Intangible assets as per IAS 38 - Essay Example

Intangible assets as per IAS 38 a) Reasons for development of IAS 38 in current form For analyzing the reasons for the development of IAS 38 in itspresent form, it is important to understand its treatment to intangible assets, both internally and externally generated. IAS 38 treats an intangible asset as an identifiable non-monetary asset without physical substance held for use. Briefly, there are three compulsory ingredients of an intangible asset, namely: a) Identifiability, b) Control, i.e., its power to obtain benefits from assets, and c) Future economic benefits. IAS 38 applies to all intangible assets except (i) financial assets, (ii) mineral rights and exploration and development costs incurred by mining and oil and gas companies, (iii) intangible assets arising from insurance contracts issued by insurance companies, and (iv) intangible assets covered by another IAS such as intangibles held for sale, deferred tax assets, assets arising from employee benefits, and goodwill (IAS 38.1) Rules laid down by IAS 38 with regard to recognition of intangible assets are as under: i) Initial measurement of an intangible asset should be at cost or its fair value. ii) Research costs are treated as expense of the period, whereas development costs are capitalized. The entire cost of research and development will be charged to revenue when enterprise is unable to distinguish between expenditure for research phase and expenditure for development phase. iii) Internally generated brands, mastheads, publishing titles, customer lists etc. are not recognized as intangibles. iv) Intangibles need to be recognized only if it is probable that future economic benefits attributable to intangibles will flow to the enterprise (IAS 38.21), and when cost of intangibles can be measured reliably. v) When these criteria are not met, IAS 38.68 clearly states that expenditures on these items should be recognized as expense when those are incurred. vi) With regard to measurement subsequent to initial recognition, IAS 38.74 seeks benchmark treatment that is to say intangible assets should be carried at cost less amortization and impairment losses. An alternative to this is revaluation model suggested by IAS 38.75, whereby intangible assets may be carried at fair value with reference to active market less any subsequent amortization and impairment losses. It is noted that IAS 38 grants recognition to certain specific types of intangible assets only on fulfillment of certain criteria. The controversial issues surrounding IAS 38 are matters concerning recognition of: a) Research and development expenses b) Intangible assets during business combinations, c) Internally generated intangible assets; and d) Upper limit of useful life of intangible assets However, during the development stages of IAS 38 these issues were considered and debated at different forums before being incorporated in their present form depicted in IAS 38. The major reasons for the present form of these controversial issues are analyzed as under: 1. IAS 38 does not recognize internally generated goodwill, mastheads, publishing titles, and similar items as assets. In addition, the standard divides research and development expenses into two phases, those incurred during research phase, and other incurred during development phase. Research phase costs are required to be expensed with, whereas development phase costs will be capitalized and then amortized. A careful study reveals that upon such treatment the income statement will displays higher income or lower losses. Also the ‘the company must a) intend to complete the intangible asset and use it or sell it and also must demonstrate the technical feasibility of doing so; b) prove the availability of adequate technical, financial, and resources to complete the development phase and the firm’s ability to use or sell the asset, offering substantiation such as business plans and letters from lenders as necessary; and c) show how the asset will generate probable future economic benefits, including the existence of a market, for the assets or its output, or if the item is to be used internally, its usefulness.’1 2. The IAS 38 presumes that intangible assets acquired in business combination can be measured reliably (IAS 38.35). Accordingly, such an acquisition of intangible assets should be recognized instantly. The standard further elaborates that intangible item in business combinations that does not meet both the definition of and recognition criteria for an intangible asset should form part of goodwill recognized at acquisition date. The reason for such a stand is that ‘the board replaced its presumption that sufficient information should always exist to measure reliably the fair value of such an asset by a rebuttable position that it is “normally” possible to measure it with sufficient reliability to qualify for recognition separately from goodwill. This change, which resulted from comments received during the field tests, acknowledges that it is very difficult in some cases to measure the fair values of individual intangible assets’2 3. According to The International Accounting Standards Committee (IASC) ‘ the development of IAS 38 was controversial and raised debates on two significant issues in particular: The first issue was whether internally generated intangible assets should be recognized in the financial statements- the standard confirms they should be but only certain strict criteria are met; The second issue is whether there should be an arbitrary upper limit on the useful life of intangible assets- although there is a presumption that useful life of intangible assets will not exceed 20 years, they are required to perform a rigorous impairment test (test for loss of value) annually and to disclose the reasons that justify the amortization period.’3 4. There is no readily available active market to evaluate the internally generated intangible assets. Accordingly, fair value for these assets cannot be assessed, and hence the basic criteria of recognition remains uncomplied. That is why the standard does not recommend the capitalization of these expenses. Kevin Stevenson, Chairman of IFRIC while commenting on the interpretation of IAS 38 said, “The interpretation clarifies the existing requirements of IAS 38, Intangible assets, as it applies to expenditure on internally developing and operating a web site. If an enterprise applies the interpretation and the outcome is to recognize the web site as an intangible asset, then unless the website has an active market and its carrying amount is revalued regularly, the enterprise will need to amortize the expenditure over a short period.”4 The basic issue is that internally developed intangible assets remains unvalued in absence of an active market for them, which forces IAS 38 not to capitalize those expenditure and amortize over a period. The above reasoning clearly justifies to an extent the present status of the standard. It is true that controversies are part of accounting treatment of business development process and that is why IAS 38 have already been revised sensing the need of the time. b) Justification for removal of current differences in treatment of intangible assets. IAS 38 does not recognize all intangibles as assets and thereby invokes various controversies. Intangible assets are important components of many enterprises. It is stressed that all intangible assets should be treated in a consistent way so that financial statements present really a true and fair view of business and other activities of organizations. Lack of consistent approach erodes the creditability and comparability qualities of financial statements. IAS 38 require a thorough revision because of the under noted reasons: 1. There should be uniform treatment of all types of intangible assets, whether monetary or non- monetary. There is no answer as to why financial assets have been left out to be recognized by IAS 38. 2. The standard has not treated the recognition of research and development expenses on some logical accounting grounds. When the entire expenditure whether incurred in research phase or development phase is going to bring in future economic benefits to the organization, then why there are two different treatments to expenditure on one particular created asset. IAS 38 does not specify the reasonability of expensing the research expenses and capitalizing the expenses during development stage, when the object of expenditure at both stages is same. 3. Where an intangible asset is the result of a contract or agreement, amortization of expenditure on such intangible asset should occur over the period of that contract or agreement. IAS 38 is silent on this issue. 4. In case of revaluation of an intangible asset the following normal rules of revaluation should apply, namely i) The entire class of assets should be revalued. ii) Increase in value on revaluation should become part of shareholders’ equity. iii) Decrease in value should be recognized as expenditure to be written off in the period of revaluation. 5. Intangible assets having indefinite useful life ask for an accounting treatment similar to goodwill. All these and other controversial issues ask for fresh debate on IAS 38, so that a uniformity and coherence of its interpretations prevails in respect of all types of intangible assets. Not only current differences are required to be removed, also there is need for a complete overall review of IAS 38 keeping in view dramatic developments in the field of intangible assets. References: 1 ‘Elaborating on R & D’ by Joseph R. Oliver, PhD, CMA, CFM, CPA, published in October 2003 issue of CPA Journal, http://www.nysscpa.org/cpajournal/2003/1003/nv/nv14.htm 2 ‘Adoption of amended IAS 36 Impairment of assets and amended IAS 38 Intangible assets’ a report on behalf of EFRAG ( European Financial Reporting Advisory Group), page 2, http://ec.europa.eu/internal_market/accounting/docs/ias/efrag/efrag-2004-06a-endorsement-letter_en.pdf 3 International Accounting, http://www.ll-a.fr/intangibles/international_accounting.htm 4 IASBs International Financial Reporting interpretation committee (ifric) issues an interpretation on website costs, 25th March, 2002, http://www.iasb.org/News/Press+Releases/Archive/2002/IASBs+International+Financial+Reporting+interpretations+committee+(ifric)+issues+an+interpretation+o.htm Read More