Chapter 8

1. Chapter 8 Accounting for intangibles

2. Objectives of this lecture • Understand what types of assets can be considered intangible assets and understand the differences between intangible and tangible assets • Understand when expenditure on intangible assets should be recognised as an asset • Understand when expenditure on intangible assets must be expensed • Understand that intangible assets will either need to be systematically amortised or be the subject of impairment testing and that this choice will depend upon whether the asset is expected to have a limited useful life or an indefinite life

3. Objectives (cont.) • Know how and when to revalue an intangible asset • Understand how to account for research and development expenditure • Be able to describe some empirical research that has been undertaken on corporate accounting practices relating to research and development • Be able to define goodwill and explain how it is calculated for accounting purposes

4. Definition of intangible assets • Non-monetary assets without physical substance • Intangible assets, as a category, must be separately disclosed in the statement of financial position • Identifiable intangible assets • Unidentifiable intangible assets • Greater value nowadays being placed on intangible assets for many companies—valuation is therefore an important issue

5. Which intangible assets can be recognised and included in the statement of financial position? AASB 138 Intangible Assets • Internally generated intangible assets (except internally generated development expenditure) are not to be carried forward as assets • Specifically, paragraph 63 states: Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets • Recognition • Separable

6. What is the initial basis of measurement of intangible assets? AASB 138 Intangible Assets • With the exception of expenditure incurred on development activities, only acquired intangibles may be recognised for balance sheet purposes • Expenditure on internally generated intangibles does not qualify for deferral and must be expensed • Cost of an asset to include the cost of acquiring the asset and preparing it for use • Acquired intangible assets may be revalued to fair value only where there is an ‘active market’ Refer to Worked Example 8.1, p. 259—Capitalising expenditure on intangible assets

7. General amortisation requirements for intangible assets • Intangible assets (other than goodwill) that are considered to have a limited useful life are required to be depreciated/amortised over their useful lives • Useful life of an intangible asset under AASB 138: The period of time over which the asset is expected to be used by the entity, or the number of production or similar units expected to be obtained from the asset by the entity • Consider the expected residual value of the asset • Under AASB 138 the residual value of intangible assets with finite lives is generally considered to be zero • Useful life, residual value and amortisation method to be reviewed annually

8. General amortisation requirements for intangible assets (cont.) • Amortisation method should reflect the pattern in which the economic benefits are derived • Intangible assets may have an ‘indefinite life’ • If the asset has an indefinite life there is no requirement to amortise • If there is an impairment in the value of the asset it is to be shown as an expense Refer to Worked Example 8.2, p. 261—Determining amortisation expense

9. Revaluation of intangible assets • AASB 138—intangible assets may be revalued only if there is an ‘active market’ • Only assets that have been acquired at cost can subsequently be revalued • Where revaluation occurs it must be to fair value of asset • Revaluations to be done regularly • Subsequent to a revaluation, any amortisation charges are to be based revalued amount • Revaluations of goodwill are not permitted in Australia Refer to Worked Example 8.3, p. 264—Revaluation of intangible assets

10. Required disclosures in relation to intangible assets Numerous disclosures are required by AASB 138 Financial statements are to disclose the following for each class of intangible assets, distinguishing between internally generated 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 statement of comprehensive income in which any amortisation of intangible assets is included • A reconciliation of the carrying amount at the beginning and end of the period

11. Required disclosures in relation to intangible assets (cont.) Financial statements are also to disclose: (a) if assessed as having an indefinite useful life, the carrying amount of that asset and the reasons supporting the assessment of an indefinite useful life. (b) a description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial statements of the entity as a whole (c) for intangible assets acquired by way of a government grant and initially recognised at fair value (d) where title is restricted and the carrying amounts of intangible assets pledged as security for liabilities (e) the amount of contractual commitments for the acquisition of intangible assets

12. Research and development Introduction • AASB 138 applies to intangible assets generally—however, there are a number of paragraphs dealing specifically with research and development Research and development • May account for a large proportion of expenditure for some entities • Accounting problem: will the expenditure, with reasonable probability, provide future benefits? • AASB 138 applies the simplifying assumption that all expenditure undertaken on the research component of research and development is to be expensed

13. Research and development (cont.) Research expenditure—to be written off as incurred AASB 138, par. 54 No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research shall be recognised as an expense when incurred In justifying the above requirement AASB 138 (par. 55) 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

14. Research and development (cont.) Development expenditure can be deferred only if the entity can show all of the following (AASB 138, par. 57): • The technical feasibility of completing the intangible asset • Its intention to complete the intangible asset, and use or sell it • Its ability to use or sell the intangible asset • How the intangible asset will generate probable future economic benefits, including the existence of a market for the intangible asset 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 • The ability to measure reliably expenditure on the intangible asset during its development

15. Research and development (cont.) Additional key issues • Where the total of the deferred development costs exceeds the expected recoverable amount, the deferred costs must be written down to the recoverable amount • If the expenditure is initially expensed in one period then it may not subsequently be written back to the statement of financial position. General principle (AASB 138, par. 71): Expenditure on an intangible item that was initially recognised as an expense shall not be recognised as part of the cost of an intangible asset at a later date AASB 138 is inconsistent with Conceptual Framework—however, accounting standard takes precedence.

16. Research and development (cont.) The requirement to write off all research expenditure as incurred: • will result in much research activity that in fact does lead to subsequent economic benefits nonetheless having to be written off • will have major implications for reported profits of entities that are heavily involved in R&D • is less conservative than US position, where all research and development expenditure must be expensed as incurred

17. Research and development (cont.) Costs included as part of research and development • Costs of internally generated assets (e.g. research and development) are all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by management (AASB 138, par. 66) Refer to Worked Example 8.4, p. 267—Amortisation of research and development

18. Research and development (cont.) Amortisation of deferred development costs AASB 138 provides a number of requirements for the amortisation of intangibles, which also apply to any development expenditure that has been capitalised and deferred to future periods Amortisation can be based on (whichever is appropriate): • output levels • expiration of time Refer to Worked Example 8.5, p. 268—Amortisation of deferred development costs Refer to Worked Example 8.6, pp. 272–73—Calculating deferred development balances

19. Goodwill What is goodwill? • Arises when one entity acquires another entity, or part thereof • An unidentifiable intangible asset • Cannot be purchased or sold separately • Represents the future economic benefits associated with an existing customer base, efficient management, reliable suppliers, etc. • Could be built up over a number periods • The relevant accounting standard is AASB 3 Business Combinations

20. Goodwill (cont.) Internally generated versus purchased goodwill • Goodwill may be internally generated or acquired by purchasing an existing business • Only purchased goodwill is permitted to be recorded. • Internally generated goodwill cannot be brought to account • Measurement of purchased goodwill Refer to Worked Example 8.7, p. 275—Calculation of goodwill

21. Impairment of goodwill Impairment testing Requirement to amortise goodwill was removed in 2005 and replaced with requirement to undertake annual ‘impairment testing’ AASB 3 (par. 55) Goodwill acquired in a business combination shall not be amortised. Instead, the acquirer shall test it for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired, in accordance with AASB 136 ‘mpairment of Assets AASB 136 (par. 124) • An impairment loss recognised for goodwill shall not be reversed in a subsequent period

22. Impairment of goodwill —Worked Example 8.8 • Where the recoverable amount of a cash-generating unit is below its carrying amount then any amount of goodwill attributed to that CGU must firstly be reduced. • If the impairment loss exceeds the amount of goodwill initially attributed to the CGU then there must also be a pro-rata reduction in the carrying value of the identifiable assets.

23. Impairment of goodwill —Worked Example 8.8 (cont.) As paragraph 104 of AASB 136 states: The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order: (a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and (b) then, to the other assets of the unit (group of units) pro rata on the basis of the carrying amount of each asset in the unit (group of units)

24. Is the approach to accounting for intangibles an improvement to what we did in Australia before the intro of IFRS in 2005? Critical perspective • The intangible asset accounting standard offers international consistency in financial reporting but some argue that it is seriously flawed and archly conservative • Fails to require recognition of many intangible assets—arguably reducing the value of statements of financial position (balance sheets) in relation to providing information about the resources under the control of the reporting entity • Places a number of severe restrictions on the recognition of internally generated intangible assets and on revaluation of those assets

25. Is the new approach to accounting for intangibles an improvement? (cont.) Critical perspective (cont.) • Users will experience a lack of information on intangibles as many now go unreported • Introduces subjectivity: rather than amortising goodwill over a set period of time, assessments will now have to be made about whether the value of goodwill has been ‘impaired’ • Requirement that all research be written off as incurred is very conservative—financial statement users will not be able to differentiate between entities that have expended resources on research that is expected to culminate in economic benefits and those that have incurred expenditure that is not expected to generate economic benefits

26. Is the new approach to accounting for intangibles an improvement? (cont.) Critical perspective (cont.) • Possible that requiring entities involved in research and development to expense all research as incurred might discourage them from undertaking certain research as it will impact negatively on profits • Previously, no prohibition on revaluing identifiable intangible assets (other than goodwill)—as a result of adopting IFRSs we are now only allowed to revalue identifiable intangible assets if there is an ‘active’ market for them

27. Is the new approach to accounting for intangibles an improvement? (cont.) Critical perspective (cont.) • Active market restrictively defined as ‘a market where the items traded are homogeneous, there are willing buyers and sellers at any time, and prices are known to the public’ • Active markets do not exist for the vast majority of intangible assets • As a result of adopting IFRSs, in most cases where intangible assets are recognised they will be recorded at cost, less accumulated amortisation and accumulated impairment losses, rather than being shown at their fair value, with ‘fair value’ potentially being more relevant to users of financial statements