MODULE ON INTANGIBLE ASSETS

PAS 38

At the end of this lesson, you will be able to:

1. Define an intangible asset and identify which assets are covered by PAS 38
2. Properly measure intangible assets, initially and subsequently
3. Enumerate and define a copyright, patent, franchise, and other examples of intangible assets
4. Explain research and development costs and enumerate its criteria for recognition as assets

Introduction
Intangible assets are assets with no physical form. Unlike any other items in the financial statements, its
nature is unique, resulting to a different treatment in its recognition, costing, and reporting. Accounting for
these assets are quite challenging because impairment and improvement cannot be directly observed.
Although PAS 38 sets out rules and guidelines on accounting for this specific item, majority are based on
judgements.

Learning Activities
1. A self test will be given to you at the end of this module for you to apply your learnings
2. A video will be sent afterwards so you can confirm your answers and listen to other important things
that are not in this module
3. If you have the book of Valix, you can read it to supplement this module
Body

Intangible assets – identifiable nonmonetary asset without physical substance. All intangible assets are
covered by this standard, except for some assets such as but not limited to:
a. Financial assets covered by PFRS 9, (bonds receivable, accounts receivable, notes, and loans
receivable)
b. Intangible development cost for wasting assets

Prepaid expenses are also covered by PAS 38: Intangible Assets.

Criteria to Identify Intangible Assets

For us to recognize and identify an intangible asset, the following criteria must be met:
1. Identifiability
An intangible asset must be identifiable, meaning, it can either be (1) sold, leased, detached, rented,
transferred, licensed, or exchanged, either individually or together with a related asset or liability or
(2) it arises from contractual or other legal rights regardless as to whether these rights are
transferrable or separable from the entity or from other rights and obligations.

Let us say you are an author of books. This is what you do for a living. The effort you put into mixing
words to create the story is an intangible asset apart from the actual book itself. However, since it is
not impossible that another person may also write the same book, you need to protect your
intellectual property for you to exclusively enjoy the fruit of your labor. When it comes to this, you
will copyright your books. The copyright is now considered your intangible asset. It is identifiable in
a sense that you can sell it without affecting your other properties or enslaving yourself to another
person(separability)

2. Control
Control is defined as the ability of the entity to manipulate future benefits arising from the asset or
restrict other for enjoying it. Often, control has legal basis and enforcement. In a case of patent, if you
patent a machine designed specifically to your needs, only you can enjoy its benefits. Otherwise, you
can file a court case for patent infringement based on decrease in revenue due to other entities
enjoying something that only you should have. However, legal basis is NOT a prerequisite for control
as it can be demonstrated through employee confidentiality.
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3. Future economic benefits

Benefits include cost reduction or additional revenue.

Initial Measurement of Intangible Assets

Intangible assets are initially measured at cost. The concept of costing an intangible asset is the same
with property, plant, equipment. Some differences exist in accounting between the two, such as
research and development costs. The cost of intangible assets are measured as follows:

1. Acquired separately – if the asset is purchased separately, its costs include the following:
a. Purchase price
b. 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. Cost 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. Cost of testing whether the asset is functioning properly

If the consideration is in the form of cash, the amount of cash is capitalized. The payment is
deferred beyond normal credit terms, the cost is the cash price equivalent. Any differences
between the cash price equivalent and the total payments is recognized as interest expense over
the period of credit.

Not all costs incurred in relation to the intangible asset is qualified for capitalization. The entity
must determine whether the costs are paid to acquire the intangible asset or to goods and
services related to the development of the asset. In the latter case, the costs can only be
capitalizable if they satisfied the criteria set for research and development costs.

2. Acquisition by government grant

Intangible assets can be received for free such as airport landing rights, licenses to operate radio
stations, etc. These can be initially measured either at (1) fair value, or (2) nominal consideration
or zero, plus directly attributable cost in preparing the asset for its intended use.

3. Exchange of assets
 If the exchange has commercial substance, the asset received will be measured as follows(same
with PPE)
a. Fair value of the asset given plus cash payment minus cash received
b. Fair value of the asset received
c. Carrying amount of the asset given plus cash payment minus cash received

If the exchange lacks commercial substance, no gains nor losses will be recognized and the asset
received will be measured using letter c.

4. Acquisition as part of business combination

Business combination pertains to a transaction where an acquirer obtains control of one or more
businesses. A business combination can be through a complete merger, where one entity
purchases the net assets (assets after liabilities) and the acquired entity ceases to exist.

Example, Entity A and Entity B are competitors. Entity A offered to purchase Entity B’s net assets
for $1,000,000 and B consented. After the transaction, the assets and liabilities of B will now be
assumed by A and B will cease to exist.

Another type of business combination is through a purchase more than 50% of stocks from an
entity. This does not dissolve the acquired entity but the parent company(owner of more than
50%) can exercise control since majority of the voting rights are owned by it.

Example, Entity A and Entity B are competitors. Entity A traced the shareholders of Entity B and
purchased their holdings to the point where more than 50% of the ordinary shares are owned by
it. Entity B will not cease to exist and will continue operations, but now under the control of a
parent entity, A. If Entity A will ask B to sell a parcel of land to it at a price significantly less than
the market value, entity B will have to comply since majority of the voting rights are owned by
the parent company.

In a business combination, assets and liabilities are recorded at fair value. If there is an excess of
the purchase price over the fair value of the net interest acquired, it is accounted for as goodwill.
Goodwill is a nonidentifiable asset and it arises from many things that are subjective in nature
when costed. Some examples of things that are included in the goodwill include customer loyalty,
expertise of the entity’s workforce, and various things. The main issue on goodwill is that it is a
nonidentifiable asset. Meaning it cannot be traced directly to any asset. In line with this, when
performing business combination, the entity must be very careful and review as to the existence
of other intangible assets that will decrease the goodwill. Some examples of intangible assets and
their major classifications are as follows:
Intangible Assets arising from Other separable intangibles
contractual/legal rights
MARKETING RELATED
Trademark, trade names, service marks,
collective marks, and certification marks
Internet domain names
Trade dress (unique color, shape, package
design)
Newspaper mastheads
Non-competition agreements
CUSTOMER RELATED
Order or production backlog Customer lists
Customer contracts and the related customer Non-contractual customer relationships
relationships
ARTISTIC RELATED
Plays, operas, ballets
 Books, magazines, newspapers, and other
literary works
Music works such as compositions, song
lyrics, and advertising jingles
Pictures and photographs
Video and audiovisual materials, including
films, music videos, and television
programmes
CONTRACT BASED
Licensing, royalty, and standstill agreements
Advertising, construction, management,
service, or supply contracts
Lease agreements
Construction permits
Franchise agreements
Operating and broadcast rights
Use rights such as drilling, water, air, mineral,
timber-cutting, and route authorities
Servicing contracts such as mortgage service
contracts
Employment contracts that are beneficial
contracts from the perspective of the
employer because the pricing of those
contracts is below their current market value
Use rights such as drilling, water, air, mineral,
timber-cutting and
route authorities
TECHNOLOGY BASED
Patented technology Unpatented technology
Computer software and maskworks Databases
Trade secrets such as formulas, processes,
and recipes

5. Internally generated
PAS 38 maintains conservatism in recognizing internally generated intangible asset since there is
difficulty as to the timing and amount of the asset. Costs are being incurred which include
researching and developing the asset. Not all these costs are capitalizable because some will
prove to have no benefit in the future.

For example, you are looking for an inspiration to make a new book. The genre you chose was
comedy and romance. You read and researched different articles and novels that will give you a
clear picture of what your book looks like. After a few months of research, you realize that the
genre does not excite you anymore and you decided to abandon the project and shift your
attention into making a sci-fi book. The costs incurred in researching about the comedy and
romance genre will absolutely not benefit you nor the book that you will make in the future so it
must not be capitalized.

Internally generated intangible assets undergo research and development costs. Research is the
original and planned investigation undertaken with the prospect of gaining new scientific or
technical knowledge and understanding. PAS 38.8 identified the following as research activities:
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 alternative 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, processes, systems or services.

During the research phase, all its costs are expensed since it is difficult to identify which costs
can be of use in the future. If the entity cannot identify an activity if it is a research or a
development cost, it is treated as a research cost.

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 or use. During the development costs, the
standard confirms the recognition of capitalizable intangible asset. However, they must qualify
with all of the following criteria:
a. the technical feasibility of completing the intangible asset so that it will be available for use
or sale;
There are available products, services, or devices that can finish the asset not just for one
time but for continuous production, if the entity intends so sell it. If it intends to use it,
adequate technical support must be ensured to make sure the asset can be maintained for its
intended use.

b. its intention to complete the intangible asset and use or sell it

This is purely subjective on the management.

c. its ability to use or sell the intangible asset

This depends on the nature of the entity and the nature of the cost.
d. how the intangible asset will generate probable future economic benefits. Among other
things, the entity can 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
If this criterion is not satisfied, even if the cost satisfied the other criteria it is still not
considered an intangible asset. The entity must assess the future benefits that will arise from
the asset.

e. the availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset
There are products, services, devices, and other things that can complete the asset. Money
shall be sufficient enough to finish it also.

f. its ability to measure reliably the expenditure attributable to the intangible asset during its
development.
The basic criteria to recognize an asset.

Internally generated brands, mastheads, publishing titles, and customer lists are not
considered intangible assets. This is because they failed to satisfy the identifiability criteria.
To be identifiable, an intangible asset is either separable or it satisfied the contractual-legal
criterion. Being internally generated, these costs can only be considered identifiable if they
are separable. They can be considered as intangible assets under business combinations.
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Subsequent Measurement of Intangible Assets

The entity can choose whether the cost or revaluation model will be used. However, it may be
difficulty to use the revaluation model because active markets for intangible assets are rare to find. Either
way, to amortize an intangible asset, it will require a useful life. Some intangible assets have legal lives such
as:
Patent – 20 years
Copyright – lifetime of the owner plus 50 years
Trademark – 10 years but can be renewed for period of 10 years each

The useful life is whichever is shorter between the estimated useful life versus the legal life.

Another factor to compute amortization is the residual value. Intangibles are assumed to have zero residual
value, unless:
a. another entity promised to buy it at the end of its useful life for a certain amount
b. there is an active market where the intangible can be disposed of at the end of its useful life

The standard allows the use of different methods such as straight-line, diminishing, output. The chosen
amortization method must reflect the use of the asset. It is forbidden to choose an amortization method based
on revenues.

Intangibles with an indefinite useful life are not subject to amortization but must be annually tested for
impairment.

Disclosures Required by PAS 38

The standard requires the following disclosures on each class of intangibles:
1. whether the useful lives are indefinite or finite and, if finite, the useful lives orthe amortisation rates
used
2. the amortisation methods used for intangible assets with finite useful lives;
3. the gross carrying amount and any accumulated amortisation (aggregated with accumulated
impairment losses) at the beginning and end of the period;
4. the line item(s) of the statement of comprehensive income in which any amortisation of intangible
assets is included;
5. a reconciliation of the carrying amount at the beginning and end of the period showing:
i. additions, indicating separately those from internal development, those acquired
separately, and those acquired through business combinations;
ii. assets classified as held for sale or included in a disposal group classified as held for
sale in accordance with IFRS 5 and other disposals;
iii. increases or decreases during the period resulting from revaluations and from
impairment losses recognised or reversed in other comprehensive income in
accordance with IAS 36 (if any);
iv. impairment losses recognised in profit or loss during the period in accordance with
IAS 36 (if any);
v. impairment losses reversed in profit or loss during the period in accordance with
IAS 36 (if any);
vi. any amortisation recognised during the period;
vii. net exchange differences arising on the translation of the financial statements into
the presentation currency, and on the translation of a foreign operation into the
presentation currency of the entity; and
viii. other changes in the carrying amount during the period.
 SELF TEST
Problem 1: K Co. incurred the ff. costs during the year:

Cost of activities aimed at obtaining new knowledge 200,000

Marketing research to study consumer tastes 100,000
Cost of developing and producing a prototype model 60,000
Cost of testing the prototype model for safety and environmental friendliness 100,000
Salaries of employees, consultants, and technicians involved in R&D 80,000
Cost of conference for the introduction of the newly developed product including fee
of a model hired as endorser 100,000
Advertising to establish recognition of the newly developed product 70,000
Cost incurred on search for alternatives for materials, devices, products, processes,
systems or services 40,000
Cost of final selection of possible alternatives for a new process 33,000
Trouble-shooting during commercial production 25,000
Periodic or routing design changes to existing products 10,000
Modification of design for a specific customer 100,000
Payments made to other company under a contract to perform research and development
to K Co. 80,000
Cost of design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production 50,000
Cost of design, construction and operation of plant that is feasible for commercial production 33,000
Cost of routine, seasonal, and periodic design of tools, jigs, mold and dies 20,000
Cost of design of tools, jigs, molds and dies involving new technology 22,000
Cost of engineering follow through in an early phase of commercial production 110,000
Cost of quality control during commercial production 35,000
Adaptation of an existing capability to a particular customer’s need 40,000
Cost of acquired building to be used in various R&D projects 500,000
Depreciation on the building described above 50,000
Cost of machine acquired to be used on only one R&D project 800,000
Radical modification to the formulation of a chemical product 60,000
Laboratory research aimed at discovering new technology 48,000

Required: Compute for research and development expense.

Problem 2: On January 1, 2016, A Co. incurred the following costs for the generation of trademark:

Cost of materials and services used or consumed in generating the trademark 500,000
Amortization of patents and licenses that were used to generate the trademark 25,000
Selling, administrative and other general overhead expenditures 60,000
Borrowing costs arising specifically from the funds borrowed for generation of the
trademark 10,000
Advertising and promotional costs for the product generated by the trademark 20,000
Costs of employee benefits incurred in generating the trademark 40,000
Fees to register the trademark 20,000

Required: Compute for the cost of the trademark

Problem 3: On January 1 of the current year, G Co. acquired the customer list of a large advertising agency for
P2,000,000. G expects to benefit from the information acquired from the customer list for a period of 5 years.

Required: Prepare the journal entries.

Problem 4: During the year 2016, A Co. incurred costs to develop and produce a routine, low-risk computer
software product as follows:
Completion of detailed program design or working model 400,000
Cost incurred for coding and testing to establish technological feasibility 50,000
Other coding costs after establishment of technological feasibility 800,000
Other testing costs after establishment of technological feasibility 700,000
Costs of producing product masters for training materials 1,600,000
Duplication of computer software sand training materials from product master 1,200,000
Packaging product 300,000

Required: Prepare all the necessary entries.

Problem 5: G Co. was granted a patent on January 1, 2014 and appropriately capitalized P450,000 of related
costs.

The entity was amortizing the patent over the useful life of 15 years.

During 2017, the entity paid P150,000 in legal costs in successfully defending an attempted infringement of
the patent.

After the legal action was completed, the entity sold the patent to the plaintiff for P750,000. The policy is to
take no amortization in the year of disposal. How much was the gain from sale of patent in 2017?