How to Account for Intangible Assets under IAS 38
Many companies incur huge costs from which they expect to benefit in the future.
For example, companies pay salaries to software engineers who develop some game or an application.
Well, how would you treat these costs?
It does not feel OK to put all salaries of these engineers in profit or loss when they are incurred, because the company will benefit from these expenses in the future.
Or, in other words, how my readers love to say it: the costs incurred now will be matched with revenues in the future.
One of the most frequent audit issues that I came across during my good old audit times was the dilemma:
Intangible asset or expense?
And, in my previous article, I covered this dilemma quite extensively with a few illustrations or examples.
But, then I received so many e-mails from you, my dear readers, asking me to cover more principles of accounting for intangibles, not only about distinguishing assets from expenses.
And yes – video!!!
So here we go. In this article, you’ll find the short summary of the main rules in IAS 38 Intangible assets and the video is in the end.
What assets are covered by IAS 38?
The standard IAS 38 prescribes the rules for accounting for all intangible assets except for the intangible assets covered by another standard.
What is excluded? Here you go:
- Deferred tax assets – covered by IAS 12 Income Taxes,
- Goodwill – covered by IFRS 3 Business Combinations,
- Intangible assets held for sale – covered by IFRS 5 Non-Current Assets Held For Sale and Discontinued Operations,
- Financial assets – covered by IAS 32 Financial Instruments: Presentation and IFRS 9 Financial Instruments,
- Exploration and evaluation assets – covered by IFRS 6 Exploration for and Evaluation of Mineral Assets,
- Expenditures for development and extraction of minerals, oils, natural gas and other non-regenerative resources, etc.
What is an intangible asset?
An intangible asset is an identifiable non-monetary asset without physical substance.
That’s the definition from IAS 38, par. 8.
People can interpret this definition in many different ways, just as they need and therefore, IAS 38 contains a good guidance on how to apply it.
Well, I wrote the full article about it, with description of every important characteristic of intangible assets and examples, so please check that out here if you need.
When can we recognize an intangible asset?
Sometimes it can happen that your item meets all the criteria and has all characteristics of an intangible asset, but you still cannot recognize it in your financial statements.
The reason for this situation could be that your item does not meet the recognition criteria.
You can recognize an intangible asset only when:
- Future economic benefits from the asset are probable;
- Cost can be measured reliably.
Again, I strongly recommend checking this article to learn more about the recognition criteria.
When you generate the asset internally…
When you actually purchase some item from someone else, it’s relatively easy to decide whether it’s an intangible asset or an expense.
Also, it’s more probable that the recognition criteria are met.
But, what about the situation when you actually develop intangible assets yourself?
Well, this area is really very complex and tricky and that’s why IAS 38 offers specific guidance for internally generated intangible assets.
Research is investigation that you undertake to acquire some information knowledge or understanding.
For example, you are evaluating different alternatives for your new software product.
Or, you are examining the competing products on the market, studying their features and trying to find their weaknesses in order to design better product.
You CANNOT capitalize any expenditure for research.
You need to expense it in profit or loss as incurred.
And, let me warn you, that yes, all feasibility studies, evaluating whether the project is viable or not, ARE research and need to be EXPENSED in profit or loss.
Yes, also when you paid huge money for it.
This applies to both internal research and research conducted by the external provider, too.
Development usually happens after the research phase.
At the development stage, you actually plan or design the new products, materials, processes, etc. – BEFORE the start of commercial production or use.
It is critical to distinguish development and research, because yes, you CAN CAPITALIZE the expenditures for the development.
But it’s not a free ride.
You have to meet 6 criteria before you can capitalize these expenditures.
If you are preparing yourself for some exam, then the great mnemonic to remember these 6 criteria is PIRATE:
- Probable future economic benefits,
- Intention to complete and use or sell the asset,
- Resources adequate and available to complete and use or sell the asset,
- Ability to use or sell the asset,
- Technical feasibility,
- Expenditures can be reliably measured.
Thank you, unknown genius, to inventing this pirate mnemonic, I used it at my own exam and it worked well!
You can capitalize the expenditures for development only when all 6 criteria are met – not before.
Also, you cannot capitalize it retrospectively.
Just as an example, let’s say that you incurred CU 5 000 for development in May 20X1 and further CU 10 000 in September 20X1.
If you met all the 6 conditions in August 20X1, you can capitalize only CU 10 000 incurred in September. Expenditure of CU 5 000 from May must be expensed in profit or loss.
Never ever capitalize internally generated goodwill.
You can only recognize the goodwill acquired at business combination, but that’s the different story (IFRS 3).
Other internally generated assets
Maybe you have created some other intangible assets, like brands, customer lists, publishing titles, mastheads or similar.
IAS 38 prohibits capitalizing these assets if created internally, because it’s hard if not impossible to measure their cost reliably.
How to measure intangible assets initially?
The initial measurement of an intangible asset depends on how you acquired the asset.
I have summarized it in the following table:
|How acquired?||How initially measured?|
|Separate purchase||Cost – see below|
|Internally generated||Directly attributable costs incurred after the asset first meet 6 PIRATE criteria – see above|
|As a part of business combination||Fair value at the acquisition date|
|By a government grant||Fair value or nominal amount + directly attributable expenditure|
|Within exchange of assets||Fair value; if not possible, then carrying amount of asset given up|
Cost of intangible asset
Cost of a separately acquired intangible asset comprises (IAS 38.27):
- Its purchase price, plus import duties and non-refundable taxes, less discounts and rebates,
- Any directly attributable costs of preparing the asset for its intended use.
I wrote a few articles about the cost of long-term assets, so you can check out this one about directly attributable cost, or this one about capitalizing assets (the part about pre-operating expenses is especially important).
What about the subsequent measurement?
Intangible assets are subsequently measured in a very similar way as property, plant and equipment.
You can chose from 2 models:
- Cost model: The intangible asset is carried at its cost less accumulated amortization (similar as depreciation) less any accumulated impairment loss.
- Revaluation model: The intangible asset is carried at its fair value at the revaluation date less accumulated amortization less any accumulated impairment loss.
Let me just add that the revaluation model is not applied very frequently for intangible assets because there must be an active market – which is rare.
And, you cannot apply the revaluation model for brands, mastheads, patents, trademarks and similar assets.
The reason is that these assets are very specific and unique and there’s no active market.
I will not deal with journal entries of amortization and revaluations, because they are almost the same as with property, plant and equipment, so please check them out in this article.
Journal entries for revaluations are covered also in the video – just scroll down and watch!
Amortization and useful life
Similarly as with property, plant and equipment, amortization is the allocation of depreciable amount of an intangible asset over its useful life.
Here, you need to decide about:
- How much to amortize, or what the depreciable amount is (cost – residual value),
- How long to amortize, or what’s the asset’s useful life, and
- How to amortize, or what amortization method you apply.
However, there’s one specific about the amortization – it is the useful life of intangible assets.
Intangibles can have:
- Finite useful life: In this case you can estimate the life of the asset up front, for example some software, or
- Indefinite useful life: There is no foreseeable limit to period over which the asset will generate cash flows, for example brands.
When you have an asset with indefinite useful life, you do NOT amortize it.
Instead, you should revise the asset’s useful life at the end of each financial year and seek for the indicators of impairment.
When to derecognize intangible assets?
You should derecognize the intangible asset either:
- When you dispose it of, or
- When no more future economic benefits are expected from the asset
The gain or loss on derecognition of intangibles is calculated as:
- Net disposal proceeds, less
- Asset’s carrying amount
Gain or loss are recognized in profit or loss.
Here’s the video with the summary of IAS 38:
Any comments or questions? Please leave me a message below. Thank you!
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