Intangible Assets - IAS 38 - Accounts

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example :- XYZ Inc. owns a freely transferable taxi operator’s license, which it acquired on Jan 1 2007 at an initial cost of 1 MINR. The useful life of the license is 5yrs. The entity uses the straight-line method to amortize the intangible. Such licenses are frequently traded either between existing operators or with aspiring operators. At the balance sheet date, on Dec 31, 2008, due to a government-permitted increase in fixed taxi fares, the traded values of such a license was 1.2 minr. The accumulated amortization on December 31, 2008, amounted to 4 lacs.

What journal entries are required at December 31, 20X2, to reflect the increase/decrease in carrying value (cost or revalued amount less accumulated depreciation) on the revaluation of the operating license based on the traded values of similar license? Also, what would be the resultant carrying value of the intangible asset after the revaluation?

Dr Intangible asset—accumulated amortization 4 lacs

Cr Intangible asset—cost 4 lacs

Dr Intangible asset—cost 6 lacs

Cr Revaluation reserve 6 lacs

The net result is that the asset has a revised carrying amount of 1.2 minr (1 – .4 + .6 )

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Acquisition as part of Business Combination

The cost of an intangible asset acquired as part of a business combination should be assessed at its fair value at the acquisition date.

Fair value may be observable from an active market or recent similar transactions. Other methods may also be used, but if no means are available of ascertaining its fair value reliably, then the asset does not meet the recognition criteria.

In such circumstances no separate intangible asset would be recognised. However, the carrying amount of goodwill would increase.

If an intangible asset acquired in a business combination is separable or arises from legal rights, sufficient information exists to measure reliably its fair value.

Some Intangible assets cannot be sold or otherwise disposed of except in the combination with other tangible or intangible assets. The acquirer should recognise that combination of assets as a single tangible or intangible asset.

Example:- Casino Licenses that attach with particular building and it cannot be sold separately from the building the license and building may only be recognised as a single asset if the useful lives of the assets are similar.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Even if the fair value of the complementary assets are individually capable of reliable measurement, the standard permits them to be recognised as one asset, if useful life is similar

Example :- Entity A acquires one of its key competitors, B.

Basic reason behind the acquisition was the intention to take entity B’s brand out. Management proposes to attribute a zero value to brand B as it will not be used in the future.

The proposed treatment is not appropriate.

Fair value under IFRS 3 “Business Combination” does not take into account the owner’s intentions for the use of the acquired assets.

The brand should, therefore, be recorded at its fair value on the date of acquisition and will be subsequently written off to the income statement if its not expected to be used.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Acquired in exchange for non-monitory Assets

An intangible asset acquired in an exchange for a non-monetary asset or a combination of a non-monetary and monetary asset should be recognised at its FV, unless,

§ the exchange transaction has no commercial substance; or

§ the FV of neither the asset received not the asset given up can be reliably measured

Where there are no comparable market transaction the fair value of either the asset given up or the asset received can still be reliably measured if;

§ the range of reasonable estimates of fair value does not vary significantly that is if the range is reasonably narrow; or

§ the range of reasonable estimates is not narrow, but the probabilities of the various estimates within the range can be reasonably assessed and used in estimating F.V.

Where both the fair value of the asset given up and the fair value of the asset received can be estimated with equal reliability The fair value of the asset given up is used to measure the cost of the asset received, unless the fair value of the asset received can be measured with more reliability.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example :- Entity A is the holder of a patent with a carrying amount of 3minr.

Entity A agreed to exchange its patent for that of entity B. The fair value of entity A’s patent has been assessed by both parties at 5minr.

Entity B’s patent cannot be measured reliably. No additional monetary or non-monetary consideration has been included in the exchange.

Entity A will record its acquired patent at a cost of 5minr, as the asset’s FV that can be measured reliably is used by both.

A gain arises on the transaction of 2minr is recognised by entity A in the income statement.

The amount is the difference between the carrying amount of entity A’s original patent (RS. 3M) and the fair value of the patent given up (Rs.5M).

Patent are inherently unique and so the exchange has commercial substance.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Application of Revaluation Model

The revaluation model may be not be applied to intangible assets that have not been recognised as intangible assets initially.

Recording assets acquired in a business combination at fair value is not the application of the revaluation model. It is a method of determining the cost to the group of individual assets acquired in a business combination.

The revaluation model may also be applied to an asset that was acquired by way of govt grant and measured on initial recognition at a nominal amount. The nominal amount could be nil if the asset was received free of charge.

Where a revalued asset’s FV can no longer be determined by reference to an active market, the carrying amount should be frozen at the revalued amount at the date of the last valuation. The carrying amount is then amortised and impaired as necessary in the normal way. The previous revaluation surplus is not reversed when the measurement by reference to an active market is no longer possible.

Valuation should remain up-to-date, as old valuation do not reflect current values. The frequency of revaluations, depends on movements in the fair value of intangibles. If an intangible asset’s fair value differs materially from its carrying amount a new valuation is needed.

In case of volatile movement, annual valuation is required.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

When an intangible asset is revalued, accumulated amortisation can be treated by :

§ Eliminated against the asset’s gross carrying amount with the net amount restated to equal the revalued amount, OR

§ Restated Proportionately with the change in the asset’s gross carrying amount such that the asset’s net book value after revaluation equal its revalued amount

Example:- Over the year and entity have accumulated number of licence in a nominal consideration of a kind that are traded on an active market. The entity has not recognised an intangible asset as the licenses were individually immaterial when acquired. Market prices for such licenses have recently risen significantly and the value of the licenses held by the entity has substantially increased.

The entity is, however, prohibited by IAS 38 from applying the revaluation model to the licence, because they have no previously been recognised as an asset.

The revaluation model applied to measure an intangible asset only subsequent to the asset’s initial recognition and measurement at cost. The method cannot be used at initial recognition to record an intangible asset at a value other than cost.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Revaluation Gain and losses

A revaluation surplus is credited directly to equity under the heading of revaluation surplus, unless it reverses revaluation decrease on the same asset previously recognised as an expense.

Reversals of previous revaluation decreases are credited to the income statement. To the extent that the decrease was recognised as an exp. The revaluation surplus transfer is made through reserves not through the income statement. Some of the surplus may also be transferred as the asset is used by the entity, that is, as the surplus is realised.

In that case, the amount transferred is the difference between amortisation based on the revalued carrying amount of the asset and amortisation based on the asset’s original cost. This amount may, therefore, be transferred from revaluation surplus to retained earnings each year, by means of reserve transfer.

A revaluation decrease should be charged against any related revaluation surplus to the extent that the decrease does not exceed the amount held in the revaluation surplus in respect of that same asset. Any balance of the decrease should then be recognised as an expense in the income statement.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Amortisation

Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its useful life. The method of amortisation that is used should reflect the pattern in which the assets future economic benefit are expected to be consumed by the entity. If the pattern cannot determined reliably the straight line method of amortisation must be used.

Amortisation applies to all intangible assets, whether held at cost of fair value, except intangible assets with indefinite useful lives. An intangible asset with an indefinite useful life should not be amortised.

Amortisation should begin as soon as an asset is available for use, that is , when its in the location and condition necessary for it to be capable of operating in the manner intended by management.

It should stop at the earlier of the date when the intangible asset is derecognised and the date when it is classified as held for sale under IFRS 5. Amortisation does not stop when an asset is retained but no longer used unless it has been fully depreciated or classified as held for sale.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Amortisation Method

There are variety of amortisation method including the straight line method, the diminishing method and the unit of production method is allowed.

The amortisation method should reflect the pattern in which future economic benefits of the intangible asset with a finite useful life are expected to be consumed. The standard states that if that pattern cannot be reliably determined the straight line method must be used.

The SLM will often be the most appropriate method to use, as well as being the “default” method where the pattern of consumption cannot be reliably determined. This is because many intangible assets relate to a time period. for example patents and licenses.

If the asset were no longer used because no future economic benefits were expected from it, it would be derecognised and a loss would be recorded. In situation where an asset is temporarily unused, because for example there is a lack of demand for the asset’s output, this would be an indication of impairment for the relevant CGU and an impairment review should be carried out.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Useful Lives – Finite and indefinite

The useful life of an intangible asset is the period over which the depreciable amount of the asset is allocated. Therefore, estimating the useful life reliably is a key factor in determining the periodic charge for amortisation. Useful life is defined as :

§ The period over which an asset is expected to be available for use by an entity.

§ The number of production expected to be obtained from the asset by an entity.

The useful life is the period when the asset is used by the entity. Assets economic life is10 yrs, but the entity intends to use the asset for 6 yrs. The useful life that the entity assigns to the asset will be 6 yrs not 10 yrs. Management should assess whether an intangible asset’s life is finite or indefinite.

Example :-

1. Patent with committed residual value :- Entity A acquires a patent whose economic life is 15 years. Entity A expects to use the patent for 5 yrs and intended to sells if after 5 yrs to entity B. Entity B has committed to buy the patent for 60% of the cost to the entity A. In this example, Entity A amortises the asset over 5 yrs. The depreciable amount is 40% and residual value is 60%

Although IAS 38 requires a residual value of nil to be assumed for intangible assets, this is one of the exception because 3rd party has committed to buy the asset.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

4. Change of useful life of trademark from indefinite to finite :- A trademark was acquired several years ago and has been treated as having an indefinite useful life as, up until now, management had expected to continue the related business indefinitely and all the other conditions are met. However, management, has now taken the decision to discontinue the business over the next 4 years. In these case, the asset should be amortised in 4 yrs during which it will be used by the entity.

The useful life of a finite life intangible asset should be reviewed at least end of each financial year. A change in estimate is accounted for prospectively with the effect of the change being recognised in the current and future period.

Where an intangible asset is not being amortised because its useful life is considered to be indefinite, an entity should carry out a review in each accounting period.

A change from an indefinite to a finite useful life is an impairment indicator under IAS 36. Therefore, if the useful life is changed from indefinite to finite the entity must carry out an impairment test under IAS 36 and charge any shortfall between recoverable amount and carrying amount as an impairment loss. In addition, where an intangible asset has an indefinite useful life is must be reviewed for impairment annually.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Residual Value

The residual value of an intangible asset with a finite useful life should be assumed to be zero, unless :

§ A 3rd Party has committed to purchase the asset at the end of its useful life

§ There is an active market for the intangible asset’s and

--- Residual value can be determined by reference to that market

--- The market is likely to exist at the end of the asset’s useful life.

Residual value is defined as the estimated amount that an entity would currently obtain from the asset’s disposal, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The word “currently obtain” make clear that inflationary increases since acquisition, but does not take amount of expected future inflation.

Residual value may increase to an amount equal to or greater than the intangible asset’s carrying amount. In such a situation, the amortisation charge would be nil, unless and until the residual value falls below the carrying amount. As with changes to estimates of residual value this situation will only occur if one or other of the two exceptions to the rule that residual values should be assumed to be zero applies.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Derecognition of Intangible Assets

An intangible asset should be derecognised when :

§ Its disposed of, or

§ No future economic benefits are expected from its use of disposal

The profit and loss on derecognition of an intangible asset is the difference between the net disposal proceeds and the carrying amount. The consideration receivable is recognised at fair value. The profit or loss on derecognition should be recognised in the income statement for the period in which derecognised occurs.

Profit and loss on disposal of intangible asset should not be recognised as revenue but are usually included in other income as gain and losses. Disposal of intangible assets may occur in variety of ways and include disposals by sale, entering into a finance lease and by donation. The date of disposal is determined by using the criteria in IAS 18 for recognising the sale of goods.

Where no future economic benefits are expected from the continuing use or disposal of the intangible asset, the intangible asset should be derecognised. A reduction in future economic benefits expected from the continuing use or disposal of the intangible asset would conversely result in the asset’s impairment.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Web site Cost – SIC 32

SIC 32 “Intangible assets – Web site costs” provide guidance on website cost. SIC 32 details the stages of a web site’s development as follows

§ Planning

§ Application and infrastructure development

§ Graphic design development

§ Content development

Once development of the site is complete, the operating stage begins.

SIC distinguishes between various types of expenditure as follows :

§ Costs of purchasing, developing and operating hardware :- Capitalised

§ Cost of hosting services are normal running cost . So it will expense.

The cost incurred at each stage in developing the site must be evaluated to determine whether they should be expensed as incurred or capitalised.

After initial recognition, a web site would normally be carried at cost less amortisation. The revaluation model would not apply, because there is no active market for websites. The SIC notes that the amortisation period for a web site should be short. This is because of rapid technological advances.