Accounting Prof Riccardo Tiscini IAS 38 Intangible Assets

Accounting Prof. Riccardo Tiscini

IAS 38: Intangible Assets Accounting 2

IAS 38: Intangible Assets Definition Recognition Measurement Impairment Disposal Disclosure An Intangible Assets: identifiable, non monetary asset without physical substance held for use in the production of goods or services, for rental to others, or for administrative purposes • Purchased Acquired in business combination Accounting Internally generated 3

IAS 38: Intangible Assets Definition Recognition Measurement Identifiability Future economic benefits Impairment Disposal Disclosure The asset is separable or divided from the entity. It can be sold, transferred, licensed, rented or exchanged either individually or together with a related contract , asset or liability It is probable that the expected future economic benefits that are attributable to the asset will flow to the entity Accounting 4

IAS 38: Intangible Assets Definition Recognition Measurement Reliability Control Impairment Disposal Disclosure The cost of the asset shall be measured reliably The asset 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 If these requirements are not met expenditure for an intangible item is an expense Accounting 5

IAS 38: Intangible Assets Purchased Acquired in business combination • Internally generated Five situations to have intangible assets An intangible asset shall be measured initially at cost Acquisition by way of government Grant Exchange of assets Accounting 6

IAS 38: Intangible Assets The cost is the price paid to acquire the asset. It includes: - import duties and non-refundable purchase taxes, net discounts; - directly attributable cost of preparing the asset for the use (costs of employees benefits, professional fees. . ) • Purchased Acquired in business combination Intangibles acquired in a business combination should be recognized as assets apart from goodwill at their fair value (according to IFRS 3): • Recognize as assets if fair value can be measured reliably • Include in goodwill if fair value cannot be measured reliably Accounting 7

IAS 38: Intangible Assets Purchase: Example A company purchases a software whose cost is Euro 350, 000. The taxes to be paid on it are Euro 10, 000 and other side costs to be paid are Euro 6, 000. The installation requires the employment of a specialized work-man for 15 days. The annual cost of this work man is Euro 96, 000. • At the end of the installation phase there is a testing phase which requires the use of a specific machinery during 1 month. This machinery has a depreciable amount of Euro 840, 000 ad a residual useful life of 10 years. • Accounting 8

IAS 38: Intangible Assets Purchase: Example Moreover, an external expert is involved in the staff training for software use. The consultancy fee is Euro 12, 000 for a 5 days training course and the annual cost of employees involved in the training course is Euro 210, 000. • Thanks to this new software, the company can reduce the production costs of the products line Beta. For this reason, an advertising campaign is developed to inform customers about the reduction of products prices. The cost of the advertising campaign is Euro 240, 000. • What is the value of the Intangible Asset to be accounted for? Accounting 9

IAS 38: Intangible Assets Purchase: Example Purchase cost Taxes Other side costs Installation Testing Total 350, 000 10, 000 6, 000 3, 945 (96, 000/365*15) 7, 000 (840, 000/10/12) 376, 945 Training and advertising costs are always expenses Accounting 10

IAS 38: Intangible Assets The assets could be recognized both at fair value or cost • Acquisition by Government grant Exchanges of assets The assets could be recognized both at fair value or cost • Accounting 11

IAS 38: Intangible Assets Internally generated Identifying whether and when there is an identifiable asset that will generate expected future economic benefits; • determine the cost of the asset reliably. • Two phases A research phase A development phase Accounting 12

IAS 38: Intangible Assets Internally generated: US GAAP Two phases A research phase A development phase Both are always expenses Accounting 13

IAS 38: Intangible Assets Internally generated: IFRS Two phases A research phase Always expenses A development phase Under certain conditions can be an intangible asset Accounting 14

IAS 38: Intangible Assets Research phase • No intangible asset arising from research shall be recognized. The expenditure shall be recognized as an expense when it is incurred. Examples: • activities aimed at obtaining new knowledge; • the search for application of research findings or other knowledge; • the search for alternatives for materials, devices, products, processes; • the formulation, design, evaluation and final selection of alternatives for new or improved materials, devices, products. . Accounting 15

IAS 38: Intangible Assets Development phase An intangible asset arising from development shall be recognized if an entity can demonstrate: • The technical feasibility of completing the intangible asset so that it will be available for use; • Its intention to complete the asset and use or sell it; • Its ability to use or sell the asset; • how the intangible asset will generate probable future economic benefit; • its ability to measure reliably the expenditure attributable to the asset during its development • Accounting 16

IAS 38: Intangible Assets Development phase Examples: • the design, construction and testing of pre-production models; • the design of tools involving new technology; • the design, construction and operation of a pilot plan; • the design, construction and testing of a chosen alternative for new or improved materials, devices, products. . To demonstrate how an intangible asset will generate probable future economic benefits an entity assesses the future economic benefits using the principles in IAS 36 Internally generated brands, mastheads, publishing titles shall note be recognized as intangible assets Accounting 17

IAS 38: Intangible Assets Items to be classified as intangible assets • Examples: – – – Computer software costs Patent, copyrights Motion picture films Mortgage servicing rights Fishing license Franchises Customer or supplier relationships Customer loyalty Market share Marketing rights Import quotas Accounting 18

IAS 38: Intangible Assets Recognition of an expense Examples: research expenses; • Expenditure on start-up activities (such as legal costs, expenditures to open a new facility. . ) unless they are included in the cost of PPE; • expenditure on training activities; • expenditure on advertising and promotional activities; • Expenditure on relocating or reorganising part or all the entity • brands • mastheads • publishing titles • Accounting 19

IAS 38: Intangible Assets Examples: 1 Internally generated Miller Corporation has developed a well-known brand name for its products. Management expects this brand name to provide benefits to the firm in the future sales of its products to customers. • How should the company record it? Accounting 20

IAS 38: Intangible Assets Examples: 1 A brand name developed by a firm is generally, however, not an accounting asset, because it is too difficult to quantify the future benefits. • Expenses Accounting 21

IAS 38: Intangible Assets Examples: 2 Internally generated Miller Corporation makes research and development expenditures each year to develop new technologies and create new products • How should the company record it? Accounting 22

IAS 38: Intangible Assets Examples: 2 • Also in this case the expenses are too generic Expenses Accounting 23

IAS 38: Intangible Assets Examples: 3 Acquisition Merck, a pharmaceutical firm, acquires a patent on a new drug from its creator for Euro 120 million. The patent gives Merck an exclusive right to manufacture and market the drug for 20 years from the patent’s initial filing date, although the time-consuming drug approval process likely reduces the expected useful life of the patent • How should the company record it? Accounting 24

IAS 38: Intangible Assets Examples: 3 In this case the transaction between Merck and the seller fixes both Merck’s right to use the patent and the cost of the expected benefits • Assets Accounting 25

IAS 38: Intangible Assets Examples: 4 Internally generated Merck spends Euro 4. 8 billion during the current year on research to identify, develop and test new drugs to combat diseases and illnesses. This example differs from Example 3 in that Merck: • (1) incurs the cost internally, • (2) does not acquire a complete asset. • How should the company record it? Accounting 26

IAS 38: Intangible Assets Examples 4: US GAAP requires firms to expense research and development costs in the period incurred because it is not possible to measure the expected economic benefits with reliability. • Expenses Accounting 27

IAS 38: Intangible Assets Examples 4: IFRS treats research costs the same as US GAAP. • When a research project reaches the stage of technical feasibility and the firm intends to continue developing the technology for ultimate use or sale, the research project moves from the research phase to the development phase. The development phase can be accounted for an intangible asset • Asset Accounting 28

IAS 38: Intangible Assets Examples 5 Business Combination e. Bay acquired all of the common stock of Skype Technologies SA for $ 2, 590 million. e. Bay identified the following tangible net assets and intangible assets acquired and measured those items at their fair value: • Tangible assets net of liabilities Customer list and user base Trade names and trademarks developed technologies Network access agreements Goodwill TOTAL -20 27 244 8 1 2330 2590 The amount of goodwill represents the excess of the total purchase price over the fair value of identifiable tangible and intangible net assets. • It refers to other unidentifiable assets, such as operating synergies. • Accounting 29

IAS 38: Intangible Assets Definition Recognition Measurement Impairment Disposal Disclosure Measurement after recognition Revaluation model Cost less any accumulated amortization and impairment losses Fair value at the date of revaluation less any accumulated amortization and impairment losses Accounting 30

IAS 38: Intangible Assets Revaluation model Revaluation shall be made on a regular base so that at the date of balance sheet the carrying amount is not really different form its fair value. • Fair value shall be determined with reference to an active market. • An active market is a market in which these conditions exist: 1. The items traded in the market are homogeneous; 2. Willing buyers and sellers can normally be found at any time 3. prices are available to the public 31

IAS 38: Intangible Assets Revaluation model It is not allowed: • the revaluation of intangible assets not previously recognized as assets; • the initial recognition of intangible assets at amounts other than costs There are few active markets for intangible assets. It will be rare for an intangible asset to be revaluated Accounting 32

IAS 38: Intangible Assets Useful life The period over which an asset is expected to be available for use by an entity • the number of production or similar units expected to be obtained from the asset by an entity • I. A. with finite Useful life I. A. with indefinite useful life The useful life of an I. A. that arises from contractual or other legal rights shall not exceed the period of the contractual or other rights, but may shorter depending on the period over which the entity expects to use the asset Accounting 33

IAS 38: Intangible Assets I. A. with finite useful life It must be amortized the depreciable amount shall be allocated on a systematic basis over its useful life; • amortization shall begin when the asset is available for use; • the amortization method shall reflect the pattern in which the asset’s future economic benefit are expected to be consumed by the entity; • if the pattern cannot be determined reliably, the straight-line method is used • Accounting 34

IAS 38: Intangible Assets I. A. with finite useful life The residual value 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 b)There is an active market for the asset and: Residual value can de determined by reference to the market; It is probable that such market will exist at the end of the asset’s useful life • The amortization period and the amortization method for an I. A. with finite useful life shall be reviewed at least at each financial year-end Accounting 35

IAS 38: Intangible Assets I. A. with indefinite useful life It shall not be amortized In accordance with IAS 36, Impairment of Assets, an entity is required to test an intangible asset with an indefinite useful life for impairment by comparing its recoverable amount with its carrying amount a) annually b) whenever there is an indication that the intangible asset may be impaired • The useful life of an intangible asset that is not being amortised shall be reviewed each period to determine whether events continue to support an indefinite useful life assessment for that asset. Accounting 36

IAS 38: Intangible Assets Examples Refer to example 3 where Merck acquires a patent from its creator. Although a patent has a legal life of up to 20 years, management expectations of technological change may lead to a shorter economic life. Merck should amortize the acquisition cost of the patent over its expected useful life, equal to the shorter of the economic life and the legal life. • Refer to example 5 for e. Bay recognized intangible assets in its acquisition of Skype Technologies and measured each intangible initially at fair value and estimated the useful life of the assets as the number of the years over which it would receive benefits. For each of these asset e. Bay will amortize the initial fair value of its intangible over its useful life. • Refer to example 5. The recognized goodwill reflects the value of knowledgeable employees, a reputation for quality products and other items not separately recognized. Under both US GAAP and IFRS goodwill has an indefinite useful life. • Accounting 37

IAS 38: Intangible Assets Definition Recognition Measurement Impairment Disposal Disclosure In accordance with IAS 36, Impairment of Assets, an entity is required to test an intangible asset with an indefinite useful life for impairment by comparing its recoverable amount with its carrying amount a) annually b) whenever there is an indication that the intangible asset may be impaired • Accounting 38

IAS 38: Intangible Assets Definition Recognition Measurement Impairment Disposal Disclosure An intangible asset shall be derecognized: a) on disposal b) when no future economic benefits are expected from its use or disposal • The gain or loss arising form derecognition is the difference between the net disposal proceeds and the carrying amount of the asset. It shall be recognised in profit or loss. Accounting 39

IAS 38: Intangible Assets Definition • Recognition Measurement Impairment Disposal Disclosure An entity shall disclose: a)If the useful lives are indefinite or finite and the amortization rate; b) the amortisation method used for intangible assets with finite useful lives; c) a reconciliation of the carrying amount at the beginning and end of the period d) the gross carrying amount and any accumulated amortization Accounting 40