B331 Tutorial 2 (2015)

HKAS 38 Intangible Assets

1. Definitions

An intangible asset is an identifiable non-monetary asset without physical substance held

for use in the production or supply of goods or services, for rental to others, or for
administrative purposes.

Research is original and planned investigation undertaken with the prospect of gaining
new scientific or technical knowledge and understanding.

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 prior to the commencement of commercial production or
use.

2. An intangible asset should be recognised if, and only if :

a) it is probable that the future economic benefits that are attributable to the
asset will flow to the enterprise; and
b) the cost of the asset can be measured reliably.

3. An intangible asset should be measured initially at cost.

Internally Generated Assets

4. Internally generated goodwill, brands, publishing titles, customer lists and items
similar in substance should not be recognised as an asset.

Internally Generated Intangible Assets

Research Phase
5. No intangible asset arising from research (or from the research phase of an
internal project) should be recognised. Expenditure on research (or on the
research phase of an internal project) should be recognised as an expense when it
is incurred. Examples of other expenditure that will not give rise to an intangible
asset include :
 expenditure on starting up an operation or a business (start-up costs)
 expenditure on training
 expenditure on advertising and/or promotion
 expenditure on relocating or re-organising part or all of an enterprise
Development Phase
6. An intangible asset arising from development (or from the development phase of
an internal project) should be recognised if, and only if, an enterprise can
demonstrate all of the following :
a) the technical feasibility of competing 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 enterprise should 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; and
f) its ability to measure the expenditure attributable to the intangible asset during
its development reliably.

7. Expenditure on an intangible item should be recognised as an expense when it is

incurred unless :
a) it forms part of the cost of an intangible asset that meets the recognition
criteria or
b) the item is acquired in a business combination that is an acquisition and
cannot be recognised as an intangible asset. If this is the case, this
expenditure (included in the cost of acquisition) should form part of the
amount attributed to goodwill (negative goodwill) at the date of
acquisition

8. Subsequent expenditure on an intangible asset after its purchase or its

completion should be recognised as an expense when it is incurred unless :
a) 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
b) this expenditure can be measured and attributed should be added to the
cost of the intangible asset.

Measurement Subsequent to Initial Recognition

Benchmark Treatment
11. After initial recognition, an intangible asset should be carried at its cost less any accumulated
amortisation and any accumulated impairment losses.

Allowed Alternative Treatment

12. After initial recognition, an intangible asset should be carried at a revalued amount, being
its fair value at the date of the revaluation less any subsequent accumulated amortisation
and any subsequent accumulated impairment losses. For the purpose of revaluations under
this Standard, fair value should be made with sufficient regularity such that the carrying
amount does not differ materially from that which would be determined using fair value at
the balance sheet date.

13. If an intangible asset is revalued, all the other assets in its class should also be revalued,
unless there is no active market for those assets.
14. If an intangible asset in a class of revalued intangible assets cannot be revalued because
there is no active market for this asset, the asset should be carried at its cost less any
accumulated amortisation and impairment losses.

15. If the fair value of a revalued intangible asset can no longer be determined by reference to an
active market, the carrying amount of the asset should be its revalued amount at the date of
the last revaluation by reference to the active market less any subsequent accumulated
amortisation and any subsequent accumulated impairment losses.

Amortisation Period

16. The depreciable amount of an intangible asset should be allocated on a systematic basis over
the best estimate presumption that the useful life of an intangible asset will not exceed
twenty years from the date when the asset is available for use. Amortisation should
commence when the asset is available for use.

17. If control over the future economic benefits from an intangible asset is achieved through
legal rights that have been granted for a finite period, the useful life of the intangible asset
should not exceed the period of the legal rights unless :
a) the legal rights are renewable; and
b) renewal is virtually certain.

Amortisation Method

18. The amortisation method used should reflect the pattern in which the asset’s economic
benefits are consumed by the enterprise. If that pattern cannot be determined reliably, the
straight-line method should be used. The amortisation charge for each period should be
recognised as an expense unless another International Accounting Standard permits or
requires it to be included in the carrying amount of another asset.

Residual Value

19. The residual value of an intangible asset should be assumed to be zero unless :
a) there is a commitment by a third party to purchase the asset at the end of its useful
life; or
b) there is an active market for the asset and :
(i) residual value can be determined by reference to that market; and
(ii) it is probable that such a market will exist at the end of the asset’s useful
life.

Retiremens and Disposals

22. An intangible asset should be derecognised (eliminated from the balance sheet) on
disposal or when no future economic benefits are expected from its use and subsequent
disposal.

23. Gains or losses arising from the retirement of disposal of an intangible asset should be
determined as the difference between the net disposal proceeds and the carrying amount
of the asset and should be recognised as income or expense in the income statement.
Case Study – Case 1
OU Motor Ltd started a project in January 2007 to develop an autopilot system to be used
in private motor cars. If successful, the computer will drive the car to the destination
automatically so long as the destination is inputted into the autopilot system. In January
2007, the company spent $300,000 to do some preliminary R&D. At this point, there was
no indication that the project would be commercially feasible.

In February 2007 and March 2007, the company spent $900,000 in some further R&D
and built an initial prototype.

In April 2007, the prototype crashed during a road test. Between April 2007 and July
2007, the company spent $500,000 in additional R&D and built another prototype.

During August 2007, the new prototype successfully completed a road test. Although the
prototype still had a number of major engineering problems, the Engineering Department
was convinced that they had a product that they would be able to sell.

Between September 2007 and October 2007, the company spent $200,000 to rectify the
engineering problems.

In November 2007, the final model emerged and the company spent $5,000 to apply for a
patent. The patent had a useful life of 3 years, but can be extended for another 3 years
upon the filing of an application form and fee.

In December 2007, the company spent another $50,000 to rectify some remaining minor
engineering problems.

Required:

Explain how you would treat each of the expenses in the above question.

Guidelines

˙ January 2007 to March 2007: $___________ expensed immediately because the

project was not yet commercially and/or technologically feasible and the company
was not yet convinced that it has a product that it can sell.

˙ April 2007 to October 2007: $____________ expensed immediately because the

company is not yet able to measure the cost of the auto-pilot system reliably due
to the major engineering problems, despite the company now has intention to
complete and sell.

˙ November 2007 to December 2007: $___________ can be capitalized because the

company now should be able to meet all the criteria for capitalization. The
company should be able to measure the cost of the system despite minor
engineering problems.
Case Study – Case 2

Year End Closing at Open Ltd

Open Ltd is a famous swimming suit manufacturer in Hong Kong. You are the
accounting manager of this company. Two weeks ago, you submitted the draft financial
statement for the year to CEO. The CEO and a non-executive director called up a
meeting to discuss the following issues with you.

R&D of SSpeed Fiber

Open Ltd’s fashion lab started the development of a new fiber (SSpeed) for the
swimming suits. This new fiber allowed the swimmers to swim faster and would be 10
times more durable than the existing materials. The R&D expenditure in the period to 31
March 2010 was:

Period from Expenditure type $m

1 Jun 2009 - 31 Aug 2009 Research on SSpeed 12
1 Sep 2009 – 30 Nov 2009 Prototype clothing and goods design 16
1 Dec 2009 - 31 Jan 2010 Staff costs in refinement of products 8
1 Feb 2010 – 28 Feb 2010 Development work undertaken to finalize 20
design of product
1 March 2010 – 31 March 2010 Production and launch of products 24
Total: 80

On 1 September 2009, the research of the new fiber was completed and the company
could use it for producing new sportswear.

The cost of the production and launch of the products include the cost of upgrading the
existing machine ($12m, net of depreciation), market research costs ($8m) and staff
training cost ($4m).

The CEO believed that all expenditures are related to the new research and insisted to
show $80m intangible asset in the financial statements for the year ended 31 March 2010.
Required:

(a) Do you agree with the CEO’s treatment on the R&D expenditures of the new
fiber?

(b) Provide extracts of financial statements showing the R&D and related
expenditures.

Please explain the rationale behind your answer.

(a)

CEO’s recommendation did not meet the requirements of HKFRS.

HKAS 38 requires that during the research phase, all expenditures incurred should be
expensed immediately in the income statement.
The cost of upgrading the existing machine can be capitalized as PPE under HKAS
16.

(b)

All the expenditures in the research phase should be expensed.

As for the expenditures in the development phase, the CEO should consider the following
factors when he decides to capitalize them:

Recognition condition Satisfy?

The technical feasibility of completing IA
Its intention to complete IA
Its ability to use or sell IA
The existence of market for output of IA or usefulness of IA
The availability of adequate technical, financial & other resources
to complete the development of IA
The ability to measure the expenditure reliably
Since all 6 conditions are satisfied, we can capitalize the expenditure.

The cost incurred should be dealt with as follows:

Statement of Financial
Position
Income Intangible Tangible asset
statement ($m) asset ($m) ($m)
Research of the
new fiber
Prototype clothing
and goods design
Staff costs
Development work
Production and
launch
Machine
Market research
Training cost
24 44 12

According to HKAS 38, market research and training shall be excluded from
development cost. They should be expensed.
The machine should be recognized as a PPE.
As a result, the development cost will consist of the prototype, staff cost and development
work.
 Open Ltd
Statement of Financial Position as at 31 March 2010 (Extract)

$m
Non-current assets
Plant, property and equipment (net)

Intangible assets
Development cost
56

Open Ltd
Income Statement for the period ended 31 March 2010 (Extract)

$m
Expenditure
Research of new fibre

Market research

Training
24
HKAS 23 Borrowing Costs

Objective

The objective of HKAS 23 is to prescribe the accounting treatment for borrowing

costs. Borrowing costs include interest on bank overdrafts and borrowings,
amortisation of discounts or premiums on borrowings, finance charges on finance
leases and exchange differences on foreign currency borrowings where they are
regarded as an adjustment to interest costs.

Key Definitions

Borrowing cost may include:

 interest expense calculated by the effective interest method under HKAS

39,

 finance charges in respect of finance leases recognised in accordance

with HKAS 17 Leases, and

 exchange differences arising from foreign currency borrowings to the

extent that they are regarded as an adjustment to interest costs

This standard does not deal with the actual or imputed cost of equity, including
any preferred capital not classified as a liability pursuant to HKAS 32.

A qualifying asset is an asset that takes a substantial period of time to get ready
for its intended use or sale. That could be property, plant, and equipment and
investment property during the construction period, intangible assets during the
development period, or "made-to-order" inventories.

Scope of HKAS 23

Two types of assets that would otherwise be qualifying assets are excluded from
the scope of HKAS 23:

 qualifying assets measured at fair value, such as biological assets

accounted for under HKAS 41 Agriculture

 inventories that are manufactured, or otherwise produced, in large

quantities on a repetitive basis and that take a substantial period to get
ready for sale (for example, maturing whisky)
Accounting Treatment

Recognition

Borrowing costs that are directly attributable to the acquisition, construction or

production of a qualifying asset form part of the cost of that asset and, therefore,
should be capitalised. Other borrowing costs are recognised as an expense.

Until that revision was effective on 1 Jan 2009, an entity could apply the previous
version of HKAS 23, which permitted, as an accounting policy option, the
'immediate expensing model'. Under that model, all borrowing costs should be
expensed in the period in which they are incurred.

Measurement

Where funds are borrowed specifically, costs eligible for capitalisation are the
actual costs incurred less any income earned on the temporary investment of
such borrowings.

Where funds are part of a general pool, the eligible amount is determined by
applying a capitalisation rate to the expenditure on that asset. The capitalisation
rate will be the weighted average of the borrowing costs applicable to the general
pool.

Capitalisation should commence when expenditures are being incurred,

borrowing costs are being incurred and activities that are necessary to prepare
the asset for its intended use or sale are in progress (may include some activities
prior to commencement of physical production).

Capitalisation should be suspended during periods in which active development

is interrupted.

Capitalisation should cease when substantially all of the activities necessary to

prepare the asset for its intended use or sale are complete. If only minor
modifications are outstanding, this indicates that substantially all of the activities
are complete.

Where construction is completed in stages, which can be used while construction

of the other parts continues, capitalisation of attributable borrowing costs should
cease when substantially all of the activities necessary to prepare that part for its
intended use or sale are complete.

Disclosure

 the accounting policy adopted [required only until 1 January 2009 if

immediate expensing model was used]

 amount of borrowing cost capitalised during the period

 capitalisation rate used

Case Study 3

B331 Tutorial 3 CaseB331 Tutorial 3 Case Study 3.pdf

Study 3.pdf
Case Study 3 Guidelines
Dr $ Cr $

1 Apr 2007 Cash

12% 10-years debenture
(Record the specific borrowing)

Cash
12% 10-years debenture
(Record the general borrowing)

Cash
6% 5-years loan
(Record the general borrowing)

Cash
10% 7-years loan
(Record the general borrowing)

1 Dec 2007 Expense

Cash
(Payment of expenditure)

31 Mar 2008 Expense

Cash
(Payments of expenditure)

Interest Expense
Interest payable
(Interest expense for 2007-2008)

30 Sep 2008 Expense

Cash
(Payments of expenditure)
31 Mar 2009
Expense
Cash
(Payments of expenditure)

Interest Expense
Interest payable
(Interest expense for 2008-2009)

Development project
Expense
(Capitalize expenses incurred during Sep to Mar)

Development project
Interest expense
(Capitalize interest of general borrowing Oct 2008- Mar 2009)

Development project
Interest expense
(Capitalize interest of general borrowing for interest expense of 1.5m on 31 Mar
2009)

Calculation of capitalization rate for general borrowing

Total interest = 6,000,000*12%+5,000,000*6%+5,000,000*10%
= ___________________--

Total borrowing = 6,000,000+5,000,000+5,000,000

=$ _______________--

Capitalization rate = 1,520,000/16,000,000= ___________%

(b)
Total cost for capitalization
=2,500,000+ (1,000,000*9.5%*6/12)+(1,500,000*9.5%*1/365)
=2,500,000+47,500+390
=$ ____________________---

(c)

HKAS 38 does not discourage research activities. Instead, it provides a clearer direction and
prevent manipulation of accounts. For example, in the past in UK, the SSAP 13 allowed the
entity to choose between capitalisation of development costs and to write off all the research
and development costs as expense immediately. Moreover, some recognition criteria of SSAP 13
were subjective. Management might manipulate the accounts by capitalising the development
costs.
Case Study 4

Big Hotel Ltd started to construct its fourth hotel on 1 April 2009 and it will be completed on 31
March 2012. Big Hotel Ltd borrows funds generally and used them for the fourth hotel. Its
outstanding borrowings on 31 March 2010 and the related interest expense for the
year were:

Outstanding borrowing ($million)

Bank overdraft (12% p.a.) 50
Short-term bank loan (10% p.a.) 100
Long-term bank loan (5% p.a.) 200
(All the borrowings were drawn on 1 April 2009)

On 1 September 2009, Big Hotel issued bonds (face value $300 million, 7% coupon rate, mature
on 31 March 2012) specifically for this construction project. All the bonds are fully subscribed.
Funds used in the construction of the fourth hotel in 2009 were:

Payment date $million

1 April 2009 80
1 July 2009 200
1 Dec 2009 200

Payments made after 1 September 2009 were paid by the proceeds from the bonds. The unutilized
funds from the bonds were temporarily invested with a return of 3% per annum.

Required:
(a) Determine the carrying amount of the fourth hotel as at 31 March 2010.

(b) Prepare journal entries to account for the borrowing costs capitalized in the financial year of
2009.

Show your workings.

Case Study 4 Guidelines
General borrowing:

Outstanding borrowing Interest

expense
Bank OD (12% p.a.) 50,000,000 6,000,000
Short-term bank loan (10% p.a.) 100,000,000 10,000,000
Long-term bank loan (5% p.a.) 200,000,000 10,000,000
350,000,000 26,000,000
Capitalisation rate= = 26,000,000
350,000,000
= 7.4%

Expenditures $m No. of years Interest cost to be

incurred during capitalised for
2009 general borrowing

1-Apr-09 80 12/12 5,920,000

1-Jul-09 200 9/12 11,100,000
17,020,000

Investment income from unutilized = (300,000,000-200,000,000)*3%*4/12

fund (1 Dec 2009 to 31 Mar 2010)
= 1,000,000
Borrowing cost from specific = 300,000,000*7%*7/12
borrowing in 2009
= 12,250,000
Total interest cost to be capitalised =17,020,000+12,250,000-1,000,000
=28,270,000
Carrying amount of 4th hotel:
Interest capitalized 28,270,000
Expenses -- 1-Apr-2009 80,000,000
1 July 2009 200,000,000
1 December 2009 200,000,000
508,270,000
(ii)

Dr Cr
Property under construction 28,270,000
Interest expense 28,270,000
Being capitalization of interest
expense

Remarks:

The 3 recognition criteria for specific borrowing cost are satisfied already on 1 Sep 2009:

Expenditures for the assets are being incurred (since 1 Apr 2009)
Borrowing costs are being incurred (since 1 Sep 2009)
Activities that are necessary to prepare the asset for its intended use or sales are in progress (since 1 Apr
2009)