Accounting for intangibles

Accounting for intangibles
Chapter 8 Accounting for intangibles Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Objectives of this lecture
Understand what types of assets can be considered intangible assets and understand the differences between intangible and tangible assets Understand when expenditure on intangible assets should be recognised as an asset Understand when expenditure on intangible assets must be expensed Understand that intangible assets will either need to be systematically amortised or be the subject of impairment testing and that this choice will depend upon whether the asset is expected to have a limited useful life or an indefinite life Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Objectives (cont.) Understand how to account for research and development expenditure Be able to describe some empirical research that has been undertaken on corporate accounting practices relating to research and development Be able to define goodwill and explain how it is calculated for accounting purposes Be able to evaluate whether the recent changes in accounting standards pertaining to intangibles led to an improvement in the information available to financial statement users Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Definition of intangible assets
Non-monetary assets without physical substance Includes patents, goodwill, mastheads, brand names, copyrights, research and development, and trademarks The lack of physical substance does not preclude an item from being considered to be an asset Intangible assets, as a category, must be separately disclosed in the statement of financial position (balance sheet) Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Definition of intangible assets (cont.)
Identifiable vs unidentifiable intangible assets Identifiable intangible assets A specific value can be placed on each individual asset, and they can be separately identified and sold For example, brand names, trademarks, research and development, patents, licences, mastheads and copyrights Internally generated intangibles (other than those relating to development expenditure, if certain criteria are satisfied) must be expensed as incurred ‘Internally generated’—if developed within the organisation rather than being acquired at cost from an external party Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Identifiable vs unidentifiable intangible assets (cont.) Unidentifiable intangible assets Intangible assets that cannot be separately sold For example, goodwill The recognition of internally generated goodwill is prohibited The unidentifiable intangible asset of goodwill is permitted to be recognised for accounting purposes only when it has been externally acquired and not when it has been internally generated (AASB 3) Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Identifiable vs unidentifiable intangible assets (cont.) Greater value nowadays being placed on intangible assets for many companies—valuation an important issue Many intangible assets to be expensed—not appearing on the statement of financial position Many internally generated intangibles must be written off as incurred despite the fact that these ‘assets’ are often expected to generate future economic benefits—a VERY restrictive (conservative) approach How informative is financial accounting in respect of providing information about valuable intangible assets? Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

AASB 138 Intangible Assets
Which intangible assets can be recognised and included in the statement of financial position? AASB 138 Intangible Assets Internally generated intangible assets (except internally generated development expenditure) are not to be carried forward as assets Specifically, paragraph 63 states: Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

AASB 138 Intangible Assets (cont.)
Which intangible assets can be recognised and included in the statement of financial position? (cont.) AASB 138 Intangible Assets (cont.) Intangible assets may be recognised only upon acquisition from an external party and only when there is an associated ‘cost’ ‘Cost’ to include purchase price (including legal fees, taxes and deducting discounts) and cost involved in getting asset ready for use Initial recognition of an intangible asset at an amount other than cost not permitted Internally generated intangibles cannot subsequently be recognised through revaluation Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Which intangible assets can be recognised and included in the statement of financial position? (cont.) AASB 138 Intangible Assets (cont.) Intangible assets other than goodwill are required to be separable if they are to be recognised as assets for statement of financial position (balance sheet) purposes ‘Separable’ refers to being able to rent, sell, exchange or distribute the specific future economic benefits attributable to the asset without also disposing of future economic benefits that flow from other assets used in the same revenue-earning activity Intangible asset (as per all assets) must be recognised when: it is probable that the future economic benefits attributable to the asset will flow to the entity cost can be measured reliably there is control over the future economic benefits Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

What is the initial basis of measurement of intangible assets?
AASB 138 Intangible Assets With the exception of expenditure incurred on development activities, only acquired intangibles may be recognised for balance sheet purposes Expenditure on internally generated intangibles does not qualify for deferral (asset recognition) and must be expensed Cost of an asset to include the cost of acquiring the asset and preparing it for use Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

What is the initial basis of measurement of intangible assets? (cont.)
AASB 138 Intangible Assets Once an item of expenditure related to an intangible asset has been written off (expensed) it must stay written off (VERY conservative!). As paragraph 71 of AASB 138 states: Expenditure on an intangible item that was initially recognised as an expense shall not be recognised as part of the cost of an intangible asset at a later date Acquired intangible assets may be revalued to fair value only where there is an ‘active market’ for such assets Refer to Worked Example 8.1 on page 253—Capitalising expenditure on intangible assets Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

General amortisation requirements for intangible assets
Intangible assets (other than goodwill) that are considered to have a limited useful life are required to be amortised over their useful lives Useful life of an intangible asset under AASB 138 The period of time over which the asset is expected to be used by the entity, or the number of production or similar units expected to be obtained from the asset by the entity If the life of an intangible asset is limited by time a method of amortisation based on time would be used Amortisation shall begin when the asset is available for use, that is when it is in a location and condition necessary for it to be capable of operating in the manner intended by management (same rule as with depreciation of property, plant and equipment) Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

General amortisation requirements for intangible assets (cont.)
In determining the amortisation charge of an asset we need to consider the expected residual value of the asset Under AASB 138 the residual value of intangible assets with finite lives is generally considered to be zero, unless: there is a commitment by a third party to purchase the asset at the end of its useful life, or there is an active market for the asset, and the residual amount can be determined by reference to that market and it is probable that the market will still exist at the end of the useful life of the asset Useful life, residual value and amortisation method to be reviewed annually Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Useful life of an intangible asset (AASB 138, par. 90) Many factors need to be considered in determining the useful life of an intangible asset, including: the expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team typical product life cycles for the asset and public information on estimates of useful lives of similar types of assets that are used in a similar way technical, technological, commercial, or other types of obsolescence the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Useful life of an intangible asset (AASB 138, par. 90) (cont.) Many factors need to be considered in determining the useful life of an intangible asset, including (cont.): (e) expected actions by competitors or potential competitors the level of maintenance expenditure required to obtain expected future economic benefits from the asset and the entity’s ability and intent to reach such a level the period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases whether the useful life of the asset is dependent on the useful life of other assets of the entity Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Amortisation method should reflect the pattern in which the economic benefits are derived—if the pattern cannot be determined reliably, the straight-line amortisation method is to be used Intangible assets may have an ‘indefinite life’ No foreseeable limit on the period over which the asset is expected to generate cash flows If the asset has an indefinite life there is no requirement to amortise—instead the asset should be subject to impairment testing at the end of each reporting period If there is an impairment in the value of the asset (recoverable amount less than carrying amount) it is to be shown as an expense Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

The assumption that an asset has an indefinite life (and therefore does not have to be amortised) is to be reviewed annually and the entity is to disclose reasons supporting the view that the asset has an indefinite life If there has been a change in the pattern of consumption of the future economic benefits embodied in the asset, the amortisation method shall be changed to reflect the changed pattern Such changes shall be accounted for as changes in accounting estimates in accordance with AASB 108 Amortisation charges to be expensed unless another standard requires the amount to be included in the carrying amount of another asset (e.g. added to cost of inventory) Amortisation to start when the intangible asset is ready for use Refer to Worked Example 8.2 on page 255—Determining the amortisation expense Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Revaluation of intangible assets
AASB 138—intangible assets may be revalued only if there is an ‘active market’ Only assets that have been acquired at cost can subsequently be revalued Active market defined as: a market exhibiting all of the following: the items traded are homogeneous, willing buyers and sellers can normally be found, and prices are publicly available It is ‘uncommon’ for active markets to exist for most intangible assets because of their unique nature Therefore, intangible assets can typically not be revalued – This has obvious implications for the possible undervaluation of assets as shown in a statement of financial position Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Revaluation of intangible assets (cont.)
Where revaluation occurs it must be to fair value of asset An amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction Revaluations to be done regularly so that recorded value does not differ materially from fair value at balance sheet date Subsequent to revaluations any amortisation charges to be based on revalued amount taking into account remaining useful life Revaluations of goodwill are not permitted in Australia, whether internally generated or externally acquired Refer to Worked Example 8.3 on page 258—Revaluation of intangible assets Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Required disclosures in relation to intangible assets
Numerous disclosures are required by AASB 138 Financial statements are to disclose the following for each class of intangible assets, distinguishing between internally generated and other intangible assets: Whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortisation rates used The amortisation methods used for intangible assets with finite useful lives The gross carrying amount and any accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period The line item(s) of the statement of comprehensive income in which any amortisation of intangible assets is included Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Required disclosures in relation to intangible assets (cont.)
(e) A reconciliation of the carrying amount at the beginning and end of the period showing: additions, indicating separately those from internal development, those acquired separately, and those acquired through business combinations retirements and disposals increases or decreases during the period resulting from revaluations and from impairment losses recognised or reversed directly in equity impairment losses recognised in the income statement during the period impairment losses reversed in the income statement during the period any amortisation recognised during the period Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Financial statements are also to disclose: (a) if an intangible asset is assessed as having an indefinite useful life, the carrying amount of that asset and the reasons supporting the assessment of an indefinite useful life. In giving these reasons the entity is to describe the factor(s) that played a significant role in determining that it has an indefinite useful life (b) a description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial statements of the entity as a whole Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Financial statements are also to disclose: (cont.) (c) for intangible assets acquired by way of a government grant and initially recognised at fair value: the fair value initially recognised for these assets their carrying amounts whether they are carried under the benchmark or the allowed alternative treatment for subsequent measurement Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Financial statements are also to disclose: (cont.) (d) the existence and carrying amounts of intangible assets whose title is restricted and the carrying amounts of intangible assets pledged as security for liabilities (e) the amount of contractual commitments for the acquisition of intangible assets Note: Additional disclosures are required in relation to research and development expenditure Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Research and development
Introduction AASB 138 applies to intangible assets generally—however, there are a number of paragraphs dealing specifically with research and development Research and development May account for a large proportion of expenditure for some entities Accounting problem: will expenditure with reasonable probability provide future benefits? AASB 138 applies the simplifying assumption that all expenditure undertaken on the research component of research and development is to be expensed Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Research and development (cont.)
Considered separately from development Generally precedes development Research is defined as: original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding Development Defined as (AASB 138, par. 8): 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 prior to the commencement of commercial production or use Typically involves the commercial application of knowledge generated in earlier research phases Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Development examples The design, construction and testing of preproduction or pre-use prototypes and models The design of tools, jigs, moulds and dies involved in 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 or improved materials, devices, products, processes or systems Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Research expenditure— to be written off as incurred AASB 138, par. 54 No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research shall be recognised as an expense when incurred In justifying the above requirement: AASB 138 (par. 55) In the research phase of an internal project, an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. Therefore, this expenditure is recognised as an expense when it is incurred Is the above requirement too conservative? Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Development expenditure can be deferred only if the entity can show all of the following (AASB 138, par. 57): The technical feasibility of completing the intangible asset Its intention to complete the intangible asset, and use or sell it Its ability to use or sell the intangible asset; how the intangible asset will generate probable future economic benefits, including the existence of a market for the intangible asset or, where the intangible asset is to be used internally, its usefulness The availability of adequate technical, financial and other resources to complete the development Its ability to measure reliably expenditure on the intangible asset during its development Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Tests for deferral similar to the case with other intangible assets An intangible asset should be recognised if, and only if: it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise, and the cost of the asset can be measured reliably Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Additional key issues Where the total of the deferred development costs exceeds the expected recoverable amount, the deferred costs must be written down to the recoverable amount Expenditure written off in one period may not be subsequently written back onto the statement of financial position (balance sheet). General principle (AASB 138, par. 71): Expenditure on an intangible item that was initially recognised as an expense shall not be recognised as part of the cost of an intangible asset at a later date Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Additional key issues (cont.) Expenditure written off AASB 138 is inconsistent with AASB Framework (par. 87)—however, accounting standard takes precedence. The AASB Framework states: - An item that, at a particular point in time, fails to meet the recognition criteria in paragraph 83 may qualify for recognition at a later date as a result of subsequent circumstances or events Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Requirement to write off all research expenditure as incurred Will result in much research activity that in fact does lead to subsequent economic benefits nonetheless having to be written off Major implications for reported profits of entities that are heavily involved in R&D Less conservative than US position, where all research and development expenditure must be expensed as incurred regardless of whether or not it generates, or is expected to generate, economic benefits Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Costs included as part of research and development Costs of internally generated assets (e.g. research and development) are all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by management (AASB 138, par. 66) Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Examples of directly attributable costs are: costs of materials and services used or consumed in generating the intangible asset costs of employee benefits (as defined in AASB 119 ‘Employee Benefits’) arising from generation of the intangible asset fees to register a legal right amortisation of patents and rights that are used to generate the intangible asset Refer to Worked Example 8.4 on page 26—Amortisation of research and development Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Amortisation of deferred development costs AASB 138 provides a number of requirements for the amortisation of intangibles, which also apply to any development expenditure that has been capitalised and deferred to future periods Amortisation can be based on (whichever is appropriate): output levels, or expiration of time Refer to Worked Example 8.5 on page 263—Amortisation of deferred development costs Refer to Worked Example 8.6 on pp —Calculating deferred development balances Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Empirical research Requiring write-off of R&D expenditure caused smaller US R&D firms to reduce R&D expenditure Requiring write-off of R&D might affect management decisions about R&D expenditure if management compensation is based on profits It will be interesting to investigate whether Australia becomes less competitive in terms of research and development now that all research must be expensed as incurred Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Goodwill What is goodwill?
Arises when one entity acquires another entity, or part thereof, e.g. one company acquires a controlling interest in another entity An unidentifiable intangible asset that cannot be individually identified and is an intrinsic part of the business Cannot be purchased or sold separately, but only as part of an entity in its entirety Represents the future economic benefits associated with an existing customer base, efficient management, reliable suppliers, etc. Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Goodwill (cont.) What is goodwill? (cont.)
Could be built up over a number periods (internally generated) or obtained (purchased) by acquiring an existing business The relevant accounting standard is AASB 3 Business Combinations, which defines goodwill as: An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Goodwill (cont.) Internally generated versus purchased goodwill
Goodwill may be internally generated or acquired by purchasing an existing business Only purchased goodwill is permitted to be recorded. The view is that: purchased goodwill can be measured more reliably than internally generated goodwill, based on the amount paid Internally generated goodwill cannot be brought to account Purchased goodwill is measured as: the excess of the cost of acquisition (purchase consideration plus incidental expenses) incurred by the acquirer over the fair value of the identifiable net assets and contingent liabilities acquired Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Goodwill (cont.) How is goodwill measured?
As we just learned, purchased goodwill is measured as the excess of the cost of acquisition (purchase consideration plus incidental expenses) incurred by the acquirer over the fair value of the identifiable net assets and contingent liabilities acquired In relation to the above measurement rule, ‘fair value’ is: the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction Purchase consideration: should be measured at the fair value of what is given up in the exchange Refer to Worked Example 8.7 on page 269—Calculation of goodwill Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Illustration Range Ltd acquired a business for the following consideration: Cash $50 000 Land—Book value $90 000 Fair value $ Shares in Range Ltd—fair value $60 000 Legal fees relating to acquisition $10 000 Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Illustration (cont.) The business being acquired had the following assets and liabilities (there were no contingent liabilities): Liabilities Bank loan $50 000 Creditors $30 000 Assets Plant and equipment $ Motor vehicle $30 000 (the plant and equipment and motor vehicle have fair value of $ and $30 000, respectively) HOW MUCH GOODWILL WAS ACQUIRED? Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Illustration—Solution
Fair value of consideration Cash $50 000 Land $ Shares $60 000 Legal fees $10 000 TOTAL $ Net assets acquired Plant and equip. $ Motor vehicles $30 000 $ Less: Liabilities $ $ Goodwill $ Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Illustration—Solution (cont.)
Dr Plant and equipment Dr Motor vehicle Dr Goodwill Cr Bank loan Cr Creditors Cr Cash Cr Legal fees payable Cr Land Cr Gain on disposal of land Cr Share capital Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Impairment of goodwill
Impairment testing Requirement to amortise goodwill was removed in 2005 and replaced with requirement to undertake annual ‘impairment testing’ AASB 3 (par. 55) Goodwill acquired in a business combination shall not be amortised. Instead, the acquirer shall test it for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired, in accordance with AASB 136 ‘Impairment of Assets’ AASB 136 (par. 124) An impairment loss recognised for goodwill shall not be reversed in a subsequent period Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Impairment of goodwill (cont.)
Key terms Impairment loss (under AASB 136) The amount by which the carrying amount of an asset or cash-generating unit exceeds its recoverable amount Recoverable amount of an asset (under AASB 136) The higher of its fair value less costs to sell and its value in use Value in use Present value of the future cash flows expected to be derived from an asset or cash-generating unit Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Impairment of goodwill (cont.)
Accounting for impairment loss of goodwill Dr Impairment loss—goodwill Cr Accumulated impairment loss—goodwill Note: Prohibition on revaluing goodwill—if the recoverable amount of goodwill is assessed as being greater than the carrying value then no revaluation may be made Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Impairment of goodwill—Worked Example 8.8 (p. 271)
It will be necessary to allocate purchased goodwill to specific cash-generating units (if there is more than one CGU) A cash-generating unit is: the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Impairment of goodwill— Worked Example 8.8 (cont.)
Where the recoverable amount of a cash-generating unit is below its carrying amount then any amount of goodwill attributed to that CGU must firstly be reduced. If the impairment loss exceeds the amount of goodwill initially attributed to the CGU then there must also be a pro-rata reduction in the carrying value of the identifiable assets. As paragraph 104 of AASB 136 states: The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order: (a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and (b) then, to the other assets of the unit (group of units) pro rata on the basis of the carrying amount of each asset in the unit (group of units) Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Is the new approach to accounting for intangibles an improvement?
Critical perspective The intangible asset accounting standard offers new levels of international consistency in financial reporting but some argue that it is seriously flawed and archly conservative Fails to require recognition of many intangible assets—will reduce the value of statements of financial position (balance sheets) in relation to providing information about the resources under the control of the reporting entity Places a number of severe restrictions on the recognition of internally generated intangible assets and on revaluation of those assets Users will experience a lack of information on intangibles as many will now go unreported Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Is the new approach to accounting for intangibles an improvement? (cont.)
Critical perspective (cont.) Introduces subjectivity: rather than amortising goodwill over a set period of time, assessments will now have to be made about whether the value of goodwill has been ‘impaired’ Requirement that all research be written off as incurred is very conservative—financial statement users will not be able to differentiate between entities that have expended resources on research that is expected to culminate in economic benefits and those that have incurred expenditure that is not expected to generate economic benefits Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Critical perspective (cont.) Possible that requiring entities involved in research and development to expense all research as incurred might discourage them from undertaking certain research as it will impact negatively on profits Previously, no prohibition on revaluing identifiable intangible assets (other than goodwill)—as a result of adopting IFRSs we are now only allowed to revalue identifiable intangible assets if there is an ‘active’ market for them Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Critical perspective (cont.) Active market restrictively defined as ‘a market where the items traded are homogeneous, there are willing buyers and sellers at any time, and prices are known to the public’ Active markets do not exist for the vast majority of intangible assets As a result of adopting IFRSs, in most cases where intangible assets are recognised they will be recorded at cost, less accumulated amortisation, rather than being shown at their fair value, with ‘fair value’ potentially being more relevant to users of financial statements Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary The main purpose of this lecture has been to consider intangible assets, specifically: How to account for: intangible assets generally research and development goodwill Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary (cont.) 1. Intangible assets
Intangible assets considered to be non-monetary assets without physical substance and include patents, goodwill, mastheads, brand names, copyrights, research and development, and trademarks General rule is that expenditure associated with internally generated intangible assets (excluding development expenditure) is to be expensed as incurred Internally generated intangibles are also not permitted to be revalued Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary (cont.) 1. Intangible assets (cont.)
Where intangible assets are revalued (typically acquired externally) such revaluations can only be undertaken where there is an ‘active market’ for such assets and fair values can be ascertained Intangible assets can be classified as either: - identifiable intangible assets, or - unidentifiable intangible assets (e.g. goodwill) Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary (cont.) 1. Intangible assets (cont.)
Intangible assets can also be considered in terms of having: a limited useful life, or an indefinite life If intangible assets are considered to have a limited life: there is a need to allocate their costs, or revalued amount, over their useful lives by periodic amortisation If intangible assets are considered to have an indefinite life: annual amortisation charges do not apply but asset is subject to annual impairment testing Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary (cont.) 2. Research and development
Research and development comprises costs of materials and services consumed in research and development activities, salaries and wages, and depreciation of research-related equipment Research expenditure is required to be expensed as incurred Development expenditure may be carried forward as an asset to the extent that future economic benefits are deemed probable, and such benefits are measurable with reasonable accuracy Development expenditure would need to be amortised in subsequent periods Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

Summary (cont.) 3. Goodwill
Goodwill is defined as future benefits from unidentifiable assets Unidentifiable assets are assets that are not capable of being either individually identified or specifically recognised Only purchased goodwill can be recognised for external reporting purposes Purchased goodwill is measured as the excess of the costs of acquisition incurred by an entity over the fair value of the identifiable net assets and contingent liabilities acquired Goodwill carried forward to future periods is subject to annual impairment testing as opposed to periodic amortisation Copyright  2010 McGraw-Hill Australia Pty Ltd PPTs to accompany Deegan, Australian Financial Accounting 6e

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