IAS 38 Intangible assets – Best complete read

IAS 38 intangibles

are identifiable non-monetary assets without physical substance.

Intangibles can be grouped into three broad categories — rights, relationships and intellectual property:

1. Rights. Leases, distribution agreements, employment contracts, covenants, financing arrangements, supply contracts, licences, certifications, franchises.
2. Relationships. Trained and assembled  workforce, customer and distribution relationships.
3. Intellectual property. Patents; copyrights; trademarks; proprietary technology (for example, formulas, recipes, specifications, formulations, training programs, marketing strategies, artistic techniques, customer lists, demographic studies, product test results); business knowledge — such as suppliers’ lead times, cost and pricing data, trade secrets and know-how.

Internally generated intangibles cannot be disclosed on the balance sheet, but are often significant in value, and should be understood and managed appropriately. Under IFRS 3, only intangibles that have been acquired can be separately disclosed on the acquiring company’s consolidated balance sheet (disclosed intangibles).

Intangible value

The following diagram illustrates how intangible value is made up of both disclosed and undisclosed value.

‘Undisclosed intangibles’, are often more valuable than the disclosed intangibles. The category includes ‘internally generated goodwill’, and it accounts for the difference between the fair market value of a business and the value of its identifiable tangible and intangibles.

Examples of intangibles

Although not an intangible asset in a strict sense — that is, a controlled ‘resource’ expected to provide future economic benefits — this residual goodwill value is treated as an intangible asset in a business combination on the acquiring company’s balance sheet. Current accounting practice does not allow for internally generated intangibles to be disclosed on a balance sheet. Under current IFRS only the value of acquired intangibles can be recognised.

Marketing related intangibles	Customers related intangibles	Contracts related intangibles	Technology related intangibles	Artistic related intangibles
Trademarks, trade names Service marks, collective marks, certification marks Trade dress (unique colour, shape, or package design) Newspapers Internet domain names Mastheads Non-competition agreements	Customer lists Order or production backlog Customer contracts & related customer relationships Non-contractual customer relationships	Licensing, royalty, standstill agreements Advertising, construction, management, service or supply contracts Lease agreements Construction permits Permits Franchise agreements Operating and broadcasting rights Use rights such as drilling, water, air, mineral, timber cutting & route authorities Servicing contracts such as mortgage servicing contracts Employment contracts	Patented technology Computer software and mask works Unpatented technology Databases Trade secrets, such as secret formulas, processes, recipes (think of Coca Cola)	Plays, operas and ballets Books, magazines, newspapers and other literary works Musical works such as compositions, song lyrics and advertising jingles Pictures and photographs Video and audio-visual material including films, music, videos, etc.

Identifiable intangibles

An intangible asset is ‘identifiable’ if it:

• is separable: i.e. 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
• 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 [par 12].

Therefore, intangibles that may be recognised on a balance sheet under IFRS are only a fraction of what are often considered to be ‘intangibles’ in a broader sense.

However, the picture has improved since 2001, when IFRS 3 in Europe, and FAS 141 in the US, started to require companies to break down the value of the intangibles they acquire as a result of a takeover into five different categories — including customer- and market related intangibles — rather than lumping them together under the catch-all term ‘goodwill’ as they had in the past.

But because only acquired intangibles, and not those internally generated, can be recorded on the balance sheet, this results in a lopsided view of a company’s value. What is more, the value of those assets can only stay the same or be revised downwards in each subsequent year, thus failing to reflect the additional value that the new stewardship ought to be creating.

Search for intangibles

In identifying potential intangibles, the search is through the profit or loss expense accounts, the link between potential intangibles and profit or loss expenses is as follows:

Potential intangibles	Profit or loss expense accounts
Patents and licenses	Scientific research expenditure
Copyright	Expenses of preparing for production
Computer software	Self-created enterprise business reputation
Entitlement to the production samples	Expenses for customer, market etc. data bases
Development and experimental costs	Advertising, marketing expenses
Costs for preparation of site for objects of nature	Expenses for training of staff
Trading brands and trademarks acquired externally	Expenses for enterprise restructuring or relocation
Measurement of business reputation acquired at takeover of enterprise or their units	Trading brands and trademarks developed by the enterprise
Entitlement to motion pictures or creation and distribution of other video and audio works

Research and development expenses

In order to recognise an item of intangibles generated internally it is subdivided into the research and development phase (stage). Intangible resources arising from the research phase are not recognised as intangibles. Any research costs are recognised as expenses for the reporting period when incurred. An approximate comparison of the research and development stages is given below.

Research stage

Development stage

‘Research’ is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. [par 8] An activity aimed at the acquisition of new knowledge; Search for the research results and for other types of application of the knowledge, their assessment and selection; Search for alternative raw materials, devices, processes, products, systems and services; Consultation, assessment and final selection of possible alternatives for new or advanced raw materials, processes, etc.

‘Development’ is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. Development does not include the maintenance or enhancement of ongoing operations. [par 8] Designing, construction and performance evaluation of production samples and models; Designing of tools, templates, forms and matrices for new or upgraded technologies; Designing and operating of and consultations in respect of new experimental equipment which is not suitable for mass production; Designing, construction and performance evaluation of the alternative raw materials, equipment, products etc.

If an internally generated intangible asset arises from the development phase of a project, then directly attributable expenditure is capitalised from the date on which the entity is able to demonstrate:

• the technical feasibility of completing the intangible asset so that it will be available for use or sale;
• its intention to complete the intangible asset and use or sell it;
• its ability to use or sell the intangible asset;
• how the intangible asset will generate probable future economic benefits;
• the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
• its ability to measure reliably the expenditure attributable to the intangible asset during its development. [par 57]

In-process research and development (R&D) acquired in a business combination is recognised initially at fair value. Subsequent to initial recognition, the intangible asset is accounted for following the general principles outlined in this chapter. [par 33–34]

In-process R&D acquired in a separate acquisition is recognised and initially measured at cost. In-process R&D acquired with a group of assets that does not constitute a business is recognised and measured based on its relative fair value in relation to the cost of the group of assets as a whole. [IFRS 3.2(b), par 8, IAS38.24, par 26]

Cryptocurrency

Holdings of a cryptocurrency (i.e. digital or virtual currency that is recorded in a distributed ledger and is not issued by a jurisdictional authority or other party) meet the definition of an intangible asset. If cryptocurrencies are held for sale in the ordinary course of business, then the entity applies the inventories standard.

Software developed for sale

There are no special requirements for software developed for sale. The costs of such software are accounted for following the general principles for internally generated intangibles. [par 57]

Internal-use software

There are no special requirements for the development of internal-use software. The costs of such software are accounted for under the general principles for internally generated intangibles or, in the case of purchased software, following the general requirements for intangibles. [par 57]

Website development costs

Costs associated with websites developed for advertising or promotional purposes are expensed as they are incurred. In respect of other websites, costs incurred during the planning stage (pre-development) are expensed when they are incurred; costs incurred during the application and infrastructure development stage, the graphical design stage and the content development stage are capitalised if the criteria for capitalising development costs are met (see above). The costs of developing content for advertising or promotional purposes are expensed as they are incurred. [SIC-32.8–9]

Cloud computing

An entity entering into a cloud computing arrangement assesses whether it receives a software asset or a service over the contract term. It receives a software asset if:

• the arrangement contains a software lease under the guidance in the leases standard (see Focus on Leases); or
• it otherwise obtains control of the software under the guidance in the standard on intangibles (see above). [IU 03-19]

If the arrangement does not contain a software lease or provide a software intangible asset, then it is a service contract and the entity expenses the cost as the services are received. [IU 03-19]

Initial recognition and measurement

An intangible asset is recognised when:

• it is probable that future economic benefits that are attributable to the asset will flow to the entity; and
• the cost of the asset can be measured reliably. [par 21]

If an intangible asset is acquired in a business combination, then these criteria are assumed to be met. If an intangible asset is acquired in a separate acquisition (i.e. outside a business combination), then the ‘probability’ criterion is assumed to be met and the ‘reliable measurement’ criterion is usually met. [par 25–26, 33]

An intangible asset separately aqcuired is recognised initially at cost. [par 24] The cost of an intangible asset acquired in a business combination is its fair value at acquisition. [IFRS 3.18, par 33] An intangible asset acquired for defensive purposes rather than for active use may also meet the above recognition criteria.

The cost of an intangible asset acquired in a separate acquisition is the cash paid or the fair value of any other consideration given plus transaction costs. [par 8, par 27]

If payment is deferred beyond normal credit terms, then the cost of the asset is the cash price equivalent, which may be different from the cash flows discounted using a market rate of interest. [par 32]

Amortisation

The useful life of intangibles other than goodwill is either finite or indefinite. intangibles with indefinite useful lives are not amortised, but instead are subject to impairment testing at least annually (see Impairment of non-financial assets). [IAS 36.10, par 89, IAS38.107–110]

An intangible asset has an ‘indefinite’ useful life if, based on an analysis of all relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. [par 88–90]

An intangible asset with a finite life is amortised on a systematic basis over its useful life. [par 97]

There is no specific guidance on the amortisation of defensive intangibles (see above) and the general principles apply. Accordingly, such assets are not written off immediately but are amortised over their useful lives and tested for impairment within the relevant CGU (see Impairment of non-financial assets).

Useful life

A change in useful life is accounted for prospectively as a change in accounting estimate (see Accounting policies errors and estimates). The amortisable amount of an intangible asset with a finite useful life is determined after deducting its residual value. The residual value of an intangible asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were of the age and in the condition expected at the end of its useful life. [par 8, par 101, par 104]

If control of an intangible asset is based on legal rights that have been granted for a finite period, then the useful life cannot exceed that period unless:

• the legal rights are renewable;
• there is evidence to support the conclusion that they will be renewed; and
• the cost of renewal of such rights is not significant. [par 94–96]

Residual value

The residual value of an intangible asset with a finite useful life is assumed to be zero unless a third party has committed to buy the asset at the end of its useful life or there is an active market from which a residual value can be obtained and it is probable that such a market will exist at the end of the asset’s useful life. [par 100]

The residual value of an intangible asset is reviewed at least at each annual reporting date. A change in the asset’s residual value is accounted for prospectively as a change in accounting estimate (see Accounting policies errors and estimates). [par 102]intangibles

Valuation of a brand

One of the most frequently used valuation model to perform a valuation of a brand is the relief from royalty method.

The ‘Royalty Relief’ (also known as Relief from Royalty) method is based on the notion that a brand holding company owns the brand and licenses it to an operating company. One method to determine the market value of Intellectual Property assets like patents, trademarks, and copyrights is to use Relief from royalty method (also known as Royalty avoidance approach or Royalty Relief approach). This approach determines the value of Intellectual Property assets by estimating what it would cost the business if it had to purchase the Intellectual Property (IP) it uses from an outsider. Other valuation methods are provide here.

This approach requires the valuation specialist to:

1. project future sales of the products that use the technology,
2. determine an appropriate reasonable royalty rate, and
3. determine either a present value factor or an appropriate discount rate.

The result is the present value of the Intellectual Property to the company.

The notional price paid by the operating company to the brand company is expressed as a royalty rate. The Net Present Value (NPV) of all forecast royalties represents the value of the brand to the business.

Example – Brand valuation

The attraction of this method is that it is based on commercial practice in the real world. It involves estimating likely future sales, applying an appropriate royalty rate to them and then discounting estimated future, post-tax royalties, to arrive at an NPV.

The ‘Royalty Relief’ method is used for 2 reasons:

1. It is favored by tax authorities and the courts because it calculates brand values by reference to documented, third-party transactions
2. It can be done based on publicly available financial information.

Steps in the Royalty Relief brand valuation process:

• Obtain brand-specific financial and revenue data,
• Model the market to identify market demand and the position of individual brands in the context of market competitors,
• Establish the notional royalty rate for each brand,
• Calculate the notional future royalty income stream for each brand,
• Calculate discount rate specific to each brand, taking account of its size, international presence, reputation, and Brand Rating,
• Discount future royalty stream to a net present value (NPV), which represent the fair value of the tradename/brand.

Calculation: IFRS 13 Relief from royalty method

WARA = Weighted Average Return on Assets

Disclosure acquired intangibles

ITV plc Annual Report and Accounts for the year ended 31 December 2014

Other intangibles intangibles other than goodwill are those which are identifiable and can be sold separately or which arise from legal rights. Within ITV there are two types of intangibles: those acquired and those that have been internally generated (such as software licences and development). intangibles acquired directly by the Group are stated at cost less accumulated amortisation. Those separately identified intangibles acquired as part of a business combination are shown at fair value at the date of acquisition less accumulated amortisation. The main intangibles the Group has valued are brands, licences, contractual arrangements, customer contracts and relationships and libraries. Each class of intangible asset’s valuation method on initial recognition, amortisation method and estimated useful life is set out in the table below:

IAS 38

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