Chapter 22

Substantive Test of Intangible Assets,

Prepaid Expenses and Deferred
Charges
 LEARNING OBJECTIVES:

After studying this chapter, you should be able to:

1. Identify the audit objectives for intangible assets, prepaid expenses, and deferred charges.
2. Explain the primary substantive audit procedures for intangible assets, prepaid expenses, and
deferred charges.
3. Identify assertions addressed by audit procedures for intangible assets, prepaid expenses, and
deferred charges.

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INTRODUCTION
• PAS 38 Intangible Asset and other relevant PFRS
- The requirement of this standard must be considered by the auditor when designing the audit
procedures to check the appropriateness of valuation and disclosure of intangible assets and
goodwill.
Identifiable Intangible Assets – e.g franchises, patents, copyrights, trademarks & etc.
Unidentifiable Intangible Assets – e.g goodwill

• Prepaid expenses and deferred charges

- The entity may pay in advance an item that can be used or can benefit more than one accounting
period, therefore the auditor should check the propriety of the amounts reported (as prepaid
asset and as current expense).

Intangible Assets, Prepaid Expenses and Deferred Charges – Income Statement

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Audit Objectives
When auditing intangible assets, prepaid expenses and deferred charges the
principal objective for the substantive tests is to determine the following:

Primary Assertion Category

Existence or Occurrence
Completeness
Valuation and Allocation
Rights and Obligations
Presentation and Disclosure

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Audit procedures for Intangible
Assets, Prepaid Expenses and
Deferred Charges

Typically include the following:

1. Analyzing and examining evidence of valuation of intangible assets, and

2. Verifying existence and valuation of prepaid expenses and deferred charges.

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Analyze and Examine
Evidence of Valuation of
Intangibles

Primary Audit Objectives:

Existence or Occurrence
Rights
Accuracy
Valuation and Allocation
Presentation and Disclosure

The auditor must obtain a schedule of

intangibles, including goodwill, and test the
bases on which additions, amortization,
impairments, and disposals are recorded.

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Verifying existence and
valuation of prepaid expenses
and deferred charges

Primary Audit Objectives:

Existence or Occurrence
Valuation and Allocation

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Special Audit Consideration for Goodwill

When auditing reported goodwill, the auditor would need an independent

appraiser to value the consideration transferred by the acquiring company against
the net asset acquired of the acquiree to check the appropriateness of the amount
reported as goodwill.

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Chapter 23
LEARNING
OBJECTIVES:
After studying this chapter, you should be able to:

1. Describe the three critical attributes of an intangible

asset.
2. Identify the different types of intangible asset.
3. Describe the initial recognition, initial measurement,
subsequent measurement, derecognition and
financial presentation of intangible asset.
4. Differentiate intangible asset under full PFRS and
PFRS for SME.
5. Calculate the correct amount of intangibles and its
related accounts.

Add a footer 10
 FR

Intangible Asset is an identifiable non-monetary asset without physical substance.

Three critical attributes of an intangible asset:

1. Identifiability
2. Control
3. Future economic benefits

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 Examples of possible intangible asset

Marketing-Related Customer-Related Artistic-Related Contract-Based Technology-Based

Intangibles Intangibles Intangibles Intangibles Intangibles

1. Brand name 1. Customer lists Ownership rights • Franchise • Patent

2. Internet 2. Order or to: • Licensing • Trade secrets
domain name production • Plays agreements
3. Newspaper backlogs • Literary works • Construction
mastheads 3. Customer • Musical works permits
4. Noncompetitio relationship • Pictures • Broadcast
n agreements • Photographs, rights
and • Service or
• Video supply
contracts
 FR
INITIAL
RECOGNITION
PAS 38 requires an entity to recognize an intangible asset if, and only if:

a. It meets the definition of an intangible asset.

b. It is probable that future economic benefits that are attributable to the asset
will flow to the entity; and
c. The cost of the asset can be measured reliably.

Internally Generated Intangible Asset – Additional recognition criteria (PAS 38)

The probability of future economic benefits must be based on the reasonable and
supportable assumptions about conditions that will exist over the life of the asset.

Recognition criteria not met. The expenditure of this item is to be recognized as an

expense when it is incurred.

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 FR
INITIAL
MEASUREMENT
Initially measured at COST.
Cost – is the amount of cash or cash equivalents paid or the fair value of other consideration given
up to acquire an asset at the time of its acquisition or construction, or when applicable, the amount
attributed to that asset when initially recognized in accordance with the specific requirements of
other PFRS.

Intangibles can be acquired:

1. By separate purchase
2. As part of a business combination
3. By government grant
4. By exchange of assets
5. By self-creation

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 Intangibles can be COST
acquired through:
By separate purchase Amount paid + Directly attributable costs
As part of a business Fair value at acquisition date
combination
By government grant Fair value or Nominal amount + Directly attributable costs
By exchange of assets • With commercial substance – fair value of the asset given up or the
asset received
• No commercial substance – carrying value of asset given up
By self-creation (internal Classification:
1. Research phase – expenditures incurred during this phase of a project are
generation) expensed.
2. Development phase - expenditures incurred during this phase is capitalized
only if all are demonstrated by the entity:
1. Technical feasibility of completing the asset to be used/sold.
2. Intention to complete the asset to use/sell it.
3. Ability to use or sell.
4. Probable future economic benefits.
5. Adequate technical, financial, and other resources
6. Measure reliably the expenditure attributable to the asset during its
development.
 FR
Research and Development
Cost
Research – is original and planned investigation undertaken with the prospect of gaining scientific or
technical knowledge and understanding.

Development – is the application of research findings or other knowledge to a plan or design for the
production of new substantially improve material, device, product, process, system, or service, prior
to the commencement of commercial production.

Note
PPE or Intangible Assets acquired:
• No alternative future use – charged to research and development expense
• Have alternative future use – depreciation or amortization shall be charged
to research and development expense

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 FR

Unable to distinguish research phase from

development phase:
The entity treats the expenditure for that project as if it were
incurred in the research phase only.

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Costs that might be capitalized
Only those costs that have been incurred from
the date when the recognition criteria were first
met can be capitalized (earlier expenses – not
included); these are the costs which are directly
attributable to creating, producing, and preparing
the asset for its intended use:
1. Materials used and services consumed.
2. Employee benefits arising from the generation
of the intangible asset.
3. Other attributable costs, such as fees to
register a legal right.
4. Amortization of patents and licenses used to
generate the asset.
5. Borrowing costs capitalized under PAS 23.
FR
Costs that are expensed
These include:
1. Selling, administrative, and other general overhead
expenditure, unless it can be directly attributed to
preparing the asset for use.
2. Identified inefficiencies and initial operating losses
incurred before an asset achieves planned
performance.
3. Expenditure on staff training to operate the asset.
4. Legal and secretarial costs of establishing a new
entity.
5. Expenditure on opening a new facility or business
(pre-opening costs)
6. Expenditures on starting new operations or
launching new products or processes (pre-operating
costs)
7. Costs written off in earlier periods
8. Advertising and promotional costs
9. Relocation or reorganization costs
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 FR

Initial recognition: In-process research and development acquired in a business combination

• Recognized as an asset at cost, even if a component is research.

• Subsequent expenditure – accounted for as any other research and development cost (expensed
except to the extent that the expenditure satisfies the criteria in PAS 38for recognizing such
expenditure as an intangible asset).

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 Subsequent
Measurement

Subsequent Expenditures
Subsequent expenditure incurred on intangible asset shall be expensed unless the following criteria are met:
1. It is probable that future economic benefits that are attributable to the subsequent expenditure will flow to
the entity and;
2. The subsequent expenditure can be measured reliably.

Cost Model Revaluation Model

 Cost Model Revaluation Model
Revalued amount:
Fair value less any subsequent amortization and
Cost less any amortization and impairment losses impairment losses (only if fv can be determined
by reference to an active market).

Intangible Amortization? Possible

asset Impairment?
Finite lives Yes Yes
Infinite Lives No Yes

If the revalued intangible asset has a finite life and is

therefore amortized, the revalued amount is amortized

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 Amortization

Amortization Period
• Shall begin when the asset is available for use and shall cease earlier of the date the asset is
classified as held for sale.

Amortization Method
Amortization method shall reflect the pattern in which the asset’s future economic benefits are
expected to be consumed by the entity, if this cannot be determined reliably – straight-line
method shall be used.
Journal entry: this is recognized each period in profit or loss
Amortization xx unless another standard requires it to be included
in the carrying amount of another asset
Acc. Amortization xx

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Revenue Based Amortization

There is a rebuttable presumption that an amortization method that is based on the revenue
generated by an activity that includes the use of an intangible asset is inappropriate.
This presumption can be overcome only in limited circumstances:
1. In which the intangible asset is expressed ass a measure of revenue; or
2. When it can be demonstrated that revenue and the consumption of the economic benefits of
the intangible asset is highly correlated

Predominant Limiting Factor

An entity should choose the predominant limiting factor inherent in the intangible asset..

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Revenue Method
It is used when the predominant limiting factor that is inherent in an intangible asset is the
achievement of a revenue threshold.

Residual Value
Intangible assets with finite useful life assumed to have a zero residual value unless:
• There is a commitment by a third party to purchase the asset at the end of its useful life; or
• There is an active market for the asset and;
1. Residual value can be determined by reference to that market; and
2. It is probable that such a market will exist at the end of the asset’s useful life.

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 Patent
-is an exclusive right granted by the government giving the holder thereof to exclusively use,
manufacture and sell a product or process for a period of 20 years without the interference or
infringement by others.

Cost of Patent
• When purchased – purchase price + directly attributable costs
• Internally developed – Licensing and other related legal fees in securing the patent rights

Cost that are expensed as incurred

1. Research and development costs
2. Legal fees and other costs of successfully prosecuting or defending a patent.
3. Legal fees and other costs of unsuccessfully prosecuting or defending a patent.

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Amortization
a. Original cost / Legal life or Useful Life (whichever is SHORTER)
b. Competitive patent was acquired. Old patent should be amortized over its remaining
life.
c. Related patent
1. Extension of Life
2. No Extension of Life

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 Copyright
-is an exclusive right granted by the government to the author, composer or artist enabling him to
publish, sell or otherwise benefit from his literary, musical or artistic work.

This right lasts during the life of the author and 50 years after his death.

Cost of copyright
1. Developed copyright – all expenses incurred in the production of the work
2. Purchased – cost paid + incidental costs

Amortization
Amortization is should be based on the copyright’s useful life. Or to directly write off the cost of the
copyright against revenue of the first printing.

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 Franchise
-is an agreement in which one party called the franchisor grants certain rights to another party called
franchisee.

Franchise Cost
1. Initial franchise fee – Lump sum payment for acquisition + all legal fees and expenses
2. Continuing (periodic) franchise fee – continues payment to franchisor for providing specific future
services

Amortization
a. Granted for a definite period – amortize over the useful life or definite period whichever is shorter.
b. Granted indefinitely – not amortized but tested for impairment (at least annually).

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 Leasehold or Lease Right
-is an right acquired by the lessee by virtue of a contract of lease to use the specific property owned
by the lessor for a definite period of time in consideration for a certain sum in money.

Cost of leasehold Accounting Treatment

a. Lump sum payment at the first negotiation of Leasehold account or prepaid rent and amortize it
the lease over the lease term
b. Amount paid in obtaining an assignment of Leasehold account
lease from the original lessee
c. Periodic payments in the form of rental Expense (lessee), income (lessor)

Amortization of leasehold: over the lease term

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 Leasehold Improvement
-are improvements or modifications on a leased property. This is considered as PPE. Upon
termination of the lease, such improvements normally become the property of the lessor without any
cost or obligation.

Depreciation
Depreciated over lease term or its useful life whichever is shorter. If the lease is terminated prior to
the agreed term – unamortized cost is considered as loss.

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 Trademark
Mark – is any visible sign capable of distinguishing the goods or services of an enterprise and shall
include a stamped or marked container of goods.

Trade name – means the name or design identifying r distinguishing an enterprise.

Cost of trademark
a. When purchased – purchased price + directly attributable cost
b. Internally developed – expenditures required to establish it

Note: Legal fees and other costs of successfully prosecuting the trademark is an outright
expense.

Amortization
Not amortized but subject to test for impairment at least annually.
Legal life – 10 years and may be renewed for periods of 10 years each.
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 Customer List
-is a database that includes names, contact information, order history, and demographic information
for a list of customers.

Cost of customer list

a. When purchased – purchase price + directly attributable costs
b. Internally developed – cost shall be expensed, until technological feasibility is established.
Capitalizable costs – cost of coding and testing and cost to produce the product masters.

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 Goodwill
-Asset arising from the excess of the consideration transferred over the fair value of the net assets
acquired.

Recognition of goodwill
Purchased Goodwill is the goodwill that arises from business combination and therefore recognized.

Measurement of Goodwill
Indirect valuation approach Direct valuation or excess of earnings
approach

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 Indirect valuation approach

Measured by:
Excess of cost of investment / FV of the net tangible assets acquired (PFRS 3)

Direct valuation or excess of earnings approach

This approach can be used to determine the reasonableness of the amount of the purchase price.
(Refer to the book for procedural approach)

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Non-amortization of Goodwill

Goodwill shall only be tested for impairment at least annually or more frequent.

Gain on Bargain Purchase (Negative Goodwill – as previously called)

When the acquirer’s interest in the net fair value of the identifiable net assets acquired exceeds the cost of the
business combination, the acquirer shall:
1. Reassess whether it has correctly identified all of the assets acquired and all of the liabilities assumed and
shall recognize any additional assets or liabilities that are identified in that view.
2. If that excess remains, the acquirer shall recognize the resulting gain in profit or loss on the acquisition date.
The gain shall be attributed to the acquirer.

Return on Average Net Assets

Procedures would be as follows:

1. Compute for average assets by totaling the total net assets for certain number of periods.
2. Get average net assets by: Total net assets / number of periods
3. Then, normal earnings: Average net assets x normal rate of return

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Intangible asset shall be derecognized or eliminated from the
statement of financial position :
a. On disposal of the asset
b. When no future economic benefits are expected from its use and
disposal. Derecognition
Gain or Loss on derecognition
= Net disposal proceeds – carrying amount (when derecognized)
The gain or loss is recognized in income statement as gains in profit
or loss and not as revenue.
Financial Statement Presentation

Presented as one line – “Intangible Assets” on the non-current section of Financial Position
For Goodwill:
a. As a separate line item under heading “Goodwill” or
b. If included in intangible assets, heading would be “Intangible Assets, including Goodwill”

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Additional Notes on PFRS for SMEs
Initial Recognition:
Does not recognize internally generated intangible assets
Research and development cost incurred is expensed immediately

Initial Measurement
Cost + Directly attributable cost

Subsequent Measurement
Use cost model.
All intangible assets including goodwill are amortized over their estimated useful life, if not reliably
measured it is identified by management.

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