Scope of IAS 38
IAS 38 prescribes accounting treatment for all intangible assets that are not specifically covered elsewhere in IFRS. Examples of intangible assets that are not within the scope of IAS 38 are given in paragraphs IAS 38.2-3.
Any expenditure that does not result in recognition of an intangible asset within the scope of other IFRS is within the scope of IAS 38. Examples of expenditures that are within the scope of IAS 38 are as follows: software, patents, motion picture films, customer lists, customer contracts and related customer relationships, licences, marketing rights, advertising, training. Obviously, not all expenditures that are within the scope of IAS 38 should be recognised as assets. Recognition criteria are discussed later in this chapter.
Rights held by a lessee under licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights are within the scope of IAS 38 and are excluded from the scope of IFRS 16 (IAS 38.6; IFRS 16.3(e)).
Assets incorporating both tangible and intangible elements
Some intangible assets are contained in or on a physical substance. For example, computer software can be pre-installed on a computer or can be written on external drive and available for installation on any computer. Judgement is needed whether such intangible assets should be accounted for under IAS 38 or IAS 16. In general, if an intangible asset is not an integral part of the related hardware, it should be accounted for separately under IAS 38 (IAS 38.4).
Examples of intangible assets to be accounted for under IAS 38 despite being contained in or on a physical substance are as follows:
- software that can be installed on any hardware
- documentation for a patent or a prototype
Examples of intangible assets to be accounted for under IAS 16 as a part of tangible assets are as follows:
- pre-installed software that a tangible asset cannot operate without
Intangible assets vs. inventory
It not always easy to decide whether an intangible asset is within the scope of IAS 2 or IAS 38, i.e. whether it is ‘a supply to be consumed in the production process or in the rendering of services’. Unlike IAS 16, IAS 38 does not limit its scope to assets that are expected to be used during more than one period. Therefore, any intangible asset that will not be ‘consumed’ after one use, can be treated as an intangible asset within the scope of IAS 38 and its amortisation to be presented below EBITDA together with depreciation of PP&E. Note also that assets that are classified as current can be within the scope of IAS 38. Such a distinction is often hard to make for assets such as rights to copyright material.
Entity A acquires a right to broadcast a movie ‘The Accountant’ via its VOD system for 6 months. It paid a fixed fee to the distributor of the movie and it can broadcast the movie to as many customers as it wishes, provided that the price to a customer will not be lower than $5.
Entity A recognises the right to the movie as an intangible asset under IAS 38, presents within current assets and amortises over 6 months with expense included below EBITDA. This right is not considered to be an inventory.
Recognition of intangible assets
General recognition criteria
An intangible asset is recognised when it meets all of the criteria below (IAS 38.18,21):
- probability of future economic benefits
- control over the future economic benefits
- reliable measurement of cost
An intangible asset is recognised at cost (IAS 38.24). IAS 38 provides application guidance for separate acquisition of intangible assets and acquisition as part of a business combination. This distinction is discussed later in this chapter.
An asset is identifiable if it either is separable or arises from contractual or other legal rights (IAS 38.12). These criteria as discussed further in IFRS 3.
Probability of future economic benefits
General concept of probability of future economic benefits is discussed in the Conceptual Framework for Financial Reporting. Paragraph IAS 38.25 states that the probability recognition criterion is always considered to be satisfied for separately acquired intangible assets.
Control over the future economic benefits
The general concept of control is discussed in the Conceptual Framework for Financial Reporting. The most common specific application of the control criterion in intangible assets relates to training expenditures and employees expertise, which normally cannot be recognised as assets because of insufficient control over the expected future economic benefits (IAS 38.15).
Separate acquisition of intangible assets
As mentioned earlier, IAS 38 provides application guidance for separate acquisition of intangible assets (IAS 38.25-32) and acquisition as part of a business combination (IAS 38.33-37).
The cost of a separately acquired intangible asset can usually be measured reliably (IAS 38.26). Most requirements relating to elements of cost of a separately acquired intangible asset mirror those included in IAS 16 and are discussed there. Requirements specific to intangible assets only are discussed below.
Separate acquisition of intangible assets is not to be confused with acquisition of services that are used by the entity do develop an intangible asset internally. In such a case, the requirements for internally generated intangible assets apply.
IAS 38 has more stringent requirements concerning capitalisation of subsequent expenditure on intangible. Paragraph IAS 38.20 states: most subsequent expenditures are likely to maintain the expected future economic benefits embodied in an existing intangible asset rather than meet the definition of an intangible asset and the recognition criteria in IAS 38. In addition, it is often difficult to attribute subsequent expenditure directly to a particular intangible asset rather than to the business as a whole. Therefore, only rarely will subsequent expenditure—expenditure incurred after the initial recognition of an acquired intangible asset or after completion of an internally generated intangible asset—be recognised in the carrying amount of an asset. In particular, subsequent expenditure on brands, mastheads, publishing titles, customer lists and items similar in substance (whether externally acquired or internally generated) is always recognised in profit or loss as incurred. This is because such expenditure cannot be distinguished from expenditure to develop the business as a whole.
Acquisition as part of a business combination
As mentioned earlier, IAS 38 provides application guidance for separate acquisition of intangible assets (IAS 38.25-32) and acquisition as part of a business combination (IAS 38.33-37).
The cost of an asset acquired as a part of a business combination is its fair value at the acquisition date, which results from IFRS 3 requirements. More on recognition of intangible assets acquired as part of a business combination can be found in IFRS 3.
Exchange of assets
Paragraphs IAS 38.45-47 cover exchange of assets. These requirements mirror those of IAS 16.
Internally generated intangible assets
Framework for recognition of internally generated intangible assets
IAS 38 provides a framework for recognition of internally generated intangible assets that helps identifying whether and when there is an identifiable asset that will generate expected future economic benefits and determining the cost of the asset reliably. To facilitate this process, IAS 38 classifies the generation of the asset into a research phase and a development phase (IAS 38.51-52).
As noted earlier, intangible assets can be generated internally with input from external parties. The mere fact that a service contributing to intangible asset is acquired from a third party does not automatically warrant capitalisation of such an expenditure. It needs to be assessed against the general criteria for capitalisation of internally generated intangible assets.
Research is defined (IAS 38.8) as original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Examples of research activities are given in paragraph IAS 38.56.
Expenditures on research or on research phase of an internal project must be expensed in P/L as incurred as an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. (IAS 38.54-55).
Development is defined (IAS 38.8) 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. Examples of development activities are given in paragraph IAS 38.59.
Expenditures on development or on development phase of an internal project are recognised if, and only if, an entity can demonstrate all of the following (IAS 38.57):
- 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.
- its ability to use or sell the intangible asset.
- how the intangible asset will generate probable future economic benefits.
- 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 above criteria are not easily translated into intangible assets generated by entities for their internal use, e.g. software for internal purposes. Unfortunately, IAS 38 does not provide any specific guidance for such intangible assets. An exception relates to web site costs that are covered by SIC-32 (discussed below) and it might be useful to look into SIC-32 to look for analogies to other intangible assets generated for internal purposes. In general, the planning phase should be treated as research phase under IAS 38 and expensed in P/L.
Web Site Costs
Interpretation SIC-32 Web Site Costs provides specific guidance concerning expenditure on an internally generated web site. This interpretation maps the typical phases of web site development to IAS 38 classification into research and development phase. This interpretation is accompanied by a useful illustrative example.
Internally generated goodwill, brands, customer lists and similar items
Internally generated goodwill, brands, customer lists and similar items cannot be recognised as an asset as expenditure on them cannot be distinguished from the cost of developing the business as a whole (IAS 38.48-50, 63-64).
Cost of internally generated intangible assets
The cost of internally generated intangible asset includes expenditure incurred from the date when all the criteria for recognition of intangible asset are met, including distinction between research and development costs (IAS 38.65). As said before, most requirements relating to elements of cost of a separately acquired intangible asset mirror those included in IAS 16.
Expenditure on an intangible item that was initially recognised as an expense cannot not be recognised as part of the cost of an intangible asset at a later date (IAS 18.71). Such a transfer from P/L to assets would mean that it is a correction of error and it should be accounted for under IAS 8, subject to materiality.
Recognition as an expense
General requirement for recognition of an expenditure on an intangible item
When an expenditure on an intangible item does not meet the recognition criteria of IAS 38, it should be expensed in P/L as incurred unless it forms part of the goodwill recognised under IFRS 3 (IAS 38.68). In other words, such expenses cannot be spread over time in P/L even if it is incurred to provide future economic benefits to an entity. Examples of expenditures that are expensed in P/L are given in paragraph IAS 38.69:
- start-up costs
- expenditure on training activities
- expenditure on advertising and promotional activities
- expenditure on relocating or reorganising part or all of an entity
Expense is recognised when goods or services are received (or more precisely, as IAS 38 puts it: when the entity has a right to access those goods/services), not when entity uses them to deliver another service.
Paragraph IAS 38.70 explains that prepayments can be recognised as assets even if the goods or services to be received will be recognised as an expense. Such an asset represents the right to receive goods or services. See the example below and also paragraphs IAS 38.BC46A-BC46I for more discussion of IASB.
Note that IFRS 15 covers capitalisation of costs to obtain and fulfil a contract with customer.
Example: prepayment on advertising services
On 1 May, Entity A ordered a promotional catalogues of its products for a new commercial period for a total cost of $1m. On the same day, it paid and advance of $0.3m to the printing house. The catalogues are delivered to Entity A on 1 August and they are sent to customers on 1 September.
On 1 May, Entity A recognised a prepayment of $0.3m as an asset. It represents the right to receive catalogues or refund in case the printing house fails to perform. On 1 August Entity A recognises expenses in P/L amounting to $1m as the catalogues are delivered. It does not matter when they will be delivered to customers at a later date (IAS 38.69A).
Measurement after recognition – cost model and revaluation model
IAS 38 allows a policy choice when measuring intangible assets – cost model or revaluation model. The same measurement model should be applied to an entire class of intangible assets (IAS 38.72-73).
Under cost model, an intangible asset is carried at cost less any accumulated amortisation and any accumulated impairment losses (IAS 38.74). Depreciation and impairment are discussed later on in this chapter.
Overview of the revaluation model
Under the revaluation model, an intangible asset is carried at its fair value (i.e. revalued amount) less any accumulated amortisation and any accumulated impairment losses Revaluations should be made with sufficient regularity to ensure that the carrying amount does not differ materially from fair value at the end of the reporting period (IAS 38.75).
The revaluation model does not allow the revaluation of intangible assets that have not previously been recognised as assets or the initial recognition of intangible assets at amounts other than cost (IAS 38.76).
IAS 38 however does allow the revaluation model to be applied to intangible assets received by way of a government grant and recognised at a nominal amount. These kinds of intangible assets (e.g. fishing licences, import quotas) may be often the only ones that that meet the active market criterion discussed below.
IAS 38 requires that the fair value should be measured by reference to an active market, i.e. Level 1 in the fair value hierarchy. IAS 38 does not allow to measure fair value using valuation techniques using Level 2 or 3 inputs (see IFRS 13 for more discussion on fair value hierarchy). IAS 38 notes that it is uncommon for an active market to exist for an intangible asset. It further explains that an active market cannot exist for unique intangible assets (e.g. brands) and that contracts for the sale of intangible assets are negotiated between individual buyers and sellers, and transactions are relatively infrequent (IAS 38.78).
Accounting treatment and entries made at the revaluation are the same as for PP&E set out in IAS 16.
IAS 38 requires an entity to determine whether the useful life of an intangible asset is finite or indefinite. An intangible asset is regarded by the entity as having an indefinite (not the same as infinite) useful life when there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity (IAS 38.88). The significance of this distinction is that intangible assets with indefinite useful life are not amortised. Paragraphs IAS 38.90-96 contain more guidance for making such a distinction, including taking into account only those renewals that can be made without significant cost.
Typical examples of assets with indefinite useful lives include: well established brands, licences for infinite period or with renewals without significant cost.
Examples of assets that normally have finite useful lives include: all kinds of rights for finite period (e.g. licences, patents), software, know-how, recently developed brands, customer relationships.
See also Examples 4-9 accompanying IAS 38.
See also accounting set out in IFRS 3 for assets acquired in a business combination that the acquirer does not intend to use.
Accounting for intangible assets with finite useful lives
Amortisation period and amortisation method
Intangible assets with finite useful lives are amortised over their useful lives. Requirements for amortisation period and amortisation method are set out in paragraphs IAS 38.97-99 and generally are the same as in IAS 16. Notable exception relates to amortisation method that is based on the revenue generated by an activity that includes the use of an intangible asset, which is prohibited for PP&E, but allowed in limited circumstances for intangible assets as explained in paragraphs IAS 38.98A-C. Additionally, IAS 38 does not introduce separate amortisation of significant parts of an intangible asset.
IAS 38 makes a rebuttable presumption that the residual value of an intangible asset should be assumed to be zero unless one of the criteria set out in paragraph IAS 38.100 are met.
Changes in estimates
Similarly to PP&E, the useful life and the amortisation method of an intangible asset with finite useful life should be reviewed at least at each financial year-end with any changes accounted for prospectively under IAS 8 as changes in accounting estimates (IAS 38.104-106).
Accounting for intangible assets with indefinite useful lives
An intangible asset with an indefinite useful life is not amortised. Instead it should be tested for impairment at least annually under IAS 36 (IAS 38.107-108). Additionally, the assessment of whether an intangible asset has indefinite useful life should be reviewed at each reporting date (IAS 38.109-110).
Retirements and disposals
Retirements and disposals of intangible assets are covered in paragraphs IAS 38.112-117. They mirror requirements for PP&E set out in IAS 16.
Disclosure requirements are set out in paragraphs IAS 38.118-128. Next to requirements similar to those required for PP&E, IAS 38 requires also explanation of assessment that an asset has indefinite useful life (IAS 38.122(a)) and encourages to disclose significant intangible assets controlled by the entity but not recognised as assets because they did not meet the recognition criteria of IAS 38 (IAS 38.128(b)).
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