Financial Reporting of Intangible Assets

Financial Reporting of Intangible Assets

There are three primary ways intangible assets may be acquired: purchased in situations other than business combinations, developed internally, and acquired in business combinations. The accounting treatment accorded to an asset depends on which of these methods is used in its acquisition.

Financial Reporting for Intangible Assets

Intangible Assets Purchased in Situations Other Than Business Combinations

Intangible assets, such as patents purchased in situations other than business combinations, are recorded at their fair value (equivalent to the purchase price) when acquired. If several intangible assets are acquired as part of a group, each asset’s purchase price is allocated based on its fair value.

Intangible Assets Developed Internally

The costs of internally developed intangible assets are generally expensed when incurred. As a result, a company that has internally developed intangible assets such as patents, copyrights, or brands through expenditures on research and development (R&D) or advertising will recognize a lower amount of assets than one that has obtained intangible assets through an external purchase.

IFRS requires that expenditures on research (or during the research phase of internal projects) be expensed rather than capitalized as an intangible asset. IFRS also allows companies to recognize an intangible asset arising from development (or during the development phase of internal projects) once certain criteria are met.

Generally, US GAAP requires both research and development costs to be expensed as they are incurred. Further, it is a US GAAP requirement that certain costs related to software development be capitalized. The costs incurred during developing a software product for sale are expensed until the product’s technological feasibility is established. The costs are capitalized after that. Similarly, companies expense the costs related to software development for internal use until it is probable that the project will be completed and the software will be used as intended. It is then that the development costs are capitalized.

Intangible Assets Acquired in a Business Combination

The ‘acquisition method’ of accounting is used whenever one company acquires another. Under this method, the acquiring entity allocates the purchase price to each asset acquired, and each liability is assumed based on its fair value. If the purchase price exceeds the sum of the amounts that can be allocated to individual identifiable assets and liabilities, the excess will be recorded as goodwill.

Under IFRS, the individual assets that can be acquired include identifiable intangible assets that meet certain definitional and recognition criteria. Otherwise, if the item is acquired in a business combination and cannot be recognized as a tangible or identifiable intangible asset, it will be recognized as goodwill.

Question 1

Which of the following statements is most accurate?

  1. A company that has developed intangible assets internally will recognize a lower amount of assets than a company that has obtained intangible assets through an external purchase.
  2. A company that has developed intangible assets internally will recognize a higher amount of assets than a company that has obtained intangible assets through an external purchase.
  3. A company that has developed intangible assets internally will report an amount of assets that is equivalent to that of a company that has obtained intangible assets through an external purchase.

Solution

The correct answer is A.

A company that has developed intangible assets internally will recognize a lower amount of assets than a company that has obtained intangible assets through an external purchase. This results from the fact that the costs to internally develop intangible assets are expensed and not capitalized when incurred.

Question 2

Compared to a company that develops an intangible asset internally, a company that purchases the same asset would exhibit:

  1. Higher cash flow from operations.
  2. Higher cash flow from investing activities.
  3. Higher cash flow from financing activities.

Solution

The correct answer is B.

The company that purchases the asset would record the whole value of the purchase as an investing outflow. On the other hand, the company developing the intangible asset internally would report costs associated with the asset’s development as an operating cash outflow until the asset developed proves to be beneficial.

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