Chapter 9 - Intangible Asset & Chapter 10 - Impairment of Asset

Intangible assetsChapter learning objectives

Upon completion of this chapter you will be able to:

• explain the nature of internallygenerated and purchased intangibles

• explain the accounting treatment of internallygenerated and purchased intangibles

• distinguish between goodwill and other intangible assets

• describe the criteria for the initial recognition of intangible assets

• describe the criteria for the initial measurement of intangible assets

• explain the subsequent accounting treatment of goodwill

• explain the principle of impairment tests in relation to goodwill

• explain why the value of the purchase consideration for an investment may be less than the value of the acquired net assets

• explain how this difference should be accounted for

• define research expenditure and development expenditure according to IAS 38

• explain the accounting requirements of IAS 38 for research expenditure and development expenditure

• account for research expenditure and development expenditure.

145

chapter

9

1 Intangible assetsIntroduction

Many businesses invest significant amounts with the intention of obtaining future value on areas such as:

All of these expenses may result in future benefits to the business, but not all can be recognised as assets.

• scientific/technical knowledge

• design of new processes and systems

• licences and quotas

• intellectual property, e.g. patents and copyrights

• market knowledge, e.g. customer lists, relationships and loyalty

• trade marks.

Objective of IAS 38 Intangible assets

The objective of IAS 38 is to prescribe the specific criteria that must be met before an intangible asset can be recognised in the accounts.

Definition

An intangible asset is an identifiable nonmonetary asset without physical substance.

To meet the definition the asset must be identifiable, i.e. separable from the rest of the business or arising from legal rights.

Intangible assets

146 KAPLAN PUBLISHING146 KAPLAN PUBLISHING

It must also meet the normal definition of an asset:

• controlled by the entity as a result of past events (normally by enforceable legal rights)

• a resource from which future economic benefits are expected to flow (either from revenue or cost saving).

Recognition

To be recognised in the financial statements, an intangible asset must:

If these criteria are met, the asset should be initially recognised at cost.

• meet the definition of an intangible asset, and

• meet the recognition criteria of the framework: – it is probable that future economic benefits attributable to the asset

will flow to the entity

– the cost of the asset can be measured reliably.

Internallygenerated intangibles

The following internallygenerated items may never be recognised:

• goodwill

• brands

• mastheads

• publishing titles

• customer lists.

How should the following intangible assets be treated in the financial statements?

• A publishing title acquired as part of a subsidiary company.

• A licence purchased in order to market a new product.

chapter 9

KAPLAN PUBLISHING 147

Test your understanding 1

Expandable text Purchased and internally generated intangibles

Measurement after initial recognition

There is a choice between:

• the cost model

• the revaluation model.

The cost model• The intangible asset should be carried at cost less amortisation and

any impairment losses.

• This model is more commonly used in practice.

The revaluation model

Features of an active market are that:

In practice such markets are rare.

• The intangible asset may be revalued to a carrying value of fair value less subsequent amortisation and impairment losses.

• Fair value should be determined by reference to an active market.

– the items traded within the market are homogeneous

– willing buyers and sellers can normally be found at any time

– prices are available to the public.

Amortisation

An intangible asset with a finite useful life must be amortised over that life, normally using the straightline method with a zero residual value.

An intangible asset with an indefinite useful life:

• should not be amortised

• should be tested for impairment annually, and more often if there is an actual indication of possible impairment.

Intangible assets

148 KAPLAN PUBLISHING

Expandable text Amortisation

Expandable text Revaluation model

What is the accounting treatment of a recognised intangible asset with an indefinite useful life?

Key disclosures

The financial statements should disclose the following for each class of intangible assets, distinguishing between internallygenerated intangible assets and other intangible assets:

• whether the useful lives are finite or indefinite

• the useful lives or the amortisation rates used for assets with finite lives

• the amortisation methods used for assets with finite lives.

2 Goodwill

The nature of goodwill

Goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable net assets.

Separable net assets are those assets (and liabilities) which can be identified and sold off separately without necessarily disposing of the business as a whole. They include identifiable intangibles such as patents, licences and trade marks.

Fair value is the amount at which an asset or liability could be exchanged in an arm’s length transaction between informed and willing parties, other than in a forced or liquidation sale.

Goodwill may exist because of any combination of a number of possible factors:

• reputation for quality or service

• technical expertise

• possession of favourable contracts

• good management and staff.

chapter 9



Expandable text Impairment losses

Purchased and nonpurchased goodwill

Purchased goodwill:

Nonpurchased goodwill:

• arises when one business acquires another as a going concern

• includes goodwill arising on the consolidation of a subsidiary or associated company

• will be recognised in the financial statements as its value at a particular point in time is certain.

• is also known as inherent goodwill

• has no identifiable value

• is not recognised in the financial statements.

IFRS 3 revised Business combinations

IFRS 3 revised governs accounting for all business combinations and deals with the accounting treatment of goodwill.

Goodwill is defined in IFRS 3 as an asset representing the future economic benefits arising from assets acquired in a business combination that are not individually identified and separately recognised.

Goodwill is calculated at the acquisition date as:

$Fair value of consideration paid (shares issued plus cash paid plus direct costs)

X

Noncontrolling interest X(valued either at fair value or as a proportion of net assets) ___

XFair value of net assets of acquiree (X) ___ X

Accounting treatment of goodwill

Purchased goodwill:

• should be capitalised as an intangible noncurrent asset


• must be tested for impairment annually in accordance with IAS 36, or more frequently if circumstances indicate that it might be impaired.

Intangible assets


An entity acquires 75% of the share capital of another entity, JKL. The consideration for the purchase was shares with a fair value of $800,000 and cash of $200,000. There were direct costs involved in the takeover of $20,000 .The noncontrolling interest is valued using the proportion of net assets method.The carrying amounts and fair values of JKL assets and liabilities at the date of acquisition were as follows:

What is the amount of goodwill be recognised on acquisition?

Carrying value Fair value $000 $000

Tangible noncurrent assets 700 950Current assets 400 350Current liabilities (200) (200)

––––– ––––– 900 1,100

What are the main characteristics of goodwill which distinguish it from other intangible assets?

State your reasons.

3 Research and development expenditureDefinitions

Research is original and planned investigation undertaken with the prospect of gaining new scientific knowledge and understanding.

Development is the 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 before the start of commercial production or use.

chapter 9




Expandable text Bargain purchases

Expandable text Purchased and nonpurchased goodwill

Accounting treatment

Research expenditure: write off as incurred to the income statement

Development expenditure: recognise as an intangible asset if, and only if, an entity can demonstrate all of the following:

• the technical feasibility of completing the intangible asset so that it will be available for use or sale

• 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. Among other things, the entity should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset

• the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset

• its ability to reliably measure the expenditure attributable to the intangible asset during its development.

An entity has incurred the following expenditure during the current year:

How should each of these costs be treated in the financial statements of the entity?

(a) $100,000 spent on the design of a new product it is anticipated that this design will be taken forward over the next two year period to be developed and tested with a view to production in three years time.

(b) $500,000 spent on the testing of a new production system which has been designed internally and which will be in operation during the following accounting year. This new system should reduce the costs of production by 20%.

Intangible assets



Expandable text

Amortisation

Development expenditure should be amortised over its useful life.

Amortisation of development expenditure

Improve has deferred development expenditure of $600,000 relating to the development of New Miracle Brand X. It is expected that the demand for the product will stay at a high level for the next three years. Annual sales of 400,000, 300,000 and 200,000 units respectively are expected over this period. Brand X sells for $10.

How should the development expenditure be amortised?

Disclosure

The key disclosures required for development costs are:

• the useful lives or the amortisation rates used for assets with finite lives

• the amortisation methods used for assets with finite lives

• the gross carrying amount and the accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period.

chapter 9


Illustration 1 – Research and development expenditure

Expandable text Solution

D&E are both development projects. Both projects are anticipated to be successful. They have clearlydefined parameters. The project expenditure is carefully controlled. The prototypes proved successful. The budgets show sales well in excess of total costs. Finance is readily available. Project D has commenced production and the revenues have started to flow in.

The company has also invested $340,000 in development project F but the tests are at present inconclusive.

Describe with reasons the accounting for the above issues.

Project Project D E

$000 $000Costs accumulated to 1.1.X5 (and meeting capitalisation criteria)

400 350

Costs incurred during the year 600 250Total anticipated net revenues 30,000 15,000Net revenues during the year 6,000 nil

Intangible assets



Chapter summary

chapter 9


Test your understanding answers

• The answer depends on whether the asset can be valued reliably. If this is possible, the title will be recognised at its fair value, otherwise it will be treated as part of goodwill on acquisition of the subsidiary.

• As the licence has been purchased separately from a business, it should be capitalised at cost.

An intangible asset with an indefinite useful life:


• should be tested for impairment annually, and more often if there is an actual indication of possible impairment.

$000Fair value of considerationShares 800Cash 200

––––– 1,000

Noncontrolling interest (1,100 x 25%) 275––––– 1,275

Net assets of acquiree (1,100)Goodwill 175

––––– Note: IFRS 3 revised requires acquisition costs to be expensed as incurred. They do not form part of the cost of acquisition.

Intangible assets





Characteristics

• It is a ‘balancing figure’. Goodwill itself is not valued but a comparison is made between the fair value of the whole business and the fair value of the separable net assets of the business. It cannot be valued on its own.

• Goodwill cannot be disposed of as a separate asset.

• The factors contributing to the value of goodwill cannot be valued, e.g. how can one value the benefit of an experienced workforce?

• The value of goodwill is volatile – it can only be given a numerical value at the time of acquisition of the whole business.

(a) These are research costs as they are only in the early design stage and therefore should be written off as part of profit and loss for the period.

(b) These would appear to be development stage costs as the new production system is due to be in place fairly soon and will produce economic benefits in the shape of reduced costs. Therefore these should be capitalised as development costs.

chapter 9




As tests are inconclusive in project F, its costs must be expensed to the income statement.

Projects D and E are both examples of development spend which meets the capitalisation critera and as such the relevant costs are shown as assets on the statement of financial position.

Project D has commenced production and so requires amortisation.

Development expenditure D E Total B/f 400 350 750Capitalised 600 250 850Amortised (6/30 × 1,000) (200) Nil (200)

–––– –––– –––– C/f 800 600 1,400Intangible noncurrent assets (Note) Development expenditure $000as at 1.1.X5 750Costs deferred 850Released to the Income statement (200)

––––– as at 31.12.X5 1,400

–––––

Intangible assets



Impairment of assetsChapter learning objectives

Upon completion of this chapter you will be able to:

• define an impairment loss

• list the circumstances which may indicate impairments to assets

• describe a cash generating unit (CGU)

• explain the basis on which impairment losses should be allocated

• allocate an impairment loss to the assets of a CGU.

159

chapter

10

1 Impairment of individual assetsObjective of IAS 36 impairment of assets

The objective is to set rules to ensure that the assets of an entity are carried at no more than their recoverable amount (i.e. value to the business).

Impairment

An asset is impaired if its recoverable amount is below the value currently shown on the statement of financial position – the asset’s current carrying value (CV).

Recoverable amount is taken as the higher of:

• fair value less costs to sell (net selling price), and

• value in use.

Impairment of assets

160 KAPLAN PUBLISHING160 KAPLAN PUBLISHING

Expandable text Excluded assets

An impairment exists if:

Recoverable amount

A company owns a car that was involved in an accident at the year end. It is barely useable, so the value in use is estimated at $1,000. However, the car is a classic and there is a demand for the parts. This results in a net realisable value of $3,000. The opening carrying value was $8,000 and the car was estimated to have a life of eight years from the start of the year.

Identify the recoverable amount of the car.

The following information relates to three assets:

What is the recoverable amount of each asset?

A B C $000 $000 $000

Carrying value 100 150 120Net realisable value 110 125 100Value in use 120 130 90

chapter 10


Illustration 1 – Impairment of individual assets


Expandable text Measurement of recoverable amount

Expandable text Solution

Calculate the impairment loss for each of the three assets.

Indications of impairment

IAS 36 requires that at each reporting date, an entity must assess whether there are indications of impairment.

Indications may be derived from within the entity itself (internal sources) or the external market (external sources).

External sources of information• The asset’s market value has declined more than expected.

• Changes in the technological, market, economic or legal environment have had an adverse effect on the entity.

• Interest rates have changed, thus increasing the discount rate used in calculating the asset’s value in use.

Internal sources of information• There is evidence of obsolescence of or damage to the asset.

• Changes in the way the asset is used have occurred or are imminent.

• Evidence is available from internal reporting indicating that the economic performance of an asset is, or will be, worse than expected.

Recognition and measurement of an impairment

Where there is an indication of impairment, an impairment review should be carried out:

The only exception to this is if the impairment reverses a previous gain taken to the revaluation reserve.

• the recoverable amount should be calculated

• the asset should be written down to recoverable amount and

• the impairment loss should be immediately recognised in the income statement.



Expandable text Annual impairment reviews

Expandable Text Illustration : recoverable amount

In this case, the impairment will be taken first to the revaluation reserve (and so disclosed as other comprehensive income) until the revaluation gain is reversed and then to the income statement.

An entity owns a property which was originally purchased for $300,000. The property has been revalued to $500,000 with the revaluation of $200,000 being recognised as other comprehensive income and recorded in the revaluation reserve. The property has a current carrying value of $460,000 but the recoverable amount of the property has just been estimated at only $200,000.

What is the amount of impairment and how should this be treated in the financial statements?

2 Cash generating units (CGUs)What is a CGU?

When assessing the impairment of assets it will not always be possible to base the impairment review on individual assets.

• The value in use calculation will be impossible on a single asset because the asset does not generate distinguishable cash flows.

• In this case, the impairment calculation should be based on a CGU.

Definition of a CGU

A CGU is defined as the smallest identifiable group of assets which generates cash inflows independent of those of other assets.

chapter 10


Expandable text Goodwill and CGUs

Expandable text Illustration CGUs

Expandable text Reversal of impairment losses


The impairment calculation

The impairment calculation is done by:

As previously, an impairment exists where the carrying value exceeds the recoverable amount.

• assuming the cash generating unit is one asset

• comparing the carrying value of the CGU to the recoverable amount of the CGU.

Impairment of a CGU

If a CGU is impaired the assets must be written down in a strict order:

Note: No individual asset should be written down below recoverable amount.

(1) any obviously impaired asset

(2) goodwill allocated to the CGU (both recognised goodwill and , where the proportion of net assets method is used to value the NCI, notional goodwill attributed to the NCI)

(3) other assets (pro rata according to carrying value).

A company runs a unit that suffers a massive drop in income due to the failure of its technology on 1 January 20X8. The following carrying values were recorded in the books immediately prior to the impairment:

$mGoodwill 20Technology 5Brands 10Land 50Buildings 30Other net assets 40




The recoverable value of the unit is estimated at $85 million. The technology is worthless, following its complete failure. The other net assets include inventory, receivables and payables. It is considered that the book value of other net assets is a reasonable representation of its net realisable value.

Show the impact of the impairment on 1 January.

chapter 10


Chapter summary



Test your understanding answers

The recoverable amounts for each asset are as follows:

A: $120,000

B: $130,000

C: $100,000

The impairment loss for each asset is as follows:

A: Nil

B: $20,000

C: $20,000

Impairment = $460,000 – 200,000 = $260,000

Of this $200,000 is debited to the revaluation reserve to reverse the previous upwards revaluation (and recorded as other comprehensive income) and the remaining $60,000 is charged to the income statement.

chapter 10




• Carrying value is $155 million.

• Recoverable value is $85 million.

• Therefore an impairment of $70 million is required.

Working

Carrying value Impairment Impaired value

Goodwill 20 (20) 0

Technology 5 (5) 0

Brands 10 (5) 5

Land 50 (25) 25

Buildings 30 (15) 15

Other 40 (0) 40

CGU 155 (70) 85

$mTotal impairment: 70Allocated – Goodwill (20)

– Technology (5)–––

Remaining 45Prorate based on carrying value:Brands 45 × 10/(10 + 50 + 30) = 5Land 45 × 50/(10 + 50 + 30) = 25Buildings 45 × 30/(10 + 50 + 30) = 15




Documents

Chapter 9 - Intangible Asset & Chapter 10 - Impairment of Asset