Lecture 7

Fundamentals of
Financial Accounting
(FFA)
Intangible Assets – IAS 38
An identifiable non-monetary asset without physical substance.

The key characteristics of an intangible non-current asset are as

follows:
• it is a resource controlled by the entity from which the entity
expects to derive future economic benefits,
• it lacks physical substance, and
• it is identifiable and separately distinguishable from goodwill.

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Intangible Assets – IAS 38
Examples of intangible assets include the following:
• licences
• patents
• brands
• trademarks
• copyrights
• Franchises
• Goodwill (Asset- Liabilities) Net Worth/Net Assets / Equity
• Development Cost

Important
Internally generated goodwill/ brand / brand names / employee
training cost are not Intangibles hence Expensed out to P&L.

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Amortization – Intangible Assets
Useful Life – Limited (Finite)
• Capitalised development costs/ Intangible must be amortised once
commercial exploitation begins.

Method
• 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.

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Amortization – Intangible Assets
Useful Life – Indefinite/ Cant be determined
• Should not be amortised.

• An asset has an indefinite useful life if there is no foreseeable limit to

the period over which the asset is expected to generate net cash
inflows for the business.

• Instead, it should be subject to an annual impairment review.

• Impairment review – Looking for conditions internal & external to the

organization that suggest reduction in value.
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Intangible Assets – IAS 38
Research & Development

Research is defined as 'original and planned investigation undertaken

with the prospect of gaining new scientific or technical knowledge
and understanding’

Development is defined as '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'

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Accounting – Research & Development
Research
• All research expenditure should be written off to the statement of profit
or loss as it is incurred. This is in compliance with the prudence concept.
(Revenue Expenditures)
Research Expense (Dr.)
Cash (Cr.)

• Research expenditure does not directly lead to future benefits and

therefore it is not possible to follow the matching concept.

• Any capital expenditure on research equipment (property, plant and

equipment) should be capitalised and depreciated as normal in
accordance with IAS 16.

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Accounting – Research & Development
Development Cost - capitalised as an intangible asset if meet the
recognition criteria.
P-I-R-A-T-E
1. P – It will generate probable future economic benefits to the Company.
2. I – There is intention to complete and use or sell the intangible asset
3. R – there are adequate technical, financial and other resources to complete the
project
4. A – there is ability to use or sell the intangible asset
5. T – it is technically feasibile to complete the intangible asset, so that it is
available for sale or for use
6. E – there is ability to reliably measure the expenditure incurred during the
development of the intangible asset.
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Accounting – Research & Development
If Criteria (P-I-R-A-T-E) is not met.

Expense out all the development cost to Statement of Profit & loss.
Development Expense (Dr.)
Cash (Cr)

Development Asset (Inatngible Asset) (Dr)

Cash (Cr.)

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Research & Development- Example 1
An entity has incurred the following expenditure during the current
year. How should each of these costs be treated in the financial
statements of the entity?

1. $100,000 spent on the initial design work of a new product – it is

anticipated that this design will be taken forward over the next
two year period to be developed and tested with a view to
production in three years' time.
2. $500,000 spent on the testing of a new production system which
has been designed internally and which will be in operation
during the following accounting year. This new system should
reduce the costs of production by 20%.
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Research & Development- Example 1 (Solution)
1. These are research costs as they are only in the early design stage
and therefore should be written off as part of profit and loss for
the period.

2. These would appear to be development stage costs as the new

production system is due to be in place fairly soon and will
produce economic benefits in the shape of reduced costs.
Therefore these should be capitalised as development costs.

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Research & Development- Example 1 (Solution)

1- Research Expense (Dr.) 100,000

Cash (Cr.) 100,000

2- Intangible Asset (Development Cost) (Dr.) 500,000

Cash (Cr.) 500,000
Research & Development- Example 2
An entity has incurred the following expenditure during the current year:

1. A brand name relating to a specific range of chocolate bars, purchased

for $200,000. By the year end, a brand specialist had valued this at
$250,000.

2. $500,000 spent on developing a new line of confectionary. Out of this

total $150,000 was spent on researching the product, before
management gave approval to fully fund the project.
3. Training costs for staff to use a new manufacturing process. The total
training costs amounted to $100,000 and staff are expected to remain
for an average of 5 years.

Explain the accounting treatment for the above issues.

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Research & Development- Example 2 (Solution)

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Research & Development- Example 2 (Solution)

1- Purchased Brand name

Brand Name (Intangible Asset) $ 200,000

Cash (Cr.) $ 200,000

2- Development Cost (Intangible Asset) (Dr.) $ 350,000

Cash (Cr.) $ 350,000
Research Expense (Dr.) $ 150,000
Cash (Cr.) $ 150,000
Research & Development- Example 2 (Solution)

3- Employee training Cost

Employee Training Expense (Dr.) $ 100,000
Cash (Cr.) $ 100,000
Intangible Asset
Useful life (Estimate)
1- Definite / Limited /determinable (4)
2- Indefinite / Unlimited / Undeterminable

Amortization
License – Rs. 1million (4 year)
St. Line 1m/4 =
CA= Cost – Acc. Amortization
Accounting – Research & Development
Subsequent treatment – Capitalized Development Expenditures
• The asset should be amortised over the period that is expected to benefit.

• Amortisation should commence with commercial production and charged

over the period over which the business expects to generate economic
benefits.

• Each project should be reviewed at the year end to ensure that the criteria
are still met. If they are no longer met, the previously capitalised
expenditure must be written off to the statement of profit or loss
immediately.

• If a policy of capitalisation is adopted, it should be applied to all projects

that meet the criteria.

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Development Cost (PIRATE)
Before starting commercial Production- at the end of each year review
/ check whether PIRATE .
The moment we think that PIRATE criteria is not met .
Development cost – Intangible Asset (Expense)
Development Expense (DR.) (St. of P&L)
Development Cost (Intangible Asset (Cr.)
Intangible Assets- Example 3

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Intangible Assets- Example 3
Profit treating development costs as expenses when
incurred – Don’t Qualify for Capitalization
20X5 20X6 20X7 20X8
$000 $000 $000 $000
Net revenue from other activities 400 500 450 400
Net revenue from widgets – 450 600 400
Development costs (900) – – –
–––– –––– –––– ––––
Net profit/(loss) (500) 950 1,050 800

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Intangible Assets- Example 3
Net profit amortising development costs over life of
widgets –Qualify for Capitalization
20X5 20X6 20X7 20X8
$000 $000 $000 $000
Net revenue from other activities 400 500 450 400
Net revenue from widgets – 450 600 400
Development costs – amortized -- (300) (300) (300)
–––– –––– –––– ––––
Net profit/(loss) 400 650 750 500
Note that amortisation is spread over the period
over which economic benefits are expected to be
received.
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Disclosure – Reconciliation of Carrying amount

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Disclosure – Reconciliation of Carrying amount
Development Licences Total
costs
Cost or valuation: $000 $000 $000
Balance b/fwd X X X
Additions X X X
Disposals (X) (X) (X)
–––– –––– ––––
Balance c/fwd X X X
–––– –––– ––––
Accumulated depreciation:
Balance b/fwd X X X
Charge for the year X X X
Disposals (X) (X) (X)
–––– –––– ––––
Balance c/fwd X X X
–––– –––– ––––
Carrying amount 31 Dec 20X4 X X X
–––– –––– ––––
Carrying amount 31 Dec 20X3 X X X 24
–––– –––– ––––