Most business owners would agree that properly accounting for intangible assets can be confusing.
But with the right guidance on recognition, measurement, and amortization rules, you can accurately report your intangibles and fully leverage their value.
In this post, we'll provide a comprehensive overview of current standards for treating intangibles - from initial recording to impairment testing. You'll learn key criteria for asset recognition, subsequent measurement methodologies, determining useful life and amortization approaches, and more.
Introduction to Intangible Asset Recognition and Amortization
Intangible assets are non-monetary assets without physical substance that provide future economic benefits to a business. According to IAS 38, an intangible asset must meet specific criteria to be recognized on the balance sheet.
Understanding IAS 38 Intangible Assets
IAS 38 outlines the accounting treatment for intangible assets. The key requirements are:
- An intangible asset must be identifiable, controllable, and expected to produce future economic benefits. Internally generated goodwill, brands, and similar cannot be recognized as assets.
- Intangible assets are initially measured at cost. Acquired assets are measured at their purchase price plus related expenses. Internally generated assets are measured at development cost.
- After initial recognition, intangible assets are measured using either the cost model or revaluation model. The cost model amortizes the asset over its useful life.
- Intangible assets must be assessed for impairment when indicators suggest the asset's carrying value exceeds its recoverable amount. An impairment loss must be recognized if appropriate.
Initial Measurement of Intangible Assets
Acquired intangible assets are initially measured at cost, including purchase price and any directly attributable expenditures related to preparing the asset for intended use.
Internally generated intangible assets can only be capitalized during the development phase under strict criteria, such as technical feasibility, intention to complete, ability to sell/use, adequacy of resources, and ability to measure costs reliably. Research phase costs are expensed as incurred.
Examples of capitalized internally generated intangible assets include patents, copyrights, software, processes/recipes. Brands and similar cannot be recognized.
Tax Amortization of Intangible Assets: An Overview
- Tax regulations often allow for faster amortization of intangibles than accounting rules. This creates deferred tax liabilities but provides increased cash flow.
- Tax amortization can be taken over 15 years for certain intangibles versus 20+ years for accounting.
- Careful projection of income and tax liability is necessary when using accelerated tax amortization. Consult a tax professional.
Useful Life and Amortization of Intangible Assets
The useful life of an intangible asset depends on contractual/legal rights as well as expectations of technical, technological, and commercial obsolescence. Assets with finite lives are amortized and assets with indefinite lives are not.
Amortization should reflect the pattern of economic benefits expected from the asset. Acceptable methods per IAS 38 include straight-line, diminishing balance, and unit of production. Impairment testing should still be performed annually for indefinite-lived assets.
What is the accounting treatment for intangible assets?
Intangible assets are non-physical assets that provide future economic benefits, such as patents, trademarks, copyrights, software, and goodwill. The accounting treatment for intangible assets involves the following key steps:
- Initial Recognition: An intangible asset is initially recorded at cost if it meets the recognition criteria under IAS 38. The cost includes purchase price and any directly attributable costs. Internally generated intangible assets are capitalized if specific criteria are met.
- Useful Life: The useful life of an intangible asset must be determined. Assets with finite lives are amortized over their useful economic life. Assets with indefinite lives are not amortized but subject to annual impairment testing.
- Amortization: Intangible assets with finite useful lives are amortized on a systematic basis over their useful life. Amortization expense is recorded on the income statement. The straight-line method is most commonly used.
- Impairment: Intangible assets are tested for impairment when there are indicators of impairment. An impairment loss is recognized if the asset's recoverable amount is below its carrying value.
In summary, intangible assets are recorded as long-term assets and amortized over their useful lives. Regular impairment testing is also required. The accounting aims to match the asset's costs to the periods expected to benefit from the asset.
Are intangible assets always expensed through amortization?
Generally, intangible assets are amortized using the straight-line expense method over their estimated useful lives. However, there are some exceptions where intangible assets are not amortized:
- Intangible assets with indefinite useful lives are not amortized. For example, a brand name with no foreseeable limit to the period over which it is expected to generate net cash inflows is considered to have an indefinite useful life.
- Internally generated intangible assets in the research phase are expensed as incurred. Costs associated with the research phase cannot be capitalized and must be expensed.
- Internally generated brands, mastheads, publishing titles, customer lists, and items similar in substance are not capitalized as intangible assets. The costs associated with internally generating these items are expensed.
So in summary, while most intangible assets are amortized over their finite useful lives, some intangible assets with perpetual lives or specific internal costs are expensed outright rather than amortized. Careful judgment is required in assessing an intangible asset's useful life and amortization method. The standard IAS 38 provides guidance on accounting treatment of intangible assets.
What are the conditions for Recognising intangible assets?
According to IAS 38, an intangible asset must meet two criteria to be recognised:
- It is probable that the expected future economic benefits attributable to the asset will flow to the entity. This means that the entity can demonstrate the commercial viability of the intangible asset and its ability to generate future revenues.
- The cost of the asset can be measured reliably. The standard states that an intangible asset shall be measured initially at cost. The cost comprises purchase price, import duties, non-refundable taxes, and any other directly attributable costs to prepare the asset for its intended use.
If an intangible asset does not meet both the above criteria, expenditure incurred to acquire it or generate it internally is recognised as an expense when incurred.
For example, expenditures on research activities are recognised as expenses when incurred because economic benefits from research cannot be reasonably foreseen. Other common examples of intangibles that may not qualify for recognition due to uncertainty of economic benefits include customer lists, magazine mastheads, etc.
On the other hand, development expenditures can be capitalised as intangible assets if the entity can demonstrate technical feasibility, intention and ability to complete the asset, ability to use or sell it, generation of future economic benefits, and reliable measurement of costs.
In summary, IAS 38 sets out strict conditions for initial recognition of intangibles to ensure only commercially viable assets that can generate measurable future economic benefits are capitalised. Meeting both the probability and reliable measurement criteria is key for recognition.
How does GAAP treat intangible assets?
Under Generally Accepted Accounting Principles (GAAP), internally developed intangible assets are typically not recognized on a company's balance sheet. Instead, the costs associated with developing intangibles like patents, trademarks, and software are expensed as incurred.
For example, the salaries of software developers working on new products would be recorded as R&D expenses on the income statement rather than capitalized as intangible assets. There are a few exceptions, such as certain software development costs that meet specific criteria for capitalization.
In contrast, under International Financial Reporting Standards (IFRS), internally generated intangibles can be recognized on the balance sheet if they meet the identifiability, control, and future economic benefit criteria outlined in IAS 38. For instance, development costs related to a new pharmaceutical drug could potentially be capitalized as an intangible asset under IFRS.
In summary, GAAP sets a higher threshold for recognizing self-created intangibles whereas IFRS provides more flexibility to reflect internally developed assets on the balance sheet. The different treatments lead to variations between companies reporting under the two standards.
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Key Recognition Criteria for Intangible Assets
For an intangible asset to be recognized on the balance sheet, it must meet several key criteria outlined in IAS 38:
Identifiability Criterion
An intangible asset must be identifiable in order to be recognized separately from goodwill. This means that the asset must either:
- Be separable, meaning it can be separated from the entity and sold, transferred, or licensed individually; or
- Arise from contractual or legal rights, regardless of whether it is separable.
For example, a patent or trademark would meet the identifiability criterion. However, customer loyalty or assembled workforce would not.
Control Criterion
The entity must have control over the intangible asset and the power to obtain future economic benefits from it. This generally means the ability to restrict others from accessing the asset and gaining economic rewards from it.
Control can be evidenced by legal rights like patents, or in some cases, technical methods that prevent replication or use by competitors. Without control, recognition is not permitted.
Future Economic Benefits Criterion
There must be an expectation that the intangible asset will generate probable future economic benefits that flow to the entity. This means that the asset must contribute directly or indirectly to future net cash inflows for the reporting entity.
If an intangible asset is not expected to provide economic rewards in the future, it would not meet the recognition criteria in IAS 38.
Examples of Internally Generated Intangible Assets
Some examples of internally generated intangible assets that could meet all recognition criteria include:
- Patented manufacturing processes developed internally
- Computer software created to be sold or licensed externally
- New pharmaceutical formulas awaiting regulatory approval
The development costs for these assets often meet the strict criteria for capitalization under IAS 38 and can be recognized separately on the balance sheet if all principles are adhered to.
Initial and Subsequent Measurement of Intangible Assets
Acquired intangible assets are initially measured at cost, which includes the purchase price and any directly attributable costs. Internally generated intangibles are not recognized on the balance sheet except in certain circumstances.
The subsequent measurement of intangible assets depends on whether they have finite or indefinite useful lives. Assets with finite lives are amortized over their useful lives. Assets with indefinite lives and goodwill are not amortized but are subject to annual impairment testing.
Acquired Intangible Assets: Cost and Valuation
Intangible assets purchased separately are measured initially at cost. This includes the purchase price and any directly attributable expenditures to prepare the asset for its intended use. Assets acquired in a business combination are recognized separately from goodwill if they are identifiable and their fair value can be reliably measured. Their initial cost is their acquisition-date fair value.
For both separately acquired assets and those from business combinations, determining initial cost requires judgment and estimates. Valuation techniques like discounted cash flows or comparative market multiples may be required.
Internally Generated Intangible Assets: Recognition and Measurement
Internally generated intangibles like brands, customer lists, and technology are not recognized on the balance sheet except under strict conditions. The asset must have a definable future economic benefit and reliable measurement of costs.
If recognized, internally generated intangibles are initially measured at development cost. This includes expenditures directly attributable to creating, producing and preparing the asset to operate as management intends.
Measurement of internally generated assets can be complex. Judgment is needed in determining appropriate capitalization dates and directly attributable costs.
Subsequent Measurement of Intangible Assets: IAS 38 Guidelines
After initial recognition, intangibles are measured at cost less accumulated amortization and impairment losses. Assets with finite useful lives are amortized over their useful lives. Assets with indefinite lives and goodwill are not amortized.
Useful life should be reviewed annually. Changes can significantly impact amortization charges and asset carrying values. Assets are tested for impairment when there is an indication of impairment.
IAS 38 has specific guidelines on acceptable amortization methods, residual value assumptions, and asset retirements. These should be consulted for appropriate subsequent measurement.
IAS 38 Intangible Assets PDF: A Reference Guide
For a comprehensive overview of IAS 38 guidelines on intangible asset measurement, Deloitte has published an excellent IAS 38 Intangible Assets PDF guide. This is a handy reference document on recognition, measurement, presentation and disclosure rules.
Useful Life and Amortization of Intangible Assets
Intangible assets provide long-term benefits to businesses. However, their costs must be appropriately allocated as expenses over time. This section explains key considerations in determining useful life and amortization methods for intangible assets.
Determining Useful Life of Intangible Assets
The useful life of an intangible asset depends on various factors:
- Legal, regulatory, or contractual provisions may specify a useful life. For example, a purchased patent's useful life is its legal life.
- Technical, technological, commercial, or other types of obsolescence indicate how long the asset will remain usable. Technology-based intangibles often have shorter useful lives.
- Expected usage, maintenance, and renewal policies impact the period over which future benefits will be received. Assets used more intensively or without adequate maintenance have shorter useful lives.
- Typical product life cycles and stability of the industry provides insight on useful life. For example, customer lists in a volatile industry have shorter useful lives than in stable industries.
If no legal, contractual, or other factors apply to determine useful life, management should make its best estimate based on experience. Useful life should be reviewed annually and revised if expectations change significantly.
Amortization Methods for Intangible Assets
Common amortization methods include:
- Straight-line: Cost evenly amortized over useful life. This is the simplest method and implies a constant consumption of the asset's benefits over time.
- Diminishing balance: Amortization is higher in earlier years, reflecting faster consumption or obsolescence. The double declining balance approach is commonly used.
Management should select the method that best reflects the asset's usage and contribution of benefits. Straight-line amortization is appropriate for assets with constant utility over their life. Diminishing methods suit assets with front-loaded benefits that decline over time.
Changes in Useful Life or Amortization Method
Useful life and amortization methods require periodic review. Changes should be accounted for prospectively as per IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors:
- Change useful life: Adjust remaining amortization over revised remaining useful life.
- Change amortization method: Adjust amortization to reflect new method prospectively.
Such changes are changes in estimates per IAS 8. Disclose the nature and amount of change, along with effect on amortization expense in current and future periods.
IAS 38 Intangible Assets Questions and Answers
Q: How to determine if an intangible asset has indefinite or finite useful life?
A: Assets with contractual, legal or similar limits have finite useful lives, as benefits end after a specified period. Assets like brands, licenses, and trademarks used indefinitely have indefinite useful lives if maintained appropriately.
Q: Can different amortization methods be used for different intangible assets?
A: Yes. The method should match usage and benefit patterns for each specific asset. For example, diminishing balance for technology assets, and straight-line for licenses with contractual limits.
Q: What disclosures are required regarding useful life and amortization methods?
A: Disclose useful life, amortization method, changes in estimates, and effect of changes per IAS 8 for each class of intangible assets. Justify why infinite useful life is used for such assets if applicable.
Impairment Testing for Intangible Assets
Impairment Indicators for Intangible Assets
Some key indicators that may signal an impairment of an intangible asset under IAS 38 include:
- Significant underperformance relative to expected historical or projected operating results
- Changes in how the asset is used or overall business strategy affecting the asset's value
- Negative industry or economic trends such as declining revenues or cash flows
- Legal, regulatory or contractual changes impacting the asset
- Increase in market interest rates negatively impacting value
Organizations should assess these internal and external factors to determine if intangible assets may be impaired and require testing.
Intangible Asset Impairment Testing
To test an intangible asset for impairment under IAS 38:
- Calculate projected undiscounted cash flows expected to be generated by the asset over its remaining useful life
- Compare projected cash flows to the asset's current carrying value on the balance sheet
- If projected cash flows are less than carrying value, calculate the asset's recoverable amount based on the higher of the asset's fair value less costs to sell OR its value in use
- Record an impairment loss as the difference between the asset's current carrying value and its recoverable amount
This process establishes the revised carrying value of the impaired intangible asset.
Accounting Treatment for Impaired Assets
For impaired intangible assets under IAS 38:
- The impairment loss is recorded as an expense on the income statement
- The asset's carrying value on the balance sheet is written down to the recoverable amount
- Notes to the financial statements should include details on the impairment loss calculation and assumptions used
- Future amortization expenses for the asset are adjusted based on the revised carrying value and remaining useful life
These entries recognize the decline in asset value and enable accurate financial reporting.
Separate Class of Intangible Assets and Impairment Considerations
If an intangible asset is part of a separate class under IAS 38, it is tested for impairment separately from other intangibles. Key factors in identifying separate classes include:
- The asset's specific useful life
- Legal, contractual, or separation restrictions
- Interdependency with other assets
For example, a brand name may be considered a separate class from customer relationships. Impairment would be assessed independently based on cash flows for the specific intangible asset class.
Conclusion and Key Takeaways
Intangible assets can provide long-term value to a business, but accounting treatment can be complex. Key takeaways regarding IAS 38 rules include:
- Strict criteria must be met for an intangible asset to be recognized on the balance sheet, including separability, control, and future economic benefit. Internally generated assets like brands and customer lists typically do not qualify.
- Initially recognized at cost. Subsequent measurement is either cost model (no revaluation) or revaluation model (fair value adjustments). Impairment testing should occur when indicators are present.
- Useful life must be determined, which can be either finite or indefinite. Finite life assets are amortized over expected benefit period. Indefinite life assets are not amortized but subject to impairment testing.
Proper accounting for intangibles requires judgment and can impact financial statements. Companies should develop policies aligned with IAS 38 and apply them consistently.
