Intangible Assets (IAS 38) and Impairment of Assets (IAS 36)

Some of the most valuable things a business owns cannot be touched: a patent, a brand it bought, the know-how from a development project. Accounting has to decide which of these to record as assets, how to spread their cost, and when to write them down. A write-down is also needed for physical assets when they are no longer worth their carrying amount.

This topic covers intangible assets and the treatment of research and development, amortisation, and the test for impairment of any asset, including how to measure the recoverable amount.

These are new items in the syllabus. In the 20 diets reviewed only a 2-mark definition and a few Section A items touch them, so expect direct questions in the new papers, usually a classification of spending as research or development, an amortisation calculation, or an impairment loss. Read the topic on depreciation first, because amortisation works the same way. The next topic covers inventory.

Intangible assets

Intangible assets are identifiable non-monetary assets without physical substance (IAS 38, paragraph 8). Patents, copyrights, trademarks and goodwill are common examples. They have these characteristics:

• No physical substance. They cannot be seen or touched: trademarks, patents, copyrights, goodwill, software, brand names.
• Identifiability. The asset is separately acquired or can be separated and sold, transferred, licensed or exchanged, or it arises from contractual or legal rights.
• Non-monetary. There is no right to receive a fixed or determinable amount of money.
• Control. The entity can restrict others from the economic benefits.
• Expected future economic benefits, such as more revenue, savings or efficiency.
• Measurable cost or value.
• Finite or indefinite useful life. A finite life is amortised. An indefinite life is not amortised but is tested annually for impairment.

There are four types: Patents (exclusive rights for inventions for a period), Copyrights (rights over original creative works), Trademarks (identifiers of a brand or product) and Goodwill (the excess of the purchase consideration over the fair value of the identifiable net assets in a business combination).

Background: IAS 38 does not allow internally generated goodwill, brands, mastheads, publishing titles or customer lists to be recognised, because their cost cannot be separated from the cost of developing the business as a whole (paragraph 63). Only purchased ones are recognised.

Research and development

R&D expenditure is the cost of developing new or improved products, processes or services. Research aims to gain new knowledge. Development applies research findings to create or improve products or processes. All research costs must be Expensed as incurred (IAS 38, paragraph 54). Development costs are capitalised only if All of these are met (paragraph 57).

1. Technical feasibility of completing the asset for use or sale.
2. Intention to complete and use or sell it.
3. Ability to use or sell it.
4. Reliable measurement of the expenditure attributable to it.
5. Future economic benefits that are probable.
6. Adequate resources, technical, financial and other, to complete and use or sell it.

Internally generated intangibles may be recognised only from the development phase, and research costs are always expensed. The cost of an intangible includes direct development costs, such as labour, materials and overheads, or the purchase price for an acquired one. Examples. Testing a production prototype is development and is capitalised if the criteria are met, otherwise expensed. A search for alternative production processes is research and is expensed.

A substantial cost of building a prototype of a new heat-resistant suit is development. Testing whether a newly found substance is waterproof is research and is expensed. An advertising campaign is an expense. It is not an intangible asset under IAS 38.

Amortisation and carrying amount

Amortisation allocates the cost of an intangible asset over its useful life, as depreciation does for tangible assets. If the pattern of benefits cannot be reliably determined, use the straight-line method. Indefinite-life assets, such as brand names and trademarks with no limit on the period of cash flows and no legal or contractual limit, are Not amortised but are tested at least annually for impairment (IAS 36, paragraph 10). The carrying amount is:

For example, a patent bought for ₦1,800,000 on 1 January with a six-year life is amortised at ₦300,000 a year (Dr Amortisation expense, Cr Accumulated amortisation), and the carrying amount after two years is ₦1,200,000. Development costs of ₦900,000 capitalised with a five-year life, with benefits starting on 1 July, are amortised at 900,000 ÷ 5 × 6/12 = ₦90,000 in the first year.

The cost of intangible assets is disclosed by class, with the amortisation method and rate, any impairment losses, and a reconciliation of the opening and closing carrying amounts showing additions, disposals, amortisation and impairment.

Impairment of assets

An asset is impaired when its carrying amount exceeds its Recoverable amount (IAS 36, paragraph 6). The principle is that an asset must not be carried at more than the highest amount recoverable through use or sale, which applies the prudence concept. An entity assesses at the end of each reporting period whether there is any indication of impairment (IAS 36, paragraph 9).

Some assets must be tested every year even without an indication (paragraph 10):

• intangible assets with an indefinite useful life;
• intangible assets not yet available for use; and
• acquired goodwill.

Indicators include a significant fall in market value, adverse changes in the technological, market, legal or economic environment, physical damage or obsolescence, and plans to dispose of or restructure the asset (paragraph 12).

Recoverable amount

• FVLCTS is what the asset would fetch in an arm’s-length sale less the costs of disposal, such as legal fees, removal costs and commissions. A property that can be sold for ₦6,400,000 with ₦240,000 of selling costs has an FVLCTS of ₦6,160,000.
• VIU is the present value of the future cash flows expected from continued use. Estimate the cash flows, choose a discount rate and compute the present value of each year’s flow.

Recognising and reversing the loss

An impairment loss is recognised when the carrying amount exceeds the recoverable amount. It is recognised in Profit or loss (IAS 36, paragraph 60). If the asset has been revalued, the loss is first treated as a revaluation decrease, in other comprehensive income, to the extent of the existing revaluation surplus on that asset. After the loss, the carrying amount equals the recoverable amount.

A loss may be Reversed if the estimates behind the recoverable amount have changed because of better economic conditions, technology, demand, or the resolution of uncertainties. The carrying amount after the reversal must not exceed the amount it would have been, net of depreciation or amortisation, had no impairment been recognised (paragraphs 117 and 118). A reversal cannot lift the asset above its depreciated historical cost.

An impairment loss on goodwill is never reversed (paragraphs 124 and 125). The notes disclose the losses and reversals recognised in profit or loss, the line items that contain them, and losses recognised in other comprehensive income for revalued assets.

The ideas in more depth

Why research is expensed. Early on it is not yet clear that any benefit will follow. Why development needs six conditions. The business must show the asset is real and likely to pay. Amortisation versus impairment. Amortisation is a planned charge. Impairment is an unplanned write-down when the asset is worth less than recorded.

The higher of two. A rational owner would use or sell the asset, whichever gives more, so the recoverable amount is the higher. Impairment is not a concept. It is a test, which is why it is not on the list of accounting concepts. After impairment. The charge for later years is based on the lower carrying amount over the remaining life.

Sources: IAS 38 Intangible Assets: paragraphs 8, 54, 57, 63 and 68. IAS 36 Impairment of Assets: paragraphs 6, 9, 10, 12, 60, 117 and 118, and 124 and 125.

Worked example: Kano Dye Works

1. FVLCTS.
   20,500,000 − 700,000 = 19,800,000.
2. VIU.
   The factors add to 0.9259 + 0.8573 + 0.7938 + 0.7350 = 3.3120.
   VIU = 6,000,000 × 3.3120 = 19,872,000.
3. Recoverable amount. The higher of 19,800,000 and 19,872,000 is 19,872,000.
4. Impairment loss.
   22,000,000 − 19,872,000 = ₦2,128,000.
   Dr Impairment loss 2,128,000, Cr Machine (accumulated impairment) 2,128,000.
   The carrying amount becomes 19,872,000.
5. Spending. The market survey (340,000) and the research (520,000) are expensed. The advertising (150,000) is expensed. The prototype (1,200,000) is development meeting the criteria, so it is capitalised as an intangible asset.
6. Amortisation.
   If the prototype starts to earn on 1 October with a five-year life, the first year’s amortisation is 1,200,000 ÷ 5 × 3/12 = 60,000.

Common mistakes in the exam

• Capitalising research costs or advertising.
• Capitalising development costs when only some of the six criteria are met.
• Amortising an indefinite-life intangible.
• Taking the lower of FVLCTS and value in use instead of the higher.
• Forgetting that the loss goes to profit or loss unless a revaluation surplus exists.
• Reversing an impairment loss above the depreciated historical cost, or reversing a goodwill loss.
• Adding up discounted cash flows wrongly. Check the arithmetic.

Quick revision

• Intangible: identifiable, non-monetary, no physical substance, controlled, future benefits.
• Research: expense. Development: capitalise if all six criteria are met. Internally generated brands: never.
• Finite life: amortise, straight-line if unknown. Indefinite life: no amortisation, annual impairment test.
• Impairment: carrying amount above recoverable amount. Recoverable amount = higher of FVLCTS and VIU.
• Loss to profit or loss (or to the revaluation surplus first). Reversal capped. Goodwill never reversed.

Practice questions

These are original questions in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one first.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

Spotted a mistake? Tell us and we will check it.