International Accounting Standard 38 (IAS 38), Intangible Assets

Transcription

1 International Accounting Standard 38 (IAS 38), Intangible Assets By BRIAN FRIEDRICH, MEd, CGA, FCCA(UK), CertIFR and LAURA FRIEDRICH, MSc, CGA, FCCA(UK), CertIFR Updated By STEPHEN SPECTOR, MA, FCGA This article is part of a series by the Friedrichs and Stephen Spector on the move to International Financial Reporting Standards to be published on PD Net. Snapshot Overview of IAS 38 Differences from Canadian GAAP Snapshot First released September 1998 Revised and re-released March 2004 Subsequent amendments May 2009 (to reflect Annual Improvements to IFRSs 2007 and 2008 ) Effective date (IASB basis) Effective date (Canadian basis) Outstanding Exposure Drafts and issues under consideration fiscal periods beginning on or after March 31, 2004 fiscal periods beginning on or after January 1, 2011 (although current section 3064 is harmonized with IAS 38) none Overview of IAS 38 As we review this standard, you will notice that there is a definite similarity to IAS 16 Property, Plant and Equipment, which was the subject of the previous article in this PD Net series. This stands to reason, given that both sections deal with longterm assets. However, IAS 38 includes additional requirements that stem from the specific characteristics and risks associated with intangibles. Objective The objective of IAS 38 is to prescribe the accounting treatment for intangible assets that are not specifically dealt with in another standard. IAS 38 defines the criteria for asset recognition, specifies how carrying amounts should be measured in subsequent periods, and provides guidance on required disclosures. CGA-Canada 2009

2 As with property, plant, and equipment (PP&E), all costs of intangible assets are accounted for by the entity at the time these costs are incurred. The entity then allocates the costs over the useful life of the asset via amortization. Any impairment losses must also be accounted for. These concepts are not new to Canadian GAAP, but IFRSs add the option to use fair value to determine the carrying value of intangibles subsequent to acquisition. Scope Common examples of intangible assets are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licenses, import quotas, franchises, customer or supplier relationships, customer loyalty, market share, and marketing rights. IAS 38 is applied in accounting for all intangible assets, except ( 2) a) intangible assets that are within the scope of another standard b) financial assets, as defined in IAS 39 Financial Instruments: Recognition and Measurement c) the recognition and measurement of exploration and evaluation assets (see IFRS 6 Exploration for and Evaluation of Mineral Resources) d) expenditure on the development and extraction of minerals, oil, natural gas, and similar non-regenerative resources For example, IAS 38 would not apply to intangible assets held by an entity for sale in the ordinary course of business (see IAS 2 Inventories), goodwill acquired in a business combination (see IFRS 3 Business Combinations), or intangibles classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. In addition to the general exclusions cited in the scope section of IAS 38, the standard provides additional guidance for specific situations. For example, some intangible assets may be contained in or on a physical substance for example, computer software residing on a computer hard drive or compact disc, licenses or patents embodied in legal documentation, and audio or film products. In cases where an asset incorporates both tangible and intangible elements, judgment is required to assess whether the tangible or intangible element is more significant; the outcome of that assessment determines whether the asset is accounted for under IAS 16 Property, Plant and Equipment or as an intangible asset under IAS 38. Consequently, the operating system of a computer is an integral part of the related hardware and it is treated as PP&E. Application software, which is not an integral part of the related hardware, is treated as an intangible asset. As a further example, research and development activities are directed to the development of knowledge. Therefore, although these activities may result in an asset with physical substance (for example, a prototype), the physical element of the asset is secondary to the knowledge embodied in it. In accordance with paragraph 2(a), leases that are within the scope of IAS 17 Leases, are dealt with under that standard. Rights under licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents, and copyrights are excluded from the scope of IAS 17 and are included in IAS 38. Moreover, IAS 17 specifies that after initial recognition, a lessee accounts for any intangible asset held under a finance lease in accordance with IAS 38. Highlights of the standard Definition of an intangible asset IAS 38 defines an intangible asset as an identifiable non-monetary asset without physical substance. All three criteria are required before the standard can be applied. The definition International Accounting Standard 38 (IAS 38), Intangible Assets 2

3 requires an intangible asset to be identifiable to distinguish it from goodwill. An asset is identifiable if it either ( 12) a) is separable, that is, is capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. Initial recognition of an intangible asset If an item meets the definition of an intangible asset, it is to be recognized if, and only if ( 21) a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and b) the cost of the asset can be measured reliably. These are the same criteria required for recognition of PP&E under IAS 16. The probability of expected future economic benefits is assessed using reasonable and supportable assumptions that represent management s best estimates of the economic conditions that will exist over the asset s useful life. If the definition and recognition criteria are met, then the item is recognized as an intangible asset. IAS 38 stipulates that intangible assets are initially recognized at cost. For separately acquired intangibles, cost includes a) the purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and b) any directly attributable cost of preparing the asset for its intended use. IAS 38 provides additional guidance on determining measurement amounts in specific cases, such as when an intangible is purchased as part of a business combination, when it is acquired by way of government grant, or when an asset exchange is involved. For example, for intangibles acquired in a business combination, paragraph 40 provides direction when there is no active market for the asset in question. Further, paragraph 41 offers guidance for entities involved in the purchase and sale of intangible assets as to how to employ techniques for estimating fair values indirectly. Under IAS 38, internally generated intangibles are, with one exception, expensed as incurred. Paragraph 63 specifically states that internally generated brands, mastheads, publishing titles, customer lists, and items similar in substance are not to be recognized as intangible assets. Paragraph 64 goes on to say that expenditures on internally generated items such as brands, mastheads, and so on, cannot be distinguished from the cost of developing the business as a whole. Therefore, internally generated goodwill is not recognized as an asset because it is not an identifiable resource controlled by the entity that can be measured reliably at cost ( 48 and 49). Other examples of items that are expensed as incurred include expenditures for start-up costs that are not included in PP&E in accordance with IAS 16 training, advertising, and promotional activities relocating or reorganizing part or all of an entity The standard does, however, allow for the recognition of development costs as an intangible asset, although this action is subject to very specific and rigid criteria. To assess whether an International Accounting Standard 38 (IAS 38), Intangible Assets 3

4 internally generated intangible asset meets these criteria, an entity must classify the expenditures into two phases: a) a research phase; and b) a development phase. ( 52) Expenditures during the research phase are expensed as incurred, because during this phase, an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. However, expenditures incurred during the development phase may be capitalized, subject to further requirements. An intangible asset arising from development can be recognized if, and only if, an entity can demonstrate all of the following ( 57): a) the technical feasibility of completing the intangible asset so that it will be available for use or sale b) the entity s intention to complete the intangible asset and use or sell it c) the entity s ability to use or sell the intangible asset d) how the intangible asset will generate probable future economic benefits. Among other things, the entity can 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 f) the entity s ability to measure reliably the expenditure attributable to the intangible asset during its development If all these criteria are met, the entity may begin capitalizing development costs. Paragraph 71 stipulates that expenditures initially recognized as expenses cannot be reversed and treated as part of the cost of an intangible asset at a later date. Carrying value after initial recognition The initial recognition of intangibles under IAS 38 is much the same as current Canadian GAAP. As we move on to discuss what happens after initial recognition, the difference between IAS 38 and current Canadian GAAP (Handbook section 3064) begins to emerge. As with PP&E (in IAS 16), IAS 38 offers management a free choice of accounting policies with respect to the carrying value of intangibles after initial recognition. Paragraph 72 stipulates that an entity can choose either the cost model or the revaluation model. Once the policy is chosen, it must be applied to all other assets in that class, unless there is no active market for those assets. A class would involve items of a similar nature or use in an entity (for example, patents, software, franchises). Application of these two models for intangibles is very similar to what we discussed with respect to PP&E in the previous PD Net article, but with a few added twists. The cost model ( 74) We begin (as always) by recognizing the asset at cost (as discussed above). Subsequent to recognition as an asset, an intangible asset accounted for under the cost model must be carried at its cost less any accumulated amortization and any accumulated impairment losses. 1 1 Impairment losses are covered in IAS 36 Impairment of Assets, which is the topic of the fifth article in this series. In brief, an impairment loss is recognized when the recoverable amount of an asset is lower than its carrying value. International Accounting Standard 38 (IAS 38), Intangible Assets 4

5 The revaluation model ( 75) Subsequent to recognition as an asset (at cost), an intangible asset accounted for under the revaluation model is to be carried at a revalued amount namely, its fair value at the revaluation date less any accumulated amortization and any accumulated impairment losses. Revaluations need to be made often enough to ensure that the carrying amount is not materially different from fair value at the end of the reporting period. Under the revaluation model, fair value must be determined by reference to an active market (in other words, if there is no active market for the intangible asset, you would need to use the cost model). This differs from the treatment of PP&E, where the revaluation model can be used without the existence of an active market, as long as fair value can be reliably measured. For the purposes of IAS 38, an active market is defined as a market in which all the following conditions exist: a) the items traded in the market are homogeneous b) willing buyers and sellers can normally be found at any time c) prices are available to the public Paragraph 78 notes that it is uncommon for such an active market to exist for intangible assets, given their unique nature. Thus, we would expect that in most cases the cost model would be used. Assuming there is an active market and the revaluation method is used, the rules for intangibles follow the same logic as the rules for revaluing PP&E. Generally speaking, if an asset s carrying value is increased as a result of revaluation, the increase is recorded as a component of other comprehensive income, and is accumulated in equity as an item of other comprehensive income under the heading Revaluation surplus. If an asset s carrying amount is decreased as a result of a revaluation, the decrease is to be recognized in profit or loss ( 85 and 86). However, if an increase or decrease reverses a previously recognized revaluation, the treatment is different. Paragraph 85 requires an increase to be recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset that was previously recognized in profit or loss. Similarly, paragraph 86 requires a decrease to be recognized in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset. For example, if the current revaluation results in a decrease in an intangible asset s value, but there was an increase previously recognized in other comprehensive income, the decrease would be recognized in other comprehensive income, where it would reduce the revaluation surplus previously accumulated in respect of that asset. Once the original increase is reversed, any additional decreases would be recognized in profit and loss. Obviously, if there are no previous increases to reverse, decreases are reflected immediately in profit and loss. As with PP&E, when an intangible asset is revalued, any accumulated amortization at the date of the revaluation is treated in one of two ways ( 80): a) restated proportionately with the change in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount, or b) eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset. As noted earlier, paragraph 72 requires all assets in a class to be treated using the same model, unless there is no active market for an asset in a class. Paragraph 81 elaborates, stating that if an intangible asset that belongs to a class of revalued intangible assets cannot be revalued because there is no active market for this asset, the asset shall be carried at its cost less any International Accounting Standard 38 (IAS 38), Intangible Assets 5

6 accumulated amortization and impairment losses. In other words, if an entity uses the revaluation model for all of its patents, but one patent can t be revalued because there is no active market for it, that patent would be carried using the cost model. But what happens if an active market disappears? Paragraph 82 states that 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 will be its revalued amount at the date of the last revaluation by reference to the active market less any subsequent accumulated amortization and any subsequent accumulated impairment losses. In other words, the asset s value is frozen at the last revalued amount where an active market existed, and it is amortized from there. Note that if an active market no longer exists for a revalued intangible asset, this may indicate that the asset may be impaired and that it needs to be tested in accordance with IAS 36. As with PP&E, the cumulative revaluation surplus is eventually transferred to retained earnings, but this doesn t occur until the surplus is realized. The whole surplus may be realized on the retirement or disposal of the asset. However, some of the surplus may be realized as the asset is used by the entity; in such a case, the amount of the surplus realized is the difference between amortization based on the revalued carrying amount of the asset and amortization that would have been recognized based on the asset s historical cost. The transfer from revaluation surplus to retained earnings is not made through profit or loss ( 87). Useful life and Amortization The accounting for intangible assets after initial recognition depends on the asset s useful life. Based on paragraph 88, an entity needs to assess whether the useful life of an intangible asset is finite or indefinite. An intangible asset has an indefinite useful life when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. If the asset s useful life is finite, an estimate is needed in terms of the length of time or the units of production that constitute the useful life. Be aware that the term indefinite does not mean infinite. Instead, it simply means that there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. Intangible assets with finite useful lives are amortized; those with indefinite useful lives are not ( 89). Instead, they are tested for impairment by comparing recoverable amount with carrying amount. Specific guidance is given regarding the useful life of an intangible asset that arises from contractual or other legal rights. The useful life cannot exceed the period of contractual or other legal rights, but may be shorter depending on the period over which the entity expects to use the asset. Furthermore, the useful life can include any renewal period(s) on the rights, but only if there is evidence to support renewal by the entity without significant cost ( 94). For intangibles with finite useful lives, the depreciable amount is allocated on a systematic basis over its useful life. As with PP&E, amortization begins when the asset is available for use, and continues until the asset is derecognized, or until it is classified as held for sale under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. The amortization method used should reflect the pattern in which the asset s future economic benefits are expected to be consumed by the entity. (If that pattern cannot be estimated reliably, the straight-line method is used.) ( 97) The depreciable amount to be allocated is determined after deducting the asset s residual value. Paragraph 100 states that the residual value of an intangible asset with a finite useful life shall 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 International Accounting Standard 38 (IAS 38), Intangible Assets 6

7 ii) it is probable that such a market will exist at the end of the asset s useful life. The amortization period and method must be reviewed at least at each financial year end and, if there has been a change in the estimated useful life or expected pattern of consumption of the future economic benefits embodied in the asset, the amortization period and/or method must be changed accordingly. These changes are accounted for prospectively as changes in accounting estimates in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (but, as with PP&E, if the method is changed for a reason other than a change in the consumption pattern, this would still be considered a change in accounting policy, which requires retroactive application). For intangibles deemed to have indefinite useful lives, this assessment is reviewed annually. If the expectation of an indefinite useful life can no longer be supported, the asset is changed to having a finite useful life and is accounted for as above, with the changes being treated as changes in estimate ( 109). Also, in accordance with IAS 36, an entity is required to test for impairment by comparing the asset s recoverable amount with its carrying amount annually, and whenever there is an indication that the intangible asset may be impaired ( 108). Impairment As previously mentioned, carrying values need to reflect any impairment losses. To determine whether an item of intangible asset is impaired, refer to IAS 36 Impairment of Assets. Derecognition An intangible asset is removed from the balance sheet (that is, derecognized) when it is disposed of, or when no future economic benefits are expected from its use or disposal. The gain or loss arising from the derecognition is included in profit or loss when the item is derecognized; moreover, gains are not to be classified as revenue ( 112 and 113). Presentation and disclosure IAS 38 provides a considerable set of disclosure requirements for intangible assets. For each class of intangibles, and distinguishing between internally generated and other assets, the financial statements must disclose ( 118) whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortization rates used the amortization methods used for intangible assets with finite useful lives the gross carrying amount and any accumulated amortization (aggregated with accumulated impairment losses) at the beginning and end of the period the line item(s) of the statement of comprehensive income in which any amortization of intangible assets is included detailed reconciliation of the carrying amount at the beginning and end of the period (showing, for example, additions, amortization, impairment losses, revaluation information, foreign currency translation impacts, and so on) The entity is also required to disclose ( 122) the carrying amount of any intangible asset assessed as having an indefinite useful life, and the reasons supporting the assessment of an indefinite useful life a description, the carrying amount, and remaining amortization period of any individual intangible asset that is material to the entity s financial statements detailed information on intangible assets acquired by way of a government grant and initially recognized at fair value International Accounting Standard 38 (IAS 38), Intangible Assets 7

8 the existence and carrying amounts of intangible assets whose titles are restricted and the carrying amounts of intangible assets pledged as security for liabilities the amount of contractual commitments for the acquisition of intangible assets If intangible assets are accounted for at revalued amounts, paragraph 124 requires the entity to disclose a) by class of intangible assets: i) the effective date of the revaluation; ii) the carrying amount of revalued intangible assets; and iii) the carrying amount that would have been recognized had the revalued class of intangible assets been measured after recognition using the cost model in paragraph 74; b) the amount of the revaluation surplus that relates to intangible assets at the beginning and end of the period, indicating the changes during the period and any restrictions on the distribution of the balance to shareholders; and c) the methods and significant assumptions applied in estimating the assets fair values. And, finally, paragraph 126 requires an entity to disclose the aggregate amount of research and development expenditure recognized as an expense during the period. Differences from Canadian GAAP Both IFRS and current Canadian GAAP require intangible assets to be identifiable nonmonetary assets without physical substance in order to be recognized. IAS 38, however, provides more direct requirements for identifiability, in terms of the need for the asset to be separable or arising from contractual or legal rights. Specifically, IAS adds the qualifier regardless of whether the entity intends to do so whereas the issue of intent is absent from section Notwithstanding, the most significant difference between IAS 38 and Handbook section 3064 is that the former allows for intangible assets to be valued using either the cost method or the revaluation method, if there is an active market for the asset, whereas section 3064 permits only the cost method. This difference is somewhat minimized in practice, because the criteria for an active market would not commonly be met. Also, both IAS 38 and section 3064 require the annual review of estimates of useful life and the method of amortization. However, IAS 38 also requires annual review of residual value estimates, whereas section 3064 is silent with respect to such actions. Finally, there are also some differences that arise based on accounting for business combinations, which will be looked at in more detail later on in this series. Articles in this series will discuss: IFRS 1 First-time Adoption of IFRS IFRS 3 Business Combinations IFRS 7 Financial Instruments: Disclosures IAS 1 Presentation of Financial Statements IAS 16 Property, Plant and Equipment IAS 27 Consolidated and Separate Financial Statements IAS 32 Financial Instruments: Presentation International Accounting Standard 38 (IAS 38), Intangible Assets 8

9 IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 38 Intangible Assets IAS 39 Financial Instruments: Recognition and Measurement For a more comprehensive introduction to the adoption of IFRSs, see the online course IAS 16/IAS 38, available on PD Net. You must be registered to access and purchase the course. If you are not registered on PD Net, register now it s fast, easy, and free. Brian and Laura Friedrich are the principals of friedrich & friedrich corporation, an accounting research, standards, and education firm. The firm provides policy, procedure, and governance guidance; develops courses, examinations, and other assessments; and supports the development of regional public accounting standards in Canada and internationally. Brian and Laura have served as authors, curriculum developers, lecturers, exam developers, and markers for numerous CGA and university courses in Canada, China, and the Caribbean. Their volunteer involvement has earned them CGA-BC s inaugural Ambassador of Distinction Award (2004) and the J.M. Macbeth Award for service at the chapter level (Brian in 2006 and Laura in 2007). Brian and Laura are also Fellows of the Chartered Association of Certified Accountants (FCCA UK). Stephen Spector is a Lecturer currently teaching Financial and Managerial Accounting at Simon Fraser University. He became a CGA in 1985 after obtaining his Master of Arts in Economics from SFU in In 1997, CGA-BC presented him with the Harold Clarke Award of Merit for recognition of his service to the By-Laws Committee for In 1999, Stephen received the Fellow Certified General Accountant (FCGA) award for distinguished service to the Canadian accounting profession. He has been on SFU s Faculty of Business Administration s Teaching Honour Roll for May 2004 to April 2005 and May 2006 to April In August 2008, he was one of the two annual winners of the Business Faculty s TD Canada Trust Distinguished Teaching Award. Stephen has held a number of volunteer positions with CGA-BC; he currently sits on CGA-BC s board of governors where he is CGA-BC s President. International Accounting Standard 38 (IAS 38), Intangible Assets 9