1. Chapter 7 Accounting for intangibles

2. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-2 Objectives Understand what types of assets can be considered as intangible assets, and the differences between intangible and tangible assets. Understand what types of assets can be considered as intangible assets, and the differences between intangible and tangible assets. Understand how to account for research and development expenditure and, in particular, be aware of how to apply the tests for deferral of research and development expenditure. Understand how to account for research and development expenditure and, in particular, be aware of how to apply the tests for deferral of research and development expenditure.

3. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-3 Objectives (cont.) Be able to describe some empirical research that has been undertaken into corporate research and development accounting practices. Be able to describe some empirical research that has been undertaken into corporate research and development accounting practices. Be able to define ‘goodwill’ and explain how it is calculated for accounting purposes. Be able to define ‘goodwill’ and explain how it is calculated for accounting purposes. Be able to explain and apply the amortisation requirements applicable to goodwill contained in FRS-36. Be able to explain and apply the amortisation requirements applicable to goodwill contained in FRS-36.

4. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-4 Objectives (cont.) Be aware of the controversies that arose as a result of the 1996 version of the Australian goodwill accounting standard. Be aware of the controversies that arose as a result of the 1996 version of the Australian goodwill accounting standard. Be able to evaluate the deferral and amortisation requirements of both the research and development and the goodwill financial reporting standards. Be able to evaluate the deferral and amortisation requirements of both the research and development and the goodwill financial reporting standards.

5. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-5 Objectives (cont.) Be aware of the brands and other internally generated intangible assets debate, and how it applies in New Zealand. Be aware of the brands and other internally generated intangible assets debate, and how it applies in New Zealand. Be aware of some of the controversies that arose as a result of the issue by the Financial Reporting Standards Board of ED-87 ‘Accounting for Intangible Assets’. Be aware of some of the controversies that arose as a result of the issue by the Financial Reporting Standards Board of ED-87 ‘Accounting for Intangible Assets’.

6. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-6 Intangible assets Non-monetary assets without physical substance. Non-monetary assets without physical substance. Includes patents, goodwill, mastheads, brand names, copyrights, research and development, and trademarks. Includes patents, goodwill, mastheads, brand names, copyrights, research and development, and trademarks. Intangible assets, as a category, must be separately disclosed in the statement of financial position. Intangible assets, as a category, must be separately disclosed in the statement of financial position.

7. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-7 Identifiable versus unidentifiable intangible assets Identifiable intangible assets Identifiable intangible assets –a specific value can be placed on each individual asset, and they can be separately identified and sold. –e.g. brand names, trademarks, research and development, patents, licences. Unidentifiable intangible assets Unidentifiable intangible assets –intangible assets that cannot be separately sold. –e.g. goodwill.

8. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-8 Amortisation of intangibles Generally intangible assets have a limited life. Generally intangible assets have a limited life. They should be amortised over their useful lives. They should be amortised over their useful lives. SSAP-3 ‘Accounting for Depreciation’ remains applicable to certain intangible assets. SSAP-3 ‘Accounting for Depreciation’ remains applicable to certain intangible assets.

9. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-9 Research and development Refer to FRS-13 ‘Accounting for Research and Development Activities’. Refer to FRS-13 ‘Accounting for Research and Development Activities’. Research must be considered separately from development. Research must be considered separately from development. Research defined as Research defined as –original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Research costs must be recognised as an expense when incurred. Research costs must be recognised as an expense when incurred.

10. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-10 Research and development (cont.) Development defined as Development defined as –the application of research findings or other knowledge to a plan or design for the production of new or substantially new improved materials, devices, products, processes, systems or services prior to the commencement of commercial production or use. Development costs recognised as an expense in the period incurred unless the criteria for asset recognition are met. Development costs recognised as an expense in the period incurred unless the criteria for asset recognition are met.

11. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-11 Development costs recognised as an asset FRS-13 5.3 when, and only when, all the following criteria are met: FRS-13 5.3 when, and only when, all the following criteria are met: –The product or process is clearly defined and the costs attributable to the product or process can be identified and measured reliably. –The technical feasibility of the product or process can be demonstrated.

12. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-12 Development costs recognised as an asset (cont.) FRS-13 5.3 when, and only when, all the following criteria are met (cont.): FRS-13 5.3 when, and only when, all the following criteria are met (cont.): –The entity intends to produce and market, or use, the product or process. –The existence of a market for the product or process or its usefulness to the entity, if it is to be used internally, can be demonstrated.

13. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-13 Development costs recognised as an asset (cont.) FRS-13 5.3 when, and only when, all the following criteria are met (cont.): FRS-13 5.3 when, and only when, all the following criteria are met (cont.): –Adequate resources exist, or their availability can be demonstrated, to complete the project and market or use the product or process.

14. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-14 Costs included as part of research and development Salaries, wages and other related costs of personnel engaged in R&D activities. Salaries, wages and other related costs of personnel engaged in R&D activities. Costs of materials and services consumed in R&D activities. Costs of materials and services consumed in R&D activities. Depreciation of equipment and facilities used in R&D. Depreciation of equipment and facilities used in R&D. Amortisation of other assets related to R&D. Amortisation of other assets related to R&D. Overhead costs related to specific R&D activities. Overhead costs related to specific R&D activities. Other costs that can be attributed to R&D activities, such as amortisation of patents. Other costs that can be attributed to R&D activities, such as amortisation of patents.

15. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-15 Amortisation of development costs Any development costs must be amortised and recognised as an expense on a systematic basis. Any development costs must be amortised and recognised as an expense on a systematic basis. Amortisation begins when the product or service is available for sale or use. Amortisation begins when the product or service is available for sale or use. Amortisation period should not exceed 5 years, unless a longer period, not exceeding twenty years, can be justified. Amortisation period should not exceed 5 years, unless a longer period, not exceeding twenty years, can be justified.

16. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-16 Amortisation of development costs (cont.) Development costs recognised as an asset should be reviewed annually to ensure the carrying amount does not exceed recoverable amount. Development costs recognised as an asset should be reviewed annually to ensure the carrying amount does not exceed recoverable amount.

17. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-17 Government grants for research and development A grant received in relation to R&D would meet the Statement of Concepts definition of revenue and should be treated as such. A grant received in relation to R&D would meet the Statement of Concepts definition of revenue and should be treated as such.

18. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-18 Empirical research Requirement to write-off R&D expenditure caused smaller US R&D firms to reduce R&D expenditure. Requirement to write-off R&D expenditure caused smaller US R&D firms to reduce R&D expenditure. Requirement to write-off R&D may affect management decisions about R&D expenditure if management compensation based on profits. Requirement to write-off R&D may affect management decisions about R&D expenditure if management compensation based on profits. May also be based on debt contract covenants. May also be based on debt contract covenants.

19. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-19 Disclosure requirements FRS-13 5.19 requires disclosure of: FRS-13 5.19 requires disclosure of: –the accounting policy adopted for R&D costs –amount of R&D costs recognised as an expense in the period –the amortisation methods used

20. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-20 Disclosure requirements (cont.) FRS-13 5.19 requires disclosure of (cont.): FRS-13 5.19 requires disclosure of (cont.): –A reconciliation of the balance of unamortised development costs at the beginning and end of the period showing development costs recognised as an asset; development costs recognised as an asset; development costs allocated to other asset accounts; and development costs allocated to other asset accounts; and development costs written back together with an explanation of the change in circumstances that led to the write-back as an asset. development costs written back together with an explanation of the change in circumstances that led to the write-back as an asset.

21. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-21 Goodwill Arises when one entity acquires another entity, or part thereof. Arises when one entity acquires another entity, or part thereof. An unidentifiable intangible asset. An unidentifiable intangible asset. Accounting governed by FRS-36. Accounting governed by FRS-36.

22. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-22 Internally generated vs. purchased goodwill Goodwill may be internally generated or acquired by purchasing an existing business. Goodwill may be internally generated or acquired by purchasing an existing business. Only purchased goodwill is permitted to be recorded Only purchased goodwill is permitted to be recorded –purchased goodwill can be measured more reliably than internally generated goodwill, based on the amount paid. Purchased goodwill is measured as the excess of the cost of acquisition incurred over the fair value of the net assets acquired. Purchased goodwill is measured as the excess of the cost of acquisition incurred over the fair value of the net assets acquired.

23. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-23 Fair value Fair value is the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction. Fair value is the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction.

24. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-24 Amortisation of goodwill Much opposition to amortisation requirements. Much opposition to amortisation requirements. When AAS 18 released, requirement to amortise over a period not exceeding 20 years. When AAS 18 released, requirement to amortise over a period not exceeding 20 years. Innovative methods used for amortising developed—inverted sum-of-years-digits. Innovative methods used for amortising developed—inverted sum-of-years-digits.

25. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-25 Amortisation of goodwill (cont.) In NZ goodwill must be amortised on a systematic basis over its useful life. In NZ goodwill must be amortised on a systematic basis over its useful life. Period must not exceed 20 years. Period must not exceed 20 years.

26. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-26 Empirical research Amortisation method may impose costs on firms with debt covenants in place. Amortisation method may impose costs on firms with debt covenants in place. May also affect management compensation contracts. May also affect management compensation contracts. Little evidence that goodwill amortisation expense used in profit calculation reflects information to investors in setting share prices and returns. Little evidence that goodwill amortisation expense used in profit calculation reflects information to investors in setting share prices and returns.

27. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-27 Accounting for brands A brand is a symbol, design, name or combination of these that identifies a seller’s product and distinguishes it from the competition. A brand is a symbol, design, name or combination of these that identifies a seller’s product and distinguishes it from the competition. Internally generated brands now being recognised by a number of NZ companies. Internally generated brands now being recognised by a number of NZ companies.

28. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-28 Background to the brand debate Two basic origins: Two basic origins: –the problem of accounting for goodwill and other assets obtained through the acquisition of another company –desire of companies to reflect value rather than cost of certain assets on statement of financial position.

29. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-29 Brand/intangible asset debate Primary issue is the trade-off between two of the qualitative characteristics of financial reporting information. Primary issue is the trade-off between two of the qualitative characteristics of financial reporting information.

30. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-30 ED-87 Intangibles requirements Expenditure incurred on internally generated assets such as brands cannot be distinguished from the costs of developing the business as a whole. Expenditure incurred on internally generated assets such as brands cannot be distinguished from the costs of developing the business as a whole. Where an intangible is recognised, it must be measured initially at cost. Where an intangible is recognised, it must be measured initially at cost.

31. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-31 ED-87 Intangibles requirements (cont.) If the intangible has been acquired as part of an acquisition resulting in an entity combination, it is not necessary for the fair value of the asset to be determined by reference to an active market. If the intangible has been acquired as part of an acquisition resulting in an entity combination, it is not necessary for the fair value of the asset to be determined by reference to an active market.

32. Copyright  2003 McGraw-Hill New Zealand Pty Ltd. PPTs t/a New Zealand Financial Accounting 2e by Deegan and Samkin Slides prepared by Grant Samkin 7-32 ED-87 Intangibles requirements (cont.) Where an active market does not exist, the fair value initially recognised must be limited to an amount that does not create or increase any negative goodwill arising at the date of acquisition. Where an active market does not exist, the fair value initially recognised must be limited to an amount that does not create or increase any negative goodwill arising at the date of acquisition.