Nature of Intangible Assets

Identifiable intangible assets include patents, copyrights, licences, customer lists, brand names, import quotas, computer software, marketing rights and specialised know‐how. These items have in common the fact that there is little or no tangible substance to them, and they have a useful life of greater than one year. In many but not all cases, the asset is separable; that is, it could be sold or otherwise disposed of without simultaneously disposing of or diminishing the value of other assets held.

Intangible assets are, by definition, assets that have no physical substance. However, there may be instances where intangibles also have some physical form. For example:

1. There may be tangible evidence of an asset's existence, such as a certificate indicating that a patent had been granted, but this does not constitute the asset itself;
2. Some intangible assets may be contained in or on a physical substance such as a USB stick or DVD (in the case of computer software); and
3. Identifiable assets that result from research and development activities are intangible assets because the tangible prototype or model is secondary to the knowledge that is the primary outcome of those activities.

In the case of assets that have both tangible and intangible elements, there may be uncertainty about whether classification should be as tangible or intangible assets. For example, the IASB has deliberately not specified whether mineral exploration and evaluation assets should be considered as tangible or intangible, but rather in IFRS 6 (see Chapter 32) has established a requirement that a reporting entity consistently account for exploration and evaluation assets as either tangible or intangible.

As a rule of thumb, an asset that has both tangible and intangible elements should be classified as an intangible asset or a tangible asset based on the relative dominance or comparative significance of the tangible or the intangible components of the asset. For instance, computer software that is not an integral part of the related hardware equipment is treated as software (i.e., as an intangible asset). Conversely, certain computer software, such as the operating system, that is essential and an integral part of a computer, is treated as part of the hardware equipment (i.e., as property, plant and equipment as opposed to an intangible asset).

Recognition Criteria

Identifiable intangible assets have much in common with tangible long‐lived assets (property, plant and equipment), and the accounting for them is accordingly very similar. Recognition depends on whether the Framework definition of an asset is satisfied. The key criteria for determining whether intangible assets are to be recognised are:

1. Whether the intangible asset can be identified separately from other aspects of the business entity;
2. Whether the use of the intangible asset is controlled by the entity as a result of its past actions and events;
3. Whether future economic benefits can be expected to flow to the entity; and
4. Whether the cost of the asset can be measured reliably.

Measurement of the Cost of Intangibles

The conditions under which the intangible asset has been acquired will determine the measurement of its cost.

The cost of an intangible asset acquired separately is determined in a manner largely analogous to that for tangible long‐lived assets as described in Chapter 9. Thus, the cost of a separately acquired intangible asset includes:

1. Its purchase price, including legal and brokerage fees, import duties and non‐refundable purchase taxes, after deducting trade discounts and rebates; and
2. Any directly attributable costs incurred to prepare the asset for its intended use. Directly attributable costs would include costs of employee benefits arising directly from bringing the asset to its intended use, professional fees incurred in bringing the asset to its working condition, and costs of testing whether the asset is functioning properly.

As with tangible assets, capitalisation of costs ceases at the point when the intangible asset is ready to be placed in service in the manner intended by management. Any costs incurred in using or redeploying intangible assets are accordingly excluded from the cost of those assets. Thus, any costs incurred while the asset is capable of being used in the manner intended by management, but while it has yet to be placed into service, would be expensed, not capitalised. Similarly, initial operating losses, such as those incurred while demand for the asset's productive outputs is being developed, cannot be capitalised. Examples of expenditures that are not part of the cost of an intangible asset include costs of introducing a new product or service, costs of conducting business in a new location or with a new class of customers, and administration and other general overhead costs. On the other hand, further costs incurred for the purpose of improving the asset's level of performance would qualify for capitalisation. In all these particulars, guidance under IAS 38 mirrors that under IAS 16.

According to IAS 38, the cost of an intangible asset acquired as part of a business combination is its fair value as at the date of acquisition. If the intangible asset is separable or arises from contractual or other legal rights sufficient information exists to measure reliably the fair value of the asset. If the intangible asset has no active market, then fair value is determined based on the amount that the entity would have paid for the asset in an arm's‐length transaction at the date of acquisition. If the fair value of an intangible asset acquired as part of a business combination cannot be measured reliably, then that asset is not separately recognised, but rather is included in goodwill. This fallback position is to be used only when direct identification of the intangible asset's value cannot be accomplished.

If payment for an intangible asset is deferred beyond normal credit terms, its cost is the cash price equivalent. The difference between this amount and the total payments is recognised as financing cost over the period of credit unless it is capitalised in accordance with IAS 23 (see Chapter 10).

Internally Generated Intangibles other than Goodwill

In many instances, intangibles are generated internally by an entity, rather than being acquired via a business combination or some other acquisitions. Because of the nature of intangibles, the measurement of the cost (i.e., the initial amounts at which these could be recognised as assets) is constrained by the fact that many of the costs have already been expensed by the time the entity is able to determine that an asset has indeed been created. For example, when launching a new magazine, an entity may have to operate the magazine at a loss in its early years, expensing large promotional and other costs which all flow through the income statement before such time as the magazine can be determined to have become established, and have branding that might be taken to represent an intangible asset. At the point the brand is determined to be an asset, all the costs of creating it have already been expensed, and no retrospective adjustment is allowed to create a recognised asset.

IAS 38 provides that internally generated intangible assets are to be capitalised and amortised over the projected period of economic utility, provided that certain criteria are met.

Expenditures pertaining to the creation of intangible assets are to be classified alternatively as being indicative of, or analogous to, either research activity or development activity.

Costs incurred in the research phase are expensed immediately; and

If costs incurred in the development phase meet the recognition criteria for an intangible asset, such costs should be capitalised. However, once costs have been expensed during the development phase, they cannot later be capitalised.

In practice, distinguishing research‐like expenditures from development‐like expenditures might not be easily accomplished. This would be especially true in the case of intangibles for which the measurement of economic benefits cannot be accomplished in anything approximating a direct manner. Assets such as brand names, mastheads and customer lists can prove quite resistant to such direct observation of value (although in many industries there are rules of thumb, such as the notion that a customer list in the securities brokerage business is worth $1,500 per name, implying the amount of promotional costs a purchaser of a customer list could avoid incurring itself).

Thus, entities may incur certain expenditures to enhance brand names, such as engaging in image‐advertising campaigns, but these costs will also have ancillary benefits, such as promoting specific products that are being sold currently, and possibly even enhancing employee morale and performance. While it may be argued that the expenditures create or add to an intangible asset, as a practical matter it would be difficult to determine what portion of the expenditures relate to which achievement, and to ascertain how much, if any, of the cost may be capitalised as part of brand names. Thus, it is considered to be unlikely that threshold criteria for recognition can be met in such a case. For this reason, IAS 38 has specifically disallowed the capitalisation of internally generated assets like brands, mastheads, publishing titles, customer lists and items similar in substance to these.

Apart from the prohibited items, however, IAS 38 permits recognition of internally created intangible assets to the extent the expenditures can be attributed to the development phase of a research and development programme. Thus, internally developed patents, copyrights, trademarks, franchises and other assets will be recognised at the cost of creation, exclusive of costs which would be analogous to research, as further explained in the following paragraphs. The Basis for Conclusions to IAS 38 notes that “some view these requirements and guidance as being too restrictive and arbitrary” and that they reflect the standard setter's interpretation of the recognition criteria but agree that they reflect the fact that it is difficult in practice to determine whether there is an internally generated asset separate from internally generated goodwill.

When an internally generated intangible asset meets the recognition criteria, the cost is determined using the same principles as for an acquired tangible asset. Thus, cost comprises all costs directly attributable to creating, producing and preparing the asset for its intended use. IAS 38 closely mirrors IAS 16 with regard to elements of cost that may be considered as part of the asset, and the need to recognise the cash equivalent price when the acquisition transaction provides for deferred payment terms. As with self‐constructed tangible assets, elements of profit must be eliminated from amounts capitalised, but incremental administrative and other overhead costs can be allocated to the intangible and included in the asset's cost provided these can be directly attributed to preparing the asset for use. Initial operating losses, on the other hand, cannot be deferred by being added to the cost of the intangible, but rather must be expensed as incurred.

The standard takes this view based on the premise that an entity cannot demonstrate that the expenditure incurred in the research phase will generate probable future economic benefits, and consequently that an intangible asset has been created (therefore, such expenditure should be expensed). Examples of research activities include activities aimed at obtaining new knowledge; the search for, evaluation and final selection of applications of research findings; and the search for and formulation of alternatives for new and improved systems, etc.

The standard recognises that the development stage is further advanced towards ultimate commercial exploitation of the product or service being created than is the research stage. It acknowledges that an entity can possibly, in certain cases, identify an intangible asset and demonstrate that this asset will probably generate future economic benefits for the organisation. Accordingly, IAS 38 allows recognition of an intangible asset during the development phase, provided the entity can demonstrate all of the following:

1. 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 either use it or sell it;
3. Its ability to use or sell the intangible asset;
4. The mechanism by which the intangible will generate probable future economic benefits;
5. The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
6. The entity's ability to reliably measure the expenditure attributable to the intangible asset during its development.

Examples of development activities include: the design and testing of preproduction prototypes or models; design of tools, jigs, moulds and dies, including new technology; design, construction and operation of a pilot plant which is not otherwise commercially feasible; and design and testing of a preferred alternative for new and improved devices, products, processes, systems or services.

Costs Not Satisfying the IAS 38 Recognition Criteria

The standard has specifically provided that expenditures incurred for non‐financial intangible assets should be recognised as an expense unless:

1. It relates to an intangible asset dealt with in another IFRS;
2. The cost forms part of the cost of an intangible asset that meets the recognition criteria prescribed by IAS 38; or
3. It is acquired in a business combination and cannot be recognised as an identifiable intangible asset. In this case, this expenditure should form part of the amount attributable to goodwill as at the date of acquisition.

As a consequence of applying the above criteria, the following costs are expensed as they are incurred:

1. Research costs;
2. Pre‐opening costs for a new facility or business, and plant start‐up costs incurred during a period prior to full‐scale production or operation, unless these costs are capitalised as part of the cost of an item of property, plant and equipment;
3. Organisation costs such as legal and secretarial costs, which are typically incurred in establishing a legal entity;
4. Training costs involved in operating a business or a product line;
5. Advertising and related costs;
6. Relocation, restructuring and other costs involved in organising a business or product line;
7. Customer lists, brands, mastheads and publishing titles that are internally generated.

In some country's entities have previously been allowed to defer and amortise set‐up costs and pre‐operating costs on the premise that benefits from them flow to the entity over future periods as well. IAS 38 does not condone this view.

The criteria for recognition of intangible assets as provided in IAS 38 are rather stringent, and many entities will find that expenditures either to acquire or to develop intangible assets will fail the test for capitalisation. In such instances, all these costs must be expensed as period costs when incurred. Furthermore, once expensed, these costs cannot be resurrected and capitalised in a later period, even if the conditions for such treatment are later met. This is not meant, however, to preclude correction of an error made in an earlier period if the conditions for capitalisation were met but interpreted incorrectly by the reporting entity at that time.

Improvements to IFRS published by the IASB in May 2008 included two amendments to IAS 38. One improvement clarifies that certain expenditures are recognised as an expense when the entity either has access to the goods or has received the services. Examples of expenditures that are recognised as an expense when incurred include research costs, expenditure on start‐up activities, training activities, advertising and promotional activities, and on relocating or reorganising part or all of an entity. Advertising and promotional activities now specifically include mail‐order catalogues. Logically, these expenditures have difficult‐to‐measure future economic benefits (e.g., advertising), or are not controlled by the reporting entity (e.g., training), and therefore do not meet the threshold conditions for recognition as assets. For some entities, this amendment may result in expenditures being recognised as an expense earlier than in the past.

In addition, a second improvement to IAS 38 removed the reference to the use of anything other than the straight‐line method of amortisation being rare, and makes it clear that entities may use the unit of production method of amortisation even if it results in a lower amount of accumulated amortisation than does the straight‐line method. This would specifically apply to some service concession arrangements, where an intangible asset for the right to charge users for public service is created. Consequently, entities will have more flexibility as to the method of amortisation of intangible assets and will need to evaluate a pattern of future benefits arising from those assets when selecting the method.

Subsequently Incurred Costs

Under the provisions of IAS 38, the capitalisation of any subsequent costs incurred on recognised intangible assets is subject to the same recognition criteria as initial costs. In practice, capitalisation of subsequent expenditure is often difficult to justify. This is because the nature of an intangible asset is such that, in many cases, it is not possible to determine whether subsequent costs are likely to enhance the specific economic benefits that will flow to the entity from those assets. Provided they meet the recognition criteria for intangible assets, any subsequent expenditure on an intangible after its purchase or its completion should be capitalised along with its cost. The following example should help to illustrate this point better.

Measurement Subsequent to Initial Recognition

IAS 38 acknowledges the validity of two alternative measurement bases: the cost model and the revaluation model. This is entirely comparable to what is prescribed under IAS 16 relative to property, plant and equipment.

Amortisation Period

IAS 38 requires the entity to determine whether an intangible has a finite or indefinite useful life. An indefinite future life means that there is no foreseeable limit on the period during which the asset is expected to generate net cash inflows. For the entity, the standard lists a number of factors to be taken into account:

1. The expected usage by the entity;
2. Typical product life cycles for the asset;
3. Technical, technological, commercial or other types of obsolescence;
4. The stability of the industry in which the asset operates;
5. Expected actions by competitors, or potential competitors;
6. The level of maintenance expenditures required to generate the future economic benefits, and the company'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 lease expiry dates);
8. Whether the useful life of the asset is dependent on the useful life of other assets of the company.

Assets having a finite useful life must be amortised over that useful life, and this may be done in any of the usual ways (pro rata over time, over units of production, etc.). If control over the future economic benefits from an intangible asset is achieved through legal rights for a finite period, then the useful life of the intangible asset should not exceed the period of legal rights, unless the legal rights are renewable, and the renewal is a virtual certainty. Thus, as a practical matter, the shorter legal life will set the upper limit for an amortisation period in most cases.

The amortisation method used should reflect the pattern in which the economic benefits of the asset are consumed by the entity. Amortisation should commence when the asset is available for use and the amortisation charge for each period should be recognised as an expense unless it is included in the carrying amount of another asset (e.g., inventory). Intangible assets may be amortised by the same systematic methods that are used to depreciate property, plant and equipment. Thus, IAS 38 permits straight‐line, diminishing balance, and units of production methods. The method used should reflect the expected pattern of the consumption of expected future economic benefits.

IAS 38 was amended effective January 1, 2016 to confirm that depreciation methods based on revenues that are generated by activities, including the use of an asset, are not appropriate, as revenue generally reflects factors other than the consumption of the economic benefits inherent within an asset. There is a rebuttable presumption that amortisation methods based on generated revenues are inappropriate. Such revenues are not only dependent on the use of the intangible asset but also dependent on other factors such as the activity itself, other inputs and processes, selling activities and changes in sales volumes and prices.

Basing amortisation on revenues is only allowed in two very limited circumstances:

1. In the situation that intangible fixed assets are a measure of revenue, i.e., when a limit is made in a contract referring to time or units.

   Example: Company ABC is allowed for six months to extract rubies from a certain designated area due to specific environmental legislation. In this situation it is determined in a contract that there is a limited period in which the company may extract the rubies and as a result, intangible fixed assets may be amortised with revenues as a basis.

2. Or the revenue and the realisation of economic benefits resulting from the intangible fixed asset are highly correlated and as such revenue is not dependent on other factors, inputs and processes or activities.

IAS 38 offers several examples of how useful life of intangibles is to be assessed. These include the following types of assets:

Residual Value

Tangible assets often have a positive residual value before considering the disposal costs because tangible assets can generally be sold, at least for scrap, or possibly can be transferred to another user that has less need for or ability to afford new assets of that type. Intangibles, on the other hand, often have little or no residual worth. Accordingly, IAS 38 requires that a zero residual value be presumed unless an accurate measure of residual value is possible. Thus, the residual value is presumed to be zero unless:

1. There is a commitment by a third party to acquire the asset at the end of its useful life; or
2. There is an active market for that type of intangible asset, and residual value can be measured reliably by reference to that market and it is probable that such a market will exist at the end of the useful life.

IAS 38 specifies that the residual value of an intangible asset is the estimated net amount that the reporting entity currently expects to obtain from disposal of the asset at the end of its useful life, after deducting the estimated costs of disposal, if the asset were of the age and in the condition expected at the end of its estimated useful life. Changes in estimated selling prices or other variables that occur over the expected period of use of the asset are not to be included in the estimated residual value, since this would result in the recognition of projected future holding gains over the life of the asset (via reduced amortisation that would be the consequence of a higher estimated residual value).

Residual value is to be assessed at the end of each reporting period. Any change to the estimated residual, other than that resulting from impairment (accounted for under IAS 36), is to be accounted for prospectively by varying future periodic amortisation. Similarly, any change in amortisation method (e.g., from accelerated to straight‐line), based on an updated understanding of the pattern of future usage and economic benefits to be reaped therefrom, is dealt with as a change in estimate, again to be reflected only through changes in future periodic charges for amortisation.

Impairment Losses

Where an asset is determined to have an indefinite useful life, the entity must conduct impairment tests annually, as well as whenever there is an indication that the intangible may be impaired. Furthermore, the presumption that the asset has an indefinite life must also be reviewed.

The impairment of intangible assets other than goodwill (such as patents, copyrights, trade names, customer lists and franchise rights) should be considered in precisely the same way that long‐lived tangible assets are dealt with. The impairment loss under IAS 36 is the amount by which carrying amount exceeds recoverable amount. Carrying amount must be compared to recoverable amount (the greater of fair value less costs to sell or value in use) when there are indications that an impairment may have been suffered. Net selling price is the price of an asset in an active market less disposal costs, and value in use is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal.

IAS 36 permits reversals of impairment losses on assets other than goodwill under defined conditions. The effects of impairment recognitions and reversals will be reflected in profit or loss, if the intangible assets in question are being accounted for in accordance with the cost method.

On the other hand, if the revaluation method of accounting for intangible assets is followed (use of which is possible only if strict criteria are met), impairments will normally be recognised in other comprehensive income to the extent that revaluation surplus exists, and only to the extent that the loss exceeds previously recognised valuation surplus will the impairment loss be reported as a charge in profit or loss. Recoveries are handled consistent with the method by which impairments were reported, in a manner entirely analogous to the explanation in Chapter 9 dealing with impairments of property, plant and equipment.

Unlike other intangible assets that are individually identifiable, goodwill is amorphous and cannot exist, from a financial reporting perspective, apart from the tangible and identifiable intangible assets with which it was acquired and remains associated. Thus, a direct evaluation of the recoverable amount of goodwill is not actually feasible.

Improvements to IFRS issued in 2009 amended the requirements for allocating goodwill to cash‐generating units as described in IAS 36, since the definition of operating segments introduced in IFRS 8 affects the determination of the largest unit permitted for goodwill impairment testing in IAS 36. For the purpose of impairment testing, goodwill acquired in a business combination should, from the acquisition date, be allocated to each of the acquirer's cash‐generating units (or groups of cash‐generating units) that is expected to benefit from synergies resulting from combination, irrespective of whether other assets or liabilities are allocated to this unit (or units).

Each cash‐generating unit should:

1. Represent the lowest level of the entity at which management monitors goodwill (which should be the same as the lowest level of operating segments at which the chief operating decision maker regularly reviews operating results in accordance with IFRS 8); and
2. Not be larger than the operating segment, as defined in IFRS 8, before any permitted aggregation.

Derecognition of Intangible Assets

An intangible asset should be derecognised (1) on disposal, or (2) when no future economic benefits are expected from its use or disposal. With regard to questions of accounting for the disposals of assets, the guidance of IAS 38 is consistent with that of IAS 16. A gain or loss arising from the derecognition of an intangible asset, determined as the difference between its carrying amount and the net disposal proceeds, is recognised in profit or loss (unless IAS 17 requires otherwise on a sale and leaseback) when the asset is derecognised. The 2004 amendment to IAS 38 observes that a disposal of an intangible asset may be effected either by a sale of the asset or by entering into a finance lease. The determination of the date of disposal of the intangible asset is made by applying the criteria in IAS 18 for recognising revenue from the sale of goods, or IAS 17 in the case of disposal by a sale and leaseback. As for other similar transactions, the consideration receivable on disposal of an intangible asset is to be recognised initially at fair value. If payment for such an intangible asset is deferred, the consideration received is recognised initially at the cash price equivalent, with any difference between the nominal amount of the consideration and the cash price equivalent to be recognised as interest revenue under IAS 18, using the effective yield method.

Website Development and Operating Costs

Websites have become integral to doing business and may be designed either for external or internal access. Those designed for external access are developed and maintained for the purposes of promotion and advertising of an entity's products and services to their potential consumers. On the other hand, those developed for internal access may be used for displaying company policies and storing customer details.

With substantial costs being incurred by many entities for website development and maintenance, the need for accounting guidance became evident. SIC 32, issued in 2002, concluded that such costs represent an internally generated intangible asset that is subject to the requirements of IAS 38, and that such costs should be recognised if, and only if, an entity can satisfy the requirements set forth in IAS 38. Therefore, website costs have been likened to “development phase” (as opposed to “research phase”) costs.

Thus, the stringent qualifying conditions applicable to the development phase, such as “ability to generate future economic benefits,” have to be met if such costs are to be recognised as an intangible asset. If an entity is not able to demonstrate how a website developed solely or primarily for promoting and advertising its own products and services will generate probable future economic benefits, all expenditure on developing such a website should be recognised as an expense when incurred.

Any internal expenditure on development and operation of the website should be accounted for in accordance with IAS 38. Comprehensive additional guidance is provided in the Appendix to SIC 32 and is summarised below:

1. Planning stage expenditures, such as undertaking feasibility studies, defining hardware and software specifications, evaluating alternative products and suppliers, and selecting preferences, should be expensed;
2. Application and infrastructure development costs pertaining to acquisition of tangible assets, such as purchasing and developing hardware, should be dealt with in accordance with IAS 16;
3. Other application and infrastructure development costs, such as obtaining a domain name, developing operating software, developing code for the application, installing developed applications on the web server and stress testing, should be expensed when incurred unless the conditions prescribed by IAS 38 are met;
4. Graphical design development costs, such as designing the appearance of Web pages, should be expensed when incurred unless recognition criteria prescribed by IAS 38 are met;
5. Content development costs, such as expenses incurred for creating, purchasing, preparing and uploading information onto the website, to the extent that these costs are incurred to advertise and promote an entity's own products or services, should be expensed immediately, consistent with how other advertising and related costs are to be accounted for under IFRS. Thus, these costs are not deferred, even until first displayed on the website, but are expensed when incurred;
6. Operating costs, such as updating graphics and revising content, adding new functions, registering the website with search engines, backing up data, reviewing security access and analysing usage of the website should be expensed when incurred, unless in rare circumstances these costs meet the criteria prescribed in IAS 38, in which case such expenditure is capitalised as a cost of the website; and
7. Other costs, such as selling and administrative overhead (excluding expenditure which can be directly attributed to preparation of website for use), initial operating losses and inefficiencies incurred before the website achieves its planned operating status, and training costs of employees to operate the website, should all be expensed as incurred as required under IFRS.