Intangible Assets

Intangible assets are defined by PAS 38 Intangible assets as identifiable non-monetary assets
without physical substance (para. 8).

The objectives of the standard

(a) To establish the criteria for when an intangible asset may or should be recognized
(b) To specify how intangible assets should be measured
(c) To specify the disclosure requirements for intangible assets (PAS 38: para. 1)
 
Definition of an intangible asset
The definition of an intangible asset is a key aspect of the standard, because the rules
for deciding whether or not an intangible asset may be recognized in the accounts of an
entity are based on the definition of what an intangible asset is.

An intangible asset is an identifiable non-monetary asset without physical substance. The asset must be:
(a) Controlled by the entity as a result of events in the past
(b) Something from which the entity expects future economic benefits to flow (PAS 38: para. 8)

Examples of items that might be considered as intangible assets include computer

software, patents, copyrights, motion picture films, customer lists, franchises and fishing
rights. An item should not be recognized as an intangible asset, however, unless it fully
meets the definition in the standard. The guidelines go into great detail on this matter.
(PAS 38: para. 9)
 
Intangible asset: must be identifiable
An intangible asset must be identifiable in order to distinguish it from goodwill. With non-
physical items, there may be a problem with 'identifiability'.
(a) If an intangible asset is acquired separately through purchase, there may be a
transfer of a legal right that would help to make an asset identifiable.
(b) An intangible asset may be identifiable if it is separable, ie if it could be rented or
sold separately. However, 'separability' is not an essential feature of an intangible asset.
(PAS 38: para. 11)
 
Intangible asset: control by the entity
Another element of the definition of an intangible asset is that it must be under the
control of the entity as a result of a past event. The entity must therefore be able to
enjoy the future economic benefits from the asset, and prevent the access of others to
those benefits. A legally enforceable right is evidence of such control, but is not
always a necessary condition.
(a) Control over technical knowledge or know-how only exists if it is protected by
a legal right.
(b) The skill of employees, arising out of the benefits of training costs, are most
unlikely to be recognizable as an intangible asset, because an entity does not control
the future actions of its staff.
(c) Similarly, market share and customer loyalty cannot normally be intangible
assets, since an entity cannot control the actions of its customers. (PAS 38: paras. 13–
16)
 
Intangible asset: expected future economic benefits
An item can only be recognized as an intangible asset if economic benefits are
expected to flow in the future from ownership of the asset. Economic benefits may come
from the sale of products or services, or from a reduction in expenditures (cost
savings). (PAS 38: para. 17)
An intangible asset, when recognized initially, must be measured at cost. It should be
recognized if, and only if both the following occur.
(a) It is probable that the future economic benefits that are attributable to the asset
will flow to the entity.
(b) The cost can be measured reliably.
Management has to exercise its judgement in assessing the degree of certainty
attached to the flow of economic benefits to the entity. External evidence is best.
(a) If an intangible asset is acquired separately, its cost can usually be measured
reliably as its purchase price (including incidental costs of purchase such as legal fees,
and any costs incurred in getting the asset ready for use).
(b) When an intangible asset is acquired as part of a business combination (ie an
acquisition or takeover), the cost of the intangible asset is its fair value at the date of the
acquisition. (PAS 38: para. 33)
PFRS 3 Business combinations explains that the fair value of intangible assets acquired
in business combinations can normally be measured with sufficient reliability to
be recognized separately from goodwill. (PFRS 3: para. B31)
In accordance with PAS 20 Accounting for government grants and disclosures of
government assistance, intangible assets acquired by way of government grant and the
grant itself may be recorded initially either at cost (which may be zero) or fair value.
(PAS 38: para. 44)
 
Exchanges of assets
 If one intangible asset is exchanged for another, the cost of the intangible asset is
measured at fair value unless:
(a) The exchange transaction lacks commercial substance, or
(b) The fair value of neither the asset received nor the asset given up can be measured
reliably.
Otherwise, its cost is measured at the carrying amount of the asset given up. (PAS 38:
para. 45)
 
Internally generated goodwill

Internally generated goodwill may not be recognized as an asset.

The standard deliberately precludes recognition of internally generated goodwill

because it requires that, for initial recognition, the cost of the asset rather than its fair
value should be capable of being measured reliably and that it should be identifiable
and controlled. Thus you do not recognize an asset which is subjective and cannot be
measured reliably. (PAS 38: paras. 48–50)
 
Research 
Research activities by definition do not meet the criteria for recognition under PAS 38.
This is because, at the research stage of a project, it cannot be certain that future
economic benefits will probably flow to the entity from the project. There is too much
uncertainty about the likely success or otherwise of the project. Research costs
should therefore be written off as an expense as they are incurred.
Examples of research costs
(a) Activities aimed at obtaining new knowledge
(b) The search for, evaluation and final selection of, applications of research findings or
other knowledge
(c) The search for alternatives for materials, devices, products, processes, systems or
services
(d) The formulation, design evaluation and final selection of possible alternatives for
new or improved materials, devices, products, systems or services (PAS 38: paras. 54–
56)
 
Development
Development costs may qualify for recognition as intangible assets provided that the
following strict criteria can be demonstrated.
(a) The technical feasibility of completing the intangible asset so that it will be available
for use or sale
(b) Its intention to complete the intangible asset and use or sell it
(c) Its ability to use or sell the intangible asset
 (d) How the intangible asset will generate probable future economic benefits. Among
other things, the entity should demonstrate the existence of a market for the output of
the intangible asset or the intangible asset itself or, if it is to be used internally, the
usefulness of the intangible asset.
(e) Its ability to measure the expenditure attributable to the intangible asset during its
development reliably
In contrast with research costs development costs are incurred at a later stage in a
project, and the probability of success should be more apparent. Examples of
development costs include:
(a) The design, construction and testing of pre-production or pre-use prototypes and
models
(b) The design of tools, jigs, moulds and dies involving new technology
(c) The design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production
(d) The design, construction and testing of a chosen alternative for new or improved
materials, devices, products, processes, systems or services (PAS 38: paras. 57–62)
 
Other internally generated intangible assets
The standard prohibits the recognition of internally generated brands, mastheads,
publishing titles and customer lists and similar items as intangible assets. These all fail
to meet one or more (in some cases all) the definition and recognition criteria and in
some cases are probably indistinguishable from internally generated goodwill. (PAS 38:
para. 63)
 
Cost of an internally generated intangible asset

Intangible assets should initially be measured at cost, but subsequently they can
be carried at cost or at a revalued amount.

The costs allocated to an internally generated intangible asset should be only costs that
can be directly attributed or allocated on a reasonable and consistent basis to creating,
producing or preparing the asset for its intended use. The principles underlying the
costs which may or may not be included are similar to those for other non-current
assets and inventory.
The cost of an internally generated intangible asset is the sum of the expenditure
incurred from the date when the intangible asset first meets the recognition criteria. If,
as often happens, considerable costs have already been recognized as expenses
before management could demonstrate that the criteria have been met, this earlier
expenditure should not be retrospectively recognized at a later date as part of the cost
of an intangible asset. (PAS 38: paras. 65–67)
 
Recognition of an expense
All expenditure related to an intangible which does not meet the criteria for recognition
either as an identifiable intangible asset or as goodwill arising on an acquisition should
be expensed as incurred. The PAS gives examples of such expenditure:

 Start up costs
 Training costs
 Advertising costs
 Business relocation costs

Prepaid costs for services, for example advertising or marketing costs for campaigns
that have been prepared but not launched, can still be recognized as a prepayment.
(PAS 38: paras. 68–70)
 
Measurement of intangible assets subsequent to initial recognition
The standard allows two methods of valuation for intangible assets after they have been
first recognized.
Applying the cost model, an intangible asset should be carried at its cost, less any
accumulated amortization and less any accumulated impairment losses. (PAS 38: para.
74)
The revaluation model allows an intangible asset to be carried at a revalued amount,
which is its fair value at the date of revaluation, less any subsequent accumulated
amortization and any subsequent accumulated impairment losses.
(a) The fair value must be able to be measured reliably with reference to an active
market in that type of asset.
(b) The entire class of intangible assets of that type must be revalued at the same time
(to prevent selective revaluations).
(c) If an intangible asset in a class of revalued intangible assets cannot be revalued
because there is no active market for this asset, the asset should be carried at its cost
less any accumulated amortization and impairment losses.
(d) Revaluations should be made with such regularity that the carrying amount does
not differ from that which would be determined using fair value at the end of the
reporting period. (PAS 38: paras. 75–77)
The guidelines state that there will not usually be an active market in an intangible
asset; therefore the revaluation model will usually not be available. For example,
although copyrights, publishing rights and film rights can be sold, each has a unique
sale value. In such cases, revaluation to fair value would be inappropriate. A fair value
might be obtainable however for assets such as fishing rights or quotas or taxi cab
licenses. (PAS 38: para. 78)
Where an intangible asset is revalued upwards to a fair value, the amount of the
revaluation should be credited directly to equity under the heading of a revaluation
surplus.
However, if a revaluation surplus is a reversal of a revaluation decrease that was
previously charged against income, the increase can be recognized as income.
Where the carrying amount of an intangible asset is revalued downwards, the amount of
the downward revaluation should be charged as an expense against income, unless
the asset has previously been revalued upwards. A revaluation decrease should be first
charged against any previous revaluation surplus in respect of that asset. (PAS 38:
para. 80)
When the revaluation model is used, and an intangible asset is revalued upwards, the
cumulative revaluation surplus may be transferred to retained earnings when the
surplus is eventually realized. The surplus would be realized when the asset is disposed
of. However, the surplus may also be realized over time as the asset is used by the
entity. The amount of the surplus realized each year is the difference between the
amortization charge for the asset based on the revalued amount of the asset, and the
amortization that would be charged on the basis of the asset's historical cost. The
realized surplus in such cases should be transferred from revaluation surplus directly to
retained earnings, and should not be taken through profit or loss. (PAS 38: para. 87) 
 
Useful life
An entity should assess the useful life of an intangible asset, which may be finite or
indefinite. An intangible asset has an indefinite useful life when there is no
foreseeable limit to the period over which the asset is expected to generate net cash
inflows for the entity.
Many factors are considered in determining the useful life of an intangible asset,
including:

 Expected usage
 Typical product life cycles
 Technical, technological, commercial or other types of obsolescence
 The stability of the industry; expected actions by competitors
 The level of maintenance expenditure required
 Legal or similar limits on the use of the asset, such as the expiry dates of
related leases

Computer software and many other intangible assets normally have short lives because
they are susceptible to technological obsolescence. However, uncertainty does not
justify choosing a life that is unrealistically short.
The useful life of an intangible asset that arises from contractual or other legal
rights should not exceed the period of the rights, but may be shorter depending on the
period over which the entity expects to use the asset. (PAS 38: paras. 88–96)
 
Amortization period and amortization method
An intangible asset with a finite useful life should be amortized over its expected useful
life.
(a) Amortization should start when the asset is available for use.
(b) Amortization should cease at the earlier of the date that the asset is classified as
held for sale in accordance with PFRS 5 Non-current assets held for sale and
discontinued operations and the date that the asset is derecognized.
(c) The amortization method used should reflect the pattern in which the asset's
future economic benefits are consumed. If such a pattern cannot be predicted
reliably, the straight-line method should be used.
(d) The amortization charge for each period should normally be recognized in profit or
loss.  (PAS 38: paras. 97–99)
The residual value of an intangible asset with a finite useful life is assumed to be
zero unless a third party is committed to buying the intangible asset at the end of its
useful life or unless there is an active market for that type of asset (so that its expected
residual value can be measured) and it is probable that there will be a market for the
asset at the end of its useful life.
The amortization period and the amortization method used for an intangible asset with a
finite useful life should be reviewed at each financial year end. (PAS 38: para. 100)
 
Intangible assets with indefinite useful lives
An intangible asset with an indefinite useful life should not be amortized. (PAS
36 Impairment of assets requires that such an asset is tested for impairment at least
annually.) (PAS 38: para. 107)
The useful life of an intangible asset that is not being amortized should be reviewed
each year to determine whether it is still appropriate to assess its useful life as
indefinite. Reassessing the useful life of an intangible asset as finite rather than
indefinite is an indicator that the asset may be impaired and therefore it should be
tested for impairment. (PAS 38: para. 109)
 
Disposals/retirements of intangible assets
An intangible asset should be eliminated from the statement of financial position when it
is disposed of or when there is no further expected economic benefit from its future use.
On disposal the gain or loss arising from the difference between the net disposal
proceeds and the carrying amount of the asset should be taken to profit or loss as a
gain or loss on disposal (ie treated as income or expense).
(PAS 38: paras. 112–117)

Classification as PPE or Intangible

Asset
The restrictions in IAS 38 – Intangible Assets – in respect of capitalizing certain
internally-generated intangible assets focus attention on the treatment of many internal
costs. In practice, items such as computer software purchased by entities are frequently
capitalized as part of a tangible asset, for example as part of an accounting or
communications infrastructure. Equally, internally written software may be capitalized as
part of a tangible production facility, and so on. Judgement must be exercised in
deciding whether such items are to be accounted for under IAS 16 Property, Plant and
Equipment or IAS 38 and this distinction becomes increasingly important if the two
standards prescribe differing treatments in any particular case. IAS 16, unlike IAS 38,
does not refer to this type of asset. IAS 38 states that an entity needs to exercise
judgement in determining whether an asset that incorporates both intangible and
tangible elements should be treated under IAS 16 or as an intangible asset under IAS
38, for example:

 computer software that is embedded in computer-controlled equipment that

cannot operate without that specific software is an integral part of the related
hardware and is treated as PP&E;
 application software that is being used on a computer is generally easily
replaced and is not an integral part of the related hardware, whereas the
operating system normally is integral to the computer and is included in
PP&E; and
 a database that is stored on a compact disc is considered to be an intangible
asset because the value of the physical medium is wholly insignificant compared to
that of the data collection. [IAS 38.4].

It is worthwhile noting that as the ‘parts approach’ in IAS 16 requires an entity to

account for significant parts of an asset separately, this raises ‘boundary’ problems
between IAS 16 and IAS 38 when software and similar expenditure are involved. It is
believed that where IAS 16 requires an entity to identify significant parts of an asset and
account for them separately, the entity needs to evaluate whether any software-type
intangible part is actually integral to the larger asset or whether it is really a separate
asset in its own right. The intangible part is more likely to be an asset in its own right if it
was developed separately or if it can be used independently of the item of PP&E.
Goodwill
What is goodwill?
Goodwill is created by good relationships between a business and its customers.
(a) By building up a reputation (by word of mouth perhaps) for high quality products or
high standards of service
(b) By responding promptly and helpfully to queries and complaints from customers
(c) Through the personality of the staff and their attitudes to customers
The value of goodwill to a business might be considerable. However, goodwill is not
usually valued in the accounts of a business at all, and we should not normally expect to
find an amount for goodwill in its statement of financial position. For example, the
welcoming smile of the bar staff may contribute more to a bar's profits than the fact that
a new electronic cash register has recently been acquired. Even so, whereas the cash
register will be recorded in the accounts as a non-current asset, the value of staff would
be ignored for accounting purposes.
On reflection, we might agree with this omission of goodwill from the accounts of a
business.

1. The goodwill is inherent in the business but it has not been paid for, and it
does not have an 'objective' value. We can guess at what such goodwill is
worth, but such guesswork would be a matter of individual opinion, and not
based on hard facts.
2. Goodwill changes from day to day. One act of bad customer relations might
damage goodwill and one act of good relations might improve it. Staff with a
favorable personality might retire or leave to find another job, to be replaced
by staff who need time to find their feet in the job, etc. Since goodwill is
continually changing in value, it cannot realistically be recorded in the
accounts of the business.

 
Purchased goodwill
There is one exception to the general rule that goodwill has no objective valuation. This
is when a business is sold. People wishing to set up in business have a choice of how
to do it – they can either buy their own long-term assets and inventory and set up their
business from scratch, or they can buy up an existing business from a proprietor willing
to sell it. When a buyer purchases an existing business, he will have to purchase not
only its long-term assets and inventory (and perhaps take over its accounts payable and
receivable too) but also the goodwill of the business.
Note: Purchased goodwill is shown in the statement of financial position because it has
been paid for. It has no tangible substance, and so it is an intangible non-current
asset. 
 
How is the value of purchased goodwill decided?
When a business is sold, there is likely to be some purchased goodwill in the selling
price. But how is the amount of this purchased goodwill decided?
This is not really a problem for accountants, who must simply record the goodwill in the
accounts of the new business. The value of the goodwill is a matter for the purchaser
and seller to agree upon in fixing the purchase/sale price. However, two methods of
valuation are worth mentioning here:

1. The seller and buyer agree on a price for the business without specifically
quantifying the goodwill. The purchased goodwill will then be the difference
between the price agreed and the value of the identifiable net assets in the
books of the new business.
2. However, the calculation of goodwill often precedes the fixing of the purchase
price and becomes a central element of negotiation. There are many ways
of arriving at a value for goodwill and most of them are related to the profit
record of the business in question.

No matter how goodwill is calculated within the total agreed purchase price, the goodwill
shown by the purchaser in his accounts will be the difference between the purchase
consideration and his own valuation of the net assets acquired. If A values his net
assets at P40,000, goodwill is agreed at P21,000 and B agrees to pay P61,000 for the
business but values the net assets at only P38,000, then the goodwill in B's books will
be P61,000 – P38,000 = P23,000.
 
IFRS 3 Business Combinations
IFRS 3 covers the accounting treatment of goodwill acquired in a business combination.

Goodwill. Future economic benefits arising from assets that are not capable of being individually iden
(IFRS 3 App A)

Goodwill acquired in a business combination is recognized as an asset and is initially

measured at cost. Cost is the excess of the cost of the combination over the acquirer's
interest in the net fair value of the acquiree's identifiable assets, liabilities and contingent
liabilities.
After initial recognition goodwill acquired in a business combination is measured at cost
less any accumulated impairment losses. It is not amortized. Instead it is tested for
impairment at least annually, in accordance with IAS 36 Impairment of assets.
Negative goodwill (gain on a bargain purchase)arises when the acquirer's interest in
the net fair value of the acquiree's identifiable assets, liabilities and contingent liabilities
exceeds the cost of the business combination. IFRS 3 refers to negative goodwill as the
'excess of acquirer's interest in the net fair value of acquiree's identifiable assets,
liabilities and contingent liabilities over cost'. (IFRS 3: para. 34)
Negative goodwill can arise as the result of errors in measuring the fair value of either
the cost of the combination or the acquiree's identifiable net assets. It can also arise as
the result of a bargain purchase.
Where there is negative goodwill, an entity should first reassess the amounts at which it
has measured both the cost of the combination and the acquiree's identifiable net
assets. This exercise should identify any errors.
Any negative goodwill remaining should be recognized immediately in profit or loss.
IFRS 3 requires extensive disclosures. These include a reconciliation of the carrying
amount of goodwill at the beginning and end of the period, showing separately:
(a) The gross amount and accumulated impairment losses at the beginning of the
period
(b) Additional goodwill recognized during the period
(c) Impairment losses recognized during the period
(d) Net exchange differences arising during the period, and
(e) The gross amount and accumulated impairment losses at the end of the period
(IFRS 3: paras. 59–63)