Intangible Assets: IAS 38 Wiecek and Young IFRS Primer Chapter 15

Intangible Assets Related standards IAS 38 Current GAAP comparisons IFRS financial statement disclosures Looking ahead End-of-chapter practice

Related Standards FAS 142 Goodwill and other intangible assets FAS 141 Business combinations FAS 86 Accounting for the costs of computer software to be sold, leased, or otherwise marketed

Related Standards IFRS 3 Business combinations IAS 36 Impairment of assets IAS 17 Leases IFRS 4 Insurance contracts IFRS 5 Non-current assets held for sale and discontinued operations IFRS 6 Exploration for and evaluation of mineral resources

IAS 38 - Overview Objective and scope Recognition and measurement Acquired intangible assets Internally generated intangibles Measurement after recognition Retirements and disposals Disclosures

IAS 38 – Objective and Scope Intangible asset: “an identifiable non-monetary asset without physical substance” Conditions Must be identifiable Will provide future economic benefits Benefits are controlled by the entity

IAS 38 – Recognition and Measurement Recognized as an intangible asset when: It is likely that the expected future economic benefits will be realized, and The cost of the asset can be reliably measured Measured initially at cost

IAS 38 – Acquired Intangible Assets

IAS 38 – Acquired Intangible Assets Acquired separately: Cost includes purchase price, duties, non-refundable taxes, net of discounts and rebates + direct costs of preparing the asset and bringing it to an appropriate condition for its intended use. Examples: franchises, patents, customer lists, trademarks

IAS 38 – Acquired Intangible Assets Not included in cost: Advertising, promotion, training associated with new products, locations, customers; administrative and other general overhead; early stage operating losses

IAS 38 – Acquired Intangible Assets Intangibles acquired in an asset exchange: Cost = fair value (FV) of what is given up, UNLESS Transaction does not have commercial substance, or The FV of neither the asset given up or the asset acquired can be reliably measured If (a) or (b), cost = carrying amount of asset(s) given up

IAS 38 – Acquired Intangible Assets Commercial substance exists if: Future cash flows (amount, timing, risk) of asset received differ from those of asset given up; or Entity-specific value has changed; and The difference in (a) or (b) is significant when compared to the FVs of the assets exchanged.

IAS 38 – Acquired Intangible Assets Acquired in a business combination: Cost is its FV Identifiable intangibles are recognized separately from goodwill Best FV is quoted market prices in an active market – if not available, other methods are used

IAS 38 Internally Generated Intangibles Internally generated goodwill is not recognized as an asset Because no identifiable resource has been created that is controlled by the entity and that can be measured reliably at cost

IAS 38 Internally Generated Intangibles To recognize an internally generated intangible, it must: be an identifiable asset that will generate expected future economic benefits, and have a cost that can be differentiated from ordinary operating costs and internally generated goodwill, and that can be measured reliably

IAS 38 Internally Generated Intangibles Two phases of costs to generate an internally generated intangible: Research phase – original and planned investigation to gain new scientific or technical knowledge: costs are expensed as incurred Development phase – application of knowledge to a plan or design for the production of new materials, devices, products, processes, systems or services before commercial production: costs are expensed as incurred, UNLESS

IAS 38 Internally Generated Intangibles Development costs are expensed as incurred unless all of the following can be demonstrated. If so, can capitalize as an intangible asset. Technical feasibility of completing Intention to complete, use or sell Ability to use or sell How it will generate future economic benefits Availability of resources to complete and use or sell, and Expenditures during development can be reliably measured, i.e., feasibility and economic viability of the asset must be established to support capitalization

IAS 38 Internally Generated Intangibles The following cannot be internally developed intangible assets because the costs of these cannot be distinguished from those to develop a business in general: Internally generated brands Mastheads Publishing titles Customer lists Others, similar in nature to these

IAS 38 Internally Generated Intangibles Cost of an internally generated intangible asset: Costs directly associated with making the asset ready for use in the manner intended by management. Examples: materials and services consumed, payroll costs, depreciation, amortization costs to generate the asset, legal fees to register **No costs can be retroactively capitalized

IAS 38 Internally Generated Intangibles In the past, a number of costs were recognized as prepaid or deferred and treated as intangibles. IAS 38 indicates: if no intangible asset is acquired that can be recognized, then expense the cost For services, recognize as an expense when service is received For goods, recognize when entity has the right to access the goods supplied

IAS 38 – Internally Generated Intangibles A prepaid asset is recognized instead of an expense only when the payment for goods and services is made before the goods are available to the entity or services have been performed Apply in all situations, e.g., pre-opening and pre-operating costs, training costs, advertising and promotional costs, relocation costs

IAS 38 – Internally Generated Intangibles Example: Ace Co. recognizes an account payable to a supplier for producing and delivering a mail-order catalog to be used over the following 12 months. What do you debit? Debit an expense. The catalog does not meet the definition of an intangible asset, inventory or a prepaid expense.

IAS 38 – Measurement after Recognition Choice: cost model (CM) or revaluation model (RM) Decision is made for each class of intangible assets so all in same class use the same model

IAS 38 – Measurement after Recognition Cost model Most widely used Asset is carried at cost less accumulated amortization and accumulated impairment losses

IAS 38 – Measurement after Recognition Revaluation model Asset is carried at its fair value at the date of the revaluation less any subsequent accumulated amortization and accumulated impairment losses Cannot use retroactively to recognize intangible assets not previously recognized Applied the same as for property, plant and equipment assets

IAS 38 – Measurement after Recognition RM – key aspects When revalued, carrying amount adjusted either by adjusting asset and accumulated amortization proportionately or eliminating the accumulated amortization and bringing the asset to its revalued amount Increase in carrying amount: credit to OCI and into revaluation surplus account; unless offset to previous loss charged to P&L when the increase can offset a prior loss.

IAS 38 – Measurement after Recognition RM – key aspects Decrease in carrying amount is applied first to any revaluation surplus in equity (through OCI); any excess to P&L When asset derecognized, transfer any revaluation surplus directly to retained earnings; or can transfer revaluation surplus to R/E as asset is used.

IAS 38 – Measurement after Recognition Useful life: Finite (like PP&E) or indefinite Indefinite means there is no foreseeable limit to the period the asset is expected to generate net cash inflows If finite – amortize. Usually no residual value. Apply IAS 36 for impairments. If indefinite – do not amortize. Apply IAS 36 for impairments.

IAS 38 – Retirement and Disposals Gain or loss on derecognition Difference between carrying amount and net proceeds on disposal Recognize in P&L

IAS 38 - Disclosures General Separately between internally generated and those purchased Accounting policies and methods used Reconciliations between opening and ending balances Additional details about those judged to have indefinite lives

IAS 38 - Disclosures Intangible assets using RM For each class, the date of the revaluation, carrying amounts, carrying amounts if cost method had been used, methods and assumptions used to determine FV, reconciliations of revaluation surplus amounts, restrictions on distribution of revaluation surplus amounts

Current GAAP Comparisons Pages 58 and 59 of 164 of Pages 13 and 14 of 49 of http://www.ey.com/Global/assets.nsf/International/IFRS_US_GAAP_vs_IFRS/$file/US_GAAP_vs_IFRS.pdf http://www.kpmg.co.uk/pubs/IFRScomparedtoU.S.GAAPAnOverview(2008).pdf

IFRS Financial Statement Disclosures The Nestlé Group http://www.nestle.com/Resource.axd?Id=24E5A5E2-93F8-43A3-956E-0F259448CB90 Valuation methods and definitions: - pages 22 and 23 of 118 Intangible Assets note: - pages 42 and 43 of 118

Looking Ahead Inconsistent treatment accorded intangible assets generated internally and those acquired is recognized No project currently on the IASB agenda Research continues in this area No changes expected in the short to medium term

End-of-Chapter Practice 15-1 The following is a list of expenditures made by Zorro Corp. (ZC) during its year ended May 31, 2008. 1. December 2007: cost of annual update on payroll software. 2. November 2007: training costs incurred for new product line. 3. December 2007: rent prepayment (six months paid in advance). 4. June 2007: payment for exclusive rights for national sports figure endorsement of ZC products for two years. 5. May 2008: payment for production of special advertisements to be run on television during world championship games in July 2008. Instructions Indicate whether ZC should report a related intangible asset on its May 31, 2008 balance sheet for each expenditure described above. Explain your answer in each case.

End-of-Chapter Practice 15-2 Three intangibles acquired by Hamm Ltd. (HL) in the current year are described below. HL, a progressive company with a variety of divisions and subsidiaries, has applied fair value measures on its balance sheet wherever permitted. Intangible #1 is a license granted by the federal government to HL that allows the company to provide essential services to a key military installation overseas. The license expires every five years, but is renewable indefinitely at little cost. Because of the profitability associated with this license, HL fully expects to renew it continually. The license is very marketable and will generate cash flows indefinitely. Intangible 2 is a non-competition covenant acquired by HL when the company bought out a major owner-managed competitor. The seller signed a contract in which she agreed not to set up or work for another business that is in direct or indirect competition with HL. The projected cash flows resulting from this agreement are expected to continue for at least 25 years. Intangible 3 are medical files. One of HL’s subsidiary companies owns several medical clinics. A recent purchase of a retiring doctor’s practice required a significant payment for the practice’s medical files and clients. HL considers that this base will benefit the business for as long as it exists, providing cash flows indefinitely. Instructions (a) Does each intangible as described above qualify to be recognized as an intangible asset? Explain briefly. (b) Identify the appropriate method of accounting for each intangible described above after acquisition, and explain the decisions you have made.

End-of-Chapter Practice 15-3 The following research and development costs were incurred by Ordo Inc. (OI) during its most recent fiscal year. Equipment acquired for use in various R&D projects (six year life)$ 90 Depreciation on the equipment above 5 Quality control costs during production, including routine product testing 30 Costs of efforts to refine, enrich, or otherwise improve the qualities of an existing product 25 Evaluation of potential new products 13 Costs of operating a lab to improve an existing formula 34 Materials cost for use in pre-production pilot plant 9 Instructions For each cost described above, indicate whether it should be capitalized as an intangible asset or whether it should be expensed. Explain briefly.

End-of-Chapter Practice 15-4 In this chapter, flag icons identify areas where there are GAAP differences between IFRS requirements and national standards. Instructions Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of the differences that are flagged throughout the chapter material.

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