aus std theory)

Lecture 6

Accounting for Intangibles

HI6025: Accounting Theory

and Current Issues

Holmes Institute 2015 2

Intangible assets defined

Non-monetary assets without physical

substance (but has value)

Includes;

Patents Copyrights

Goodwill Trademarks

Mastheads Research & Development

Brand names.

Value of Intangible assets example

“Trademarks can be a valuable asset to a company. The

trademark "COCA-COLA" has been estimated to have a

value ranging from twenty to seventy billion dollars under

various valuation models. Commentators have noted

that if all of the physical assets of the company were

destroyed (e.g. the buildings, the trucks, the bottling

companies), the "COCA-COLA" trademark and other

intellectual property would be sufficient valuable to

enable positive cash flow within one year. In other

words, its branding and other intangible assets would

comprise all that is necessary to fuel its rebirth. The time

and money that the company has spent on its brand has

built recognition and loyalty that support demand for its

products worldwide”. (Brandwise, July 6, 2009)

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The lack of physical substance does not

preclude an item from being considered to be an

asset – In Australia, corporations typically trade

for 5 times the value of their physical assets; in

the USA, that ratio is typically 12 to 15 times. For

example: What makes Microsoft profitable?

Intangible assets, as a category, must be

separately disclosed in the statement of financial

position (balance sheet)


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Identifiable intangible assets

A specific value can be placed on each individual asset, and they can be separately identified and sold

For example, brand names, trademarks, research and development, patents, licences, mastheads and copyrights

Internally generated intangibles (other than those relating to development expenditure, if certain criteria are satisfied) must be expensed as incurred

‘Internally generated’—if developed within the organisation rather than being acquired at cost from an external party (i.e. no market or independent third party to verify the value of the intangible).



Unidentifiable or inseparable intangible assets

Intangible assets that cannot be separately sold

For example, goodwill

The recognition of internally generated goodwill is prohibited

Unidentifiable goodwill is permitted to be recognised only when it has been externally acquired (AASB 3)

Many internally generated intangibles must be written off as incurred despite the fact that these ‘assets’ are often expected to generate future economic benefits—a VERY restrictive (conservative) approach


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Which can be recognised?

AASB 138 Intangible Assets Internally generated intangible assets (except

internally generated development expenditure) are not to be carried forward as assets

Specifically, paragraph 63 states:

“Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets”

Refer to Worked Example 8.1 on page 253—

Capitalising expenditure on intangible assets


Which can be recognised?

AASB 138 Intangible Assets (cont.)

Intangible assets may be recognised only upon acquisition from an external party and only when there is an associated ‘cost’

‘Cost’ to include purchase price (including legal fees, taxes and deducting discounts) and cost involved in getting asset ready for use.

Internally generated intangibles cannot subsequently be recognised through revaluation


Which can be recognised (cont.)

Intangible asset (as per all assets) must be recognised when:

it is probable that the future economic benefits attributable to the asset will flow to the entity

cost can be measured reliably

there is control over the future economic benefits


Amortisation requirements

Intangible assets (other than goodwill) are required to be amortised over their useful lives

Useful life of an intangible asset under AASB 138

The period of time over which the asset is expected to be used by the entity, or the number of production or similar units expected to be obtained from the asset by the entity


Amortisation requirements (cont.)

If the life of an intangible asset is limited by

time a method of amortisation based on time

would be used

Amortisation shall begin when the asset is

available for use, that is when it is in a

location and condition necessary for it to be

capable of operating in the manner intended

by management (same rule as with

depreciation of property, plant and

equipment)



Under AASB 138 the residual value of intangible assets with finite lives is generally considered to be zero, unless: there is a commitment by a third party to purchase the

asset at the end of its useful life, or

there is an active market for the asset, and the residual amount can be determined by reference to that market and it is probable that the market will still exist at the end of the useful life of the asset

Useful life, residual value and amortisation method to be reviewed annually

Refer to Worked Example 8.2 on page 255 (shown following slides)

Determining the amortisation expense


Worked example 8.2

During the year ending 30/6/2011, Shoreham

Ltd acquired the following intangible assets;

A patent at a cost of $500K. Patent allowed for

production of 200,000 units. During year, Shoreham

produced 40,000

The right to use the trade name “Coco Cooler” in the

local district for $700K. “CC” is a highly-recognised

brand of soft drink, popular for 50 years, expected to

continue. As at 30/6/2011, Shoreham would easily be

able to obtain $700K if they wished to dispose of the

trade name.

Determine the amortisation expense for Shoreham


Solution – worked example 8.2

Patent – would be amortised on the basis of

production which would be 20% (200,000 units

permitted, 40,000 produced. So the amount to

amortised would be $100,000

Trade name – considered to have an

indefinite useful life so would be subject to

annual impairment testing. The directors

would probably determine that as the value of

the trade name has not been impaired, no

impairment expense would be recognised.


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Factors to be considered in determining the useful life :

(a) the expected usage

(b) typical product life cycles

(c) technical, technological, commercial, or other types of

obsolescence

(d) the stability of the industry and changes in the market

demand for the products or services output

(e) expected actions by competitors

(f) the level of maintenance expenditure required

(g) the period of control over the asset, such as the expiry

dates of related leases

(h) whether the useful life of the asset is dependent on the

useful life of other assets of the entity



Amortisation method should reflect the pattern in which the economic benefits are derived—if the pattern cannot be determined reliably, the straight-line amortisation method is to be used

Intangible assets may have an ‘indefinite life’

No foreseeable limit on the period over which the asset is expected to generate cash flows


Amortisation requirements (cont.)

If the asset has an indefinite life there is no

requirement to amortise—instead the asset

should be subject to impairment testing at

the end of each reporting period.

If there is an impairment in the value of the

asset (recoverable amount less than

carrying amount) it is to be shown as an

expense


Revaluation of intangible assets

Intangible assets may be revalued only if

there is an ‘active market’ and only if

acquired at cost

Active market defined as:

“a market exhibiting all of the following: the

items traded are homogeneous, willing

buyers and sellers can normally be found,

and prices are publicly available”.

Must also consider the depth and breadth

of the market – MB Logs.


Revaluation of intangible assets (cont.)

It is ‘uncommon’ for active markets to exist for

most intangible assets because of their unique

nature

Therefore, intangible assets can typically not

be revalued

Where revaluation occurs it must be to fair

value of asset

An amount for which an asset could be

exchanged between knowledgeable, willing

parties in an arm’s length transaction


Disclosure requirements

Numerous disclosures are required by AASB 138

For each class of intangible assets, distinguishing between internally generated and other intangible assets:

(a) Whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortisation rates used

(b) The amortisation methods used

(c) The gross carrying amount and any accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period

(d) The line item(s) of the statement of comprehensive income in which any amortisation of intangible assets is included


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Disclosure requirements

Financial statements are also to disclose:

(a) If an intangible asset is assessed as having an indefinite useful life, the carrying amount of that asset and the reasons supporting the assessment of an indefinite useful life.

(b) A description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial statements of the entity as a whole

(c) For intangible assets acquired by way of a government grant and initially recognised at fair value:

(i) The fair value initially recognised for these assets

(ii)Their carrying amounts

(iii)Whether they are carried under the benchmark or the allowed alternative treatment for subsequent measurement


Research & development

AASB 138 applies to intangible assets generally—

however, a number of paragraphs deal specifically

with R&D.

Research and development

Accounting problem: will expenditure with

reasonable probability provide future benefits?

AASB 138 applies the simplifying assumption that

all expenditure undertaken on the research

component of research and development is to be

expensed



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:

“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 prior to the commencement of

commercial production or use”


Research & development Research expenditure—to be written off as incurred

AASB 138, par. 54

“No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research shall be recognised as an expense when incurred”.

In justifying the above requirement:

AASB 138 (par. 55)

“In the research phase of an internal project, an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. Therefore, this expenditure is recognised as an expense when it is incurred”


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Development expenditure can be deferred only if the entity can show all of the following (AASB 138, par. 57):

The technical feasibility of completing the intangible asset

Its intention to complete the intangible asset, and use or sell it

Its ability to use or sell the intangible asset; how the intangible asset will generate probable future economic benefits, including the existence of a market for the intangible asset or, where the intangible asset is to be used internally, its usefulness

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Development expenditure (cont.) can also be

deferred only if the entity can show all of the

following (AASB 138, par. 57):

The availability of adequate technical, financial

and other resources to complete the

development

Its ability to measure reliably expenditure on the

intangible asset during its development



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Tests for deferral similar to the case with other

intangible assets

An intangible asset should be recognised if, and

only if:

(a)It is probable that the future economic

benefits that are attributable to the

asset will flow to the enterprise, and

(b)The cost of the asset can be measured

reliably


Research & Development

Refer to Worked Example 8.4 on page

262—Amortisation of research and

development (shown following slides)

and to Worked Example 8.5 on page

263—Amortisation of deferred

development costs (following)


Amortisation of R&D Worked Ex. 8.4

Portsea Ltd has spent $300K (on demand for

product) on R&D for a product called the “burble”.

They also spent $250K testing the compounds of

the product.

As a result of the knowledge gained from the

above, company has designed machinery to make

the product, expected to cost $600K. It is expected

that millions of “burbles” will be sold at $10 each.

All the expenditure occurred in one period.

Required: how much of the above expenditure

would qualify to be shown as an intangible asset?


Accounting standards require the expensing of all

research expenditure.

The $300K and $250K constitute research and

expensed in the year they were incurred.

The $600K for machine design would satisfy

development and to the extent that future economic

benefits are measureable with reasonable accuracy

and are probable, the amount would be recognised

in the Balance Sheet. The amount would be subject

to future amortisation charges (unless it could be

justified that the life of the asset was indefinite).

Amortisation of R&D Worked Ex. 8.4


Amortisation of deferred development costs

Ex: Streaky Bay Ltd is involved in R&D and for year-

ending 30/6/2011, R&D on Project “X” is as follows;

Research: $185,000

Development: $300,000

Project “X” is expected to return profits of $250K

over next 4 years (with about $62,500 expected to

be recognised per annum) commencing from

1/7/2011. Streaky bay uses a discount rate of 8%/

How much R&D will be expensed for YE30/6/2011?

How much R&D will be amortised for YE30/6/2011?


R& D to be expensed

Research 185,000

Development 300,000

Amount to be recouped (207,008) 92,992

R& D expensed in 2011 277,992

Calculation of amount recouped

Equation 1-(1+i)yx +/-p/i

So 1-(1+0.08)yx +/-4/0.08 = 3.31212684 x 62,500 = 207,008



R&D to be amortized

As the development has a limited life (4 years in this

case), should be amortised over the periods during

which the entity is expected to benefit from the

expenditure.

We would apply Straight-line method so;

$207,008/4 = $51,752.

Note: slight conflicting error in text book. The

$207,008 is the correct amount (rounded off).



Goodwill (Cont’d)

What is goodwill?

Arises when one entity acquires another entity, or part thereof, e.g. one company acquires a controlling interest in another entity

An unidentifiable intangible asset that cannot be individually identified and is an intrinsic part of the business

Cannot be purchased or sold separately, but only as part of an entity in its entirety

Represents the future economic benefits associated with an existing customer base, efficient management, reliable suppliers, etc.


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Goodwill (Cont’d)

What is goodwill? (cont.)

Could be built up over a number periods (internally generated) or obtained (purchased) by acquiring an existing business

The relevant accounting standard is AASB 3 Business Combinations, in which goodwill is defined as:

“An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised”


Goodwill (Cont’d)

Internally generated versus purchased goodwill

Goodwill may be internally generated or

acquired by purchasing an existing business

Only purchased goodwill is permitted to be

recorded. The view is that:

purchased goodwill can be measured more

reliably than internally generated goodwill,

based on the amount paid


Goodwill (cont’d)

Internally generated goodwill cannot be

brought to account

Purchased goodwill is measured as:

the excess of the cost of acquisition

(purchase consideration plus incidental

expenses) incurred by the acquirer over

the fair value of the identifiable net assets

and contingent liabilities acquired


Goodwill (Cont’d)

How is goodwill measured?

Purchased goodwill is measured as the excess of the cost of acquisition (purchase consideration plus incidental expenses over the fair value of the identifiable net assets and contingent liabilities acquired

Purchase consideration:

should be measured at the fair value of what is given up in the exchange

Refer to Worked Example 8.7 on page 269—Calculation of goodwill


Goodwill calculated

P acquires S and pays

Cash: 250,000

Land: Book value-$225K, Fair value-$280K

Shares: Market value-$50,000

S has assets of $580K, Liabilities of $80,000

All assets of S are fairly valued except for

building, which in BS shows $90K but FV is

$130K.

How much goodwill needs to be recognised?

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Solution to example (Goodwill)

P paid

Cash 250,000

Land 280,000

Shares 50,000

Total 580,000

S – fair value

Assets 580,000

Plus FV-bldg 40,000

Less Liab. 80,000

Total 540,000

As P paid $580K for S, and S Net assets after

FV was $540K, Goodwill is $40K

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Goodwill impairment

Impairment testing Requirement to amortise goodwill was removed in 2005

and replaced with requirement to undertake annual ‘impairment testing’

AASB 3 (par. 55)

“Goodwill acquired in a business combination shall not be amortised. Instead, the acquirer shall test it for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired, in accordance with AASB 136 ‘Impairment of Assets”

AASB 136 (par. 124)

“An impairment loss recognised for goodwill shall not be reversed in a subsequent period”


Goodwill impairment

Impairment loss (under AASB 136)

The amount by which the carrying amount of an

asset or cash-generating unit exceeds its

recoverable amount

Recoverable amount of an asset (under AASB 136)

The higher of its fair value less costs to sell and its

value in use

Value in use

Present value of the future cash flows expected to

be derived from an asset or cash-generating unit


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Goodwill impairment

Accounting for impairment loss of goodwill

Dr Impairment loss—goodwill xx

Cr Accumulated impairment loss—goodwill xx

To recognise the impairment loss on Goodwill

Note: Prohibition on revaluing goodwill—if the

recoverable amount of goodwill is assessed as being

greater than the carrying value then no revaluation may

be made

Refer to Worked Example 8.8 (pp 271)


Is the new approach working? Critical perspective

New levels of international consistency in financial reporting but some argue that it is seriously flawed and archly conservative

Fails to require recognition of many intangible assets—will reduce the value of statements of financial position (balance sheets) in relation to the resources under the control of the reporting entity

Places a number of severe restrictions on the recognition of internally generated intangible assets and on revaluation of those assets

Introduces subjectivity: assessments will now have to be made about whether the value of goodwill has been ‘impaired’


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Is the new approach working?

Critical perspective (cont.)

Possible that requiring entities involved in research and development to expense all research as incurred might discourage them from undertaking certain research as it will impact negatively on profits

Active market restrictively defined as ‘a market where the items traded are homogeneous, there are willing buyers and sellers at any time, and prices are known to the public’

Active markets do not exist for the vast majority of intangible assets

As a result of adopting IFRSs, in most cases where intangible assets are recognised they will be recorded at cost, less accumulated amortisation, rather than being shown at their fair value, with ‘fair value’ potentially being more relevant to users of financial statements


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