Chapter 19 Intangible assets

Main purpose The main purpose of this chapter is to consider the accounting treatments of: research and development; goodwill and intangible assets; brands; emissions trading certificates.

Objectives By the end of this chapter, you should be able to: define and explain how to account for: legally enforceable intangibles and internally generated intangibles; research and development (R&D); goodwill; brands; and emission trading certificates; account for development costs; comment critically on the IASB requirements in IAS 38 and IFRS 3.

Chapter 19 covers Accounting for intangible assets Accounting treatment for research and development Research and development – why not capitalised Capitalising development costs Disclosure of R&D IFRS for SMEs – treatment of intangible assets Goodwill The accounting treatment of goodwill Critical comment on the methods used for goodwill accounting

Chapter 19 covers (Continued) Negative goodwill Brand accounting Justifications for reporting all brands as assets Accounting for acquired brands Emissions trading Intellectual property Review of implementation of IFRS 3

Intangible assets – purchased Separately purchased, included in goodwill and with a finite life Capitalise as part of goodwill. Separately purchased and capable of reliable measurement Capitalise separately from goodwill and amortise.

Intangible assets – internally developed Capitalise IF Readily ascertainable market value

Intangible assets – indefinite useful economic life Annual impairment review Improve transparency Improve comparability.

We now consider the accounting treatments of Research and development Goodwill Brands.

R&D scorecard The 2008 R&D scoreboard published by the Department of Innovation, Universities and Skills showed the scale of R&D expenditure: £274 billion was invested globally in 2007–2008 by most active 1,400 companies most active in R&D which was an increase of 9.5% on the previous year. Almost 80% of global R&D occurred in five countries: USA, Japan, Germany, France and the UK. Global R&D intensity, measured as R&D expenditure as a proportion of sales, had remained broadly similar to the previous year at 3.3%. The 88 UK companies in this group increased their R&D spend at a faster rate (10.3%) with 20% of the total taking place in the pharmaceuticals and aerospace sectors.

Research defined Obtaining new knowledge Search for alternatives materials products processes Evaluation of alternatives.

IAS 38 – accounting treatment for R&D Expense in the year in which it is incurred Not to be carried forward in statement of financial position.

IAS 38 intangible assets Development defined Application of research findings to a plan for production of new or substantially improved products processes systems Prior to commencement of commercial production.

Development costs comprise Directly attributable costs materials labour fees such as patents. Allocatable on a reasonable and consistent basis Necessary and identifiable overheads depreciation insurance premiums, rent.

IAS 38 – development recognition criteria Technical feasibility Intention to complete and use or sell Generate future economic benefits Existence of market for asset or output Availability of adequate resources to complete Technical Financial Reliable measurement of costs possible Expense if not recoverable from future revenue.

Activities that are neither research or development SSAP 13 (but not IAS 38) identifies activities related to research and development, but is not classified for the purposes of the standard, e.g.: Engineering follow­through in an early phase of commercial production. Quality control during commercial production, including routine testing. Troubleshooting in connection with breakdowns during production. Routine efforts to improve the qualities of an existing product.

Introduction to goodwill and intangible assets The main requirements of IFRS 3 Business Combinations and IAS 38 Intangible Assets are Purchased goodwill and intangible assets should be capitalised as assets. Internally generated goodwill should not be capitalised. Internally developed intangible assets should be capitalised only where it is probable that future economic benefits attributable to the asset will flow to the enterprise and the cost of the asset can be measured reliably. Capitalised assets are subject to amortisation and/impairment review.

IFRS 3 Business Combinations Purchased goodwill is based on Transaction with third party at arm’s length. Internally generated goodwill is based on Directors’ valuation of internal goodwill by valuing business as a whole separable assets.

The cost of purchased goodwill IFRS 3 Business Combinations states: Goodwill is the difference between the cost of acquisition and the acquirer’s interest in the fair value of the identifiable assets, liabilities and contingent liabilities acquired at the date of the exchange transaction.

Accounting treatment of goodwill Purchased goodwill is recognised in the statement of financial position as an asset Amortisation prohibited Annual impairment reviews Inherent goodwill not normally recognised in the accounts.

Economic consequence of write-off/amortisation ROCE Write-off reduces shareholders’ reserves and capital employed. Gearing Write-off reduces shareholders’ reserves and so capital employed How this affects investor decisions How this affects creditor decisions.

Negative goodwill – related to expectation of losses and expenses Credit income statement immediately.

Brand accounting Include in statement of financial position to pre-empt equity depletion caused by goodwill write-offs or amortisation. Typically not amortised but subject to impairment review.

Discussion Explain how primary ratios were distorted by immediate write-off of goodwill against reserves. Explain the criteria for recognising internally generated intangible assets.

Discussion (Continued) Explain why companies began to recognise brands in their statement of financial position. Explain the requirement at the year end with respect to intangible assets with an indefinite useful economic life. Why do you think companies were motivated to measure intellectual capital?

Discussion (Continued) What indications may there be that an impairment review of an intangible asset is necessary? Explain the criteria to be satisfied for development costs to be capitalised. Discuss why intellectual property has become increasingly important.

Review questions 5. IFRS 3 has introduced a new concept into accounting for purchased goodwill – annual impairment testing, rather than amortisation. Consider the effect of a change from amortisation of goodwill (in IAS 22) to impairment testing and no amortisation in IFRS 3, and in particular: the effect on the financial statements; the effect on financial performance ratios;

Review questions (Continued) 5. the effect on the annual impairment or amortisation charge and its timing; which method gives the fairest charge over time for the value of the goodwill when a business is acquired; whether impairment testing with no amortisation complies with the IASC’s Framework for the Preparation and Presentation of Financial Statements; why there has been a change from amortisation to impairment testing – is this pandering to pressure from the US FASB and/or listed companies?