FINANCIAL ACCOUNTING AND REPORTING
INTANGIBLE ASSETS
Definitions
Intangible
asset
|
An identifiable nonmonetary asset without physical substance.
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Amortization
|
The systematic allocation of the depreciable amount of an intangible
asset over its useful life.
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Cost
|
The amount of cash or cash equivalents paid or the fair value of
other consideration given to acquire an asset at the time of its acquisition
or construction, or, when applicable, the amount attributed to that asset
when initially recognized in accordance with the specific requirements of
other PFRSs.
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Fair
value
|
The amount for which that asset could be exchanged between
knowledgeable, willing parties in an arm’s length transaction.
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Monetary
assets
|
Money held and assets to be received in fixed or determinable amounts
of money.
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Research
|
Original and planned investigation undertaken with the prospect of
gaining new scientific or technical knowledge and understanding.
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Development
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The application of research findings or other knowledge to a plan or design
for the production of new or substantially improved materials, devices,
products, processes, systems or services before the start of commercial
production or use.
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Two important aspects of the definition
of an Intangible Asset are:
(a) Is
separable, it is capable of being separated or divided from the entity and
sold, transferred, licensed, rented or exchanged, either individually or
together with a related contract, asset or liability OR
(b) Arises from contractual or other legal rights,
regardless of
whether those rights are transferable or separable from the entity or from
other rights and obligations.
II. Inherent characteristics of assets are:
(a) Control - An entity controls an asset if
the entity has the power to obtain the future economic benefits flowing from
the underlying resource and to restrict the access of others to those
benefits.
(b) Future
Economic Benefits - The future economic benefits flowing from an intangible asset may include
revenue from the sale of products or services, cost savings, or other benefits
resulting from the use of the asset by the entity.
(c) Cost – An asset
shall only be recognized if its cost or value can be measured reliably.
KEY OBSERVATIONS
Ø
Identifiability is the major reason
why internally generated goodwill is not recognized as an asset. Aside from lacking control and unmeasurable
cost of goodwill.
Ø
Control is the reason why
internally generated brands and the skills of employees arising from training
or experience is not an asset. However,
cost also plays a major role in its non recognition.
Recognition and Initial Measurement
Ø An enterprise to
recognize an intangible asset, whether purchased or self-created AT COST if, and only if:
·
It
is probable that the future economic benefits that are attributable to the
asset will flow to the enterprise; and
·
The
cost of the asset can be measured reliably.
Initial Measurement and Subsequent
Expenditures
Ø Intangible assets are
initially measured at cost.
Ø Subsequent expenditure
on an intangible asset after its purchase or completion should be recognized as
an expense when it is incurred
Ø However in very rare
cases that it is probable that this expenditure will enable the asset to
generate future economic benefits in excess of its originally assessed standard
of performance and the expenditure can be measured and attributed to the asset
reliably.
Internally
Generated Intangible Assets
I.
It is sometimes
difficult to assess whether an internally generated intangible asset qualifies
for recognition because of problems in
(a) Identifying
whether and when there is an identifiable asset that will generate expected
future economic benefits;
(b) Determining
the cost of the asset reliably. In some
cases, the cost of generating an intangible asset internally cannot be
distinguished from the cost of maintaining or enhancing the entity’s internally
generated goodwill or of running day-to-day operations.
II.
To assess whether an internally generated
intangible asset meets the criteria for recognition, an entity classifies the
generation of the asset into:
(a) A research phase (b) A
development phase
III. If an entity cannot distinguish the research phase
from the development phase of an internal project to create an intangible
asset, the entity treats the expenditure on that project as if it were incurred
in the research phase only.
Research Phase
I.
No intangible asset arising from
research (or from the research phase of an internal project) shall be
recognized. Expenditure on research (or
on the research phase of an internal project) shall be recognized as an expense
when it is incurred.
II.
In the research
phase of an internal project, an entity cannot demonstrate that an intangible
asset exists that will generate probable future economic benefits. Therefore, this expenditure is recognized as
an expense when it is incurred.
III.
Examples of
research activities are:
(a) Activities aimed at obtaining
new knowledge
(b) The search for, evaluation
and final selection of, applications of research findings or other knowledge
(c) The search for alternatives
for materials, devices, products, processes, systems or services
(d) The formulation, design,
evaluation and final selection of possible alternatives for new or improved
materials, devices, products, processes, systems or services.
Development Phase
I.
An intangible asset arising from
development (or from the development phase of an internal project) shall be
recognized if, and only if, an entity can demonstrate all of the following:
(a) The technical feasibility of completing the
intangible asset so that it will be available for use or sale.
(b) Its intention to complete the intangible asset
and use or sell it.
(c) Its ability to use or sell the intangible
asset.
(d) How the intangible asset will generate
probable future economic benefits. Among
other things, the entity can demonstrate the existence of a market for the
output of the intangible asset or the intangible asset itself or, if it is to
be used internally, the usefulness of the intangible asset.
(e) The availability of adequate technical,
financial and other resources to complete the development and to use or sell
the intangible asset.
(f) Its ability to measure reliably the
expenditure attributable to the intangible asset during its development.
II. In the development phase of an internal project, an
entity can, in some instances, identify an intangible asset and demonstrate
that the asset will generate probable future economic benefits. This is because the development phase of a
project is further advanced than the research phase.
III. Examples of development activities are:
(a) The design,
construction and testing of pre-production or pre-use prototypes and models;
(b) The design
of tools, jigs, moulds and dies involving new technology;
(c) The design,
construction and operation of a pilot plant that is not of a scale economically
feasible for commercial production; and
(d) The design,
construction and testing of a chosen alternative for new or improved materials,
devices, products, processes, systems or services.
IV. Internally generated brands, mastheads, publishing titles, customer
lists and items similar in substance shall not be recognized as intangible
assets.
V.
Expenditure on
internally generated brands, mastheads, publishing titles, customer lists and
items similar in substance cannot be distinguished from the cost of developing
the business as a whole. Therefore, such
items are not recognized as intangible assets.
Measurement Subsequent
to Acquisition
Cost model. After initial
recognition the benchmark treatment is that intangible assets should be carried
at cost less any amortization and impairment losses.
Revaluation model. Intangible assets
may be carried at a revalued amount (based on fair value) less any subsequent
amortization and impairment losses only if fair value can be determined by
reference to an active market. Such active markets are expected to be uncommon
for intangible assets.
Classification of
Intangible Assets Based on Useful Life
Intangible assets are classified as:
·
Indefinite life: No
foreseeable limit to the period over which the asset is expected to generate
net cash inflows for the entity.
·
Finite life: A limited
period of benefit to the entity.
Measurement Subsequent
to Acquisition of Intangible Assets with Finite Lives
The cost less residual value of an intangible asset with a finite
useful life should be amortized over that life:
- The
amortization method should reflect the pattern of benefits.
- If
the pattern cannot be determined reliably, amortize by the straight-line
method.
- The
amortization charge is recognized in profit or loss unless another PFRS
requires that it be included in the cost of another asset.
- The
amortization period should be reviewed at least annually.
·
The
asset should also be assessed for impairment in accordance with PAS 36.
Measurement Subsequent
to Acquisition of Intangible Assets with Indefinite Lives
·
An
intangible asset with an indefinite useful life should not be amortized.
·
Its
useful life should be reviewed each reporting period to determine whether
events and circumstances continue to
support an indefinite useful life assessment for that asset. If they do not, the change in the useful life
assessment from indefinite to finite should be accounted for as a change in an
accounting estimate.
·
The
asset should also be assessed for impairment in accordance with PAS 36.
Key Principles on Certain Intangible Assets
Patents
·
An exclusive right granted by the government to an
inventor to control the manufacture, use or sale of an invention
·
Cost – Licensing and registration fees only for APPLIED
AND REGISTERED patents and purchase price and any directly attributable
expenditure necessary in preparing the asset for its intended use for PURCHASED
PATENTS.
·
Principles on amortization:
§ Amortization is based
on the useful life or legal life (20 years), which ever is shorter.
§ If a competing patent
is acquired to protect an original patent.
The cost of the new patent and the carrying amount of the original
patent is amortized over the remaining life of the original patent.
§ If a related patent
is acquired to extend the life of an existing patent. The cost of the new patent and the carrying
amount of the original patent is amortized over the extended period, unless if
the remaining life of the new patent is shorter than the extended period.
Goodwill
·
An
unidentifiable intangible asset that allows an enterprise to earn above normal
income how
·
It
is only purchased goodwill that is recognized as an asset which is the cost in
excess of the fair value of the net assets acquired in a business combination. This the premium paid in acquiring another
business or ordinary shares when control is achieved. Countless of times goodwill is referred to as
BADWILL because seemingly the purchaser had gotten fleeced in the sale of the
net assets of the seller.
·
Internally generated goodwill shall not be
recognized as an asset.
·
Impairment of goodwill is discussed in Hand Out #22
·
Methods
of estimating goodwill
Ø
Capitalization
of “average excess earnings”
Ø
Capitalization
of “average earnings”
Ø
Purchase
or multiples of “average excess
earnings”
Ø
Present
value of “average excess earnings”
EXAMPLE :
Lets
assume that a buyer is planning to buy the business of a competitor. The
cumulative net earnings for the past 5 years was P18,000,000. The current value
of net assets of the seller was 10,000,000 only. Meaning if the buyer is able to acquire the
assets and assume the liabilities at fair value, the purchase price would only
be 10,000,000. But let us say that buyer will account for the past performance
of the seller and determine it as a contributor to additional income in the
future from the purchase of the seller’s business. Goodwill is determined by the
following assuming a 20 percent rate of return and a 25% capitalization rate?
Average earnings
(18M / 5)
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3,600,000
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Less: Normal
earnings (10M x 20%)
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2,000,000
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Excess earnings or
earnings from goodwill
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1,600,000
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Capitalized at 25%
or divided by
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25%
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Goodwill
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6,400,000
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Ø The purchase price
will then be 16,400,000 which is the price at fair value plus the goodwill
added to the fair value.
Ø A multiplier of let’s
say 3 years if the “multiples of
excess earnings” is used or a PV factor of 3.17 if the discount rate is 10%
and 4 periods shall be used to compute for goodwill if for example the “PV of
excess earnings” will be used.
|
|
Average earnings
(18M / 5)
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3,600,000
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Capitalized at 25%
or divided by
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25%
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Purchase price
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14,400,000
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Ø Remember from above
that 2M came from the net assets and 1.6M came from goodwill. That’s why if you add the two together the
3.6M comes from the net assets with the goodwill or simply the purchase
price.
|
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Trademark
·
An
exclusive right granted by the government that permits the use of distinctive
symbols, labels, and designs associated with the product or the organization.
·
Cost
– Licensing and registration fees only for developed trademarks Cost of research,
survey, design and development cost is expensed.
·
The
legal life of a trademark is 10 years however it may be renewed for an
additional 10 year period for an unlimited number of times. Therefore the legal life of a trademark is
indefinite and is not subject to amortization but instead tested for
impairment.
·
Computer Software
·
IF
the software is an integral part
of the hardware for example the operating system of the PC, the cost of the
software shall be included in hardware cost
·
Internally
developed (whether for use or sale) charge
to expense until technological feasibility is achieved
·
Cost
to develop the software shall be capitalized once technological feasibility is
reached either from the creation of a “working model or a detailed program
design”. Probable future benefits, intent and ability to use or sell the
software, resources to complete the software, and ability to measure cost are
also requirements for capitalization.
·
Development
activities have concluded and commercial production shall commence once the
final or “beta” version of the software has been produced. In accounting specially in US GAAP, the final
version is known as the “product master”
·
The
amortization method for computer software should reflect the pattern in which
the asset’s future economic benefits are expected to be consumed by the
entity. If such pattern cannot be
determined reliably, the straight-line method is used.
Leasehold
Improvements
Ø Permanent upgrading
on leased property under an operating lease.
Ø This is a tangible
asset by nature, however classified as an intangible asset because its an asset
where the ownership is not with the lessee who constructed or added the cost to
the leased property but ownership is with the lessor since the improvements
cannot be detached or taken by the lessee at the expiration of the
leaseterm. This will be subject to
amortization.
Ø If the lease contract
is nonrenewable, the LHI is simply amortized using the shorter period between
the remaining leaseterm and the useful life of the LHI.
Ø If the lease is
renewable, the additional period shall be added to the remaining leaseterm if
the extention option has already been
exercise or the intention to
renew is certain. This total
period will be the one compared to the life of the LHI.
Ø As you can imagine,
this topic is a source of “changes in accounting estimates”.
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