IAS 38 INTANGIBLE ASSETS

1 SCOPE OF IAS 38

IAS 38 prescribes the accounting treatment for intangible assets. Intangible assets subject to the scope of another standard are excluded from the scope of IAS 38, e.g. (IAS 38.2–8.3):

  • Intangible assets that are held by an entity for sale in the ordinary course of business (IAS 2 and IAS 11).
  • Intangible assets subject to leases within the scope of IAS 17.
  • Goodwill acquired in a business combination (IFRS 3).
  • Non-current intangible assets classified as “held for sale” in accordance with IFRS 5.

In determining whether an asset that incorporates both intangible and tangible elements should be treated as property, plant, and equipment according to IAS 16 or as an intangible asset according to IAS 38, it is necessary to assess which element is more significant. For example, software for a computer-controlled machine tool that cannot operate without that specific software is considered an integral part of the related machine. The software is treated as part of the machine tool (i.e. as property, plant, and equipment) if the physical and not the intangible component is more significant. By contrast, when a physical and an intangible asset do not constitute an integral unit (e.g. application software for a computer) they are treated as two different assets (IAS 38.4).

Rights under licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents, and copyrights are excluded from the scope of IAS 17 and are included within the scope of IAS 38 (IAS 38.6 and IAS 17.2).

2 THE TERM “INTANGIBLE ASSET”

An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity (IAS 38.8 and F49a). An intangible asset is an identifiable non-monetary asset of the entity without physical substance. Monetary assets comprise money held and assets to be received in fixed or determinable amounts of money (IAS 38.8).

In practice, a large number of intangible items exists (e.g. software, patents, and customer loyalty). However, not all of them are intangible assets. According to the definitions above, an intangible item meets the definition of an intangible asset only if all of the following three criteria are met (IAS 38.8–38.17):

  • Future economic benefits: It is expected that future economic benefits will flow to the entity from the item (IAS 38.8). The future economic benefits may include revenue from the sale of products or services or other benefits (e.g. cost savings) resulting from the use of the item by the entity (IAS 38.17).
  • Control: This criterion is met if the entity has the power to obtain the future economic benefits flowing from the underlying item and to restrict the access of others to these benefits. Normally, control stems from legally enforceable rights, although such rights are not always a prerequisite (IAS 38.13–38.16).
  • Identifiability: This criterion, which refers to the discriminability from goodwill, is – along the lines of IFRS 3 (IFRS 3.Appendix A) – met if one of the following conditions is met (IAS 38.11–38.12):
    • The item is separable, i.e. 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 (criterion “separability”).
    • The item 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 (contractual-legal criterion).

3 RECOGNITION AND INITIAL MEASUREMENT

3.1 Introduction

The question of whether an intangible item is recognized as an intangible asset in the statement of financial position is answered in two steps (IAS 38.18):

1. The item must meet the definition of an intangible asset, i.e. it must meet the criteria described in Section 2 (IAS 38.8–38.17).
2. If the item has met the definition of an intangible asset, the intangible asset must additionally meet the recognition criteria, i.e. the inflow of future economic benefits has to be probable and it must be possible to measure the cost of the intangible asset reliably (IAS 38.21–38.23).

This procedure not only applies to the costs incurred initially to acquire or internally generate an intangible item, but also to those incurred subsequently to add to, replace part of, or service an intangible asset (IAS 38.18). However, in practice most subsequent expenditures for intangible assets will not meet the criteria for recognition in the statement of financial position (IAS 38.20).

An intangible asset is measured initially at cost (IAS 38.24).

3.2 Separate Acquisition of Intangible Assets

For separately acquired intangible assets, it is always presumed that the probability recognition criteria (IAS 38.21a) are met (IAS 38.25). Moreover, the cost of a separately acquired intangible asset can usually be measured reliably (IAS 38.26). The costs also include any directly attributable cost of preparing the asset for its intended use (IAS 38.27–38.32).

3.3 Acquisition of Intangible Assets as Part of a Business Combination

IAS 38.33–38.43 contain rules with respect to the acquisition of intangible assets as part of a business combination in addition to IFRS 3. These rules are in line with those of IFRS 3.1

3.4 Internally Generated Intangible Assets

In addition to the general requirements for the recognition and initial measurement of an intangible item, IAS 38 contains further requirements and guidance for internally generated intangible items (IAS 38.51).

First it is necessary to distinguish between research and development (IAS 38.8):

  • Research is the original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
  • Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, processes, products, systems or services before the start of commercial production or use.

The following are examples of research activities (IAS 38.56):

  • Activities aimed at obtaining new knowledge.
  • The search for alternatives for materials, devices, processes, products, systems or services.

The following are examples of development activities (IAS 38.59):

  • The design, construction, and testing of pre-use or pre-production prototypes and models.
  • The design of tools and dies involving new technology.
  • The design, construction, and operation of a pilot plant that is not of a scale economically feasible for commercial production.

The internal generation of intangible assets is divided into two phases (IAS 38.8 and 38.52):

  • Research phase
  • Development phase

Although the terms “research” and “development” are defined in the standard, the terms “research phase” and “development phase” have a broader meaning (IAS 38.52). They are not restricted to the generation of new technology. Instead, these terms are used in a broader context, whereby the research phase is the early, conceptual phase of the generation of an intangible asset, and the development phase is the advanced phase, near to realization. Consequently, even the creation of a website consists of a research phase and a development phase (SIC 32) as well as the generation of human capital (e.g. competitive athletes and artists).

Sometimes an entity cannot distinguish between the research phase and the development phase of an internal project to create an intangible asset. In this case, the expenditure on that project is treated as if it were only incurred in the research phase (IAS 38.53).

Expenditure on research (or on the research phase of an internal project) is recognized as an expense when it is incurred (IAS 38.54).

An intangible asset arising from development (or from the development phase of an internal project) is recognized in the statement of financial position, if the entity can demonstrate all of the following (IAS 38.57):

  • The technical feasibility of completing the asset so that it will be available for sale or use.
  • Its intention to complete the asset and sell or use it.
  • Its ability to sell or use the asset.
  • How the asset will generate probable future economic benefits. Among others, the entity must be able to demonstrate the existence of a market for the output of the asset or the asset itself or, if it is to be used internally, the usefulness of the asset. The economic benefits are assessed according to the principles in IAS 36. If the intangible asset will generate economic benefits only in combination with other assets, the entity applies the concept of cash-generating units in IAS 36 (IAS 38.60).
  • The availability of adequate technical, financial, and other resources to complete the development and to use or sell the asset (demonstrated for example by a business plan or a lender's indication of willingness to fund the plan – IAS 38.61).
  • Its ability to reliably measure the expenditure attributable to the asset during its development.

The capitalization of development costs, i.e. the interpretation and application of the criteria above, is an area in which discretion is exercised. How the discretion is exercised depends on the profit situation of the entity and of the industry in which it operates. Huge differences in interpreting the criteria can be observed internationally between the pharmaceutical industry and the automotive industry.

An intangible asset is measured initially at cost (IAS 38.24). For this purpose, cost is the sum of expenditure incurred from the date when the intangible asset first meets the recognition criteria in IAS 38.21–38.22 and 38.57 (see above). The standard prohibits capitalization of expenditure initially recognized as an expense (IAS 38.65 and 38.71).

The cost of an internally generated intangible asset comprises all directly attributable costs that are necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management (IAS 38.66).

Goodwill resulting from a business combination has to be recognized in the consolidated statement of financial position.2 However, internally generated goodwill must not be recognized in the statement of financial position. Internally generated goodwill results from expenditures incurred to generate future economic benefits that do not result in the creation of an intangible asset that meets the recognition criteria of IAS 38 (IAS 38.48–38.50).

Irrespective of the criteria described in this chapter, recognition of the following internally generated items as intangible assets in the statement of financial position is always prohibited (IAS 38.63–38.64):

  • Brands
  • Mastheads
  • Publishing titles
  • Customer lists
  • Items similar in substance

Criteria for the recognition of borrowing costs as an element of the cost of an internally generated intangible asset are specified in IAS 23 (IAS 38.66).

4 FURTHER PROHIBITIONS OF CAPITALIZATION

Further examples of expenditure that is recognized as an expense when it is incurred include (IAS 38.69):

  • Expenditure on start-up activities (i.e. start-up costs), unless this expenditure is included in the cost of property, plant, and equipment (IAS 16). Start-up costs may consist of:
  • establishment costs such as secretarial and legal costs incurred in establishing a legal entity,
  • expenditure to open a new facility or business (i.e. pre-opening costs), or
  • expenditures for starting new operations or launching new products or processes (i.e. pre-operating costs).
  • Expenditure on training activities.
  • Expenditure on advertising and promotional activities.
  • Expenditure on relocating or reorganizing all or part of an entity.

Expenditure on an intangible item that was initially recognized as an expense must not be capitalized (i.e. must not be recognized as part of the cost of an intangible asset) at a later date (IAS 38.71).

5 MEASUREMENT AFTER RECOGNITION

5.1 Cost Model and Revaluation Model

After recognition, intangible assets are measured either according to the cost model or according to the revaluation model (IAS 38.72).

If an intangible asset is accounted for using the cost model, it is measured at its cost less any accumulated amortization and less accumulated impairment losses (IAS 38.74).

The main features of the revaluation model for intangible assets (IAS 38.75–38.87) are generally consistent with those of property, plant, and equipment (IAS 16.31–16.42).3

In contrast to IAS 16 for the purpose of revaluations according to IAS 38, fair value has to be determined by reference to an active market (IAS 38.75). An active market is a market that meets all the following criteria (IAS 38.8):

  • The items traded in the market are homogeneous.
  • Willing sellers and buyers can normally be found at any time.
  • Prices are available to the public.

It is uncommon for an active market to exist for an intangible asset, although this may happen. For example, in some countries, an active market may exist for freely transferable taxi licenses, fishing licenses or production quotas. However, an active market cannot exist for brands, music and film publishing rights, newspaper mastheads, patents or trademarks because each of such intangible assets is unique (IAS 38.78).

If the revaluation model is applied to an intangible asset, all the other assets in its class also have to be accounted for according to the revaluation model, unless there is no active market for those assets. However, it is possible to apply the revaluation model to a particular class of intangible assets while other classes are accounted for using the cost model (IAS 38.72 and 38.81). A class is a grouping of intangible assets of a similar nature and use in an entity's operations (IAS 38.73 and 38.119).

In many countries, revaluations of intangible assets are rare or do not occur at all.4

5.2 Intangible Assets With Finite Useful Lives

Intangible assets with finite useful lives5 are amortized (IAS 38.89). In determining the useful life of an intangible asset, many factors are considered and the entity exercises discretion (IAS 38.90). Software and many other intangible assets are susceptible to technological obsolescence. Thus, it is likely that their useful lives are short. Uncertainty justifies estimating useful lives on a prudent basis, but does not justify choosing useful lives that are unrealistically short (IAS 38.92–38.93).

The useful life of an intangible asset that arises from contractual or other legal rights must not exceed the period of these rights, but may be shorter depending on the period over which the entity expects to use the asset. If these rights are conveyed for a limited term that can be renewed, the useful life includes the renewal period(s) only if there is evidence to support renewal by the entity without significant cost. The useful life of a reacquired right recognized as an intangible asset in a business combination is the remaining contractual period of the contract in which the right was granted and does not include renewal periods (IAS 38.94–38.96, IFRS 3.55, and 3.B35).

The depreciable amount (i.e. the cost or other amount substituted for cost less residual value – IAS 38.8) of an intangible asset with a finite useful life is allocated on a systematic basis over its useful life (IAS 38.97). In the case of an intangible asset with a finite useful life, residual value is normally zero (IAS 38.100–38.101).

Amortization of an intangible asset begins when it is available for use, i.e. when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management (IAS 38.97).

Amortization of an intangible asset ceases at the earlier of the following dates (IAS 38.97):

  • Date at which the asset is classified as “held for sale” (or included in a disposal group that is classified as “held for sale”) according to IFRS 5.
  • Date at which the asset is derecognized.

The amortization method used has to reflect the pattern in which the future economic benefits of the intangible asset are expected to be consumed by the entity. The amortization method is applied consistently from period to period, unless there is a change in the expected pattern. If the pattern cannot be determined reliably, the straight-line method has to be applied (IAS 38.97–38.98).

Amortization is recognized in profit or loss unless IAS 38 or another Standard permits or requires it to be included in the carrying amount of another asset (IAS 38.97 and 38.99).

At least at the end of each financial year, the amortization period and the amortization method for an intangible asset with a finite useful life have to be reviewed. If the expected useful life is different from previous estimates, the amortization period has to be changed accordingly. If there has been a change in the expected pattern of consumption of the future economic benefits embodied in the intangible asset, the amortization method has to be changed to reflect the changed pattern. These changes are treated as changes in accounting estimates according to IAS 8 (IAS 38.104–38.106).

5.3 Intangible Assets With Indefinite Useful Lives

The useful life of an intangible asset is indefinite when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity (IAS 38.88). The term “indefinite” does not mean “infinite” (IAS 38.91).

Rights which are obtained only for a limited term but can be renewed at a low cost may have an indefinite life. A typical example is a brand protected by law only for 10 years but with an option to renew the protection several times for another 10 years without significant cost.

An intangible asset with an indefinite useful life is not amortized (IAS 38.89 and 38.107). However, it is necessary to test such an asset for impairment by comparing its recoverable amount with its carrying amount annually, i.e. even if there is no indication of impairment. The same applies to intangible assets not yet available for use (IAS 38.108 and IAS 36.9–36.10).

In the case of an intangible asset that is not being amortized, its useful life has to be reviewed each period to determine whether it is still appropriate to assume that the useful life of the asset is indefinite. Reassessing the useful life as finite rather than indefinite is an indicator of impairment. Therefore, the asset is tested for impairment by comparing its recoverable amount with its carrying amount (IAS 38.109–38.110).

5.4 Impairment

The issue of impairment is dealt with in the chapter on IAS 36 in this book (IAS 38.111).

6 DERECOGNITION

An intangible asset is derecognized on disposal (e.g. by sale or by entering into a finance lease) or when no future economic benefits are expected from its use or disposal. The gain or loss arising from derecognition (i.e. the difference between the net disposal proceeds, if any, and the carrying amount of the asset) is recognized in profit or loss when the asset is derecognized (unless IAS 17 requires otherwise on a sale and leaseback6). Gains must not be classified as revenue (IAS 38.112–38.114).

According to the recognition principle (IAS 38.21)7 if an entity recognizes the cost of a replacement for part of an intangible asset in the carrying amount of the asset, then it derecognizes the carrying amount of the replaced part (IAS 38.115).

7 EXAMPLES WITH SOLUTIONS

Reference to another chapter

With regard to the revaluation model, we refer to the chapter on IAS 16 (Examples 6 and 7).

Example 1
Scope of IAS 38
Case (a): Entity E acquired a computer-controlled machine for production purposes together with software. Without the software the machine would not be able to operate. The tangible element (i.e. the machine) is more significant than the intangible element (i.e. the software).
Case (b): E has produced a new computer game. E sells this game to its customers in the ordinary course of business.
Case (c): E created a software program that is used by E's employees for handling E's accounting.
Required
Assess which standard has to be applied by E to the items described above.
Hints for solution
In particular Section 1.
Solution
Case (a): The software is an integral part of the machine because the machine would not be able to operate without the software. Since the tangible element is more significant than the intangible element, the machine (including the software) is treated as property, plant, and equipment according to IAS 16 (IAS 38.4).
Case (b): The computer game is held for sale in the ordinary course of business. Consequently IAS 2 is applicable instead of IAS 38 (IAS 38.3a and IAS 2.6).
Case (c): The software is not excluded from the scope of IAS 38. Therefore the rules of IAS 38 for internally generated intangible assets are applied in order to determine which costs have to be capitalized.
Example 2
Is capitalization of the following expenses appropriate?
In 01 entity E incurred the following expenses:
  • Implementation of an advertising campaign
  • Testing of a preproduction prototype
  • Internal generation of a brand
  • Search for alternatives for a production process
Required
Assess if these expenses have to be capitalized.
Hints for solution
In particular Sections 3.4 and 4.
Solution
Implementation of an advertising campaign These costs are not capitalized, because IAS 38 prohibits the capitalization of expenditure on advertising and promotional activities (IAS 38.69c).
Testing of a pre-production prototype These activities are development activities (IAS 38.59a). The expenses are capitalized as part of the cost of the internally generated asset (IAS 38.24 and 38.65–38.67) if the entity can demonstrate that all of the criteria in IAS 38.57 are met.
Internal generation of a brand IAS 38.63–38.64 prohibit the recognition of internally generated brands as intangible assets.
Search for alternatives for a production process These activities are research activities (IAS 38.56c). Consequently, the expenditures are not capitalized (IAS 38.54–38.55).
Example 3
Human capital
Entity E, which produces musicals, discovers an exceptionally talented promising singer. E engages her for six years and gives her lessons in singing and acting, free of charge.
Required
Assess the treatment of the singer according to IAS 38.
Hints for solution
In particular Section 3.4.
Solution
Although the terms “research” and “development” are defined in the standard, the terms “research phase” and “development phase” have a broader meaning (IAS 38.52). They are not restricted to the generation of new technology. Instead, these terms are used in a broader context, whereby the research phase is the early, conceptual phase of the generation of an intangible asset and the development phase is the advanced phase, near to realization.
With regard to the promising singer, capitalization of costs starts as soon as the recognition criteria in IAS 38.57 for development costs are met.
Example 4
Research and development costs – pharmaceutical industry
Entity E operates in the pharmaceutical industry. From Jan 01, 01 until May 31, 01, research costs (within the meaning of IAS 38) of CU 15 are incurred for a new research project.
On the basis of the research results, E starts the development (within the meaning of IAS 38) of a new medicine on Jun 01, 01. On Nov 30, 01, E receives market approval for the new medicine. E regards the recognition criteria for development costs (IAS 38.57) as being fulfilled on this date, but not earlier. However, the development phase ends on this date. On Dec 01, 01, commercial production of the medicine begins. From Jun 01, 01 until Nov 30, 01, development costs of CU 27 were incurred. This amount does not include the following costs because E was not sure how to treat them:
Jun 01, 01 until Nov 30, 01 Dec, 01
Administrative costs for the project management 3
Allocation of general administrative costs of E to the project 3
Costs of an advertising campaign for the new medicine 7
Posting status:
All of the expenditure mentioned above was recognized as an expense in 01.
Required
Assess which costs have to be capitalized in E's financial statements as at Dec 31, 01.
Hints for solution
In particular Sections 3.4 and 4.
Solution
The research costs of CU 15 were not capitalized, which is correct (IAS 38.54). The development costs of CU 30 (CU 27 + the administrative costs for the project management of CU 3) are not capitalized because the criteria in IAS 38.57 are met on Nov 30, 01 (i.e. at the end of the development phase) and it is prohibited to capitalize expenditure previously recognized as expense (IAS 38.71). It is also prohibited to capitalize the general administrative costs of E of CU 3 allocated to the project and the costs of the advertising campaign of CU 7 (IAS 38.67a and 38.69c).
Example 5
Research and development costs – software
Programmers of entity E have created new software in 01, which will be used by E for administrative purposes. During the generation of the software there were creative phases of generating new ideas, as well as phases of programming these ideas. There were a large number of such phases that alternated permanently (i.e. generating ideas was followed by programming and programming was followed by a new phase of generating ideas and so on). In 01 research and development costs for the software were CU 20. Due to the characteristics of the process of generating the software described above, it was not possible to separate the research phase from the development phase.
Posting status:
The expenditures of CU 20 were recognized in profit or loss in 01.
Required
Assess how the generation of the software has to be accounted for in E's financial statements as at Dec 31, 01, according to IAS 38.
Hints for solution
In particular Section 3.4.
Solution
E cannot distinguish the research phase from the development phase. This is because there were a large number of research and development phases that alternated permanently (i.e. generating ideas was followed by programming and programming was followed by a new phase of generating ideas and so on). There was not a process that started with the research phase followed by the development phase once the whole research phase was completed.
Therefore, the expenditures of CU 20 are treated as if they were incurred in the research phase in total (IAS 38.53), i.e. they must not be capitalized (IAS 38.54). Consequently, there is no further entry in this example.
Example 6
TV rights
On Nov 10, 01, entity E acquires the TV rights for the coming soccer world championship that will take place in 02 for CU 10. Advertising income associated with the tournament begins to flow in, during Feb, 01. The soccer world championship starts on Jun 01, 02 and ends on Jun 30, 02.
Required
Describe how the TV rights are treated in E's financial statements as at Dec 31 for the years 01 and 02 and prepare any necessary entries.
Hints for solution
In particular Section 5.2.
Solution
The TV rights represent current intangible assets (provided that the acquisition of the TV rights is not regarded as a prepayment). They are treated according to IAS 38, which is not restricted to non-current intangible assets.
Unnumbered Display Equation
Although advertising income associated with the soccer world championship begins to flow in before the tournament, the TV rights are amortized over the period of time in which the tournament takes place. This procedure is justified by the fact that the main part of the income arises during the tournament.
The TV rights are not yet amortized in the financial statements as at Dec 31, 01. However, an intangible asset not yet available for use has to be tested for impairment annually by comparing its carrying amount with its recoverable amount (irrespective of whether there is any indication of impairment). Since the TV rights were initially recognized in 01, they have to be tested for impairment before the end of 01 (IAS 36.10a). In this example it is assumed that the recoverable amount of the TV rights is not below their carrying amount.
During the soccer world championship (June 02), the TV rights are amortized (see above):
Example 7
Customer relationships
Entity E acquires 100% of the shares of entity F. F owns a radio station. F negotiates airtimes directly with advertisers, which are mostly large entities. The advertising contracts are renegotiated every six months. F presumes that the relationships with the advertisers (customer relationships) are long term, and that their length can be estimated approximately.
E recognizes the customer relationships of F in its consolidated statement of financial position.
Required
Describe the measurement after recognition of the customer relationships recognized in E's consolidated statement of financial position.
Hints for solution
In particular Sections 5.2 and 5.3.
Solution
According to IAS 38, the useful life of an intangible asset is indefinite when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity (IAS 38.88). The term “indefinite” does not mean “infinite” (IAS 38.91).
Given the definition of the term “indefinite,” it is unlikely that customer relationships have indefinite useful lives. The reason for this is that the customers may be lost to another entity or that the corporate strategy may change.8
In this example, the customer relationships do not have indefinite useful lives. Consequently, amortization has to be calculated. In determining the useful lives, E exercises discretion (IAS 38.89–38.93).

1 See the chapter on IFRS 3, Section 6.2.

2 See the chapter on IFRS 3, Sections 6.1 and 6.4.

3 See the chapter on IAS 16, Section 4.1.

4 See Christensen/Nikolaev, Does fair value accounting for non-financial assets pass the market test?, working paper no. 09-12; ICAEW, EU implementation of IFRS and the fair value directive, a report for the European Commission, 2007, p. 122–123; and KPMG/von Keitz, The Application of IFRS: Choices in Practice, 2006, p. 11.

5 See Section 5.3 with regard to the distinction from an indefinite useful life.

6 See the chapter on IAS 17, Section 6.

7 See Section 3.1.

8 See PwC, IFRS Manual of Accounting 2008, 15.208.

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