Presentation Transcript

1. ACCG224 – Session 1, 2013 Week 5

   Accounting for Intangibles
2. Learning objectives Understand the nature of intangibles; understand the recognition criteria for intangibles; understand how to measure intangibles on initial recognition; explain how to measure and amortise intangibles subsequent to initial recognition; understand internally generated intangibles; explain how to account for research and development costs; explain how to account for goodwill; apply the disclosure requirements of AASB 138.
3. Relation to previous weeks Week 3 & 4 – Property, Plant and Equipment (PPE): tangible assets (AASB 116); including tax implications (AASB 112); Week 5 – Intangibles: assets of a special nature; individual accounting standard and rules (AASB 138); It is important to understand the different nature of tangible and intangible assets and its impact on accounting.
4. Overview of AASB 138: Intangible assets Intangible assets: nature and types of intangible assets; importance of intangible assets.  Recognition and initial measurement: depending on way of acquisition; special case: internally generated intangible assets: research and development costs (R&D); other internally generated intangible assets; unidentifiable intangible assets: goodwill (AASB 3); Subsequent measurement: cost or revaluation model; amortisation; impairment; Disclosure requirements. discussed in week 6
5. The nature of intangible assets AASB 138 provides the following definition for intangible assets: “An identifiable non-monetary asset without physical substance” Three key characteristics of intangible assets: non-monetary (i.e., it is not a financial asset); identifiable; lack of physical substance (i.e., it is, for example, not an item of PPE).
6. Some types of intangible assets
7. The nature of intangible assets: identifiability For an intangible asset to be identifiable one of the following two criteria must be met: It is separable from the entity, i.e. capable of being transferred separately: e.g. customers lists and non-contractual customer relationships are not separately transferable. It arises from a contractual or some other legal right: e.g. trademarks; franchise agreements. Figure 9.3 of text lists items that meet the identifiability criteria.
8. The nature of intangible assets: lack of physical substance Non-physical assets have a number of unique characteristics such as: they they are non-rival assets; they are characterised by large fixed costs and negligible marginal costs; they are not subject to diminishing returns characteristic of physical assets; they may have network effects; they may be more difficult to operate and manage than tangible assets; there is in general an absence of organised and competitive markets..
9. Increasing importance of intangible assets Intangible assets have been increasing in importance due to: intensified business competition; the advent of information technologies. The above factors have resulted in a fundamental corporate change. Significant increase in: innovation related intangible assets; human resource related intangible assets; organisational intangible assets.
10. Identifying intangible assets An asset is defined in the Conceptual Framework as a resource controlled by the entity. Control usually stems from legal or other rights and can be difficult to establish. Example: highly trained staff do not qualify as intangible assets due to the lack of control the entity has over the staff. If at all, such benefits may be recognised as part of goodwill (refer later slides on goodwill). Note link to identifiability criterion discussed earlier.
11. Recognition and initial measurement An intangible asset shall be measured initially at cost (AASB 138 para. 24). Any subsequent expenditure is to be expensed, unless both the following criteria are satisfied: it is probable that the expenditure will increase the future economic benefits embodied in the asset in excess of the standard of performance assessed immediately before the expenditure was made; and the expenditure can be measured reliably to the asset. Expenditure on an intangible item that was initially recognised as an expense cannot be recognised as part of the cost of an intangible asset at a later date (AASB 138 para. 71).
12. Recognition and initial measurement (cont’d) Intangible assets may be acquired in the following ways: by separate acquisition; as part of a business combination; by way of a government grant; in exchange for non-monetary asset; they may be internally generated. Each of these options are discussed in detail on the following slides.
13. Recognition and initial measurement:separate acquisition AASB 138 considers the probability recognition criteria always to be satisfied for separately acquired intangible assets. Cost can usually be measured reliably, although there may be issues where the acquirer is giving up non-monetary assets, rather than cash.
14. Recognition and initial measurement:acquisition as part of a business combination Intangible assets acquired as part of a business combination are not initially measured at cost, but at fair value in accordance with AASB 3 ‘Business Combinations’. Fair value measures used may include: quoted market prices in an active market → rare for intangible assets that an active market exists; recent transactions in the same or similar items → due to the unique nature of intangible assets this is also uncommon; using other measurement techniques → e.g. present value/earnings multiple valuation techniques.
15. Recognition and initial measurement:acquisition by way of a government grant Examples: airport landing rights; licences to operate radio or television stations; import licences or quotas or rights to access other restricted resources. AASB 120 ‘Accounting for Government Grants and Disclosure of Government Assistance’ is applicable, choice between: fair value: both the intangible asset and the grant are initially recognised at fair value; cost: intangible asset is initially recognised at a nominal amount plus directly attributable costs.
16. Recognition and initial measurement:acquisition in exchange for non-monetary assets Given infrequent comparable market transactions in exchanges of intangible assets, often cost is determined by fair value of assets given. The cost of such an intangible asset is measured at fair value unless the exchange transaction lacks commercial substance or the fair value of neither the asset received nor the asset given up is reliably measurable. Then carrying value of given assets is transferred to received intangible assets.
17. Recognition and initial measurement:internally generated intangible assets AASB 138 distinguishes between the following internally generated intangible assets: research and development costs (R&D): accounting treatment see following slides; other internally generated intangible assets: like brands, mastheads, publishing titles, customer lists and similar items; excluded from recognition as per AASB 138! Goodwill represents unidentifiable assets: no intangible asset as per AASB 138 definition, excluded from recognition as per AASB 138! However, the other internally generated intangible assets and goodwill are recognised at their fair value when acquired as part of a business combination (AASB 3).
18. Recognition and initial measurement:R&D Determining when to commence capitalising costs depends on whether the asset was generated in the research or development phase. Research (AASB 138, para. 8): original and planned investigation to gain new knowledge and understanding (earlier stages of a project); e.g., the search for new knowledge/search for alternative processes; accounting treatment →all research costs are expensed.
19. Recognition and initial measurement:R&D (cont’d) Development (AASB 138, para 8): knowledge applied to a plan or design for the production of new or substantially improved products etc. before commercial production or use. e.g., the design, construction, testing and operation of prototypes, models and pilot plants; accounting treatment: development costs that meet the recognition criteria (refer to next slide) may be capitalised; expenditure from the date the recognition criteria was first met can be capitalised; previously expensed items cannot be reinstated and capitalised.
20. Recognition and initial measurement:R&D (cont’d) High degree of uncertainty about whether expenditure incurred on research and development ultimately generate future economic benefits. Research expenditure must be written off when incurred, whereas development expenditure may be capitalised to the extent that certain conditions are met.
21. Recognition and initial measurement:R&D (cont’d) Research phase: Research should be considered separately from development: research generally precedes development. Research is original investigation, while development is defined as activities undertaken with specific commercial objectives, and involves the translation of research knowledge into designs for new products. In relation to research expenditures AASB 138, para. 54 states “No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. It shall be recognised as an expense when it is incurred”.
22. Recognition and initial measurement:R&D (cont’d) Research phase (cont’d): Research is expensed by virtue of the view that it is undertaken in the early stages of development of new product or process and the likelihood of it being possible to link the expenditure with future economic benefits is deemed to be uncertain. “In the research phase of an internal project, an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. Therefore, this expenditure is recognised as an expense when it is incurred” (AASB 138, para. 55).
23. Recognition and initial measurement:R&D (cont’d) Development phase: As we move towards the development stage uncertainty of future economic benefits is deemed to reduce. Paragraph 57requires that expenditure on development may be deferred only if the entity can show all of the following:  the technical feasibility of completing the intangible asset so that it will be available for use or sale; its intention to complete the intangible asset, and use or sell it; its ability to use or sell the intangible asset; /...
24. Recognition and initial measurement:R&D (cont’d) Development phase (cont’d): how the intangible asset will generate probable future economic benefits, including the existence of a market for the output of the intangible asset, or the intangible asset itself, or where the intangible asset is to be used internally, its usefulness; the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and its ability to measure reliably expenditure on the intangible asset during its development.
25. Recognition and initial measurement:R&D (cont’d) Development phase (cont’d): The test for deferral is the same that applies to other intangible assets (AASB 138, para. 21): An intangible asset should be recognised if and only if:  it is probable that the future economic benefits that are attributable to the asset will flow to the entity; and the cost of the asset can be measured reliably.
26. Example Classic Laboratories Ltd is undertaking a major research and development project, major components of which are described below. January 2011: Classic established a new research project concerned with identifying radically different poisons, useful for controlling pests. During January experiments were conducted, using a variety of chemical compositions, on a variety of pests. Costs incurred were $1 million. 
27. Example (cont’d) March 2011: The experiments conducted established that a particular chemical composition was lethal to mice. Classic's management believed that a large potential market existed for an effective mice poison that was chemically different from those currently available. While experiments established that the poison was lethal to mice, a large quantity of it (in its present form) was required to kill significant mice populations. Thus, the poison was not a commercially viable product in its present form. Classic undertook additional research to find a more concentrated form of the new poison. Costs incurred in March were $1.5 million.
28. Example (cont’d) June 2011: Additional research resulted in a more concentrated form of the new poison and experiments confirmed that it was lethal to mice. However, as the new poison had a radically different chemical composition, it was necessary for the research team to undertake additional work to determine how to produce the new poison economically. Production might require modifications to the chemical composition of the new poison. Market research confirmed that there was a large market for a chemically different mice poison. Costs incurred in June were $4 million.
29. Example (cont’d) September 2011: The research team devised a means of mass producing the new poison economically. The costs incurred in September on this task were $3 million. Classic constructed production facilities for the new poison at a cost of $10 million. Production began in October. Required Determine the total research and development costs that should be deferred, in accordance with AASB 138, at the end of 2011. Justify your answer. Show the necessary journal entries to record all the events.
30. Example – solution The criteria in AASB 138 para. 57 are:  technical feasibility; intention to complete and sell; ability to use or sell; existence of a market; availability of resources; ability to measure costs reliably. On the basis of the analysis, the criteria are met in September. Hence, costs incurred before this point are expensed: January $1.0m March $1.5m June $4.0m
31. Example – solution (cont’d) Capitalised costs: September $3m Production facility $10m Journal entries January Research Expense $1m Cash $1m March Research Expense $1.5m Cash $1.5m 
32. Example – solution (cont’d) Journal entries (cont’d) June Research Expense $4m Cash $4m September *Development Cost $3m Cash $3m  *Plant $10m Cash $10m *assets
33. Recognition and initial measurement:other internally generated intangible assets AASB 3 prescribes all intangible assets purchased as part of a business combination to be recognised at fair value. BUT AASB 138 does not allow other internally generated intangible assets to be recognised. Why is this so? The AASB considers business combinations as market transactions evidencing the recognition criteria to be met.
34. Digression: purchased goodwillAASB 3 Goodwill – excess of the cost of acquisition over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities:  cannot be identified individually; a composite asset; can only be identified in relation to total business value during a sale or purchase. The acquirer shall, at the acquisition date: recognise goodwill acquired as an asset; and initially measure that goodwill at its cost (AASB 3 ‘Business Combinations’, para. 51).
35. Example Ruby Ltd has purchased 100 per cent of Loxy Ltd on 1 January 2011, for a cash payment of $900,000. An extract from the statement of financial position for Loxy Ltd at the date of acquisition is shown on the following slide. Additional information: The assets and liabilities of Loxy Ltd are all stated at fair value except that: land and buildings have a fair value of $300,000; accounts receivable have a fair value of $20,000; Loxy owns a licence that has not been recorded in the accounts. Its fair value is $150,000.
36. Example (cont’d)
37. Example (cont’d) Required: What is the amount of purchased goodwill, if any, that has been acquired by Ruby Ltd? Show the journal entry for the books of Ruby Ltd assuming that Loxy Ltd ceases to exist and all asset and liabilities are transferred to Ruby Ltd within this business combination.
38. Example – solution Purchased goodwill Goodwill = cost of acquisition – net fair value of identifiable assets acquired cost of acquisition = $900,000 net fair value of identifiable assets acquired: see restated statement of financial position on the following slide. goodwill = 900,000 – 701,000 = 199,000
39. Example – solution (cont’d)
40. Example – solution (cont’d) Journal entry Cash 12,000 Accounts receivable 20,000 Inventory 80,000 Land and buildings 300,000 Vehicles 90,000 Equipment 157,000 Licence 150,000 Goodwill 199,000 Accounts payable 8,000 Loan 100,000 Cash 900,000 End of digression
41. Subsequent measurement of intangible assets: measurement basis Choice of cost or revaluation models available (consistent with accounting for PPE). Where the revaluation model is applied, the fair value must be determined by reference to an active market. As there is no active market for unique assets (which includes most intangible assets), such items must be measured under the cost model. Subsequent expenditure on intangible assets are required to be expensed. The exception to this is subsequent development expenditure which meets the criteria on slides 23 and 24.
42. Subsequent measurement of intangible assets: amortisation Need to assess whether the useful life is finite or indefinite (i.e. there is no foreseeable end to the life of the asset) Finite useful life: Amortisation principles are the same as for depreciating PPE. Straight-line method most commonly used. Residual value assumed to be zero in most cases. Amortisation period generally over life of contract (may include contract renewal period). Indefinite useful life: no amortisation charge; subject to annual impairment tests (for additional details on impairment, see AASB 136 ‘Impairment of Assets’ – week 6).
43. General disclosure requirements:AASB 138, para. 118 An entity shall disclose the following for each class of intangible assets, distinguishing between internally generated intangible and other intangible assets: whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortisation rates used; the amortisation methods used for intangible assets with finite useful lives; the gross carrying amount and any accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period; the line item(s) of the income statement in which any amortisation of intangible assets is included;
44. General disclosure requirements:AASB 138, para. 118 (cont’d) a reconciliation of the carrying amount at the beginning and end of the period showing: additions, indicating separately those from internal development, those acquired separately, and those acquired through business combinations; … any amortisation recognised during the period; etc. (see AASB 138, para. 118)
45. General disclosure requirements:AASB 138, para. 122 An entity shall also disclose: for an intangible asset assessed as having an indefinite useful life, the carrying amount of that asset and the reasons supporting the assessment of an indefinite useful life. In giving these reasons, the entity shall describe the factor(s) that played a significant role in determining that the asset has an indefinite useful life; a description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the entity’s financial statements;
46. General disclosure requirements:AASB 138, para. 122 (cont’d) for intangible assets acquired by way of a government grant and initially recognised at fair value (see para. 44): the fair value initially recognised for these assets; their carrying amount; and whether they are measured after recognition under the cost model or the revaluation model; the existence and carrying amounts of intangible assets whose title is restricted and the carrying amounts of intangible assets pledged as security for liabilities; and the amount of contractual commitments for the acquisition of intangible assets.