Intangible assets are identifiable non-monetary assets without physical substance. Examples include patents, trademarks, customer contact lists, licences, brands etc.
Three important characteristics of intangible assets defined above are:
- It is identifiable. For an asset to be identifiable it has to be either:
- Separable i.e. it can be separated from the entity and can be sold, exchanged, contracted. For example, patent can be sold without selling a whole company; or
- Arise from legal rights (contract or other) irrespective of the fact that such rights are separable
- It is non-monetary. These assets are not in the form of currency. For example cash is not an intangible asset rather it is a financial asset.
- Without physical substance. It doesn’t have any material form or can’t be sensed with either of the five senses. For example formula to make medicine doesn’t hold any physical form.
1 Recognition of Intangible asset
Just like other non-current assets, intangible assets must meet the definition of asset and also the recognition criteria to formally record the item in the financial books of the entity.
For an intangible item or an expenditure to be considered intangible asset:
- it should be under the control of entity; and
- the future economic benefits arising from the item should flow to the entity
If it fulfills the definition of asset, it has to meet the recognition criteria:
- the future economic benefits arising from the asset are flowing to the entity; and
- the cost of the asset can be measured reliably
If an expenditure fails to meet the definition of asset or recognition criteria then it should be recognized as an expense in the period it is incurred.
1.1 Acquisition of Intangible asset
An intangible asset can be acquired in either of the two ways:
- Internally developed as a result of application of existing knowledge or new research by entity.
- Externally purchased separately or came with the entity purchased or obtained as grant from government.
1.2 Valuation and measurement of Intangible assets
Intangible assets that are purchased are valued at cost of acquisition i.e. fair value of asset acquired or the fair value of asset exchanged as consideration plus any expenditure incurred specifically to make intangible asset ready for intended purpose.
Valuation and measurement of internally generated assets on the other hand involve a different approach as they pass through two separate phases:
Research: it is a planned and organized activity undertaken to acquire new knowledge or to improve current understanding. In this phase the entity does not make anything tangible or intangible in nature. Its simple knowledge acquisition activity.
Expenditures made on research phase are expensed out as they incur.
Development: it is the application of knowledge obtained as a result of research to make something new or improve existing assets so that additional future economic benefits flow to the entity. Once this phase completes entity usually have a fully working prototype for assessment before full blown commercial production or use of the asset starts.
Expenditures on development phase are capitalized only if ALL of the following conditions are fulfilled:
- Future economic benefits from selling or using the developed asset will flow to the entity
- Management intends to complete the development process
- Entity has the necessary resources to complete the development
- The asset under development is capable of being used or sold
- Development and later deployment for use or sale is technically feasible
- Entity has the mechanism to track all the expenditures incurred on development
Entity starts capitalizing expenditures as an asset once all the conditions mentioned above are fulfilled. Any expenditure before fulfillment of criteria are expensed out in the period they are incurred.
- Brands
- Mastheads
- Customer lists
- Goodwill
- Publishing titles
The above assets may be recognized only if they are acquired as part of business combination deal i.e. when entity bought another entity under a takeover bid or merger etc.
2 Amortization of intangible assets
Just like other tangible non-current assets for which periodic depreciation charge is calculated, intangible assets with finite useful life are also reduced periodically following a systematic approach. But for intangible assets periodic charge is called amortization instead of depreciation though conceptually they are same.
Intangible assets with infinite useful life are not amortized. However, they are checked for possible impairment if necessary.
Example: Amortization of intangible asset
Entity has finally completed the development of new technology in photography industry which will help take pictures in extremely low light. Entity has spent total of 6 million on development, however on investigation it is revealed that conditions for capitalization were met when three-quarters of total cost was already incurred. It is estimated that entity will benefit from this development for next 5 years.
Calculate the amount capitalized as asset and yearly amortization charge if entity uses straight-line method.
Solution:
Although according to management total developmental cost is 6 million but we can capitalize on those expenditures that were incurred AFTER all the conditions were satisfied. Situation mentions that three-fourth of total expenditures were already incurred before criteria was even met. Therefore, only one-fourth of 6 million qualifies for capitalization which is 1.5 million (6m x 1/ 4)
Amortization charge for the year can be calculated by dividing capitalized amount over the expected useful life of 5 years.
= 1,500,000 / 5 = $300,000