Week 5 Accounting for Intangible Assets and Goodwill
Week 5: Accounting for Intangible Assets and Goodwill Financial Accounting BFA 201
Learning Objectives To demonstrate your understanding of: 1. AASB 138 – Intangible assets 2. R&D (Research & Development) 3. Expensing vs capitalising 4. Intangible assets vs goodwill 2
Readings and references • Deegan Chapter 8 • AASB 138 Intangible Assets • AASB 136 Impairment of Assets • AASB 3 Business Combinations (B 31 – B 40) 3
Independent Study Tasks Tutorial questions (for workbooks) Independent study questions 4
Summary of this lecture 1. Definition of Intangibles 2. Accounting for Research and Development Costs 3. Accounting for Goodwill
Summary Before We Start Intangible assets • Intangible assets considered to be non-monetary assets without physical substance and include patents, goodwill, mastheads, brand names, copyrights, research and development, and trademarks 1. • General rule is that expenditure associated with internally generated intangible assets (excluding development expenditure) is to be expensed as incurred • Internally generated intangibles are also not permitted to be revalued 6
Summary Before We Start • Where intangible assets are revalued (typically acquired externally) such revaluations can only be undertaken where there is an ‘active market’ for such assets and fair values can be ascertained • Intangible assets can also be considered in terms of having: – a limited useful life; or – an indefinite life. • If intangible assets are considered to have a limited life: – there is a need to allocate their costs, or revalued amount, over their useful lives by periodic amortisation • If intangible assets are considered to have an indefinite life: – annual amortisation charges do not apply but asset is subject to annual impairment testing 7
Summary Before We Start 2. Research and development • Research and development comprises costs of materials and services consumed in research and development activities, salaries and wages, and depreciation of research-related equipment • Research expenditure is required to be expensed as incurred • Development expenditure may be carried forward as an asset to the extent that future economic benefits are deemed probable, and such benefits are measurable with reasonable accuracy • Development expenditure would need to be amortised in subsequent periods 8
Summary Before We Start 3. • Goodwill represents the future economic benefits associated with an existing customer base, efficient management, good reputation etc. • It is an asset recognised in a business combination representing the future economic benefits arising from other assets acquired in a the combination that are not individually identified and separately recognised. • Only purchased goodwill can be recognised for external reporting purposes • Purchased goodwill is measured as the excess of the costs of acquisition incurred by an entity over the fair value of the identifiable net assets and contingent liabilities acquired • Goodwill carried forward to future periods is subject to annual impairment testing as opposed to periodic amortisation 9
1. Definition of Intangibles 10
Definition of intangible assets • An identifiable, non-monetary assets without physical substance (AASB 138: 8) • Includes patents, goodwill, mastheads, brand names, copyrights, research and development, licences, software, and trademarks • Intangible assets, as a category, must be separately disclosed in the balance sheet 11
Definition of intangible assets 1. Identifiable 2. Non-monetary assets 3. Without physical substance 12
Intangible assets AASB 138 EXAMPLES: • brand names, • trademarks, • computer software • research and development, • patents, • fishing licenses, 13
Intangible assets AASB 138 EXAMPLES cont. : • mastheads • copyrights © Copyright University of Tasmania, School of Accounting & Corporate Governance. All rights reserved. • motion picture films • contractual or legal rights 14
Definition of intangible assets Identifiable Non. Monetary Asset Without Physical Substance 15
Definition of intangible assets Identifiable Non. Monetary Asset Without Physical Substance 16
Definition of intangible assets : Without physical substance • Tangible assets are those with physical form such as property, plant and equipment. • AASB 138: 8 indicates that an intangible asset is one without physical substance. • The reason for distinguishing between physical and non-physical assets is due to the fact that the nature of non-physical assets requires different recognition and measurement requirements to a physical asset. 17
Without physical substance • No discussion in AASB 138 • Accounting problems Characteristics: – – – – can be in or on a physical substance non-rival assets large fixed costs; min. incremental costs network effects difficult to manage uncertainty with FEBs generally no active market 18
Definition of intangible assets Identifiable Non. Monetary Asset Without Physical Substance 19
Definition of intangible assets: Non -monetary assets • AASB 138: 8 defines monetary assets as ‘money held and assets to be received in fixed or determinable amounts of money’. 20
Definition of intangible assets Identifiable Non. Monetary Asset Without Physical Substance 21
Identifiable: para 12 Separable OR 2. Contractual or other legal rights 22
Definition of intangible assets: Identifiable • AASB 138: 11 indicates the definition of an intangible asset requires it to be identifiable so as to distinguish it from goodwill • AASB 138: 12 indicates that an asset is identifiable if it either: • Is separable (i. e. is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged; or • Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity. • A separate value can be placed on each individual asset and they can be separately identified and sold. • The AASB Framework does not include this criterion for assets. 23
Definition of intangible assets 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
Definition of intangible assets: Three Essential Characteristics Control Indentifiability Expected Economic Benefits 25
Definition of intangible assets • Identifiability • Already discussed, but covered in AASB 138: 11 and 12 • Future Economic Benefits • Set out in AASB 138: 17 • Must include revenue from the sale of products or services, cost savings or other benefits resulting from the use of the asset by the entity • Control – Control: normally in the possession of, or are owned by, the entity deriving the benefits. Control usually stems from legal or other rights and can be difficult to establish. – E. g. highly trained staff do not qualify as intangibles due to lack of control. – Much debate about such items – hence the requirement of identifiably (and separability). – As good staff relations do not meet the separability criteria they cannot be recognised as an intangible asset. – If at all, may be recognised as part of goodwill
Recognition & initial measurement • Intangibles may be acquired by: • Separate acquisition • As part of a business combination • A government grant • Exchanges with another intangible • They may be internally generated Subsequent expenditure to be expensed 27
Recognition and Initial Measurement • Internally generated intangible assets (except internally generated development expenditure) are not to be carried forward as assets • 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 with getting asset ready for use • Initial recognition of an intangible asset at an amount other than cost not permitted • Internally generated intangibles cannot subsequently be recognised through revaluation 28
Recognition and Initial Measurement • With the exception of expenditure incurred on development activities, only acquired intangibles may be recognised for balance sheet purposes • Expenditure on internally generated intangibles does not qualify for deferral (asset recognition) and must be expensed • Once an item of expenditure related to an intangible asset has been written off (expensed) it must stay written off • Acquired intangible assets may be revalued to fair value only where there is an active market for such assets 29
Purchased or developed internally? Cost Model Purchased (capitalised) Intangible Assets Internally Generated (Expensed – except development costs) Revaluation Model (rare) [Active market] Research (expensed) Development Costs (Para. 57)
Measurement subsequent to initial recognition – AASB 138 Intangible Asset Measurement Basis AASB 138 Cost Model (para. 74) Revaluation Model (para. 75) • Original Cost • Fair value (in active market) • Less Amortisation • Less Amort. & impair. loss • Less Impairment loss • Regular revaluation
Amortisation • Intangible assets must be classified as: a) having a LIMITED useful life (must be systematically amortised over useful life) OR b) having an INDEFINITE life (must NOT be amortised; is reviewed annually; is subject to impairment testing as per AASB 136) • • Amortisation charge based on cost – residual value Residual value = 0 unless active market or 3 rd party commitment to buy Method should reflect the pattern in which economic benefits are derived — otherwise straight-line Method & period reviewed annually & changed if req. • • 32
General amortisation requirements for intangible assets • Intangible assets (other than goodwill) that are considered to have a limited useful life 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 • If life of an intangible asset is limited by time a method of amortisation based on time would be used • In determining amortisation charge of an asset we need to consider the expected residual value of the asset 33
General amortisation requirements for intangible assets • 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 • If 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 34
Revaluation of intangible assets • AASB 138—intangible assets may be revalued only if there is an ‘active market’’ • Most intangibles will not be revalued as no active market • 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 • Only assets that have been acquired at cost can subsequently be revalued—there is a restriction on the revaluation of internally generated intangible assets 35
Revaluation of intangible assets • 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 • Revaluations to be done regularly so that recorded value does not differ materially from fair value at balance sheet date • Subsequent to revaluations any amortisation charges to be based on revalued amount taking into account remaining useful life • Revaluations of goodwill are not permitted in Australia, whether internally generated or externally acquired 36
2. Accounting for Research and Development Costs 37
Research and development Introduction • AASB 138 applies to intangible assets generally—number of paragraphs dealing with research and development • May account for a large proportion of expenditure for some entities • 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 38
Research and development Definitions Research • Considered separately from development • Generally precedes development • Defined as: – Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding 39
Research and development Definitions Development Defined as (AASB 138, par. 8): – 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 – Typically involves the commercial application of knowledge generated in earlier research phases 40
Research and development – Development examples (a) The design, construction and testing of preproduction or pre-use prototypes and models (b) The design of tools, jigs, moulds and dies involved in new technology (c) The design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production (a) The design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes or systems 41
Research and development – Research expenditure written off as incurrred 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 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 42
Research and development – Development Expenditure 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; and – the availability of adequate technical, financial and other resources to complete the development; and – the ability to measure reliably expenditure on the intangible asset during its development 43
Internally generated intangibles • The following are specifically excluded from recognition per AASB 138 (para. 63): • • Internally generated brands Mastheads Publishing titles Customer lists • CAN be recognised at FV if purchased as part of a business combination 44
Lecture Example 1 45
Solution 1. 2. ALL criteria in para. 57 met at end of May Hence, the following costs would be written off as incurred: January $145 000 February 165 000 March 54 000 April 135 000 May 65 000 3. Acquiring fibres div. from Durban Ltd 4. Patent & brand amortised over 10 years – to be reassessed 5. Capitalise development costs of $45 000 in June. 6. Marketing costs $25 000 (June) expensed - not part of the development process. 46
NEW IDEAS: The market value of Scandia (1998)
3. Accounting for Goodwill 48
Goodwill represents the future economic benefits associated with an existing customer base, efficient management, good reputation etc. 2 ways that goodwill arises in an entity: 1. internally generated or 2. acquired by purchasing an existing business • Goodwill is only recognised as an asset where it is acquired in an arm’s length purchase
Distinguishing intangible assets from goodwill • Intangible assets are identifiable (AASB 138) • Purchased goodwill: – is the excess of the cost of acquisition incurred over the fair value of the net assets acquired • Goodwill represents: – Future economic benefits from assets that are not capable of being individually identified and separately recognised • Goodwill is NOT an intangible asset according to AASB 138
Accounting for Goodwill • Initial recognition: – AASB 138 prohibits the recognition of internally generated goodwill – AASB 3 requires the amount of goodwill to be measured at its cost • Subsequent recognition: – Goodwill cannot be amortised (AASB 3, para 55) – cannot be revalued – is subject to annual impairment testing
Goodwill Internally generated Purchased Acquisition cost Less: FV net assets FV intangibles Contingent Liabilities Test for IMPAIRMENT as part of CGU BFA 201_BS 11 DO NOT amortise CANNOT be recognised
Goodwill What is goodwill? • Arises when one entity acquires another entity, or part thereof, e. g. one company acquires a controlling interest in another entity • 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. • Could be built up over a number periods or obtained by acquiring an existing business 53
Goodwill • Only purchased goodwill is permitted to be recorded – Purchased goodwill can be measured more reliably than internally generated goodwill, based on the amount paid • Internally generated goodwill cannot be brought to account • Purchased goodwill is measured as the excess of the cost of acquisition incurred over the fair value of the net assets acquired 54
Goodwill How is goodwill measured? • 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 Fair value • The amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction Purchase consideration • Should be measured at the fair value of what is given up in the exchange
Lecture Example 2 56
Solution Lecture Example 2 Fair value of identifiable assets is: Accounts receivable $720 000 Inventory $1 440 000 PP&E $1 560 000 Brandnames $500 000 Total = $4 220 000 Fair value of liabilities and contingent liabilities is: Accounts payable $680 000 Provision for employee benefits $220 000 Contingent liabilities $150 000 Total = $1 050 000 57 Net fair value = $3 170 000
Impairment of goodwill 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 58
Impairment losses and CGUs with goodwill (para 81) • Acquired Goodwill – No revaluation; no amortisation » ONLY impaired (tested annually) (or more frequently if there is an indication that the CGU may be impaired) » » No independent cash flows Allocated to lowest level Impairment loss in a CGU with goodwill STEPS (para 104): 1. Reduce the carrying amount of the CGU’s goodwill to zero 2. Remainder to the other assets of the CGU on a pro rata basis 59
Lecture Example 3 60
Lecture Example 3 A Ltd has identified an impairment loss of $300, 000 on one of its CGUs which consists of the following assets (stated at current carrying amounts): • Buildings 500, 000 • Equipment 300, 000 • Land 250, 000 • Goodwill 150, 000 Required: Calculate the allocation of impairment loss against all assets in the CGU. 61
Solution CA Goodwill Prorata 150, 000 Impairment loss allocated Adjusted CA 150, 000* - Buildings 500, 000 500/1, 050 71, 429** 428, 571 Equipment 300, 000 300/1, 050 42, 857 257, 143 Land 250, 000 250/1, 050 35, 714 214, 286 1, 050, 000 300, 000 * Remaining impairment loss still to be allocated = $150, 000 ** 500/1, 050 x $150, 000 = 71, 429 62
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