9 INTANGIBLE ASSETS PERSPECTIVE AND ISSUESLong-lived assets are those that will provide economicbenefits to an enterprise for a number of future periods.Accounting standards regarding long-lived assets involvedetermination of the appropriate cost at which to recordthe assets initially, the amount at which to present theassets at subsequent reporting dates, and the appropriatemethod(s) to be used to allocate the cost or other recordedvalues over the periods being benefited. Underinternational accounting standards, while historical cost isthe defined benchmark treatment, revalued amounts mayalso be used for presenting long-lived assets in thestatement of financial position if certain conditions aremet.Long-lived assets are primarily operational in character,and they may be classified into two basic types: tangibleand intangible. Tangible assets have physical substance,while intangible assets either have no physical substance,or have a value that is not conveyed by what physicalsubstance they do have (e.g., the value of computersoftware is not reasonably measured with reference to thecost of the diskettes on which these are contained).The value of an intangible asset is a function of the rightsor privileges that its ownership conveys to the businessenterprise. Intangible assets can be further categorized aseither1. Identifiable, or2. Unidentifiable (i.e., goodwill).Identifiable intangibles include patents, copyrights, brandnames, customer lists, trade names, and other specificrights that typically can be conveyed by an owner without
necessarily also transferring related physical assets.Goodwill, on the other hand, cannot be meaningfullytransferred to a new owner without also selling the otherassets and/or the operations of the business.Research and development costs are also addressed in thischapter. Formerly the subject of a separate internationalstandard (IAS 9), but more recently guided by the standardcovering all intangibles (IAS 38), research costs must beexpensed as incurred, whereas development costs, asdefined and subject to certain limitations, are to beclassified as assets and amortized over the period to bebenefited.The standard on impairment of assets (IAS 36) pertains toboth tangible and intangible long-lived assets. Thischapter will consider the implications of this standard forthe accounting for intangible assets. The matter ofgoodwill, an unidentifiable intangible asset deemed to bethe residual cost of a business combination accounted foras an acquisition, has been addressed by IAS 22 and iscovered in Chapter 11; accounting for all otherintangibles, addressed in IAS 38, is discussed in thischapter.As part of its twin projects considering revisions to thestandards on business combinations and related topics,which are now anticipated to result in new or revisedstandards no earlier than 2004, the IASB has beenreviewing the accounting for intangibles in general. Theobjective is for the accounting for acquired intangibles,including goodwill and in-process research anddevelopment, to be made more consistent with thatprescribed for intangibles acquired by other means orinternally generated by the reporting entity.
With regard to goodwill (discussed in greater detail inChapter 11, Business Combinations and ConsolidatedFinancial Statements, it is expected that an acquirer will berequired, as of the acquisition date to1. Recognize goodwill acquired in a businesscombination as an asset; and2. Initially measure that goodwill at its cost, being theexcess of the cost of the business combination over theacquirer’s interest in the net fair value of the identifiableassets, liabilities, and any contingent liabilities recognized.It is well established that goodwill acquired in a businesscombination represents a payment made by the acquirer inanticipation of future economic benefits from assets thatare not capable of being individually identified andseparately recognized. To the extent that the acquiree’sidentifiable assets, liabilities, or contingent liabilities donot satisfy the criteria for separate recognition at theacquisition date, there is a resulting impact on the amountrecognized as goodwill. This is because goodwill ismeasured as the residual cost of the business combinationafter recognizing the acquiree’s identifiable assets,liabilities, and contingent liabilities.Under the anticipated IAS revisions, subsequent to initialrecognition, the acquiring entity will be required tomeasure goodwill acquired in a business combination atcost less any accumulated impairment losses. This willessentially replicate the approach adopted under USGAAP (SFAS 142), which is a stark departure fromhistorical practice. Rather than being amortized over itsestimated economic life, goodwill acquired in a businesscombination will have to be tested for impairmentsannually, or more frequently if events or changes in
circumstance indicate that it might be impaired, inaccordance with IAS 36.Sources of IASIAS 36, 38 SIC 6, 32DEFINITIONS OF TERMSAmortization. In general, the systematic allocation of thecost of a long-term asset over its useful economic life; theterm is also used specifically to define the allocationprocess for intangible assets.Carrying amount. The amount at which an asset ispresented on the balance sheet, which is its cost (or otherallowable basis), net of any accumulated depreciation andimpairment losses.Cash generating unit. The smallest identifiable group ofassets that generates cash inflows from continuing use,largely independent of the cash inflows associated withother assets or groups of assets.Corporate assets. Assets, excluding goodwill, thatcontribute to future cash flows of both the cash generatingunit under review for impairment and other cashgenerating units.Cost. Amount of cash or cash equivalent paid or the fairvalue of other consideration given to acquire or constructan asset.Depreciable amount. Cost of an asset or the other amountthat has been substituted for cost, less the residual value ofthe asset.Depreciation. Systematic and rational allocation of thedepreciable amount of an asset over its economic life.Development. The application of research findings orother knowledge to a plan or design for the production ofnew or substantially improved materials, devices,products, processes, systems, or services prior to
commencement of commercial production or use. Thisshould be distinguished from research.Fair value. Amount that would be obtained for an asset inan arm’s-length exchange transaction betweenknowledgeable willing parties.Goodwill. The excess of the cost of a businesscombination accounted for as an acquisition over the fairvalue of the net assets thereof, to be amortized over itsuseful economic life that, as a rebuttable presumption, isno greater than twenty years.Impairment loss. The excess of the carrying amount of anasset over its recoverable amount.Intangible assets. Nonmonetary assets without physicalsubstance that are held for use in the production or supplyof goods or services or for rental to others, or foradministrative purposes, which are identifiable and arecontrolled by the enterprise as a result of past events, andfrom which future economic benefits are expected to flow.Monetary assets. Assets whose amounts are fixed in termsof units of currency. Examples are cash, accountsreceivable, and notes receivable.Net selling price. The amount which could be realizedfrom the sale of an asset by means of an arm’s-lengthtransaction, less costs of disposal.Nonmonetary transactions. Exchanges and nonreciprocaltransfers that involve little or no monetary assets orliabilities.Nonreciprocal transfer. Transfer of assets or services inone direction, either from an enterprise to its owners oranother entity, or from owners or another entity to theenterprise. An enterprise’s reacquisition of its outstandingstock is a nonreciprocal transfer.
Recoverable amount. The greater of an asset’s net sellingprice or its value in use.Research. The original and planned investigationundertaken with the prospect of gaining new scientific ortechnical knowledge and understanding. This should bedistinguished from development.Residual value. Estimated amount expected to beobtained on ultimate disposition of the asset after its usefullife has ended, net of estimated costs of disposal.Useful life. Period over which an asset will be employedin a productive capacity, as measured either by the timeover which it is expected to be used, or the number ofproduction units expected to be obtained from the asset bythe enterprise.CONCEPTS, RULES, AND EXAMPLESBackgroundOver the years, the role of intangible assets has grownmore important for the operations and prosperity of manytypes of businesses, as the “knowledge-based” economybecomes more dominant. However, until recently,accounting standards have tended to give scant attentionto, or ignore entirely, the appropriate means of reportingupon such assets. As a consequence, practice has beenexceptionally diverse, with enterprises in nations whosestandards had not addressed accounting for intangiblestypically being much more aggressive in capitalizing arange of intangibles, including internally generatedgoodwill, vis-à-vis those entities operating under morestrictly defined rules limiting cost deferral and requiringrapid amortization of those costs which could be deferred.Thus, in many countries it has been common practice todefer recognition of certain types of expenditures,including advertising costs and setup costs, the future
benefits of which are very difficult to demonstrate. Inaddition, when intangibles such as “brand names” and“internally generated goodwill” have been capitalized,there has often been a great reluctance to amortize thecosts against earnings over a reasonable time horizon, onthe basis that these have either indefinite or infinite lives.While advocates for such practices have made the claimthat future benefits will flow from such expenditures (else,why incur those costs?), experience has shown that thesedeferrals often result in a subsequent year in large “bigbath” write-offs. This pattern of foregone periodicexpense and sporadic charge-offs clearly impedes theutility of financial statements for one of their primarypurposes, namely, the predicting of future economicperformance (both in terms of earnings and cash flows) ofthe reporting entity. While all can agree that predictingthe useful economic lives of certain intangibles isexceptionally challenging, the need to honor the matchingprinciple and to provide relevant information for use byinvestors, creditors and others has driven most standardsetters to impose rather stringent requirements on therecognition and measurement of intangible assets.International accounting standards first addressedaccounting for intangibles in a thorough way with IAS 38,which was promulgated after a rather long and contentiousgestation period that included the issuance of twoExposure Drafts. IAS 38 is a comprehensive standardwhich superseded an earlier standard dealing solely withresearch and development expenditures. It establishesrecognition criteria, measurement bases, and disclosurerequirements for intangible assets. The standard alsoprescribes impairment testing for intangible assets, to beundertaken on a regular basis. This is to ensure that only
assets having recoverable values are capitalized andcarried forward to future periods.It is interesting to note that in prescribing the amortizationperiod, IAS 38 has ruled out the concept of intangibleassets having infinite or indefinite lives. In fact, byimposing additional burdens on those who would assignlives greater than twenty years to such assets, the standardset a rather conservative approach to recognition andmeasurement of intangibles. However, the IASB iscurrently weighing revisions that would remove therefutable presumption of a twenty-year maximumeconomic life and would further acknowledge theexistence of indefinite-life intangibles, not subject toamortization at all (at least, until a finite life wasdeterminable). These potential revisions are beingpondered largely as part of IASB’s effort to “converge” itsstandards, in this case to the recently revised US GAAPstandards on business combinations and intangibles. Ifadopted, goodwill will no longer be subject toamortization, but will have to be evaluated for impairmentregularly, reversing the position taken by IAS 38. (Seefurther discussion in Chapter 11.)Also, by simultaneously withdrawing the existing standardon research and development costs (the former IAS 9) andrevising the standard on business combinations (IAS 22),the former IASC considerably streamlined andrationalized the accounting standards relating toaccounting for intangible assets. As the rules presentlyexist, therefore, they do form a coherent and consistent setof requirements for the financial reporting on all suchassets.Scope of the standard. The standard applies to allenterprises. It prescribes the accounting treatment for
intangible assets, including development costs. However,it does not apply to intangible assets covered by other IAS;for instance, deferred tax assets covered under IAS 12,leases that fall within the purview of IAS 17, goodwillarising on a business combination and dealt with by IAS22, assets arising from employee benefits that are coveredby IAS 19, and financial assets as defined by IAS 32 andcovered by IAS 27, 28, 31, and 39. This standard does notapply to intangible assets arising in insurance companiesfrom contracts with policyholders, nor to mineral rightsand the costs of exploration for, or development andextraction of, minerals, oil, natural gas, and similarnonregenerative resources. However, the standard doesapply to intangible assets that are used to develop ormaintain these activities.Identifiable intangible assets include patents, copyrights,licenses, customer lists, brand names, import quotas,computer software, leasehold improvements, marketingrights, and specialized know-how. These items have incommon the fact that there is little or no tangiblesubstance to them, they have an economic life of greaterthan one year, and they have a decline in utility over thatperiod which can be measured or reasonably assumed. Inmany but not all cases, the asset is separable; that is, itcould be sold or otherwise disposed of withoutsimultaneously disposing of or diminishing the value ofother assets held.Intangible assets are, by definition, assets that have nophysical substance. However, there may be instanceswhere intangibles also have some physical form. Forexample
• There may be tangible evidence of an asset’sexistence, such as a certificate indicating that a patent hadbeen granted, but this does constitute the asset itself;• Some intangible assets may be contained in or on aphysical substance such as a compact disc (in the case ofcomputer software); and• Identifiable assets that result from research anddevelopment activities are intangible assets because thetangible prototype or model is secondary to the knowledgethat is the primary outcome of those activities.In the case of assets that have both tangible and intangibleelements, there may be some confusion about whether toclassify them as tangible or intangible assets.Considerable judgment is required in properly classifyingsuch assets as either intangible or tangible assets. As arule of thumb, the asset should be classified as either anintangible asset or a tangible asset based on the relative orcomparative dominance or significance of the tangible orthe intangible component (or element) of the asset. Forinstance, computer software that is not an integral part ofthe related hardware equipment is treated as software (i.e.,as an intangible asset). Conversely, certain computersoftware, such as the operating system, that is essentialand an integral part of a computer, is treated as part of thehardware equipment (i.e., as property, plant, andequipment as opposed to an intangible asset).The concept embodied in this standard is somewhatcontroversial, and in some respects also vague andunclear, being subjective and open to interpretation. Invarious attempts to explain this concept, differenttechniques have been used by commentators. Some haverestricted themselves to detailed examples, while others(perhaps exhibiting over enthusiasm to clarify the concept)
have gone further, even so far as to argue that IAS 38draws a distinction between an “intangible asset” and an“intangible resource.” In this typology, the latterexpression has been conceived of a broader concept thatincludes intangible assets (as defined by IAS 38), as wellas other hypothetical assets. For example, intangibleresources would include not only items such as patentsand copyrights (which would meet the qualifying criteriaset forth for intangible assets in IAS 38), but also itemssuch as customer lists and internally generated brands(which do not meet the definition of intangible assets).While this may serve some useful purpose, the coining ofa phrase such as “intangible resources” (which is foundneither in the IASC Framework nor in IAS 38) to be usedin distinction from the term “intangible asset,” is ill-advised. Given the fact that IAS 38 (paragraph 7) hasdefined an asset as a “resource…controlled by theenterprise…”, the creation of alternative definitions andconcepts is probably not appropriate.Recognition CriteriaIdentifiable intangible assets have much similarity totangible long-lived assets (property, plant, andequipment), and the accounting for them is accordinglyvery similar. The key criteria for determining whetherintangible assets are to be recognized are1. Whether the intangible asset has an identity separatefrom other aspects of the business enterprise;2. Whether the use of the intangible asset is controlledby the enterprise as a result of its past actions and events;3. Whether future economic benefits can be expected toflow to the enterprise; and4. Whether the cost of the asset can be measuredreliably.
Identifiability. As to the first issue, the principal concernis to distinguish these intangibles from goodwill arisingfrom a business combination, the accounting for which isaddressed by IAS 22. Goodwill is the residual cost of abusiness acquisition that cannot be assigned either totangible assets, net of any liabilities assumed, or toidentifiable intangibles. Unlike identifiable intangibles,goodwill cannot be separated from the assets (the physicalas well as the identifiable intangible) it was acquired with.Since goodwill cannot be severed and sold, its real value isoften questioned and the period over which it can beamortized is, accordingly, often made as brief as possible.(But note that goodwill may become a nonamortizing,impairment-tested asset under a revised or superseded IAS22; see Chapter 11 for a discussion.)To capitalize the cost of an intangible asset other thangoodwill, it must have an independently observableexistence and a cost that can be assigned to it.Independently observable existence can be established ifthe enterprise can rent, sell, exchange, or distribute thefuture economic benefits from the assets without alsodisposing of other assets; that is, that an owner can conveythem without necessarily also transferring related physicalassets. Goodwill, on the other hand, cannot bemeaningfully transferred to a new owner without alsoselling other assets, and hence, will not meet therecognition criteria for intangible assets as defined by IAS38.Identifiability can be demonstrated by a legal right over anasset or by the fact that the asset is separable from the restof the business. It is worth noting that while IAS 38 doesnot regard “separability” as an additional recognitioncriterion, some national standards (UK GAAP, for
instance) still retain it as one of the qualifying criteria forrecognition. At the time it adopted IAS 38, the IASCBoard rejected the views of commentators on theantecedent Exposure Drafts who had advocated theinclusion of “separability” as an additional recognitioncriterion. In setting forth the basis for its conclusions, theBoard cited several reasons for this rejection. Amongthese, perhaps the most noteworthy is the following:…if a “separability” criterion was applicable to allintangible assets, many intangible assets (for example, alicense to operate a radio station) would not be shownseparately in the financial statements even if they meet the(IASC) Framework’s definition of, and recognition criteriafor, an asset.While not supportive of imposing separability as athreshold criterion for intangible assets, IASC supportedthe view that1. Demonstration of the separability of an asset canassist an enterprise in identifying an intangible asset; and2. The inability of an enterprise to demonstrate theseparability of an asset will make it harder to demonstratethat there is an identifiable intangible asset.Currently, IASB is embarked upon a thorough review ofaccounting for business combinations, a corollary ofwhich is the accounting for intangibles (includinggoodwill and in-process research and development)acquired in such combinations. Based on deliberations tomid-2002, it appears that the existing philosophy forintangible asset recognition will be essentially continued.A replacement for IAS 22 will likely stipulate thatintangible assets acquired in a business combinationshould be recognized separately from goodwill if theyarise as a result of contractual or legal rights or are
separable from the business. The existence of contractualor legal rights and separability will not, however, formpart of the definition of an asset, but rather, will serve asindicators that an entity controls the future economicbenefits embodied in the item. It would appear, therefore,that neither of these characteristics are intended to beabsolute requirements, which would continue currentpractice in this area.Control. The provisions of IAS 38 require that anenterprise should be in a position to control the use of theintangible asset. Control implies the power to both obtainfuture economic benefits from the asset as well as restrictthe access of others to those benefits. Normallyenterprises register patents, copyrights, etc. to ensure itscontrol over an intangible asset. A patent gives the holderthe exclusive right to use the underlying product orprocess without any interference or infringement fromothers. Intangible assets arising from technical knowledgeof staff, customer loyalty, long-term training benefits, etc.,will have difficulty meeting this recognition criteria inspite of expected future economic benefits from them.This is due to the fact that the enterprise would find itimpossible to fully control these resources or to preventothers from controlling them.For instance, even if an enterprise incurs considerableexpenditure on training that will supposedly increase staffskills, the economic benefits from skilled staff cannot becontrolled, since trained employees could leave theircurrent employment and move on in their career to otheremployers. Hence, staff training expenditures, no matterhow material in amount, do not qualify as an intangibleasset. In other words, the practice of deferring trainingcosts based on the reasoning that future economic benefits
from enhanced staff skills will flow to the enterprise canno longer be justified, after the promulgation of the IASon Intangible Assets. Other often-quoted examples ofexpenses that do not qualify as intangible assets based onthe criterion of control are market share, customerrelationships, customer loyalty (unless protected byenforceable legal rights), and portfolio of clients.Future economic benefits. Under IAS 38, it is mandatedthat an intangible asset be recognized only if it is probablethat future economic benefits specifically associatedtherewith will flow to the reporting entity, and the cost ofthe asset can be measured reliably. The recognitioncriteria for intangible assets are derived from the (IASC)Framework and are similar to the recognition criteria fortangible assets (property, plant, and equipment).The future economic benefits envisaged by the standardmay take the form of revenue from the sale of products orservices, cost savings, or other benefits resulting from theuse of the intangible asset by the enterprise. A goodexample of other benefits resulting from the use of theintangible asset is the use by an enterprise of a secretformula (which the enterprise has protected legally) thatleads to reduced future production costs (as opposed toincreased future revenue).Measurement of Cost of IntangiblesThe conditions under which the intangible asset has beenacquired will determine the measurement of cost.The cost of an intangible asset acquired separately isdetermined in a manner largely analogous to that fortangible long-lived assets as described in Chapter 8. Thus,the cost comprises the purchase cost, including any taxesand import duties, less any trade discounts and rebates,plus any directly attributable expenditures incurred in
preparing the asset for its intended use. Directlyattributable expenditures would include fully loaded laborcosts, thus including employee benefits arising directlyfrom bringing the asset to its working condition. It wouldalso include professional fees and other costs.As with tangible assets, capitalization of costs ceases atthe point when the intangible asset is ready to be placed inservice in the manner intended by management. Any costsincurred in using or redeploying intangible assets areaccordingly to be excluded from the cost of those assets.Thus, any costs incurred while the asset is capable ofbeing used in the manner intended by management, butwhile it has yet to be placed into service, would beexpenses, not capitalized. Similarly, initial operatinglosses, such as those incurred while demand for the asset’sproductive outputs is being developed, cannot becapitalized. On the other hand, further expenditures madefor the purpose of improving the asset’s level ofperformance would qualify for capitalization.Changes being made to IAS 38 as a consequence of theIASB’s Improvements Project will emphasize the fact thatcertain operations may occur in connection with thedevelopment of an intangible asset, but not be necessary inorder to bring the asset to the condition where it would becapable of operating in the manner intended bymanagement. These incidental operations could occureither before or during the development activities.Because by definition such operations are not necessary tobring an asset to the condition necessary for it to becapable of operating in the manner intended bymanagement, the income and related expenses ofincidental operations must be recognized in the operating
results for the current period, to be reported in therespective classification of income and expense.Under IAS 38, a condition for the recognition of anintangible asset is that the cost of the asset can bemeasured reliably. The changes made to IAS 38consequent to the IASB’s Improvements Project clarifiedthat the reporting entity would be unable to determinereliably the fair value of an intangible asset whencomparable market transactions are infrequent and whenalternative estimates of fair value (e.g., those based ondiscounted cash flow projections) cannot be calculated.Furthermore, the cost of an intangible asset acquired inexchange for a similar asset would be measured at thecarrying amount of the asset given up when the fair valueof neither of the assets exchanged could be easilydetermined reliably.In some situations, identifiable intangibles are acquired aspart of a business combination or other bulk purchasetransaction. According to the provisions of IAS 38, thecost of an intangible asset acquired as part of a businesscombination is its fair value as at the date of acquisition.If the intangible asset can be freely traded in an activemarket, then the quoted market price is the bestmeasurement of cost. If the intangible asset has no activemarket, then cost is determined based on the amount thatthe enterprise would have paid for the asset in an arm’s-length transaction at the date of acquisition. If the cost ofan intangible asset acquired as part of a businesscombination cannot be measured reliably, then that asset isnot recognized, but rather, is included in goodwill.Under US GAAP, the aggregate purchase cost is to beallocated to assets acquired and liabilities assumed. If oneor more of the assets are intangibles, the extent of
judgment required in the allocation process becomessomewhat greater than would otherwise be the case; inextreme situations it may be impossible to determine howmuch, if any, of the aggregate cost should be allocated tointangibles. It is most likely to be determinable when theintangibles were actually negotiated for in the transactionrather than being thrown in to the deal. Furthermore, ifthe allocation of the purchase price to individual assets isaccomplished by applying discounted present valuemeasures to future revenue streams, unless this sameprocess is usable with regard to the intangibles, it is likelythat any unallocated purchase price will have to beassigned to goodwill.In some instances, intangible assets are obtained inexchange for equity instruments of the reporting entity.The revisions to IAS 38 will stipulate that under suchcircumstances the cost of the asset is the fair value of theequity instruments issued. Where the fair value for theitem received is more clearly evident than the fair value ofthe equity instruments issued, however, that should beused to measure its cost.In other situations, intangible assets may be acquired inexchange or part exchange for other dissimilar intangibleassets or other assets. Unless the “like-kind” exceptiondescribed in the following paragraph applies, the costs ofthe assets obtained are measured at the fair values of theassets given up, adjusted by the amount of any cash orcash equivalents transferred. However, if the fair valuesof the assets received are more clearly evident than the fairvalues of the assets given up, those values are to be usedto measure the transaction. These procedures arepredicated upon the ability to reliably measure costs;absent this ability, as when comparable market
transactions are infrequent and alternative estimates of fairvalue (e.g., based on discounted cash flow projections)cannot be calculated, acquired assets would not be subjectto recordation.The revisions to IAS 38 also will establish accountingprocedures for what is commonly known as a like-kindexchange. In such instances, the cost of an intangibleasset acquired is measured at the carrying amount of theasset given up when the fair value of neither of the assetsexchanged can be determined reliably.Internally generated goodwill is not recognized as anintangible asset because it fails to meet the recognitioncriteria of• Reliable measurement at cost,• Lack of an identity separate from other resources, and• Control by the reporting enterprise.In practice, accountants are usually confronted with thedesire to recognize internally generated goodwill based onthe premise that at a certain point in time the market valueof an enterprise exceeds the carrying value of itsidentifiable net assets. However, as IAS 38 categoricallypoints out, such differences cannot be considered torepresent the cost of intangible assets controlled by theenterprise, and hence, would not meet the criteria forrecognition (i.e., capitalization) of such an asset on thebooks of the enterprise.Intangibles acquired by means of government grants. Ifthe intangible is acquired free of charge or by payment ofnominal consideration, as by means of a government grant(e.g., when the government grants the right to operate aradio station) or similar program, and assuming thebenchmark accounting treatment (historical cost) isemployed, obviously there will be little or no amount
reflected as an asset. If the asset is important to thereporting entity’s operations, however, it must beadequately disclosed in the notes to the financialstatements. If the allowed alternative (fair value) methodis used, the fair value should be determined by referenceto an active market. However, given the probable lack ofan active market, since government grants are generallynot transferable, it is unlikely that this situation will beencountered. If an active market does not exist for thistype of an intangible asset, the enterprise must recognizethe asset at cost. Cost would include those that aredirectly attributable to preparing the asset for its intendeduse.Intangibles Acquired through an Exchange of AssetsIf an intangible asset is acquired in exchange or partialexchange for a dissimilar intangible or other asset, then thecost of the asset is measured at its fair value. This amountis to be ascertained by reference to the fair value of theasset received, which is equivalent to the fair value of theasset given up in the exchange, adjusted for any cash orcash equivalents transferred.If the exchange involves similar assets to be used by theenterprise in essentially the same manner and for the samepurpose as the item given up in the exchange, theexchange is not deemed to be the culmination of anearnings process, and accordingly, no gain or loss isrecognized. The new asset will be recorded at the carryingamount of the asset given up, adjusted for any cash or cashequivalent (often called “boot”) given or received.Internally Generated Intangibles other than GoodwillIn many instances, intangibles are generated internally byan entity, rather than being acquired via a businesscombination or some other purchase transaction. Because
of the nature of intangibles, the actual measurement of thecost (i.e., the initial amounts at which these could berecognized as assets) can prove to be rather challenging inpractice, and for that reason, historically there wassomewhat of a bias against recognition of internallygenerated intangible assets. However, a failure torecognize such assets would not only cause the entity’sbalance sheet to underreport its economic resources, butwould also result in a mismatching of income and expensein both the period of expenditure and later periods whenthe related benefits would be reaped. Accordingly, IAS 38provides that internally generated intangible assets,provided certain criteria are met, are to be capitalized andamortized over the projected period of economic utility.Under the now-superseded IAS 9, it was established thatresearch costs were to be expensed as incurred, but thatdevelopment costs were to be deferred (i.e., capitalized)and expensed over the periods of expected benefit. IAS38 absorbed the guidance formerly found in IAS 9 andexpanded it to cover other internally generated intangibleassets. Thus, expenditures pertaining to the creation ofintangible assets are to be classified alternatively as beingindicative of, or analogous to, research activity ordevelopment activity. The former costs are expensed asincurred; the latter are capitalized, if future economicbenefits are reasonably likely to be received by thereporting entity. Per IAS 38,1. Costs incurred in the research phase are expensedimmediately; and2. If costs incurred in the development phase meet therecognition criteria for an intangible asset, such costsshould be capitalized. However, once costs have been
expensed during the development phase, they cannot laterbe capitalized.In practice, distinguishing research-like expenditures fromdevelopment-like expenditures may not be easilyaccomplished. This would be especially true in the case ofintangibles for which the measurement of economicbenefits cannot be performed in anything approximating adirect manner. Assets such as brand names, mastheads,and customer lists can prove quite resistant to such directobservation of value (although in many industries there arebenchmark monetary amounts commonly associated withsuch items, such as the oft-expressed notion that acustomer list in the securities brokerage business is worth$1,500 per name, implying the amount of avoidablepromotional costs each qualified name is worth).Thus, entities may incur certain expenditures in order toenhance brand names, such as engaging in image-advertising campaigns, but these costs will also haveancillary benefits, such as promoting specific products thatare being sold currently, and possibly even enhancingemployee morale and performance. While it may beargued that the expenditures create or add to an intangibleasset, as a practical matter it would be difficult todetermine what portion of the expenditures relate to whichachievement, and to ascertain how much, if any, of thecost may be capitalized as part of brand names. Thus, it isconsidered to be unlikely that threshold criteria forrecognition can be met in such a case. For this reason thestandard has specifically disallowed the capitalization ofinternally generated assets like brands, mastheads,publishing titles, customer lists, and items similar to thesein substance.
Apart from the prohibited items, however, IAS 38 permitsrecognition of internally created intangible assets to theextent the expenditures can be analogized to thedevelopment phase of a research and developmentprogram. Thus, internally developed patents, copyrights,trademarks, franchises, and other assets will be recognizedat the cost of creation, exclusive of costs which would beanalogous to research, as further explained in thefollowing paragraphs.When an internally generated intangible asset meets therecognition criteria, the cost is determined using the sameprinciples as for an acquired tangible asset. Thus, costcomprises all costs directly attributable to creating,producing, and preparing the asset for its intended use.IAS 38 closely follows IAS 16 with regard to elements ofcost that may be considered as part of the asset, and theneed to recognize the cash equivalent price when theacquisition transaction provides for deferred paymentterms. As with self-constructed tangible assets, elementsof profit must be eliminated from amounts capitalized, butincremental administrative and other overhead costs canbe allocated to the intangible and included in the asset’scost. Initial operating losses, on the other hand, cannot bedeferred by being added to the cost of the intangible, butmust be expensed as incurred.As noted above, the standard presents the concepts of theresearch phase and the development phase of a researchand development project. IAS 38 mandates that theexpenditure incurred during the research phase of aninternal project should be recognized as an expense whenincurred (as opposed to recognizing it as an intangibleasset). The standard takes this view based on the premisethat an enterprise cannot demonstrate that the expenditure
incurred in the research phase will generate probablefuture economic benefits, and consequently, that anintangible asset exists (thus, such expenditure should beexpensed). Examples of research activities include:activities aimed at obtaining new knowledge; the searchfor, evaluation, and final selection of applications ofresearch findings; and the search for and formulation ofalternatives for new and improved systems, etc.The standard recognizes that the development stage isfurther advanced than the research stage, and that anenterprise can possibly, in certain cases, identify anintangible asset and demonstrate that this asset willprobably generate future economic benefits for theorganization. Thus, the standard allows recognition of anintangible asset during the development phase, providedthe enterprise can demonstrate all the following:• Technical feasibility of completing the intangibleasset so that it will be available for use or sale;• Its intention to complete the intangible asset andeither use it or sell it;• Its ability to use or sell the intangible asset;• The mechanism by which the intangible will generateprobable future economic benefits;• The availability of adequate technical, financial andother resources to complete the development and to use orsell the intangible asset; and• The entity’s ability to reliably measure theexpenditure attributable to the intangible asset during itsdevelopment.Examples of development activities include: the designand testing of preproduction models; design of tools, jigs,molds, and dies; design of a pilot plant which is not
otherwise commercially feasible; design and testing of apreferred alternative for new and improved systems, etc.Recognition of internally generated computer softwarecosts. The recognition of computer software costs posesseveral questions.1. In the case of a company developing softwareprograms for sale, should the costs incurred in developingthe software be expensed, or should the costs becapitalized and amortized?2. Is the treatment for developing software programsdifferent if the program is to be used for in-houseapplications only?3. In the case of purchased software, should the cost ofthe software be capitalized as a tangible asset or as anintangible asset, or should it be expensed fully andimmediately?In view of the current IAS on intangible assets, theposition can be clarified as follows:1. In the case of a software-developing company, thecosts incurred in the development of software programsare research and development costs. Accordingly, allexpenses incurred in the research phase would beexpensed. Thus, all expenses incurred until technologicalfeasibility for the product has been established should beexpensed. The enterprise would have to demonstratetechnical feasibility and probability of its commercialsuccess. Technological feasibility would be established ifthe enterprise has completed a detailed program design orworking model. The enterprise should have completed theplanning, designing, coding, and testing activities andestablished that the product can be successfully produced.Apart from being capable of production, the enterpriseshould demonstrate that it has the intention and ability to
use or sell the program. Action taken to obtain controlover the program in the form of copyrights or patentswould support capitalization of these costs. At this stagethe software program would be able to meet the criteria ofidentifiability, control, and future economic benefits, andcan thus be capitalized and amortized as an intangibleasset.2. In the case of software internally developed for in-house use, for example, a payroll program developed bythe reporting enterprise itself, the accounting approachwould be different. While the program developed mayhave some utility to the enterprise itself, it would bedifficult to demonstrate how the program would generatefuture economic benefits to the enterprise. Also, in theabsence of any legal rights to control the program or toprevent others from using it, the recognition criteria wouldnot be met. Further, the cost proposed to be capitalizedshould be recoverable. In view of the impairment testprescribed by the standard, the carrying amount of theasset may not be recoverable and would accordingly haveto be adjusted. Considering the above facts, such costsmay need to be expensed.3. In the case of purchased software, the treatmentwould differ on a case-to-case basis. Software purchasedfor sale would be treated as inventory. However, softwareheld for licensing or rental to others should be recognizedas an intangible asset. On the other hand, cost of softwarepurchased by an enterprise for its own use and which isintegral to the hardware (because without that software theequipment cannot operate), would be treated as part ofcost of the hardware and capitalized as property, plant, orequipment. Thus, the cost of an operating systempurchased for an in-house computer, or cost of software
purchased for computer-controlled machine tool, aretreated as part of the related hardware.Cost of other software programs should be treated asintangible assets (as opposed to being capitalized alongwith the related hardware), as they are not an integral partof the hardware. For example, the cost of payroll orinventory software (purchased) may be treated as anintangible asset provided it meets the capitalization criteriaunder IAS 38 (in practice, the conservative approachwould be to expense such costs as they are incurred, sincetheir ability to generate future economic benefits is alwaysquestionable).Costs Not Satisfying the IAS 38 Recognition CriteriaThe standard has specifically provided that expendituresincurred for nonmonetary intangible assets should berecognized as an expense unless1. It relates to an intangible asset dealt with in anotherIAS;2. The cost forms part of the cost of an intangible assetthat meets the recognition criteria prescribed by IAS 38; or3. It is acquired in a business combination and cannot berecognized as an identifiable intangible asset. In this case,this expenditure should form part of the amountattributable to goodwill as at the date of acquisition.As a consequence of applying the above criteria, thefollowing costs are expensed as they are incurred:• Research costs;• Preopening costs to open a new facility or business,and plant start-up costs incurred during a period prior tofull-scale production or operation, unless these costs arecapitalized as part of the cost of an item of property, plant,and equipment;
• Organization costs such as legal and secretarial costs,which are typically incurred in establishing a legal entity;• Training costs involved in operating a business or aproduct line;• Advertising and related costs;• Relocation, restructuring, and other costs involved inorganizing a business or product line;• Customer lists, brands, mastheads, and publishingtitles that are internally generated.Thus, the IASC has finally resolved the controversyregarding the potential deferral of costs like preoperatingexpenses. In the past, many enterprises have been knownto defer setup costs and preoperating costs on the premisethat benefits from them flow to the enterprise over futureperiods as well. Due to the unequivocal stand taken by theIASC on this contentious issue, enterprises can no longerdefer such costs. Further, by adding the provision relatingto annual impairment testing of all internally generatedintangible assets being amortized (over a period exceedingtwenty years), the IASC has ensured that all such costscapitalized in the past would need to be adjusted forimpairment.The criteria for recognition of intangible assets asprovided in IAS 38 are rather stringent, and manyenterprises will find that expenditures either to acquire orto develop intangible assets will fail the test forcapitalization. In such instances, all these costs must beexpensed currently as incurred. Furthermore, onceexpensed, these costs cannot be resurrected and capitalizedin a later period, even if the conditions for such treatmentare later met. This is not meant, however, to precludecorrection of an error made in an earlier period if the
conditions for capitalization were met but interpretedincorrectly by the reporting entity at that time.)Subsequently Incurred CostsUnder the provisions of IAS 38, the capitalization of anysubsequent costs incurred on intangible assets is difficultto justify. This is because the nature of an intangible assetis such that, in many cases, it is not possible to determinewhether subsequent costs are likely to enhance the specificeconomic benefits that will flow to the enterprise fromthose assets. Thus, subsequent costs incurred on anintangible asset should be recognized as an expense whenthey are incurred unless1. It is probable that those costs will enable the asset togenerate specifically attributable future economic benefitsin excess of its assessed standard of performanceimmediately prior to the incremental expenditure; and2. Those costs can be measured reliably and attributedto the asset reliably.Thus, if the above two criteria are met, any subsequentexpenditure on an intangible after its purchase or itscompletion should be capitalized along with its cost. Thefollowing example should help to illustrate this pointbetter.ExampleAn enterprise is developing a new product. Costs incurredby the R&D department in 2003 on the “research phase”amounted to $200,000. In 2004, technical and commercialfeasibility of the product was established. Costs incurredin 2004 were $20,000 personnel costs and $15,000 legalfees to register the patent. In 2005, the enterprise incurred$30,000 to successfully defend a legal suit to protect thepatent. The enterprise would account for these costs asfollows:
• Research and development costs incurred in 2003,amounting to $200,000, should be expensed, as they donot meet the recognition criteria for intangible assets. Thecosts do not result in an identifiable asset capable ofgenerating future economic benefits.• Personnel and legal costs incurred in 2004,amounting to $35,000, would be capitalized as patents.The company has established technical and commercialfeasibility of the product, as well as obtained control overthe use of the asset. The standard specifically prohibitsthe reinstatement of costs previously recognized as anexpense. Thus $200,000, recognized as an expense in theprevious financial statements, cannot be reinstated andcapitalized.• Legal costs of $30,000 incurred in 2005 to defend theenterprise in a patent lawsuit should be expensed. UnderUS GAAP, legal fees and other costs incurred insuccessfully defending a patent lawsuit can be capitalizedin the patents account, to the extent that value is evident,because such costs are incurred to establish the legal rightsof the owner of the patent. However, in view of thestringent conditions imposed by IAS 38 concerning therecognition of subsequent costs, the IASC seems to be infavor of the conservative approach of expensing suchcosts. Only such subsequent costs should be capitalizedwhich would enable the asset to generate future economicbenefits in excess of the originally assessed standards ofperformance. This represents, in most instances, a veryhigh, possibly insurmountable hurdle. Thus, legal costsincurred in connection with defending the patent, whichcould be considered as expenses incurred to maintain theasset at its originally assessed standard of performance,would not meet the recognition criteria under IAS 38.
• Alternatively, if the enterprise were to lose the patentlawsuit, then the useful life and the recoverable amount ofthe intangible asset would be in question. The enterprisewould be required to provide for any impairment loss, andin all probability, even to fully write offthe intangible asset. What is required must be determinedby the facts of the specific situation.Measurement subsequent to Initial RecognitionBenchmark treatment. After initial recognition, anintangible asset should be carried at its cost less anyaccumulated amortization and any accumulatedimpairment losses.Allowed alternative treatment—revaluation. As withtangible assets under IAS 16, the standard for intangiblespermits revaluation subsequent to original acquisition,with the asset being written up to fair value. Inasmuch asmost of the particulars of IAS 38 follow IAS 16 to theletter, and were described in detail in Chapter 8, these willnot be repeated here. The unique features of IAS 38 are asfollows:1. If the intangibles were not initially recognized (i.e.,they were expensed rather than capitalized) it would notbe possible to later recognize them at fair value.2. Deriving fair value by applying a present valueconcept to projected cash flows (a technique that can beused in the case of tangible assets under IAS 16) isdeemed to be too unreliable in the realm of intangibles,primarily because it would tend to commingle the impactof identifiable assets and goodwill. Accordingly, fairvalue of an intangible asset should only be determined byreference to an active market in that type of intangibleasset. Active markets providing meaningful data are notexpected to exist for such unique assets as patents and
trademarks, and thus it is presumed that revaluation willnot be applied to these types of assets in the normal courseof business. As a consequence, the IASC has effectivelyrestricted revaluation of intangible assets to only freelytradable intangible assets.As with the rules pertaining to plant, property, andequipment under IAS 16, if some intangible assets in agiven class are subjected to revaluation, all the assets inthat class should be consistently accounted for unless fairvalue information is not or ceases to be available. Also incommon with the requirements for tangible fixed assets,IAS 38 requires that revaluations be taken directly toequity through the use of a revaluation surplus account,except to the extent that previous impairments had beenrecognized by a charge against income.Example of revaluation of intangible assetsA patent right is acquired July 1, 2003, for $250,000;while it has a legal life of 15 years, due to rapidlychanging technology, management estimates a useful lifeof only 5 years. Straight-line amortization will be used.At January 1, 2004, management is uncertain that theprocess can actually be made economically feasible, anddecides to write down the patent to an estimated marketvalue of $75,000. Amortization will be taken over 3 yearsfrom that point. On January 1, 2006, having perfected therelated production process, the asset is now appraised at asound value of $300,000. Furthermore, the estimateduseful life is now believed to be 6 more years. The entriesto reflect these events are as follows:7/1/03 Patent 250,000 Cash, etc. 250,00012/31/03 Amortization expense 25,000
Patent 25,0001/1/04 Loss from asset impairment 150,000 Patent 150,00012/31/04 Amortization expense 25,000 Patent 25,00012/31/05 Amortization expense 25,000 Patent 25,0001/1/06 Patent 275,000 Gain on asset value recovery 100,000 Revaluation surplus 175,000Certain of the entries in the foregoing example will beexplained further. The entry at year-end 2003 is to recordamortization based on original cost, since there had beenno revaluations through that time; only a half-yearamortization is provided [($250,000/5) x ½]. On January1, 2004, the impairment is recorded by writing down theasset to the estimated value of $75,000, which necessitatesa $150,000 charge to income (carrying value, $225,000,less fair value, $75,000).In 2004 and 2005, amortization must be provided on thenew lower value recorded at the beginning of 2004;furthermore, since the new estimated life was 3 years fromJanuary 2004, annual amortization will be $25,000.As of January 1, 2006, the carrying value of the patent is$25,000; had the January 2004 revaluation not been made,the carrying value would have been $125,000 ($250,000original cost, less 2.5 years amortization versus an originalestimated life of 5 years). The new appraised value is$300,000, which will fully recover the earlier write-downand add even more asset value than the originallyrecognized cost. Under the guidance of IAS 38, therecovery of $100,000 that had been charged to expense
should be taken into income; the excess will be credited tostockholders’ equity.Development costs pose a special problem in terms of theapplication of the allowed alternative method under IAS38. The utilization of the allowed alternative method ofaccounting for long-lived intangibles is only permissiblewhen stringent conditions are met concerning theavailability of fair value information. In general, it willnot be possible to obtain fair value data from activemarkets, as is required by IAS 38, and this is particularlytrue with regard to development costs. Accordingly, theexpectation is that the benchmark (historical cost) methodwill be almost universally applied for development costs.The use of the available alternative method fordevelopment costs, while theoretically valid, is expectedto be very unusual in practice.Example of development cost capitalizationAssume that Creative, Incorporated incurs substantialresearch and development costs for the invention of newproducts, many of which are brought to marketsuccessfully. In particular, Creative has incurred costsduring 2003 amounting to $750,000, relative to a newmanufacturing process. Of these costs, $600,000 wereincurred prior to December 1, 2003. As of December 31,the viability of the new process was still not known,although testing had been conducted on December 1. Infact, results were not conclusively known until February15, 2004, after another $75,000 in costs were incurredpost–January 1. Creative, Incorporated’s financialstatements for 2003 were issued February 10, 2004, andthe full $750,000 in research and development costs wereexpensed, since it was not yet known whether a portion ofthese qualified as development costs under IAS 38. When
it is learned that feasibility had, in fact, been shown as ofDecember 1, Creative management asks to restore the$150,000 of post–December 1 costs as a developmentasset. Under IAS 38 this is prohibited. However, the2004 costs ($75,000 thus far) would qualify forcapitalization, in all likelihood, based on the facts known.If, however, it is determined that fair value informationderived from active markets is indeed available, and theenterprise desires to apply the allowed alternative(revaluation) method of accounting to development costs,then it will be necessary to perform revaluations on aregular basis, such that at any reporting date the carryingamounts are not materially different from the current fairvalues. From a mechanical perspective, the adjustment tofair value can be accomplished either by “grossing up” thecost and the accumulated amortization accountsproportionally, or by netting the accumulatedamortization, prerevaluation, against the asset account andthen restating the asset to the net fair value as of therevaluation date. In either case, the net effect of theupward revaluation will be recorded in stockholders’equity as revaluation surplus; the only exception would bewhen an upward revaluation is in effect a reversal of apreviously recognized impairment which was reported as acharge against earnings or a revaluation decrease (reversalor a yet earlier upward adjustment) which was reflected inearnings.The accounting for revaluations is illustrated as follows:Example of accounting for revaluation of developmentcostAssume Breakthrough, Inc. has accumulated developmentcosts that meet the criteria for capitalization at December31, 2003, amounting to $39,000. It is estimated that the
useful life of this intangible asset will be 6 years;accordingly, amortization of $6,500 per year isanticipated. Breakthrough uses the allowed alternativemethod of accounting for its long-lived tangible andintangible assets. At December 31, 2005, it obtainsmarket information regarding the then-current fair value ofthis intangible asset, which suggests a current fair value ofthese development costs is $40,000; the estimated usefullife, however, has not changed. There are two ways toapply IAS 38: the asset and accumulated amortization canbe “grossed up” to reflect the new fair value information,or the asset can be restated on a “net” basis. These areboth illustrated below. For both illustrations, the bookvalue (amortized cost) immediately prior to therevaluation is $39,000 – (2 x $6,500) = $26,000. The netupward revaluation is given by the difference between fairvalue and book value, or $40,000 – $26,000 = $14,000.If the “gross up” method is used: Since the fair value after2 years of the 6-year useful life have already elapsed isfound to be $40,000, the gross fair value must be 6/4 x$40,000 = $60,000. The entries to record this would be asfollows:Development cost (asset) 21,000Accumulated amortization—development cost 7,000Revaluation surplus (stockholders’ equity) 14,000If the “netting” method is used: Under this variant, theaccumulated amortization as of the date of the revaluationis eliminated against the asset account, which is thenadjusted to reflect the net fair value.
Accumulated amortization—development cost 13,000Development cost (asset) 13,000Development cost (asset) 14,000Revaluation surplus (stockholders’ equity) 14,000Amortization PeriodAs with tangible assets subject to depreciation ordepletion, the cost (or revalued carrying amount) ofintangible assets is subject to rational and systematicamortization. Given that the useful economic life of manyintangibles would be difficult to assess, the rule is that amaximum twenty-year life is permissible, withamortization being over a shorter useful life if known.The only exceptions would occur in those instances wherethe legal right has a life of greater than twenty years andeither of the following conditions exists:1. The intangible has an existence that is not separablefrom a specific tangible asset, the useful life of which canbe reliably determined to exceed twenty years, or2. There is an active secondary market for theintangible.The thrust of these requirements is to make the twenty-year life an upper limit for most intangibles.If there is persuasive evidence that the useful life of anintangible asset is longer than twenty years, then thetwenty-year presumption is rebutted and the enterprisemust• Amortize the intangible asset over that longer period;• Estimate the recoverable amount of the intangibleasset at least annually in order to identify any impairmentloss; and• Disclose the reasons why the presumption has beenrebutted.
Note that IAS 38 provides for amortization of allintangible assets; it does not subscribe to the view that anyintangible asset can possess an infinite life. The thrust ofthese requirements is to make the twenty-year life anupper limit for most intangibles.If control over the future economic benefits from anintangible asset is achieved through legal rights for a finiteperiod, then the useful life of the intangible asset shouldnot exceed the period of legal rights, unless the legal rightsare renewable and the renewal is a virtual certainty. Thus,as a practical matter, the shorter legal life will set theupper limit for an amortization period in most cases.The amortization method used should reflect the pattern inwhich the economic benefits of the asset are consumed bythe enterprise. Amortization should commence when theasset is available for use and the amortization charge foreach period should be recognized as an expense unless it isincluded in the carrying amount of another asset (e.g.,inventory). Intangible assets may be amortized by thesame systematic and rational methods that are used todepreciate tangible fixed assets. Thus, IAS 38 wouldseemingly permit straight-line, diminishing balance, andunits of production methods. If a method other thanstraight-line is used, it must accurately mirror theexpiration of the asset’s economic service potential.Residual ValueTangible assets often have a positive residual value beforeconsidering the disposal costs because tangible assets cangenerally be sold for scrap, or possibly be transferred toanother user that has less need for or ability to afford newassets of that type. Intangibles, on the other hand, lackingthe physical attributes that would make scrap value ameaningful concept, often have little or no residual worth.
Accordingly, IAS 38 requires that a zero residual value bepresumed unless an accurate measure of residual ispossible. Thus, the residual value is presumed to be zerounless• There is a commitment by a third party to purchasethe asset at the end of its useful life; or• There is an active market for that type of intangibleasset, and residual value can be measured reliably byreference to that market and it is probable that such amarket will exist at the end of the useful life.IAS 38, as revised by the consequential changes wroughtby the IASB Improvements Project, specifies that theresidual value of an intangible asset is the estimated netamount that the reporting entity currently expects to obtainfrom disposal of the asset at the end of its useful life, afterdeducting the estimated costs of disposal, if the asset wereof the age and in the condition expected at the end of itsestimated useful life. In other words, changes in prices orother variables over the expected period of use of the assetare not to be included in the estimated residual value,since this would result in the recognition of estimatedholding gains over the life of the asset (via reducedamortization that would be the consequence of a higherestimated residual value).Residual value is to be assessed at each balance sheet date.Any change to the estimated residual, other than thatresulting from impairment (accounted for under IAS 36) isto be accounted for prospectively, only by varying futureperiodic amortization. Similarly, any change inamortization method (e.g., from accelerated to straight-line) is dealt with as a change in estimate, again to bereflected only in future periodic charges for amortization.
Periodic review of useful life assumptions andamortization methods employed. As for fixed assetsaccounted for in conformity with IAS 16, the newerstandard on intangibles suggests that the amortizationperiod be reconsidered at the end of each reporting period,and that the method of amortization also be reviewed atsimilar intervals. There is the expectation that due to theirnature intangibles are more likely to require revisions toone or both of these judgments. In either case, a changewould be accounted for as a change in estimate, affectingcurrent and future periods’ reported earnings but notrequiring restatement of previously reported periods.Impairment LossesIAS 38 has provided that• Amortization of an asset should commence when theasset is available for use; and• The amortization period should not exceed twentyyears, although this presumption is rebuttable.In view of the above, some enterprises may be tempted to• Capitalize intangible assets and defer amortization forlong periods on the grounds that the assets are notavailable for use; and/or• Rebut the presumption of twenty-year life andamortize assets over a longer period.To combat the risk that either of these strategies might beemployed, the standard provides that in addition to theuniversal provisions of IAS 36 (which require that therecoverable amount of an asset should be estimated whencertain indications of impairment exist, as described indetail in Chapter 8), IAS 38 requires that an enterpriseshould estimate the recoverable amount of the followingintangible assets at least at each financial year-end even ifthere is no indication of impairment:
1. Intangible assets that are not yet ready for use; and2. Other intangible assets that are amortized over aperiod exceeding twenty years from the date when theasset becomes available for use.Apart from the special case of assets not yet in use, orbeing amortized over greater than twenty years, the majorcomplication arises in the context of goodwill. Unlikeother intangible assets that are individually identifiable,goodwill is amorphous and cannot exist, from a financialreporting perspective, apart from the tangible andidentifiable intangible assets with which it was acquired.Thus, a direct evaluation of the recoverable amount ofgoodwill is not actually feasible; accordingly, the standardrequires that goodwill be combined with other assetswhich together define a cash generating unit, and that anevaluation of any potential impairment (if warranted bythe facts and circumstances) be conducted on an aggregatebasis. A more detailed consideration of goodwill ispresented in Chapter 11.The impairment of intangible assets other than goodwill(such as patents, copyrights, trade names, customer lists,and franchise rights) should be considered in precisely thesame way that long-lived tangible assets are dealt with.Carrying amounts must be compared to the greater of netselling price or value in use when there are indications thatan impairment may have been suffered. Reversals ofimpairment losses under defined conditions are alsorecognized. The effects of impairment recognitions andreversals will be reflected in current period operatingresults, if the intangible assets in question are beingaccounted for in accordance with the benchmark methodset forth in IAS 38 (i.e., at historical cost). On the otherhand, if the allowed alternative method (presenting
intangible assets at revalued amounts) is followed,impairments will normally be charged to stockholders’equity to the extent that revaluation surplus exists, andonly to the extent that the loss exceeds previouslyrecognized valuation surplus will the impairment loss bereported as a charge against earnings. Recoveries arehandled consistent with the method by which impairmentswere reported, in a manner entirely analogous to theexplanation earlier in this chapter dealing withimpairments of plant, property, and equipment.Disposals of Intangible AssetsWith regard to questions of accounting for the dispositionof assets, the guidance of IAS 38 virtually mirrors that ofIAS 16. Gain or loss recognition will be for the differencebetween carrying amount (net, if applicable, of anyremaining revaluation surplus) and the net proceeds fromthe sale. The amendment to IAS 38 made by the IASB’sImprovements Project observes that a disposal of anintangible asset may result from either a sale of the assetor by entering into a finance lease. The determination ofthe date of disposal of the intangible asset is made byapplying the criteria in IAS 18 for recognizing revenuefrom the sale of goods, or IAS 17 in the case of disposalby a sale and leaseback. As for other similar transactions,the consideration receivable on disposal of an intangibleasset is to be recognized initially at fair value. If paymentfor such an intangible asset is deferred, the considerationreceived is recognized initially at the cash priceequivalent, with any difference between the nominalamount of the consideration and the cash price equivalentto be recognized as interest revenue under IAS 18, usingthe effective yield method.Website Development and Operating Costs
With the advent of the Internet and growing popularity of“e-commerce,” many businesses now have their ownwebsites. Websites have become integral to doingbusiness and may be designed either for external orinternal access. Those designed for external access aredeveloped and maintained for the purposes of promotionand advertising of an entity’s products and services totheir potential consumers. On the other hand, thosedeveloped for internal access may be used for displayingcompany policies and storing customer details.With substantial costs being incurred by many entities forwebsite development and maintenance, the need foraccounting guidance became evident. The recentlypromulgated interpretation, SIC 32, concluded that suchcosts represent an internally generated intangible asset thatis subject to the requirements of IAS 38, and that suchcosts should be recognized if, and only if, an enterprisecan satisfy the requirements of IAS 38, paragraph 45.Therefore, website costs have been likened to“development phase” (as opposed to “research phase”)costs.Thus the stringent qualifying conditions applicable to thedevelopment phase, such as “ability to generate futureeconomic benefits,” have to be met if such costs are to berecognized as an intangible asset. If an enterprise is notable to demonstrate how a website developed solely orprimarily for promoting and advertising its own productsand services will generate probable future economicbenefits, all expenditure on developing such a websiteshould be recognized as an expense when incurred.Any internal expenditure on development and operation ofthe website should be accounted for in accordance withIAS 38. Comprehensive additional guidance is provided
in the Appendix to the Interpretation and is summarizedbelow.1. Planning stage expenditures, such as undertakingfeasibility studies, defining hardware and softwarespecifications, evaluating alternative products andsuppliers, and selecting preferences, should be expensed;2. Application and infrastructure development costspertaining to acquisition of tangible assets, such aspurchasing and developing hardware, should be dealt within accordance with IAS 16;3. Other application and infrastructure developmentcosts, such as obtaining a domain name, developingoperating software, developing code for the application,installing developed applications on the web server andstress testing, should be expensed when incurred unlessthe conditions prescribed by IAS 38, paragraphs 19 and45, are met;4. Graphical design development costs, such asdesigning the appearance of web pages, should beexpensed when incurred unless conditions prescribed byIAS 38, paragraphs 19 and 45, are met;5. Content development costs, such as creating,purchasing, preparing, and uploading information on thewebsite before completion of the website’s developmentshould be expensed when incurred under IAS 38,paragraph 57(c), to the extent content is developed toadvertise and promote an enterprise’s own products orservices; otherwise, expensed when incurred, unlessexpenditure meets conditions prescribed by IAS 38,paragraphs 19 and 45;6. Operating costs, such as updating graphics andrevising content, adding new functions, registering websitewith search engines, backing up data, reviewing security
access and analyzing usage of the website should beexpensed when incurred, unless in rare circumstancesthese costs meet the criteria prescribed in IAS 38,paragraph 60, in which case such expenditure iscapitalized as a cost of the website; and7. Other costs, such as selling and administrativeoverhead (excluding expenditure which can be directlyattributed to preparation of website for use), initialoperating losses and inefficiencies incurred before thewebsite achieves planned performance, and training costsof employees to operate the website, should be expensedwhen incurred.This interpretation became effective in March 2002. Theeffects of adopting this Interpretation was to be accountedfor using the transition provisions originally established byIAS 38. For instance, when a website does not meet therequirements of this SIC but was previously recognized asan asset, the item was to be derecognized at the date whenthis SIC becomes effective. If previously capitalized costsare written off due to the imposition of SIC 32, theexpense may be handled under either the benchmark oralternative treatments specified by IAS 8.Disclosure RequirementsThe disclosure requirements set out in IAS 38 forintangible assets and those imposed by IAS 16 forproperty, plant, and equipment are very similar, and bothdemand extensive details to be disclosed in the financialstatement footnotes. Another marked similarity is theexemption from disclosing “comparative information”with respect to the reconciliation of carrying amounts atthe beginning and end of the period. While this may bemisconstrued as a departure from the well-knownprinciple of presenting all numerical information in
comparative form, it is worth noting that it is in line withthe provisions of IAS 1. IAS 1, paragraph 38,categorically states that “(u)nless an InternationalAccounting Standard permits or requires otherwise,comparative information should be disclosed in respect ofthe previous period for all numerical information in thefinancial statements….” (Another standard that contains asimilar exemption from disclosure of comparativereconciliation information is IAS 37—please refer to therelevant chapter of the book for details.)For each class of intangible assets (distinguishing betweeninternally generated and other intangible assets),disclosure is required of1. The amortization method(s) used;2. Useful lives or amortization rates used;3. The gross carrying amount and accumulatedamortization (including accumulated impairment losses) atboth the beginning and end of the period;4. A reconciliation of the carrying amount at thebeginning and end of the period showing additions,retirements, disposals, acquisitions by means of businesscombinations, increases or decreases resulting fromrevaluations, reductions to recognize impairments,amounts written back to recognize recoveries of priorimpairments, amortization during the period, the net effectof translation of foreign entities’ financial statements, andany other material items; and5. The line item of the income statement in which theamortization charge of intangible assets is included.The standard explains the concept of “class of intangibleassets” as a “grouping of assets of similar nature and usein an enterprise’s operations.” Examples of intangible
assets that could be reported as separate classes (ofintangible assets) are1. Brand names;2. Licenses and franchises;3. Mastheads and publishing titles;4. Computer software;5. Copyrights, patents and other industrial propertyrights, service and operating right;6. Recipes, formulae, models, designs and prototypes;and7. Intangible assets under development.The above list is only illustrative in nature. Intangibleassets may be combined (or disaggregated) to report largerclasses (or smaller classes) of intangible assets if thisresults in more relevant information for financialstatement users.In addition, the financial statements should also disclosethe following:1. If the amortization period for any intangibles exceedstwenty years, the justification therefor;2. The nature, carrying amount, and remainingamortization period of any individual intangible asset thatis material to the financial statements of the enterprise as awhole;3. For intangible assets acquired by way of agovernment grant and initially recognized at fair value, thefair value initially recognized, their carrying amount, andwhether they are carried under the benchmark or allowedalternative treatment for subsequent measurement;4. Any restrictions on titles and any assets pledged assecurity for debt; and5. The amount of outstanding commitments for theacquisition of intangible assets.
In addition, the financial statements should disclose theaggregate amount of research and developmentexpenditure recognized as an expense during the period.Examples of Financial Statement DisclosuresNovartis AGFor the Fiscal Year ending December 31, 2002Notes to the consolidated financial statementsIntangible assets. These are valued at their cost andreviewed periodically and adjusted for any diminution invalue as noted in the preceding paragraph. Any resultingimpairment loss is recorded in the income statement ingeneral overheads. In the case of business combinations,the excess of the purchase price over the fair value of netidentifiable assets is recorded as goodwill in the balancesheet. Goodwill, which is denominated in the localcurrency of the related acquisition, is amortized to incomethrough administration and general overheads on astraight-line basis over its useful life. The amortizationperiod is determined at the time of the acquisition, basedupon the particular circumstances, and ranges from five totwenty years. Goodwill relating to acquisitions arisingprior to January 1, 1995, has been fully written off againstreserves.Management determines the estimated useful life ofgoodwill based on its evaluation of the respectivecompany at the time of the acquisition, considering factorssuch as existing market share, potential sales growth andother factors inherent in the acquired company.Other acquired intangible assets are written off on astraight-line basis over the following periods:Trademarks 10 to 15 yearsProduct and marketing rights 5 to 20 years
Software 3 yearsOthers 3 to 5 yearsTrademarks are amortized on a straight-line basis over theestimated economic or legal life, whichever is shorter,while the history of the Group has been to amortizeproduct rights over estimated useful lives of five to twentyyears. The useful lives assigned to acquired product rightsare based on the maturity of the products and the estimatedeconomic benefit that such product rights can provide.Marketing rights are amortized over their useful livescommencing in the year in which the rights first generatesales.9. Intangible asset movementsGoodwill Product and marketing rightsTrademarksSoftware Other intangibles Totals 2002 2001(in CHF millions)Cost, January 1 2,736 4,222 614 85 333 7,990 6,508Consolidation changes 1 -- (11) 49 457 496 752Additions 937 51 13 5 65 1,071 696Disposals(7) (6) (6) (6) (17) (42) (42)Translation effects (399) (330) (95) (9) (58)(891) 76December 31 3,267 3,938 515 124 780 8,624 7,990
Accumulated amortizationJanuary 1(442) (577) (132) (62) (229) (1,442) (678)Consolidation charges (20) (50) (1) (42) (82) (195) (16)Amortization charge (141) (286) (41) (16) (67) (551) (564)Disposals3 2 6 6 26 43 45Impairment charge (369) (102) (18) (6)(495) (216)Translation effects 94 53 25 5 9 186(13)December 31 (875) (960) (161) (109) (349) (2,454) (1,442)Net book value—December 31 2,392 2,978 354 15 431 6,170 6,548The principal additions in both years were goodwill onacquisition and in 2001 pitavastatin marketing rights.In 2002, goodwill impairment charges were recorded ofCHF 369 million mainly related to the Pharmaceuticalsdivision research and biotechnology activities of GeneticTherapy Inc., Systemix Inc., Imutran Ltd., due to changesin the research and development strategy, and relating tothe Medical Nutrition and OTC business units. Themajority of the product and marketing rights impairmentrelated to a CHF 80 million charge to the pitavastatinrights (2001: CHF 216 million).Bayer AktingesellschaftYear ended December 31, 2002
 Intangible assetsAcquired intangible assets other than goodwill arerecognized at cost and amortized by the straight-linemethod over a period of four to fifteen years, dependingon their estimated useful lives. Write-downs are made forimpairment losses. Assets are written back if the reasonsfor previous years’ write-downs no longer apply.Goodwill, including that resulting from capitalconsolidation, is capitalized in accordance with IAS 22(Business Combinations) and amortized on a straight-linebasis over a maximum estimated useful life of twentyyears. The value of goodwill is reassessed regularly basedon impairment indicators and written down if necessary.In compliance with IAS 36 (Impairment of Assets), suchwrite-downs of goodwill are measured by comparison tothe discounted cash flows expected to be generated by theassets to which the goodwill can be ascribed.Self-created intangible assets generally are not capitalized.Certain development costs relating to the applicationdevelopment stage of internally developed software arecapitalized in the Group balance sheet. These costs areamortized over their useful life from the date they areplaced in service.Changes in intangible assets in 2002 were as follows: Acquired concessions, industrial property rights,similar rights and assets, and licenses thereunderAcquired goodwill
Accumulated amortization and write-downs, Dec. 31,20021,966 442--2,408Net carrying amounts, Dec. 31, 2002 5,957 2,864 58 8,879Net carrying amounts, Dec. 31, 2001 3,997 975 42 5,014The exchange differences are the differences between thecarrying amounts at the beginning and the end of the yearthat result from translating foreign companies’ figures atthe respective different exchange rates and changes intheir assets during the year at the average rate for the year.In 2002, as required by the newly implemented SFAS 142,the Group ceased amortization of its goodwill recordedunder IAS, its indefinite-lived intangible asset, the Bayer“Cross” and the pre-1995 goodwill recognized for USGAAP purposes. The adjustment reverses theamortization recorded under IAS for the Group’s IASgoodwill of €11 million.In-process research and developmentIAS does not consider that in-process research anddevelopment (IPR&D) is an intangible asset that can beseparated from goodwill. Under US GAAP it isconsidered to be a separate asset that needs to be writtenoff immediately following an acquisition as the feasibilityof the acquired research and development has not beenfully tested and the technology has no alternative futureuse.
During 2002, IPR&D has been identified for US GAAPpurposes in connection with the Aventis CropScience andVisible Genetics acquisitions. Fair value determinationswere used to establish €133 million of IPR&D for bothacquisitions, which was expensed immediately. Theindependent appraisers used a discounted cash flowapproach and relied upon information provided by Groupmanagement. The discounted cash flow approach uses theexpected future net cash flows, discounted to their presentvalue, to determine an asset’s current fair value.As a whole, the income booked for the reversal of theamortization of IPR&D recorded under IAS as acomponent of other operating expense and selling expenseamounted to €5 million in 2002.