The development of accounting standards has been faced with controversy with some countries not adopting the international accounting standards (IAS). Relevance and reliability are the two main characteristics causing the difference. In the European countries, reliability is regarded as more important than relevance while in Anglo-American countries relevance dominates. This has occurred when it comes to accounting for intangible assets especially internally generated intangibles of a company or organization. This raises the question of what are intangible assets and how should they be accounted for? Can companies include internally generated assets in their balance sheets or not? What are the limits of the IAS 38 when it comes to intangible assets?
Aim of the study
This research aims to examine the definition and nature of intangible assets, how their recognition is made, their measurement both initial and subsequent, their disclosure by companies, and how internally generated intangible assets are dealt with. Moreover, the study examines the limitations of IAS 38 on companies when it comes to the issue of internally generated intangible assets.
Importance of Study
Changes in the economic and financial scene have made the issue of intangible assets be addressed since it has become a big part of companies’ wealth and successes (Stolowy and Haller 1). According to Stolowy and Haller, the accounting consequence of intangible assets is a “hot issue” and its practical relevance is great due to the relative significance which these assets may have on the presentation of companies’ balance sheet and market value (1). Thus, an in-depth study on intangible assets is required to clearly define ways of accounting for them.
An intangible asset is an asset that can be identified; it is not in form of money nor can it be touched. A company has control over the asset and any future economic benefit arising out of the asset flows to the company. Furthermore, its cost can be measured reliably (Pietersz 5). Examples of intangible assets include brands, research and development expenditure, copyright agreements, patents, construction permits, licensing agreements, advertising contracts, and franchises. An intangible asset can be identified if it is detachable or separable, i.e. it can be divided from a company or entity or if it is arising from legal rights. The asset can be licensed, rented, sold, transferred, or exchanged. There is usually no addition or replacement of intangible assets thus the expenditure maintains the expected future economic benefit.
Recognition and measurement of intangible assets
Recognition of intangible assets involves ensuring the cost of the asset is measurable and a possible economic benefit will flow to the company. In addition, a clear definition of the intangible asset should exist.
Reliable measurement of cost (Initial measurement)
Intangible assets are measured initially at cost and this depends on the way they have been acquired which can be through Government grants, asset exchange, and separate acquisition, part of business acquisition or internally generated assets such as brands.
Assets acquired through Government grants, asset exchange and as part of a business combination are normally measured at their fair value or nominal value at the time they are acquired. According to IASC, assets acquired through business mergers may not be reliably measured at fair value when they are not separable or there is no evidence of exchange transactions for similar assets (2).
The cost of separately acquired assets is the purchase price of the asset. Typically, the purchase price includes import duties, non-refundable taxes and any direct costs used for the asset preparation. Any discounts and rebates awarded during the asset acquisition are deducted from the purchase price. The probability recognition criteria for separately acquired assets and those acquired through a business combination is always satisfactory for intangible assets therefore no issues arise (IASC 1).
For internally generated assets, it becomes hard to determine whether they qualify for recognition (IPSAS 17). To be able to ascertain that they are indeed intangible assets, they are categorised into two phases. These are the research and development phases. A clear difference should be made between the research and development phases of a project. If a company can not differentiate between the two, then a project is assumed to be in the research stage and all incurred expenditure is treated as expenses and the asset is not termed as intangible. However, if a project is in the development stage and a company is able to prove the technical viability of a project, its capability to sell or use the end product, the available resources for project completion and how the economic benefit arising out of the project will be generated, then it can be regarded as an intangible asset.
The importance of internally generated intangibles has reflected greatly in the increasing share of an entity’s market value. In some companies, brand assets have contributed massively to the shareholder market value while in others, an omission is made in the balance sheet. This is due to a lack of relation between their future revenue and costs (Austin 64). Depending on a company’s interpretation of intangibles, some choose not to capitalise them other than those meeting the research and development criterion. IAS 38 also prohibits capitalisation of some assets whether they meet the development criterion or not. This is in case of brands, goodwill, mast-heads and publishing titles.
Internally generated goodwill is not considered an intangible asset because, even though a future economic benefit may arise out of it, no asset creation occurs, i.e. it is not identifiable (separable or arising out of binding arrangements).
In subsequent measurement of intangible assets, two models are used. These are the cost model and the revaluation model.
- Cost model. In this model, the cost of the intangible asset is used as a base figure. To be able to accurately determine the value of the asset, accumulated amortisation and impairment losses are deducted from the cost.
- Revaluation model. In this model, the asset’s fair value is used less the accumulated amortisation and impairment. The fair value is determined by comparing the asset value to an active market value. The value of the asset should be close to its fair value at the date the revaluation is done, i.e. the variance should be minimal.
Impairment and Amortisation
An entity is required to gauge the useful life of the intangible assets into those with either finite or indefinite life (Austin 69). When assets are assessed, those possessing finite life are amortised. Amortisation is carried out by evenly allocating a depreciating amount over the asset useful life (Sangtani 24). Sometimes, there is no predictable limit to the period for cash flow to an entity. Assets which possess such life are said to have an indefinite life (IASC 3). Therefore, those with indefinite lives must be annually assessed for any form of impairment and adjusted accordingly.
Internally generated goodwill has its cash flow attached to other assets other than the goodwill itself hence its impairment is difficult. To test for impairment, a comparison is made between the balance sheet value and the current market value.
Entities normally disclose each class of intangible assets to distinguish between other intangible assets and internally generated intangible assets by:
- Their useful life, i.e. whether finite or indefinite and the amortization rates used.
- The method used for amortization for finite useful life intangible assets.
- The gross carrying amount.
- The effective date of revaluation for assets which are accounted for at revaluation.
- The reconciliation carrying amount.
Intangible assets have controversial measurement and recognition features which have made it hard for some countries to adopt the standard. The IAS 38 imposes limits on the recognition of some assets, for example, the internally generated intangible assets. This has made some companies to “derecognise” some assets leading to a drop in their market value and a change in their financial statements. Despite this, the IAS 38 has made recognition of intangibles in other situations such as separate acquisition and business mergers which provides a relief to most companies.
Austin, Lloyd. Accounting for Intangible Assets. University of Auckland Business Review. 9.1(2007): 63-72. Web.
International Accounting Standards Committee. IAS 38 Intangible Assets. 2009. Web.
International Public Sector Standards Board. Intangible Assets. IPSAS. 2010. Web.
Pietersz, Graeme. Intangible Assets. 2011.
Sangtani, Gaurav. Intangible Assets. Web.
Stolowy, Herve and Haller, Axel. Accounting for Brands in IAS 38 of IASC (Intangible assets) compared with French and German practises. 1999. Web.