ACC/ACF3100 Advanced Financial Accounting

Lecture 4

Intangibles

Department of Accounting
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Minimum Readings

Henderson: Chapter 10

AASB138 Intangible Assets

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 Learning Objectives
At the end of this lecture you should be able to:
1. Define an intangible asset and discuss its characteristics.
2. Understand the recognition issues and subsequent
measurement (revaluation, amortisation, impairment) for
intangibles as per AASB 138.
3. Differentiate and account for research and development
expenditure.
4. Understand accounting for intangibles as a controversial
issue with significant impacts on the capital markets.

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 Intangibles – Do they matter?
Survey of ASX 200 conducted by PWC during 2005
• 51% of market capitalisation unexplained by balance sheets (%
too high?)

• Sectors with smallest difference

– Consumer Staples & Discretionary
• Sectors with largest difference
– Telecommunications
– Information Technology
– Energy
– Metals & Mining

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 Intangibles - Importance
• Increasing business expenditure on intangibles

• BUT by and of themselves neither create value or

generate growth

• Intangibles need support and enhancement systems to

create value

• Without support loses value very quickly

• Far quicker than the value of tangible assets

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 Intangibles – Dot com crash

• Dot-com bubble 1995-2000

• Internet boom
• During 1999 and early 2000 the US Federal Reserve
increased interest rates six times
• Economy began to lose speed
• Dot-com bubble burst Friday 10 March 2000
• Stock market crash 2000-2002 $5 trillion loss in market
value

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 Intangibles – IFRS impact

Shrinking Balance Sheets

• EY predicted $40Bn wipe out off value of intangibles by

Australian companies
• Coca-Cola wrote-off $1.9Bn of internally generated
intangible assets (bottlers agreements) to comply with
IFRS
• Fosters wrote-off $1.2Bn (brand names & mailing lists)

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Asset Definition vs Intangible Assets Definition
• The Conceptual Framework definition of an asset:
“A resource controlled by the entity as a result of past
events from which the future economic benefits are
expected to flow to the entity.”

• AASB 138 Intangible Assets defines intangible asset:

“An identifiable non-monetary asset without physical
substance.” (para 8)
Examples: Patents, copyrights, trademarks, brand names,
contracts, business processes and systems
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• The Conceptual Framework does not define any
differences between assets.

 It does not specify that identifiability (separability),

tangibility, and existence of markets for the asset are
relevant in the decision about whether to record and
report an asset.

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 Intangibles – Definition

‘Identifiable’
• Identifiability creates barriers to recognition in financial
statements. It is a test of:
 Separability: The capacity of being separated from the
entity and sold, transferred, licensed, rented or exchanged.

 Contractual or other legal rights: to demonstrate control

over the asset.

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 Intangibles - Definition
‘Non-monetary’

• Monetary assets: Money, or assets to be received in fixed or

determinable amounts of money.
• Intangibles are not financial assets.
• Future economics benefits associated with intangibles are
often not fixed or determinable.

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 Intangibles - Definition

‘Without physical substance’

• Something that is ‘incapable of being touched’.

• Tangibility is not an essential attribute of an asset under

the CF.

• Existence of intangibles is only demonstrable by observing

the economic transactions.

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 AASB 138 Intangible Assets 1 Jan 2005

Para 63

Internally generated brands, mastheads, publishing

titles, consumer lists and items similar in substance
shall not be recognised

Therefore only purchased Intangibles can be recorded on a

Balance Sheet.

• Barker and McGeachin (2015):

 Does AASB 138 lead to ‘conservative’ accounting?

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 Intangibles - Recognition Issues
Initial
Recognition Measurement

Internally • Generally: Not capitalized (e.g., customer list, Expensed

generated mastheads) Not recognized on
intangibles  Not separable a Balance Sheet
 Recognition criteria of assets hardly satisfied

• Expenditures to build a brand name are immediately

expensed.

• Internally developed research costs are expensed.

• Exception: Development expenditure (discussed

later), and exploration and evaluation costs (see
AASB 6).

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 Intangibles - Recognition Issues
Recognition Initial Measurement

Externally Acquired Can be capitalised Cost – AASB138 Para 24

acquired separately  If Separable - Para 12 =Purchase price + tax +
intangibles  Tends to satisfy asset direct cost (legal, consulting,
Acquired recognition tests registration etc)
through
business
combination Cost
=Fair value at acquisition
date

Goodwill purchased through Cost

business combination =Acquisition cost less FV of
net asset of acquired entity
AASB3

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 Intangibles -Subsequent Measurement

Issue 1: Policy choice

• Cost model or
• Revaluation model

Issue 2: Consumption of future economic benefits

• Systematic allocation
(eg depreciation/amortisation)
• Impairment

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 Intangibles -Subsequent Measurement

On Issue 1, AASB138 stipulates

Elect either cost or revaluation provided there is an active
market (AASB138.72)

Cost Model (AASB138.74)

•CA = Cost less Accumulated Amortisation and
Accumulated Impairment Losses

Revaluation Model (AASB138.75)

•CA = FV less Accumulated Amortisation and Accumulated
Impairment Losses

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 Intangibles -Subsequent Measurement

Cost Model
Cost comprises:
• Purchase price, import duties and any other costs directly
attributable to the cost of preparing the asset for intended
use
• Discounts and rebates are deducted from cost

• AASB138 Para 65 prohibits the ‘expense and reinstate’

method.

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 Intangibles -Subsequent Measurement
Revaluation Model
FV needs active market AASB138 Para 78
AASB 13 Appendix A Defined Terms
‘active market’ A market in which transactions for the
asset ...take place with sufficient frequency and volume to
provide pricing information on an ongoing basis.
Para 78 An active market cannot exist for brands,
newspaper mastheads, music and film publishing rights,
patents or trademarks.
Exceptions: transferable taxi licences, fishing licences and
production quotas
Effectively, AASB138 rules out the revaluation of intangible
assets.
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 Intangibles -Subsequent Measurement

On Issue 2, AASB138 stipulates

Regardless of cost or revaluation model both amortisation
and impairment must be considered
Assess useful life Para.88
• Finite
• Indefinite (no foreseeable limit, not the same as infinite)

Where this life arises from a contract, useful life may

be shorter but not longer than the contractual term
(unless renewal is possible without significant cost
Para 94)

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 Intangibles -Subsequent Measurement

Finite useful lives AASB138 Para 97

Depreciable amount amortised systematically over the

useful life

• Reflecting the pattern of FEB, or

• On a straight line basis
• From the date the asset is available for use
• Until classified as held for sale (AASB 5) or derecognized
• So Depreciable amount = Cost or other amount less
residual value
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 Intangibles -Subsequent Measurement

Residual Value AASB138 Para 100

Assume zero unless

Commitment to purchase by 3rd party OR

Active market AND

• This market facilitates reliable measurement of residual

value
• Probable that the market will exist at end of useful life

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 Intangibles -Subsequent Measurement

Review Amortisation Period and Amortisation Method

AASB138 Para 104

Review annually

Revise accordingly as a change in estimate under AASB108

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 Intangibles -Subsequent Measurement

Indefinite Useful Lives

An intangible asset with an indefinite useful life shall not be

amortised AASB138 Para 107

Review useful life each period and revise accordingly as a

change in estimate under AASB108 if necessary

Impairment test annually

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 Lecture Illustrative Example 1
The following are transactions incurred by Ben Ltd:

• A brand was purchased with cash for $2.6 million on 1 July 2015. The
company estimates that the future benefits from this asset will be generated
indefinitely.

• Ben Ltd’s customer base increased by 30% during the financial year.

• A patent was acquired with cash for $800,000 on 1 July 2015. Patent Law
indicates the patent is legally valid for 10 years. Ben Ltd expects to hold the
patent for 8 years.

Required:
(a) Explain the accounting treatment for the brand name, customer base and
patent with respect to AASB138 Intangible Assets for both initial and
subsequent measurement and recognition.
(b) Provide the journal entries to record the patent for the year ending 30 June
2016. 25
Solution to Illustrative Example 1(a)
Initial recognition and Subsequent measurement
measurement
Brand • No active market, cannot be
name Recognised as an asset
at cost–externally revalued
acquired • Not amortized due to indefinite life
• Subject to impairment testing
(impaired if CA>RA)

Customer No transaction –internally

base generated, cannot be N/A
reliably measured

Patent Recognised as an asset • No active market, cannot be

at cost–externally revalued
acquired • Amortized due to finite life over 8
years (straight line) based on
mgm’s best estimate
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Solution to Illustrative Example 1(b)

1 July 2015 To record patent acquisition

Dr Patent $800,000
Cr Cash $800,000

30 June 2016 To record patent amortisation expense

Dr Amortisation expense 800k/8= $100,000
Cr Accumulated amortisation $100,000

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 Research and Development Expenditures
Research
Original and planned investigation undertaken
with the prospect of gaining new scientific or
technical knowledge and understanding.
Examples (see AASB138 Para 56):
• Activities aimed at obtaining new
knowledge
• Searching for alternatives for materials,
processes
Expenditure on research shall be recognised
as an expense (AASB138 Para 54).
 Cannot suitably demonstrate that it will at
this stage generate future economic
benefits.
Development
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.
Examples (seeAASB138 Para 59):
• Design and testing of a pre-production
prototype
• Design of tools, moulds and dies involved in
new technology
All six conditions must be satisfied before
development costs can be capitalised
(AASB138 Para 57)
• Reliable measurement
• Adequate resources
• Technical feasibility
• Probable future economic benefits
• Ability to use or sell
• Intention to complete
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 Lecture Illustrative Example 2:
Research and Development
Monash Solutions Ltd has been involved in a research
project in 2015, the following related to the expenditure:
Research phase $30,000
Development phase $400,000

A successful product had been developed from the project

and the manager estimates that the future revenue to be
earned from the product will be $360,000 over the next six
years.
How should Monash Solutions account for the above
expenditure?

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 Solution to Illustrative Example 2
1. Write off research expense as incurred:
Dr Research expense 30,000
Cr Cash 30,000

2. Capitalised development cost assuming all six conditions are satisfied:

Dr Deferred Development Cost (Asset) 400,000
Cr Cash 400,000

3. Impairment recognition:
Dr Impairment loss 400k-360k=40,000
Cr Accumulated impairment- Deferred Development Cost (Asset) 40,000

4. Amortisation of development costs:

Dr Amortisation for deferred development cost 360k/6=60,000
Cr Accumulated amortisation- Deferred Development Cost (Asset) 60,000
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 Lecture Illustrative Example 3

Innovator Ltd incurred expenditure researching and

developing a cure for a common disease found in turnips. At
the end of 2017 management determined that the research
and development project was unlikely to succeed because
trials of the prototype had been unsuccessful.

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During 2018 a breakthrough in agricultural science improved
chances of the product succeeding and development
resumed. The project was completed in 2018. At the end of
2018 costs incurred on the project were expected to be
recoverable. Innovator expects that 10% of the project
revenue will be received in 2019, 20% in 2020, 30% in 2021,
30% in 2022 and 10% in 2023. After five years the product
will be at the end of its useful life because the disease found
in turnips will have been eradicated. Costs incurred were as
follows:
Research Development
($000) ($000)
2017 40 10
2018 12 60 32
 Required:

a) How much research expenditure and development expenditure

should be recognised as an expense in 2017?
b) How much research and development expenditure should be
recognised as an expense in 2018?
c) State how much expenditure should be carried forward (deferred)
and reported in the balance sheet at the end of 2017 and 2018.
d) Prepare journal entries for the amortisation of deferred costs in
2019 and 2020, assuming that actual revenues are as expected.
e) Assume that after charging amortisation based on sales revenue at
the end of 2021 the discounted net cash flows expected to be
generated from the deferred expenditure were estimated as
$15,000. Prepare any journal entries required to account for this
information.

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 Solution to Illustrative Example 3

Required:
(a) How much research expenditure and development expenditure should be
recognised as an expense in 2017?

$50,000 to be expensed
= $40,000 research expenditure must be expensed
+ $10,000 development expenditure (unsuccessful prototype, not expecting
feb)

(b) How much research and development expenditure should be recognised as

an expense in 2018?

$12,000 research expenditure must be expensed.

(c) State how much expenditure should be carried forward (deferred) and
reported in the balance sheet at the end of 2017 and 2018.

 2017: $nil

 2018: $60,000

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 Solution to Illustrative Example 3 (continued)

(d) Prepare journal entries for the amortisation of deferred costs in 2019 and
2020, assuming that actual revenues are as expected.

2019 Dr Development expense 60,000*10% $6,000

Cr Accumulated Amort. - Deferred Development Costs $6,000
(Amortisation of deferred developments costs—turnip project)

2020 Dr Development expense 60,000*20% 12,000

Cr Accumulated Amort. - Deferred Development Costs $12,000
(Amortisation of deferred developments costs—turnip project)

2019 ($000) 2020 ($000)

Deferred development cost 60 60
Accumulated amortisation 6 18=(6+12)
Carrying amount 54 42

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 Solution to Illustrative Example 3 (continued)

(e) Assume that after charging amortisation based on sales revenue at the end of
2021 the discounted net cash flows expected to be generated from the deferred
expenditure were estimated as $15,000. Prepare any journal entries required to
account for this information.

Carrying amount after amortization in 2021

=$60k-$6k 10% (2019)-$12k 20% (2020)-$18k 30%(2021)=$24k
Recoverable amount $15k
Carrying amount>recoverable amount: therefore recognize an impairment loss and
write the asset down to recoverable amount

2021 Dr Impairment Loss $9k

Cr Accumulated Impairment - Deferred Development Costs $9k
(Impairment of deferred developments costs—turnip project)

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 Accounting for Intangibles as a Controversial
Issue

• Differential accounting treatment for Intangibles is criticised

• Understatement of assets because internally generated
Intangibles are not recognised.
 Implications on agency relationship?

• Companies with significant investment in Intangible items are

likely to be undervalued.
 Create a significant difference between a company’s book
and market value.
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 Accounting for Intangibles as a Controversial
Issue

• It reduces the information content of financial statements.

 Ongoing tension between the reporting of relevant and

faithfully represented information.
 Research evidence shows that information about
investments in intangibles and the outcomes of this
investment such as patents is highly relevant to
investors.

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 Accounting for Intangibles as a Controversial
Issue

• Barker and McGeachin (2015):

 How might AASB 138 promote “unconditional

conservatism”?
 How might AASB 138 promote “conditional
conservatism”?

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Disclosure Requirements For Intangible Assets
General requirements:
(a) Each class of intangible asset, distinguishing between
internally generated and other intangible assets.
(b) Where useful lives are indefinite and finite. If finite – the
useful lives or amortisation rates and the methods used.
(c) Opening and closing amounts for accumulated
amortisation, impairments, revaluations and movements in
income statement line items e.g. amortisation expense
(d) Where intangible assets are measured after acquisition
using revaluation models, full details of revaluations.
Opening and closing balances and reconciliations.
Significant assumptions in determining fair values.
Para 118
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Disclosure Requirements For Intangible Assets

For Research & Development:

The Standard specifically requires the entity to disclose the
aggregate amount of research and development recognised
as expenditure during the period. Para 126

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