ACC/ACF3100 Advanced Financial Accounting

Lecture 4

Intangibles

Department of Accounting
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Minimum Readings

Deegan 8th Ed: Chapter 8

AASB138 Intangible Assets

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 Learning Objectives
At the end of this lecture you should be able to:
1. Define an intangible asset and discuss its characteristics.
2. Understand the recognition issues and subsequent
measurement (revaluation, amortisation, impairment) for
intangibles as per AASB 138.
3. Differentiate and account for research and development
expenditure.
4. Understand accounting for intangibles as a controversial
issue with significant impacts on the capital markets.

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Asset Definition vs Intangible Assets Definition
The Conceptual Framework definition of an asset:
A resource controlled by the entity as a result of past
events from which the future economic benefits are
expected to flow to the entity.

AASB 138 Intangible Assets defines intangible asset:

An identifiable non-monetary asset without physical
substance. (para 8)
Examples: Patents, copyrights, trademarks, brand names,
contracts, business processes and systems
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 The Conceptual Framework does not define any
differences between assets.

It does not specify that identifiability (separability),

tangibility, and existence of markets for the asset are
relevant in the decision about whether to record and
report an asset.

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 Intangibles Definition

Identifiable
Identifiability creates barriers to recognition in financial
statements. It is a test of:
Separability: The capacity of being separated from the
entity and sold, transferred, licensed, rented or exchanged.

Contractual or other legal rights: to demonstrate control

over the asset.

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 Intangibles - Definition
Non-monetary

Monetary assets: Money, or assets to be received in fixed or

determinable amounts of money.
Intangibles are not financial assets.
Future economics benefits associated with intangibles are
often not fixed or determinable.

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 Intangibles - Definition

Without physical substance

Something that is incapable of being touched.

Tangibility is not an essential attribute of an asset under

the CF.

Existence of intangibles is only demonstrable by observing

the economic transactions.

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 Intangibles - Importance
Increasing business expenditure on intangibles

BUT by and of themselves neither create value or

generate growth

Intangibles need support and enhancement systems to

create value

Without support loses value very quickly

Far quicker than the value of tangible assets

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 AASB 138 Intangible Assets 1 Jan 2005

Para 63

Internally generated brands, mastheads, publishing

titles, consumer lists and items similar in substance
shall not be recognised

Therefore only purchased Intangibles can be recorded on a

Balance Sheet. Why?

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 Intangibles Dot com crash

Dot-com bubble 1995-2000

Internet boom
During 1999 and early 2000 the US Federal Reserve
increased interest rates six times
Economy began to lose speed
Dot-com bubble burst Friday 10 March 2000
Stock market crash 2000-2002 $5 trillion loss in market
value
Worldcom illegal accounting practices

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 Intangibles Do they matter?
Survey of ASX 200 conducted by PWC during 2005
51% of market capitalisation unexplained by balance sheets (%
too high?)

Sectors with smallest difference

Consumer Staples & Discretionary
Sectors with largest difference
Telecommunications
Information Technology
Energy
Metals & Mining

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 Intangibles IFRS impact

Shrinking Balance Sheets

EY predicted $40Bn wipe out off value of intangibles by

Australian companies
Coca-Cola wrote-off $1.9Bn of internally generated
intangible assets (bottlers agreements) to comply with
IFRS
Fosters wrote-off $1.2Bn (brand names & mailing lists)

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 Intangibles Accounting Treatment

Intangible Assets treat like any other assets?

Resources controlled by the entity

As a result of a past event
From which future economic benefits are expected to flow
Now recognition criteria.
Not necessarily probable that FEBs will eventuate?
Difficult to measure reliably?

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 Intangibles Accounting Treatment

However, when these intangibles are purchased the

recognition criteria are met

In an arms length transaction

Payment would not be made if FEBs not considered

probable
Two knowledgeable, willing parties have negotiated a price
and would only settle on this price if it was the fair value

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 Intangibles - Recognition Issues
Initial
Recognition Measurement

Internally Generally: Not capitalized (e.g., customer list, Expensed

generated mastheads) Not recognized on
intangibles Not separable a Balance Sheet
Recognition criteria of assets hardly satisfied

Expenditures to build a brand name are immediately

expensed.

Internally developed research costs are expensed.

Exception: Development expenditure (discussed

later), and exploration and evaluation costs (see
AASB 6).

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 Intangibles - Recognition Issues
Recognition Initial Measurement

Externally Acquired Can be capitalised Cost AASB138 Para 24

acquired separately If Separable - Para 12 =Purchase price + tax +
intangibles Tends to satisfy asset direct cost (legal, consulting,
recognition tests registration etc)
Acquired
through
business Cost
combination =Fair value at acquisition
date

Goodwill purchased through Cost

business combination =Acquisition cost less FV of
net asset of acquired entity
AASB3

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 Intangibles -Subsequent Measurement

Issue 1: Policy choice

Cost model or
Revaluation model

Issue 2: Consumption of future economic benefits

Systematic allocation
(eg depreciation/amortisation)
Impairment

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 Intangibles -Subsequent Measurement

On Issue 1, AASB138 stipulates

Elect either cost or revaluation provided there is an active
market (AASB138.72)

Cost Model (AASB138.74)

CA = Cost less Accumulated Amortisation and
Accumulated Impairment Losses

Revaluation Model (AASB138.75)

CA = FV less Accumulated Amortisation and Accumulated
Impairment Losses

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 Intangibles -Subsequent Measurement

Cost Model
Cost comprises:
Purchase price, import duties and any other costs directly
attributable to the cost of preparing the asset for intended
use
Discounts and rebates are deducted from cost

AASB138 Para 65 prohibits the expense and reinstate

method.

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 Intangibles -Subsequent Measurement
Revaluation Model
FV needs active market AASB138 Para 78
AASB 13 Appendix A Defined Terms
active market A market in which transactions for the asset
...take place with sufficient frequency and volume to
provide pricing information on an ongoing basis.
Para 78 An active market cannot exist for brands,
newspaper mastheads, music and film publishing rights,
patents or trademarks.
Exceptions: transferable taxi licences, fishing licences and
production quotas
Effectively, AASB138 rules out the revaluation of intangible
assets.
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 Quiz: Does an active market exist for the following intangibles?

Brand Franchise Newspaper masthead

Fishing Licence Trademark

Patent 22
 Intangibles -Subsequent Measurement

On Issue 2, AASB138 stipulates

Regardless of cost or revaluation model both amortisation
and impairment must be considered
Assess useful life Para.88
Finite
Indefinite (no foreseeable limit, not the same as infinite)

Where this life arises from a contract, useful life may

be shorter but not longer than the contractual term
(unless renewal is possible without significant cost
Para 94)

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 Intangibles -Subsequent Measurement

Finite useful lives AASB138 Para 97

Depreciable amount amortised systematically over the

useful life

Reflecting the pattern of FEB, or

On a straight line basis
From the date the asset is available for use
Until classified as held for sale (AASB 5) or derecognized
So Depreciable amount = Cost or other amount less
residual value
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 Intangibles -Subsequent Measurement

Residual Value AASB138 Para 100

Assume zero unless

Commitment to purchase by 3rd party OR

Active market AND

This market facilitates reliable measurement of residual

value
Probable that the market will exist at end of useful life

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 Intangibles -Subsequent Measurement

Review Amortisation Period and Amortisation Method

AASB138 Para 104

Review annually

Revise accordingly as a change in estimate under AASB108

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 Intangibles -Subsequent Measurement

Indefinite Useful Lives

An intangible asset with an indefinite useful life shall not be

amortised AASB138 Para 107

Review useful life each period and revise accordingly as a

change in estimate under AASB108 if necessary

Impairment test annually

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Quiz: Do we amortise the following intangibles?
Useful life Amortised?
finite or
indefinite?

Acquired customer list

Expecting future economic benefits for at
least 1 year but no more than 4 years

Acquired copyright
Remaining legal life of 40 years
Market trends shows only 25 more years of
future economic benefits

Airline route authority between MEL and SYD

Expires in 3 years, renewable every four
years

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 Lecture Illustrative Example 1
The following are transactions incurred by Ben Ltd:

A brand was purchased with cash for $2.6 million on 1 July 2015. The
company estimates that the future benefits from this asset will be generated
indefinitely.

Ben Ltds customer base increased by 30% during the financial year.

A patent was acquired with cash for $800,000 on 1 July 2015. Patent Law
indicates the patent is legally valid for 10 years. Ben Ltd expects to hold the
patent for 8 years.

Required:
(a) Explain the accounting treatment for the brand name, customer base and
patent with respect to AASB138 Intangible Assets for both initial and
subsequent measurement and recognition.
(b) Provide the journal entries to record the patent for the year ending 30 June
2016. 29
Solution to Illustrative Example 1(a)
Initial recognition and Subsequent measurement
measurement
Brand No active market, cannot be
Recognised as an asset
name revalued
at costexternally
acquired Not amortized due to indefinite life
Subject to impairment testing
(impaired if CA>RA)

Customer No transaction internally

base generated, cannot be N/A
reliably measured

Patent Recognised as an asset No active market, cannot be

at costexternally revalued
acquired Amortized due to finite life over 8
years (straight line) based on
mgms best estimate
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Solution to Illustrative Example 1(b)

1 July 2015 To record patent acquisition

Dr Patent $800,000
Cr Cash $800,000

30 June 2016 To record patent amortisation expense

Dr Amortisation expense 800k/8=$100,000
Cr Accumulated amortisation $100,000

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 Research and Development Expenditures
Research Development
Original and planned investigation undertaken Application of research findings or other
with the prospect of gaining new scientific or knowledge to a plan or design for the production
technical knowledge and understanding. of new or substantially improved materials,
devices, products, processes, systems or
services before the start of commercial
production or use.

Examples (see AASB138 Para 56): Examples (seeAASB138 Para 59):

Activities aimed at obtaining new Design and testing of a pre-production
knowledge prototype
Searching for alternatives for materials, Design of tools, moulds and dies involved in
processes new technology

Expenditure on research shall be recognised All six conditions must be satisfied before
as an expense (AASB138 Para 54). development costs can be capitalised
(AASB138 Para 57)
Cannot suitably demonstrate that it will at
this stage generate future economic Reliable measurement
benefits.
Adequate resources
Technical feasibility
Probable future economic benefits
Ability to use or sell
Intention to complete 32
 Lecture Illustrative Example 2:
Research and Development
Monash Solutions Ltd has been involved in a research
project in 2015, the following related to the expenditure:
Research phase $30,000
Development phase $400,000

A successful product had been developed from the project

and the manager estimates that the future revenue to be
earned from the product will be $360,000 over the next six
years.
How should Monash Solutions account for the above
expenditure?

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 Solution to Illustrative Example 2
1. Write off research expense as incurred:
Dr Research expense 30,000
Cr Cash 30,000

2. Capitalised development cost assuming all six conditions are satisfied:

Dr Deferred Development Cost (Asset) 400,000
Cr Cash 400,000

3. Impairment recognition:
Dr Impairment loss 400k-360k=40,000
Cr Accumulated impairment- Deferred Development Cost (Asset) 40,000

4. Amortisation of development costs:

Dr Amortisation for deferred development cost 360k/6=60,000
Cr Accumulated amortisation- Deferred Development Cost (Asset) 60,000
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 Lecture Illustrative Example 3

Deegan 8th Ed Chapter 8

Innovator Ltd incurred expenditure researching and

developing a cure for a common disease found in turnips. At
the end of 2017 management determined that the research
and development project was unlikely to succeed because
trials of the prototype had been unsuccessful.

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During 2018 a breakthrough in agricultural science improved
chances of the product succeeding and development
resumed. The project was completed in 2018. At the end of
2018 costs incurred on the project were expected to be
recoverable. Innovator expects that 10% of the project
revenue will be received in 2019, 20% in 2020, 30% in 2021,
30% in 2022 and 10% in 2023. After five years the product
will be at the end of its useful life because the disease found
in turnips will have been eradicated. Costs incurred were as
follows:
Research Development
($000) ($000)
2017 40 10
2018 12 60 36
 Required:

a) How much research expenditure and development expenditure

should be recognised as an expense in 2017?
b) How much research and development expenditure should be
recognised as an expense in 2018?
c) State how much expenditure should be carried forward (deferred)
and reported in the balance sheet at the end of 2017 and 2018.
d) Prepare journal entries for the amortisation of deferred costs in 2019
and 2020, assuming that actual revenues are as expected.
e) Assume that after charging amortisation based on sales revenue at
the end of 2021 the discounted net cash flows expected to be
generated from the deferred expenditure were estimated as
$15,000. Prepare any journal entries required to account for this
information.

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 Solution to Illustrative Example 3

Required:
(a) How much research expenditure and development expenditure should be
recognised as an expense in 2017?

$50,000 to be expensed
= $40,000 research expenditure must be expensed
+ $10,000 development expenditure (unsuccessful prototype, not expecting feb)

(b) How much research and development expenditure should be recognised as

an expense in 2018?

$12,000 research expenditure must be expensed.

(c) State how much expenditure should be carried forward (deferred) and
reported in the balance sheet at the end of 2017 and 2018.

2017: $nil

2018: $60,000

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 Solution to Illustrative Example 3 (continued)

(d) Prepare journal entries for the amortisation of deferred costs in 2019 and
2020, assuming that actual revenues are as expected.

2019 Dr Development expense 60,000*10% $6,000

Cr Accumulated Amort. - Deferred Development Costs $6,000
(Amortisation of deferred developments coststurnip project)

2020 Dr Development expense 60,000*20% 12,000

Cr Accumulated Amort. - Deferred Development Costs $12,000
(Amortisation of deferred developments coststurnip project)

2019 ($000) 2020 ($000)

Deferred development cost 60 60
Accumulated amortisation 6 18=(6+12)
Carrying amount 54 42

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 Solution to Illustrative Example 3 (continued)

(e) Assume that after charging amortisation based on sales revenue at the end
of 2021 the discounted net cash flows expected to be generated from the
deferred expenditure were estimated as $15,000. Prepare any journal entries
required to account for this information.

Carrying amount after amortization in 2021

=$60m-$6m 10% (2019)-$12m 20% (2020)-$18m 30%(2021)=$24m
Recoverable amount $15m
Carrying amount>recoverable amount: therefore recognize an impairment loss and
write the asset down to recoverable amount

2021 Dr Impairment Loss $9m

Cr Accumulated Impairment - Deferred Development Costs $9m
(Impairment of deferred developments coststurnip project)

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 Prescribed Article
Mitrione, L., Tanewski, G., & Birt, J. (2014). The relevance
to firm valuation of research and development
expenditure in the Australian health-care industry.
Australian Journal of Management, 39(3), 425452.

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 Prescribed Article

Purpose
Investigate the value relevance (i.e. information useful for
decision making) of R&D expenditure in the Australian
health care sector following the adoption of IAS 38
(AASB138)
Why are we reading this article?
Linked to intangible assets (R&D), qualitative
characteristics of information, agency theory.
This article provides insights to regulators (e.g., the AASB,
the IASB) in policy making relating to R&D reporting.
Positive Research
Sample:186 Australian health-care firms (20062009)
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Major findings:

Expensed R&D is negatively related to share price (low probability of

future economic benefits)
Expect capitalised R&D to be positively related to share price (high
probability of future economic benefits) however this relationship is
not significant Possibly, investors associate that with managerial
manipulations?
Investors perceive both capitalised and expensed R&D expenditure
reported under the new standard is more useful for decision-making
compared to the old standard due to stricter requirements.
Investors value capitalized and expensed R&D costs differently
according to whether the firms are profit-making or loss-making.
E.g., For loss making firms that have R&D: Both expensed and
capitalised R&D are positively related to share prices Investors view
that the losses driven by R&D are just temporary.

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 Accounting for Intangibles as a Controversial
Issue

Differential accounting treatment for Intangibles is criticised

Understatement of assets because internally generated
Intangibles are not recognised.
Implications on agency relationship?

Companies with significant investment in Intangible items are

likely to be undervalued.
Create a significant difference between a companys book
and market value.
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 Accounting for Intangibles as a Controversial
Issue

It reduces the information content of financial statements.

Ongoing tension between the reporting of relevant and

faithfully represented information.
Research evidence shows that information about
investments in intangibles and the outcomes of this
investment such as patents is highly relevant to
investors.

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Disclosure Requirements For Intangible Assets
General requirements:
(a) Each class of intangible asset, distinguishing between
internally generated and other intangible assets.
(b) Where useful lives are indefinite and finite. If finite the
useful lives or amortisation rates and the methods used.
(c) Opening and closing amounts for accumulated
amortisation, impairments, revaluations and movements in
income statement line items e.g. amortisation expense
(d) Where intangible assets are measured after acquisition
using revaluation models, full details of revaluations.
Opening and closing balances and reconciliations.
Significant assumptions in determining fair values.
Para 118
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Disclosure Requirements For Intangible Assets

For Research & Development:

The Standard specifically requires the entity to disclose the
aggregate amount of research and development recognised
as expenditure during the period. Para 126

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