CHAPTER 3
Amortizing Intangible Assets

Like goodwill, some intangible assets have indefinite lives. An intangible asset is considered to have an indefinite life if the entity finds that there are no “legal, regulatory, contractual, competitive, economic, or other factors” that limit its useful life.1 However, indefinite life does not mean infinite for the purposes of ASC 350-30;2 it simply means the benefits from an intangible asset extend beyond the foreseeable future.3 According to the FASB, most intangible assets have finite lives.4 Intangible assets with indefinite lives and goodwill are not amortized, except for goodwill acquired by a private company.5

When an intangible asset has a finite life, its remaining useful life must be estimated, and its carrying amount must be amortized over that remaining useful life using an appropriate amortization method.

A. Determining the Estimated Useful Life

The estimated useful life of an intangible asset to an entity is the period over which the asset is expected to contribute either directly or indirectly to the entity's cash flows.6 A customer list is an example of an intangible asset that contributes directly to an entity's cash flows and a non-compete agreement is an example of an intangible asset that contributes indirectly to an entity's cash flows (by allowing the entity to retain customers that a past employee otherwise might entice away from the entity).

The FASB has identified six general factors to guide constituents when determining the useful life of an intangible asset. These factors must be analyzed within the context of the previous definition of estimated useful life. The FASB's factors are:7

  • The expected use of the asset by the entity.
  • The expected useful life of another asset or group of assets to which the useful life of the intangible asset may relate.
  • Any legal, regulatory, or contractual provisions that may limit the useful life. The cash flows and useful lives of intangible assets that are based on legal rights are constrained by the duration of those legal rights. Thus, the useful lives of such intangible assets cannot extend beyond the length of their legal rights and may be shorter.
  • The entity's own historical experience in renewing or extending similar arrangements, consistent with the intended use of the assets by the entity, regardless of whether those arrangements have explicit renewal or extension provisions.
  • The effects of obsolescence, demand, competition, and other economic factors such as the stability of the industry, known technological advances, legislative action that results in uncertainty or changing regulatory environment, and expected changes in distribution channels.
  • The level of maintenance expenditures required to obtain the expected future cash flows from the asset. For example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a limited useful life. As in determining the useful life of depreciable tangible assets, regular maintenance may be assumed but enhancements may not.

    The estimate of an intangible asset's useful life is based on an analysis of all pertinent factors. Therefore, an entity may also consider other factors besides those listed above. In fact, the SEC has identified the following additional factors:

    • Uncertain continuity of revenues dependent on retention of key employees
    • The churn rate of customers
    • The mobility of the customer and employee base

Thus, all of these factors, as well as other factors relevant to a particular entity, may be relevant in determining the useful life of an intangible asset.

The determination of useful life does not follow an easy set of rules. The entire process is riddled with judgment, but that does not mean that any guess will do. Nevertheless, generally, it is easier to determine the useful life of an intangible asset that meets the contractual-legal criterion than one that meets only the separability criterion.

1. Considerations for Intangible Assets That Meet the Contractual-Legal Criterion

The useful life of an intangible asset that meets the contractual-legal criterion is not necessarily the contract term. Rather, an entity must consider potential renewals or extensions of the contract term. Renewal or extension assumptions used to determine the useful life of a recognized intangible asset are addressed in ASC 350-30-35-3(d).

ASC 350-30-35-3(d) reads as follows:

The estimate of the useful life of an intangible asset to an entity shall be based on an analysis of all pertinent factors, in particular … [t]he entity's own historical experience in renewing or extending similar arrangements, consistent with the intended use of the asset by the entity, regardless of whether those arrangements have explicit renewal or extension provisions. In the absence of that experience, the entity shall consider the assumptions that market participants would use about renewal or extension consistent with the highest and best use of the asset by market participants, adjusted for entity-specific factors in this paragraph.

In applying ASC 350-30-35-3(d) when developing renewal or extension assumptions, an entity is to consider its history of renewing or extending similar arrangements. If the entity has no history to consider, it must use industry assumptions and adjust those assumptions for entity-specific factors.10

A useful approach to determining the life of an intangible asset that meets the contractual-legal criterion is summarized in the flowchart shown in Exhibit 3.1.11

EXHIBIT 3.1 Critical Decisions for Determining the Useful Life of an Intangible Asset

  • Are Benefits from the Contract or Legal Arrangement Expected to Last at Least the Contractual/Legal Term?
 If the cash flows are not going to last as long as the contract, then the length of time the cash flows will last must be estimated if it is not known. For example, the contract might have a life of 10 years, but the entity, taking advantage of an “early out” clause in the contract, expects to buy out the contract or discontinue the legal arrangement after five years.
  • Does the Company Have the Intention and Ability to Renew or Extend the Contract/Legal Life?
 This question includes both intention and capability. The most useful guide for both of these is the company history. The intention is a question the company can probably answer easily. It might have renewed or extended the intangible asset in the past and can do so in the future. Capability is different from intention. Even if the history of the contract might indicate that it was easily renewed in the past and all expectations are that it will be easily renewed in the future, the possibility of non-renewal must be investigated. However, unless something points to the possibility that the contract might not be renewed, the life continues to be indefinite.
  • Will Renewal or Extension Require Substantial Cost?
 The question of the cost of renewing or extending the contract/legal arrangement is straightforward. What does the company have to pay out in order to renew the contract or extend the arrangement? The contract or arrangement has a value to the company, and this value is compared to the cost. If the value is nonmonetary, then the comparison is likely to be based on “judgment.” If the contract or arrangement has a monetary value, then the company should compare the net present value of the estimated future benefits to the cost.15
  • Will Renewal or Extension Result in Material Modifications?
 Two things can happen here. The first is that the cost of the material modification is too much. The second is that the material modification changes the intangible asset so much that it is not the same asset.
  1. The Cost of the Material Modification
 The question is, “What is the cost of the material modification to the company?” If the cost of the modification exceeds the monetary benefit from the renewal or extension, then the contractual/legal arrangement should not be renewed, and the company might have to look elsewhere. Of course, if the benefit from the arrangement is nonmonetary, the company will have to decide whether the benefit or the cost is greater and proceed accordingly.
  1. Changes in Asset Caused by the Material Modification
 It is possible that a once-useful intangible asset is changed so much during the renewal or extension that it is no longer very useful. The contract or renewal essentially creates a new intangible asset. The company must determine whether it wishes to look elsewhere or it will continue with the newly created intangible asset. If the company does continue with the newly created intangible asset, will it fulfill the needs of the company as well as the old intangible asset did?
  • Will the Benefits Provided by the Asset Continue Indefinitely?
 By the time a company reaches this question, most of the criteria that would suggest that an intangible asset has a finite life have been ruled out, leaving a high probability that the intangible asset has an indefinite life. At this point, if there is no foreseeable limit on the period over which the asset is expected to contribute to the entity's cash flows, then the asset's life is indefinite.16
In the Basis for Conclusion section of FAS 142, the FASB noted that “even if the precise useful life of a finite-lived intangible asset is not determinable, the intangible asset still would have to be amortized, and the amortization period would reflect the best estimate of the useful life of that asset.”17 Therefore, if an entity determines that the useful life of an intangible asset is not indefinite (based on facts and circumstances) but the useful life is not determinable (i.e., the asset's life is indeterminable), then the entity must amortize the asset over its best estimate of the asset's life.18
The determination of an indefinite life for an intangible asset is inherently judgmental. Indefinite is, by definition, an unknown period. As long as the period continues to be unknown for the foreseeable future, the useful life of the intangible asset is indefinite. When the period becomes known or estimable, the useful life is finite and the intangible asset must be amortized over that period.19

2. Considerations for Intangible Assets That Meet the Separability Criterion

Customer lists and unpatented technology are two examples of intangible assets that do not meet the contractual/legal criterion but do meet the separability criterion. Because there is no contractual term associated with such assets, determining their useful life can require even more judgment than determining the useful life of contractual/legal-based intangible assets. Yet, an entity must estimate the useful life of such assets because many intangible assets do not have indefinite useful lives.20

a. Customer Lists

The SEC has stated that it is very rare for a customer list to have an indefinite useful life given that customer relationships tend to churn over time. Thus, the SEC Staff believes the customer turnover rate (i.e., the churn rate) is very important in estimating a customer list's useful life.21

b. Unpatented Technology

If the company believes it needs new technology to replace the existing technology, the life of the existing technology is finite and the best estimate of the useful life is made. On the other hand, the technology might allow the company to operate at a significant advantage for the foreseeable future. If it does, its life is considered indefinite.

3. Estimated Useful Lives of Defensive Assets

A defensive intangible asset's useful life is the period over which an entity anticipates it will consume the asset's expected benefits. It is determined by estimating the period over which the defensive intangible asset will diminish in fair value, which is a proxy for the period over which the reporting entity expects the asset to contribute directly or indirectly to the future cash flows of the entity. It would be rare for a defensive intangible asset to have an indefinite life because its fair value will generally diminish over time as a result of a lack of market exposure or as a result of competitive or other factors.22

4. Changes in the Determination of Useful Life

An entity must reevaluate the remaining useful life of an intangible asset each reporting period to determine whether events and circumstances warrant a revision of the remaining useful life. The result of the reevaluation could be either a change in the estimated useful life or a determination that the asset now has an indefinite useful life. If the estimate of the useful life has changed, then the remaining carrying amount of the asset is amortized prospectively over the revised remaining useful life.23 If an intangible asset is subsequently determined to have an indefinite useful life, the entity, upon making this determination, must test the asset for impairment under the principles in ASC 350-30-35-18 through ASC 350-30-35-20, which contain the impairment test for indefinite-lived intangible assets.24 This impairment test is discussed in Section 4.C. Any resulting impairment loss is recognized as a change in estimate (rather than a change in accounting principle) and thus presented in the income statement in the same manner as other impairment losses.25

Similarly, an entity must reevaluate an intangible asset that has an indefinite useful life each reporting period to determine whether the asset now has a finite useful life. An entity might determine that an intangible asset now has a finite life, for example, if unanticipated competition enters the market during the reporting period. Upon determining that an intangible asset now has a finite useful life, the entity must first perform the impairment test in ASC 350-30-35 that it uses on intangible assets with indefinite lives.26 Once the asset has been tested for impairment and any impairment loss has been recognized, the intangible asset must be amortized prospectively over its remaining useful life.27 The entity will subsequently test for the intangible asset impairment under ASC 360-10, as it does for other tangible and intangible assets with finite lives.

B. Amortization Methods for Intangible Assets

The carrying amount of an intangible asset with a finite life less any residual value is amortized over the asset's useful life.29 The residual value is presumed to be zero unless the entity expects the asset to continue to have a useful life to another party at the end of the asset's useful life to the entity. However, to reduce the carrying amount by such an expected residual value, the entity must either (1) have a commitment from a third party to purchase the intangible asset at the end of its useful life or (2) be able to determine the residual value by reference to an exchange transaction in an existing market for that intangible asset (and that market must be expected to exist at the end of the asset's useful life to the entity).30

The amortization method used should relate to the actual pattern of the decrease in the value of the intangible asset over its useful life. If the pattern cannot be reliably determined, then straight-line amortization is used.31

C. Amortizing Goodwill—Private Companies

Under ASU 2014-02, private companies can elect to amortize goodwill over a period of up to 10 years on a straight-line basis or for a shorter period if they can demonstrate that it is more appropriate.35 If they do amortize goodwill, annual impairment testing is not required. Instead, goodwill is tested for impairment only when a triggering event suggests that the fair value of the entity (or reporting unit) may be below its carrying amount.36 Moreover, the impairment test itself is simplified for a private company. The simplified impairment test and the triggering events are described in Section 4.D.7.

This accounting alternative for private companies, if elected, should be applied prospectively to goodwill existing as of the beginning of the period of adoption and new goodwill recognized in annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. Early application is permitted, including application to any period for which the entity's annual or interim financial statements have not yet been made available for issuance.37

Upon making this election and adopting ASU 2014-02, a private company should assess any existing goodwill on its books to determine the remaining useful life of that goodwill. In no event, however, may it amortize the carrying amount of such existing goodwill over a period of more than 10 years.

A private company is any entity that is not: (1) a public business entity, (2) a not-for-profit entity, or (3) an employee benefit plan (within the scope of ASC 960 through ASC 965 on plan accounting).39 In the case of a not-for-profit entity that files consolidated financial statements with its for-profit subsidiary, the reporting entity (i.e., the not-for-profit consolidated entity) is not permitted to adopt the accounting alternative in ASU 2014-02 since it does not meet the definition of a private company. However, the for-profit subsidiary could adopt the accounting alternative in ASU 2014-02 in its separate financial statements.40 The term public business entity encompasses more than SEC registrants. Specifically, that term is defined by the FASB as follows:41

A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity nor an employee benefit plan is a business entity.

  1. It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
  2. It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
  3. It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
  4. It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
  5. It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.

An entity may meet the definition of a public business entity solely because its financial statements or financial information is included in another entity's filing with the SEC. In that case, the entity is only a public business entity for purposes of financial statements that are filed or furnished with the SEC.

D. IFRS Intangibles—Measurement after Recognition

1. Determining the Estimated Useful Life

As under U.S. GAAP, an entity under IFRS must determine whether an identified intangible asset has a finite or indefinite useful life. The useful life of an intangible asset is indefinite if there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows to the entity. An intangible asset can have an indefinite useful life even if the entity must expend future amounts to maintain the asset at its current standard of performance as long as the entity has the ability and intention to so maintain the asset at that level. However, if the entity is planning a future expenditure that exceeds what is required to maintain the asset at its current standard of performance, then that asset likely does not have an indefinite life, but rather its useful life likely ends at the point the entity is planning to make these additional expenditures.42

If an intangible asset has a finite life, the entity must determine the length of that life, either in years or in number of production or similar units.43 In broad terms, the useful life of an intangible asset is based on the economic factors that indicate how long the entity can expect to receive economic benefits from the asset. These economic factors include the entity's intent regarding use of the asset. However, there may be legal factors that can limit the entity's access to those economic benefits, thereby limiting the asset's useful life.44 IAS 38 identifies several economic factors (and one legal factor) that are relevant to determining an intangible asset's useful life:45

  1. the expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team;
  2. typical product life cycles for the asset and public information on estimates of useful lives of similar assets that are used in a similar way;
  3. technical, technological, commercial or other types of obsolescence;
  4. the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset;
  5. expected actions by competitors or potential competitors;
  6. the level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity's ability and intention to reach such a level;
  7. the period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases; and
  8. whether the useful life of the asset is dependent on the useful life of other assets of the entity.

Legal factors that can limit an intangible asset's useful life are present when the intangible asset is based on contractual or other legal rights. Specifically, the useful life of an intangible asset arising from contractual or other legal rights cannot exceed the period of the contractual or other legal rights (including renewals), but may be shorter depending on the period over which the entity expects to use the asset. Moreover, an entity cannot assume that agreements will be renewed if the renewal will involve significant costs. The exact language in IAS 38 on renewals reads as follows: “If the contractual or other legal rights are conveyed for a limited term that can be renewed, the useful life of the intangible asset shall include the renewal period(s) only if there is evidence to support renewal by the entity without significant cost.”46 It lists three factors to help entities apply this renewal principal:47

  1. Is there evidence, possibly based on experience, that the contractual or other legal rights will be renewed? If renewal is contingent upon the consent of a third party, there must be evidence that the third party will give its consent.
  2. Is there evidence that any conditions necessary to obtain renewal will be satisfied?
  3. Is the cost to the entity of renewal not significant when compared with the future economic benefits expected to flow to the entity from renewal? If the cost of renewal is significant when compared with the future economic benefits expected to flow to the entity from renewal, the ‘renewal’ cost represents, in substance, the cost to acquire a new intangible asset at the renewal date.

Reacquired rights. An exception to the renewal principal exists for reacquired rights recognized in business combinations. The useful life of such reacquired rights is the remaining contractual period and may not include renewal periods.48

Useful lives of technology-based intangible assets. The above guidelines for assessing the useful life of intangible assets apply to intangible assets that are technological in nature. However, IAS 38 notes that such intangible assets, including computer software, typically have short useful lives due to the rapid pace of advancements in technology.49

2. Cost-versus-Revaluation Model

Under IFRS, all acquired intangible assets are measured at cost (which is determined by reference to the assets' fair values). Subsequently, an entity must elect to continue measuring these intangible assets either at cost or under a revaluation model. Such an election amounts to an accounting policy. If an intangible asset is accounted for using the revaluation model, all the other assets in its class must also be accounted for using the same model, unless there is no active market for those assets.50

a. Cost Model

After initial recognition, an intangible asset is carried at its cost less any accumulated amortization and any accumulated impairment losses. This model is similar to U.S. GAAP.51

b. Revaluation Model

After initial recognition at cost, an intangible asset is carried at a revalued amount, which is its fair value at the date of the revaluation less any subsequent accumulated amortization and any subsequent accumulated impairment losses. For the purpose of revaluations under IFRS, fair value must be measured by reference to an active market. Revaluations are required to be made regularly (but not necessarily during each reporting period) so that the carrying amount of the asset does not materially differ from its fair value.

If an active market is not present for an intangible asset, then the revaluation model should not be used.52 It may be difficult to establish an active market for most intangible assets due to the infrequent nature of exchange transactions involving such assets and the private nature of most of those transactions. However, some examples of intangible assets for which the revaluation model likely is appropriate are as follows: (1) milk quotas, (2) stock exchange seats, and (3) taxi medallions.

Mechanically under the revaluation method, an intangible asset must be revalued when its fair value differs materially from its carrying amount. The initial carrying amount is the asset's cost, but once the asset is revalued its carrying amount becomes the revalued amount. The adjustment to the carrying amount can be accomplished in one of two ways. First, the asset's gross carrying amount can be adjusted to the asset's fair value, with the accumulated amortization being adjusted to equal the difference between the gross carrying amount and the carrying amount after taking into account accumulated impairment losses. Second, the asset's accumulated amortization can be eliminated against the gross carrying amount, with the amount eliminated being treated as the increase or decrease in carrying amount, which is accounted for under the rules discussed after the following examples.

Under the revaluation model, an increase in the carrying amount of the intangible asset from a revaluation is recognized in profit or loss to the extent that it reverses a previous revaluation decrease in the asset's carrying amount. Any remaining increase is recognized in other comprehensive income, which is accumulated in equity under the heading “revaluation surplus.”53 Any decrease in the asset's carrying amount from a revaluation is recognized in other comprehensive income to the extent of any credit balance in that asset's revaluation surplus account. Any remaining decrease is recognized in profit and loss.54 This entire cumulative revaluation surplus is transferred directly to retained earnings (without going through profit and loss) as the surplus is realized through the asset's retirement or disposal. However, the entity may gradually transfer this surplus as it uses the asset. In this later instance, the amount transferred during an accounting period is the difference between the asset's amortization expense based on the revalued carrying amount and the amortization expense that would have been recognized based on the asset's historical cost.55

3. Amortization of Intangible Assets

The amortization of intangible assets under IFRS is similar to the amortization rules in ASC 350. The classification of intangible assets is (a) those with finite lives and (2) those with indefinite lives.56

a. Finite Lives

The cost less the residual value of an intangible asset with a finite life is amortized over the useful life of that asset. The amortization method should reflect the pattern of benefits from the intangible asset. If it is not possible to discern the pattern, use the straight-line method.57 The amortization period is reviewed annually.58

b. Indefinite Lives

A company should not amortize intangible assets with indefinite lives. The company should review the useful lives annually to determine if events and circumstances continue to support an indefinite useful life. If they do not support an indefinite useful life, the change in the useful life from indefinite to finite is accounted for as a change in an accounting estimate.59

Intangible assets with indefinite lives are subject to an annual impairment test following the requirements of IAS 36.60

Notes

..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset