Study Zone

Intangible assets

PQ magazine's resident IFRS expert, tackles IAS 38, which deals with the treatment of intangible assets

Traditionally, lecturers introduce intangible assets as 'assets you can't kick'. All successful companies will have assets that we traditionally class as intangible – that is without physical substance. They include:
* An established list of customers.
* An experienced workforce.
* Strategic location.
* Reputation.
* Good labour relations, etc.
These items and others can contribute to or influence, the value of goodwill (remember, purchased goodwill is covered by IFRS 3).
When asked about IAS 38, if you are going to discuss goodwill make sure it is internally generated goodwill – not purchased goodwill you are discussing. The accounting rule is simple: the standard does not allow you to include internally generated goodwill as an asset on the balance sheet – period.
Other transactions you could discuss when answering IAS 38 questions would include expenditure incurred on stuff like patents, brands, advertising, training, software, licences, etc, and assets you have purchased without physical substance (things you can't kick!). The standard prescribes the treatment of intangible assets that are not dealt with specifically by other standards. Intangibles can only be recognised if certain criteria are met.

Transactional example
Lockwood Inc has introduced a new razor to their men's toiletry range. It decided to hire the services of the famous motorcyclist-turned-rock star, Christopher Swallow, to head up their advertising campaign. They are paying $3,000,000 and they believe the benefit from this promotion will last three years. They are planning to spread his fee over the next three years, recognising the rest as an intangible asset. It will not be possible to treat these costs as an asset. The standard is clear that costs of introducing new products or services such as advertising cannot be included. The costs will have to be expensed immediately.
Accounting practice
Intangibles should be recognised if, and only if, the following criteria are met:
* It is probable that the future economic benefits will flow to the enterprise.
* The cost of the asset can be measured reliably.
It is important to recognise the difference between internally generated intangibles and purchased intangibles.

Internally generated
intangible assets
Problems arise with these because of the need, as above, to identify a probable future economic benefit and in reliably determining its cost. For this reason the standard does not allow internally generated goodwill to go on the balance sheet as an asset. The same issue arises if you are being asked about other internally generated intangibles such as brands, mastheads, publishing titles, customer lists and similar items – you cannot put them on the balance sheet as an asset.
All internally generated intangibles must be treated as either research or development costs.
Costs for assets in the research phase must be charged to the income statement, whilst those in the development phase must be capitalised if criteria are met. The criteria for capitalising internally generated intangibles are:
* Technically feasible.
* Intention to complete and use or sell the asset.
* Ability to use or sell the asset.
* Existence of a market or demonstration of usefulness of intangible.
* Availability of technical, financial or other resources to complete the asset.
* Measure the cost reliably.

Purchased intangibles
For purchased intangibles the probability criteria is always met and therefore they are recognised on the balance sheet, albeit subject to an impairment review.
For intangibles acquired in a business combination there is an assumption that the probability criteria is met, and there is always information to measure the cost separately from goodwill. This means the following sorts of intangibles (plus others) must be recognised separately from goodwill:
* Customer lists.
* In progress R&D.
* Employment contracts below market rate.
* Order or production backlogs.
Intangible assets should be amortised over their useful economic lives. If no amortisation is charged because the life is indefinite the asset must be subject to an annual impairment review. Intangibles can be revalued only if an active market exists for the asset (very rare).
Conclusion
It is necessary to have an accounting standard on intangibles. Without one we got situations such as the 1988 accounts of Rank Hovis McDougall, a UK company. They decided back in 1988 to bring more than 50 of their internally developed brand names, such as 'Hovis', onto the balance sheet. They came up with the figure of £678 million and, hey presto, increased net asset value per share from 83p to 272p. Although other UK companies had purchased brand names and capitalised them on the balance sheet, this was the start of a new trend – capitalising internally generated brands. There was no accounting standard at the time to prevent such a practice. IAS 38 provides such a standard.
* Clare Finch is a top tutor at Kaplan Financial

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