Accounting Notes - FAR

Intangible Assets
Reference Materials:
Intermediate Accounting Volume 1 by Conrado T. Valix, et al.

Intangible Asset
PAS 38, paragraph 8, simply defines an intangible asset as an identifiable nonmonetary asset without
physical substance. It must be controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.

Intangible Asset - GOODWILL

Valuation of contributions of partners
a. Cash and cash equivalents - Face Amount (PAS 7)
b. Non-cash assets & liabilities - Agreed Values, otherwise Fair Value (Art. 1787, PFRS 2); not given, Book
Value
i. Inventory - Lower of Cost and Net Realizable Value (PAS 2)
Special Notes:
➔ Receivable - accounted for at gross amount; ADA is established separately
➔ PPE - accounted for at net of Accumulated Depreciation; Accumulated Depreciation is not
carried forward
c. Service or industry - memo entry

Note:
No contribution shall be valued at an amount that exceeds the contribution’s recoverable amount (higher
between asset’s FV - cost to sell and value in use)

Partner’s Capital account - real account and has a normal credit balance.
Debit: (a) Permanent withdrawals of capital
(b) Share in losses
(c) Debit balance of drawings account

Credit: (a) Initial investment

(b) Additional investments
(c) Share in profits
Partner’s Drawings Account - nominal account and has a normal debit balance; closed to the related capital
account at the end of the period (contra equity account)
Debit: (a) Temporary withdrawals during the period
(b) Temporary funds held to be remitted to the partnership
Credit: (a) Recurring reimbursable costs paid by the partner

Bonus on Initial Investments - capital account is credited for an amount greater than the fair value of his
contributions

Bonus Method - the additional credit to the partner’s capital “bonus” is accounted for as deduction from the
capital of the other partners.

Formation of Partnership
1. Formation of a partnership for the first time
 2. Conversion of a sole proprietorship to a partnership
a. A sole proprietor allows another individual, who has no business of his own to join his business
b. Two or more sole proprietors form a partnership
3. Admission of a new partner

❖ PARTNERSHIP FORMATION FOR THE FIRST TIME - Initial Investment

- normal entries for initial investments except that capital accounts for each partner are
maintained

❖ SOLE PROPRIETOR AND ANOTHER INDIVIDUAL FORM A PARTNERSHIP

Journal entries will depend on whether:
1. The books (old books) of the sole proprietorship are to be used for the newly formed
partnership or
2. New books are to be opened.

Case 1. Sole Proprietorship's Books are Retained for the Partnership.

1. Adjust the assets of the sole proprietor in accordance with the agreement. Adjustments are to
be made to his capital account.
2. Record the investment of the other partner.

Case 2. New Books are Opened for the Partnership.

Books of the Sole Proprietor:
1. Adjust the assets of the sole proprietor according to the agreement. Adjustments are to be
made to his capital account.
2. Close the books.
Books of the Partnership:
1. Record the investment of the sole proprietor (i.e., his assets and liabilities).
2. Record the investment of the other partner.

❖ TWO PROPRIETORS FORM A PARTNERSHIP

- accounting procedures described in the preceding section are also applicable
- books of one of the sole proprietorship may be used or a new set of books may be opened

!!! Reminders !!!

● “AGREEMENT over GENERAL RULE”
● Adjustments in valuation accounts not in the balance sheet account
● Capital Agreed Contribution is different from Profit or Loss Sharing Agreement
○ Investment > Agreed Capital ⇒ Bonus to existing partners
○ Investment < Agreed Capital ⇒ Bonus to new partner
GOODWILL
DEFINITION
- referred to as the most intangible of all intangible assets.

- It is unique in the sense that goodwill standing alone cannot be bought and sold.

- An intangible asset that is not specifically identifiable, has an indeterminate life, is inherent in a
continuing business and relates to the entity as a whole.

- Goodwill arises when earnings exceed normal earnings by reason of good name, capable staff and
personnel, high credit standing, reputation for fair dealings, reputation for superior products, favorable
location and a list of regular customers.

RECOGNITION OF GOODWILL
The two distinction in recognizing goodwill are:

● Developed goodwill
- also known as internal goodwill in which the goodwill is generated internally because of good
name, capable staff and personnel, superior quality of products, favorable location and high
credit standing.

- According to PAS 38, paragraph 48 it provides that internally generated goodwill shall not be
recognized as an asset.

● Purchased goodwill
- Arises when a business is purchased and that has been paid for.

- When an entity acquires an existing business, it will have to pay not only for the net tangible and
identifiable intangible assets but also the goodwill of the business.

- Recognized as an asset because it has been paid for.

MEASUREMENT OF GOODWILL
Two approaches in measuring goodwill:
➔ Residual Approach
➔ Direct Approach

Residual Approach
● This is known as the “residual approach” because goodwill is simply the residual after deducting the fair
value of net tangible and identifiable assets from the purchase price for the entity agreed upon between
the buyer and the seller.

● Must be measured at fair value

The excess of the purchase price over the fair value of net tangible and identifiable assets is considered as
goodwill.

Direct Approach
● Goodwill is measured on the basis of the future earnings of the entity. An attempt is made to value the
anticipated excess earnings which are the essential components of goodwill.
 ● If future earnings exceed the normal earnings, the excess earnings indicates that there are
unidentifiable intangible assets. Such unidentifiable intangible assets are called goodwill.

The application of this approach requires the following:

a. Normal rate of return - the rate of return which usually attracts investors in a particular industry.
b. The fair value of tangible assets and any identifiable intangible assets.
c. The estimated future normal earnings of the entity
d. The probable duration of any “excess earnings” attributable to goodwill.

Under the direct approach there four (4) methods:

1. Purchase of “average excess earnings”
2. Capitalization of “average excess earnings
3. Capitalization of average earnings
4. Present value method

Impairment of Goodwill
● PAS 38, paragraph 107, mandates that goodwill shall not be amortizaed because the useful life is
indefinite.
● Goodwill shall be tested for impairment at least annually and whenever there is an indication that it may
be impaired.

NEGATIVE GOODWILL
● PFRS 3, paragraph 34, provides that such negative goodwill is recognized in profit or loss as “gain on
bargain purchase”.

● If the purchase price or consideration transferred for the entity is less than the net fair value of the
identifiable assets acquired and liabilities assumed, the difference is negative goodwill or gain on
purchase bargain.
Intangible Assets
General Concepts
Nature of an Intangible Asset:
An intangible asset is an identifiable non-monetary asset without physical substance (IAS 38.8)
-Essential criteria of an intangible asset
1. Identifiability- an asset is identifiable when:
● It is separable (i.e., 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)
● It arises from contractual or other legal rights
2. Control- an entity controls an asset if the entity has the power to obtain the future economic
benefits flowing from the underlying resource and to restrict the access of others to those
benefits
3. Future economic benefits - the future economic benefits flowing from an intangible asset may
include revenue from the sale of products or services, cost savings, or other benefits resulting
from the use of the asset by the entity

Recognition (IAS 38.21)

An intangible asset shall be recognized if, and only if:
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 intangible asset can be measured reliably

Judgment is usually exercised in assessing the degree of certainty of the tuture economic benetits based on
external evidence

Assets with both intangible and tangible assets

The entity uses judgment to assess which element between PPE or Intangible Assets are more significant
- If the intangible component is an integral part of the asset as a whole, the intangible element is treated
as PPE. Otherwise, it is a separate intangible asset

Measurement (IAS 38.24)

Initial
An intangible asset shall be initially measured at cost

Acquisition Bases
A. Separate Acquisition
The cost of a separately acquired intangible comprises:
- Purchase price, including import duties and non-refundable purchase taxes, after deducting trade
discounts and rebates
- Any directly attributable cost of preparing the asset for its intended use
○ Example of directly attributable costs (IAS 38.28)
■ costs of employee benefits as defined in IAS 19) arising directly from bringing the asset
to its working condition;
■ professional fees arising directly from bringing the asset to its working condition; and
■ costs of testing whether the asset is functioning properly.
○ Examples of expenditures that are not part of the cost of an intangible asset (IAS 38.29-30)
■ Cost of introducing a new product or service, including costs of advertising and
promotional
■ Costs of conducting business in a new location or with a new class of customer,
including costs of staff trading
 ■ Administration and other general overhead costs
■ Costs incurred while an asset is already capable of operating in a manner intended by
management have yet to be brought into use
■ Initial operating loss
○ Recognition of costs in the carrying amount of an intangible asset ceases when the asset is in
the condition necessary for it to be capable of operating in the manner intended by
management.

B. Deferred Basis (IAS 38.32)

If payment for an intangible asset is deferred beyond normal credit terms, its cost is the cash price equivalent.
- the difference between this amount and the total payments is recognized as interest expense over the
credit period
- If cash price is not given, use the present value equivalent of the liability

C. Acquisition as part of a business combination (IAS 38.33)

Fair Value at the date of acquisition

D. Government Grant (IAS 38.44)

The entity may choose to recognize both the intangible asset and the grant initially at
a. fair value
b. nominal amount plus any expenditures that are directly attributable in preparing the asset for its
intended use

E. Exchange
Fair value of the asset given up plus any cash payment minus cash received unless the exchange transaction
lacks commercial substance (in order of priority if not given: fair value of asset given up, fair value of asset
received, carrying amount of asset given up)
- If the transaction lacks commercial substance, the cost is measured at the carrying amount of the asset
given up plus any cash payment minus cast received

F. Internal Generation
The cost of an internally generated intangible asset comprises directly attributable costs necessary to create,
produce and prepare the asset to be capable of operating it in the manner intended by the management
- Examples of directly attributable costs (IAS 38.66):
○ Cost of materials and services used or consumed in generating the intangible asset
○ Fess to register a legal right
○ Amortization of patents and licenses that are used to generate the intangible asset
○ Cost of employee benefits arising from the generation of the intangible asset
○ Capitalizable borrowing costs for qualifying intangible assets
- Not components of the cost of a internally generated intangible asset (IAS 38.67):
○ selling, administrative and other general overhead expenditure unless this expenditure can be
directly attributed to preparing the asset for use;
○ identified inefficiencies and initial operating losses incurred before the asset achieves planned
performance: and
○ expenditure on training staff to operate the asset
- Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance
shall not be recognized as intangible assets lAS 38.63)

G. Lump Sum
Basket price. The lump sum acquisition cost is allocated to the intangible assets based on their relative fair
values
Expense recognition (IAS 38.68)
Expenditure on an intangible item shall be recognized as an expense when it is incurred unless:
a. it forms part of the cost of an intangible asset that meets the recognition criteria
b. the item is acquired in a business combination and cannot be recognized as an intangible asset. If
this is the case, it forms part of the amount recognized as goodwill at the acquisition date

Subsequent Measurement lAS 38.72)

An intangible asset may be subsequently measured using the cost model or the revaluation model
Cost Model
Cost XXX
Accumulated Amortization (XXX)
Accumulated Impairment Losses (XXX)
Carrying Value XXX

Revaluation Model
Revalued Amount (or fair value at date of reval) XXX
Accumulated Amortization (XXX)
Accumulated Impairment Losses (XXX)
Carrying Value XXX

The revaluation model can only be used only if there is an active market for the intangible asset

Unidentifiable Intangible Asset - intangible assets that cannot be sold, transferred, licensed, rented or
exchanged separately. Inherent in a continuing business and can only be identified with the entity as a whole.

Amortization - systematic allocation of the amortizable amount of an intangible asset over the useful life. The
amortizable amount is the cost of the intangible asset less residual value.
- Recorded by debiting amortization expense and crediting the intangible asset account
- Begins when the asset is available for use (location and condition for intended use)
- Ceases when the intangible asset is derecognized or when the asset is classified as held for sale

Definite and Indefinite Useful Life

A. Definite - useful life can be expressed in terms of years or the number of units to he produced
B. Indefinite - no foreseeable limit to the period over which the asset is expected to generate net cash
flows (no legal, contractual, competitive and other factors that would limit the useful life of the intangible
asset)

Intangible Assets with Definite Life Intangible Assets with Indefinite Life

Examples Patent Goodwill

Copyright Trademark
Fixed-term franchise Perpetual Franchise
License
Computer software

Amortization Amortized over their useful life Not Amortized

The method of amortization shall

reflect the pattern in which the future economic
benefits from the asset are expected to be
consumed by the entity. However, if such
pattern cannot be determined reliably, the
straight-line method of amortization shall be
used
 Impairment is Tested for impairment whenever there is an Tested for impairment
indication of impairment at the end of the [Link] least annually
reporting period. 2. Whenever there is an indication of impairment

Recognized if the recoverable amount (higher Same recognition of Impairment in definite intangible
between fair value less cost of disposal and assets
value of use) is less than the carrying amount

Computation of value in Future cash flows x PV Factors Annual Cash flow / Discount Rate
use

Residual Value of an Intangible Asset (IAS 38.100)

The residual value of an intangible asset with a finite useful life shall be assumed to be zero unless:
- There is a commitment by a third party to purchase the asset at the end of its useful life
- There is an active market for the asset
○ Residual value can be determined by reference to that market and
○ It is probable that such a market will exist at the end of the asset's useful life

Subsequent Expenditures
Subsequent expenditure of an intangible asset shall be recognized as an expense
- Most subsequent expenditures are likely to maintain only the expected future economic benefits
embodied in the intangible asset
- The subsequent expenditure may be capitalized or added to the cost of the intangible asset it the
following recognition criteria for an intangible asset are met:
○ It is probable that future economic benefits that are attributable specifically to the subsequent
expenditure will flow to the entity
○ The subsequent expenditure can be measured reliably
- The nature of an intangible asset is such that (in many cases) it is not possible to determine whether
subsequent expenditure is likely to enhance the economic benefits that will flow to the entity to the
intangible asset
- Examples of expenditures recognized as an expense
○ Start-up costs (organization costs)
■ May consist of establishment costs such as: legal and secretarial costs incurred in
establishing a legal entity, expenditure to open a new facility or business (pre-opening
costs), or expenditures for starting new operations or launching new products or
processes (pre-operating costs)
○ Expenditure on training activities
○ Expenditure on advertising and promotional activities
○ Litigation costs of defending an intangible asset, whether the defense is successful or not
○ Costs of relocating or reorganizing part or all of an entity
○ Initial operating losses

Derecognition (IAS 38.112)

An intangible asset shall be derecognized from the statement of financial position
- On disposal
- When no future economic benefits are expected from its use and disposal
Net Proceeds XXX
Carrying value at date of derecognition (XXX)
Gain (loss) on disposal- P/L XXX(XXX)

Financial Statement Presentation

Intangible assets are presented under noncurrent assets of the SFP.
Research and Development Cost
PAS 38, paragraph 52, provides that to assess whether an internally generated intangible asset meets the
criteria for recognition, an entity classifies the generation of the asset into a research phase and a
development phase.

RESEARCH - original and planned investigation undertaken with the prospect of gaining scientific or technical
knowledge and understanding.
DEVELOPMENT - application of research findings or other knowledge to plan or design for the production of
new or substantially improved material, device, product, process, system, or service prior to the
commencement of commercial production.

Research Cost Development Cost

Objective - To discover new knowledge that will - Application of research findings to

be useful in developing a new product develop a new product
or will result in significant improvement
of an existing product

Examples ★ Laboratory research aimed at ❖ Design construction, and testing of

obtaining/discovering new knowledge preproduction prototype and model
★ Searching for application of research ❖ Design of tools, jigs, molds, and dies
findings and other knowledge involving new technology
★ Conceptual formulation and design of ❖ Design construction and operation of
possible product/process alternative a pilot plant that is not a scale
★ Testing in search for product/process economically feasible to the entity for
alternative commercial production
❖ Design, construction, and testing of
a chosen alternative for a new or
improved product or process

Accounting ➔ Recognized as an expense when ➔ Recognized as an intangible asset

incurred if qualifies at the criteria for
◆ Too much uncertainty about recognition
the success of the project (so ➔ Otherwise, recognized as an
dli ma consider agad na asset) expense

CRITERIA RECOGNITION (if Intangible Asset ang Development Cost)

Capitalization of development costs depends if the entity can demonstrate ALL of the following criteria:
The technical feasibililty of completing the intangible asset so that it will be available for use.
The intention to complete the intangible asset and use or sell it
The ability to use or sell the intangible asset
How the asset will generate Probable future economic benefits
Availability of adequate technical financial, and other resources to complete the development and to
use or sell the asset
Ability to measure reliably the expenditure attributable to the asset during its development
💖NOTES
➢ R & D activities occur prior to the beginning of commercial production and distribution of a product or
process.
➢ Activities related to commercial production do not result in R & D cost (recognized as an
EXPENSE)
○ Examples
■ Engineering follow through in an early phase of commercial production
■ Quality control during commercial production including routine testing
■ Trouble shooting breakdown during production
■ Routine ongoing effort to refine, enrich or improve quality of an existing product
■ Adaptation of an existing capability to a particular requirement or customer need
■ Periodic design changes to existing products
■ Routine design of tools, jigs, molds, and dies
■ Activity, including design and construction engineering related to construction, relocation,
rearrangement or start-up facilities and equipment.
➢ If the entity cannot distinguish the research phase from the development phase, the entity shall treat
the expenditure as if it were incurred in the research phase only
➢ The cost of PPE, materials, and intangible assets acquired and used in R & D activities is included in
R & D expense as follows;
○ If the item of PPE, material or intangible asset has an alternative use, it is par capitalized and
will form part of R & D expense upon usage or consumption
○ If the item has no alternative use, the cost is expensed immediately in its entirety as R & D
expense