, excluding goodwill 7,500,000
Goodwill 2. 500.000

Method 4 Present value method

Under this method, the goodwill is the discounted value or

present value of the average excess earnings that are expected
to become available in future periods.

For example, if the average excess earnings of P100,000 are

expected to be received annually in 5 years, the goodwill,
assuming a discount rate of 12% is computed as follows:

Average excess earnings 100,000

Multiply by the present value of an ordinary
annuity of 1 for 5 years at 12% 3.605

Goodwill 360, 500

Impairmentof goodwill
PAS 38, paragraph 107, mandates that goodwill shall not be
amortized because the useful life is indefinite.

However, goodwill shall be tested for impairment at least

annually and whenever there is an indication that it may be
impaired.

Moreover, goodwill shall be tested for impairment at the

operating segment level or any lower level.
An impairment loss recognized for goodwill shall not be
reversed in a subsequent period.

The impairment of goodwillis extensively discussedalready

in Chapter 30.

912
 N
egative goodwill I

If 13.116
'PurChaseprice or consideration transferred for the
entlty 18less than the net fair value of the identifiable assgts
acqmrgd and liabilities assumed,the difference is negatwe
goodwzll.

.PFRS 3, paragraph34, providesthat suchnegativegoodwill

13 recogmzed 1n profit or loss as
"gain on bargain purchase".
The standard has already
dropped the term negative goodwill.
Illustration
An entity purchased an ongoing business for P8,000, 000 cash.
The assets and liabilities of the acquired business measured
at fair value are:
Cash "
500,000
Accounts receivable 2, 000,000
Inventory . 2,500,000
Land 3,000,000
'
Plant and equipment 6,000,000
Accounts payable (1 ,000,000)
Bonds payable 4, 000 ,000)
Net assets at fair value 9,000,000

Purchase price 8,000,000

N et assets acquired at fair value 9,000,000
Negative goodwill (1,000,000)

J ournal entry

Cash 500,000
Accountsreceivable 2,000,000
Inventory 2.500,000
Land 3,000,000
Plant andequipment 6,000,000
Amtaountspalyfib18 1,000,000
Bonds payable 4,000,000
Cash 8,000,000
Gain on bargainpurchase 1,000,000

918