2.1.1 Identifiability

IAS 38's requirement that an intangible asset must be ‘identifiable’ was introduced to try to distinguish it from internally generated goodwill (which, outside a business combination, should not be recognised as an asset [IAS 38.48]), but also to emphasise that, especially in the context of a business combination, there will be previously unrecorded items that should be recognised in the financial statements as intangible assets separately from goodwill. [IAS 38.BC7, BC8].

IFRS 3 defines goodwill as ‘representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.’ [IFRS 3 Appendix A]. For example, future economic benefits may result from synergy between the identifiable assets acquired or from assets that, individually, do not qualify for recognition in the financial statements. [IAS 38.11].

IAS 38 states that an intangible asset is identifiable when it either: [IAS 38.12]

1. is separable, meaning that it is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or
2. arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

The explicit requirement to recognise assets arising from contractual rights alone confirms the IASB's position that the existence of contractual or legal rights is a characteristic that distinguishes an intangible asset from goodwill, even if those rights are not readily separable from the entity as a whole. The Board cites as an example of such an intangible asset a licence that, under local law, is not transferable except by sale of the entity as a whole. [IAS 38.BC10]. Therefore, the search for intangible assets is not restricted to rights that are separable.

However, preparers should not restrict their search for intangible assets to those embodied in contractual or other legal rights, since the definition of identifiability merely requires such rights to be capable of separation. Non-contractual rights are required to be recognised as an intangible asset if the right could be sold, transferred, licensed, rented or exchanged. In considering the responses to ED 3 – Business Combinations – the Board observed that the existence of an exchange transaction for a non-contractual relationship provides evidence both that the item is separable, and that the entity is able to control the expected future economic benefits flowing from it, meaning that the relationship should be recognised as an intangible asset. Only in the absence of exchange transactions for the same or similar non-contractual customer relationships would an entity be unable to demonstrate that such relationships are separable or that it can control the expected future economic benefits flowing from those relationships. [IAS 38.BC13].

2.1.2 Control

IAS 38 defines control as the power to obtain the future economic benefits generated by the resource and the ability to restrict the access of others to those benefits. Control normally results from legal rights, in the way that copyright, a restraint of trade agreement or a legal duty on employees to maintain confidentiality protects the economic benefits arising from market and technical knowledge. [IAS 38.13‑14]. While it will be more difficult to demonstrate control in the absence of legal rights, the standard is clear that legal enforceability of a right is not a necessary condition for control, because an entity may be able to control the future economic benefits in some other way. [IAS 38.13]. The existence of exchange transactions for similar non-contractual rights can provide sufficient evidence of control to require separate recognition as an asset. [IAS 38.16]. Obviously, determining that this is the case in the absence of observable contractual or other legal rights requires the exercise of judgement based on an understanding of the specific facts and circumstances involved.

For example, the standard acknowledges that an entity usually has insufficient control over the future economic benefits arising from an assembled workforce (i.e. a team of skilled workers, or specific management or technical talent) or from training for these items to meet the definition of an intangible asset. [IAS 38.15]. There would have to be other legal rights before control could be demonstrated.

In neither of the above examples is an asset being recognised for the assembled workforce. In the case of the football team, the asset being recognised comprises the economic benefits embodied in the players’ registrations, arising from contractual rights. In particular, it is the ability to prevent other entities from using that player's services (i.e. restricting the access of others to those benefits), [IAS 38.13], combined with the existence of exchange transactions involving similar players’ registrations, [IAS 38.16], that distinguishes this type of arrangement from a normal contract of employment. In cases when the transfer fee is a stand-alone payment and not part of a business combination, i.e. when an entity separately acquires the intangible resource, it is much more likely that it can demonstrate that its purchase meets the definition of an asset (see 4 below).

Similarly, an entity would not usually be able to recognise an asset for an assembled portfolio of customers or a market share. In the absence of legal rights to protect or other ways to control the relationships with customers or the loyalty of its customers, the entity usually has insufficient control over the expected economic benefits from these items to meet the definition of an intangible asset. However, exchange transactions, other than as part of a business combination, involving the same or similar non-contractual customer relationships may provide evidence of control over the expected future economic benefits in the absence of legal rights. In that case, those customer relationships could meet the definition of an intangible asset. [IAS 38.16]. IFRS 3 includes a number of examples of customer-related intangible assets acquired in business combinations that meet the definition of an intangible asset, which are discussed in more detail at 5 below. [IFRS 3.IE23‑31].

It is worth emphasising that intangible assets should only be recognised when they meet both the definition of an intangible asset and the applicable recognition criteria in IAS 38, [IAS 38.18], which are discussed at 3.1 below. All that is established in the discussion above is whether the intangible right meets the definition of an asset.

The extract below illustrates the range of intangible assets that require recognition under IAS 38.

2.1.3 Future economic benefits

Future economic benefits include not only future revenues from the sale of products or services but also cost savings or other benefits resulting from the use of the asset by the entity. For example, the use of intellectual property in a production process may reduce future production costs rather than increase future revenues. [IAS 38.17].

2.2.1 Whether to record a tangible or intangible asset

Before the advent of IAS 38 many entities used to account for assets without physical substance in the same way as property, plant and equipment. Indeed, the standard notes that intangible assets can be contained in or on a physical medium such as a compact disc (in the case of computer software), legal documentation (in the case of a licence or patent) or film, requiring an entity to exercise judgement in determining whether to apply IAS 16 or IAS 38. [IAS 38.4]. For example:

• software that is embedded in computer-controlled equipment that cannot operate without it is an integral part of the related hardware and is treated as property, plant and equipment; [IAS 38.4]
• application software that is being used on a computer is treated as an intangible asset because it is generally easily replaced and is not an integral part of the related hardware, whereas the operating system normally is integral to the computer and is included in property, plant and equipment; [IAS 38.4]
• a database that is stored digitally is considered to be an intangible asset where the value of the physical medium is wholly insignificant compared to that of the data collection; and
• research and development expenditure may result in an asset with physical substance (e.g. a prototype), but as the physical element is secondary to its intangible component, the related knowledge, it is treated as an intangible asset. [IAS 38.5].

It is worthwhile noting that the ‘parts approach’ in IAS 16 requires an entity to account for significant parts of an asset separately because they have a different economic life or are often replaced, [IAS 16.44], (see Chapter 18). This raises ‘boundary’ problems between IAS 16 and IAS 38 when software and similar expenditure is involved. We believe that where IAS 16 requires an entity to identify parts of an asset and account for them separately, the entity needs to evaluate whether any intangible-type part is actually integral to the larger asset or whether it is really a separate asset in its own right. The intangible part is more likely to be an asset in its own right if it was developed separately or if it can be used independently of the item of property, plant and equipment of which it apparently forms part.

This view is consistent with that taken in IFRS 3, when it asserts that related tangible and intangible components of an asset with similar useful lives (meaning that IAS 16 would not require separate accounting of parts of an asset) can be combined into a single asset for financial reporting purposes. [IFRS 3.B32(b)].

2.2.2 Classification of programme and other broadcast rights as inventory or intangible assets

The appropriate classification of broadcast rights depends on the particular facts and circumstances as they apply to an entity. However, it is possible for an entity to conclude that some of its broadcast rights are intangible assets while others should be treated as inventory.

Programme and other broadcast rights meet the definition of intangible assets because they are identifiable non-monetary assets without physical substance. IAS 38 specifically includes within its scope rights under licensing agreements for items such as motion picture films and video recordings. [IAS 38.6]. In addition, a broadcast right meets the other criteria for recognition as an intangible asset, being identifiable, as it arises from contractual rights [IAS 38.12(b)] and controlled by the entity. [IAS 38.13].

Rights to programmes held exclusively for sale to other parties also meet the definition of inventory and are therefore within the scope of IAS 2. [IAS 38.3]. It is possible to argue that programmes held with a view to broadcasting them to an audience are comparable to ‘materials or supplies to be consumed in the production process or in the rendering of services’, [IAS 2.6], which would mean that they could also be treated as inventory. Equally, it can be argued that such programme rights are intangible assets as they are used in the production or supply of services but not necessarily consumed because they can be used again.

Therefore, it is possible for entities to choose whether programme or other broadcast rights are classified as intangible assets or as inventory. However, the classification of income, expenses and cash flows in respect of those rights should be consistent with the manner of their classification in the statement of financial position.

Accordingly, where a broadcast right is classified as an intangible asset:

• it is classified in the statement of financial position as current or non-current according to the entity's operating cycle (see 10.2 below);
• the intangible asset is amortised, with amortisation included in the statement of profit or loss within the depreciation and amortisation expense, or within a functional expense category (such as cost of sales);
• in the cash flow statement, payments for the acquisition of intangible broadcast rights are classified as an investing activity (if the asset is classified as non-current on acquisition) or as an operating activity if the asset is classified as current; and
• rights are measured at a revalued amount only if the criteria in IAS 38 are met (see 8.2 below). Otherwise the asset is carried at cost less accumulated amortisation and impairments. Any impairment of the asset is determined in accordance with IAS 36.

Where a broadcast right is classified as inventory:

• it is classified in the statement of financial position as a current asset either as part of inventory or as a separate category;
• the entity recognises an expense in cost of sales as the right is consumed;
• payments for the acquisition of inventory are classified as operating activities in the statement of cash flows; and
• rights are carried at the lower of cost and net realisable value.

Both of these classifications are found in practice. Vivendi accounts for its film and television rights catalogues as intangible assets (see Extract 17.3 at 3.1.1 below). ITV on the other hand, presents its programme rights as current assets under the caption ‘Programme rights and other inventory’.

3.1.1 When to recognise programme and other broadcast rights

Television stations frequently enter into contracts to buy programme rights related to long-running televisions series or future sports events that are not yet available for broadcast, sometimes over a specified period or for a certain number of showings or viewings. Payments might be made at the beginning of or during the broadcast period, which raises the question of when those programme rights and the related obligations for payment should be recognised in the statement of financial position.

The IASB's Conceptual Framework discusses the concept of executory contracts. An executory contract is a contract, or a portion of a contract, that is equally unperformed – neither party has fulfilled any of its obligations, or both parties have partially fulfilled their obligations to an equal extent. [CF 4.56]. An executory contract establishes a combined right and obligation to exchange economic resources. This combined right and obligation are interdependent and cannot be separated, hence they constitute a single asset or liability. [CF 4.57]. To the extent that either party fulfils its obligations under the contract, the contract is no longer executory. If the reporting entity performs first under the contract, that performance is the event that changes the reporting entity's right and obligation to exchange economic resources into a right to receive an economic resource. That right is an asset. If the other party performs first, that performance is the event that changes the reporting entity's right and obligation to exchange economic resources into an obligation to transfer an economic resource. That obligation is a liability. [CF 4.58]. Therefore, obligations under contracts that are equally proportionately unperformed are generally not recognised as liabilities in the financial statements. For example, liabilities in connection with non-cancellable orders of inventory or items of property, plant and equipment are generally not recognised in an entity's statement of financial position until the goods have been delivered. The same approach can also be applied to broadcast rights.

Accordingly, an entity recognises a broadcast right at the first date that it controls an asset. The meaning of control is discussed at 2.1.2 above.

Determining the date at which control is obtained is a complex matter that depends on the specific facts and circumstances of each case. Factors that may be relevant include whether:

1. the underlying resource is sufficiently developed to be identifiable. For example, a right to broadcast a film or play might not be sufficiently developed until a manuscript or screenplay is written or a director and actors are hired. For a right to broadcast a sporting event to be identifiable it might be appropriate to establish the existence of a venue, participants or the number or timing of events subject to the right;
2. the entity has legal, exclusive rights to broadcast (with exclusivity potentially defined in terms of a defined period or geographical area);
3. there is a penalty payable for non-delivery of the content (e.g. the film or sporting event subject to the broadcast right);
4. it is probable that the event will occur or the content will be delivered (e.g. completion of a film or a lack of history of cancellations, strikes or rain-outs); and
5. it is probable that economic benefits will flow to the entity.

This approach is illustrated in the extract from Vivendi below, which distinguishes between contracts requiring recognition and commitments to pay amounts in future periods when content is delivered.

As illustrated in Extract 17.2 at 2.2.2 above, ITV follows a similar type of approach for acquired programme rights under which an asset is recognised as payments are made and is recognised in full when the acquired programming is available for transmission.

4.7.1 Measurement of assets exchanged

In the context of asset exchanges, the standard contains guidance on the reliable determination of fair values in the circumstances where market values do not exist. Note that while fair value is defined by reference to IFRS 13 (see Chapter 14), the requirements in this section are specific to asset exchanges in IAS 38.

IAS 38 requires all acquisitions of intangible assets in exchange for non-monetary assets, or a combination of monetary and non-monetary assets, to be measured at fair value. The acquired intangible asset is measured at fair value unless: [IAS 38.45]

1. the exchange transaction lacks commercial substance; or
2. the fair value of neither the asset received nor the asset given up is reliably measurable.

The acquired asset is measured in this way even if an entity cannot immediately derecognise the asset given up. If an entity is able to reliably determine the fair value of either the asset received or the asset given up, then it uses the fair value of the asset given up to measure cost unless the fair value of the asset received is more clearly evident. [IAS 38.47]. If the fair value of neither the asset given up, nor the asset received can be measured reliably the acquired intangible asset is measured at the carrying amount of the asset given up. [IAS 38.45].

In this context the fair value of an intangible asset is reliably measurable if the variability in the range of reasonable fair value measurements is not significant for that asset or the probabilities of the various estimates within the range can be reasonably assessed and used when measuring fair value. [IAS 38.47].

4.7.2 Commercial substance

A gain or loss is only recognised on an exchange of non-monetary assets if the transaction is determined to have commercial substance. Otherwise, the acquired asset is measured at the cost of the asset given up. [IAS 38.45].

The commercial substance test for asset exchanges was put in place to prevent gains being recognised in income when the transaction had no discernible effect on the entity's economics. [IAS 16.BC21]. The commercial substance of an exchange is determined by forecasting and comparing the future cash flows expected to be generated by the incoming and outgoing assets. Commercial substance means that there must be a significant difference between the two forecasts. An exchange transaction has commercial substance if: [IAS 38.46]

1. the configuration (i.e. risk, timing and amount) of the cash flows of the asset received differs from the configuration of the cash flows of the asset transferred; or
2. the entity-specific value of the portion of the entity's operations affected by the transaction changes as a result of the exchange; and
3. the difference in (a) or (b) is significant relative to the fair value of the assets exchanged.

IAS 38 defines the entity-specific value of an intangible asset as the present value of the cash flows an entity expects to arise from its continuing use and from its disposal at the end of its useful life. [IAS 38.8]. In determining whether an exchange transaction has commercial substance, the entity-specific value of the portion of the entity's operations affected by the transaction should reflect post-tax cash flows. [IAS 38.46]. This is different to the calculation of an asset's value in use under IAS 36 (see Chapter 20), as it uses a post-tax discount rate based on the entity's own risks rather than IAS 36, which requires use of the pre-tax rate that the market would apply to a similar asset.

The standard acknowledges that the result of this analysis might be clear without having to perform detailed calculations. [IAS 38.46].

5.1.1 Probable inflow of benefits

In the case of a business combination, the probability recognition criterion is always considered to be satisfied. The cost of the intangible asset is its fair value at the acquisition date. The standard indicates that the fair value reflects expectations about the probability that the future economic benefits embodied in the asset will flow to the entity. [IAS 38.33]. In other words, the existence of a fair value means that an inflow of economic benefits is considered to be probable, in spite of any uncertainties about timing or amount.

5.1.2 Reliability of measurement

Under IFRS 3, the cost of the intangible asset acquired in a business combination can always be measured reliably. [IAS 38.BC19A].

In developing IFRS 3, the Board concluded that the needs of users were better served by recognising intangible assets, on the basis of an estimate of fair value, rather than subsuming them in goodwill, even if a significant degree of judgement is required to estimate fair value. [IAS 38.BC19B]. Accordingly, if an asset acquired in a business combination is separable or arises from contractual or other legal rights, there is sufficient information to measure reliably the fair value of the asset. Thus, the requirement at 3.1 above for reliable measurement of cost is always considered to be satisfied for intangible assets acquired in business combinations. [IAS 38.33].

5.1.3 Identifiability in relation to an intangible asset acquired in a business combination

Intangible assets need to be identifiable to distinguish them from goodwill and the two elements of identifiability are the existence of contractual or other legal rights and separability. Separability means that the asset is capable of being sold, transferred, licensed, rented or exchanged without having to dispose of the whole business. An intangible asset is considered to be separable regardless of whether the entity intends to sell or otherwise transfer it. [IAS 38.12].

If an intangible asset acquired in a business combination is separable or arises from contractual or other legal rights, sufficient information exists to measure reliably the fair value of the asset. Where there are a range of possible outcomes with different probabilities in estimating an intangible asset's fair value, this uncertainty should be factored into the measurement of the asset's fair value. [IAS 38.35].

The IASB recognised that an intangible asset acquired in a business combination might be separable, but only together with a related contract, identifiable asset or liability. In such cases, IAS 38 requires the acquirer to recognise the intangible asset separately from goodwill, but together with the related contract, asset or liability. [IAS 38.36].

Acquirers are permitted to recognise a group of complementary intangible assets as a single asset provided the individual assets in the group have similar useful lives. For example, the terms ‘brand’ and ‘brand name’ are often used as synonyms for trademarks and other marks. However, ‘brands’ are regarded as general marketing terms that are typically used to refer to a group of complementary assets such as a trademark or service mark and its related trade name, formulas, recipes and technological expertise. [IAS 38.37]. Anheuser-Busch In Bev, for example, acknowledges the relationship between trademarks and other complementary assets such as formulas, recipes or technological expertise acquired in business combinations.

IFRS 3 contains additional guidance on the application of the contractual-legal and separability criteria that indicate how far the IASB expects entities to go to ensure that intangible assets acquired in a business combination are recognised separately from goodwill.

6.2.1 Research phase

An entity cannot recognise an intangible asset arising from research or from the research phase of an internal project. Instead, any expenditure on research or the research phase of an internal project should be expensed as incurred because the entity cannot demonstrate that there is an intangible asset that will generate probable future economic benefits. [IAS 38.54‑55].

If an entity cannot distinguish the research phase from the development phase, it should treat the expenditure on that project as if it were incurred in the research phase only and recognise an expense accordingly. [IAS 38.53].

6.2.2 Development phase

The standard requires recognition of an intangible asset arising from development (or the development phase of an internal project) while it imposes stringent conditions that restrict recognition. These tests create a balance, ensuring that the entity does not recognise unrecoverable costs as an asset.

An intangible asset arising from development or from the development phase of an internal project should be recognised if, and only if, an entity can demonstrate all of the following:

1. the technical feasibility of completing the intangible asset so that it will be available for use or sale;
2. its intention to complete the intangible asset and use or sell it;
3. its ability to use or sell the intangible asset;
4. how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
5. the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
6. its ability to measure reliably the expenditure attributable to the intangible asset during its development. [IAS 38.57].

The fact that an entity can demonstrate that the asset will generate probable future economic benefits distinguishes development activity from the research phase, where it is unlikely that such a demonstration would be possible. [IAS 38.58].

It may be challenging to obtain objective evidence on each of the above conditions because:

• condition (b) relies on management intent;
• conditions (c), (e) and (f) are entity-specific (i.e. whether development expenditure meets any of these conditions depends both on the nature of the development activity itself and the financial position of the entity); and
• condition (d) above is more restrictive than is immediately apparent because the entity needs to assess the probable future economic benefits using the principles in IAS 36, i.e. using discounted cash flows. If the asset will generate economic benefits only in conjunction with other assets, the entity should apply the concept of cash-generating units. [IAS 38.60]. The application of IAS 36 is discussed in Chapter 20.

IAS 38 indicates that evidence may be available in the form of:

• a business plan showing the technical, financial and other resources needed and the entity's ability to secure those resources;
• a lender's indication of its willingness to fund the plan confirming the availability of external finance; [IAS 38.61] and
• detailed project information demonstrating that an entity's costing systems can measure reliably the cost of generating an intangible asset internally, such as salary and other expenditure incurred in securing copyrights or licences or developing computer software. [IAS 38.62].

In any case, an entity should maintain books and records in sufficient detail that allow it to prove whether it meets the conditions set out by IAS 38.

Certain types of product (e.g. pharmaceuticals, aircraft and electrical equipment) require regulatory approval before they can be sold. Regulatory approval is not one of the criteria for recognition under IAS 38 and the standard does not prohibit an entity from capitalising its development costs in advance of approval. However, in some industries regulatory approval is vital to commercial success and its absence indicates significant uncertainty around the possible future economic benefits. This is the case in the pharmaceuticals industry, where it is rarely possible to determine whether a new drug will secure regulatory approval until it is actually granted. Accordingly, it is common practice in this industry for costs to be expensed until such approval is obtained. See Extract 17.7 and the discussion at 6.2.3 below.

The standard does not define the terms ‘research phase’ and ‘development phase’ but explains that they should be interpreted more broadly than ‘research’ and ‘development’ which it does define. [IAS 38.52]. The features characterising the research phase have less to do with what activities are performed, but relate more to an inability to demonstrate at that time that there is an intangible asset that will generate probable future benefits. [IAS 38.55]. This means that the research phase may include activities that do not necessarily meet the definition of ‘research’. For example, the research phase for IAS 38 purposes may extend to the whole period preceding a product launch, regardless of the fact that activities that would otherwise characterise development are taking place at the same time, because certain features that would mean the project has entered its development phase are still absent (such as confirming an ability to use or sell the asset; demonstrating sufficient market demand for a product; or uncertainty regarding the source of funds to complete the project). As a result, an entity might not be able to distinguish the research phase from the development phase of an internal project to create an intangible asset, in which case it should treat the expenditure on that project as if it were incurred in the research phase only and recognise an expense accordingly. [IAS 38.53]. It also means that the development phase may include activities that do not necessarily meet the definition of ‘development’. The example below illustrates how an entity would apply these rules in practice.

As the above example illustrates, the guidance in IAS 38 seems to take a somewhat restricted view as to how internally generated intangible assets are created and managed in practice, as well as the types of internally generated intangible assets. It requires activity to be classified into research and development phases, but this analysis does not easily fit with intangible assets that are created for use by the entity itself. The standard therefore does not address the everyday reality for software companies, television production companies, newspapers and data vendors that produce intangible assets in industrial-scale routine processes.

Many of the intangible assets produced in routine processes (e.g. software, television programmes, newspaper content and databases) meet the recognition criteria in the standard, but no specific guidance is available that could help an entity in dealing with the practical problems that arise when accounting for them.

Generally, entities disclose little detail of the nature of their research and development activities and the costs that they incur, instead focusing on the requirements of IAS 38 that must be met before development expenditure can be capitalised.

The difficulty in applying the IAS 38 recognition criteria for development costs in the pharmaceutical industry are discussed further at 6.2.3 below. Technical and economic feasibility are typically established very late in the process of developing a new product, which means that usually only a small proportion of the development costs is capitalised.

When the development phase ends will also influence how the entity recognises revenue from the project. As noted at 4.4 above, during the development phase an entity can only recognise income from incidental operations, being those not necessary to develop the asset for its intended use, as revenue in profit or loss. [IAS 38.31]. During the phase in which the activity is necessary to bring the intangible asset into its intended use, any income should be deducted from the cost of the development asset. Examples include income from the sale of samples produced during the testing of a new process or from the sale of a production prototype. Only once it is determined that the intangible asset is ready for its intended use would revenue be recognised from such activities. At the same time capitalisation of costs would cease and the related costs of the revenue generating activity would include a measure of amortisation of the asset.

6.2.3 Research and development in the pharmaceutical industry

Entities in the pharmaceutical industry consider research and development to be of primary importance to their business. Consequently, these entities spend a considerable amount on research and development every year and one might expect them to carry significant internally generated development intangible assets on their statement of financial position. However, their financial statements reveal that they often consider the uncertainties in the development of pharmaceuticals to be too great to permit capitalisation of development costs.

One of the problems is that, in the case of true ‘development’ activities in the pharmaceutical industry, the final outcome can be uncertain and the technical and economic feasibility of new products or processes is typically established very late in the development phase, which means that only a small proportion of the total development costs can ever be capitalised. In particular, many products and processes require approval by a regulator such as the US Food and Drug Administration (FDA) before they can be applied commercially and until that time the entity may be uncertain of their success. After approval, of course, there is often relatively little in the way of further development expenditure.

In the pharmaceutical sector, the capitalisation of development costs for new products or processes usually begins at the date on which the product or process receives regulatory approval. In most cases that is the point when the IAS 38 criteria for recognition of intangible assets are met. It is unlikely that these criteria will have been met before approval is granted by the regulator.

Extracts 17.7 and 17.8 below illustrate some of the difficulty in applying the IAS 38 recognition criteria for development costs in the pharmaceutical industry.

6.2.4 Internally generated brands, mastheads, publishing titles and customer lists

IAS 38 considers internally generated brands, mastheads, publishing titles, customer lists and items similar in substance to be indistinguishable from the cost of developing a business as a whole so it prohibits their recognition. [IAS 38.63‑64]. As discussed at 3.3 above, the same applies to subsequent expenditures incurred in connection with such intangible assets even when originally acquired externally. [IAS 38.20]. For example, expenditure incurred in redesigning the layout of newspapers or magazines, which represent subsequent expenditure on publishing titles and mastheads, should not be capitalised.

6.2.5 Website costs (SIC‑32)

SIC‑32 clarifies how IAS 38 applies to costs in relation to websites designed for use by the entity in its business. An entity's own website that arises from development and is for internal or external access is an internally generated intangible asset under the standard. [SIC‑32.7]. A website designed for external access may be used for various purposes such as to promote and advertise an entity's own products and services, provide electronic services to customers, and sell products and services. A website may be used within the entity to give staff access to company policies and customer details, and allow them to search relevant information. [SIC‑32.1].

SIC‑32 does not apply to items that are accounted for under another standard, such as the development or operation of a website (or website software) for sale to another entity (IAS 2 and IFRS 15); acquiring or developing hardware supporting a website (IAS 16); or a website (or website software) subject to a leasing arrangement (IFRS 16). [SIC‑32.5‑6].

Under SIC‑32, an intangible asset should be recognised for website development costs if and only if, it meets the general recognition requirements in IAS 38 (see 3.1 above) and the six conditions for recognition as development costs (see 6.2.2 above). Most important of these is the requirement to demonstrate how the website will generate probable future economic benefits. [SIC‑32.8]. The Interpretation deems an entity unable to demonstrate this for a website developed solely or primarily for promoting and advertising its own products and services. All expenditure on developing such a website should be recognised as an expense when incurred. Accordingly, it is unlikely that costs will be eligible for capitalisation unless an entity can demonstrate that the website is used directly in the income-generating process, for example where customers can place orders on the entity's website. [SIC‑32.8].

The following stages of a website's development are identified by the interpretation: [SIC‑32.2, 9]

1. planning includes undertaking feasibility studies, defining objectives and specifications, evaluating alternatives and selecting preferences. Expenditures incurred in this stage are similar in nature to the research phase and should be recognised as an expense when they are incurred;
2. application and infrastructure development includes obtaining a domain name, purchasing and developing hardware and operating software, installing developed applications and stress testing. The requirements of IAS 16 are applied to expenditure on physical assets. Other costs are recognised as an expense, unless they can be directly attributed, or allocated on a reasonable and consistent basis, to preparing the website for its intended use and the project to develop the website meets the SIC‑32 criteria for recognition as an intangible asset;
3. graphical design development includes designing the appearance of web pages. Costs incurred at this stage should be accounted for in the same way as expenditure incurred in the ‘application and infrastructure development’ stage described under (b) above;
4. content development includes creating, purchasing, preparing and uploading information, either textual or graphical in nature, on the website before the completion of the website's development. The costs of content developed to advertise and promote an entity's own products and services are always expensed as incurred. Other costs incurred in this stage should be recognised as an expense unless the criteria for recognition as an asset described in (b) above are satisfied; and
5. the operating stage, which starts after completion of the development of a website, when an entity maintains and enhances the applications, infrastructure, graphical design and content of the website. [SIC‑32.3]. Expenditure incurred in this stage should be expensed as incurred unless it meets the asset recognition criteria in IAS 38.

In making these assessments, the entity should evaluate the nature of each activity for which expenditure is incurred, independently of its consideration of the website's stage of development. [SIC‑32.9]. This means that even where a project has been determined to qualify for recognition as an intangible asset, not all costs incurred in relation to a qualifying stage of development are eligible for capitalisation. For example, whilst the direct costs of developing an online ordering system might qualify for recognition as an asset, the costs of training staff to operate that system should be expensed because training costs are deemed not necessary to creating, producing or preparing the website for it to be capable of operating (see 6.3 above). [IAS 38.67]. Examples of other costs that would be recognised as an expense regardless of the stage of the project are given in the Illustrative Example to SIC‑32, including:

1. selling, administrative and other general overhead expenditure unless it can be directly attributed to preparing the web site for use to operate in the manner intended by management;
2. clearly identified inefficiencies in the project, such as those relating to alternative solutions explored and rejected; and
3. initial operating losses incurred before the web site achieves planned performance.

A website qualifying for recognition as an intangible asset should be measured after initial recognition by applying the cost model or the revaluation model in IAS 38 as discussed at 8.1 and 8.2 below. In respect of the useful life of website assets, the expectation is that it should be short. [SIC‑32.10].

The criteria for recognition as an asset are restrictive. On-line fashion retailer, ASOS, does not capitalise website development costs, as demonstrated in the extract below.

6.3.1 Establishing the time from which costs can be capitalised

The cost of an internally generated intangible asset is the sum of the expenditure incurred from the date when the intangible asset first meets the recognition criteria of the standard, [IAS 38.65], and meets the detailed conditions for recognition of development phase costs as an asset (see 6.2.2 above).

Costs incurred before these criteria are met are expensed, [IAS 38.68], and cannot be reinstated retrospectively, [IAS 38.65], because IAS 38 does not permit recognition of past expenses as an intangible asset at a later date. [IAS 38.71].

The following example, which is taken from IAS 38, illustrates how these above rules should be applied in practice.

6.3.2 Determining the costs eligible for capitalisation

The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Examples of directly attributable costs are:

1. costs of materials and services used or consumed in generating the intangible asset;
2. costs of employee benefits arising from the generation of the intangible asset;
3. fees to register a legal right;
4. amortisation of patents and licences that are used to generate the intangible asset; and
5. borrowing costs that meet the criteria under IAS 23 for recognition as an element of cost. [IAS 38.66].

Indirect costs and general overheads, even if they can be allocated on a reasonable and consistent basis to the development project, cannot be recognised as part of the cost of any intangible asset. The standard also specifically prohibits recognition of the following items as a component of cost:

1. selling, administrative and other general overhead expenditure unless this expenditure can be directly attributed to preparing the asset for use;
2. identified inefficiencies and initial operating losses incurred before the asset achieves planned performance; and
3. expenditure on training staff to operate the asset. [IAS 38.67].

For these purposes it does not make any difference whether the costs are incurred directly by the entity or relate to services provided by third parties.

8.2.1 Revaluation is only allowed if there is an active market

An entity can only elect to apply the revaluation model if the fair value can be determined by reference to an active market for the intangible asset. [IAS 38.81‑82]. An active market is defined in IFRS 13 as one in which transactions for the item take place with sufficient frequency and volume to provide pricing information on an ongoing basis. [IFRS 13 Appendix A].

Few intangible assets will be eligible for revaluation and indeed the standard concedes that such an active market would be uncommon. Nevertheless, in some jurisdictions, an active market may exist for freely transferable taxi licences, fishing licences or production quotas. [IAS 38.78]. However, by their very nature most intangible assets are unique or entity-specific. The standard lists brands, newspaper mastheads, music and film publishing rights, patents or trademarks as items that are ineligible for revaluation because each such asset is unique. [IAS 38.78]. The existence of a previous sale and purchase transaction is not sufficient evidence for the market to be regarded as active because of the requirement in the definition for a sufficient frequency and volume of transactions to allow the provision of ongoing pricing information. The standard notes that where contracts are negotiated between individual buyers and sellers or when transactions are relatively infrequent, the price of a previous transaction for one intangible asset may not provide sufficient evidence of the fair value of another. In addition, if prices are not available to the public, this is taken as evidence that an active market does not exist. [IAS 38.78].

An entity should stop revaluing an asset if the market used to determine its fair value ceases to meet the criteria for an active market. The valuation is ‘frozen’ from that date, and reduced thereafter by subsequent amortisation and any subsequent impairment losses. [IAS 38.82]. The IASB believes that the disappearance of a previously active market may indicate that the asset needs to be tested for impairment in accordance with IAS 36. [IAS 38.83].

If an active market for the previously revalued asset emerges at a later date, the entity is required to apply the revaluation model from that date. [IAS 38.84].

8.2.2 Frequency of revaluations

IAS 38 requires revaluations to be performed ‘with such regularity that at the end of the reporting period the carrying amount of the asset does not differ materially from its fair value’. [IAS 38.75]. The standard lets entities judge for themselves the frequency of revaluations depending on the volatility of the fair values of the underlying intangible assets. Significant and volatile movements in fair value would necessitate annual revaluation, whereas a less frequent update would be required for intangibles whose price is subject only to insignificant movements. [IAS 38.79]. Nevertheless, since an entity can only revalue assets for which a price is quoted in an active market, there should be no impediment to updating that valuation at each reporting date. As noted above, when an entity has a number of items in the same class of intangible assets, the standard requires that they are all valued at the same time. [IAS 38.73].

8.2.3 Accounting for revaluations

Increases in an intangible asset's carrying amount as a result of a revaluation should be credited to other comprehensive income under the heading of revaluation surplus, except to the extent that the revaluation reverses a revaluation decrease of the same asset that was previously recognised in profit or loss. [IAS 38.85]. Conversely, decreases in an intangible asset's carrying amount as a result of a revaluation should be recognised in profit or loss, unless the decrease reverses an earlier upward revaluation, in which case the decrease should first be recognised in other comprehensive income to extinguish the revaluation surplus in respect of the asset. [IAS 38.86]. The example below illustrates how this works.

In the example above, the impact of amortisation on the carrying amount of the assets and the revaluation surplus was ignored for the sake of simplicity. However, the cumulative revaluation surplus included in other comprehensive income may be transferred directly to retained earnings when the surplus is realised, which happens either on the retirement or disposal of the asset, or as the asset is used by the entity. [IAS 38.87]. In the latter case, the amount of the surplus regarded as realised is the amount of amortisation in excess of what would have been charged based on the asset's historical cost. [IAS 38.87]. See Chapter 18 at 6.2 for an example. In practice this means two things:

• an entity applying the revaluation model would need to track both the historical cost and revalued amount of an asset to determine how much of the revaluation surplus has been realised; and
• any revaluation surplus is amortised over the life of the related asset. Therefore, in the case of a significant downward revaluation there is a smaller revaluation surplus available against which the downward revaluation can be offset before recognition in the statement of profit or loss.

The transfer from revaluation surplus to retained earnings is not made through profit or loss. [IAS 38.87]. It is not the same as recycling a gain or loss previously recognised in other comprehensive income. Accordingly, the transfer will appear as a line item in the Statement of Changes in Equity rather than in other comprehensive income.

When an intangible asset is revalued, the carrying amount of that asset is adjusted to the revalued amount. At the date of the revaluation, the asset is treated in one of the following ways:

1. the gross carrying amount is adjusted in a manner that is consistent with the revaluation of the carrying amount of the asset. For example, the gross carrying amount may be restated by reference to observable market data or it may be restated proportionately to the change in the carrying amount. The accumulated amortisation at the date of the revaluation is adjusted to equal the difference between the gross carrying amount and the carrying amount of the asset after taking into account accumulated impairment losses; or
2. the accumulated amortisation is eliminated against the gross carrying amount of the asset. [IAS 38.80].

The example below illustrates how the adjustments are calculated.

9.1.1 Factors affecting the useful life

The standard identifies a number of factors that may affect the useful life of an intangible asset:

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, discussed further at 9.1.2 below; and
8. whether the useful life of the asset is dependent on the useful life of other assets of the entity. [IAS 38.90].

The standard explicitly warns against both:

• overestimating the useful life of an intangible asset. For example, a history of rapid changes in technology means that the useful lives of computer software and many other intangible assets that are susceptible to technological obsolescence will be short; [IAS 38.92] and
• underestimating the useful life. Whilst uncertainty justifies estimating the useful life of an intangible asset on a prudent basis, it does not justify choosing a life that is unrealistically short. [IAS 38.93].

Where an intangible asset is acquired in a business combination, but the acquiring entity does not intend to use it to generate future cash flows, it is unlikely that it could have anything other than a finite useful life. Indeed, whilst in our view an entity would not recognise an immediate impairment loss on acquisition, the estimated useful life of the asset is likely to be relatively short (see Chapter 9 at 5.5.6).

The following examples, based on those in IAS 38's Illustrative Examples, show how some of the features that affect the useful life are taken into account in assessing that life.

It is clear from the above discussion that despite the fairly detailed guidance in the standard an entity will need to exercise judgement in estimating the useful life of intangible assets.

9.1.2 Useful life of contractual or other legal rights

Where an intangible asset arises from contractual or other legal rights, the standard requires an entity to take account of both economic and legal factors influencing its useful life and determine the useful life as the shorter of:

• the period of the contractual or other legal rights; and
• the period (determined by economic factors) over which the entity expects to obtain economic benefits from the asset. [IAS 38.94‑95].

If the contractual or other legal rights can be renewed, the useful life of the intangible asset should include the renewal period only if there is evidence to support renewal by the entity without significant cost.

However, renewal periods must be ignored if the intangible asset is a reacquired right that was recognised in a business combination. [IAS 38.94]. The existence of the following factors may indicate that an entity is able to renew the contractual or other legal rights without significant cost:

1. there is 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, this includes evidence that the third party will give its consent;
2. there is evidence that any conditions necessary to obtain renewal will be satisfied; and
3. the cost to the entity of renewal is not significant when compared with the future economic benefits expected to flow to the entity from renewal. [IAS 38.96].

A renewal period is only added to the estimate of useful life if its cost is insignificant when compared with the future economic benefits expected to flow to the entity from renewal. [IAS 38.94]. If this is not the case, then the original asset's useful life ends at the contracted renewal date and the renewal cost is treated as the cost to acquire a new intangible asset. [IAS 38.96]. An entity needs to exercise judgement in assessing what it regards as a significant cost.

In the case of a reacquired contractual right, recognised as an intangible asset in a business combination accounted for under IFRS 3, its useful life is the remaining contractual period of the contract in which the right was granted. Renewal periods may not be taken into account. [IAS 38.94].

The following examples are derived from those in IAS 38's Illustrative Examples and show the effect of contractual or other legal rights on the useful life of an intangible asset, when assessed together with other factors. The useful life may be shorter than the legal rights or, if supported by facts and circumstances, renewal rights could mean that the intangible asset's life is indefinite.

9.2.1 Amortisation period and method

Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its useful life. The depreciable amount is the cost of an asset, or other amount substituted for cost (e.g. revaluation), less its residual value. [IAS 38.8]. The depreciable amount of an intangible asset with a finite useful life should be allocated on a systematic basis over its useful life in the following manner: [IAS 38.97]

• amortisation should begin when the asset is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Therefore, even if an entity is not using the asset, it should still be amortised because it is available for use, although there may be exceptions from this general rule (see 9.2.3 below);
• amortisation should cease at the earlier of:
  • the date that the asset is classified as held for sale, or included in a disposal group that is classified as held for sale, in accordance with IFRS 5; and
  • the date that the asset is derecognised.
• the amortisation method should reflect the pattern of consumption of the economic benefits that the intangible asset provides. If that pattern cannot be reliably determined, a straight-line basis should be used.

Amortisation of an intangible asset with a finite useful life continues until the asset has been fully depreciated or is classified as held for sale, as noted above, or derecognised. Amortisation does not cease simply because an asset is not being used, [IAS 38.117], although this fact might give rise to an indicator of impairment.

The standard allows a variety of amortisation methods to be used to depreciate the asset on a systematic basis over its useful life, such as the straight-line method, the diminishing balance method and the unit of production method. [IAS 38.98]. The factors to consider in determining the most appropriate amortisation method are similar to those that are relevant for the depreciation of property, plant and equipment in accordance with IAS 16 (see Chapter 18). For example, entities can adopt a ‘sum of the digits’ methodology, where amortisation reflects higher consumption of benefits in the earlier part of the asset's useful life, as this is a variant of the diminishing balance method (see Chapter 18).

In selecting an appropriate amortisation method for intangible assets acquired in a business combination, entities should ensure consistency with any assumptions that were used in determining the fair value of the asset. For example, a customer relationship asset may be valued by taking into account an assumed churn-rate that implies a higher level of customer relationships ending in the earlier periods following the business combination. These factors may indicate that a straight-line method of amortisation is not the most appropriate method to reflect the pattern of consumption of the economic benefits that the intangible asset provides, as the valuation assumed that benefit to be frontloaded.

The amortisation charge for each period should be recognised in profit or loss unless IFRS specifically permits or requires it to be capitalised as part of the carrying amount of another asset (e.g. inventory or work in progress). [IAS 38.97, 99].

There is a rebuttable presumption that an amortisation method based on the pattern of expected revenues is not appropriate. This is because a revenue-based method reflects a pattern of generation of economic benefits from operating the business (of which the asset is a part), rather than the consumption of the economic benefits embodied in the asset itself (see 9.2.2 below). By contrast, an amortisation method based on estimated total output (a unit of production method) is appropriate.

The future economic benefits of some intangible assets are clearly consumed on a declining balance basis. This often applies to customer relationships and similar assets acquired as part of a business combination. Both the fair value and the future economic benefits from the customer relationship or similar asset decline over time as the consumption of the economic benefits embodied in the asset declines. Therefore amortising the customer relationship on a declining balance method would be appropriate.

It is important to distinguish this from an asset whose fair value shows a declining balance profile over its life but where the future economic benefits are consumed on a time basis, e.g. a motor vehicle where the entity will obtain as much benefit in year 4 as in year 1. A straight-line method of amortisation properly reflects the consumption of benefits from the motor vehicle.

9.2.2 Revenue-based amortisation

Consumption of the future economic benefits of an asset is the principle on which amortisation is based. Whether this completely precluded revenue-based methods of amortisation had become a matter of debate, particularly in the context of service concession arrangements that are accounted for using the intangible asset model (see Chapter 25 at 4.3.1).

In May 2014, the IASB clarified IAS 38 by introducing a rebuttable presumption that a revenue-based approach is not appropriate. Revenue reflects the output of the intangible asset but it also measures the impact of other factors, such as changes in sales volumes and selling prices, the effects of selling activities and changes to inputs and processes. The price component of revenue may be affected by inflation. [IAS 38.98A].

The following example illustrates how a revenue-based method of amortisation diverges from the units-of-production method when the price per unit is not fixed.

The IASB acknowledged certain ‘limited circumstances’ that would allow revenue-based amortisation. Therefore, the presumption that they are not acceptable is rebuttable only:

1. when the rights embodied in that intangible asset are expressed as a measure of revenue; or
2. when it can be demonstrated that revenue and the consumption of the economic benefits embodied in the intangible asset are highly correlated. [IAS 38.98A].

A ‘highly correlated’ outcome would only be achieved where a revenue-based method of amortisation is expected to give a similar answer as one of the other methods permitted by IAS 38. For example, if revenue is earned evenly over the expected life of the asset, the pattern of amortisation would be similar to a straight-line basis. In situations where unit prices are fixed and all production is sold, the pattern of amortisation would replicate the use of the units-of-production method. However, when unit prices are not fixed, revenue would not provide the same answer and its use would therefore be inappropriate (as in the example above). [IAS 38.98B]. The revised standard notes that revenue is the predominant limiting factor that is inherent in the intangible asset in circumstances in which it is appropriate to use it as the basis of amortisation. In other words, in these circumstances, revenue determines the useful life of the asset, rather than, for example, a number of years or the number of units produced.

The amended standard includes two examples in which revenue earned can be regarded as a measure of consumption of an intangible asset.

• A contract may allow the extraction of gold from a mine until total cumulative revenue from the sale of gold reaches $2 billion; or
• The right to operate a toll road could be based on a fixed total amount of revenue to be generated from cumulative tolls, i.e. the operator can collect up to €100 million from the tolls collected. [IAS 38.98C].

Some respondents had argued that a units of production method did not seem practicable when the units of production were not homogeneous. For example, a producer of a motion picture generates revenue through showing the picture in theatres, selling DVDs, licensing the rights to characters to toy manufacturers and licensing the broadcast rights to television. The IASB acknowledges that such situations require the exercise of judgement. The Board did consider whether an intangible asset should be divided into components for amortisation purposes ‘but refrained from developing guidance in this respect for intangible assets’. [IAS 38.BC72H-72I].

9.2.3 Review of amortisation period and amortisation method

An entity should review the amortisation period and the amortisation method for an intangible asset with a finite useful life at least at each financial year-end. If the expected useful life of the asset has changed, the amortisation period should be changed accordingly. [IAS 38.104]. An entity may, for example, consider its previous estimate of the useful life of an intangible asset inappropriate upon recognition of an impairment loss on the asset. [IAS 38.105].

If the expected pattern of consumption of the future economic benefits embodied in the asset has changed, the amortisation method should be changed to reflect the new pattern. [IAS 38.104]. The standard provides two examples of when this might happen:

• if it becomes apparent that a diminishing balance method of amortisation is appropriate rather than a straight-line method; [IAS 38.106] and
• if use of the rights represented by a licence is deferred pending action on other components of the business plan. In this case, economic benefits that flow from the asset may not be received until later periods. [IAS 38.106]. This implies that circumstances may exist in which it is appropriate not to recognise an amortisation charge in relation to an intangible asset, because the entity may not yet be ready to use it. For example, telecommunication companies acquired UMTS (3G) licences, before constructing the physical network necessary to use the licence. Note that an entity must perform an impairment test at least annually for any intangible asset that has not yet been brought into use. [IAS 36.10].

Both changes in the amortisation period and the amortisation method should be accounted for as changes in accounting estimates in accordance with IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors – which requires such changes to be recognised prospectively by revising the amortisation charge in the current period and for each future period during the asset's remaining useful life. [IAS 8.36, 38, IAS 38.104].

9.2.4 Residual value

The residual value of an intangible asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. [IAS 38.8].

IAS 38 requires entities to assume a residual value of zero for an intangible asset with a finite useful life, unless there is a commitment by a third party to purchase the asset at the end of its useful life or there is an active market (as defined by IFRS 13) for the asset from which to determine its residual value and it is probable that such a market will exist at the end of the asset's useful life. [IAS 38.100]. This presumption has been retained from the previous version of IAS 38 as an anti-abuse measure to prevent entities from circumventing the requirement to amortise all intangible assets. [IAS 38.BC59].

Given the definition of ‘active market’ (see 8.2.1 above) it seems highly unlikely that, in the absence of a commitment by a third party to buy the asset, an entity will ever be able to prove that the residual value is other than zero. A residual value other than zero implies that the entity intends to dispose of the asset before the end of its economic life. [IAS 38.101]. Third party commitments can be found in contracts in the scope of IFRIC 12 – Service Concession Arrangements (see Chapter 25) and one of IAS 38's Illustrative examples includes a residual value; see Example 17.15 below.

If an entity can demonstrate a case for estimating a residual value other than zero, its estimate should be based on current prices for the sale of a similar asset that has reached the end of its useful life and has operated under conditions similar to those in which the asset will be used. [IAS 38.102]. The standard requires a review of the residual value at each financial year end. This review can result in an upward or downward revision of the estimated residual value and thereby affect the depreciable amount of the asset; that change to depreciation should be accounted for prospectively as a change in an accounting estimate in accordance with IAS 8. [IAS 38.102].

The following example is based on one of IAS 38's Illustrative Examples. The intangible asset being considered has a residual value at the end of its useful life.

The standard does not permit negative amortisation in the event that the residual value of an intangible asset increases to an amount greater than the asset's carrying amount. Instead, the asset's amortisation charge will be zero until its residual value decreases to an amount below the asset's carrying amount. [IAS 38.103].

9.5.1 Derecognition of parts of intangible assets

The standard requires an entity to recognise the cost of replacing a part of an intangible asset as a component of the asset's carrying amount and to derecognise that component when the part is replaced. ‘If it is not practicable for an entity to determine the carrying amount of the replaced part, it may use the cost of the replacement as an indication of what the cost of the replaced part was at the time it was acquired or internally generated.’ [IAS 38.115]. As noted by the standard, the nature of intangible assets is such that, in many cases, there are no additions or replacements that would meet its recognition criteria, so this should be an unlikely event (see 3.3 above). [IAS 38.20].

However, this requirement raises the question of how to account for the disposal of a part of a larger intangible item, acquired in a single transaction but capable of being subdivided for separate disposal. An example would be the division of the global rights to sell a particular product into a number of agreements providing exclusive rights over a particular continent or other geographic territory. In this case, the part disposed of is an identifiable and separable part of the original intangible asset. Because the rights are exclusive, the part still meets the definition of an intangible asset because it is embodied in legal rights that allow the acquirer to control the benefits arising from the asset, either by providing access to earn revenues in that geographic market or by restricting the access of others to that market. [IAS 38.13]. In that case, an entity would apply the requirements above for the derecognition of a replacement part of an asset, by determining the carrying amount of the separate part or, if to do so is impracticable, deducting the proceeds of disposal from the depreciated replacement cost of the original asset (in effect treating the value of the newly separated part as an indicator of original cost).

Where the subdivision of rights is not established on an exclusive basis, it would be more difficult to regard a separable component of the original intangible as having been disposed of. For example, rights might be assigned to a third party over a geographic area, but the entity retains the ability to sell goods in that market as well. In such circumstances it may not be appropriate to derecognise a portion of the original intangible asset. Instead the entity may have transferred a right of use (or lease) over the asset to the third party, or entered into a form of joint arrangement. The issues raised by the partial disposal of previously undivided interests in property, plant and equipment are discussed in Chapter 18.

Accounting for the partial derecognition of goodwill on the disposal of an operation that forms part of a cash-generating unit is discussed in Chapter 20 at 8.5.

11.2.1 Emissions trading schemes – IFRIC 3

IFRIC 3 dealt with accounting for cap and trade schemes by entities that participated in them.¹¹ The provisions of the interpretation were also considered to be relevant to other schemes designed to encourage reduced levels of emissions and share some of the features outlined above.¹²

IFRIC 3 took the view that a cap and trade scheme did not give rise to a net asset or liability, but that it gave rise to various items that were to be accounted for separately:¹³

1. an asset for allowances held – Allowances, whether allocated by government or purchased, were to be regarded as intangible assets and accounted for under IAS 38. Allowances issued for less than fair value were to be measured initially at their fair value;¹⁴
2. a government grant – When allowances are issued for less than fair value, the difference between the amount paid and fair value was a government grant that should be accounted for under IAS 20. Initially the grant was to be recognised as deferred income in the statement of financial position and subsequently recognised as income on a systematic basis over the compliance period for which the allowances were issued, regardless of whether the allowances were held or sold;¹⁵
3. a liability for the obligation to deliver allowances equal to emissions that have been made – As emissions are made, a liability was to be recognised as a provision that falls within the scope of IAS 37. The liability was to be measured at the best estimate of the expenditure required to settle the present obligation at the reporting date. This would usually be the present market price of the number of allowances required to cover emissions made up to the reporting date.¹⁶

The interpretation also noted that the existence of an emission rights scheme could represent an indicator of impairment of the related assets, requiring an IAS 36 impairment test to be performed, because the additional costs of compliance could reduce the cash flows expected to be generated by those assets.¹⁷

Those who called for the withdrawal of IFRIC 3 identified a number of accounting mismatches arising from its application:¹⁸

• a measurement mismatch between the assets and liabilities recognised in accordance with IFRIC 3;
• a mismatch in the location in which the gains and losses on those assets are reported; and
• a possible timing mismatch because allowances would be recognised when they are obtained – typically at the start of the year – whereas the emission liability would be recognised during the year as it is incurred.

In light of these accounting mismatches, it is perhaps no surprise that in practice very few companies have applied IFRIC 3 on a voluntary basis. Instead companies have developed a range of different approaches in accounting for cap and trade emission rights schemes, which are discussed below:

• ‘net liability’ approaches;
• ‘government grants’ approach.

Whatever approach is used, companies should disclose their accounting policies regarding grants of emission rights, the emission rights themselves, the liability for the obligation to deliver allowances equal to emissions that have been made and the presentation in the statement of profit or loss. [IAS 1.117, 121].

11.2.2 Emissions trading schemes – Net liability approaches

Under the ‘net liability’ approach emission allowances received by way of grant are recorded at a nominal amount and the entity will only recognise a liability once the actual emissions exceed the emission rights granted and still held, thereby requiring the entity to purchase additional allowances in the market or incur a regulatory penalty. Purchased grants are initially recognised at cost.

We believe that an entity can apply such a ‘net liability’ approach, because in the absence of specific guidance on the accounting for emission rights, IAS 20 allows non-monetary government grants and the related asset (in this case the emission rights) received to be measured at a nominal amount (i.e. nil). [IAS 20.23].

Under IAS 37, a provision can only be recorded if the recognition criteria in the standard are met, including that the entity has a present obligation as a result of a past event, it is probable that an outflow of economic resources will be required to settle the obligation and a reliable estimate can be made, [IAS 37.14], (see Chapter 26). As far as emissions are concerned, the ‘obligating event’ is the emission itself, therefore a provision is considered for recognition as emissions are made, but an outflow of resources is not probable until the reporting entity has made emissions in excess of any rights held. This means that an entity should not recognise a provision for any anticipated future shortfall of emission rights, nor should it accrete a provision over the period of the expected shortfall.

Under IAS 37 the entire obligation to deliver allowances should be measured on the basis of the best estimate of the expenditure required to settle the present obligation at the end of the reporting period (see Chapter 26). [IAS 37.36]. Accordingly any provision is based on the lower of the expected cost to purchase additional allowances in the market or the amount of any regulatory penalty.

Although it has been criticised for using a nominal value for the rights and a net approach for measuring the liability, the ‘net liability’ approach appears to have gained acceptance in practice.

In the above example, the company cannot anticipate the future shortfall of 2,000 tonnes before the fourth quarter by accreting the provision over the year, nor can it recognise on day one the full provision for the 2,000 tonnes expected shortfall. This is because there is no past obligating event to be recognised until the emissions target has actually been exceeded.

Some schemes operate over a period of more than one year, such that the entity is unconditionally entitled to receive allowances for, say, a 3‑year period, and it is possible to carry over unused emission rights from one year to the next. In our view, these circumstances would justify application of the net liability approach for the entire period concerned, not just the reporting period for which emission rights have been transferred to the entity. When applying the net liability approach, an entity may choose an accounting policy that measures deficits on the basis of:

• an annual allocation of emission rights; or
• an allocation that covers the entire first period of the scheme (e.g. 3 years) provided that the entity is unconditionally entitled to all the allowances for the first period concerned.

For such schemes, the entity must apply the chosen method consistently at every reporting date. If the entity chooses the annual allocation basis, a deficit is measured on that basis and there can be no carrying over of rights from one year to the next or back to the previous year.

In Example 17.18 above, the entity had an expected shortfall of 2,000 tonnes. Suppose that during the year it had purchased emission rights to cover some or all of the expected shortfall. How should these be accounted for?

Because the cost of emissions can only be settled by delivering allowances and the liability to the government cannot be transferred, it is argued that the cost to the entity of settling the obligation is represented by the current carrying value of the emission rights held.

Another view is that measurement of the obligation should be determined independently of considerations as to how settlement may be funded by the entity. Accordingly, the provision would be measured, as in Example 17.18, at €32,000 (based on the market value of emission rights at the year-end). However, the entity may consider the emission rights it holds as a reimbursement right under IAS 37, which is recognised at an amount not exceeding the related provision (see Chapter 26). [IAS 37.53].

Under this alternative ‘net liability / reimbursement rights’ approach, the entity would re-measure (to fair value) the emission rights that it holds. Therefore although Company A has recognised a provision (and an expense) of €32,000, at the same time it would revalue its purchased emission rights, as a reimbursement right, from €12/tonne to €16/tonne. It would thus recognise a gain of €4,000 (1,000 tonnes × €4/tonne), resulting in a net expense of €28,000 in the statement of profit or loss. This is the same as the profit or loss effect of applying the ‘net liability / carrying value’ approach.

In practice both the ‘net liability’ approach and the ‘net liability / reimbursement rights’ approach have gained acceptance.

In the extract below, MOL Hungarian Oil and Gas Plc applies a ‘net liability’ approach, i.e. emission rights granted free of charge are accounted for at their nominal value of zero and no government grant is recognised. A liability for the obligation to deliver allowances is only recognised when the level of emissions exceed the level of allowances granted. MOL Hungarian Oil and Gas Plc measures the liability at the cost of purchased allowances up to the level of purchased allowances held, and then at the market price of allowances ruling at the reporting date, with movements in the liability recognised in operating profit.

11.2.3 Emissions trading schemes – Government grant approach

Another approach which has gained acceptance in practice is to recognise the emission rights granted by the government initially at their fair value and record a corresponding government grant in the statement of financial position. The government grant element is subsequently recognised as income in accordance with the requirements of IAS 20. To that extent, the approach follows that required by IFRIC 3. However, rather than measuring the liability for the obligation to deliver allowances at the present market price of those allowances, the liability is measured instead by reference to the amounts recorded when those rights were first granted.

As with the ‘net liability’ approach, critics have argued that the government grant approach would not be in line with the ‘best estimate’ determined under IAS 37 as the amount that an entity would rationally pay to settle the obligation at the reporting date or to transfer it to a third party at that time. [IAS 37.37].

Repsol initially recognises the emission rights at fair value as a government grant under IAS 20 and illustrates clearly that the measurement of the liability follows that of the related emission rights. To the extent that emissions are not covered by emission rights, the liability is recognised at the fair value of such allowances at the reporting date.

The fair value on initial recognition of emission rights that are accounted as intangible assets will be based on the requirements of IFRS 13 which are discussed in Chapter 14. If there is no active market for emission rights, the selection of appropriate valuation techniques, inputs to those valuation techniques and the application of the fair value hierarchy are discussed in Chapter 14.

11.2.4 Amortisation and impairment testing of emission rights

In the case of cap and trade schemes, emission rights that are accounted for as intangible assets are unlikely to be amortised as their depreciable amount is usually nil. Their expected residual value at inception will be equal to their fair value. Thereafter, although their residual value is equal to their market value, there is no consumption of economic benefit while the emission right is held. The economic benefits are realised instead by surrendering the rights to settle obligations under the scheme for emissions made, or by selling rights to another party. It is necessary to perform an IAS 36 impairment test whenever there is an indication of impairment (see Chapter 20). If the market value of an emission right drops below its carrying amount, this does not automatically result in an impairment charge because emission rights are likely to be tested for impairment as part of a larger cash generating unit.

11.2.5 Emission rights acquired in a business combination

At the date of acquisition of a business, an acquirer is required to recognise the acquiree's identifiable intangible assets, in this case emission rights, at their fair values. [IFRS 3.18].

However, an acquirer should only recognise a provision for actual emissions that have occurred up to that date. This means that an acquirer cannot apply the ‘net liability’ approach to emission rights acquired in a business combination. Instead, an acquirer should treat acquired emission rights in the same way as purchased emission rights (see 11.2.2 above). An acquirer that applies IFRIC 3 or the ‘government grant’ approach would recognise acquired emission rights at their fair value, but cannot recognise a deferred credit for a ‘government grant’ as it acquired the emission rights by way of a business combination.

Consequently, an acquirer may report a higher emission expense in its statement of profit or loss in the compliance period in which it acquires a business.

11.2.6 Sale of emission rights

The sale of emission rights that are accounted for as intangible assets should be recognised in accordance with IAS 38. This means that they should be derecognised on disposal or when no future economic benefits are expected from their use or disposal. [IAS 38.112]. The gain or loss arising from derecognition of the emission rights should be determined as the difference between the net disposal proceeds and the carrying amount of emission rights. [IAS 38.113].

Prior to the sale the entity may not have recognised the obligation, to deliver allowances equal to the emissions caused, at its fair value at the date of derecognition. If that were the case then the entity would need to ensure that the liability in excess of the emission rights held by the company after the sale is recognised at the present fair value of the emission rights.

Both the gain or loss on the derecognition of the emission rights and the adjustment of the liability should be recognised when the emission rights are derecognised. Any gain should not be classified as revenue. [IAS 38.113].

If an entity that applies the ‘net liability’ approach were to sell all its emission rights at the start of the compliance period, it would not be permitted to defer the gain on that sale even if it was certain that the entity would need to repurchase emission rights later in the year to cover actual emissions. A gain is recognised immediately on the sale and a provision is recognised as gases are emitted.

If an entity enters into a forward contract to sell an emission right, it may be acting effectively as a broker-trader. The entity should determine whether the contract is a derivative within the scope of IFRS 9 by applying the requirements in that Standard (see Chapter 46).

11.2.7 Accounting for emission rights by brokers and traders

IFRIC 3 did not address accounting by brokers and traders that are not themselves participants in a cap and trade scheme. However, they hold emission rights as assets held for sale in the ordinary course of business, which means that they meet the definition of inventories in IAS 2. [IAS 2.6]. Under that standard a broker-trader may choose between measuring emission rights at the lower of cost and net realisable value or at fair value less costs to sell. Commodity broker-traders who measure their inventories at fair value less costs to sell may recognise changes in fair value less costs to sell in profit or loss in the period of the change. [IAS 2.3].

When a company trades derivatives based on the emission rights, they fall within the scope of IFRS 9 and are accounted for at fair value through profit or loss unless they hedge the fair value of the emission rights granted to the company or qualify for the ‘own use exemption’. [IFRS 9.2.4].

When an entity holds emission rights for own use and also has a trading department trading in emission rights, the company should split the books between emission rights held for own use and those held for trading. The emission rights should be treated as intangible assets and inventory respectively. This is illustrated in Extract 17.15 above.

11.3.1 Accounting by producers using renewable energy sources

As in the case of emission rights, the award of green certificates is treated as a government grant by a producer. An intangible asset representing an entitlement to that grant is recognised at the point in time when the green electricity is produced. As with any government grant, the entitlement is initially measured at either fair value or a nominal amount, depending on the entity's chosen policy. [IAS 20.23].

Where the entitlement asset is initially recognised at fair value, a credit entry is recorded in the statement of profit or loss as either a reduction in production costs for the period (on the basis that the purpose of the grant is to compensate the producer for the higher cost of using renewable energy sources) or as other income, but not as revenue. [IAS 20.29]. Subsequent revaluation of the intangible asset is only allowed if an active market exists for the green certificates, and the other requirements of IAS 38 are applied (see 8.2 above). The intangible is derecognised when the certificate is sold by the producer.

11.3.2 Accounting by distributors of renewable energy

When the distributor is also a producer of renewable energy, it has the option to use certificates granted to it or to sell them in the market. Accordingly, the permissible accounting treatments of green certificates are in principle the same as those for emission rights discussed at 11.2 above. The distributor is obliged to remit certificates and therefore recognises a provision as sales are recorded (in the same way that a provision for emission rights is recognised as emissions are made). The distributor might apply a ‘net liability’ approach, discussed at 11.2.2 above, and only start to recognise a provision once it has achieved a level of sales exceeding that covered by certificates granted to the entity in its capacity as a producer.

If a distributor is not also a producer of renewable energy, it recognises a provision as sales are made, measured at the fair value of green certificates to be remitted. A corresponding cost is included in cost of sales. The provision is remeasured to fair value at each reporting date. If the entity purchases certificates in the market, they are recognised as an intangible asset and initially measured at cost. Subsequent revaluation is only allowed if an active market exists for the green certificates, and the other requirements of IAS 38 are applied (see 8.2 above).

Alternatively, as discussed in Example 17.19 at 11.2.2 above, the asset held may be designated by management as a reimbursement right in respect of the associated liability, allowing remeasurement to fair value. Similarly, the entity could apply a carrying value method, measuring the provision based on the value and extent of certificates already held and applying fair value only to the extent that it has an obligation to make further purchases in the market or to incur a penalty if it fails to do so.

11.3.3 Accounting by brokers and traders

As discussed at 11.2.7 above, brokers and traders should apply IAS 2 where green certificates are held for sale in the ordinary course of business; account for derivatives based on green certificates in accordance with IFRS 9; and properly distinguish those held for own use (carried within intangible assets) from certificates held for trading (included in inventory).

11.4.1 Costs of registering a new substance performed by the entity itself

If the entity itself incurs REACH costs, these activities meet the definition of development in IAS 38. [IAS 38.8]. Accordingly, the entity must also meet the rigorous rules in the standard described at 6.2.2 above which confirm that the related development project is at a sufficiently advanced stage, is economically viable and includes only directly attributable costs. [IAS 38.57].

Costs of identifying the substances that need to be registered would have to be recognised as an expense when incurred, as this activity is regarded as research. [IAS 38.56].

11.4.2 Costs of acquiring test data from an existing registrant

An entity may acquire test data from an existing registrant that has already been used by it in its earlier application for registration. These costs should be capitalised as a separately acquired intangible asset (see 4 above).

11.4.3 Costs of registering an existing substance performed by the entity itself

In this case two alternative treatments are acceptable. If the costs of obtaining a REACH registration for existing substances used in existing processes are regarded as subsequent expenditure on an existing intangible asset, the related costs should be recognised as an expense as incurred, [IAS 38.20], (see 3.3 above). As unregistered substances will no longer be available for use, this might indicate that the registration maintains the economic benefits associated with the related production process or product and does not improve it.

Alternatively, it could be argued that the cost of registering existing substances should be regarded as no different to the cost of registering a new product. Accordingly, for the reasons noted at 11.4.1 above, such costs should be capitalised as an internally generated intangible asset.

11.5.1 Crypto-assets – Recognition and initial measurement

Crypto-assets that meet the definition of an intangible asset and are being accounted for under IAS 38 are only recognised if it is probable that future economic benefits will flow to the entity and its cost can be measured reliably (see 3.1 above). Separately acquired intangible assets will normally be recognised, as IAS 38 assumes that the acquisition price reflects the expectation about future economic benefits. Thus, an entity always expects future economic benefits, for these intangibles, even if there is uncertainty about the timing or amount (See 4.1 above).

Crypto-assets that meet the definition of an intangible asset and are being accounted for under IAS 38 are initially measured at cost (see 3.2 above).

The cost of acquiring crypto-assets would typically include the purchase price (after deducting trade discounts and rebates if any) and the related transaction costs, which could include blockchain processing fees. Where an intangible asset is acquired in exchange for another non-monetary asset, the cost is measured at fair value, unless the transaction lacks commercial substance or the fair value of neither the asset acquired nor the asset given up can be measured reliably. In such instances, the cost of the intangible asset is measured as the carrying amount of the asset given up.

11.5.2 Crypto-assets – Subsequent measurement

As discussed at 8 above, there are two subsequent measurement approaches under IAS 38 that can be applied as an accounting policy choice to each class of intangible asset, namely:

• Cost model.
• Revaluation model (subject to criteria as discussed below).

An entity that holds different types of crypto-assets would need to assess whether they constitute different classes of intangible assets as the rights and underlying economics of different crypto-assets vary widely.

11.5.3 Crypto-assets – Standard setter activity

Accounting standard setters are monitoring the development of crypto-assets and the related accounting practices by holders. Some standard setters have undertaken research into the accounting for crypto-assets, while some have expressed a view on what they consider to be appropriate accounting under IFRS. For example, in Japan the standard setter has issued authoritative guidance for the accounting of crypto-assets under local GAAP.

In November 2018, the IASB decided not to add to its work plan a project on holdings of cryptocurrencies or initial coin offerings, but instead would monitor the development of crypto-assets. The IASB asked the Interpretations Committee to consider publishing an agenda decision on how entities apply existing IFRS Standards to holdings of cryptocurrencies, a subset of crypto assets.²¹

In June 2019, the Committee published an agenda decision on this matter. The Committee observed that a holding of cryptocurrency meets the definition of an intangible asset under IAS 38 because it is capable of being separated from the holder and sold or transferred individually, and does not give the holder a right to receive a fixed or determinable number of units of currency. The Committee concluded that where cryptocurrencies are held for sale in the ordinary course of business, then IAS 2 applies, otherwise they should be accounted for under IAS 38.

The Committee determined that cryptocurrencies are not financial assets as they are not cash or equity instruments of another entity. They also do not give rise to a contractual right for the holder, and they are not a contract that will or may be settled in the holder's own equity instruments.²²

11.6.1‘Software as a Service’ cloud computing arrangements

‘Software as a Service’ (‘SaaS’) cloud computing arrangements are becoming increasingly common. Typically, in these arrangements a customer pays a fee in exchange for a right to access a supplier's application software for a specific period. The software runs on cloud computing infrastructure managed and supplied by the software supplier. The customer then has access to the software as required via the internet or a dedicated line.

The Interpretation Committee considered the accounting for such arrangements by the customer and issued an agenda decision in March 2019. The Committee noted that a customer has a software asset at the commencement of the contract if either the contract contains a lease or an entity otherwise obtains control of software at the contract commencement date.

In determining whether the arrangement contains a lease a customer would consider the requirements of IFRS 16. The Committee observed that a right to receive access to a suppliers’ software running on the supplier's cloud infrastructure does not in itself result in the existence of a lease. This is because a right to receive future access does not give the customer any decision-making rights about how and for what purpose the software is used.

The Committee also observed that a right to receive future access to the supplier's software does not, at the contract commencement date, give the customer the power to obtain future economic benefits flowing from the software itself and to restrict others’ access to those benefits. On that basis the right to future access to the software would not give rise to the recognition of an intangible asset at the contract commencement date. Therefore, a contract that only gives the customer the right to access the supplier's application software in the future is a service contract. However, a customer who pays before receiving the service would recognise an asset for the prepayment.

The Committee concluded that the requirements in existing IFRS Standards provide an adequate basis for an entity to account for these arrangements and decided not to add the matter to its standard-setting agenda.²³

11.6.2 Cloud computing implementation costs

Entities typically incur implementation costs in moving from on-site software to cloud-based applications. These implementation costs include preliminary research and feasibility assessments in determining the most appropriate cloud-based solution, data transfer and conversion costs, and staff training costs.

In determining whether these costs should be expensed or capitalised, entities should look to the existing requirements of IAS 38.

The costs associated with preliminary research and feasibility assessments will normally be expensed as incurred (see 6.2.1 above). Data transfer and conversion costs are generally expensed as they are examples of start-up costs (see 4.3 above). An exception to this may be if the costs incurred qualify for recognition as intangible assets in their own right (e.g. the development or purchase of software used in the data transfer or conversion process). Finally, staff training costs are expensed as incurred under IAS 38 (see 4.3 above). [IAS 38.69].