PAS 38: INTANGIBLE ASSETS

CRITERIA FOR RECOGNITION

Identifiability
In order to meet the definition of an intangible asset, expenditure on an item must
be separately identifiable in order to distinguish it from goodwill. An asset meets
the identifiability criterion when it
• Is capable of being separated from the entity and sold, transferred, licensed, or
rented either individually or in combination with a related contract, asset, or
liability
• Arises from contractual or other legal rights, regardless of whether those rights
are transferable or separable from the entity or other rights or obligations

Control
An entity controls an asset if it has the power to obtain the future economic
benefits flowing from the underlying resource and to restrict the access of others
to those benefits. Usually this control would flow from legally enforceable rights.
However, legal enforceability is not necessary if control can be enforced in some
other way.

For example, one method of control is keeping something secret through employee
confidentiality.
Control needs to be looked at carefully. An entity may be able to identify skills
in its workforce and to measure the costs of providing those skills to its staff
(via training). However, the entity usually does not have control over the expected
economic benefits arising from the skilled staff, as they can leave their
employment.

Even if the skills are protected in some way such that departing staff are not
permitted to use them elsewhere, the entity has lost the future benefit of the
skills imbued in the departing staff member.

Similarly, the purchase of customer lists or expenditure on advertising, while

identifiable, does not provide control to an entity over the expected future
benefits. Customers are not forced to buy from the entity and can go elsewhere.

Future Economic Benefit

Future economic benefit may include revenue from the sale of products, services, or
processes, but also includes cost savings or other benefits from use of an asset.

Use of intellectual property can reduce operating costs rather than produce
revenue.

RECOGNITION AND MEASUREMENT

An item may be recognized as an intangible asset when it meets the definition of an
intangible asset (see previous) and meets these recognition criteria
• It is probable that the expected future economic benefits that are attributable
to the asset will flow to the entity.
• The cost of the asset can be measured reliably.

Initially, intangible assets shall be measured at cost. The cost of separately

acquired intangible assets comprises
• Purchase price, including any import duties and nonrefundable purchase taxes,
less discounts and rebates.
• Directly attributable costs of preparing the asset for use.
Directly attributable costs can include employee benefits, professional fees, and
costs of testing.

Costs that cannot be included are

• Costs of introducing new products or services, such as advertising
• Costs of conducting new business
• Administration costs
• Costs incurred while an asset that is ready for use is awaiting deployment
• Costs of redeployment of an asset
• Initial operating losses incurred from operation

If payment for an intangible asset is deferred beyond normal credit terms, then the
cost is the cash price and the balance is treated as a finance charge over the
period of the finance.

If intangible assets are acquired as part of a business combination, as defined in

PFRS 3, their cost is their fair value at the acquisition date. The probability of
future economic benefit is reflected in their fair value, and, therefore, the
probability of future economic benefit required for recognition is presumed. In a
business combination, such intangible assets are to berecognized separately from
goodwill.

Assessing the fair value of an intangible asset in a business combination can be

difficult; obvious techniques are the use of comparable market transactions or
quoted prices. Sometimes there may be a range of values to which probabilities can
be assigned. Such uncertainty enters into the measurement of the asset rather than
demonstrating an inability to measure the value. If an intangible asset has a
finite life, then it is presumed to have a reliably measurable fair value.

In some circumstances, it may not be possible to reliably measure the fair value of
an intangible asset in a business
combination because it is inseparable or there is no history or evidence of
exchange transactions for the asset, and any fair value estimates would be based on
immeasurable variables.

If an intangible asset is acquired in exchange for another asset, then the acquired
asset is measured at its fair value unless the exchange lacks commercial substance
or the fair value cannot be reliably measured, in which case the acquired asset
should be measured at the carrying amount of the asset given up, where carrying
amount is equal to cost less accumulated depreciation and impairment losses. For
impairment losses, reference should be made to PAS 36. In this context, any
compensation received for impairment or loss of an asset shall be included in the
income statement.

INTERNALLY GENERATED INTANGIBLE ASSETS

With internally generated intangible assets, problems arise in identifying whether
there is an identifiable asset that will
generate future economic benefit and in reliably determining its cost.

Goodwill
The Standard proscribes the recognition of internally generated goodwill as an
asset. The rationale behind this is that any expenditure incurred does not result
in an asset that is an identifiable resource—it is not separable, nor does it arise
from contractual or other legal rights—or that is controlled by the entity. In
addition, any costs incurred are unlikely to be specifically identifiable as
generating the goodwill. The position that the difference between a valuation of a
business and the carrying amount of its individual assets and liabilities may be
capitalized as goodwill falls down insofar as that difference cannot be categorized
as the cost and therefore cannot be recognized as an asset.

Other Internally Generated Intangible Assets

The Standard sets out rules for the recognition of other internally generated
intangible assets and broadly defines such expenditures as research and
development. It proscribes the recognition of internally generated brands,
mastheads, publishing titles, customer lists, and similar items, because
expenditure thereon, like expenditure on internally generated goodwill, cannot be
distinguished from the cost of developing the business as a whole and is therefore
not separately identifiable.

In order to determine whether an internally generated intangible asset qualifies

for recognition, its generation is divided into a research phase and a development
phase. If the two phases cannot be distinguished, then the entire expenditure is
classified as research.

Expenditure on research (or the research phase of an internal project) is to be

written off as an expense as and when
incurred, as it is not possible to demonstrate that an asset exists that will
generate future economic benefit. Examples
include
• Activities aimed at obtaining new knowledge
• The search for, evaluation, and selection of applications of research findings or
knowledge
• The search for alternatives for materials, devices, products, systems, or
processes
• The formulation, design, evaluation, and selection of possible alternatives for
new or improved materials, devices,
products, systems, or processes

Development expenditure may be recognized as an intangible asset when, and only

when, all of the following can be
demonstrated:
• The technical feasibility of completing the asset so that it will be available
for use or sale
• The intention to complete the asset and use or sell it
• The ability to use or sell the asset
• How the asset will generate probable future economic benefit, including
demonstrating a market for the asset’s
output, or for the asset itself, or the asset’s usefulness
• The availability of sufficient technical, financial, and other resources to
complete the development and to use or sell
the asset
• The ability to reliably measure the expenditure attributable to the asset during
its development

Examples of activities that may fail to be recognized as intangible assets include

• The design, construction, and testing of preuse prototypes or models
• The design of tools and jigs involving new technology
• The design, construction, and operation of a pilot plant that is not capable of
commercial production
• The design, construction, and testing of a chosen alternative for new or improved
materials, devices, products,
systems, or processes

RECOGNITION OF AN EXPENSE
The Standard requires that all expenditure on an intangible item be written off as
an expense unless it meets the recognition criteria or it is acquired as part of a
business combination and cannot be separately identified, in which case it is
subsumed as part of goodwill and treated in accordance with PFRS 3. Examples
include
• Expenditure on start-up activities (start-up costs) or on opening a new facility
or business (preoperative expenses)
• Expenditure on training
• Expenditure on advertising and promotional activities (including mail order
catalogues)
• Expenditure on relocating or reorganizing part or all of an entity

WEB SITE DEVELOPMENT COSTS

The advent of the Internet has created new ways of performing tasks that were
unknown in the past. Most entities have their own Web site that serves as an
introduction of the entity and its products and services to the world at large. A
Web site has many of the characteristics of both tangible and intangible assets.
With virtually every entity incurring costs on setting up its own Web site, there
was a real need to examine this issue from an accounting perspective. An
interpretation was issued that addressed Web site costs: SIC 32, Intangible Assets—
Web site Costs.

SIC 32 lays down guidance on the treatment of Web site costs consistent with the
criteria for capitalization of costs
established by PAS 38. According to SIC 32, a Web site that has been developed for
the purposes of promoting and
advertising an entity’s products and services does not meet the criteria for
capitalization of costs under PAS 38. Thus costs incurred in setting up such a Web
site should be expensed.

MEASUREMENT AFTER RECOGNITION

The Standard states that, after recognition, intangible assets may be measured
using either a cost model or a revaluation model. However, if the revaluation model
is used, then all assets in the same class are to be treated alike unless there is
no active market for those assets.

“Classes of intangible assets” refers to groupings of similar items, such as

patents and trademarks, concession rights, or brands. Assets in each class must be
treated alike in order to avoid mixes of costs and values.

If the cost model is selected, then after initial recognition, an intangible asset
shall be carried at cost less accumulated amortization and impairment losses.

If the revaluation model is selected, the intangible asset shall be carried at its
fair value less subsequent accumulated
amortization and impairment losses. Fair values are to be determined from an active
market and are to be reassessed with regularity sufficient to ensure that, at the
end of the reporting period, the carrying amount does not differ materially from
its fair value.

A revaluation increase is to be recognized in other comprehensive income and

accumulated in equity unless it reverses a previously recognized impairment loss,
in which case it shall be recognized in profit or loss. If, in subsequent years,
revaluation decreases on the same asset occur, such decreases are recognized in
other comprehensive income to the extent of any credit balance in the revaluation
surplus in respect of that asset. Otherwise the reduction is recognized in profit
or loss.

Any revaluation reserve in respect of a particular intangible asset is transferred

to retained earnings when it is realized. This could be on disposal, although it is
permitted to treat the additional amortization resulting from the revaluation as a
realization of that surplus and transfer this amount from revaluation reserve to
retained earnings. Under no circumstances can the revaluation reserve, or part
thereof, be credited to profit or loss.

USEFUL LIFE
The useful life of an intangible asset must be assessed on recognition as either
indefinite or finite. If the assessment
determines the life to be finite, then the length of life or number of units to be
produced must be determined also. An
indefinite useful life may be determined when there is no foreseeable limit to the
period over which the entity will continue to receive economic benefit from the
asset. All relevant factors must be considered in this assessment and may include
• Expected usage by the entity and whether it could be used by new management teams
• Product life cycles
• Rates of technical or commercial change
• Industry stability
• Likely actions by competitors
• Legal restrictions
• Whether the useful life is dependent on the useful lives of other assets
“Indefinite” does not mean “infinite.”

Additionally, assessments should not be made based on levels of future expenditure

over and above that which would normally be required to maintain the asset at its
initial standard of performance.

AMORTIZATION
The depreciable amount of an intangible asset with a finite useful life is to be
allocated over its useful life. The depreciable amount is the cost of the asset (or
other amount substituted for cost, e.g., in a revaluation model) less its residual
value. Amortization shall commence when the asset is ready for use and shall cease
when it is derecognized or is reclassified as held for sale under PFRS 5.

The residual value is to be assumed to be zero unless there is a commitment by a

third party to acquire the asset at the end of its useful life or there is an
active market for the asset and the residual value can be determined by reference
to that market, and it is probable that an active market will continue to exist at
the end of the asset’s useful life.

Therefore, an asset with a residual value at anything other than zero assumes that
the entity will dispose of the asset prior to the end of the asset’s economic life.

The Standard requires that the residual value be reassessed at each balance sheet
date. Any changes are to be treated as changes in accounting estimates. In
practice, this is unlikely to have any impact in view of the basic presumption of a
zero residual value.

Similarly, the useful life is to be reassessed annually. Any changes are also to be
treated as changes in accounting estimates.

Intangible assets with indefinite useful lives are not to be amortized. However,
the asset must be tested for impairment annually and whenever there is an
indication that it may be impaired. PAS 36 provides guidance on impairment.
Additionally, the determination of an indefinite useful life must be reassessed at
each balance sheet date. If the assessment changes, it is to be treated as a change
in accounting estimate.

Accounting for Specific Intangible Assets

Patent
A patent gives the holder exclusive right to use, manufacture, and sell a product
or a process without interference or
infringement by others.

Acquired
Same with PPE - (Cost depends on manner of acquisition)
Internally generated
Expensed – R&D costs related to the development of the product, process, or idea
that is subsequently patented
Capitalized – Costs to secure the patent right

Amortization
Over its legal life (20 years) or its useful life, whichever is shorter.

Trademark
A trademark or trade name is a word, phrase, or symbol that distinguishes or
identifies a particular entity or product.

Measurement
Same with patents

Legal life
Legal protection for an indefinite number of renewals for a period of 10 years
(Sec. 145 RA 8293) each.

Amortization
Limited life - Amortized over the life of the trademark
Indefinite life - not amortized

Franchise
A franchise is a contractual arrangement under which the franchisor grants the
franchisee the right to sell certain products or services, to use certain
trademarks or trade names, or to perform certain functions, usually within a
designated geographical area.

Fees related to franchise

Initial – capitalized; amount depends on the manner of payment
Periodic – expensed when incurred

Amortization
Limited life - Amortized over the life of the franchise
Indefinite life - not amortized

Goodwill
An asset representing the future economic benefits arising from other assets
acquired in a business combination that are not individually identified and
separately recognized. (PFRS 3 Appendix)

Determination of Goodwill
Specific attributes approach
The attributes and components of goodwill are identified and valued accordingly.