F7:Financial Reporting (FR) 周冬华

Intangible assets explain the nature of internally-generated and purchased intangibles explain the accounting treatment of internally-generated and purchased intangibles distinguish between goodwill and other intangible assets describe the criteria for the initial recognition of intangible assets describe the criteria for the initial measurement of intangible assets explain the subsequent accounting treatment of goodwill explain the principle of impairment tests in relation to goodwill explain why the value of the purchase consideration for an investment may be less than the value of the acquired net assets explain how this difference should be accounted for define research expenditure and development expenditure according to IAS 38 explain the accounting requirements of IAS 38 for research expenditure and development expenditure account for research expenditure and development expenditure. 2

framework 3

It must also meet the normal definition of an asset: An intangible asset is an identifiable non-monetary asset without physical substance. To meet the definition the asset must be identifiable, i.e. separable from the rest of the business or arising from legal rights. It must also meet the normal definition of an asset: controlled by the entity as a result of past events (normally by enforceable legal rights) a resource from which future economic benefits are expected to flow (either from revenue or cost saving). 4

meet the definition of an intangible asset, Recognition To be recognised in the financial statements, an intangible asset must: meet the definition of an intangible asset, meet the recognition criteria of the framework: –it is probable that future economic benefits attributable to the asset will flow to the entity –the cost of the asset can be measured reliably If these criteria are met, the asset should be initially recognised at cost. 5

Internally-generated intangibles Internally generated goodwill may not be recognized as an asset. 6

Purchased and internally generated intangibles Purchased intangibles Recognition of intangible assets is initially at cost, which could be in cash or the fair value of equity shares given in exchange. If an intangible asset is acquired in a business combination, the fair value of that asset at the date of acquisition is taken. The determination of that fair value is easy if an active market exists, otherwise it may be necessary to take the price the entity would have paid in an arm’s length transaction. Any intangible which cannot be measured reliably in an acquisition has to be included in goodwill.   7

Test your understanding 1 How should the following intangible assets be treated in the financial statements? A publishing title acquired as part of a subsidiary company. A licence purchased in order to market a new product. 8

Solution The answer depends on whether the asset can be valued reliably. If this is possible, the title will be recognised at its fair value, otherwise it will be treated as part of goodwill on acquisition of the subsidiary. As the licence has been purchased separately from a business, it should be capitalised at cost. 9

Measurement after initial recognition There is a choice between: the cost model the revaluation model. 10

This model is more commonly used in practice. The cost model The intangible asset should be carried at cost less amortisation and any impairment losses. This model is more commonly used in practice. 11

The revaluation model The intangible asset may be revalued to a carrying value of fair value less subsequent amortisation and impairment losses. Fair value should be determined by reference to an active market. Features of an active market are that: –the items traded within the market are homogeneous –willing buyers and sellers can normally be found at any time –prices are available to the public. In practice such markets are rare. SEE the question on P94 12

An intangible asset with an indefinite useful life: Amortisation An intangible asset with a finite useful life must be amortised over that life, normally using the straight-line method with a zero residual value（OR Unless on P95）. An intangible asset with an indefinite useful life: should not be amortised should be tested for impairment annually, and more often if there is an actual indication of possible impairment. 13

Test your understanding 2 What is the accounting treatment of a recognised intangible asset with an indefinite useful life? 14

An intangible asset with an indefinite useful life: solution An intangible asset with an indefinite useful life: should not be amortised should be tested for impairment annually, and more often if there is an actual indication of possible impairment. 15

Goodwill The nature of goodwill Goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable net assets. Separable net assets are those assets (and liabilities) which can be identified and sold off separately without necessarily disposing of the business as a whole. They include identifiable intangibles such as patents, licences and trade marks. Fair value is the amount at which an asset or liability could be exchanged in an arm’s length transaction between informed and willing parties, other than in a forced or liquidation sale. 16

reputation for quality or service technical expertise Goodwill may exist because of any combination of a number of possible factors: reputation for quality or service technical expertise possession of favourable contracts good management and staff. 17

Purchased and non-purchased goodwill arises when one business acquires another as a going concern includes goodwill arising on the consolidation of a subsidiary or associated company will be recognised in the financial statements as its value at a particular point in time is certain. Non-purchased goodwill: is also known as inherent goodwill has no identifiable value is not recognised in the financial statements. 18

Accounting treatment of goodwill Purchased goodwill: should be capitalised as an intangible non-current asset should not be amortised must be tested for impairment annually in accordance with IAS 36, or more frequently if circumstances indicate that it might be impaired. 19

Test your understanding 3 An entity acquires 75% of the share capital of another entity, JKL. The consideration for the purchase was shares with a fair value of $800,000 and cash of $200,000. There were direct costs involved in the takeover of $20,000 .The non-controlling interest is valued using the proportion of net assets method.The carrying amounts and fair values of JKL assets and liabilities at the date of acquisition were as follows: What is the amount of goodwill be recognised on acquisition? 20

Solution Note: IFRS 3 revised requires acquisition costs to be expensed as incurred. They do not form part of the cost of acquisition. 21

Negative goodwill ANY negative goodwill remaining should be recognized immediately in profit or loss. 22

Research and development expenditure Definitions Research is original and planned investigation undertaken with the prospect of gaining new scientific knowledge and understanding. 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. Development expenditure should be amortised over its useful life. 23

Accounting treatment Research expenditure: write off as incurred to the income statement Development expenditure: recognise as an intangible asset if, and only if, an entity can demonstrate all of the following: the technical feasibility of completing the intangible asset so that it will be available for use or sale its intention to complete the intangible asset and use or sell it its ability to use or sell the intangible asset 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 its ability to reliably measure the expenditure attributable to the intangible asset during its development. 24

Test your understanding 4 An entity has incurred the following expenditure during the current year: （A）$100,000 spent on the design of a new product - it is anticipated that this design will be taken forward over the next two year period to be developed and tested with a view to production in three years time. (B)$500,000 spent on the testing of a new production system which has been designed internally and which will be in operation during the following accounting year. This new system should reduce the costs of production by 20%. How should each of these costs be treated in the financial statements of the entity? 25

solution (a)These are research costs as they are only in the early design stage and therefore should be written off as part of profit and loss for the period. (b)These would appear to be development stage costs as the new production system is due to be in place fairly soon and will produce economic benefits in the shape of reduced costs. Therefore these should be capitalised as development costs. 26

Chapter summary 27