F3 Financial Accounting

LECTURER: Marlon Smith

Class Notes 6 – Intangible non-current assets

Intangible assets
Intangible assets are long-term assets, which have a value to the business because they have been paid for,
but which do not have any physical substance. Example of intangible includes goodwill, patents, research
and deferred development costs, performing rights and authorship rights.

Accounting for intangible assets

Intangible assets are usually capitalised in the accounts and amortised over the estimated economic life of
the intangible assets. Using the accrual concept, amortisation is intended to write off the asset over its
economic life.

Example

A business buys a patent for $50,000. It expects to use the patent for the next ten years, after which it will
have no value.

Research and development cost

Companies spent large amount of money on research and development (R&D). The accounting problem
is how to treat the debit balance on the R&D account.

There are two possible treatments that companies can take, either

• Transferred the balance to the income statement

• The amount on the account could be capitalised (deferring the expenditure) in the statement of
financial position, the argument is based on the accrual concept. Therefore if the R&D activity ‘bears
fruit’ in the future, which will generate revenue, the cost being carried forward can be matched against
revenue in future accounting periods.

IAS 38 Intangible assets were developed to deal with the treatment of research and development costs.
The standard was published in September 1998 and was revised in March 2004.

The standard gives the following definitions

• An intangible asset is an identifiable non-monetary asset without physical substance. The asset must
be:

- Controlled by the entity as a result of past events; and

- Something from which the entity expects future economic benefits to flow
F3 Financial Accounting
LECTURER: Marlon Smith
Class Notes 6 – Intangible non-current assets

• Research is the original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.

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

• Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its
useful life. Amortisation period and amortisation method should be reviewed at each financial year-
end.

• Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual
value.

• Useful life is:

(a) The period over which an asset is expected to be available for the use by an entity; or

(b) The number of production or similar units expected to be obtained from the asset by an entity.

The standard goes on to give example of activities which might be included in either research or
development or which are neither but may be closely associated with both.

Research
- Activities aimed at obtaining new knowledge

- The search for application of research findings or other knowledge

- The search for product or process alternatives

- The formulation and design of possible new or improved product or process alternatives

Development
- The design, construction and testing of pre-production prototypes and models

- The design of tools, jigs, moulds and dies involving new technology

- The design, construction and operation of a pilot plant that is not of a scale economically feasible
for commercial production

- The design, construction and testing of a chosen alternative for new/improved materials
F3 Financial Accounting
LECTURER: Marlon Smith
Class Notes 6 – Intangible non-current assets

Components of R&D costs

Research and development cost will involve those costs that are directly attributable to research and
development activities, or that can be allocated on a reasonable basis.

The standard lists the costs that may be included in R&D, where applicable

• Salaries, wages and other employment related costs of personnel engaged in R&D activities

• Costs of materials and services consumed in R&D activities

• Depreciation of property, plant and equipment to the extent that these assets are used for R&D
activities

• Overhead costs, other than general administrative costs, related to R&D activities; these costs are
allocated on bases similar to those used in allocating overhead costs to inventories

• Other costs, such as the amortisation of patents and licences, to the extent that these assets are used for
R& D activities.

Recognition of R&D costs

Recognition of R&D cost as an asset will only occur where it is probable that the cost will produce future
economic benefits for the entity and where the cost can be reliable measured.

(a) In the case of research costs, this will not be the case due to uncertainty about the resulting benefit
from them and therefore should be expensed in the period in which they are incurred.

(b) Development activities tend to be much further advanced than research stage and so it may be possible
to determine the likelihood of future economic benefit. Where this can be determined, the
development costs should be carried forward as an asset.

Research costs should be recognised as an expense in the period in which they are incurred. They should
not be recognised as an asset in later period.

Development costs, in most instances, will be recognised as an expense in the period in which they are
incurred unless the criteria for asset recognition identified below are met. Development cost initially
recognised as expensed should not be recognised as an asset in later period.

Development expenditure should be recognised as an asset only when the business can demonstrate all of
the following.

• The technical feasibility of completing the intangible asset so that it will be available for use or sale

• Its intention to complete the intangible asset and use or sell it

F3 Financial Accounting
LECTURER: Marlon Smith
Class Notes 6 – Intangible non-current assets

• Its ability to use or sell the intangible asset

• How the intangible asset will generate probable future economic benefits. The entity should
demonstrate the existence of a market for the output of the intangible asset itself, or if it is to be used
internally, the usefulness of the intangible asset

• The availability of adequate technical, financial and other resources to complete the development and
to use or sell the intangible asset

• Its ability to measure reliably the expenditure attributable to the intangible asset during its
development

The development cost of a project recognised as an asset should not exceed the amount that it is probable
will be recovered from related future economic benefits, after deducting further development costs,
related to production costs, and selling and administrative costs directly incurred in marketing the product.

Amortisation of development costs

Development cost that have been capitalised must be amortised and recognised as an expense to match the
costs with the related revenue or cost savings. This must be done on a systematic basis, so as to reflect the
pattern in which the related economic benefits are recognised.

The entity must consider either:

(a) The revenue or other benefits from sale or use of the product or process

(b) The period of time over which the product or process is expected to be sold or used

If the pattern cannot be determined reliably, the straight-line method should be used. Once the intangible
asset is available for use it should be amortised.

Where an intangible asset is considered having an indefinite useful life, it should not be amortised but
should be subjected to an annual review.

Impairment of development costs

Impairment is the fall in value of an asset. Development costs should be written down to the extent that
the unamortised balance is no longer probable of being recovered from the expected future economic
benefit.

Disclosure requirement of R& D

IAS 38 Intangible assets have fairly extensive disclosure requirements. The financial statements should
disclose the accounting policies for intangible assets that have been adopted.
F3 Financial Accounting
LECTURER: Marlon Smith
Class Notes 6 – Intangible non-current assets

For each class of intangible assets (including development costs), disclosure is required of the following.

• The method of amortisation used

• The useful life of the assets or the amortisation rate used

• The gross carrying amount, the accumulated amortisation and the accumulated impairment losses as at
the beginning and the end of the period

• A reconciliation of the carrying amount as at the beginning and at the end of the period (additions,
retirements/disposals, revaluation, impairment losses, impairment losses reversed, amortisation charge
for the period, net exchange differences, other movements)