Rhia Pixie T.

Cañaveral
BS Accountancy

Assignment: Intangible Asset

Intermediate Accounting 1

Intangible Asset
PAS 38, paragraph 8, simply defines an intangible asset as an identifiable nonmonetary asset without
physical substance. Paragraph 8 further states that "the intangible asset must be controlled by the
entity as a result of past event and from which future benefits are expected to flow to the entity."

Accordingly, there are three essential criteria in the definition of an intangible asset, namely:
a. Identifiability
b. Control
c. Future economic benefits

Identifiability
The definition of an intangible asset requires that an intangible asset must be identifiable in order to
distinguish it clearly from goodwill. With nonphysical items, there may be a problem with
identifiability.

An asset is identifiable when:

a. It is separable. This means that the asset is capable of being separated from the entity and
sold, transferred, licensed, rented or exchanged, either individually or together with a
related asset or liability.
b. It arises from contractual or other legal rights. This is regardless of whether these rights are
transferable or separable from the entity or from other rights and obligations.

Control
Another element in the definition of an intangible asset is that "it must be under the control of the
entity as a result of a past event." Control is the power of the entity to obtain the future economic
benefits flowing from the intangible asset and restrict the access of others to those benefits.

In other words, the entity must be able to enjoy the future conomic benefits from the asset and
prevent others from enjoying the same benefits. The capacity of an entity to control the future
economic benefits from an intangible asset normally would stem from legal rights that are
enforceable in a court of law.

The capacity to control future economic benefits is much pronounced in the case of trademark,
copyright and patent. In the absence of legal rights, it is more difficult to demonstrate control.
However, legal enforceability of a right is not always a necessary condition for control since an entity
may be able to control the future benefits in some other way.

Future economic benefits

Future economic benefits 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.

An intangible asset shall be recognized if the following conditions are present:

a. It is probable that future economic benefits attributable to the asset will flow to the entity.
b. The cost of the intangible asset can be measured reliably.

Judgment is usually exercised in assessing the degree of certainty of the future economic benefits.
The judgment is based on external evidence.

Initial measurement of intangible asset

PAS 38, paragraph 24, provides that an intangible asset shall be measured initially at cost. The cost of
an intangible asset depends on the following:
 a. Separate acquisition
b. Acquisition as part of a business combination
c. Acquisition by way of a government grant
d. Acquisition by exchange
e. Acquisition by self-creation or internal generation

Separate acquisition
If an intangible asset is acquired separately, the cost of the intangible asset can be, measured reliably,
particularly so if the purchase consideration is in the form of cash or other monetary assets.

The cost of a separately acquired intangible asset comprises:

a. Purchase price
b. Import duties and nonrefundable purchase taxes
c. Directly attributable costs of preparing the asset for the intended use

Directly attributable costs include the following:

a. Costs of employee benefits arising directly from bringing the asset to its working condition.
b. Professional fees arising directly from bringing the asset to its working condition.
c. Costs of testing whether the asset is functioning properly.

Costs which are not capitalizable

Examples of costs that are not included in the cost of an intangible asset but expensed immediately
are:
a. Costs of introducing a new product or service, including costs of advertising and
promotional activities
b. Costs of conducting business in a new location or with a new class of customer, including
costs of staff training
c. Administration and other general overhead costs
d. Costs incurred while an asset capable of operating in a manner intended by management
has yet to be brought into use
e. Initial operating loss

Acquisition as part of business combination

If an intangible asset is acquired in a business combination, the cost of the intangible asset is based on
the fair value on the date of acquisition.

Acquisition by government grant

An intangible asset may be acquired by way of a government grant, free of charge or for nominal
consideration. This may occur when a government transfers or allocates to an entity intangible assets
such as:
a. Airport land rights
b. Licenses to operate radio or television stations
c. Import licenses or quotas or rights to access restricted resources.
The intangible asset acquired by way of government grant may be initially recorded at either:
a. Fair value
b. Nominal amount or zero, plus any expenditure that is directly attributable to preparing the
asset for its intended use.

Acquisition by exchange
The cost of the intangible asset is measured at fair value of the asset given up plus any cash payment,
unless the exchange transaction lacks commercial substance. If the exchange transaction lacks
commercial substance, the intangible asset is measured at the carrying amount of the asset given up
plus any cash payment. An exchange transaction lacks commercial substance when the cash flows of
the asset received do not differ significantly from the cash flows of the asset transferred.

Internally generated intangible asset

The cost of an internally generated intangible asset comprises all directly attributable costs necessary
to create, produce and prepare the asset to be capable of operating it in the manner intended by
management.
Examples of directly attributable costs are:
a. Cost of materials and services used or consumed in generating the intangible asset.
b. Costs of employee benefits arising from the generation of the intangible asset.
c. Fees to register a legal right.
d. Amortization of patents and licenses that are used to generate the intangible asset.
However, the following expenditures are not components of the cost of an internally generated
intangible asset:
a. Selling, administrative and other general overhead, unless this expenditure can be directly
attributed to preparing the asset for use.
b. Clearly identified inefficiencies and initial operating losses incurred before an asset achieves
planned performance.
c. Expenditure on training staff to operate the asset.
PAS 38, paragraph 63, explicitly provides that "internally generated brands, mastheads, publishing
titles, customer lists and items similar in substance shall not be recognized as intangible assets".

Recognition as an expense
An expenditure on an intangible item that does not meet the recognition criteria for an intangible
asset shall be expensed when incurred.
Examples of expenditures that are expensed when incurred include:
a. Start up costs
Start up costs may consist of organization costs such as legal and secretarial costs incurred in
establishing a legal entity. Start up costs also include preopening costs or expenditures to open a new
facility or business, and preoperating costs or expenditures for commencing new operation or
launching new product.
b. Training costs
c. Advertising and promotional costs
d. Business relocation or reorganization costs

Subsequent expenditure
As a rule, a subsequent expenditure on an intangible asset shall be recognized as expense. The reason
is that most subsequent expenditures are likely to maintain only the expected future economic
benefits embodied in the intangible asset. However, the subsequent expenditure may be capitalized
or added to the cost of the intangible asset if the following recognition criteria for an intangible asset
are met:
a. It is probable that future economic benefits that are attributable specifically to the
subsequent expenditure will flow to the entity.
b. The subsequent expenditure can be measured reliably.
The nature of an intangible asset is such that, in many cases, it is not possible to determine whether
subsequent expenditure is likely to enhance the economic benefits that will flow to the entity from
the intangible asset. Therefore, only rarely will a subsequent expenditure on an intangible asset result
to an addition to the cost of the intangible asset.

Identifiable intangible assets

PAS 38 specifically pertains to identifiable intangible assets. If the intangible asset is acquired through
purchase, there is a transfer of legal right that would make the asset identifiable. Moreover, if the
asset could be sold, transferred, licensed, rented or sold separately, the intangible asset is
identifiable.

Examples of identifiable intangible assets are:

a. Patent
b. Copyright
c. Franchise
d. Trademark or brandname
e. Customer list £ Computer software
 f. Broadcasting license, airline right and fishing right
Unidentifiable intangible asset
An intangible asset is unidentifiable if it cannot be sold, transferred, licensed, rented or exchanged
separately. The intangible asset is inherent in a continuing business and can only be identified with
the entity as a whole. This unidentifiable intangible asset squarely describes a goodwill.

Classification of intangible assets

a. Intangible assets with definite life
Typical examples include patent, copyright, franchise with fixed term, computer software, customer
list and license.
b. Intangible assets with indefinite life
Typical examples include goodwill, trademark and perpetual franchise.

Measurement after recognition

An entity shall choose either the cost model or revaluation model as an accounting policy.
1. Cost model-An intangible asset shall be carried at cost, less any accumulated amortization
and any accumulated impairment loss.
2. Revaluation model - An intangible asset shall be carried at a revalued amount, less any
subsequent amortization and any subsequent accumulated impairment loss.
The revalued amount is the fair value at the date of revaluation and is determined by reference to an
active market. Thus, an intangible asset can only be carried at revalued amount if there is an active
market for the asset.

Amortization and impairment of intangible assets

PAS 38, paragraph 97, states that intangible assets with limited or finite life are amortized over their
useful life. Intangible assets with finite useful life are tested for impairment whenever there is an
indication of impairment at the end of reporting period. Paragraphs 107 and 108 state that intangible
assets with indefinite life are not amortized but are tested for impairment at least annually and
whenever there is an indication that the intangible asset may be impaired. An impairment loss on an
intangible asset is recognized if the recoverable amount is less than the carrying amount. The
recoverable amount of the intangible asset is the higher between fair value less cost of disposal and
value in use.

Amortization
Amortization is the systematic allocation of the amortizable amount of an intangible, asset over the
useful life. The amortizable amount is the cost of the intangible asset less residual value. The
amortization is recorded by debiting amortization expense and crediting the intangible asset account.
Normally, the intangible asset account is credited directly for the periodic amortization but an
accumulated amortization account may be maintained.

Amortization period
The amortizable amount of an intangible asset shall be amortized on a systematic basis over the
useful life. Amortization shall begin wher the asset is available for use, meaning, when the asset is in
the location and condition for the intended use. Amortization shall cease when the intangible asset is
derecognized or when the asset is classified as "held for sale".

Useful life
The useful life of an intangible asset must be assessed as either indefinite or finite. If finite, the useful
life may be expressed in terms of years or the number of units to be produced. The useful of an
intangible asset is indefinite when there is no foreseeable limit to the period over which the asset is
expected to generate net cash flows.

Factors affecting useful life

a. Technical, technological, commercial or other type of obsolescence
b. Expected action by competitors or potential competitors
c. Expected usage of the asset by the entity
d. Typical product life cycle for the asset
 e. Stability of the industry in which the asset operates
f. Level of maintenance expenditure required to obtain the expected future economic
benefits from the asset
g. The useful life of the asset may be dependent on the useful life of other assets of the entity.
h. Period of control over the asset and legal or similar limits on the use of the asset, such as
expiry dates of related leases.

Amortization method
The method of amortizatio shall reflect the pattern in which the future economic benefits from the
asset are expected to be consumed by the entity. However, if such pattern cannot be determined
reliably, the straight line method of amortization shall be used.

Residual value
The residual value of an intangible asset shall be presumed to be zero, except:
a. When a third party is committed to buy the intangible asset at the end of the useful life.
b. When there is an active market for the intangible asset so that the expected residual value
can be measured and it is probable that there will be a market for the asset at the end of
the useful life.
The residual value is reviewed at each financial year-end. A change in the residual value is accounted
for as a change in accounting estimate. The residual value of an intangible asset may increase to
amount equal to or greater than the carrying amount.

Change in amortization method and useful life

The amortization method and the useful life of an intangible asset shall be reviewed at each financial
year-end. If the expected useful life of the intangible asset is significantly different from previous
estimate, the amortization period shall be changed accordingly.
If there has been a significant change in the expected pattern of economic benefits from the asset,
the amortization method shall be changed to reflect the new pattern. Such changes shall be
accounted for as changes in accounting estimates and therefore, shall be treated currently and
prospectively.

Derecognition of an intangible asset

An intangible asset shall be derecognized or eliminated from the statement of financial position:
a. On disposal of the asset
b. When no future economic benefits are expected from use and disposal of the asset
Gain and loss arising from the derecognition of an intangible asset shall be determined as the
difference between the net disposal proceeds and the carrying amount of the asset.

Disclosures related to intangible assets

1. Whether useful lives are indefinite or finite, and if finite, the useful lives or the amortization
rate.
2. The amortization method.
3. The carrying amount and any accumulated amortization at the beginning and end of the
period.
4. The line item in the income statement in which any amortization of intangible asset is
included.
5. Additions, separately showing those internally generated, acquired separately and acquired
through business combination.
6. Intangible assets classified as held for sale
7. Increases and decreases in intangible assets resulting from revaluations.
8. Impairment losses and reversal of impairment losses.
9. Net exchange differences on translation.
10. The carrying amount of intangible asset with indefinite life and the reason for the indefinite
life.
11. The carrying amount and remaining amortization period of intangible assets that are
material
 12. The carrying amount of intangible asset whose title is restricted or pledged as collateral
security.
13. Contractual commitments for intangible assets.
14. Intangible assets acquired by way of government grant and initially recognized at fair value.
15. The amount of research and development expenditure recognized as expense during the
period.

Goodwill
Goodwill is undeniably a unique asset presented in the financial statements. Goodwill is often
referred to as the most intangible of all intangible assets. Goodwill is unique in the sense that
goodwill standing alone cannot be bought and sold. The goodwill can only be identified with the
entity as a whole. Goodwill is an intangible asset that is not specifically identifiable, has an
indeterminate life, is inherent in a continuing business and relates to the entity as a whole.

What is goodwill?
Goodwill arises when earnings exceed normal earnings by reason of good name, capable staff and
personnel, high credit standing. reputation for fair dealings, reputation for superior products,
favorable location and a list of regular customers.
In other words, goodwill is created by a good relationship between an entity and the customers:
a. By building up a reputation by word of mouth for high quality products or high standard of
service.
b. By responding promptly and helpfully to queries and complaints of customers.
c. Through the personality of the staff and their attitude to the customers.
d.
Recognition of goodwill
In recognizing goodwill, distinction should be made between developed goodwill and purchased
goodwill.
Developed goodwill or internal goodwill is that goodwill which is generated internally because of good
name, capable staff and personnel, superior quality of products, favorabie location and high credit
standing.

PAS 38, paragraph 48, provides that internally generated goodwill shall not be recognized as an asset.
Purchased goodwill is the goodwill that has been paid for.

Purchased goodwill arises when a business is purchased. People wishing to set up a business either
would start the business from scratch or buy an existing business. When an enti acquires an existing
business, it will have to pay not only for the net tangible and identifiable intangible assets but also the
goodwill of the business. Purchased goodwill is recognized as an asset because it has been paid for.

Measurement of goodwill
The measurement of goodwill is not really a problem for accountants who will simply record the
goodwill in the accounts of the new business. The value of goodwill is a matter for the purchaser and
seller to agree upon in fixing the purchase price of the business. Two approaches may be followed in
measuring goodwill, namely residual approach and direct approach.

Residual approach
Under the residual approach, goodwill is measured by comparing the purchase price for the entity
with the net tangible and identifiable assets, meaning total assets excluding goodwill minus liabilities
assumed. The net assets acquired must be measured at fair value. The excess of the purchase price
over the fair value of net tangible and identifiable assets is considered as goodwill.

Direct approach
Under this approach, goodwill is measured on the basis of the future earnings of the entity. An
attempt is made to value the anticipated excess earnings which are the essential component of
goodwill.
This approach seems to be a systematic and logical way of measuring goodwill because if future
earnings exceed normal earnings, the excess earnings are indicative of the fact that there is an
unidentifiable intangible asset that is causing the excess earnings. Such unidentifiable intangible asset
is called goodwill.

A sophisticated application of this approach requires the following information:

a. A normal rate of return for representative entities in the industry. The normal rate of return
is that rate of return which usually attracts investors in a particular industry.
b. The fair value of tangible assets and any identifiable intangible assets.
c. The estimated future normal earnings of the entity.
d. The probable duration of any "excess earnings" attributable to goodwill.

Impairment of goodwill
PAS 38, paragraph 107, mandates that goodwill shall not be amortized because the useful life is
indefinite. However, goodwill shall be tested for impairment at least annually and whenever there is
an indication that it may be impaired.
Moreover, goodwill shall be tested for impairment at the operating segment level or any lower level.
An impairment loss recognized for goodwill shall not be reversed in a subsequent period.

Negative goodwill
If the purchase price or consideration transferred for the entity is less than the net fair value of the
identifiable assets acquired and liabilities assumed, the difference is negative goodwill.
PFRS 3, paragraph 34, provides that such negative goodwill is recognized in profit or loss as "gain on
bargain purchase".