IAS 38 Intangible Assets: Recognition, Research and Development Costs

A brand, a patent, a software licence or a development project can be worth more to a business than its buildings, but it has no physical form. The question for the accountant is whether money spent on such an item is an asset or just an expense. International Accounting Standard (IAS) 38 Intangible Assets sets the rules.

It treats an intangible asset like any other asset, but it is stricter about what qualifies because it is harder to prove that an asset exists, that the entity controls it and that it will earn income. This topic covers the definition, the recognition tests, the ways an intangible asset can be acquired, research and development, and intangibles bought in a business combination. The next topic covers measurement after recognition and amortisation.

The topic is examined directly. In November Diet, 2021, Question 6(a) gave 9 marks for the meaning of research and development with two examples of each, and for five conditions for capitalising development costs. In May Diet, 2022, the compulsory accounts question includes computer software whose purchase, customisation and consultancy costs are capitalised and whose training and general overheads are expensed. Read lessee accounting first.

Definition and recognition

IAS 38 was developed on the view that an asset is an asset, so intangible and tangible assets should follow similar rules, as in IAS 16. The extra guidance exists because it is harder to tell that an intangible asset exists.

An intangible asset is an identifiable, non-monetary asset without physical substance. Spending on an intangible item must satisfy two sets of tests before it is an asset.

• The definition of an asset: a resource controlled by the entity as a result of past events and from which future economic benefits are expected.
• The definition of an intangible asset: identifiable, non-monetary, without physical substance.

Control

Control means the entity has the power to obtain the future benefits from the resource and to restrict others’ access to them. Legal rights, such as patents and copyrights, usually give control, but legal enforceability is not essential. Control is why some items are not assets. Staff training builds skills, but staff can leave and take the skills with them.

A customer list gives no control, because customers are free to buy elsewhere.

Identifiability and future benefits

An intangible asset is identifiable if it is separable, meaning it can be separated from the entity and sold, transferred, licensed, rented or exchanged, or if it arises from contractual or other legal rights. Future economic benefits can be revenues or cost savings, and evidence of their probability can come from market research, feasibility studies and a business plan showing the resources needed.

Without physical substance

Some intangibles sit in or on something physical. Judgement decides which part is more significant. Software that a computer-controlled machine tool cannot work without is part of the machine and is property, plant and equipment, as is a computer’s operating system. Other software is an intangible asset. Licences, patents and films are intangible assets.

The physical element of a prototype from a development project is secondary to the knowledge it embodies, so the result is an intangible asset.

Recognition criteria

An intangible item that meets the definitions is recognised if, and only if:

1. it is probable that the future economic benefits attributable to the asset will flow to the entity, judged on reasonable and supportable assumptions that represent management’s best estimate of the economic conditions over the asset’s useful life; and
2. the cost can be measured reliably.

How an intangible asset can be obtained

An entity may buy it separately, acquire it in exchange for another asset, receive it as a government grant, generate it internally, or acquire it in a business combination. IAS 38 gives extra guidance for each.

Cost of a separately acquired intangible

The probability criterion is always met for a separately acquired intangible, because the price paid reflects expectations of benefit, and the cost is usually reliable, especially for cash purchases. The cost comprises:

• the purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and
• directly attributable expenditure on preparing the asset for its intended use, such as employee benefit costs that arise directly, professional fees for legal services, and the costs of testing whether the asset functions properly.

Recognition of costs stops when the asset is ready to operate as management intends. Deferred payment is recorded at the cash price equivalent, with the difference treated as interest. Costs not included are staff training, selling and administration overheads and initial operating losses.

An asset obtained in an exchange is measured at fair value unless the exchange lacks commercial substance or the fair value of neither asset can be measured reliably, in which case it is measured at the carrying amount of the asset given up.

An asset received free or for a nominal sum under a government grant may be recorded at fair value or at a nominal amount plus directly attributable costs.

Later expenditure

Later spending is capitalised only if it can be measured and attributed to the asset and increases its value. That is rare, because most later spending maintains the benefits already in the asset, and it is hard to attribute to a single asset. Maintenance spending is expensed.

Internally generated intangible assets

It is often hard to say whether something an entity has built for itself qualifies, because it may not be identifiable or its cost may not be reliably measurable. IAS 38 therefore prohibits recognising these internally generated items: goodwill, brands, mastheads (the title at the head of a newspaper), publishing titles and customer lists.

The costs of producing them cannot be separated from the costs of developing the business as a whole. The same items are recognised if they are bought separately.

Goodwill is an asset representing the future economic benefits from other assets acquired in a business combination that are not individually identified and separately recognised. Most businesses are worth more than their net assets, but internally generated goodwill is not recognised. Goodwill appears only when one company buys control of another, in the buyer’s group statements.

Research and development

To judge whether an internally generated intangible qualifies, the work is split into two phases. If the research phase cannot be told apart from the development phase, all the spending is treated as research.

Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Examples are activities aimed at obtaining new knowledge; the search for, and evaluation of, applications of research findings; the search for alternative materials, products or processes; and the formulation and testing of possible alternatives for new materials, products or processes. Research costs cannot be an intangible asset. They are expensed when incurred.

Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use.

Examples are the design, construction and testing of pre-production prototypes and models; the design of tools involving new technology; the construction and operation of a pilot plant that is not large enough for commercial production; and the design, construction and testing of a chosen alternative for new or improved materials, products or processes.

Development costs are capitalised only if all these conditions can be demonstrated:

1. it is technically feasible to complete the project;
2. the entity intends to complete the asset and to use or sell it;
3. the entity is able to use or sell the asset;
4. the asset will generate probable future economic benefits, shown for example by a market for its output or its usefulness within the entity;
5. adequate technical, financial and other resources are available to complete the project and use or sell the asset; and
6. the expenditure can be measured reliably, for example through costing records.

If any condition is not met, the expenditure is treated like research and expensed. Only expenditure after all the conditions are met can be capitalised, and expenditure already expensed cannot later be reinstated as an asset.

Cost of an internally generated intangible

The cost is the total of the expenditure from the date the item first meets the recognition criteria. It includes materials and services used, the pay and related costs of the people directly engaged in generating the asset, and other directly attributable expenditure, and it may include borrowing costs that qualify under IAS 23. It excludes selling and administration overheads, initial operating losses, training, and costs previously expensed.

Intangibles acquired in a business combination

When a parent buys control of another company, in a business combination under International Financial Reporting Standard (IFRS) 3, any intangible asset the target has that meets the definition is recognised in the group statements.

Both recognition criteria are treated as always satisfied: the fair value of the asset reflects the expected benefits, and if the asset is separable or arises from legal rights there is enough information to measure its fair value reliably. The cost of the intangible is its fair value at the acquisition date. If it cannot be measured reliably it is subsumed in goodwill.

The effect is that an intangible that the target never recognised may be recognised by the group. Company Y has a well-known brand it built itself. It cannot recognise it. When Company X buys Company Y, part of the price is for the brand, so X’s group statements recognise it at fair value.

The same applies to in-process research and development: if the target expensed ₦600,000 on a project and its know-how has a fair value of ₦500,000 to the buyer, the group recognises ₦500,000, provided the know-how meets the asset definition and is identifiable. Later spending on that project is capitalised only if the development conditions are met.

Items that would meet the definition if acquired in a combination include trademarks, internet domain names, newspaper mastheads, customer lists and relationships, order backlogs, publishing rights, films and music, licensing and franchise agreements, operating and broadcasting rights, patented and unpatented technology, software and databases and trade secrets.

The ideas in more depth

Why the tests are tougher

For a machine, there is something to see, count and insure. For a project in progress, the entity could easily claim future benefits that never come. The conditions for development costs force management to show feasibility, intention, ability, market, resources and reliable costing before spending becomes an asset. Without them, an entity could improve its profit by capitalising spending on projects that later fail.

One-way rule for expensed costs

Expenditure expensed in an earlier period or an interim report cannot be reinstated. A project that later meets the conditions starts its asset only from that date.

Sources and references

• IAS 38 Intangible Assets: definition, recognition, separate acquisition, internally generated intangibles, research and development, and business combinations.
• IFRS 3 Business Combinations; IAS 16 Property, Plant and Equipment; IAS 23 Borrowing Costs; IAS 20 Accounting for Government Grants and Disclosure of Government Assistance.

These points are stated as at 5 November 2026.

Worked examples

1. Before the conditions. ₦400,000 was spent before all the conditions were met, so it is expensed and cannot be reinstated.
2. After the conditions.
   ₦1,500,000 − ₦400,000 = ₦1,100,000 is capitalised as an intangible asset.

1. Capitalise. Purchase price ₦2,400,000, customisation ₦300,000 and consultancy ₦200,000 are directly attributable.
2. Expense. Training ₦150,000 and general overheads ₦120,000 are not part of cost.
3. Cost.
   ₦2,400,000 + ₦300,000 + ₦200,000 = ₦2,900,000.

1. Brand. Y cannot recognise it, but for the group it is a purchased asset. X recognises it at its fair value at the acquisition date.
2. In-process project. The know-how is identifiable and meets the asset definition. The group recognises it at fair value, ₦700,000, not at the ₦900,000 that Y spent.

How to answer in the exam

• Define and give examples. One sentence for the definition and two examples of each. A 4-mark question wants research and development, each with an explanation and two examples.
• List the conditions. Write all six, one line each. Five of them were asked for in a past diet, so learn the six and write the five you remember best.
• Calculate cost. List each item and say capitalise or expense. Training and general overheads are expensed.
• Explain the prohibition. Internally generated brands and similar items cannot be separated from the cost of the business as a whole.

Common mistakes in the exam

• Capitalising research costs.
• Capitalising development costs incurred before all six conditions are met.
• Including staff training or general overheads in the cost of software.
• Recognising an internally generated brand or customer list.
• Reinstating development costs that were expensed earlier.
• Forgetting that a purchased brand is recognised, as is a brand acquired in a business combination.

Quick revision

• Intangible asset: identifiable, non-monetary, no physical substance. Control and future benefits needed.
• Recognise if probable benefits and reliable cost. Measure at cost.
• Research: expense. Development: capitalise only after all six conditions are met.
• Never recognise internal goodwill, brands, mastheads, publishing titles or customer lists.
• Business combination: recognise at fair value; includes in-process research and development.
• Cost of purchased intangible: price plus directly attributable costs; not training or overheads.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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