Chapter 4

IAS 38 Intangible Assets

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Chapter 6 IAS 38 Intangible Assets

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IAS 38 Intangible Assets

Definition

An intangible asset is a non-current asset that is

identifiable and without physical substance.

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IAS 38 Intangible Assets
An intangible asset is identifiable when it:

• is separable (it can be sold, transferred, licensed or exchanged) or

• arises from contractual or other legal rights
A non-current asset is a resource controlled due to past events, from
which future economic benefits are expected to flow and is owned for
more than a year.

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IAS 38 Intangible Assets
Intangible assets that have been purchased can be capitalised and
included in the statement of financial position as non-current assets.
However, intangible assets internally generated by the business cannot
be capitalised. Typically, this includes goodwill and brands.

Once an intangible asset is capitalised, it must be amortised. The

amortisation of an intangible asset is the same as the
depreciation of a tangible non-current asset. Amortisation charge
measures the consumption, or usage, of the intangible asset.

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IAS 38 Intangible Assets
Examples of Intangible Assets

Examples of intangible assets include:

• Computer software
• Patents and licences (exclusive rights to use a process, product or
name)

• Copyright (legal right belonging to the originator of a material which

cannot be reproduced or copied)

• Trademarks (a legally registered or established symbol or word that is

used to represent a company or product)

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IAS 38 Intangible Assets
Examples of Intangible Assets

• Brands (a symbol or wording identifying a product)

• Intellectual property (technical knowledge obtained from a
development activity)

• Goodwill (value of business above the value shown in the financial

statement, coming from the strength of a brand and reputation)

• Development cost

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Amortisation
The amortizable (depreciable) amount should be allocated
systematically over the best estimate of useful life. The amortisation
period:

• commences when the asset is available for use

• ceases when the asset is derecognised (if it is sold)

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Amortisation
The carrying amount (Intangible Asset Cost – Accumulated
Amortisation) is reduced to reflect the consumption of economic benefits
over time. The following factors should be considered:

• expected usage of the asset

• typical product life cycles for the asset
• technical obsolescence, etc
• stability of industry and market demand

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Amortisation
• expected competition
• maintenance required
• period of control (e.g. the legal limit on a lease)
• dependency on the useful lives of other assets

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Amortisation
Amortisation Method

The amortisation method should reflect the consumption pattern (For

example, the unit of the production method). The straight-line method
should be used if a pattern cannot be determined reliably.

The amortisation charge is recognised as an expense unless included in

the carrying amount of another asset.

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Amortisation
Amortisation Method

Amortisation methods should be reviewed at least annually at each

financial year-end. The amortisation charge for current and future
periods should be adjusted for any changes in the:

• period (if the expected useful life is significantly different)

• method (to reflect a changed pattern).

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Amortisation
Residual Value

The residual value is assumed to be zero unless there exists:

• a commitment by a third party to purchase the asset at the end of its

useful life; or

• an active market for the asset.

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Double Entries for Intangible Assets
Capitalising an intangible asset means that it can be accounted for and
included on the statement of financial position.

The double entry to record the purchase of an intangible asset is:

Individual Account Category Explanation

DR Intangible Asset – Cost (SFP) Asset Intangible Asset
(Asset) is
recognised
CR Bank (Asset) has
Bank/Cash (SFP) Asset
decreased

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Double Entries for Intangible Assets
Amortisation is the systematic allocation of the depreciable amount of
an intangible asset (its cost minus residual value) over the period
expected to benefit from its use.

The double entry to record the amortisation of an intangible asset is:

Individual Account Category Explanation

DR Amortisation (SPL) Expense
Amortisation
(Expense) increased

CR Acc. amortisation
Intangible Asset – Acc.
Asset reduces the value of
Amortisation (SFP)
IA

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Activity 1
Match the incomplete statement in the left column to the
corresponding statement in the right to complete each sentence.

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Activity 1 Answer

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Activity 2 New Product Development
In 20X4, Brock Co spent $2m on developing a new line of foods for
infant nutrition. On 1 January 20X5, the directors approved to fund the
rest of the project and a further $1m was spent in the first quarter of
20X5. On 1 April 20X5, Brock Co’s application for an infant food licence
was rejected as sugar substitutes in a milk formula did not comply with
the standards of the Food Safety Authority (FSA).

Brock Co spent a further $1m in the second quarter of 20X5 and the
FSA approved Brock Co’s reapplication for a licence on 1 July 20X5.
Brock Co then spent a further $1.5m developing the product range
before its launch on 1 October 20X5. The new product line is expected
to generate revenues in excess of $20m and have a useful life of five
years.

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Activity 2 New Product Development
Required:

Explain how the development expenditure should be accounted

for in the financial statements for the year ended 31 December
20X5.

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Activity 2 Answer
Brock Co should recognise only $1.5m of expenditure as the cost of an
intangible asset, as it is only from 1 July 20X5 that all of the
development criteria are met. Even though the asset is likely to
generate significant benefit and a total of $5.5m of costs have been
incurred, the costs incurred before 1 July 20X5 cannot be capitalised.
The $2m expensed in 20X4 cannot be subsequently recognised as part
of the cost of the intangible asset; nor the $2m incurred in the first six
months of 20X5 that must be expensed during the year.

As the product range was launched on 1 October, $75,000 amortisation

will be expensed to profit or loss (3/12 months × $1.5m/5 years) and
the carrying amount of the intangible asset in the statement of financial
position will be $1.425m ($1.5m – $0.075m). The intangible asset is
unique and cannot be revalued.

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Recognition of Intangible Assets
Research and Development

It may be challenging for businesses to determine a value of an

internally generated intangible asset. Specifically, it is often difficult to
determine whether:

• there is an identifiable asset

• future economic benefits are probable
• cost can be measured reliably.
It isn’t easy to distinguish the cost of generating a brand, for example,
from the cost of developing the business as a whole, maintaining
goodwill, or operating on a day-to-day basis.

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Recognition of Intangible Assets
Research and Development

Therefore, internally generated intangible assets such as brands,

publishing titles, customer lists and items similar in substance cannot
be capitalised and recognised as intangible assets in the Statement of
Financial Position.

The only exception is research and development costs.

Research: Research is an original and planned investigation

undertaken to gain new scientific or technical knowledge and
understanding.

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Recognition of Intangible Assets
Research and Development

Development: 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 commencement of commercial production or use.

Research is gathering new knowledge, and development is the

application of the knowledge gained before the business can use it
commercially.

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Recognition of Intangible Assets
Research and Development

For example, a company that makes medicines carries out research into
the use of herbs to cure headaches. This research results in the
company finding one herb with unique properties for curing headaches.
The company then uses this research and develops a headache pill using
this herb, which is tested and then made ready to sell to the public.

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Recognition of Intangible Assets
Research and Development

Typically Considered Research

Aiming to obtain new knowledge.
Seeking applications of research findings.
Seeking and evaluating product or process alternatives.
Formulating and designing possible new or improved product or
process alternatives.

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Recognition of Intangible Assets
Research and Development

Typically Considered Development

Design, construction and testing of pre-production prototypes
and models and
chosen alternative materials, processes, etc.

Designing tools, etc., involving anew technology.

Design, construction and operation of a pilot plant (not of a
scale economically feasible for commercial production).

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Recognition of Intangible Assets
Research and Development

Related to, but Neither Research nor Development

Engineering follow-through in an early phase of commercial
production.
Quality control during commercial production, including routine
product testing.
Troubleshooting commercial production breakdowns.
Routine refining or otherwise improving existing products.
Adapting an existing capability (for example, to a particular
customer's requirement)
Seasonal/periodic design changes to existing products.
Routine design of tools, etc.

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Accounting for Research and Development
Research and development expenditure includes all costs incurred
directly from carrying out the R&D or can be allocated reasonably.

Costs that may be included as a result of the research and development

activities are:

• Salaries and Wages – Any employment-related costs for staff carrying

out the research and development activities can be included. For
example, salaries, wages, payroll taxes, pension contributions

• Materials and Services – Any materials or services used in the

research and development activity can be included. For example,
product development materials and external market research experts.

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Accounting for Research and Development
• Overhead Costs – Any overhead costs (excluding general overheads)
related to the research and development activity can be included. For
example, energy and security costs.

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Accounting for Research and Development
Recognition of Research

Research costs are always treated as expenses and cannot be

capitalised as intangible assets because it is uncertain whether the
research will generate future economic benefits.

The double entry to account for research expenditure is:

Individual Account Category Explanation

DR Research (SPL) Expense Research (Expense) has increased

CR Bank (Asset) has decreased

Bank/Cash (SFP) Asset

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Accounting for Research and Development
Recognition of Development

Development cost can only be capitalised as an intangible asset if it

meets all the following criteria below:

• Technical feasibility of completing the development of the

intangible asset

• Intention to complete the development of the intangible asset

• Ability to use or sell the intangible asset
• The intangible asset will generate future economic benefit

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Accounting for Research and Development
Recognition of Development

• Sufficient resources to complete the intangible asset

• Cost can be measured reliably

Individual Account Category Explanation

DR Intangible Asset (SFP) Asset Intangible Asset
(Asset) is recognised

CR Bank (Asset)
decreased to pay for
Bank/Cash (SFP) Asset
development cost

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Accounting for Research and Development
Recognition of Development

The capitalised development cost will be amortised over its useful life
and charged to the Statement of Profit or Loss. Development
expenditure has no residual value since no active market exists (each
development will be unique).

If any of the above criteria is not met, the development cost cannot be
capitalised and must be treated as an expense in the Statement of Profit
or Loss.
Individual Account Category Explanation
DR Development (SPL) Expense Development
(Expense) has
increased
CR Bank (Asset) has
Bank/Cash (SFP) Asset
decreased
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Accounting for Research and Development
Recognition of Development

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Example 1
On 1 April 20X6, Brooks established a new research and development
unit to acquire scientific knowledge on the use of synthetic chemicals for
pain relief. The following expenses were incurred during the year ended
31 March 20X7.

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Example 1
1. Purchase of building for $400,000. The building is to be depreciated
on a straight-line basis at the rate of 4% per annum on cost.

The purchase of a building is a tangible non-current asset purchase,

not an intangible asset. Brooks will capitalise the purchase cost with
the following entry:

DR Building - Cost $400,000

CR Bank $400,000

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Example 1
At the year-end, the depreciation charge is $400,000 x 4% = $16,000
and should be expensed off by:

DR Depreciation (Expense) $16,000

Building – Acc.
CR $16,000
Depreciation

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Example 1
2. Wages and salaries of research staff are $2,355,000.

Research costs must always be expensed off. The double entry is:

DR Research (Expense) $2,355,000

CR Bank $2,355,000

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Example 1
3. Development cost that meets the criteria to be capitalised has been
calculated to be $60,000. It is amortised using the straight-line
method of 25% per annum.

The cost to be capitalised is $60,000. The double entry is:

DR Intangible Asset $60,000

CR Bank $60,000

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Example 1
The amortisation charge for the year is $60,000 x 25% = $15,000

DR Amortisation (Expense) $15,000

Intangible Asset – Acc.
CR $15,000
Amortisation

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Example 1
The total amount expensed in the statement of profit or loss is:

Building depreciation ($400,000 × 4%) $16,000

Wages and salaries of research staff $2,355,000

Intangible Asset Amortisation ($60,000 × 15%) $15,000

$2,401,000

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Activity 3
In its first year of trading, which ended 31 July 20X6, Eco-chem incurred
the following expenditures on research and development (none related
to the cost of property, plant and equipment).

1. $12,000 on successfully devising processes for converting seaweed

into chemicals X, Y and Z.

2. $60,000 on developing a headache pill based on chemical Z.

No commercial uses have yet been discovered for chemicals X or Y.

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Activity 3
Commercial production and sales of the headache pill commenced on 1
April 20X6 and are expected to produce steady, profitable income for
five years before being replaced. Adequate resources exist to achieve
this.

Determine the amount of development expenditure which may

be carried forward (remain as an amortising asset) at 31 July
20X6 under IAS 38.

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Activity 3 Answer
The processes in (1) are research and cannot be recognised as an asset.
Item (2) is development.

Capitalise: Item (2) meets the criteria $60,000

to be capitalised.
Amortisation: Amortise from 1 April 20X6 $4,000
over five years. With a year-
end of 31 July, four months
of amortisation will be taken.
The amortisation for the year
ended 31 July 20X6 is:
$60,000 ÷ 5 years x 4/12
months = $4,000
Carry forward amount: $56,000

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Activity 4 Capitalised Development Expenditure
In its first year of trading to 31 December, Eco-chem incurred the
following expenditure on research and development, none of which
related to the purchase of property, plant and equipment.

1. $12,000 on successfully devising processes to convert the sap

extracted from mangroves into chemicals X, Y and Z.

2. $60,000 on developing an analgesic medication based on chemical Z.

No commercial uses have yet been discovered for chemicals X and Y.

Commercial production and sales of the analgesic commenced on 1

September, and are expected to produce steady profitable income during
a five-year period before being replaced. Adequate resources exist for
the company to achieve this.

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Activity 4 Capitalised Development Expenditure
Required:

Assuming no impairment, determine the maximum amount of

development expenditure which may be carried forward at 31
December under IAS 38.

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Activity 4 Answer
Cost

1. This is research expenditure which cannot be capitalised under any

circumstances and must therefore be expensed to profit or loss.

2. Initially recognised cost is $60,000. Residual value is presumed to be

zero.

Amortisation

Amortise from 1 September for a period of 5 years.

Expense for 4 months is: 4/60 × $60,000 = $4,000

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Activity 4 Answer
Carrying amount

This is the maximum carry forward, assuming no impairment.

$60,000 − $4,000 = $56,000.

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Intangible Assets Disclosures
Disclosure Requirements

IAS 38 Intangible Assets include very detailed requirements about what

should be disclosed concerning non-current assets in a set of financial
statements. These disclosures will typically be included in the notes to
the financial statements.

The standard requires a reconciliation between the opening and closing

carrying amounts of the non-current assets prepared and disclosed.

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Intangible Assets Disclosures
Disclosure Requirements

The financial statements should disclose each class of intangible assets:

• Useful lives or amortisation rates used.

• Amortisation methods used.
• Gross carrying amount and accumulated amortisation.
• A reconciliation of the carrying amount at the beginning and the end
of the period showing additions, disposals, amortisation, etc.

The aggregate amount of R&D expenditure recognised as an expense

during the period.

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Example 2
The disclosure note for intangible assets in the financial statements is as
follows:

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Summary

• IAS 38 applies, among other things, to research and development activities. It

defines intangible assets, research and development.
• An intangible asset should be recognised (at cost) only if the asset recognition
criteria are met.
• Purchased goodwill is the difference between what an acquirer pays for a
business as a whole less the fair value of all the individual assets and liabilities
acquired.
• Unlike all other intangible assets, purchased goodwill is not amortised and
never revalued upwards.
• Internally generated goodwill and brands must not be recognised as assets.
• Research is an original investigation undertaken to gain new scientific or
technical knowledge and understanding.

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Summary

• Expenditure on research is recognised as an expense.

• Development includes the application of research findings in designing new
products before commercial production.
• Development expenditure must be recognised as an asset if it meets all the
criteria.
• An intangible asset should be amortised systematically over the best estimate
of useful life.
• Amortisation methods should be reviewed at least annually.
• Residual value is assumed to be zero unless certain conditions are met.

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