9 INTANGIBLE ASSETS PERSPECTIVE AND ISSUES

Long-lived assets are those that will provide economic benefits to an enterprise for a number of future periods. Accounting standards regarding long-lived assets involve determination of the appropriate cost at which to record the assets initially, the amount at which to present the assets at subsequent reporting dates, and the appropriate method(s) to be used to allocate the cost or other recorded values over the periods being benefited. Under international accounting standards, while historical cost is the defined benchmar treatment, revalued amounts may also be used for presenting long-lived assets in the statement of financial position if certain conditions are met. Long-lived assets are primarily operational in character, and they may be classified into two basic types! tangible and intangible. "angible assets have physical substance, while intangible assets either have no physical substance, or have a value that is not conveyed by what physical substance they do have (e.g., the value of computer software is not reasonably measured with reference to the cost of the dis ettes on which these are contained). "he value of an intangible asset is a function of the rights or privileges that its ownership conveys to the business enterprise. #ntangible assets can be further categori$ed as either %. #dentifiable, or &. Unidentifiable (i.e., goodwill). #dentifiable intangibles include patents, copyrights, brand names, customer lists, trade names, and other specific rights that typically can be conveyed by an owner without necessarily also transferring related physical assets. 'oodwill, on the other hand, cannot be meaningfully transferred to a new owner without also selling the other assets and(or the operations of the business. )esearch and development costs are also addressed in this chapter. *ormerly the sub+ect of a separate international standard (#A, -), but more recently guided by the standard covering all intangibles (#A, ./), research costs must be e0pensed as incurred, whereas development costs, as defined and sub+ect to certain limitations, are to be classified as assets and amorti$ed over the period to be benefited. "he standard on impairment of assets (#A, .1) pertains to both tangible and intangible long-lived assets. "his chapter will consider the implications of this standard for the accounting for intangible assets. "he matter of goodwill, an unidentifiable intangible asset deemed to be the residual cost of a business combination accounted for as an acquisition, has been addressed by #A, && and is covered in 2hapter %%3 accounting for all other intangibles, addressed in #A, ./, is discussed in this chapter. As part of its twin pro+ects considering revisions to the standards on business combinations and related topics, which are now anticipated to result in new or revised standards no earlier than &445, the #A,6 has been reviewing the accounting for intangibles in general. "he ob+ective is for the accounting for acquired intangibles, including goodwill and in-process research and development, to be made more consistent with that prescribed for intangibles acquired by other means or internally generated by the reporting entity. 7ith regard to goodwill (discussed in greater detail in 2hapter %%, 6usiness 2ombinations and 2onsolidated *inancial ,tatements, it is e0pected that an acquirer will be required, as of the acquisition date to %. )ecogni$e goodwill acquired in a business combination as an asset3 and

&. #nitially measure that goodwill at its cost, being the e0cess of the cost of the business combination over the acquirer8s interest in the net fair value of the identifiable assets, liabilities, and any contingent liabilities recogni$ed. #t is well established that goodwill acquired in a business combination represents a payment made by the acquirer in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recogni$ed. "o the e0tent that the acquiree8s identifiable assets, liabilities, or contingent liabilities do not satisfy the criteria for separate recognition at the acquisition date, there is a resulting impact on the amount recogni$ed as goodwill. "his is because goodwill is measured as the residual cost of the business combination after recogni$ing the acquiree8s identifiable assets, liabilities, and contingent liabilities. Under the anticipated #A, revisions, subsequent to initial recognition, the acquiring entity will be required to measure goodwill acquired in a business combination at cost less any accumulated impairment losses. "his will essentially replicate the approach adopted under U, 'AA9 (,*A, %5&), which is a star departure from historical practice. )ather than being amorti$ed over its estimated economic life, goodwill acquired in a business combination will have to be tested for impairments annually, or more frequently if events or changes in circumstance indicate that it might be impaired, in accordance with #A, .1. ,ources of #A, #A, .1, ./ ,#2 1, .& :;*#<#"#=<, =* ";)>, Amorti$ation. #n general, the systematic allocation of the cost of a long-term asset over its useful economic life3 the term is also used specifically to define the allocation process for intangible assets. 2arrying amount. "he amount at which an asset is presented on the balance sheet, which is its cost (or other allowable basis), net of any accumulated depreciation and impairment losses. 2ash generating unit. "he smallest identifiable group of assets that generates cash inflows from continuing use, largely independent of the cash inflows associated with other assets or groups of assets. 2orporate assets. Assets, e0cluding goodwill, that contribute to future cash flows of both the cash generating unit under review for impairment and other cash generating units. 2ost. Amount of cash or cash equivalent paid or the fair value of other consideration given to acquire or construct an asset. :epreciable amount. 2ost of an asset or the other amount that has been substituted for cost, less the residual value of the asset. :epreciation. ,ystematic and rational allocation of the depreciable amount of an asset over its economic life. :evelopment. "he application of research findings or other nowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services prior to commencement of commercial production or use. "his should be distinguished from research. *air value. Amount that would be obtained for an asset in an arm8s-length e0change transaction between nowledgeable willing parties. 'oodwill. "he e0cess of the cost of a business combination accounted for as an acquisition over the fair value of the net assets thereof, to be amorti$ed over its useful economic life that, as a rebuttable presumption, is no greater than twenty years.

#mpairment loss. "he e0cess of the carrying amount of an asset over its recoverable amount. #ntangible assets. <onmonetary assets without physical substance that are held for use in the production or supply of goods or services or for rental to others, or for administrative purposes, which are identifiable and are controlled by the enterprise as a result of past events, and from which future economic benefits are e0pected to flow. >onetary assets. Assets whose amounts are fi0ed in terms of units of currency. ;0amples are cash, accounts receivable, and notes receivable. <et selling price. "he amount which could be reali$ed from the sale of an asset by means of an arm8s-length transaction, less costs of disposal. <onmonetary transactions. ;0changes and nonreciprocal transfers that involve little or no monetary assets or liabilities. <onreciprocal transfer. "ransfer of assets or services in one direction, either from an enterprise to its owners or another entity, or from owners or another entity to the enterprise. An enterprise8s reacquisition of its outstanding stoc is a nonreciprocal transfer. )ecoverable amount. "he greater of an asset8s net selling price or its value in use. )esearch. "he original and planned investigation underta en with the prospect of gaining new scientific or technical nowledge and understanding. "his should be distinguished from development. )esidual value. ;stimated amount e0pected to be obtained on ultimate disposition of the asset after its useful life has ended, net of estimated costs of disposal. Useful life. 9eriod over which an asset will be employed in a productive capacity, as measured either by the time over which it is e0pected to be used, or the number of production units e0pected to be obtained from the asset by the enterprise. 2=<2;9",, )UL;,, A<: ;?A>9L;, 6ac ground =ver the years, the role of intangible assets has grown more important for the operations and prosperity of many types of businesses, as the @ nowledge-basedA economy becomes more dominant. Bowever, until recently, accounting standards have tended to give scant attention to, or ignore entirely, the appropriate means of reporting upon such assets. As a consequence, practice has been e0ceptionally diverse, with enterprises in nations whose standards had not addressed accounting for intangibles typically being much more aggressive in capitali$ing a range of intangibles, including internally generated goodwill, vis-C-vis those entities operating under more strictly defined rules limiting cost deferral and requiring rapid amorti$ation of those costs which could be deferred. "hus, in many countries it has been common practice to defer recognition of certain types of e0penditures, including advertising costs and setup costs, the future benefits of which are very difficult to demonstrate. #n addition, when intangibles such as @brand namesA and @internally generated goodwillA have been capitali$ed, there has often been a great reluctance to amorti$e the costs against earnings over a reasonable time hori$on, on the basis that these have either indefinite or infinite lives. 7hile advocates for such practices have made the claim that future benefits will flow from such e0penditures (else, why incur those costsD), e0perience has shown that these deferrals often result in a subsequent year in large @big bathA write-offs. "his pattern of foregone periodic e0pense and sporadic charge-offs clearly impedes the utility of financial statements for one of their primary purposes, namely, the predicting of future economic performance (both in terms of earnings and cash flows) of the reporting entity. 7hile all can agree that predicting the useful economic lives of certain

intangibles is e0ceptionally challenging, the need to honor the matching principle and to provide relevant information for use by investors, creditors and others has driven most standard setters to impose rather stringent requirements on the recognition and measurement of intangible assets. #nternational accounting standards first addressed accounting for intangibles in a thorough way with #A, ./, which was promulgated after a rather long and contentious gestation period that included the issuance of two ;0posure :rafts. #A, ./ is a comprehensive standard which superseded an earlier standard dealing solely with research and development e0penditures. #t establishes recognition criteria, measurement bases, and disclosure requirements for intangible assets. "he standard also prescribes impairment testing for intangible assets, to be underta en on a regular basis. "his is to ensure that only assets having recoverable values are capitali$ed and carried forward to future periods. #t is interesting to note that in prescribing the amorti$ation period, #A, ./ has ruled out the concept of intangible assets having infinite or indefinite lives. #n fact, by imposing additional burdens on those who would assign lives greater than twenty years to such assets, the standard set a rather conservative approach to recognition and measurement of intangibles. Bowever, the #A,6 is currently weighing revisions that would remove the refutable presumption of a twenty-year ma0imum economic life and would further ac nowledge the e0istence of indefinite-life intangibles, not sub+ect to amorti$ation at all (at least, until a finite life was determinable). "hese potential revisions are being pondered largely as part of #A,68s effort to @convergeA its standards, in this case to the recently revised U, 'AA9 standards on business combinations and intangibles. #f adopted, goodwill will no longer be sub+ect to amorti$ation, but will have to be evaluated for impairment regularly, reversing the position ta en by #A, ./. (,ee further discussion in 2hapter %%.) Also, by simultaneously withdrawing the e0isting standard on research and development costs (the former #A, -) and revising the standard on business combinations (#A, &&), the former #A,2 considerably streamlined and rationali$ed the accounting standards relating to accounting for intangible assets. As the rules presently e0ist, therefore, they do form a coherent and consistent set of requirements for the financial reporting on all such assets. ,cope of the standard. "he standard applies to all enterprises. #t prescribes the accounting treatment for intangible assets, including development costs. Bowever, it does not apply to intangible assets covered by other #A,3 for instance, deferred ta0 assets covered under #A, %&, leases that fall within the purview of #A, %E, goodwill arising on a business combination and dealt with by #A, &&, assets arising from employee benefits that are covered by #A, %-, and financial assets as defined by #A, .& and covered by #A, &E, &/, .%, and .-. "his standard does not apply to intangible assets arising in insurance companies from contracts with policyholders, nor to mineral rights and the costs of e0ploration for, or development and e0traction of, minerals, oil, natural gas, and similar nonregenerative resources. Bowever, the standard does apply to intangible assets that are used to develop or maintain these activities. #dentifiable intangible assets include patents, copyrights, licenses, customer lists, brand names, import quotas, computer software, leasehold improvements, mar eting rights, and speciali$ed now-how. "hese items have in common the fact that there is little or no tangible substance to them, they have an economic life of greater than one year, and they have a decline in utility over that period which can be measured or reasonably assumed. #n many but not all cases, the asset is separable3 that is, it could be sold or

otherwise disposed of without simultaneously disposing of or diminishing the value of other assets held. #ntangible assets are, by definition, assets that have no physical substance. Bowever, there may be instances where intangibles also have some physical form. *or e0ample F "here may be tangible evidence of an asset8s e0istence, such as a certificate indicating that a patent had been granted, but this does constitute the asset itself3 F ,ome intangible assets may be contained in or on a physical substance such as a compact disc (in the case of computer software)3 and F #dentifiable assets that result from research and development activities are intangible assets because the tangible prototype or model is secondary to the nowledge that is the primary outcome of those activities. #n the case of assets that have both tangible and intangible elements, there may be some confusion about whether to classify them as tangible or intangible assets. 2onsiderable +udgment is required in properly classifying such assets as either intangible or tangible assets. As a rule of thumb, the asset should be classified as either an intangible asset or a tangible asset based on the relative or comparative dominance or significance of the tangible or the intangible component (or element) of the asset. *or instance, computer software that is not an integral part of the related hardware equipment is treated as software (i.e., as an intangible asset). 2onversely, certain computer software, such as the operating system, that is essential and an integral part of a computer, is treated as part of the hardware equipment (i.e., as property, plant, and equipment as opposed to an intangible asset). "he concept embodied in this standard is somewhat controversial, and in some respects also vague and unclear, being sub+ective and open to interpretation. #n various attempts to e0plain this concept, different techniques have been used by commentators. ,ome have restricted themselves to detailed e0amples, while others (perhaps e0hibiting over enthusiasm to clarify the concept) have gone further, even so far as to argue that #A, ./ draws a distinction between an @intangible assetA and an @intangible resource.A #n this typology, the latter e0pression has been conceived of a broader concept that includes intangible assets (as defined by #A, ./), as well as other hypothetical assets. *or e0ample, intangible resources would include not only items such as patents and copyrights (which would meet the qualifying criteria set forth for intangible assets in #A, ./), but also items such as customer lists and internally generated brands (which do not meet the definition of intangible assets). 7hile this may serve some useful purpose, the coining of a phrase such as @intangible resourcesA (which is found neither in the #A,2 *ramewor nor in #A, ./) to be used in distinction from the term @intangible asset,A is ill-advised. 'iven the fact that #A, ./ (paragraph E) has defined an asset as a @resourceGcontrolled by the enterpriseGA, the creation of alternative definitions and concepts is probably not appropriate. )ecognition 2riteria #dentifiable intangible assets have much similarity to tangible long-lived assets (property, plant, and equipment), and the accounting for them is accordingly very similar. "he ey criteria for determining whether intangible assets are to be recogni$ed are %. 7hether the intangible asset has an identity separate from other aspects of the business enterprise3 &. 7hether the use of the intangible asset is controlled by the enterprise as a result of its past actions and events3 .. 7hether future economic benefits can be e0pected to flow to the enterprise3 and 5. 7hether the cost of the asset can be measured reliably.

#dentifiability. As to the first issue, the principal concern is to distinguish these intangibles from goodwill arising from a business combination, the accounting for which is addressed by #A, &&. 'oodwill is the residual cost of a business acquisition that cannot be assigned either to tangible assets, net of any liabilities assumed, or to identifiable intangibles. Unli e identifiable intangibles, goodwill cannot be separated from the assets (the physical as well as the identifiable intangible) it was acquired with. ,ince goodwill cannot be severed and sold, its real value is often questioned and the period over which it can be amorti$ed is, accordingly, often made as brief as possible. (6ut note that goodwill may become a nonamorti$ing, impairment-tested asset under a revised or superseded #A, &&3 see 2hapter %% for a discussion.) "o capitali$e the cost of an intangible asset other than goodwill, it must have an independently observable e0istence and a cost that can be assigned to it. #ndependently observable e0istence can be established if the enterprise can rent, sell, e0change, or distribute the future economic benefits from the assets without also disposing of other assets3 that is, that an owner can convey them without necessarily also transferring related physical assets. 'oodwill, on the other hand, cannot be meaningfully transferred to a new owner without also selling other assets, and hence, will not meet the recognition criteria for intangible assets as defined by #A, ./. #dentifiability can be demonstrated by a legal right over an asset or by the fact that the asset is separable from the rest of the business. #t is worth noting that while #A, ./ does not regard @separabilityA as an additional recognition criterion, some national standards (UH 'AA9, for instance) still retain it as one of the qualifying criteria for recognition. At the time it adopted #A, ./, the #A,2 6oard re+ected the views of commentators on the antecedent ;0posure :rafts who had advocated the inclusion of @separabilityA as an additional recognition criterion. #n setting forth the basis for its conclusions, the 6oard cited several reasons for this re+ection. Among these, perhaps the most noteworthy is the following! Gif a @separabilityA criterion was applicable to all intangible assets, many intangible assets (for e0ample, a license to operate a radio station) would not be shown separately in the financial statements even if they meet the (#A,2) *ramewor 8s definition of, and recognition criteria for, an asset. 7hile not supportive of imposing separability as a threshold criterion for intangible assets, #A,2 supported the view that %. :emonstration of the separability of an asset can assist an enterprise in identifying an intangible asset3 and &. "he inability of an enterprise to demonstrate the separability of an asset will ma e it harder to demonstrate that there is an identifiable intangible asset. 2urrently, #A,6 is embar ed upon a thorough review of accounting for business combinations, a corollary of which is the accounting for intangibles (including goodwill and in-process research and development) acquired in such combinations. 6ased on deliberations to mid-&44&, it appears that the e0isting philosophy for intangible asset recognition will be essentially continued. A replacement for #A, && will li ely stipulate that intangible assets acquired in a business combination should be recogni$ed separately from goodwill if they arise as a result of contractual or legal rights or are separable from the business. "he e0istence of contractual or legal rights and separability will not, however, form part of the definition of an asset, but rather, will serve as indicators that an entity controls the future economic benefits embodied in the item. #t would appear, therefore, that neither of these characteristics are intended to be absolute requirements, which would continue current practice in this area.

2ontrol. "he provisions of #A, ./ require that an enterprise should be in a position to control the use of the intangible asset. 2ontrol implies the power to both obtain future economic benefits from the asset as well as restrict the access of others to those benefits. <ormally enterprises register patents, copyrights, etc. to ensure its control over an intangible asset. A patent gives the holder the e0clusive right to use the underlying product or process without any interference or infringement from others. #ntangible assets arising from technical nowledge of staff, customer loyalty, long-term training benefits, etc., will have difficulty meeting this recognition criteria in spite of e0pected future economic benefits from them. "his is due to the fact that the enterprise would find it impossible to fully control these resources or to prevent others from controlling them. *or instance, even if an enterprise incurs considerable e0penditure on training that will supposedly increase staff s ills, the economic benefits from s illed staff cannot be controlled, since trained employees could leave their current employment and move on in their career to other employers. Bence, staff training e0penditures, no matter how material in amount, do not qualify as an intangible asset. #n other words, the practice of deferring training costs based on the reasoning that future economic benefits from enhanced staff s ills will flow to the enterprise can no longer be +ustified, after the promulgation of the #A, on #ntangible Assets. =ther often-quoted e0amples of e0penses that do not qualify as intangible assets based on the criterion of control are mar et share, customer relationships, customer loyalty (unless protected by enforceable legal rights), and portfolio of clients. *uture economic benefits. Under #A, ./, it is mandated that an intangible asset be recogni$ed only if it is probable that future economic benefits specifically associated therewith will flow to the reporting entity, and the cost of the asset can be measured reliably. "he recognition criteria for intangible assets are derived from the (#A,2) *ramewor and are similar to the recognition criteria for tangible assets (property, plant, and equipment). "he future economic benefits envisaged by the standard may ta e the form of revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the intangible asset by the enterprise. A good e0ample of other benefits resulting from the use of the intangible asset is the use by an enterprise of a secret formula (which the enterprise has protected legally) that leads to reduced future production costs (as opposed to increased future revenue). >easurement of 2ost of #ntangibles "he conditions under which the intangible asset has been acquired will determine the measurement of cost. "he cost of an intangible asset acquired separately is determined in a manner largely analogous to that for tangible long-lived assets as described in 2hapter /. "hus, the cost comprises the purchase cost, including any ta0es and import duties, less any trade discounts and rebates, plus any directly attributable e0penditures incurred in preparing the asset for its intended use. :irectly attributable e0penditures would include fully loaded labor costs, thus including employee benefits arising directly from bringing the asset to its wor ing condition. #t would also include professional fees and other costs. As with tangible assets, capitali$ation of costs ceases at the point when the intangible asset is ready to be placed in service in the manner intended by management. Any costs incurred in using or redeploying intangible assets are accordingly to be e0cluded from the cost of those assets. "hus, any costs incurred while the asset is capable of being used in the manner intended by management, but while it has yet to be placed into service, would be e0penses, not capitali$ed. ,imilarly, initial operating losses, such as

those incurred while demand for the asset8s productive outputs is being developed, cannot be capitali$ed. =n the other hand, further e0penditures made for the purpose of improving the asset8s level of performance would qualify for capitali$ation. 2hanges being made to #A, ./ as a consequence of the #A,68s #mprovements 9ro+ect will emphasi$e the fact that certain operations may occur in connection with the development of an intangible asset, but not be necessary in order to bring the asset to the condition where it would be capable of operating in the manner intended by management. "hese incidental operations could occur either before or during the development activities. 6ecause by definition such operations are not necessary to bring an asset to the condition necessary for it to be capable of operating in the manner intended by management, the income and related e0penses of incidental operations must be recogni$ed in the operating results for the current period, to be reported in the respective classification of income and e0pense. Under #A, ./, a condition for the recognition of an intangible asset is that the cost of the asset can be measured reliably. "he changes made to #A, ./ consequent to the #A,68s #mprovements 9ro+ect clarified that the reporting entity would be unable to determine reliably the fair value of an intangible asset when comparable mar et transactions are infrequent and when alternative estimates of fair value (e.g., those based on discounted cash flow pro+ections) cannot be calculated. *urthermore, the cost of an intangible asset acquired in e0change for a similar asset would be measured at the carrying amount of the asset given up when the fair value of neither of the assets e0changed could be easily determined reliably. #n some situations, identifiable intangibles are acquired as part of a business combination or other bul purchase transaction. According to the provisions of #A, ./, the cost of an intangible asset acquired as part of a business combination is its fair value as at the date of acquisition. #f the intangible asset can be freely traded in an active mar et, then the quoted mar et price is the best measurement of cost. #f the intangible asset has no active mar et, then cost is determined based on the amount that the enterprise would have paid for the asset in an arm8s-length transaction at the date of acquisition. #f the cost of an intangible asset acquired as part of a business combination cannot be measured reliably, then that asset is not recogni$ed, but rather, is included in goodwill. Under U, 'AA9, the aggregate purchase cost is to be allocated to assets acquired and liabilities assumed. #f one or more of the assets are intangibles, the e0tent of +udgment required in the allocation process becomes somewhat greater than would otherwise be the case3 in e0treme situations it may be impossible to determine how much, if any, of the aggregate cost should be allocated to intangibles. #t is most li ely to be determinable when the intangibles were actually negotiated for in the transaction rather than being thrown in to the deal. *urthermore, if the allocation of the purchase price to individual assets is accomplished by applying discounted present value measures to future revenue streams, unless this same process is usable with regard to the intangibles, it is li ely that any unallocated purchase price will have to be assigned to goodwill. #n some instances, intangible assets are obtained in e0change for equity instruments of the reporting entity. "he revisions to #A, ./ will stipulate that under such circumstances the cost of the asset is the fair value of the equity instruments issued. 7here the fair value for the item received is more clearly evident than the fair value of the equity instruments issued, however, that should be used to measure its cost. #n other situations, intangible assets may be acquired in e0change or part e0change for other dissimilar intangible assets or other assets. Unless the @li e- indA e0ception described in the following paragraph applies, the costs of the assets obtained are

measured at the fair values of the assets given up, ad+usted by the amount of any cash or cash equivalents transferred. Bowever, if the fair values of the assets received are more clearly evident than the fair values of the assets given up, those values are to be used to measure the transaction. "hese procedures are predicated upon the ability to reliably measure costs3 absent this ability, as when comparable mar et transactions are infrequent and alternative estimates of fair value (e.g., based on discounted cash flow pro+ections) cannot be calculated, acquired assets would not be sub+ect to recordation. "he revisions to #A, ./ also will establish accounting procedures for what is commonly nown as a li e- ind e0change. #n such instances, the cost of an intangible asset acquired is measured at the carrying amount of the asset given up when the fair value of neither of the assets e0changed can be determined reliably. #nternally generated goodwill is not recogni$ed as an intangible asset because it fails to meet the recognition criteria of F )eliable measurement at cost, F Lac of an identity separate from other resources, and F 2ontrol by the reporting enterprise. #n practice, accountants are usually confronted with the desire to recogni$e internally generated goodwill based on the premise that at a certain point in time the mar et value of an enterprise e0ceeds the carrying value of its identifiable net assets. Bowever, as #A, ./ categorically points out, such differences cannot be considered to represent the cost of intangible assets controlled by the enterprise, and hence, would not meet the criteria for recognition (i.e., capitali$ation) of such an asset on the boo s of the enterprise. #ntangibles acquired by means of government grants. #f the intangible is acquired free of charge or by payment of nominal consideration, as by means of a government grant (e.g., when the government grants the right to operate a radio station) or similar program, and assuming the benchmar accounting treatment (historical cost) is employed, obviously there will be little or no amount reflected as an asset. #f the asset is important to the reporting entity8s operations, however, it must be adequately disclosed in the notes to the financial statements. #f the allowed alternative (fair value) method is used, the fair value should be determined by reference to an active mar et. Bowever, given the probable lac of an active mar et, since government grants are generally not transferable, it is unli ely that this situation will be encountered. #f an active mar et does not e0ist for this type of an intangible asset, the enterprise must recogni$e the asset at cost. 2ost would include those that are directly attributable to preparing the asset for its intended use. #ntangibles Acquired through an ;0change of Assets #f an intangible asset is acquired in e0change or partial e0change for a dissimilar intangible or other asset, then the cost of the asset is measured at its fair value. "his amount is to be ascertained by reference to the fair value of the asset received, which is equivalent to the fair value of the asset given up in the e0change, ad+usted for any cash or cash equivalents transferred. #f the e0change involves similar assets to be used by the enterprise in essentially the same manner and for the same purpose as the item given up in the e0change, the e0change is not deemed to be the culmination of an earnings process, and accordingly, no gain or loss is recogni$ed. "he new asset will be recorded at the carrying amount of the asset given up, ad+usted for any cash or cash equivalent (often called @bootA) given or received. #nternally 'enerated #ntangibles other than 'oodwill

#n many instances, intangibles are generated internally by an entity, rather than being acquired via a business combination or some other purchase transaction. 6ecause of the nature of intangibles, the actual measurement of the cost (i.e., the initial amounts at which these could be recogni$ed as assets) can prove to be rather challenging in practice, and for that reason, historically there was somewhat of a bias against recognition of internally generated intangible assets. Bowever, a failure to recogni$e such assets would not only cause the entity8s balance sheet to underreport its economic resources, but would also result in a mismatching of income and e0pense in both the period of e0penditure and later periods when the related benefits would be reaped. Accordingly, #A, ./ provides that internally generated intangible assets, provided certain criteria are met, are to be capitali$ed and amorti$ed over the pro+ected period of economic utility. Under the now-superseded #A, -, it was established that research costs were to be e0pensed as incurred, but that development costs were to be deferred (i.e., capitali$ed) and e0pensed over the periods of e0pected benefit. #A, ./ absorbed the guidance formerly found in #A, - and e0panded it to cover other internally generated intangible assets. "hus, e0penditures pertaining to the creation of intangible assets are to be classified alternatively as being indicative of, or analogous to, research activity or development activity. "he former costs are e0pensed as incurred3 the latter are capitali$ed, if future economic benefits are reasonably li ely to be received by the reporting entity. 9er #A, ./, %. 2osts incurred in the research phase are e0pensed immediately3 and &. #f costs incurred in the development phase meet the recognition criteria for an intangible asset, such costs should be capitali$ed. Bowever, once costs have been e0pensed during the development phase, they cannot later be capitali$ed. #n practice, distinguishing research-li e e0penditures from development-li e e0penditures may not be easily accomplished. "his would be especially true in the case of intangibles for which the measurement of economic benefits cannot be performed in anything appro0imating a direct manner. Assets such as brand names, mastheads, and customer lists can prove quite resistant to such direct observation of value (although in many industries there are benchmar monetary amounts commonly associated with such items, such as the oft-e0pressed notion that a customer list in the securities bro erage business is worth I%,J44 per name, implying the amount of avoidable promotional costs each qualified name is worth). "hus, entities may incur certain e0penditures in order to enhance brand names, such as engaging in image-advertising campaigns, but these costs will also have ancillary benefits, such as promoting specific products that are being sold currently, and possibly even enhancing employee morale and performance. 7hile it may be argued that the e0penditures create or add to an intangible asset, as a practical matter it would be difficult to determine what portion of the e0penditures relate to which achievement, and to ascertain how much, if any, of the cost may be capitali$ed as part of brand names. "hus, it is considered to be unli ely that threshold criteria for recognition can be met in such a case. *or this reason the standard has specifically disallowed the capitali$ation of internally generated assets li e brands, mastheads, publishing titles, customer lists, and items similar to these in substance. Apart from the prohibited items, however, #A, ./ permits recognition of internally created intangible assets to the e0tent the e0penditures can be analogi$ed to the development phase of a research and development program. "hus, internally developed patents, copyrights, trademar s, franchises, and other assets will be recogni$ed at the

cost of creation, e0clusive of costs which would be analogous to research, as further e0plained in the following paragraphs. 7hen an internally generated intangible asset meets the recognition criteria, the cost is determined using the same principles as for an acquired tangible asset. "hus, cost comprises all costs directly attributable to creating, producing, and preparing the asset for its intended use. #A, ./ closely follows #A, %1 with regard to elements of cost that may be considered as part of the asset, and the need to recogni$e the cash equivalent price when the acquisition transaction provides for deferred payment terms. As with self-constructed tangible assets, elements of profit must be eliminated from amounts capitali$ed, but incremental administrative and other overhead costs can be allocated to the intangible and included in the asset8s cost. #nitial operating losses, on the other hand, cannot be deferred by being added to the cost of the intangible, but must be e0pensed as incurred. As noted above, the standard presents the concepts of the research phase and the development phase of a research and development pro+ect. #A, ./ mandates that the e0penditure incurred during the research phase of an internal pro+ect should be recogni$ed as an e0pense when incurred (as opposed to recogni$ing it as an intangible asset). "he standard ta es this view based on the premise that an enterprise cannot demonstrate that the e0penditure incurred in the research phase will generate probable future economic benefits, and consequently, that an intangible asset e0ists (thus, such e0penditure should be e0pensed). ;0amples of research activities include! activities aimed at obtaining new nowledge3 the search for, evaluation, and final selection of applications of research findings3 and the search for and formulation of alternatives for new and improved systems, etc. "he standard recogni$es that the development stage is further advanced than the research stage, and that an enterprise can possibly, in certain cases, identify an intangible asset and demonstrate that this asset will probably generate future economic benefits for the organi$ation. "hus, the standard allows recognition of an intangible asset during the development phase, provided the enterprise can demonstrate all the following! F "echnical feasibility of completing the intangible asset so that it will be available for use or sale3 F #ts intention to complete the intangible asset and either use it or sell it3 F #ts ability to use or sell the intangible asset3 F "he mechanism by which the intangible will generate probable future economic benefits3 F "he availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset3 and F "he entity8s ability to reliably measure the e0penditure attributable to the intangible asset during its development. ;0amples of development activities include! the design and testing of preproduction models3 design of tools, +igs, molds, and dies3 design of a pilot plant which is not otherwise commercially feasible3 design and testing of a preferred alternative for new and improved systems, etc. )ecognition of internally generated computer software costs. "he recognition of computer software costs poses several questions. %. #n the case of a company developing software programs for sale, should the costs incurred in developing the software be e0pensed, or should the costs be capitali$ed and amorti$edD

&. #s the treatment for developing software programs different if the program is to be used for in-house applications onlyD .. #n the case of purchased software, should the cost of the software be capitali$ed as a tangible asset or as an intangible asset, or should it be e0pensed fully and immediatelyD #n view of the current #A, on intangible assets, the position can be clarified as follows! %. #n the case of a software-developing company, the costs incurred in the development of software programs are research and development costs. Accordingly, all e0penses incurred in the research phase would be e0pensed. "hus, all e0penses incurred until technological feasibility for the product has been established should be e0pensed. "he enterprise would have to demonstrate technical feasibility and probability of its commercial success. "echnological feasibility would be established if the enterprise has completed a detailed program design or wor ing model. "he enterprise should have completed the planning, designing, coding, and testing activities and established that the product can be successfully produced. Apart from being capable of production, the enterprise should demonstrate that it has the intention and ability to use or sell the program. Action ta en to obtain control over the program in the form of copyrights or patents would support capitali$ation of these costs. At this stage the software program would be able to meet the criteria of identifiability, control, and future economic benefits, and can thus be capitali$ed and amorti$ed as an intangible asset. &. #n the case of software internally developed for in-house use, for e0ample, a payroll program developed by the reporting enterprise itself, the accounting approach would be different. 7hile the program developed may have some utility to the enterprise itself, it would be difficult to demonstrate how the program would generate future economic benefits to the enterprise. Also, in the absence of any legal rights to control the program or to prevent others from using it, the recognition criteria would not be met. *urther, the cost proposed to be capitali$ed should be recoverable. #n view of the impairment test prescribed by the standard, the carrying amount of the asset may not be recoverable and would accordingly have to be ad+usted. 2onsidering the above facts, such costs may need to be e0pensed. .. #n the case of purchased software, the treatment would differ on a case-to-case basis. ,oftware purchased for sale would be treated as inventory. Bowever, software held for licensing or rental to others should be recogni$ed as an intangible asset. =n the other hand, cost of software purchased by an enterprise for its own use and which is integral to the hardware (because without that software the equipment cannot operate), would be treated as part of cost of the hardware and capitali$ed as property, plant, or equipment. "hus, the cost of an operating system purchased for an in-house computer, or cost of software purchased for computer-controlled machine tool, are treated as part of the related hardware. 2ost of other software programs should be treated as intangible assets (as opposed to being capitali$ed along with the related hardware), as they are not an integral part of the hardware. *or e0ample, the cost of payroll or inventory software (purchased) may be treated as an intangible asset provided it meets the capitali$ation criteria under #A, ./ (in practice, the conservative approach would be to e0pense such costs as they are incurred, since their ability to generate future economic benefits is always questionable). 2osts <ot ,atisfying the #A, ./ )ecognition 2riteria "he standard has specifically provided that e0penditures incurred for nonmonetary intangible assets should be recogni$ed as an e0pense unless

%. #t relates to an intangible asset dealt with in another #A,3 &. "he cost forms part of the cost of an intangible asset that meets the recognition criteria prescribed by #A, ./3 or .. #t is acquired in a business combination and cannot be recogni$ed as an identifiable intangible asset. #n this case, this e0penditure should form part of the amount attributable to goodwill as at the date of acquisition. As a consequence of applying the above criteria, the following costs are e0pensed as they are incurred! F )esearch costs3 F 9reopening costs to open a new facility or business, and plant start-up costs incurred during a period prior to full-scale production or operation, unless these costs are capitali$ed as part of the cost of an item of property, plant, and equipment3 F =rgani$ation costs such as legal and secretarial costs, which are typically incurred in establishing a legal entity3 F "raining costs involved in operating a business or a product line3 F Advertising and related costs3 F )elocation, restructuring, and other costs involved in organi$ing a business or product line3 F 2ustomer lists, brands, mastheads, and publishing titles that are internally generated. "hus, the #A,2 has finally resolved the controversy regarding the potential deferral of costs li e preoperating e0penses. #n the past, many enterprises have been nown to defer setup costs and preoperating costs on the premise that benefits from them flow to the enterprise over future periods as well. :ue to the unequivocal stand ta en by the #A,2 on this contentious issue, enterprises can no longer defer such costs. *urther, by adding the provision relating to annual impairment testing of all internally generated intangible assets being amorti$ed (over a period e0ceeding twenty years), the #A,2 has ensured that all such costs capitali$ed in the past would need to be ad+usted for impairment. "he criteria for recognition of intangible assets as provided in #A, ./ are rather stringent, and many enterprises will find that e0penditures either to acquire or to develop intangible assets will fail the test for capitali$ation. #n such instances, all these costs must be e0pensed currently as incurred. *urthermore, once e0pensed, these costs cannot be resurrected and capitali$ed in a later period, even if the conditions for such treatment are later met. "his is not meant, however, to preclude correction of an error made in an earlier period if the conditions for capitali$ation were met but interpreted incorrectly by the reporting entity at that time.) ,ubsequently #ncurred 2osts Under the provisions of #A, ./, the capitali$ation of any subsequent costs incurred on intangible assets is difficult to +ustify. "his is because the nature of an intangible asset is such that, in many cases, it is not possible to determine whether subsequent costs are li ely to enhance the specific economic benefits that will flow to the enterprise from those assets. "hus, subsequent costs incurred on an intangible asset should be recogni$ed as an e0pense when they are incurred unless %. #t is probable that those costs will enable the asset to generate specifically attributable future economic benefits in e0cess of its assessed standard of performance immediately prior to the incremental e0penditure3 and &. "hose costs can be measured reliably and attributed to the asset reliably.

"hus, if the above two criteria are met, any subsequent e0penditure on an intangible after its purchase or its completion should be capitali$ed along with its cost. "he following e0ample should help to illustrate this point better. ;0ample An enterprise is developing a new product. 2osts incurred by the )K: department in &44. on the @research phaseA amounted to I&44,444. #n &445, technical and commercial feasibility of the product was established. 2osts incurred in &445 were I&4,444 personnel costs and I%J,444 legal fees to register the patent. #n &44J, the enterprise incurred I.4,444 to successfully defend a legal suit to protect the patent. "he enterprise would account for these costs as follows! F )esearch and development costs incurred in &44., amounting to I&44,444, should be e0pensed, as they do not meet the recognition criteria for intangible assets. "he costs do not result in an identifiable asset capable of generating future economic benefits. F 9ersonnel and legal costs incurred in &445, amounting to I.J,444, would be capitali$ed as patents. "he company has established technical and commercial feasibility of the product, as well as obtained control over the use of the asset. "he standard specifically prohibits the reinstatement of costs previously recogni$ed as an e0pense. "hus I&44,444, recogni$ed as an e0pense in the previous financial statements, cannot be reinstated and capitali$ed. F Legal costs of I.4,444 incurred in &44J to defend the enterprise in a patent lawsuit should be e0pensed. Under U, 'AA9, legal fees and other costs incurred in successfully defending a patent lawsuit can be capitali$ed in the patents account, to the e0tent that value is evident, because such costs are incurred to establish the legal rights of the owner of the patent. Bowever, in view of the stringent conditions imposed by #A, ./ concerning the recognition of subsequent costs, the #A,2 seems to be in favor of the conservative approach of e0pensing such costs. =nly such subsequent costs should be capitali$ed which would enable the asset to generate future economic benefits in e0cess of the originally assessed standards of performance. "his represents, in most instances, a very high, possibly insurmountable hurdle. "hus, legal costs incurred in connection with defending the patent, which could be considered as e0penses incurred to maintain the asset at its originally assessed standard of performance, would not meet the recognition criteria under #A, ./. F Alternatively, if the enterprise were to lose the patent lawsuit, then the useful life and the recoverable amount of the intangible asset would be in question. "he enterprise would be required to provide for any impairment loss, and in all probability, even to fully write off the intangible asset. 7hat is required must be determined by the facts of the specific situation. >easurement subsequent to #nitial )ecognition 6enchmar treatment. After initial recognition, an intangible asset should be carried at its cost less any accumulated amorti$ation and any accumulated impairment losses. Allowed alternative treatmentLrevaluation. As with tangible assets under #A, %1, the standard for intangibles permits revaluation subsequent to original acquisition, with the asset being written up to fair value. #nasmuch as most of the particulars of #A, ./ follow #A, %1 to the letter, and were described in detail in 2hapter /, these will not be repeated here. "he unique features of #A, ./ are as follows! %. #f the intangibles were not initially recogni$ed (i.e., they were e0pensed rather than capitali$ed) it would not be possible to later recogni$e them at fair value.

&. :eriving fair value by applying a present value concept to pro+ected cash flows (a technique that can be used in the case of tangible assets under #A, %1) is deemed to be too unreliable in the realm of intangibles, primarily because it would tend to commingle the impact of identifiable assets and goodwill. Accordingly, fair value of an intangible asset should only be determined by reference to an active mar et in that type of intangible asset. Active mar ets providing meaningful data are not e0pected to e0ist for such unique assets as patents and trademar s, and thus it is presumed that revaluation will not be applied to these types of assets in the normal course of business. As a consequence, the #A,2 has effectively restricted revaluation of intangible assets to only freely tradable intangible assets. As with the rules pertaining to plant, property, and equipment under #A, %1, if some intangible assets in a given class are sub+ected to revaluation, all the assets in that class should be consistently accounted for unless fair value information is not or ceases to be available. Also in common with the requirements for tangible fi0ed assets, #A, ./ requires that revaluations be ta en directly to equity through the use of a revaluation surplus account, e0cept to the e0tent that previous impairments had been recogni$ed by a charge against income. ;0ample of revaluation of intangible assets A patent right is acquired Muly %, &44., for I&J4,4443 while it has a legal life of %J years, due to rapidly changing technology, management estimates a useful life of only J years. ,traight-line amorti$ation will be used. At Manuary %, &445, management is uncertain that the process can actually be made economically feasible, and decides to write down the patent to an estimated mar et value of IEJ,444. Amorti$ation will be ta en over . years from that point. =n Manuary %, &441, having perfected the related production process, the asset is now appraised at a sound value of I.44,444. *urthermore, the estimated useful life is now believed to be 1 more years. "he entries to reflect these events are as follows! E(%(4. 9atent &J4,444 2ash, etc. &J4,444 %&(.%(4. Amorti$ation e0pense&J,444 9atent &J,444 %(%(45 Loss from asset impairment %J4,444 9atent %J4,444 %&(.%(45 Amorti$ation e0pense&J,444 9atent &J,444 %&(.%(4J Amorti$ation e0pense&J,444 9atent &J,444 %(%(41 9atent &EJ,444 'ain on asset value recovery %44,444 )evaluation surplus %EJ,444 2ertain of the entries in the foregoing e0ample will be e0plained further. "he entry at year-end &44. is to record amorti$ation based on original cost, since there had been no revaluations through that time3 only a half-year amorti$ation is provided N(I&J4,444(J) 0 OP. =n Manuary %, &445, the impairment is recorded by writing down the asset to the estimated value of IEJ,444, which necessitates a I%J4,444 charge to income (carrying value, I&&J,444, less fair value, IEJ,444).

#n &445 and &44J, amorti$ation must be provided on the new lower value recorded at the beginning of &4453 furthermore, since the new estimated life was . years from Manuary &445, annual amorti$ation will be I&J,444. As of Manuary %, &441, the carrying value of the patent is I&J,4443 had the Manuary &445 revaluation not been made, the carrying value would have been I%&J,444 (I&J4,444 original cost, less &.J years amorti$ation versus an original estimated life of J years). "he new appraised value is I.44,444, which will fully recover the earlier write-down and add even more asset value than the originally recogni$ed cost. Under the guidance of #A, ./, the recovery of I%44,444 that had been charged to e0pense should be ta en into income3 the e0cess will be credited to stoc holders8 equity. :evelopment costs pose a special problem in terms of the application of the allowed alternative method under #A, ./. "he utili$ation of the allowed alternative method of accounting for long-lived intangibles is only permissible when stringent conditions are met concerning the availability of fair value information. #n general, it will not be possible to obtain fair value data from active mar ets, as is required by #A, ./, and this is particularly true with regard to development costs. Accordingly, the e0pectation is that the benchmar (historical cost) method will be almost universally applied for development costs. "he use of the available alternative method for development costs, while theoretically valid, is e0pected to be very unusual in practice. ;0ample of development cost capitali$ation Assume that 2reative, #ncorporated incurs substantial research and development costs for the invention of new products, many of which are brought to mar et successfully. #n particular, 2reative has incurred costs during &44. amounting to IEJ4,444, relative to a new manufacturing process. =f these costs, I144,444 were incurred prior to :ecember %, &44.. As of :ecember .%, the viability of the new process was still not nown, although testing had been conducted on :ecember %. #n fact, results were not conclusively nown until *ebruary %J, &445, after another IEJ,444 in costs were incurred postQManuary %. 2reative, #ncorporated8s financial statements for &44. were issued *ebruary %4, &445, and the full IEJ4,444 in research and development costs were e0pensed, since it was not yet nown whether a portion of these qualified as development costs under #A, ./. 7hen it is learned that feasibility had, in fact, been shown as of :ecember %, 2reative management as s to restore the I%J4,444 of postQ :ecember % costs as a development asset. Under #A, ./ this is prohibited. Bowever, the &445 costs (IEJ,444 thus far) would qualify for capitali$ation, in all li elihood, based on the facts nown. #f, however, it is determined that fair value information derived from active mar ets is indeed available, and the enterprise desires to apply the allowed alternative (revaluation) method of accounting to development costs, then it will be necessary to perform revaluations on a regular basis, such that at any reporting date the carrying amounts are not materially different from the current fair values. *rom a mechanical perspective, the ad+ustment to fair value can be accomplished either by @grossing upA the cost and the accumulated amorti$ation accounts proportionally, or by netting the accumulated amorti$ation, prerevaluation, against the asset account and then restating the asset to the net fair value as of the revaluation date. #n either case, the net effect of the upward revaluation will be recorded in stoc holders8 equity as revaluation surplus3 the only e0ception would be when an upward revaluation is in effect a reversal of a previously recogni$ed impairment which was reported as a charge against earnings or a revaluation decrease (reversal or a yet earlier upward ad+ustment) which was reflected in earnings. "he accounting for revaluations is illustrated as follows! ;0ample of accounting for revaluation of development cost

Assume 6rea through, #nc. has accumulated development costs that meet the criteria for capitali$ation at :ecember .%, &44., amounting to I.-,444. #t is estimated that the useful life of this intangible asset will be 1 years3 accordingly, amorti$ation of I1,J44 per year is anticipated. 6rea through uses the allowed alternative method of accounting for its long-lived tangible and intangible assets. At :ecember .%, &44J, it obtains mar et information regarding the then-current fair value of this intangible asset, which suggests a current fair value of these development costs is I54,4443 the estimated useful life, however, has not changed. "here are two ways to apply #A, ./! the asset and accumulated amorti$ation can be @grossed upA to reflect the new fair value information, or the asset can be restated on a @netA basis. "hese are both illustrated below. *or both illustrations, the boo value (amorti$ed cost) immediately prior to the revaluation is I.-,444 Q (& 0 I1,J44) R I&1,444. "he net upward revaluation is given by the difference between fair value and boo value, or I54,444 Q I&1,444 R I%5,444. #f the @gross upA method is used! ,ince the fair value after & years of the 1-year useful life have already elapsed is found to be I54,444, the gross fair value must be 1(5 0 I54,444 R I14,444. "he entries to record this would be as follows! :evelopment cost (asset) &%,444 Accumulated amorti$ationLdevelopment cost )evaluation surplus (stoc holders8 equity) E,444 %5,444

#f the @nettingA method is used! Under this variant, the accumulated amorti$ation as of the date of the revaluation is eliminated against the asset account, which is then ad+usted to reflect the net fair value. Accumulated amorti$ationLdevelopment cost :evelopment cost (asset) %.,444 :evelopment cost (asset) %5,444 )evaluation surplus (stoc holders8 equity) %.,444 %5,444

Amorti$ation 9eriod As with tangible assets sub+ect to depreciation or depletion, the cost (or revalued carrying amount) of intangible assets is sub+ect to rational and systematic amorti$ation. 'iven that the useful economic life of many intangibles would be difficult to assess, the rule is that a ma0imum twenty-year life is permissible, with amorti$ation being over a shorter useful life if nown. "he only e0ceptions would occur in those instances where the legal right has a life of greater than twenty years and either of the following conditions e0ists! %. "he intangible has an e0istence that is not separable from a specific tangible asset, the useful life of which can be reliably determined to e0ceed twenty years, or &. "here is an active secondary mar et for the intangible. "he thrust of these requirements is to ma e the twenty-year life an upper limit for most intangibles. #f there is persuasive evidence that the useful life of an intangible asset is longer than twenty years, then the twenty-year presumption is rebutted and the enterprise must F Amorti$e the intangible asset over that longer period3 F ;stimate the recoverable amount of the intangible asset at least annually in order to identify any impairment loss3 and F :isclose the reasons why the presumption has been rebutted.

<ote that #A, ./ provides for amorti$ation of all intangible assets3 it does not subscribe to the view that any intangible asset can possess an infinite life. "he thrust of these requirements is to ma e the twenty-year life an upper limit for most intangibles. #f control over the future economic benefits from an intangible asset is achieved through legal rights for a finite period, then the useful life of the intangible asset should not e0ceed the period of legal rights, unless the legal rights are renewable and the renewal is a virtual certainty. "hus, as a practical matter, the shorter legal life will set the upper limit for an amorti$ation period in most cases. "he amorti$ation method used should reflect the pattern in which the economic benefits of the asset are consumed by the enterprise. Amorti$ation should commence when the asset is available for use and the amorti$ation charge for each period should be recogni$ed as an e0pense unless it is included in the carrying amount of another asset (e.g., inventory). #ntangible assets may be amorti$ed by the same systematic and rational methods that are used to depreciate tangible fi0ed assets. "hus, #A, ./ would seemingly permit straight-line, diminishing balance, and units of production methods. #f a method other than straight-line is used, it must accurately mirror the e0piration of the asset8s economic service potential. )esidual Salue "angible assets often have a positive residual value before considering the disposal costs because tangible assets can generally be sold for scrap, or possibly be transferred to another user that has less need for or ability to afford new assets of that type. #ntangibles, on the other hand, lac ing the physical attributes that would ma e scrap value a meaningful concept, often have little or no residual worth. Accordingly, #A, ./ requires that a $ero residual value be presumed unless an accurate measure of residual is possible. "hus, the residual value is presumed to be $ero unless F "here is a commitment by a third party to purchase the asset at the end of its useful life3 or F "here is an active mar et for that type of intangible asset, and residual value can be measured reliably by reference to that mar et and it is probable that such a mar et will e0ist at the end of the useful life. #A, ./, as revised by the consequential changes wrought by the #A,6 #mprovements 9ro+ect, specifies that the residual value of an intangible asset is the estimated net amount that the reporting entity currently e0pects to obtain from disposal of the asset at the end of its useful life, after deducting the estimated costs of disposal, if the asset were of the age and in the condition e0pected at the end of its estimated useful life. #n other words, changes in prices or other variables over the e0pected period of use of the asset are not to be included in the estimated residual value, since this would result in the recognition of estimated holding gains over the life of the asset (via reduced amorti$ation that would be the consequence of a higher estimated residual value). )esidual value is to be assessed at each balance sheet date. Any change to the estimated residual, other than that resulting from impairment (accounted for under #A, .1) is to be accounted for prospectively, only by varying future periodic amorti$ation. ,imilarly, any change in amorti$ation method (e.g., from accelerated to straight-line) is dealt with as a change in estimate, again to be reflected only in future periodic charges for amorti$ation. 9eriodic review of useful life assumptions and amorti$ation methods employed. As for fi0ed assets accounted for in conformity with #A, %1, the newer standard on intangibles suggests that the amorti$ation period be reconsidered at the end of each reporting period, and that the method of amorti$ation also be reviewed at similar intervals. "here is the e0pectation that due to their nature intangibles are more li ely to require revisions

to one or both of these +udgments. #n either case, a change would be accounted for as a change in estimate, affecting current and future periods8 reported earnings but not requiring restatement of previously reported periods. #mpairment Losses #A, ./ has provided that F Amorti$ation of an asset should commence when the asset is available for use3 and F "he amorti$ation period should not e0ceed twenty years, although this presumption is rebuttable. #n view of the above, some enterprises may be tempted to F 2apitali$e intangible assets and defer amorti$ation for long periods on the grounds that the assets are not available for use3 and(or F )ebut the presumption of twenty-year life and amorti$e assets over a longer period. "o combat the ris that either of these strategies might be employed, the standard provides that in addition to the universal provisions of #A, .1 (which require that the recoverable amount of an asset should be estimated when certain indications of impairment e0ist, as described in detail in 2hapter /), #A, ./ requires that an enterprise should estimate the recoverable amount of the following intangible assets at least at each financial year-end even if there is no indication of impairment! %. #ntangible assets that are not yet ready for use3 and &. =ther intangible assets that are amorti$ed over a period e0ceeding twenty years from the date when the asset becomes available for use. Apart from the special case of assets not yet in use, or being amorti$ed over greater than twenty years, the ma+or complication arises in the conte0t of goodwill. Unli e other intangible assets that are individually identifiable, goodwill is amorphous and cannot e0ist, from a financial reporting perspective, apart from the tangible and identifiable intangible assets with which it was acquired. "hus, a direct evaluation of the recoverable amount of goodwill is not actually feasible3 accordingly, the standard requires that goodwill be combined with other assets which together define a cash generating unit, and that an evaluation of any potential impairment (if warranted by the facts and circumstances) be conducted on an aggregate basis. A more detailed consideration of goodwill is presented in 2hapter %%. "he impairment of intangible assets other than goodwill (such as patents, copyrights, trade names, customer lists, and franchise rights) should be considered in precisely the same way that long-lived tangible assets are dealt with. 2arrying amounts must be compared to the greater of net selling price or value in use when there are indications that an impairment may have been suffered. )eversals of impairment losses under defined conditions are also recogni$ed. "he effects of impairment recognitions and reversals will be reflected in current period operating results, if the intangible assets in question are being accounted for in accordance with the benchmar method set forth in #A, ./ (i.e., at historical cost). =n the other hand, if the allowed alternative method (presenting intangible assets at revalued amounts) is followed, impairments will normally be charged to stoc holders8 equity to the e0tent that revaluation surplus e0ists, and only to the e0tent that the loss e0ceeds previously recogni$ed valuation surplus will the impairment loss be reported as a charge against earnings. )ecoveries are handled consistent with the method by which impairments were reported, in a manner entirely analogous to the e0planation earlier in this chapter dealing with impairments of plant, property, and equipment. :isposals of #ntangible Assets

7ith regard to questions of accounting for the disposition of assets, the guidance of #A, ./ virtually mirrors that of #A, %1. 'ain or loss recognition will be for the difference between carrying amount (net, if applicable, of any remaining revaluation surplus) and the net proceeds from the sale. "he amendment to #A, ./ made by the #A,68s #mprovements 9ro+ect observes that a disposal of an intangible asset may result from either a sale of the asset or by entering into a finance lease. "he determination of the date of disposal of the intangible asset is made by applying the criteria in #A, %/ for recogni$ing revenue from the sale of goods, or #A, %E in the case of disposal by a sale and leasebac . As for other similar transactions, the consideration receivable on disposal of an intangible asset is to be recogni$ed initially at fair value. #f payment for such an intangible asset is deferred, the consideration received is recogni$ed initially at the cash price equivalent, with any difference between the nominal amount of the consideration and the cash price equivalent to be recogni$ed as interest revenue under #A, %/, using the effective yield method. 7ebsite :evelopment and =perating 2osts 7ith the advent of the #nternet and growing popularity of @e-commerce,A many businesses now have their own websites. 7ebsites have become integral to doing business and may be designed either for e0ternal or internal access. "hose designed for e0ternal access are developed and maintained for the purposes of promotion and advertising of an entity8s products and services to their potential consumers. =n the other hand, those developed for internal access may be used for displaying company policies and storing customer details. 7ith substantial costs being incurred by many entities for website development and maintenance, the need for accounting guidance became evident. "he recently promulgated interpretation, ,#2 .&, concluded that such costs represent an internally generated intangible asset that is sub+ect to the requirements of #A, ./, and that such costs should be recogni$ed if, and only if, an enterprise can satisfy the requirements of #A, ./, paragraph 5J. "herefore, website costs have been li ened to @development phaseA (as opposed to @research phaseA) costs. "hus the stringent qualifying conditions applicable to the development phase, such as @ability to generate future economic benefits,A have to be met if such costs are to be recogni$ed as an intangible asset. #f an enterprise is not able to demonstrate how a website developed solely or primarily for promoting and advertising its own products and services will generate probable future economic benefits, all e0penditure on developing such a website should be recogni$ed as an e0pense when incurred. Any internal e0penditure on development and operation of the website should be accounted for in accordance with #A, ./. 2omprehensive additional guidance is provided in the Appendi0 to the #nterpretation and is summari$ed below. %. 9lanning stage e0penditures, such as underta ing feasibility studies, defining hardware and software specifications, evaluating alternative products and suppliers, and selecting preferences, should be e0pensed3 &. Application and infrastructure development costs pertaining to acquisition of tangible assets, such as purchasing and developing hardware, should be dealt with in accordance with #A, %13 .. =ther application and infrastructure development costs, such as obtaining a domain name, developing operating software, developing code for the application, installing developed applications on the web server and stress testing, should be e0pensed when incurred unless the conditions prescribed by #A, ./, paragraphs %- and 5J, are met3

5. 'raphical design development costs, such as designing the appearance of web pages, should be e0pensed when incurred unless conditions prescribed by #A, ./, paragraphs %- and 5J, are met3 J. 2ontent development costs, such as creating, purchasing, preparing, and uploading information on the website before completion of the website8s development should be e0pensed when incurred under #A, ./, paragraph JE(c), to the e0tent content is developed to advertise and promote an enterprise8s own products or services3 otherwise, e0pensed when incurred, unless e0penditure meets conditions prescribed by #A, ./, paragraphs %- and 5J3 1. =perating costs, such as updating graphics and revising content, adding new functions, registering website with search engines, bac ing up data, reviewing security access and analy$ing usage of the website should be e0pensed when incurred, unless in rare circumstances these costs meet the criteria prescribed in #A, ./, paragraph 14, in which case such e0penditure is capitali$ed as a cost of the website3 and E. =ther costs, such as selling and administrative overhead (e0cluding e0penditure which can be directly attributed to preparation of website for use), initial operating losses and inefficiencies incurred before the website achieves planned performance, and training costs of employees to operate the website, should be e0pensed when incurred. "his interpretation became effective in >arch &44&. "he effects of adopting this #nterpretation was to be accounted for using the transition provisions originally established by #A, ./. *or instance, when a website does not meet the requirements of this ,#2 but was previously recogni$ed as an asset, the item was to be derecogni$ed at the date when this ,#2 becomes effective. #f previously capitali$ed costs are written off due to the imposition of ,#2 .&, the e0pense may be handled under either the benchmar or alternative treatments specified by #A, /. :isclosure )equirements "he disclosure requirements set out in #A, ./ for intangible assets and those imposed by #A, %1 for property, plant, and equipment are very similar, and both demand e0tensive details to be disclosed in the financial statement footnotes. Another mar ed similarity is the e0emption from disclosing @comparative informationA with respect to the reconciliation of carrying amounts at the beginning and end of the period. 7hile this may be misconstrued as a departure from the well- nown principle of presenting all numerical information in comparative form, it is worth noting that it is in line with the provisions of #A, %. #A, %, paragraph ./, categorically states that @(u)nless an #nternational Accounting ,tandard permits or requires otherwise, comparative information should be disclosed in respect of the previous period for all numerical information in the financial statementsG.A (Another standard that contains a similar e0emption from disclosure of comparative reconciliation information is #A, .ELplease refer to the relevant chapter of the boo for details.) *or each class of intangible assets (distinguishing between internally generated and other intangible assets), disclosure is required of %. "he amorti$ation method(s) used3 &. Useful lives or amorti$ation rates used3 .. "he gross carrying amount and accumulated amorti$ation (including accumulated impairment losses) at both the beginning and end of the period3 5. A reconciliation of the carrying amount at the beginning and end of the period showing additions, retirements, disposals, acquisitions by means of business combinations, increases or decreases resulting from revaluations, reductions to recogni$e impairments, amounts written bac to recogni$e recoveries of prior

impairments, amorti$ation during the period, the net effect of translation of foreign entities8 financial statements, and any other material items3 and J. "he line item of the income statement in which the amorti$ation charge of intangible assets is included. "he standard e0plains the concept of @class of intangible assetsA as a @grouping of assets of similar nature and use in an enterprise8s operations.A ;0amples of intangible assets that could be reported as separate classes (of intangible assets) are %. 6rand names3 &. Licenses and franchises3 .. >astheads and publishing titles3 5. 2omputer software3 J. 2opyrights, patents and other industrial property rights, service and operating right3 1. )ecipes, formulae, models, designs and prototypes3 and E. #ntangible assets under development. "he above list is only illustrative in nature. #ntangible assets may be combined (or disaggregated) to report larger classes (or smaller classes) of intangible assets if this results in more relevant information for financial statement users. #n addition, the financial statements should also disclose the following! %. #f the amorti$ation period for any intangibles e0ceeds twenty years, the +ustification therefor3 &. "he nature, carrying amount, and remaining amorti$ation period of any individual intangible asset that is material to the financial statements of the enterprise as a whole3 .. *or intangible assets acquired by way of a government grant and initially recogni$ed at fair value, the fair value initially recogni$ed, their carrying amount, and whether they are carried under the benchmar or allowed alternative treatment for subsequent measurement3 5. Any restrictions on titles and any assets pledged as security for debt3 and J. "he amount of outstanding commitments for the acquisition of intangible assets. #n addition, the financial statements should disclose the aggregate amount of research and development e0penditure recogni$ed as an e0pense during the period. ;0amples of *inancial ,tatement :isclosures <ovartis A' *or the *iscal Tear ending :ecember .%, &44& <otes to the consolidated financial statements #ntangible assets. "hese are valued at their cost and reviewed periodically and ad+usted for any diminution in value as noted in the preceding paragraph. Any resulting impairment loss is recorded in the income statement in general overheads. #n the case of business combinations, the e0cess of the purchase price over the fair value of net identifiable assets is recorded as goodwill in the balance sheet. 'oodwill, which is denominated in the local currency of the related acquisition, is amorti$ed to income through administration and general overheads on a straight-line basis over its useful life. "he amorti$ation period is determined at the time of the acquisition, based upon the particular circumstances, and ranges from five to twenty years. 'oodwill relating to acquisitions arising prior to Manuary %, %--J, has been fully written off against reserves. >anagement determines the estimated useful life of goodwill based on its evaluation of the respective company at the time of the acquisition, considering factors such as e0isting mar et share, potential sales growth and other factors inherent in the acquired company.

=ther acquired intangible assets are written off on a straight-line basis over the following periods! "rademar s %4 to %J years 9roduct and mar eting rights J to &4 years ,oftware . years =thers . to J years "rademar s are amorti$ed on a straight-line basis over the estimated economic or legal life, whichever is shorter, while the history of the 'roup has been to amorti$e product rights over estimated useful lives of five to twenty years. "he useful lives assigned to acquired product rights are based on the maturity of the products and the estimated economic benefit that such product rights can provide. >ar eting rights are amorti$ed over their useful lives commencing in the year in which the rights first generate sales. -. #ntangible asset movements 'oodwill 9roduct and mar eting rights "rademar s ,oftware =ther intangibles "otals &44& &44% (in 2B* millions) 2ost, Manuary % &,E.1 5,&&& 1%5 /J 2onsolidation changes % -(%%) Additions -.E J% %. J 1J :isposals (E) (1) (1) (1) (%E) "ranslation effects (.--) (..4) (-J) (-) :ecember .% .,&1E .,-./ J%J %&5 E/4

... 5%,4E% (5&) (J/) /,1&5

E,--4 1,J4/ 5JE 5-1 EJ& 1-1 (5&) (/-%) E1 E,--4

Accumulated amorti$ation Manuary % (55&) (JEE) (%.&) (1&) 2onsolidation charges (&4) (J4) Amorti$ation charge (%5%) (&/1) (5%) :isposals . & 1 1 #mpairment charge (.1-) (%4&) (%/) "ranslation effects -5 J. &J :ecember .% (/EJ) (-14) (%1%) (%4-)

(&&-) (%) (%1) &1

(%,55&)(1E/) (5&) (/&) (%-J) (%1) (1E) (JJ%) (J15) 5. 5J (1) (5-J) (&%1) J %/1 (%.) (.5-) (&,5J5)(%,55&)

<et boo valueL:ecember .% &,.-& &,-E/ .J5 %J

5.%

1,%E4 1,J5/

"he principal additions in both years were goodwill on acquisition and in &44% pitavastatin mar eting rights. #n &44&, goodwill impairment charges were recorded of 2B* .1- million mainly related to the 9harmaceuticals division research and biotechnology activities of 'enetic "herapy #nc., ,ystemi0 #nc., #mutran Ltd., due to changes in the research and

development strategy, and relating to the >edical <utrition and ="2 business units. "he ma+ority of the product and mar eting rights impairment related to a 2B* /4 million charge to the pitavastatin rights (&44%! 2B* &%1 million). 6ayer A tingesellschaft Tear ended :ecember .%, &44& N%/P #ntangible assets Acquired intangible assets other than goodwill are recogni$ed at cost and amorti$ed by the straight-line method over a period of four to fifteen years, depending on their estimated useful lives. 7rite-downs are made for impairment losses. Assets are written bac if the reasons for previous years8 write-downs no longer apply. 'oodwill, including that resulting from capital consolidation, is capitali$ed in accordance with #A, && (6usiness 2ombinations) and amorti$ed on a straight-line basis over a ma0imum estimated useful life of twenty years. "he value of goodwill is reassessed regularly based on impairment indicators and written down if necessary. #n compliance with #A, .1 (#mpairment of Assets), such write-downs of goodwill are measured by comparison to the discounted cash flows e0pected to be generated by the assets to which the goodwill can be ascribed. ,elf-created intangible assets generally are not capitali$ed. 2ertain development costs relating to the application development stage of internally developed software are capitali$ed in the 'roup balance sheet. "hese costs are amorti$ed over their useful life from the date they are placed in service. 2hanges in intangible assets in &44& were as follows! Acquired concessions, industrial property rights, similar rights and assets, and licenses thereunder

Acquired goodwill

Advance payments

"otal (U million) 'ross carrying amounts, :ec. .%, &44% J,&54 %,.-- 5& ;0change differences (J&-) (%1.) (5) (1-1) 2hanges in scope of consolidation & E -Acquisitions .,4JE &,&1E -J,.&5 2apital e0penditures .1. -E& 5.J )etirements (&5-) (&45) (%.) (511) "ransfers .-- (.-) -'ross carrying amounts, :ec. .%, &44& E,-&. .,.41 J/ Accumulated amorti$ation and write-downs, :ec. .%, &44% %,&5. 5&5 1,1/%

%%,&/E

-%,11E ;0change differences (%5-) (5.) -(%-&) 2hanges in scope of consolidation ----Amorti$ation and write-downs in &44& %,4J/ &4J -of which write-downs(&5-) (%%) (--) (&14) 7rite-bac s ----)etirements (%/1) (%55) -(..4) "ransfers --- --Accumulated amorti$ation and write-downs, :ec. .%, &44& %,-11 55& -&,54/ <et carrying amounts, :ec. .%, &44& J,-JE &,/15 J/ <et carrying amounts, :ec. .%, &44% .,--E -EJ 5&

%,&1.

/,/EJ,4%5

"he e0change differences are the differences between the carrying amounts at the beginning and the end of the year that result from translating foreign companies8 figures at the respective different e0change rates and changes in their assets during the year at the average rate for the year. #n &44&, as required by the newly implemented ,*A, %5&, the 'roup ceased amorti$ation of its goodwill recorded under #A,, its indefinite-lived intangible asset, the 6ayer @2rossA and the pre-%--J goodwill recogni$ed for U, 'AA9 purposes. "he ad+ustment reverses the amorti$ation recorded under #A, for the 'roup8s #A, goodwill of U%% million. #n-process research and development #A, does not consider that in-process research and development (#9)K:) is an intangible asset that can be separated from goodwill. Under U, 'AA9 it is considered to be a separate asset that needs to be written off immediately following an acquisition as the feasibility of the acquired research and development has not been fully tested and the technology has no alternative future use. :uring &44&, #9)K: has been identified for U, 'AA9 purposes in connection with the Aventis 2rop,cience and Sisible 'enetics acquisitions. *air value determinations were used to establish U%.. million of #9)K: for both acquisitions, which was e0pensed immediately. "he independent appraisers used a discounted cash flow approach and relied upon information provided by 'roup management. "he discounted cash flow approach uses the e0pected future net cash flows, discounted to their present value, to determine an asset8s current fair value. As a whole, the income boo ed for the reversal of the amorti$ation of #9)K: recorded under #A, as a component of other operating e0pense and selling e0pense amounted to UJ million in &44&.