Intangible Assets Management and Evaluation - Essay Example

IAS 38 Intangible Assets Introduction According to Powell, 2003, International Accounting Standard (IAS) resulted from issuance by the antecedent International Accounting Standards Council (ISAC), endorsed and amended by the International Accounting Standards Board (IASB). The IAS 38 intangible asset standard remained established with the aim of providing an accounting treatment for intangible assets that not dealt with in other accounting standards. An intangible asset refers to an identifiable non-monetary asset with no physical substance. In addition, the standard also specifies how the carrying amount of the intangible assets is measurable and determines the specified disclosures of the asset (Austin, 2007). Identification of an intangible asset is possible if it attains a specific criterion. The criteria used in the recognition of these assets involve a demonstration by the entity that the item meets the outlined definition of an intangible asset and the recognition criteria. Intangible assets that meet the relevant criteria are measurable at cost, subsequently measured at cost or using the revaluation model and amortized on a systematic basis over their useful lives. However, intangible assets with indefinite useful life are not amortized (Dumitrescu, 2012). Examples of assets that may remain classified as intangible items include trademarks, patents, fishing licenses, and computer software and import duties. An asset is identifiable when it is transferrable separately, rented, exchanged or licensed (Crema and Nosella, 2014). Intangible asset is recognizable if there exist probability of expecting future economic benefits related to asset will flow and entity or cost of the asset that is measurable reliably (Martins and Alves, 2010). Most often, it is confused how intangible assets can be classified as non-monetary when valuing them in the financial statements. In the definition, items such as cash, bank deposits and trade receivables are monetary assets and remains excluded. In addition, brand image and goodwill are intangible assets instances that needs separate identification before inclusion as business assets. Where there exists external acquisition of goodwill and brands, their cost and existence remains identified and capitalized. Internally generated goodwill is not recognizable as an asset since it is not distinguishable from the business. Moreover, goodwill does not arise from contractual or other legal rights. Its cost cannot remain measured reliably (Martins and Alves, 2010). This paper provides an inclusive discussion relating to the IAS 38 intangible asset accounting standard and theories applicable to the standard. It also looks into reporting entities most affected by the standard, academic or non-academic research relevant to the standard and a critical evaluation of the standard. Background of the Standard IAS 38 intangible assets define the inherent accounting practices bestowed on needs for non-tangible assets. Such intangible assets referred inside relates to those assets with no physical substance, non-monetary, and identifiable. The intangible assets have the potential of providing a business with future economic benefits (Lenciu and Matis, 2014). The referred identifiable may either arise from legal rights or be separable. An entity remains fundamental in recognition of intangible assets applicable to this standard after meeting the outlined criteria. In most cases, the intangible assets addressed by standard may remain acquired through exchange services, government grant, separate purchase, self-creation, or section of business combination. Measuring at cost is imperative in determining satisfaction of the inherent relevant criteria outlined for intangible assets for the IAS 38 intangible Assets standard. Subsequent steps in meeting the criteria entails use of revaluation model systematic amortization based on their useful lives (Matolcsy and Wyatt, 2006). Such later steps remains a possibility only of the asset in revaluation possess indefinite useful life. Otherwise, there would follow no amortization process. The inherent intangible assets governed by the standard involve those acquired in business combinations managed after or during March 31, 2004. Development of the standard that governs business combination intangible assets accounting began in February 1977 until its final revision in March 2004. Subsequently, the IAS 38 intangible assets standard has remained amended over the years from 2008 until the latest change in 2014. IAS has the fundamental objective of prescribing the most perceptive accounting practices for the assets mentioned above. Such assets remains as the business combinations not explored particularly with IFRS. By using specifically intangible assets in exception of IAS 38.2-3 with particular disclosures, the standard explains the process of estimating carrying amounts of the assets (Zeghal and Maaloul, 2011). The intangible assets referred within include expenditures relating to extraction of natural resources such as oil, natural gas, and minerals or financial assets. Additional intangible assets relates to those covered by another IFRS including deferred tax assets, intangible held for sale, good will, and employee benefits assets. Moreover, evaluation and exploration assets and insurance contracts entail part of the intangible assets under the standard. Furthermore, the intangible assets include import duties, computer software, fishing licenses, trademarks, and patents. However, there is need to understand reasons why intangible assets are classifiable as non-monetary irrespective of their financial statement value (Zeghal and Maaloul, 2011). Theories Applicable to the Standard The two major theories applicable in the IAS 38 accounting standard include the positive accounting theory and the normative accounting theory. The theories play key role in studies and applications involving financial principles. Accounting theories are subject to changes since the reporting mechanisms evolve through new technological standards, ways of doing business and presence of need gaps. Positive accounting theory Positive accounting theory tries to explain and predict which accounting policies are best fit for various firms. Its basis are facts and aims at performing a critical analysis on the company’s economic statistics or data at hand in order to attain conclusions based on the figures used (Rankin et al, 2012). Moreover, the theory gives an analysis of past financial events and the present financial position of the business. The analysis involves creation of financial documents such as the cash flow statements and balance sheets. The positive accounting theory predicts the financial position of a business by using three major hypotheses: the bonus plan hypothesis, debt covenant hypothesis and the political cost hypothesis (Rankin et al, 2012). Bonus plan hypothesis requires that the firms to use accounting procedures whose overall effect is shifting reported earnings that are of future periods to current period hence increasing the bonuses for the company in the current year. Debt covenant hypothesis requires firms to choose accounting procedures that shift reported earnings to present period from future period whenever the firm is about to violate accounting-based debt covenants. Increased current earnings therefore restrain the firm from violating the debt covenant or any constraints while managing the business. The political cost hypothesis, the firm adopts accounting procedures preferring future reported earnings to the current ones whenever the political costs increase. To achieve positive accounting theory in a firm measures such as timing the adoption of new accounting standards, changing the accounting policies and changing real variables (Sauce and Sale, 2012). Normative accounting theory Normative accounting theory plays a key role in determining and setting future economic policies for a business. These policies include the company’s mission statement or the market strategies among others (Sacui and Sala, 2012). The theory is subjective since it presents subjective morality into the business through value judgment. It uses formulas to determine the economic future of the business instead of observation. In order to establish a proper financial plan in a business, both the positive accounting theory and normative accounting theory need analysis. This is because through normative accounting, financial policies arise. However, the basis of these normative statements is financial realities calculated using positive accounting (Rankin et al, 2012). Both theories are therefore interrelated. IAS 38 accounting standard require empirical research methods to study. Since positive accounting, theory also arises from empirical studies; the IAS 38 standard can form part of the positive accounting theory. IAS 38 standard is therefore an objective type of accounting standard. Research relevant to the Standard IAS 38 necessitates that any project with the ability to cause generation of a resource to the entity grouped as either a research phase or development phase. Research phase describes the original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development phase refers to the application of research findings to a design for manufacture of novel or considerably enhanced products and services before the start of commercial production or use (Lenciu and Matis, 2014). Such expenses undergo accounting treatment based on if they are research or development. However, in some cases, distinctions are inapplicable. According to IAS38, in such a situation, the entire project should undergo research treatment and be expensed through the statement of comprehensive income. Research expenditure is highly speculative whereas development expenditure is less speculative. This is because in research expenditure, there is no certainty that future economic benefits will flow to the entity thus prompting expense via statement of comprehensive income. In development expenditure, future economic benefits that are likely to flow to the entity can be predicted (Violeta and Mariana, 2011). Therefore, capitalization of development expenditure is because it generates future economic benefits. Classification of research and development expenditure is highly subjective and sometimes depends on director’s intention. Reporting entities affected by the standard The IAS 38 standard requires an entity to recognize an intangible asset based on whether or not accomplishments of certain criteria take place. An intangible is a non-monetary asset with no physical substances; several entities control the asset because of past events such as purchase or self-creation and from which future economic benefits such as inflows of cash (Sacui and Sala, 2012). These three critical entities include identifiability; control also referred to as power to obtain benefits from the asset and lastly the future economic benefits such as revenues or reduced future costs. Identifiability An intangible asset remains identifiable when separated. In addition, the intangible asset can remain identified if it is because of contractual or legal rights despite the rights being transferable or separable from, the entity or from other rights and obligations. Acquisition of the intangible assets occurs through exchange of assets, separate purchase, government grant, as section of a business combination or self-creation (Martins and Alves, 2010). The intangible assets include import quotas, customer lists, mortgage servicing rights, franchise agreements, marketing rights, and customer and supplier relationships. Others include video and visionary material, patented technology, computer software, databases and trade secrets, trademarks, trade dress, newspaper mastheads, and internet domains, licensing, royalty and standstill agreements. Recognition criteria According to the IAS 38 standard, an entity should recognize an intangible irrespective of the mode of acquisition. The recognition criteria work if and only if there is a probability that future economic benefits in relation to the asset will flow, entity and cost of the asset that is measurable reliably. The criteria majorly depend on whether the intangible asset remains acquired externally or developed internally. This criterion uses intangible assets acquired separately or in a business combination (Violeta and Mariana, 2011). In addition, the future economic benefits must have based on reasonable and supportable assumptions concerning the conditions expected to exist over the life of the asset. For intangible assets that do not meet the definition and the recognition criterion, their expenditure recognized as an expense whenever it remains incurred. The standard presumes that the fair value of an intangible asset acquired in a business combination measured reliably (Powell, 2003). However, expenditure incurred because of intangible assets that do not meet the recognition criterion remains component of the amount related to the goodwill recognized at the acquisition date. The standard prohibits also the reinstatement of intangible assets expenditure that remained originally charged to expense. Initial recognition can remain carried out based on research and development cost, in which case, all research cost is chargeable to expense. Development costs undergo capitalization depending on whether the establishment of commercial and technical feasibility of the asset for use or sale. However, initial recognition for in process-research and development acquired in business combination is recognizable as an asset at cost (Dumitrescu, 2012). Subsequent expenditure on the project is accountable for as any other research and development cost. There is an initial recognition for all the intangible assets in the IAS 38 accounting standard. Parties with most gain or loss from the standard Parties that gain most from the IAS 38 accounting include businesses involved in intangible assets. For instance, those engage in patented technology, computer software, databases and trade secrets videos and audiovisual material. Others are mortgage-servicing rights, trademarks; trade dress, newspaper mastheads, internet domains, and customer and supplier relationships, customer lists licensing, royalty and standstill agreements. Businesses that engage in marketing rights, patents, goodwill, copyrights, import quotas and franchise agreements (Austin, 2007). Parties that lose most from the IAS 38 accounting standard include businesses that deals in intangible assets that come from insurance contracts emanating from insurance companies, intangible assets covered by other IFRS and general expenditure on the development and extraction of minerals, oil, natural gas and similar resources. Critical evaluation of the standard The major objective of IAS 38 is to predict the accounting treatment offered for intangible assets not dealt with in other IFRS. The standard measures of the carrying amount of intangible assets and necessitates particular disclosures regarding intangible assets. IAS accounting standard applies to all intangible assets in the exception of financial assets, another IFRS covered intangible assets including those held for sale, and exploration and evaluation assets. Others relates to intangible assets emanating from insurance contracts provided insurance companies, and expenditure on the development and extraction of minerals, natural gas, oils and similar resources (Crema and Nosella, 2014). Initial measurement of intangible assets usually carried out at a cost. Measurement to acquisition can remain based on whether the intangible asset remains grouped as a cost model or revaluation model. For the cost model intangible assets, attract a cost less accumulated amortization and impairment losses. For the revaluation model, intangible assets may remain carried at a revalued amount less any consequent impairment and amortization losses when fair value remains established through active market reference (Matolcsy and Wyatt, 2006). The markets, however uncommon, may exist in taxi licenses, fishing licenses and production quotas. Revaluation increases remains recognized in other comprehensive income and accumulated in the revaluation surplus within equity with the exception of the extent that it reveres a revaluation decrease previously recognized in profit or loss. Intangible assets can remain classified based on their useful life as either indefinite or infinite life. In indefinite life, there exists no predictable limit to time that the asset remains expected to produce net cash inflows for the inherent entity. Finite life refers to a limited period of benefit to the entity. Measurement subsequent to acquisition based on finite or infinite lives of an intangible asset can also remain carried out (Zeghal and Maaloul, 2011). Useful life defines the time of expecting production units from specified asset through an entity or availability of the asset for use by an entity. In measuring subsequent to acquisition of intangible assets with finite lives, the cost less residual value of the asset amortized on a systemic basis over that of life. The foundation of the amortization method adopted is the pattern of benefits or by the straight-line method if the determination of the pattern is impossible. It is imperative to review annually the amortization period. The amortization charge is recognizable in profit or loss. However, another IFRS can require the charge to be included in the cost of another asset in which case, the standard stands. Normally, an intangible asset having a limited useful life has its residual value assumed as zero. Such remains a possibility unless there is assurance of purchasing the asset in case of an active market or near the end of its useful life. The residual value will remain acquired via reference to that market (Powell, 2003). An entity has the requirement of testing an intangible asset with imprecise useful life for impairment through comparison of its annual carrying amount with its recoverable amount. Such is imperative whenever there is an indication that the intangible asset may face impairment. In the measurement of subsequent to acquisition of intangible assets with indefinite useful lives, the asset should not remain amortized. Its useful life is reviewable every period of reporting to establish whether circumstances and events persist in supporting an indefinite useful life appraisal for that asset (Powell, 2003). If they do not, the change in the useful life assessment from indefinite to finite should remain accounted for as a change in an accounting estimate. Full good will approach The full goodwill approach remained adopted as an alternative to purchased goodwill approach. The dissimilarity between the inherent approaches is that in full goodwill approach, recognition of the whole goodwill of acquired business remains performed. However, in purchased approach goodwill, only the acquirer’s share of goodwill is attainable. Moreover, good will is measurable as the difference between aggregate of the consideration transferred. Such measurement is possible at acquisition date fair value at the amount of any non-controlling interest or that of the acquirers previously held equity interest (Violeta and Mariana, 2011). Non-controlling interests can remain measured using either of the two alternative techniques relating to fair value or the non-controlling interests proportionate share of identifiable net assets. Due to the nature of intangible assets, subsequent expenditure will only rarely meet the criteria for recognition in the carrying amount of an asset. Subsequent expenditure on brands, publishing titles, mastheads, customer lists among others must always remain recognized in profit or loss as incurred. The following should remain disclosed in each class of intangible asset; gross carrying amount, useful life or amortization rate, gross carrying amount, and line items in the income statement. Additional disclosures includes accumulated amortization and impairment losses, reconciliation of the carrying amount at the beginning and end of particular periods, and contractual commitments to acquire intangible assets. In addition, it is imperative to disclose the basis for determining whether an intangible asset has an indefinite life. It extends to information about intangible assets whose title is restricted, description and carrying amount of individually material intangible assets, and certain special disclosures about intangible assets acquired by way of government grants (Austin, 2007). Recommendations Recommendations proposed about the IAS 38 include: Improvement of relevance by IAS 38 allowing the reinstatement of previously expensed costs. Future economic benefits of research and development activities in an enterprise are usually uncertain. If the internally generated intangible resources do not cause any, economic benefits at the initial stage, exposure of their cost takes place once incurred (Austin, 2007). Improvement of reliability and comparability, by establishing IAS 38 rules that determine how an enterprise can prove that internally generated intangible assets produce probable future economic benefits The ED 2013/6 leases proposal to have a change in the accounting procedure for leases. It also proposes that IAS 38 should remain amended to eliminate reference to IAS 17 and financial leases. The IASB propose adoption of new standards on the insurance contracts. Their aim is to amend the IAS 38 and eliminate all insurance contracts from the scope of IAS 38. Conclusion An intangible asset is recognizable only if the cost of the asset valuation is reliable. It is probable that the asset will result in a flow of economic benefits to an entity and it meets the definition of an intangible asset (Dumitrescu, 2012). Most of the costs associated with most internally generated intangible assets face exposure to profit or loss with the exception of the development costs. For subsequent initial recognition, it is required that an entity should choose either revaluation model or cost for each class of intangible assets. However, revaluation model may also find application when determining fair value by reference to an active market. Intangible assets with a finite life must remain amortized on a systematic basis over their useful life. Moreover, there should be no amortization of intangible assets with an infinite life. However, it is essential to assess all intangible assets for impairment in accordance with the standard. References Austin, L. (2007). Accounting for intangible assets. University Of Auckland Business Review, 9(1), 63-72. Crema, M., & Nosella, A. (2014). Intangible Assets Management and Evaluation: Evidence from SMEs. Engineering Management Journal, 26(1), 8-20. Dumitrescu, A. S. (2012). Intangible Assets: Are These Resources Sufficiently Visible And Properly Controlled?. Accounting & Management Information Systems / Contabilitate Si Informatica De Gestiune, 11(4), 545-563. Ienciu, N. M., & Matiş, D. (2014). Inflection points in the development of IAS 38. 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(2011). The Intangible Assets Investments Characteristics and the Accounting Treatment. Annals of the University Of Oradea, Economic Science Series, 20(1), 295-300. Zéghal, D., & Maaloul, A. (2011). The accounting treatment of intangibles – A critical review of the literature. Accounting Forum, 35(4), 262-274. doi:10.1016/j.accfor.2011.04.003 Read More