Intangible Assets

Intangible assets are non-monetary assets without physical substance. They are identifiable, which implies that they are either separable (capable of being separated and sold, transferred, licensed, rented, or exchanged) or arise from contractual or other legal rights. Examples include patents, trademarks, copyrights, and goodwill. However, it’s important to note that goodwill is not separately identifiable.

Intangible Assets Reporting

Under IFRS, intangible assets may be reported either using the cost or revaluation model (in the presence of an active market). In the cost model, an asset is carried at its cost less any accumulated amortization and any accumulated impairment losses.

On the other hand, in the revaluation model, as asset is carried at a revalued amount, being its fair value at the date of revaluation less any subsequent accumulated amortization and any subsequent accumulated impairment losses. The revaluation model is chosen if there exists an active market for an intangible asset.

The US GAAP permits intangible assets to be measured using only the cost model.

Useful Life and Amortization of Intangible Assets

A company assesses whether its intangible assets’ useful life is finite or indefinite. Indefinite life implies that the asset has no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. On the other hand, having a finite life implies an intangible asset has a limited period of benefit to the entity.

Based on the useful life information, impairment and amortization principles apply as follows:

• Finite useful life intangible assets are amortized on a systematic basis over the best estimate of their useful life. The useful life estimate and amortization should be reviewed at least annually.
• An intangible asset with a finite useful life has a similar impairment principle to PP&E.
• Indefinite useful life intangible assets are not amortized. A review of the reasonableness of assuming an indefinite useful life and asset impairment testing is done at least annually.

Valuation and Analysis

Traditionally, financial analysts approach the reported values of intangible assets, especially goodwill, with a degree of skepticism. As a result, when evaluating financial statements, some analysts choose to disregard the book value of intangibles, thereby lowering net equity by a corresponding amount to achieve a “tangible book value” and adjusting pretax income to account for any associated amortization expenses or impairments.

It is generally not recommended to assign a zero value to intangibles arbitrarily; rather, analysts should individually assess each intangible asset to determine if any adjustments are warranted. Disclosures in the notes regarding intangible assets can offer valuable insights to analysts, including details about their useful lives, amortization methods and rates, and any recognized or reversed impairment losses.

Additionally, a company may possess internally developed intangible assets that are only recognized under specific conditions. There may also be assets that never appear on the balance sheet because they are not easily identifiable, and the company lacks adequate control over its future economic benefits. Examples of these assets include the management and technical skills of employees, market share, brand recognition, and a strong customer reputation.

Although not recorded on the balance sheet, these assets are valuable and theoretically reflected in the market price of the company’s equity securities and the potential sale price of the company’s equity in an acquisition. In the event of a sale, these assets may be classified as goodwill by the acquiring entity.

Identifiable Intangiblebles

According to IFRS, identifiable intangible assets are recorded on the balance sheet when there is a likelihood that they will bring future economic benefits to the company and when their cost can be reliably determined.

Identifiable intangible assets, such as patents, trademarks, copyrights, franchises, licenses, and other rights, can be either internally developed within the company or purchased by the company.

Internally Created Identifiable Intangibles

Establishing the value of internally developed intangible assets can be challenging and open to interpretation. Consequently, under both IFRS and US GAAP, the standard practice is to expense internally created identifiable intangibles instead of including them on the balance sheet.

Under both IFRS and GAAP, the treatment of internally generated intangible assets involves strict criteria that must be met for an asset to be recognized on the balance sheet. This recognition process is separated into two phases: the research phase and the development phase.

The research phase involves endeavors to acquire new knowledge or develop new products. Following this, the development phase takes place, which is focused on the design and testing of prototypes and models.

IFRS

Under IFRS, the treatment of internally generated intangible assets is slightly different. IAS 38, which is the standard governing intangible assets under IFRS, requires that all costs incurred in the research phase be expensed as incurred. However, costs incurred in the development phase of an internally generated intangible asset may be capitalized 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.
• The availability of adequate technical, financial, and other resources to complete the development and to use or sell the intangible asset.
• Its ability to measure reliably the expenditure attributable to the intangible asset during its development.

 US GAAP

Under U.S. GAAP, the costs incurred during the research phase and the development phase of an internally generated intangible asset are typically expensed as incurred. Capitalizing such costs is prohibited.

The following categories of expenses are expensed under US GAAP (as well as under IFRS):

• Internally created mastheads, brands, customer lists, and publishing titles.
• Training cost.
• Start-up cost.
• General overheads and administration costs.
• Promotion and advertising.
• Reorganization and relocation expenses.
• Redundancy and termination costs.

Acquired or Purchased Intangibles

Unlike internally generated intangibles, acquired or purchased intangible assets are capitalized and recorded as distinct identifiable intangibles, provided they originate from contractual rights such as licensing agreements, other legal rights such as patents or can be separated and sold such as customer lists.

Question

McGill Corp. has been developing a product for the past five years, but they lack the funds to finish the product and start its sale. Which of the following would be the most appropriate action to take under IFRS.

1. Capitalize all costs related to the development of the product.
2. Expense the costs related to the development of the product.
3. Do nothing.

Solution

The correct answer is B.

Since the company lacks the ability to complete the product, they have failed to meet the criteria necessary to capitalize the product as an intangible asset; thus, the cost will be expensed to the income statement.