Revise lecture 11 1

The nature of goodwill Goodwill is the difference between the value of a business as a whole and the aggregate of the fair values of its separable net assets. Separable net assets are those assets (and liabilities) which can be identifiable and sold off separately without necessarily disposing of the business as a whole. They include identifiable intangibles such as patents, licences and trade marks. 2

Revise lecture 11 Fair value is the amount at which an asset or liability could be exchanged in an arm’s length transaction between informed and willing parties, other than in a forced or liquidation sale. 3

Revise lecture 11 Goodwill may exist because of any combination of a number of possible factors: 1.Reputation for quality or service 2.Technical expertise 3.Possession of favourable contracts 4.Good management and staff 4

Revise lecture 11 Purchased and non-purchased goodwill Purchased goodwill: 1.Arises when one business acquires another as a going concern 2.Includes goodwill arising on the consolidation of a subsidiary or associated company 3.Will be recognised in the financial statements as its value at a particular point in time is certain 5

Revise lecture 11 Non-purchased goodwill: 1.Is also known as inherent goodwill 2.Has no identifiable value 3.Is not recognised in the fianncial statement 6

IAS 38 Research and development (IAS 38) 7

Definitions: Research can be defined as original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding 8

Research and development (IAS 38) Definitions: Development can be defined as 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 start of commercial production or use. 9

Research and development (IAS 38) Accounting treatment of research and development Where a company undertakes research and development, expenditure is being incurred with the intention of producing future benefits. The accounting issue is therefore whether these costs should be expensed to the income statement or capitalised as an intangible asset on the statement of financial position to match to future benefits arising. 10

Research and development (IAS 38) Accounting treatment of research All research expenditure should be written off to the income statement as it is incurred. This is compliance with the prudence concept. Research expenditure does not directly lead to future benefits and therefore it is not possible to follow the matching concept. Any capital expenditure on research equipment should be capitalised and depreciated as normal. 11

Research and development (IAS 38) Accounting treatment of development Development expenditure must be capitalised as an intangible asset provided that certain criteria are met: 1.Separate project 2.Expenditure identifiable and reliably measured 3.Commercially viable 4.Technically feasible 5.Overall profitable 6.Resources available to complete 12

Research and development (IAS 38) If the above criteria (SECTOR) are not met, development expenditure must be written off to the income statement as it is incurred. Once expenditure has been treated as an expense, it cannot be reinstated as an asset. 13

Subsequent treatment of capitalised development expenditure 1.The asset should be amortised over the period that is expected to benefit. This ensures that costs are matched to the revenue in the income statement. 2. Amortisation should commence with commercial production. It should be charged over the period of benefit, and also in proportion to the revenue generated 14

Subsequent treatment of capitalised development expenditure 3. Each project should be reviewed at the year end to ensure that the ‘SECTOR’ criteria are still met. If they are no longer met, the previously capitalised expenditure must be written off to the income statement immediately. 4. If a policy of capitalisation is adopted, it should be applied to all projects that meet the criteria. 15

Amortisation Development expenditure should be amortised over its useful life as soon as commercial production begins. If the useful life of an intangible asset is finite, its capitalised development costs must be amortised once commercial exploitation begins. 16

Amortisation The amortisation method used should reflect the pattern in which the asset’s economic benefits are consumed by the enterprise. If that pattern cannot be determined reliably, the straight-line method should be used. An intangible asset with an indefinite useful life should not be amortised. An asset has an indefinite useful life if there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the business. 17

Disclosure The financial statements should disclose the following for capitalised development costs: 1.The amortisation method used and the expected period of amortisation 2.A reconciliation of the carrying amounts at the beginning and end of the period, showing new expenditure incurred, amortisation and amounts written off because a project no longer qualifies for capitalisation 3.Amortisation during the year 18

Question Which of the following should be classified as development? 1.ABC Ltd has spent Rs300,000 investigating whether a particular substance, flubber, found in the Amazon rainforest is resistant to heat. 2.XYZ Ltd has incurred Rs 120,000 expenses in the course of making a new waterproof and windproof material with the idea that it may be used for ski-wear. 19

Question 3. Apple Ltd has found that a chemical compound, known as TTT, is not harmful to the human body. 4. Boots Ltd has incurred a further Rs450,000 using flubber in creating prototypes of a new heat-resistant suit for stuntmen 20

Answer Both 1 and 3 involve researching materials, without any form of commercial production in mind. Therefore 2 and 4 should be classified as development. 21