Processing, Reporting and Auditing Financial Accounts Intangible Assets & Impairment IAS 38, IAS 36 and IFRS 3

Intangible Assets - IAS 38 3 Criteria Identifiable Separable (capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or as part of a package) or Arises from contractual or other legal rights Control over a resource Means the company should have the power to obtain future economic benefits Usually derived from a legal right Note IFAC definition of “intangible” includes Human Capital Existence of future economic benefits This is expected over a period of years Intangibles are always Non-Current Assets

Examples Examples of possible intangible assets include: computer software patents copyrights motion picture films customer lists mortgage servicing rights licenses import quotas

Examples Intangibles can be acquired: by separate purchase as part of a business combination by a government grant by exchange of assets by self-creation (internal generation)

Recognition Recognition criteria. IAS 38 requires an enterprise to recognise an intangible asset, whether purchased or self-created (at cost) if, and only if it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise the cost of the asset can be measured reliably.

Measurement When an item is recognised as intangible it is measured initially at cost. Purchased intangibles Can add directly attributable costs Once intangible is in a condition where it can be used All costs treated as operating expenses

Failure to meet the criteria If an intangible item does not meet both the definition of and the criteria for recognition as an intangible asset then IAS 38 requires the expenditure on this item to be recognised as an expense when it is incurred

Amortisation Intangibles are non-current assets Therefore should be amortised 2 models of carrying amounts A model must be chosen for each class of intangible asset Cost model or Revaluation model

2 models Cost model Carrying amount = Cost Less accumulated amortisation Less accumulated impairment losses Revaluation model After initial recognition at cost Fair value at date of (regular) revaluation Less accumulated amortisation since revaluation Less accumulated impairment losses since revaluation

Fair Value Fair value can only be determined by reference to an active market Such active markets are expected to be uncommon for intangible assets Examples might be Milk quotas Freely traded taxi licences Where no active market exists – use cost model

Accounting Under the revaluation model revaluation increases are credited directly to "revaluation surplus" within equity except to the extent that it reverses a revaluation decrease previously recognised in the income statement If the revalued intangible has a finite life and is, therefore, being amortised the revalued amount is amortised

Classification of Intangible Assets Based on Useful Life Intangible assets are classified as Indefinite life: No foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. Finite life: A limited period of benefit to the entity.

Measurement Subsequent to Acquisition: Intangible Assets with Finite Lives The cost less residual value of an intangible asset with a finite useful life should be amortised over that life The amortisation method should reflect the pattern of benefits If the pattern cannot be determined reliably, amortise by the straight line method The amortisation charge is recognised in profit or loss unless another IFRS requires that it be included in the cost of another asset. The amortisation period should be reviewed at least annually The asset should also be assessed for impairment in accordance with IAS 36

Measurement Subsequent to Acquisition: Intangible Assets with Indefinite Lives An intangible asset with an indefinite useful life should not be amortised Its useful life should be reviewed each reporting period to determine whether events and circumstances continue to support an indefinite useful life assessment for that asset If they do not, the change in the useful life assessment from indefinite to finite should be accounted for as a change in an accounting estimate The asset should also be assessed for impairment in accordance with IAS 36

Research & Development (R&D) Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding Development Application of research findings to a plan or design for production of new or substantially improved materials, devices etc before the start of commercial production or use

Basic rules are Charge all research cost to expense Development costs are capitalised only after technical and commercial feasibility of the asset for sale or use have been established Therefore the enterprise must intend and be able to complete the intangible asset and either use it or sell it and be able to demonstrate how the asset will generate future economic benefits

Basic rules are If an enterprise cannot distinguish the research phase of an internal project to create an intangible asset from the development phase the enterprise treats the expenditure for that project as if it were incurred in the research phase only If an asset is recognised as intangible It is shown in BS as development costs capitalised It will be amortised from time it is available for use Over period of expected economic benefit

Internally-generated Internally-generated intangible assets May capitalise Costs of materials Labour costs Fees to register legal rights

As an example Computer Software Purchased: capitalise Operating system for hardware: include in hardware cost Internally developed (whether for use or sale): charge to expense until technological feasibility, probable future benefits, intent and ability to use or sell the software, resources to complete the software, and ability to measure cost. Amortisation: over useful life, based on pattern of benefits (straight-line is the default)

Another example Inventions Ltd a company making microwave/radar equipment wants to capitalise the following Calibration equipment made by company ($600,000) used in calibrating lab equipment Microwave detection equipment ($1.5m) has been made but found to be too large for aircraft. Company believes further $0.5m development would make a viable saleable product In flight tracking system ($1.25m) has been trialled and planned production is for summer. Have advanced orders for 2 units & commercial viability is high.

What are NOT intangibles Brands Mastheads Publishing titles Customer lists and Items similar in substance that are internally generated

Goodwill and IFRS 3 Goodwill is the difference between Purchase value of a business and Fair value of separable net assets Inherent (internally-generated) goodwill cannot be an intangible asset Purchased Goodwill is and is the expectation of future economic benefits for the purchaser

Conditions applying to recognition of Goodwill as an intangible Goodwill is recognised by the acquirer as an asset from the acquisition date and is initially measured as the excess of the cost of the business combination over the acquirer's share of the net fair values of the acquiree's identifiable assets, liabilities and contingent liabilities IFRS 3 prohibits the amortisation of goodwill Instead goodwill must be tested for impairment at least annually in accordance with IAS 36 Impairment of Assets Negative goodwill If the acquirer's interest in the net fair value of the acquired identifiable net assets exceeds the cost of the business combination that excess must be recognised immediately in the income statement as a gain

Impairment of Assets- IAS 36 Purpose of IAS 36 To ensure that assets are carried at no more than their recoverable amount, and to define how recoverable amount is calculated

Definitions Impairment an asset is impaired when its carrying amount exceeds its recoverable amount. Carrying amount the amount at which an asset is recognised in the balance sheet after deducting accumulated depreciation and accumulated impairment losses Recoverable amount the higher of an asset's fair value less costs to sell and its value in use

Definitions Fair value the amount obtainable from the sale of an asset in a bargained transaction between knowledgeable, willing parties. Value in use the discounted present value of estimated future cash flows expected to arise from: the continuing use of an asset, and from its disposal at the end of its useful life

Cash-Generating Units Recoverable amount should be determined for the individual asset, if possible If it is not possible to determine the recoverable amount (fair value less cost to sell and value in use) for the individual asset then determine recoverable amount for the asset's cash-generating unit Which is the smallest identifiable group of assets that generates cash inflows from continuing use, and that are largely independent of the cash inflows from other assets or groups of assets

Indications of Impairment External sources: market value declines negative changes in technology, markets, economy, or laws increases in market interest rates company stock price is below book value Internal sources: obsolescence or physical damage asset is part of a restructuring or held for disposal worse economic performance than expected

Impairment Testing When an asset is tested for impairment Its recoverable amount needs to be determined This = the higher of.. Value in Use and Fair Value less costs to sell

Fair Value Less Costs to Sell If there is a binding sale agreement, use the price under that agreement less costs of disposal If there is an active market for that type of asset, use market price less costs of disposal If there is no active market, use the best estimate of the asset's selling price less costs of disposal Costs of disposal are the direct added costs only (not existing costs or overhead)

Value in Use Should reflect an estimate of the future cash flows the entity expects to derive from the asset in an arm's length transaction