Financial Reporting of Intangible Assets

There are three primary ways in which intangible assets may be acquired: purchased in situations other than business combinations; developed internally; and acquired in business combinations. The accounting treatment will depend on which of these methods was used to acquire the asset.

Financial Reporting for Intangible Assets

Intangible Assets Purchased in Situations other than Business Combinations

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

Intangible Assets Developed Internally

The costs to internally develop 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 a company that has obtained intangible assets through an external purchase.

IFRS requires that expenditures on research (or during the research phase of internal projects) should 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 that both research and development costs are expensed as they are incurred, but require capitalization of certain costs related to software development. The costs incurred to develop a software product for sale are expensed until the product’s technological feasibility is established and are capitalized thereafter. Similarly, companies will expense the costs that are related to the development of software for internal use until it is probable that the project will be completed and that the software will be used as intended, after which the development costs will be capitalized.

Intangible Assets Acquired in a Business Combination

The ‘acquisition method’ of accounting is used whenever one company acquires another.  Under the acquisition method, the acquirer allocates the purchase price to each asset acquired and each liability assumed, on the basis of 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 have been 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?

A. A company that has internally developed intangible assets will recognize a lower amount of assets than a company that has obtained intangible assets through an external purchase.

B. A company that has internally developed intangible assets will recognize a higher amount of assets than a company that has obtained intangible assets through an external purchase.

C. A company that has internally developed intangible assets 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 internally developed intangible assets 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

As compared to a company developing an intangible asset internally, a company that would purchase the same identical asset would exhibit:

A. Higher cash flow from operations.

B. Higher cash flow from investing activities.

C. Higher cash flow from financing activities.

Solution

The correct answer is A.

The company purchasing the asset would record the whole value of the purchase as an investing outflow whereas 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.

Reading 26 LOS 26b:

Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination


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