IAS 38 - Intangibles

Academic Resource Center Intangibles Page 2 Executive summary ► IFRS permits periodic revaluation of intangible assets (except for goodwill) to fair value. US GAAP does not allow revaluation. ► IFRS requires that development costs are capitalized when technical and economic feasibility of a project can be demonstrated in accordance with specific criteria. Under US GAAP, most types of development costs are expensed as incurred.

Academic Resource Center Intangibles Page 3 Progress on convergence ► In 2006, the FASB and the IASB agreed to converge their standards on intangible assets. However, in 2007 both Boards agreed not to add a project to their joint agenda. In 2008, the FASB indicated that it will consider in the future whether to undertake a project to eliminate the differences in the accounting for research and development costs by fully adopting IAS 38 at some point in the future.

Academic Resource Center Intangibles Page 4 Characteristics The definition of intangible assets is non- monetary assets without physical substance. The recognition criteria require there be probable future economic benefits and costs that can be reliably measured. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 5 Acquisition of intangibles Purchased intangibles In general, intangible assets that are acquired outside of a business combination are recognized at fair value at the time of acquisition. Direct costs of securing a patent, including an acquisition from others, are included in the cost. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 6 Acquisition of intangibles Purchased intangibles IFRS ► These costs would be expensed, except in the rare circumstance that they improve future economic benefit. US GAAP ► Permits certain costs incurred subsequent to its initial recognition (e.g., legal costs to defend a patent infringement) to be capitalized.

Academic Resource Center Intangibles Page 7 Acquisition of intangibles Internally created intangibles Internally generated assets other than goodwill, brands, mastheads, publishing titles, newspapers and customer lists may be recognized as assets if certain additional criteria are met. These additional criteria will be discussed in research and development. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 8 Types of intangibles Market-related intangible assets. Customer-related intangible assets. Similar Artistic-related intangible assets — these ownership rights are protected by copyrights. IFRSUS GAAP Contract-related intangible assets — a common form is a franchise. Technology-related intangible assets. Similar

Academic Resource Center Intangibles Page 9 Periodic revaluation Carrying value Assuming no impairment, intangible assets are valued at cost less any accumulated amortization. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 10 Periodic valuation Carrying value IFRS ► Revaluation to the fair value of intangible assets other than goodwill is an allowable alternative treatment: ► Because this requires reference to an active market for the specific type of intangible, it is relatively uncommon in practice. ► Increases in value should be credited to the account “revaluation surplus.” Revaluation surplus is an account that is included in accumulated OCI. Increases in value are not recorded in the revaluation surplus account if the increase reverses a loss that was previously expensed; that portion may be credited to an unrealized gain account which will flow through net income. ► Any decrease in value should be included as an unrealized loss in income unless it reverses the revaluation surplus relating to the same asset; that portion can be debited to revaluation surplus (OCI). US GAAP ► Revaluation is not permitted.

Academic Resource Center Intangibles Page 11 Periodic valuation Carrying value IFRS ► Revaluation (continued): ► If the revalued basis of an asset exceeds the cost basis, there will be an increase in the annual amortization. To the extent there is an increase in amortization expense, per IAS 38, paragraph 87, an entity may reverse the portion of reserve surplus related to this increase by debiting revaluation surplus and crediting retained earnings. Alternatively, this transfer may be completed upon disposal of the asset. ► When an asset is disposed of, any remaining revaluation surplus related to that asset can be transferred to retained earnings. US GAAP ► Revaluation is not permitted.

Academic Resource Center Intangibles Page 12 Periodic valuation Carrying value IFRS ► Revaluation (continued): ► If an intangible asset is revalued, an entity can account for the accumulated amortization at the date of revaluation by: ► Amortization elimination method: the accumulated amortization can be eliminated against the intangible asset itself. ► Proportionate restatement method: the accumulated amortization can be restated proportionately with the change in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount. The proportionate restatement method is rarely used in practice, thus no example is provided. US GAAP ► Revaluation is not permitted.

Academic Resource Center Intangibles Page 13 Carrying value example Revaluation Example 1 Intangibles Inc. owns a freely transferable bus operator’s license, which it acquired on January 1, 2010 at an initial cost of $100,000. The useful life of the license is five years (based on the date until which it is valid). The entity uses the straight-line method to amortize the intangible. Such licenses are frequently traded between existing operators. At the balance sheet date, December 31, 2011, due to a government-permitted increase in fixed bus fares, the traded value of such a license was $130,000. The accumulated amortization on December 31, 2011, amounted to $40,000. ► What journal entries are required on December 31, 2011, to reflect the change in carrying value (cost or revalued amount less accumulated amortization) on the revaluation of the operating license using US GAAP and IFRS? ► What journal entries are required on December 31, 2012, using US GAAP and IFRS?

Academic Resource Center Intangibles Page 14 Carrying value example Revaluation Example 1 solution: 2011 US GAAP: Revaluation is not permitted. IFRS: Accumulated amortization$ 40,000 Intangible asset$ 40,000 Intangible asset$ 70,000 Revaluation surplus – intangibles (OCI) $ 70,000 The net result is that the asset has a revised carrying amount of $130,000 ($100,000 – $40,000 + $70,000). The accumulated amortization may alternatively be restated proportionately US GAAP: Amortization expense$ 20,000 Accumulated amortization$ 20,000 IFRS: Amortization expense$ 43,333 Accumulated amortization$ 43,333 Revaluation surplus – intangibles (OCI)$ 23,333 Retained earnings$ 23,333 Note that this journal entry is optional.

Academic Resource Center Intangibles Page 15 Carrying value example Revaluation Example 2 Peter’s Photography, Inc. (PPI) reports using IFRS and acquires the ownership rights to a celebrity photograph on December 1, 2010, for $530. PPI accounts for these rights under the revaluation model. Assume, for the sake of simplicity, that there is no amortization recognized on this asset. The fair value of the asset changes as follows: ► What are the balances in revaluation surplus at the end of each year? ► How much revaluation is recognized through OCI each year? ► How much revaluation is recognized in income each year? December 1, 2010$530 December 31, 2010$550 December 31, 2011$520 December 31, 2012$510 December 31, 2013$555

Academic Resource Center Intangibles Page 16 Example 2 solution: The upward revaluation at A is accounted for in revaluation surplus through OCI. The downward revaluation at B first reduces revaluation surplus for that asset to zero and the excess of $10 is recognized as a loss in income. The second downward revaluation at C is recognized as a loss in income. The upward revaluation at D first reverses the cumulative loss recognized in income and the excess of $25 is accounted for through OCI in revaluation surplus. Carrying value example Revaluation Value of asset End-of-year balance in the revaluation surplus account Annual effect on OCI Annual effect on net income December 1, 2010$530––– A – December 31, $20 – B – December 31, –(20) $(10) C – December 31, ––(10) D – December 31,

Academic Resource Center Intangibles Page 17 Carrying value example Restatement of accumulated amortization at revaluation Example 3 The Boston Commons Company (BCC) reports using IFRS and owns a franchise of tea shops in the Boston area named Tea Party. BCC currently carries the franchise rights for Tea Party at $120,000. In this last year, Tea Party’s business has been quite successful due to the demand for its English tea products. This success resulted in an increase in the market value of the franchise rights to $150,000. Accordingly, BCC has revalued these rights. The original cost basis of the rights is $300,000, and the current accumulated amortization is $180,000. ► Please provide the journal entries to record the revaluation of these franchise rights.

Academic Resource Center Intangibles Page 18 Carrying value example Restatement of accumulated amortization at revaluation Example 3 solution: Amortization elimination: Accumulated amortization$180,000 Franchise rights$180,000 Franchise rights$30,000 Revaluation surplus – franchise (OCI) $30,000

Academic Resource Center Intangibles Page 19 Periodic valuation Impairment – definition of impairment indicators Impairment indicators for an asset include such items as significant change in its use, projected losses related to its use and a significant decline in its market value. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 20 Periodic valuation Impairment – recognition An impaired asset must be written down and the write-down should be recorded in net income. IFRSUS GAAP Similar, although an exception exists where an intangible asset has been revalued and the impairment loss is reversing an accumulated revaluation surplus balance for that asset. In that case, the portion of impairment that is reversing a prior increase in valuation may be debited to revaluation surplus (thus decreasing accumulated OCI).

Academic Resource Center Intangibles Page 21 Cost allocation Finite-lived intangible assets Amortization of intangible assets over their estimated useful lives is generally required. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 22 Cost allocation Finite-lived intangible assets IFRS ► This method is not prohibited, but it is not required. US GAAP ► Under ASC , capitalized software costs are amortized on a product- by-product basis: ► The annual amortization is the greater of the amount computed using: (a) the ratio that current gross revenues for a product bear to the total of the current and anticipated future gross revenues for that product; or (b) the straight-line method over the remaining estimated economic life of the product, including the period being reported.

Academic Resource Center Intangibles Page 23 Cost allocation Indefinite-lived intangible assets If there is no foreseeable limit to the period during which an intangible asset is expected to generate net cash inflows to the entity, the useful life is considered to be indefinite and is not amortized. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 24 Goodwill Goodwill is recognized only as a result of a business combination. For a 100% acquisition, the acquirer recognizes the acquiree’s net identifiable assets (including any intangible assets) at fair value at the acquisition date and recognizes goodwill, which represents the excess of the purchase price over the acquirer’s interest in the fair value of the identifiable net assets of the acquiree. Similar IFRS US GAAP Goodwill is subject to an annual impairment test. Negative goodwill is recognized immediately as income (after reassessing the purchase price allocation). Similar

Academic Resource Center Intangibles Page 25 Research and development Internal costs related to the research phase of research and development are expensed as incurred under both accounting models. Under converged standards, in-process research and development is to be recognized as an indefinite-lived intangible asset separately from goodwill at its acquisition-date fair value. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 26 Research and development IFRS ► Development costs are capitalized when technical and economic feasibility of a project can be demonstrated in accordance with specific criteria. Some of the criteria include: demonstrating technical feasibility, intent to complete the asset and ability to sell the asset in the future, as well as others. US GAAP ► Development costs are expensed as incurred, unless addressed by a separate standard.

Academic Resource Center Intangibles Page 27 Research and development example Example 9 – Internet Imaging Inc. (Triple I), is working on a project to create a database of picture images which it intends to sell over the internet. Triple I has identified the following stages and costs incurred in its project: Research stage This stage included identifying the system requirements, searching for an appropriate database and other system materials and images to purchase, gaining the technical knowledge necessary to collect and transfer the images and overall project feasibility. Costs incurred were $50,000 during the period of January 1, 2010 through March 31, On April 1, 2010, Triple I determined that it would complete the intended project. Additional research costs of $75,000 were incurred during the period of April 1, 2010 through June 30, Development stage This stage included performing market analysis to identify potential demand, acquiring system materials and images to populate the database; designing the website; and testing a system prototype. During the period of May 1, 2010 through August 31, 2010, Triple I incurred development costs of $100,000. On August 31, 2010, Triple I determined that its project was technically feasible. During the period of September 1, 2010 through October 31, 2010, Triple I incurred development costs of $50,000. On October 31, 2010, Triple I received its results from its market study and determined that the project was economically feasible. Additional development costs of $200,000 were incurred during the period of November 1, 2010 through December 31, Production stage Triple I will launch its imaging database on the internet on January 1, 2011.

Academic Resource Center Intangibles Page 28 Research and development example Example 9 continued: ► Complete the diagram below by inputting the research and development costs for 2010 in the appropriate periods based on the information above. ► Based on the diagram, determine which research and development costs Triple I can capitalize related to this project during 2010 using US GAAP and IFRS? Research phase Development phase $$ $$$ January 1, 2010 March 31, 2010 April 1, 2010 May 1, 2010 June 30, 2010 August 31, 2010 September 1, 2010 October 31, 2010 November 1, 2010 December 31, 2010 Research Initiated Decision to complete the project Development initiated Research completed Technical feasibility reached Economic feasibility reached Development completed

Academic Resource Center Intangibles Page 29 Research and development example Example 9 solution: Using US GAAP, Triple I cannot capitalize any research and development costs. Using IFRS, Triple I cannot capitalize any research costs, similar to US GAAP; however, Triple I may capitalize development costs when technical and economic feasibility of a project can be demonstrated in accordance with specific criteria. Some of the stated criteria include: demonstrating technical feasibility, intent to complete the asset and ability to sell the asset in the future, as well as others. As shown in the diagram below, Triple I met these criteria on October 31, 2010; therefore, the $200,000 incurred from November 1, 2010 through December 31, 2010, prior to the product launch on January 1, 2011, may be capitalized. Research phase Development phase $50,000$75,000 $100,000$50,000$200,000 January 1, 2010 March 31, 2010 April 1, 2010 May 1, 2010 June 30, 2010 August 31, 2010 September 1, 2010 October 31, 2010 November 1, 2010 December 31, 2010 Research Initiated Decision to complete the project Developmen t initiated Research completed Technical feasibility reached Economic feasibility reached Development completed

Academic Resource Center Intangibles Page 30 Other costs Start-up costs, including initial operating losses, cannot be capitalized. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 31 Other costs IFRS ► Advertising and promotional costs are expensed as incurred. A prepayment may be recognized as an asset only when payment for the goods or services is made in advance of the entity having access to the goods or receiving the services. US GAAP ► Advertising and promotional costs are either expensed as incurred or expensed when the advertising takes place for the first time under US GAAP. Direct-response advertising may be capitalized if the specific criteria in ASC , Other Assets and Deferred Costs-Capitalized Advertising Costs-Recognition, are met.

Academic Resource Center Intangibles Page 32 Disclosures The disclosure requirements under US GAAP and IFRS for intangible assets are, in most respects, similar. Similar IFRSUS GAAP

Academic Resource Center Intangibles Page 33 Disclosures US GAAP ► GAAP does not, within a single standard, address comprehensive disclosure requirements for intangible assets: ► Under SEC rules, SEC registrants are required to disclose identifiable intangible assets separately from unidentifiable intangible assets and goodwill, along with the method of determining their respective amounts. ► Despite the additional disclosures required by SEC rules, it is likely that there will be more disclosures for intangible assets under IAS 38 than under US GAAP IFRS ► IAS 38 includes a long list of general disclosures for each class of intangible asset: ► Internally generated intangible assets must be distinguished from other intangible assets. ► Separate disclosure is required for intangible assets being amortized over more than 20 years, for intangible assets being carried under the allowed alternative treatment at revalued amounts, and for research and development expenditures. ► IAS 38 encourages disclosure of a description of any fully amortized intangible asset that is still in use and disclosure of a description of any intangible asset that did not meet the recognition criteria.

Academic Resource Center Intangibles Page 34 Disclosures IFRS ► Requires disclosures about impairment losses in the aggregate and by class of asset and reportable segment and, if material, by individual asset or CGU. ► IAS 36 specifies additional reporting requirements for impairment losses and the reversal of those impairment losses for revalued assets. US GAAP ► Requires disclosures about impairment losses and the circumstances giving rise to those losses. However, detailed disclosures by individual asset or CGU are not required. ► Because ASC 360 does not permit the revaluation of assets, it does not provide guidance on revaluation.

Academic Resource Center Intangibles Page 35 Disclosures IFRS ► If an asset’s recoverable amount is measured as its value in use, IAS 36 requires disclosure of the discount rate used in calculating that measure and encourages, but does not require, disclosure of the key assumptions used. US GAAP ► If a surrogate for fair value is developed by discounting an enterprise’s estimates of an asset’s future cash flows, ASC 360 requires disclosure of that fact, but not of the discount rate or the key assumptions used.