INTANGIBLE ASSETS (IAS 38)

RECOGNITION AND MEASUREMENT

Case Study 1
Facts
Brilliant Inc. acquires copyrights to the original recordings of a famous singer. The agreement with
the singer allows the company to record and rerecord the singer for a period of five years. During the
initial six-month period of the agreement, the singer is very sick and consequently cannot record. The
studio time that was blocked by the company had to be paid even during the period the singer could
not sing.

These costs were incurred by the company:

(a) Legal cost of acquiring the copyrights $10 million
(b) Operational loss (studio time lost, etc.) during start-up period $ 2 million
(c) Massive advertising campaign to launch the artist $ 1 million

Required
Which of the above items is a cost that is eligible for capitalization as an intangible asset?
Solution
(a) The legal cost of acquiring the copyright can be capitalized.
(b) “Operational costs” during the start-up period are not allowed to be capitalized.
(c) Massive advertising campaign to launch the artist is not allowed to be capitalized.

Other Internally Generated Intangible Assets

Case Study 2
Facts
Extreme Inc. is a newly established enterprise. It was set up by an entrepreneur who is generally
interested in the business of providing engineering and operational support services to aircraft
manufacturers.

Extreme Inc., through the contacts of its owner, received a confirmed order from a well known
aircraft manufacturer to develop new designs for ducting the air conditioning of their aircraft. For this
project, Extreme Inc. needed funds aggregating to $1 million. It was able to convince venture
capitalists and was able to obtain funding of $1 million from two Silicon Valley venture capitalists.
The expenditures Extreme Inc. incurred in pursuance of its research and development project follow,
in chronological order:

• January 15, 20X5: Paid $175,000 toward salaries of the technicians (engineers and consultants)
• March 31, 20X5: Incurred $250,000 toward cost of developing the duct and producing the test
model
• June 15, 20X5: Paid an additional $300,000 for revising the ducting process to ensure that product
could be introduced in the market
• August 15, 20X5: Developed, at a cost of $80,000, the first model (prototype) and tested it with
the air conditioners to ensure its compatibility
• October 30, 20X5: A focus group of other engineering providers was invited to a conference for
the introduction of this new product. Cost of the conference aggregated to $50,000.

• December 15, 20X5: The development phase was completed and a cash flow budget was prepared.
Net profit for the year 20X5 was estimated to equal $900,000.
Required
What is the proper accounting treatment for the various costs incurred during 20X5?

Solution
Treatment of various costs incurred during 20X5 depends on whether these costs can be capitalized or
expensed as per IAS 38. Although IAS 38 is clear that expenses incurred during the research phase
should be expensed, it is important to note that not all development costs can be capitalized. In order
to be able to capitalize costs, strict criteria established by IAS 38 should be met. Based on the criteria
prescribed by IAS 38, these conclusions can be drawn:

(1) It could be argued that the technical feasibility criterion was established at the end of August
20X5, when the first prototype was produced.

(2) The intention to sell or use criterion was met at the end of August 20X5, when the sample was
tested with the air-conditioning component to ensure it functions. But it was not until October
20X5 that the product’s marketability was established. The reason is attributable to the fact that
the entity had doubts about the new models being compatible with the air conditioners and that
the sample would need further testing, had it not functioned.

(3) In October 20X5, the existence of a market was clearly established.

(4) The financial feasibility and funding criterion was also clearly met because Extreme Inc. has
obtained a loan from venture capitalists and it had the necessary raw materials.

(5) Extreme Inc. was able to measure its cost reliably, although this point was not addressed
thoroughly in the question. Extreme Inc. can easily allocate labor, material, and overhead costs
reliably.
Therefore, the costs that were incurred before October 20X5 should be expensed. The total costs that
should be expensed = $175,000 + $250,000 + $300,000 + $80,000 = $805,000.
The costs eligible for capitalization are those incurred after October 20X5. However, conference costs
of $50,000 would need to be expensed because they are independent from the development process.
Thus there are no total costs to be capitalized in terms of IAS 38.

Case Study 3
Facts
Costs generally incurred by a newly established entity include
(a) Preopening costs of a business facility
(b) Recipes, secret formulas, models and designs, prototype
(c) Training, customer loyalty, and market share
(d) An in-house–generated accounting software
(e) The design of a pilot plan
(f) Licensing, royalty, and stand-still agreements
(g) Operating and broadcast rights
(h) Goodwill purchased in a business combination
(i) A company-developed patented drug approved for medical use
(j) A license to manufacture a steroid by means of a government grant
(k) Cost of courses taken by management in quality engineering management
(l) A television advertisement that will stimulate the sales in the technology industry

Required
Which of the above-mentioned costs are eligible for capitalization according to IAS 38, and which of
them should be expensed when they are incurred?
Solution
Costs that are eligible for capitalization include items (b), (e), (f), (g), and (h); for item (j), after initial
recognition at cost, both the asset and the grant can be recognized at fair value.
These costs are eligible for capitalization under IAS 38 because
• They meet the criteria of “identifiability” (i.e., they are separable or they arise from contractual
rights).
• It is probable that future economic benefits will flow to the entity.
• These costs can be measured reliably.
Costs that should be expensed because they do not meet the criteria under IAS 38 include items
(a), (c), and (d). Item (i) is a case of an internally generated intangible asset that can be capitalized
only provided it meets the development criterion. The main issue with item (k) is that the entity does
not have “control” over its workforce. Despite the obvious benefit of item (l) to the business, such
expenditure on advertisement does not meet the criterion of “control.”
MEASUREMENT AFTER RECOGNITION
Case Study 4
Active Asset Inc. owns a freely transferable taxi operator’s license, which it acquired on January 1,
20X1, at an initial cost of $10,000. The useful life of the license is five years (based on the date it is
valid for). The entity uses the straight-line method to amortize the intangible.

Such licenses are frequently traded either between existing operators or with aspiring operators. At
the
balance sheet date, on December 31, 20X2, due to a government-permitted increase in fixed taxi fares,
the traded values of such a license was $12,000. The accumulated amortization on December 31,
20X2, amounted to $4,000.

Required
What journal entries are required at December 31, 20X2, to reflect the increase/decrease in carrying
value (cost or revalued amount less accumulated depreciation) on the revaluation of the operating
license based on the traded values of similar license? Also, what would be the resultant carrying value
of the intangible asset after the revaluation?

Solution
The journal entries to be recorded in the books of account are

Dr Intangible asset—accumulated amortization $4,000

Cr Intangible asset—cost $4,000
(Being elimination of accumulated depreciation against the cost of the asset)

Dr Intangible asset—cost $6,000

Cr Revaluation reserve $6,000
(Being uplift of net book value to revalued amount)
The net result is that the asset has a revised carrying amount of $12,000 ( $10,000 – $4,000 + $6,000).