IAS 38 Made Simple: Recognition of Intangible Assets for ACCA DipIFR Students

1. IAS 38 Made Simple: Recognition of Intangible Assets for ACCA DipIFR Students Background In previous blog we had seen what property, plant and equipment (PPE) is and its recognition and initial measurement principles under International Financial Reporting Standards (IFRS) as per IAS 16 – PPE. In this blog we will understand accounting for an equally important resource or asset for a business, however, which does not have physical substance, called as intangible asset. Intangible assets cannot be seen or touched because they lack physical substance for e.g. brands, copyrights, patents, trademarks, trade names, Customer relations etc. Intangible assets are crucial for businesses in some sectors because they provide competitive advantage, innovative capabilities and long- term value, in the business. IAS 38 – Intangible assets under IFRS framework provides the detailed accounting for such intangible resources. It provides in depth guidance on the topics like which resources can be considered as intangible assets (IA), when entity is eligible to recognise IA in the financial statements, how to measure that initially i.e. measurement basis (viz. cost) and which expenses incurred will be included as a part of the cost of an asset (for e.g. borrowing costs, directly attributable costs etc.), how to measure assets on subsequent reporting date, i.e. measurement basis (cost or revaluation model), how to determine the asset’s useful life, amortisation methods, impairment of those assets etc. For students pursuing a Diploma in IFRS, or ACCA FR or ACCA SBR, having in depth knowledge on IAS 38 is fundamental just like having knowledge on IAS 16 – PPE. This standard provides accounting of intangible assets and helps in better analysing the financial statements of any entity. It is vital for ensuring accurate and reliable financial reporting, which in turn enhances the credibility of an entity’s financial statements. In this blog, we will discuss about recognition principle of intangible assets as per IAS 38 under IFRS framework which are bit different from tangible assets. We already had

2. covered initial measurement principle of IA as a part of our previous blog along with PPE. Definition of Intangible Asset: IAS 38 defines Intangible Asset as: Intangible Asset is: An identifible non-monetary asset. Without a physical substance. • • A resource to be termed as an ‘intangible asset’ must meet the definition of intangible asset i.e. identifiability, control over resource and existence of future economic benefit. The definition of an intangible asset requires an intangible asset to be identifiable to distinguish it from goodwill. Goodwill recognised in a business combination is an asset representing the future economic benefits arising from such assets acquired in a business combination that are not individually capable of being identified and separately recognised. For e.g. market share or skilled workforce acquired by an acquirer in a business acquisition transaction is not capable of calling it as asset because it is not in control of the acquirer even after the acquisition. Such a consideration paid over and above the fair of identifiable net asset is subsumed in the line item called goodwill. Under IFRS framework (IAS 38), internally generated goodwill can not be recognised in the books, it has to be acquired as a part of business combination. • • • As the resource is not tangible or visible, its existence can be felt only if it is identifiable by some or the other way. Hence, identifiability is the most important criteria for an invisible resource to be called as intangible asset. For an intangible asset to be identifiable if must satisfy either of the two conditions mentioned below: Non-monetary asset is an asset which does not have fixed or determinable contractual cash flows. Without physical substance: Intangible asset cannot be seen or touched and often contained in/ on a physical substance. Where separation of such tangible and intangible element is not possible, judgement is required which element is more significant. For e.g. a software on a CD drive, DVD containing film recording or computer system with a database. • •

3. We will understand the concept of intangible assets with the help of couple of examples: Example 1: Entity ‘Oxytel’, is in telecommunication sector and has a wide distribution network which requires regular upkeep. Oxytel maintains maps of the entire network in a soft form which enables maintenance team to locate the assets that form the system. Oxytel has incurred substantial cost in developing these maps. These maps are of specific use to the Oxytel and thus cannot be sold and transferred in any form to any other entity. Also, Oxytel can seek a legal action in case of unauthorized use of these maps by any other company. Question arises as to whether Oxytel can consider these maps as an intangible asset? In order to call maps as intangible assets, we need to first evaluate whether maps are identifiable resources. Although the maps are not separable from the entity, management has control over the intellectual property that maps represent. Third parties do not have permission to use the maps as it will lead to copyright issues. Thus, maps being an intellectual propertyarises from theother legal rights. Economic benefits will flow to the entity in the form of savings in maintenance costs that the entity will experience from having access to the maps. The costs incurred to develop the map may therefore be regarded as an intangible asset. Example 2: Prohealth Limited is a successful Pharma company. By providing innovative and quality products, Prohealth has achieved a market share for its products of about 30%. Prohealth Limited is thinking of recognising an intangible asset for this market share. Can Prohealth Limited consider such market share as an intangible asset? Market share does not meet the definition of an intangible asset because it is not resource which is controlled by an entity. Further, it is not separable, and it does not arise from legal rights. Recognition To recognise IA, all the below conditions must be satisfied: Notes: Meaning of ‘Probable’ is ‘more likely than not’ (provided under IFRS framework). •

4. • Costs that can be measured reliably includes the costs incurred till date and costs that will be incurred in future for its acquisition or construction. In case of externally acquired intangible asset, ‘probability of future economic benefits’ criteria is assumed to be satisfied. If entity can calculate fair value of such intangible asset, ‘reliable measurement of costs’ criteria is also assumed to be satisfied. • • Internally Generated Intangible Assets Sometimes it is difficult to assess the recognition of internally generated intangible assets in the books. For e.g., expenses incurred on research and development activity may not be recognised as intangible assets because of the fact that: Whether expenses incurred on R&D activity will generate future economic benefits, and if yes then from when it will generate such economic benefits. Research activity may or may not be completed successfully and raises significant uncertainties over probability criteria. Even if the probability criteria is met by few internally generated assets, determining the cost incurred reliably may be difficult. This is because, many times cost of generating intangible asset internally cannot be distinguished from the costs of running day-to-day operations or maintaining or enhancing entity’s internally generated goodwill. For e.g. generating customer lists or a brand value can be called as intangible assets which has probability of future economic benefit, however, determining the costs or expenses that incurred to develop brand or customer list is not possible because these are the output of running day to day business over the years. • • Thus, to assess the recognition criteria for internally generated intangible assets, following activity is required: The process of generating an intangible asset is divided in to: Research Phase No intangible asset arising from research shall be recognised. Expenditure on research shall be recognised as an expense when it is incurred. This is because research phase cannot

5. demonstrate that an intangible asset exists that will generate probable future economic benefits. Therefore, this expenditure is recognised as an expense when it is incurred. Development Phase An intangible asset arising from development shall be recognised if, and only if, an entity can demonstrate all of the following: 01. Technical feasibility of completing intangible asset so that it is available for use. 02. Intention to complete the intangible asset and use it. 03. Ability to use or sell the intangible asset. 04. Demonstrate market for output of intangible or demonstrate usefulness. 05. Availability of adequate technical, financial and other resources to complete the development. 06. Ability to measure reliably the expenditure attributable to the development. • • • • • • Treatment of research and development expenditure in Summary Let us understand the recognition of intangible asset with the help of one example. Example 3: Bijoy Sales Private Limited (‘BSPL’), a wholesale supplier in a consumer markets sector, has been in the market for many years and has developed a list of customers with which it currently transacts. The customer list prepared by ‘BSPL’ is large and complete in terms of information about the customers. Management of ‘BSPL’ considers that the list has a significant value. ‘BSPL’ also acquires a medium-sized competitor that also has a large customer list with information such as name, address, contacts and average purchase amount. The customer list has a value, and management could sell it to third parties. Its fair value can be measured reliably and there are no substantive legal reasons that preclude client information from being exchanged or traded. The entity should recognise the customer list acquired in the business combination as an intangible asset, provided its fair value can be reliably measured. The ability to sell the

6. customer list or to exchange it provides evidence that it is separately identifiable from the goodwill arising in the acquisition. The entity may not, however, recognise an intangible asset for the internally generated customer list despite the fact that it clearly has satisfied the control criterion. Ind AS 38 specifically prohibits an entity from recognising internally generated intangible assets other than development expenditure that meets the conditions in the standard for recognition. This is because the cost of the customer list cannot be distinguished from the cost of developing, running and maintaining the business as a whole. So, as the use and importance of intangible assets continue to grow, staying up to date with IAS 38 and its application is key to maintaining strong and compliant financial practices. Whether you are working through your DipIFRS exam or applying these standards in a professional context, a solid understanding of intangible asset recognition will serve as an invaluable asset in your career. Thank you for reading this article. Stay Tuned to our next blog!