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IAS 38 Intangible assets
Solutions
Instituut van de Bedrijfsrevisoren 1
December 12, 2008
IAS 38 Intangible assets
Solutions
Véronique Weets
IAS 38 Intangible assets
Solutions
Instituut van de Bedrijfsrevisoren 2
December 12, 2008
TABLE OF CONTENT
Table of content ............................................................................................................................................. 2
IAS 38 Intangible assets .................................................................................................................................. 3
Purchased intangible assets ....................................................................................................................... 3
Research and development ........................................................................................................................ 4
Cost of an internally generated intangible asset ........................................................................................ 9
Intangible assets acquired in a business combination ............................................................................. 14
Assessing the useful lives of intangible assets .......................................................................................... 20
Amortization of Intangible assets ............................................................................................................. 23
Impairment of intangible assets ............................................................................................................... 26
Subsequent costs ...................................................................................................................................... 28
Comprehensive case ................................................................................................................................. 31
Annual improvements 2007 ......................................................................................................................... 33
IFRIC 12 – Service concession arrangements ............................................................................................... 34
Scope ........................................................................................................................................................ 34
Financial asset/Intangible asset ................................................................................................................ 36
AccountIng for service concession arrangements .................................................................................... 37
IAS 38 Intangible assets
Purchased intangible assets
Instituut van de Bedrijfsrevisoren 3
December 12, 2008
IAS 38 INTANGIBLE ASSETS
PURCHASED INTANGIBLE ASSETS
1. Operator F pays commissions of 175 to a third party dealer for the acquisition of a subscriber
that has passed the usual credit check. The subscriber signs a 12‐month contract with a minimum revenue
guarantee. Operator F has estimated that the expected margin from the minimum contracted revenues
will be 250. The subscriber acquisition costs are expected to be recovered in full within the initial contract
term. Operator F tracks subscriber acquisition costs by subscriber (PWC, Telecom, 122.39).
Should subscriber acquisition costs be capitalised as an intangible asset ?
Operator F should record the payment of 175 as an intangible asset. Operator F has acquired an
identifiable benefit, namely the minimum contractual net cash flows from the subscriber. Operator F has a
legally enforceable contractual right to receive the minimum net cash flows. It is probable that the
economic benefits of the contract will flow to F.
Each subscriber acquired is identifiable because F's systems can track each acquisition payment by
subscriber. This also enables F to
Assess the recoverability of each intangible asset; and
Identify any assets which are impaired within the contract term.
2. When a customer connects to its network on tariff AAA, Operator B agrees to make payments to
dealers of 12% of the gross billings to the customer over the life of the contract. Typically, the revenue
share payments are calculated monthly and paid quarterly in arrears. The subscriber signs a 12‐month
contract. Operator B expects that each AAA customer will generate gross billings of 1 000 over the
contract period. The dealer has no further service to render to the operator (such as billings, customer
care etc). Therefore, the contract between the dealer and operator B is not an executory contract (PWC,
Telecom 122.41).
How should an operator account for commitments to share customer revenues with dealers ?
The contract represents a financial liability for Operator B. Operator B should recognise a financial liability
of 120 when the customer is connected, being the fair value of the expected cash outflows to the dealer
which are independent on future gross billings. The estimated costs are directly related to the acquisition
of the customer, so Operator B should record subscriber acquisition costs of 120 as an intangible asset. The
financial liability will be re‐measured each month when the revenue share payments are calculated and as
the expected gross billings vary.
The intangible asset is not re‐measured but is amortised over the life of the contact and reviewed for
impairment when necessary. The asset is measured at the amount that management estimates as its
expected cost per customer.
IAS 38 Intangible assets
Research and development
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December 12, 2008
RESEARCH AND DEVELOPMENT
1. Consider the development of new technology to be used in a manufacturing plant. The process could
be split into the following stages (PWC, pg 15027‐15028):
Stage 1: Identify a need for/benefit of new technology
Stage 2: Board commissions a project to investigate the new technology
Stage 3: Investigate other technologies available in the market
Stage 4: Investigate competitors’ use of other technology
Stage 5: Commission the design of alternative types of new technology and get input from the
manufacturing floor for feasibility
Stage 6: Prepare a shortlist of five alternatives from stage 5 and prepare costing
Stage 7: Board prepares a budget for the new technology and agrees to the shortlist and the
replacement of technology
Stage 8: Send the shortlist to line managers for input and list three based on feedback
Stage 9: Present the final three to the board for final selection
Stage 10: Finalize a development plan for the final selection
Stage 11: Develop new technology
Stage 12: Test new technology
Stage 13: Train staff on new technology
Stage 14: Roll out new technology to the production line
Determine at what stage the entity should start to capitalize the costs of the project.
Stage 5: criteria (a) and (c) have been met because the feasibility of completing the intangible asset for use and
the entity’s ability to use it have been confirmed
Stage 7: Criteria (a), (c), (d) and (e) have been met at the end of this stage as a budget has been produced, it
has been agreed to proceed with replacing the technology and adequate resources exist to complete the
development.
Stage 10: All the criteria have been met at this stage as, in addition to the above, the board has approved the
project (evidence of the entity’s intention to complete the asset – criterion (b)) and the development plan,
based on the budgets, evidences the entity’s ability to measure the expenditure reliably (criterion f).
Note that the training of the staff should be expensed.
2. Stellenbosch Laboratories Ltd manufactures and distributes a wide range of general pharmaceutical
products. Selected audited data for the financial year ended 31 December 20X5 are as follows (Alfredson et
al.(2007), pg. 476, problem 11.2):
CU
Gross Profit 17 600 000
Profit before income tax 1 700 000
Income tax expense 500 000
Profit for the period 1 200 000
Total assets:
Current 7 300 000
Non‐current 11 500 000
IAS 38 Intangible assets
Research and development
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December 12, 2008
The company uses a standard mark‐up on cost. From your audit files, you ascertain that total research and
development expenditure for the year amounted to 4 700 000 CU. This amount is substantially higher than in
previous years and has eroded the profitability of the company. M. Bosch, the company's finance director, has
asked for your firm's advice on whether it is acceptable accounting practice for the company to carry forward
any of its expenditure to a future accounting period.
Your audit files disclose that the main reason for the significant increase in research and development costs
was the introduction of a planned five‐year laboratory program to attempt to find an antidote for the common
cold. Salaries and identifiable equipment costs associated with this program amounted to 2 350 000 for the
current year.
The following additional items were included in research and development costs for the year:
• Costs to test a new tamper‐proof dispenser pack for the company's major selling line (20% of sales) of
antibiotic capsules ‐ 760 000 CU. The new packs are to be introduced in the 20X6 financial year.
• Experimental costs to convert a line of headache powders to liquid form ‐ 590 000 CU. The company
hopes to phase out the powder form if the tests to convert to the stronger and better handling liquid form
prove successful.
• Quality control required by stringent company policy and by law on all items of production for the
year ‐ 750 000 CU.
• Costs of a time and motion study aimed at improving production efficiency by redesigning plan layout
of existing equipment ‐ 50 000 CU
• Construction and testing of a new prototype machine for producing hypodermic needles ‐ 200 000
CU. Testing has been successful to date and is nearing completion. Hypodermic needles accounted for 1% of
the company's sales in the current year, but it is expected that the company's market share will increase
following introduction of this new machine.
Respond to M. Bosch's question for each item above.
The outlays must be analyzed using IAS 38.57:
• Technical feasibility:
• Intention to complete and sell:
• Ability to use or sell:
• Existence of a market:
• Availability of resources:
• Ability to measure costs reliably:
Dispenser pack: As the dispenser pack was a new product, costs incurred until the pack developed met the
IAS18.57 tests are expensed. In this case, determining the technical feasibility of the pack and developing a cost
effective product would have been two key issues.
Converting powders to liquid form: The tests have not yet proven successful, therefore the technical feasibility
test would not be met and the 590 000 CU must be expensed.
Costs of quality control: These costs relate to products being produced and hence can be capitalized into the
products produced. No separate intangible such as “Superior Quality” could be raised as such an asset is not
identifiable.
IAS 38 Intangible assets
Research and development
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December 12, 2008
Costs of time and motion study: As the equipment is being used in current production, the costs could be
capitalized into the cost of the equipment.
New prototype machine: This is a difficult one to classify. The question hinges on the “nearing completion”
statement. It is a question of what has yet to be done. Questions relating to the IAS 18.57 criteria need to be
asked. For example: has technical feasibility been established, and is it only minor adjustments that are being
made? Do any minor adjustments have a material effect on the determination of the costs of the machine?
3. a. A pharmaceutical entity has obtained scientific regulatory approval for a new respiratory drug in
Country Agara. It is now progressing through the additional development procedures necessary to gain
approval in Country Belan. Management believes that achieving regulatory approval in this secondary market
is a formality. Mutual recognition treaties and past experience show that Belan's authorities rarely refuse
approval for a new drug that has been approved in Agara.
b. A pharmaceutical entity has obtained scientific regulatory approval for a new AIDS drug in Country
Spartek and is progressing through the additional development procedures necessary to gain approval in
Country Oceana. Experience shows that significant additional clinical trials will be necessary to meet the
Oceanese scientific regulatory approval requirements. Some drugs accepted in Spartek have not been
accepted for sale in Oceana, even after additional clinical trials (PWC, Pharma, 2).
Should the development costs in each scenario be capitalized ?
The company in scenario 1 should capitalize any additional development costs. The criterion of technical
feasibility in Country Belan appears to have been met, as registration is highly probable and there are likely to
below barriers to obtaining regulatory approval.
Conversely, the company in scenario 2 should not capitalize additional development expenditure. It cannot
show that it has met the criterion of technical feasibility, if registration in another market requires significant
effort and approval in one market does not necessarily predict approval in the other.
4. A Pharmaceutical entity is developing a generic version of a painkiller that has been sold in the market
by another company for many years. The technical feasibility of the asset has already been established
because it is a generic version of a product that has already been approved, and its chemical equivalence has
been demonstrated. The lawyers advising the entity do not anticipate that any significant difficulties will delay
the process of obtaining commercial regulatory approval (PWC, Pharma, 3).
Should management capitalize the development costs at this point ?
It is probable that commercial regulatory approval will be achieved and, since the remaining criteria have been
met, management should start capitalizing internal development costs.
5. Pharmaceutical entity MagicCure has obtained scientific regulatory approval for a new respiratory
drug and is now incurring expenditure to educate its sales force and perform market research (PWC, Pharma,
4).
Should it capitalize these costs ?
MagicCure should expense sales and marketing expenditure such as training a sales force or performing market
research. This type of expenditure does not create, produce or prepare the asset for its intended use.
Expenditure on training staff, selling and administration should not be capitalized.
IAS 38 Intangible assets
Research and development
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December 12, 2008
6. Pharmaceutical entity Astro engages a contract research organisation (CRO) to perform research
activities for a period of 2 years in order to obtain know‐how and try to discover a cure for AIDS. The CRO is
well known in the industry for having modern facilities and good practitioners dedicated to investigation. The
CRO receives a non‐refundable, upfront payment of CU 3 million in order to carry out the research under the
agreement. It will have to present a quarterly report to Astro with the results of its research. Astro has full
rights of access to all the research performed, including control of the research undertaken on the potential
cure for AIDS. The CRO has no rights to use the results of the research for its own purposes (PWC, Pharma, 16).
How should Astro account for upfront payments made to third parties to conduct research ?
Astro will have access to the research being carried out over a two‐year period. The upfront payment should
therefore be deferred as a pre‐payment and recognized in the income statement over the life of the research. If
the research terminates early, Astro should write off the remainder of the pre‐payment immediately. The costs
of carrying out the research should be classified as research and development expenditure in the income
statement.
7. Van Gogh Ltd. Has obtained regulatory approval for its new antidepressant drug and has started
commercialization. Van Gogh is now undertaking studies to verify the advantages of its drug over competing
drugs already on the market. These studies will support Van Gogh's sales efforts (PWC, Pharma, 38).
Should costs incurred to compare various drugs with the intent of determining relative performance for
certain indications, be capitalized as development costs ?
The expenditure incurred for studies to identify performance features should not be capitalized as part of the
development cost as it does not qualify for capitalization. The studies are directed at providing marketing
support and the nature of the amounts spent is that of selling ad distribution expense. This expense should be
included in the appropriate income statement classification.
8. Da Vinci Pharma is currently developing a drug that will be used in the treatment of a very specific
ailment affecting a small group of patients. Generally, Da Vinci pursues development of a drug if the market
potential is sufficient to obtain future economic benefits. However, Da Vinci has decided to pursue with this
drug for reputation reasons. Da Vinci has filed for initial regulatory approval, and believes that all other
capitalization criteria have been met except for concerns about its market potential (PWC, Pharma, 39).
Do limits to potential sales markets prevent management from capitalizing development costs related to
this drug ?
Da Vinci should capitalize development costs for this drug, beginning no later than final submission for
regulatory approval but limited to the amount recoverable following commercialization. Da Vici will need to
assess the capitalized costs for any indication of impairment at each reporting date and test for impairment
annually as long as the asset is not available for use.
9. Sisley Pharma contracts with Wright Pharma to research possible candidates for further development
in its anti‐hypertension program. Sisley pays Wright on a cost‐plus basis for the research, plus CU 100 000 per
development candidate which Sisley elects to pursue further. Sisley will own the rights to any such
development candidates. After two years, Wright succeeds in confirming 10 candidates that will be used by
Sisley (PWC, Pharma, 43).
How should payments for pharmaceutical research that subsequently becomes development be accounted
for ?
IAS 38 Intangible assets
Research and development
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December 12, 2008
Costs incurred for research should not be capitalized. Accordingly, Sisley’s payments relating to the cost‐plus
portion of the contract should be expensed. Sisley’s payments relating to the successful development
candidates should also be expensed. The development candidates were previously identified by Sisley, so no
separate intangible has been acquired and the technological feasibility criterion is not met. The research costs
previously expensed cannot be reversed and capitalized with these rights.
IAS 38 Intangible assets
Cost of an internally generated intangible asset
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December 12, 2008
COST OF AN INTERNALLY GENERATED INTANGIBLE ASSET
1. Operator A is considering upgrading its billing system. A completed a feasibility study that
considered several software systems before deciding whether to go ahead with the upgrade. A
subsequently decided to upgrade its billing system. The development will take six months to complete. A
will use internal resources to customize the software. The total cost is expected to be 250 000, including
10 000 for the feasibility study, 25 000 to train the personnel who will be using the billing system and 215
000 of labour time for those personnel who were dedicated to the customization and upgrade of the
billing system (PWC, Telecom, 122.1).
When should an operator capitalize internally‐developed software ?
Operator A should expense the costs of 10 000 associated with the feasibility study and the training costs
of 25 000 as incurred. The direct personnel costs of 215 000 should be capitalized as part of the cost of the
new billing system.
A must capitalize the cost of customizing the software as part of the cost of the software, provided:
it has the resources to complete the project;
the software will be used in operating the business; and
it is probable the system will generate future economic benefits.
The costs that may be capitalized are those directly attributable to the project, including the salaries of
personnel directly engaged on the project. Costs that are not necessary for the development of the
software, such as the feasibility study are expensed as incurred. Training costs are never capitalized,
because employees do not represent a resource controlled by the organization.
2. Pharmaceutical entity Pilax has obtained a loan from Qula, another pharmaceutical company, to
finance the late‐stage development of a drug to treat cancer. Qula will have co‐marketing rights over any
product that is developed. Pilax's management has decided to capitalize all the development costs
incurred after filing for scientific regulatory approval (PWC, Pharma, 23).
Should Pilax capitalize the interest incurred for borrowings obtained to finance R&D activities ?
Borrowing costs incurred before capitalization of development costs are expensed. Borrowing costs should
be capitalized for qualifying assets once development costs are being capitalized. Capitalization of
borrowing costs should cease once the drug has been fully developed and is available for sale.
3. Coupono plc has incurred 1200000 CU in capital expenditure for the development of new
software during the year, for its time recording and link with invoicing. At year‐end, 120 000 CU related to
the construction of the software is included in creditors. The software is considered to be a qualifying
asset under IAS 23 ‐ Borrowing Costs.
Coupono plc has the following borrowings outstanding:
• Bank overdraft: 120 000 CU at 16% • Long‐term loan: 300 000 CU at 5,1% (nominal interest rate) • Debentures: 1 100 000 CU at 6,8%
IAS 38 Intangible assets
Cost of an internally generated intangible asset
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December 12, 2008
Ancillary costs of 5000 CU have been incurred in connection with the arrangement of the long‐term loan,
which has the following characteristics:
• Issuing date: 1 January of year 1 • Maturity date: 3 years • Repayment schedule: 300000 CU at maturity date
a. Determine the interest rate on the long‐term loan using the effective interest rate method.
IRR(‐295000(*);15300(**);15300(**);315300(***)) = 5,72%
(*) 300000‐5000
(**) 5,1%*300000
(***) 300000+15300
b. Account for the long‐term loan.
1 January of year 1
Dr Cash 295 000
Cr Long term loan 295 000
31 December of year 1
Dr Interest expense 16 875 (*)
Cr Cash 15 300 (**)
Cr Long term loan 1 575
(*)5,72%*295000
(**)5,1%*300000
31 December of year 2
Dr Interest expense 16 965
Cr Cash 15 300
Cr Long‐term loan 1 665
31 December of year 3
Dr Interest expense 17 060
Cr Cash 15 300
Cr Long‐term loan 1760
Dr Long term loan 300 000
Cr Cash 300 000
IAS 38 Intangible assets
Cost of an internally generated intangible asset
Instituut van de Bedrijfsrevisoren 11
December 12, 2008
c. Calculate the amount of borrowing costs to be capitalized, assuming that Coupono plc has a 31
December year‐end and that the expenditures took place on the following dates:
• 1 February 600000 CU • 1 July 400000 CU • 1 November 200000 CU
The weighted average interest rate is:
(120000*16%)+(295000*5,72%)+(1100000*6,8%) /(120000+295000+1100000) = 7,32%
Given the uneven nature of the capital expenditure during the year, it is appropriate to apply the
capitalization rate to the weighted average capital expenditure incurred in the year.
(600000*11/12+400000*6/12+80000*2/12) = 763333
Note that the 120000 not yet paid at year‐end is excluded.
763333*7,32% = 55876
Dr Work in process 55 876
Cr Interest expense 55 876
d. Calculate the amount of borrowing costs to be capitalized, assuming that the debentures were
not in existence. The entity applies the same method as in d)
The weighted average interest rate: (120000*16%)+(295000*5,72%)/ (120000+295000) = 8,69%
Amount of borrowing costs to be capitalized: 763 333 *8,69% = 66333,64
However, borrowing costs actually incurred on the two borrowings during the year are only 36074.
(=16%*120000+5.72%*295000). So only 36074 can be capitalized.
Dr Work in process 36 074
Cr Interest expense 36 047
4. Tiepolo Pharma has appointed Tintoretto Laboratories, a third party, to develop an existing
compound owned by Tiepolo on its behalf. Tintoretto will act purely as a service provider without taking
any risks during the development phase and will have no further involvement after regulatory approval.
Tiepolo will retain full ownership of the compound. Tintoretto will not participate in any marketing and
production arrangements. A milestone plan is included in the contract. Tiepolo agrees to make the
following non‐refundable payments to Tintoretto (PWC, Pharma, 44):
CU 2 million on signing the agreement
CU 3 million on successful completion of phase 2
How should pharmaceutical entities account for upfront payments and subsequent milestone payments
in a long‐term research and development arrangement in which a third party develops their intellectual
property ?
IAS 38 Intangible assets
Cost of an internally generated intangible asset
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December 12, 2008
Tiepolo owns the compound. Tintoretto performs development on Tiepolo’s behalf. No risks and rewards
of ownership are transferred between the parties. By making the initial upfront payment and the
subsequent milestone payment to Tintoretto, Tiepolo does not acquire a separate intangible asset, which
could be capitalized. The payments represent funding for development by a third party, which needs to be
expensed over the development period provided that the recognition criteria for internally generated
intangible assets are not met.
5. Tiepolo Pharma has appointed Tintoretto Laboratories, a third party, to develop an existing
compound owned by Tiepolo on its behalf. The agreement effectively out‐licenses Tiepolo's compound to
Tintoretto. Tiepolo and Tintoretto will set up a development steering committee to jointly perform the
development and will participate in the funding of the development costs according to specific terms.
Tiepolo agrees to make the following payments to Tintoretto:
CU 5 million on signing the agreement as an advance payment. Tintoretto has to refund the entire payment in the event of failure in development
50% of total development costs on successful completion of phase 2 (after deducting the advance payment)
In the case of successful completion of development and commercialization, Tintoretto will receive milestone payments and royalty streams (PWC, Pharma, 45).
How should pharmaceutical entities account for upfront payments and subsequent milestone payments
in a long‐term research and development arrangement in which a third party develops their intellectual
property ?
Tintoretto becomes party to substantial risks in the development of Tiepolo’s compound, as it is only partly
compensated for its development activities if the development succeeds (thereby buying into the potential
success of the future product). Tiepolo effectively reduces its exposure to ongoing development costs and
to potential failure of the development of its compound. However, by paying the refundable advance
payment and the subsequent milestone payment (determined to be 50% of total development costs),
Tiepolo does not acquire a separate intangible asset which could be capitalized. The payment and the
milestone payment should be expensed as incurred. Tiepolo should expense the refundable advance
payment once successful completion of phase 2 is probable.
6. Sargent and Chagall enter into a collaboration deal in which Sargent will pay Chagall for
developing and manufacturing a new antibiotic originally discovered by Chagall. Sargent will have
exclusive marketing rights of the antibiotic if it is approved. The contract terms require the following
payments:
Upfront payment of CU 5 million on signing of the contract
Milestone payment of CU 5 million on filing for stage 3 clinical trial approval
Milestone payment of CU 7 million on securing final regulatory approval, and
CU 11.5 per unit, which equals the estimated cost plus 15% once commercial production begins
The cost‐plus 15% is consistent with Sargent's other recently negotiated supply arrangements for drugs
with comparable manufacturing complexity (PWC, Pharma, 47).
How should pharmaceutical entities account for collaboration agreements to develop a new drug
compound ?
IAS 38 Intangible assets
Cost of an internally generated intangible asset
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December 12, 2008
There is no indication that the agreed prices for the various elements are not at fair value. In particular,
the terms for product supply at cost plus 15% are consistent with Sargent’s other supply arrangements.
Therefore, Sargent should capitalize the upfront purchase of the compound and subsequent milestone
payments as incurred, and consider impairment at each financial reporting date. Amortization should
begin once regulatory approval has been obtained. Costs for the products have to be accounted for as
inventory and then expensed as costs of goods sold as incurred.
If the contract terms did not represent fair value, the payments would have to be allocated to the
development and production supply components of the arrangement using fair value as the allocation key.
IAS 38 Intangible assets
Intangible assets acquired in a business combination
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December 12, 2008
INTANGIBLE ASSETS ACQUIRED IN A BUSINESS COMBINATION
1. The following are examples of identifiable intangible assets acquired in a business combination. Some
of the examples may have characteristics of assets other than intangible assets.
Intangible assets are identifiable if they have a contractual basis or if they are separable. Intangible assets
identified as having a contractual basis might also be separable but separability is not a necessary condition for
an asset to meet the contractual‐legal criterion.
Explain for the following intangible assets why they meet the definition of an identifiable asset.
Marketing‐related intangible assets
Trademarks, trade names, service
marks, collective marks and
certification marks
Trademarks, trade names, service marks, collective marks and
certification marks may be protected legally through registration with
governmental agencies, continuous use in commerce or by other
means. If it is protected legally through registration or other means, a
trademark or other mark acquired in a business combination is an
intangible asset that meets the contractual‐legal criterion. Otherwise, a
trademark or other mark acquired in a business combination can be
recognised separately from goodwill if the separability criterion is met,
which normally it would be.
Internet domain names An Internet domain name is a unique alphanumeric name that is used
to identify a particular numeric Internet address. Registration of a
domain name creates an association between that name and a
designated computer on the Internet for the period of the registration.
Those registrations are renewable. A registered domain name acquired
in a business combination meets the contractual‐legal criterion.
Customer‐related intangible assets
Customer lists A customer list consists of information about customers, such as their
names and contact information. A customer list also may be in the form
of a database that includes other information about the customers,
such as their order histories and demographic information. A customer
list does not usually arise from contractual or other legal rights.
However, customer lists are often leased or exchanged. Therefore, a
customer list acquired in a business combination normally meets the
separability criterion.
IAS 38 Intangible assets
Intangible assets acquired in a business combination
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December 12, 2008
Order or production backlog An order or production backlog arises from contracts such as purchase
or sales orders. An order or production backlog acquired in a business
combination meets the contractual‐legal criterion even if the purchase
or sales orders can be cancelled.
Customer contracts and the related
customer relationships
If an entity establishes relationships with its customers through
contracts, those customer relationships arise from contractual rights.
Therefore, customer contracts and the related customer relationships
acquired in a business combination meet the contractual‐legal
criterion, even if confidentiality or other contractual terms prohibit the
sale or transfer of a contract separately from the acquiree.
A customer contract and the related customer relationship may
represent two distinct intangible assets. Both the useful lives and the
pattern in which the economic benefits of the two assets are consumed
may differ.
A customer relationship exists between an entity and its customer if (a)
the entity has information about the customer and has regular contact
with the customer and (b) the customer has the ability to make direct
contact with the entity. Customer relationships meet the contractual‐
legal criterion if an entity has a practice of establishing contracts with
its customers, regardless of whether a contract exists at the acquisition
date. Customer relationships may also arise through means other than
contracts, such as through regular contact by sales or service
representatives.
Non‐contractual customer
relationships
A customer relationship acquired in a business combination that does
not arise from a contract may nevertheless be identifiable because the
relationship is separable. Exchange transactions for the same asset or a
similar asset that indicate that other entities have sold or otherwise
transferred a particular type of non‐contractual customer relationship
would provide evidence that the relationship is separable.
Artistic‐related intangible assets
Plays, operas and ballets
Books, magazines, newspapers and
other literary works
Musical works such as compositions,
song lyrics and advertising jingles
Pictures and photographs
Artistic‐related assets acquired in a business combination are
identifiable if they arise from contractual or legal rights such as those
provided by copyright. The holder can transfer a copyright, either in
whole through an assignment or in part through a licensing agreement.
An acquirer is not precluded from recognising a copyright intangible
asset and any related assignments or licence agreements as a single
asset, provided they have similar useful lives.
IAS 38 Intangible assets
Intangible assets acquired in a business combination
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December 12, 2008
Video and audiovisual material,
including motion pictures or films,
music videos and television
programmes
Contract based intangible assets
Servicing contracts, such as
mortgage servicing contracts
Contracts to service financial assets are one type of contract‐based
intangible asset. Although servicing is inherent in all financial assets, it
becomes a distinct asset (or liability) by one of the following:
(a) when contractually separated from the underlying financial
asset by sale or securitization of the assets with servicing retained;
(b) through the separate purchase and assumption of the
servicing.
If mortgage loans, credit card receivables or other financial assets are
acquired in a business combination with servicing retained, the
inherent servicing rights are not a separate intangible asset because
the fair value of those servicing rights is included in the measurement
of the fair value of the acquired financial asset.
Employment contracts Employment contracts that are beneficial contracts from the
perspective of the employer because the pricing of those contracts is
favorable relative to market terms are one type of contract‐based
intangible asset.
Use rights, such as drilling, water,
air, timber cutting and route
authorities
Use rights include rights for drilling, water, air, timber cutting and
route authorities. Some use rights are contract‐based intangible assets
to be accounted for separately from goodwill. Other use rights may
have characteristics of tangible assets rather than of intangible assets.
An acquirer should account for use rights on the basis of their nature.
Computer software and mask works Computer software and program formats acquired in a business
combination that are protected legally, such as by patent or copyright,
meet the contractual‐legal criterion for identification as intangible
assets.
Mask works are software permanently stored on a read‐only memory
chip as a series of stencils or integrated circuitry. Mask works may have
legal protection. Mask works with legal protection that are acquired in
a business combination meet the contractual‐legal criterion for
identification as intangible assets.
IAS 38 Intangible assets
Intangible assets acquired in a business combination
Instituut van de Bedrijfsrevisoren 17
December 12, 2008
Databases, including title plants Databases are collections of information, often stored in electronic
form (such as on computer disks or files). A database that includes
original works of authorship may be entitled to copyright protection. A
database acquired in a business combination and protected by
copyright meets the contractual‐legal criterion. However, a database
typically includes information created as a consequence of an entity's
normal operations, such as customer lists, or specialized information,
such as scientific data or credit information. Databases that are not
protected by copyright can be, and often are, exchanged, licensed or
leased to others in their entirety or in part. Therefore, even if the future
economic benefits from a database do not arise from legal rights, a
database acquired in a business combination meets the separability
criterion.
Title plants constitute a historical record of all matters affecting title to
parcels of land in a particular geographical area. Title plant assets are
bought and sold, either in whole or in part, in exchange transactions or
are licensed. Therefore, title plant assets acquired in a business
combination meet the separability criterion.
Trade secrets such as secret
formulas, processes and recipes
A trade secret is 'information, including a formula, pattern, recipe,
compilation, program, device, method, technique, or process that (a)
derives independent economic value, actual or potential, from not
being generally known and (b) is the subject of efforts that are
reasonable under the circumstances to maintain its secrecy.'1 If the
future economic benefits from a trade secret acquired in a business
combination are legally protected, that asset meets the contractual‐
legal criterion. Otherwise, trade secrets acquired in a business
combination are identifiable only if the separability criterion is met,
which is likely to be the case.
IAS 38 Intangible assets
Intangible assets acquired in a business combination
Instituut van de Bedrijfsrevisoren 18
December 12, 2008
2. Determine for the following situations whether an intangible assets should be recognised
2.1 Acquirer Company (AC) acquires Target Company (TC) in a business combination on 31 December 20X5. TC
has a five‐year agreement to supply goods to Customer. Both TC and AC believe that Customer will renew the
agreement at the end of the current contract. The agreement is not separable.
The agreement, whether cancellable or not, meets the contractual‐legal criterion. Additionally, because TC
establishes its relationship with Customer through a contract, not only the agreement itself but also TC's
customer relationship with Customer meet the contractual‐legal criterion.
2.2. AC acquires TC in a business combination on 31 December 20X5. TC manufactures goods in two
distinct lines of business: sporting goods and electronics. Customer purchases both sporting goods and
electronics from TC. TC has a contract with Customer to be its exclusive provider of sporting goods but has no
contract for the supply of electronics to Customer. Both TC and AC believe that only one overall customer
relationship exists between TC and Customer.
The contract to be Customer's exclusive supplier of sporting goods, whether cancellable or not, meets the
contractual‐legal criterion. Additionally, because TC establishes its relationship with Customer through a
contract, the customer relationship with Customer meets the contractual‐legal criterion. Because TC has only
one customer relationship with Customer, the fair value of that relationship incorporates assumptions about
TC's relationship with Customer related to both sporting goods and electronics. However, if AC determines that
the customer relationships with Customer for sporting goods and for electronics are separate from each other,
AC would assess whether the customer relationship for electronics meets the separability criterion for
identification as an intangible asset.
2.3. AC acquires TC in a business combination on 31 December 20X5. TC does business with its customers
solely through purchase and sales orders. At 31 December 20X5, TC has a backlog of customer purchase orders
from 60 % of its customers, all of whom are recurring customers. The other 40 % of TC's customers are also
recurring customers. However, as of 31 December 20X5, TC has no open purchase orders or other contracts
with those customers.
Regardless of whether they are cancellable or not, the purchase orders from 60 % of TC's customers meet the
contractual‐legal criterion. Additionally, because TC has established its relationship with 60 % of its customers
through contracts, not only the purchase orders but also TC's customer relationships meet the contractual‐legal
criterion. Because TC has a practice of establishing contracts with the remaining 40 % of its customers, its
relationship with those customers also arises through contractual rights and therefore meets the contractual‐
legal criterion even though TC does not have contracts with those customers at 31 December 20X5.
2.4. AC acquires TC, an insurer, in a business combination on 31 December 20X5. TC has a portfolio of one‐
year motor insurance contracts that are cancellable by policyholders.
Because TC establishes its relationships with policyholders through insurance contracts, the customer
relationship with policyholders meets the contractual‐legal criterion. IAS 36 Impairment of Assets and IAS 38
Intangible Assets apply to the customer relationship intangible asset.
IAS 38 Intangible assets
Intangible assets acquired in a business combination
Instituut van de Bedrijfsrevisoren 19
December 12, 2008
3. Olegna acquires Enile on 30 December 20X8. In the balance sheet of Enile there is amount recognized
for goodwill in relation to an acquisition on 1 February 2008 of Siabot.
Is this goodwill part of the identifiable assets acquired an liabilities assumed in the business combination on
30 December 20X8 ?
No, goodwill is defined as an asset representing the future economic benefits arising from other assets acquired
in a business combination that are not individually identified and separately recognized.
IAS 38 Intangible assets
Assessing the useful lives of intangible assets
Instituut van de Bedrijfsrevisoren 20
December 12, 2008
ASSESSING THE USEFUL LIVES OF INTANGIBLE ASSETS
Determine the useful life and the subsequent accounting for each of the following examples of acquired
intangible assets.
1. A direct‐mail marketing company acquires a customer list and expects that it will be able to derive
benefit from the information on the list for at least one year, but no more than three years.
The customer list would be amortized over management's best estimate of its useful life, say 18 months.
Although the direct‐mail marketing company may intend to add customer names and other information to the
list in the future, the expected benefits of the acquired customer list relate only to the customers on that list at
the date it was acquired. The customer list also would be reviewed for impairment in accordance with IAS 36 ‐
Impairment of assets by assessing at the end of each reporting period whether there is any indication that the
customer list may be impaired.
2. An entity acquires a patent that expires in 15 years. The product protected by the patented
technology is expected to be a source of net cash inflows for at least 15 years. The entity has a commitment
from a third party to purchase that patent in five years for 60 % of the fair value of the patent at the date it
was acquired, and the entity intends to sell the patent in five years.
The patent would be amortized over its five‐year useful life to the entity, with a residual value equal to the
present value of 60 % of the patent's fair value at the date it was acquired. The patent would also be reviewed
for impairment in accordance with IAS 36 by assessing at the end of each reporting period whether there is any
indication that it may be impaired.
3. An acquired copyright has a remaining legal life of 50 years. An analysis of consumer habits and
market trends provides evidence that the copyrighted material will generate net cash inflows for only 30 more
years.
The copyright would be amortized over its 30‐year estimated useful life . The copyright also would be reviewed
for impairment in accordance with IAS 36 by assessing at the end of each reporting period whether there is any
indication that it may be impaired.
4. A broadcasting company acquires a broadcasting license that expires in five years. The broadcasting
license is renewable every 10 years if the entity provides at least an average level of service to its customers
and complies with the relevant legislative requirements. The license may be renewed indefinitely at little cost
and has been renewed twice before the most recent acquisition. The acquiring entity intends to renew the
license indefinitely and evidence supports its ability to do so. Historically, there has been no compelling
challenge to the license renewal. The technology used in broadcasting is not expected to be replaced by
another technology at any time in the foreseeable future. Therefore, the license is expected to contribute to
the entity's net cash inflows indefinitely.
The broadcasting license would be treated as having an indefinite useful life because it is expected to
contribute to the entity's net cash inflows indefinitely. Therefore, the license would not be amortized until its
useful life is determined to be finite. The license would be tested for impairment in accordance with IAS 36
annually and whenever there is an indication that it may be impaired.
5. The licensing authority for the broadcasting license in the previous example subsequently decides
that it will no longer renew broadcasting licenses, but rather will auction the licenses. At the time the licensing
authority's decision is made, the entity's broadcasting license has three years until it expires. The entity
expects that the license will continue to contribute to net cash inflows until the license expires.
IAS 38 Intangible assets
Assessing the useful lives of intangible assets
Instituut van de Bedrijfsrevisoren 21
December 12, 2008
Because the broadcasting license can no longer be renewed, its useful life is no longer indefinite. Thus, the
acquired license would be amortized over its remaining three‐year useful life and immediately tested for
impairment in accordance with IAS 36.
6. An acquired airline route authority between two European cities that expires in three years. The route
authority may be renewed every five years, and the acquiring entity intends to comply with the applicable
rules and regulations surrounding renewal. Route authority renewals are routinely granted at a minimal cost
and historically have been renewed when the airline has complied with the applicable rules and regulations.
The acquiring entity expects to provide service indefinitely between the two cities from its hub airports and
expects that the related supporting infrastructure (airport gates, slots, and terminal facility leases) will remain
in place at those airports for as long as it has the route authority. An analysis of demand and cash flows
supports those assumptions.
Because the facts and circumstances support the acquiring entity's ability to continue providing air service
indefinitely between the two cities, the intangible asset related to the route authority is treated as having an
indefinite useful life. Therefore, the route authority would not be amortized until its useful life is determined to
be finite. It would be tested for impairment in accordance with IAS 36 annually and whenever there is an
indication that it may be impaired.
7. An entity acquired a trademark used to identify and distinguish a leading consumer product that has
been a market‐share leader for the past eight years. The trademark has a remaining legal life of five years but
is renewable every 10 years at little cost. The acquiring entity intends to renew the trademark continuously
and evidence supports its ability to do so. An analysis of (1) product life cycle studies, (2) market, competitive
and environmental trends, and (3) brand extension opportunities provides evidence that the trademarked
product will generate net cash inflows for the acquiring entity for an indefinite period.
The trademark would be treated as having an indefinite useful life because it is expected to contribute to net
cash inflows indefinitely. Therefore, the trademark would not be amortized until its useful life is determined to
be finite. It would be tested for impairment in accordance with IAS 36 annually and whenever there is an
indication that it may be impaired.
8. An entity acquired a trademark acquired 10 years ago that distinguishes a leading consumer product.
The trademark was regarded as having an indefinite useful life when it was acquired because the trademarked
product was expected to generate net cash inflows indefinitely. However, unexpected competition has
recently entered the market and will reduce future sales of the product. Management estimates that net cash
inflows generated by the product will be 20 % less for the foreseeable future. However, management expects
that the product will continue to generate net cash inflows indefinitely at those reduced amounts.
As a result of the projected decrease in future net cash inflows, the entity determines that the estimated
recoverable amount of the trademark is less than its carrying amount, and an impairment loss is recognized.
Because it is still regarded as having an indefinite useful life, the trademark would continue not to be amortized
but would be tested for impairment in accordance with IAS 36 annually and whenever there is an indication
that it may be impaired.
9. An entity acquired a trademark for a line of products that was acquired several years ago in a business
combination. At the time of the business combination the acquiree had been producing the line of products
for 35 years with many new models developed under the trademark. At the acquisition date the acquirer
expected to continue producing the line, and an analysis of various economic factors indicated there was no
limit to the period the trademark would contribute to net cash inflows. Consequently, the trademark was not
amortized by the acquirer. However, management has recently decided that production of the product line
will be discontinued over the next four years.
IAS 38 Intangible assets
Assessing the useful lives of intangible assets
Instituut van de Bedrijfsrevisoren 22
December 12, 2008
Because the useful life of the acquired trademark is no longer regarded as indefinite, the carrying amount of
the trademark would be tested for impairment in accordance with IAS 36 and amortized over its remaining
four‐year useful life.
IAS 38 Intangible assets
Amortization of intangible assets
Instituut van de Bedrijfsrevisoren 23
December 12, 2008
AMORTIZATION OF INTANGIBLE ASSETS
1. Operator D pays commissions of 175 to a third party dealer for the acquisition of a subscriber
that has passed the usual credit check. The subscriber signs a 12‐month contract. The average life of D's
subscribers is 24 months. Operator D can reliably establish the recoverability of the 175 and has the
systems to track the payment for each subscriber acquired separately (PWC, Telecom, 122.40).
Over what period should an operator amortize subscriber acquisition costs ?
Operator D should record the payment of 175 as an intangible asset. Operator D should amortize the 175
on a straight line basis over the 12 month life of the contract. The fact that the average life of D's
subscribers is 24 month is not relevant in considering the initial useful life because D is not able to control
whether or not the subscriber renews the contract.
2. Operator B purchases a telecom license in 1999 for 1 million. The license has a term of 12 years.
B then constructs its telecom network. The telecom network is capable of delivering service in 20X1, two
years after the license was initially purchased. The license has a remaining term of 10 years. C expects its
subscriber base to grow over the next few years and reach a critical mass in four years' time ‐ that is, 20X5
(PWC , Telecom, 122.2 and 122.3).
When should an operator commence the amortization of its telecom license ?
Operator B should commence amortizing its telecom license from the date the network, and hence the
license, is available for use ‐ that is, in 20X1. B should undertake an annual impairment review in the years
when the license is not being amortized.
The depreciable amount of an intangible asset is allocated over the best estimate of its useful life. An
asset's useful life is defined as "the period of time over which the asset is expected to be used by an
entity."
The telecom license is capable of being used on the date it is purchased, but cannot be used until the
associated network assets necessary are available for use. Amortization of the license should commence
when the associated network assets are available for use.
Which basis of amortization should an operator adopt in respect of its telecom licenses ?
Operator C should amortize the full value of the license on a straight‐line basis over its remaining term of
10 years.
The amortization method should reflect the pattern in which the entity consumes the asset's economic
benefits. The license does not suffer wear and tear from usage (i.e. the number of customers using the
service). The economic benefits of a license relate to C's ability to benefit from the use of the license. The
economic benefit consumed relates to the fact that a period of time has passed and that the useful life of
the license is now shorter by that period. Accordingly the asset depletes on a time basis and the straight‐
line basis of amortization is the most appropriate one. The presumption for intangible assets is that
straight‐line is the most appropriate basis of amortization.
IAS 38 Intangible assets
Amortization of intangible assets
Instituut van de Bedrijfsrevisoren 24
December 12, 2008
3. Operator D purchased a telecom license in 20C for 1 billion. The license has an initial term of 10
years. The license agreement is silent about D's right to renew the license. While D expects to be able to
renew its license at the end of its initial term, it is not known what charge, if any, the government would
make for such a renewal (PWC, Telecom, 122.4).
Over what period should an operator amortize its telecom license ?
Operator D should amortize the full value of the license on a straight‐line basis over 10 years. D plans to
renew the license, but it has no experience of the government renewing telecom licenses. It cannot reliably
determine what amount, if any, would be payable to the government for the renewal of the license, the
likelihood of renewal or any related costs.
4. Operator E purchased a telecom license in 20X0 for 1 billion. The license has an initial term of 10
years. Te license agreement is silent about E's right to renew the license. There is an established practice
of the regulator granting a single renewal of telecom licenses at no additional cost provided operators
adhere to the requirements of the license. The license requires E to meet certain network build
milestones, to provide service to a fixed percentage of the population and to adhere to any new
regulations issued. E has already met the first two criteria and management intends to comply with new
regulations as and when they are issued (PWC, Telecom, 122.5).
Over what period should an operator amortize its telecom license ?
Operator E should amortize the full value of the license on a straight‐line basis over 20 years. There is
experience in E's country of the regulator renewing licenses for one additional term at no cost to the
operator. E has met the conditions of the license and intends to continue to adhere to any additional
requirements the regulator sets out.1.
5. A pharmaceutical entity acquired a compound in development for CU5 million on 1 January
20X3. The entity amortizes its intangible assets on a straight‐line basis over the estimated useful life of the
asset. The entity receives regulatory and marketing approval on 1 March 20 and starts using the
compound in its production process on 1 June 20X4 (PWC, Pharma, 7).
When should it begin amortizing its intangible assets ?
Amortization should begin from 1 March 20X4, because this is the date from which the asset is available
for use. Prior to that date, the intangible asset should be tested for impairment at least annually,
irrespective of whether any indication of impairment exists.
6. Picasso Pharma has acquired a new drug compound, which is currently in phase I clinical
development. Picasso has capitalized the costs for acquiring the new drug compound as an intangible
asset. Subsequently, Picasso's scientists detect that the new drug substance is much more effective when
used in a combination therapy with another drug. Management stops the current development activities
for the new drug. New phase I clinical trials are started for the combination therapy (PWC, Pharma, 49).
How should a pharmaceutical entity amortize an intangible asset related to an acquired early‐stage
project when utilizing the results for development of a drug other than the drug for which the project
was originally acquired ?
IAS 38 Intangible assets
Amortization of intangible assets
Instituut van de Bedrijfsrevisoren 25
December 12, 2008
Picasso should not amortize the intangible asset subsequent to its acquisition, as it is not yet available for
use. Picasso should start amortizing the intangible asset when the combination therapy obtains regulatory
approval and is available for use.
The intangible asset is not impaired by cessation of development of the initial drug compound as a stand‐
alone product. The intangible asset continues to be developed by Picasso, which expects to create more
value with it by using the new drug compound as part of a combination therapy.
7. Raphael & Co has begun commercial production and marketing of an approved product.
Development costs for this product were capitalized in accordance with the criteria specified in IAS 38.
The patent underlying the new product will expire in 10 years (PWC, Pharma, 66).
Once a drug is being used as intended, what is the appropriate method of amortizing the capitalized
development costs ?
Raphael should amortize the capitalized development costs on a straight‐line basis over the patent’s 10‐
year life, unless the business plan indicates use of the patent over a shorter period. Use of the straight‐line
method reflects consumption of benefits available from the patent, which is based upon the passage of
time. If the time over which the patent will generate economic benefits decreases, Raphael should perform
impairment test and a systematic and rational amortization method should be utilized over this shortened
remaining useful life.
8. Raphael & Co has begun commercial production and marketing of an approved product.
Development costs for this product were capitalized in accordance with the criteria specified in IAS 38.
The patent underlying the new product will expire in 10 years; however, Raphael's business plan is to use
the compound in an over‐the‐counter drug after nine years to establish market presence. The business
plan indicates a future economic useful life for the compound of 10 years after patent expiry and supports
separate attribution of the intangible cost to the patent and the compound (PWC, Pharma 67).
Once a drug is being used as intended, what is the appropriate method of amortizing the capitalized
development costs ?
The intangible asset cost should be separately attributed to the patent and the compound. Each of these
intangibles should be amortized on a straight‐line basis. The intangible asset attributable to the paten
should be amortized over its nine‐year expected useful life. The intangible asset attributable to the
compound should be amortized over the full 20‐year life (10 years under patent plus 10years thereafter).
Amortization of both intangibles should be recorded during the first nine years, as both intangible assets
are available for use. Use of the straight‐line method reflects consumption of benefits available from the
patent, which is based upon the passage of time. If the time over which the patent will generate economic
benefits decreases, Raphael should perform impairment testing and a systematic and rational
amortization method should be utilized over this shortened remaining useful life.
IAS 38 Intangible assets
Impairment of intangible assets
Instituut van de Bedrijfsrevisoren 26
December 12, 2008
IMPAIRMENT OF INTANGIBLE ASSETS
1. Dali Pharmaceuticals has capitalized external development costs as an intangible asset relating to
a compound that has not been approved. Subsequently, Dali identified side effects associated with the
compound that indicate its value is severely diminished and an impairment charge must be recognized
(PWC, Pharma, 60).
Where should pharmaceutical entities classify impairment charges on development intangible assets
before such assets are available for use ?
Dali should classify the impairment charge relating to the unapproved drug as a component of R&D
expense, if presenting the income statement by function. If presenting the income statement by nature of
expense, Dali should classify the charge as an impairment charge.
2. Dali Pharmaceuticals has capitalized development costs as an intangible asset relating to a drug
that has been approved and is being marketed. Competitive pricing pressure from the early introduction
of generic drugs causes Dali to recognize an impairment of the intangible asset (PWC, Pharma 61).
Where should pharmaceutical entities classify impairment charges on development intangible assets
which are currently marketed ?
The impairment of a marketed product represents the acceleration of amortization. Accordingly, Dali
should classify the impairment consistently with the amortization expense, which is in cost of goods sold if
presenting the income statement by function. If presenting the income statement by nature of expense,
Dali should classify the charge as an impairment charge.
3. By way of a collaboration agreement, Veronese SpA acquired the rights to market a topical
fungicide cream in the Eastern Hemisphere. The acquired rights apply broadly to the entire territory. For
unknown reasons, patients in Greece prove far more likely to develop blisters from use of the cream,
causing Veronese to withdraw the product from that country. As fungicide sales in Greece were not
expected to be significant, loss of the territory, taken in isolation, does not cause the overall net present
value from sales of the drug to be less than its carrying value (PWC, Pharma, 62).
How should pharmaceutical companies account for the rescission of a drug's marketing approval in a
specific territory ?
The cash‐generating unit for the acquired marketing right should be viewed as sales from the entire
Eastern Hemisphere. Accordingly, withdrawal from one territory does not cause the asset’s value in use to
be less than its carrying value and no impairment loss should be recognized.
If Veronese has capitalized any additional development costs specifically for achieving regulatory approval
in Greece, these capitalized development costs must be written off with the withdrawal of the product
from the territory.
IAS 38 Intangible assets
Impairment of intangible assets
Instituut van de Bedrijfsrevisoren 27
December 12, 2008
However, Veronese’s management should carefully consider whether the blistering in one jurisdiction is
indicative of potential problems in other territories. If the issue cannot be isolated, a broader impairment
analysis should be performed, including the potential for more wide‐ranging sales losses.
4. Seurat Pharmaceutical acquired a new drug compound, which is currently in phase I clinical
development. Seurat capitalized the costs for acquiring the drug as an intangible asset. Soon after
acquisition of the drug, the results of the clinical trials show that the drug is not likely to be effective for
the intended therapy. Management terminates development of the drug. Seurat's scientists will use
technology directly related to the acquired intangible in developing one of Seurat's other drugs (PWC,
Pharma, 63).
How should a pharmaceutical entity amortise an intangible asset related to an acquired early‐stage
project when utilising the results for development of a drug other than the drug for which the project
was originally acquired ?
Seurat should not start to amortize the intangible asset when it is acquired, as it is not ready for use. The
poor results of the clinical trials indicate that the intangible asset may be impaired. Management must
perform an impairment test on the intangible asset and may have to write it down to the higher of the
compound’s fair value less cost to sell or the value in use of the directly related technology. Amortization
of any remaining carrying value of the intangible asset should occur over the estimated development
period of Seurat’s other drug, as the intangible is linked to the technology being used in the development
of a new drug.
5. Rubens Corp. markets a weight‐loss drug for which development costs have been capitalized. A
competing drug was launched on the market with much lower pricing. Rubens recorded an impairment of
the capitalized development intangible asset due to a reduction in the amounts it estimated that it could
recover as a result of this rival drug. Subsequently, the competing drug was removed from the market
because of safety concerns. The market share and forecast cash flows generated by Ruben's drug
significantly increased (PWC, Pharma, 64).
How should pharmaceutical entities account for reversals of impairment losses for intangible assets
accounted for under the cost model ?
The value in use calculation resulting in the impairment loss included an estimate of market share. An
identifiable change in estimate exists and the previously recorded impairment should be reversed. Rubens
should recalculate the value in use of the drug. The revised carrying value of the intangible asset cannot
exceed the amount, net of amortization, that would have been recognized if no impairment charge had
been recognized.
IAS 38 Intangible assets
Subsequent costs
Instituut van de Bedrijfsrevisoren 28
December 12, 2008
SUBSEQUENT COSTS
1. Velazquez Pharma has a registered patent on a currently marketed drug. Uccello Medicines Ltd.
copies the drug's active ingredient and sells the drug during the patent protection period. Velazquez goes
to trial and is likely to win the case, but has to pay costs for its lawyers and other legal charges (PWC,
Pharma, 42).
Should legal costs relating to the defense of pharmaceutical patents be capitalized ?
Velazquez should not capitalize patent defense costs as they maintain rather than increase the expected
future economic benefits from an intangible asset. They therefore do not meet the recognition criteria.
Therefore, patent defense costs have t be expensed as incurred.
2. The Hy‐Tech Services Corporation employs researchers based in countries around the world.
Employee time is the basis upon which charges to many customers are made. The geographically
dispersed nature of its operations makes it extremely difficult for the payroll staff to collect time records,
so the management team authorized the design of an in‐house, Web‐based timekeeping system (Epstein,
pg 303).
a. Determine for the following costs incurred by the project team whether they should be
expensed or capitalized
Cost type Amount Expensed Capitalized
Concept design 2500 X
Evaluation of design alternatives 3 700 X
Determination of required technology 8 100 X
Final selection of alternatives 1 400 X
Software design 28 000 X
Software coding 42 000 X
Quality assurance testing 30 000 X
Data conversion costs 3900 X
Training 14 000 X
Overhead allocation 6 900 X
General and administrative costs 11 200 X
Ongoing maintenance costs 6 000 X
b. Determine the amortization charge to be recognized as soon as all testing is completed. The
estimated useful life of the timekeeping system is five years.
100 000/60 months = 1 666.67
IAS 38 Intangible assets
Subsequent costs
Instituut van de Bedrijfsrevisoren 29
December 12, 2008
c. Once operational, management elects to construct another module for the system that issues an
e‐mail reminder for employees to complete their timesheets. This represents significant added
functionality. The following costs are incurred:
Labor type Labor cost Payroll taxes Benefits Total cost
Software developers 11 000 842 1 870 13 712
Quality assurance testers 7 000 536 1 190 8 726
Total 18 000 1 378 3 060 22 438
By the time this additional work is completed, the original system has been in operation for one year.
Should the company capitalize these costs ? If yes, what would be amortization charge ?
The full 22 438 amount of these costs should be capitalized since the work represents significant added
functionality. The additional amortization charge amounts to : 22 438/48 months = 467.46
d. After the system has been operating for two years, a Hy‐tech customer sees the timekeeping
system in action and begs management to sell it as a stand‐alone product. The customer becomes a
distributor, and lands three sales in the first year. From these sales Hy‐Tech receives revenues of 57 000
and incurs the following related expenses:
Distributor commission (25%) 14 250
Service costs 1 900
Installation costs 4 300
Total 20 450
Give the appropriate journal entries
The net proceeds from the software sale is 36 550 (57 000 – 20 450). Rather than recording these
transactions as revenue and expense, the 36 550 net proceeds are offset against the remaining
unamortized balance of the software asset with the following entry:
Dr Revenue 57 000
Cr Intangible assets – software 36 550
Cr Commission expense 14 250
Cr Service expense 1 900
Cr Installation expense 4 300
e. Immediately thereafter, Hy‐Tech’s management receives a sales call from an application service
provider who manages an Internet‐based timekeeping system. The terms offered are so attractive that
Hy‐Tech abandons its in‐house system at once and switches to the server system.
What should the entity do ?
IAS 38 Intangible assets
Subsequent costs
Instituut van de Bedrijfsrevisoren 30
December 12, 2008
As a result of this change, the company writes off the remaining unamortized balance of its time‐keeping
system.
Dr Accumulated depreciation 45 610
Dr Loss on asset disposal 40 278
Cr Fixed assets ‐ software 85 888
3. An entity is developing a new production process. During 20X5, expenditure incurred was CU1
000, of which CU900 was incurred before 1 December 20X5 and CU100 was incurred between 1
December 20X5 and 31 December 20X5. The entity is able to demonstrate that, at 1 December 20X5, the
production process met the criteria for recognition as an intangible asset. The recoverable amount of the
know‐how embodied in the process (including future cash outflows to complete the process before it is
available for use) is estimated to be CU500.
When should the entity recognize an intangible asset and for what amount ?
At the end of 20X5, the production process is recognized as an intangible asset at a cost of CU100
(expenditure incurred since the date when the recognition criteria were met, ie 1 December 20X5). The
CU900 expenditure incurred before 1 December 20X5 is recognized as an expense because the recognition
criteria were not met until 1 December 20X5. This expenditure does not form part of the cost of the
production process recognized in the statement of financial position.
During 20X6, expenditure incurred is CU2 000. At the end of 20X6, the recoverable amount of the know‐
how embodied in the process (including future cash outflows to complete the process before it is
available for use) is estimated to be CU1 900.
How should the entity account for the subsequent cost and the recoverable amount ?
At the end of 20X6, the cost of the production process is CU2 100 (CU100 expenditure recognized at the
end of 20X5 plus CU2 000 expenditure recognized in 20X6). The entity recognizes an impairment loss of
CU200 to adjust the carrying amount of the process before impairment loss (CU2 100) to its recoverable
amount (CU1 900). This impairment loss will be reversed in a subsequent period if the requirements for the
reversal of an impairment loss in IAS 36 are met.
IAS 38 Intangible assets
Comprehensive case
Instituut van de Bedrijfsrevisoren 31
December 12, 2008
COMPREHENSIVE CASE
1. Bitterfontein plc is a South African mail‐order film developer. Although the photo‐developing business
in South Africa is growing slowly, Bitterfontein plc has reported significant increases in sales and net income in
recent years. While sales increased from 50 mCU in 20X1 to 120 mCU in 20X4, profit increased from 3 mCU to
12 mCU over the same period. The stock market and analysts believe that the company’s future is very
promising. In early 20X5, the company was valued at 350 mCU, which is three times its 20X4 sales and 26 times
its estimated 20X5 profit.
What is the secret of Bitterfontein plc’s success? Company management and many investors attribute the
company’s success to its marketing flair and expertise. Instead of competing on price, Bitterfontein plc prefers
to focus on service and innovation, including
• offering customers a CD of their photos and a set of prints from the same roll of film for a set price • giving customers (at no extra charge) a “picture index” showing mini photos of every photo on the roll • giving every customer a replacement roll (at no extra charge) with every development order.
As a result of such innovations, customers accept prices that are 60% above those of competing discount‐film
developers, and Bitterfontein plc maintains a gross profit margin of around 40%.
Nevertheless, some investors have doubts about the company because they are uneasy about certain
accounting policies it has adopted. For example, Bitterfontein plc capitalizes the costs of its direct mailings to
prospective customers (4,2 mCU at 30 June 20X4) and amortizes them on a straight‐line basis over three years.
This practice is considered to be questionable as there is no guarantee that customers will be obtained and
retained from direct mailings.
In addition to the mailing lists developed by in‐house marketing staff, Bitterfontein plc purchased a customer
list from a competitor for 800 000 CU on 4 July 20X5. This list is also recognized as a non‐current asset.
Bitterfontein plc estimates that this list will generate sales for at least another two years, more likely another
three years. The company also plans to add names, obtained from a telephone survey conducted in August
20X5, to the list. These extra names are expected to extend the list’s useful life by another year.
Bitterfontein plc’s 20X4 statement of financial position also reported 7,5 mCU of marketing costs as non‐
current assets. If the company had expensed marketing costs as incurred, 20X4 net income would have been
10 mCU instead of the reported 12 mCU. The concerned investors are uneasy about this capitalization of
marketing costs, as they believe that Bitterfontein plc’s marketing practices are relatively easy to replicate.
However, Bitterfontein plc argues that its accounting is appropriate. Marketing costs are amortized at an
accelerated rate (55% in the first year, 29% in the second year, and 16% in the third year), based on 15 years
knowledge and experience of customer purchasing behaviour.
Explain how Bitterfontein plc’s costs should be accounted for under IAS 38, giving reasons for your answers
(Alfredson et al.(2007), pg. 478, problem 11.6)
Costs of direct mailings to prospective customer: Under IAS 38 internally generated customer lists and items
similar in substance shall not be recognized as intangible assets.
Accordingly, Bitterfontein plc should:
• Write off all costs capitalised to date; and
• Expense all such costs as incurred from now on.
IAS 38 Intangible assets
Comprehensive case
Instituut van de Bedrijfsrevisoren 32
December 12, 2008
Purchased customer list: It meets the asset definition. Bitterfontein plc has control as it has the power to obtain
the future economic benefits flowing from it and can restrict the access of others to it. Future economic
benefits exist in the form of potential sales. It also meets the intangible asset definition, as it is non‐monetary,
has no physical substance, and is identifiable as it can be sold. Assuming that it is probable that future
economic benefits will be obtained from this list, Bitterfontein plc’s treatment is correct – i.e. recognize it as an
intangible asset at cost and then, as the question indicates that Bitterfontein plc has chosen the cost model,
amortise it.
Cost of phone survey conducted after customer list purchased: Under IAS 38 subsequent expenditure on
customer lists and items similar in substance (whether externally acquired or internally generated) is always
expensed as incurred. Hence, Bitterfontein plc should expense the cost of the phone survey.
Marketing costs: They do not meet the asset definition. Bitterfontein plc cannot demonstrate control over he
future economic benefits flowing from them, as it cannot restrict the access of others to those benefits. IAS 38
states that control normally arises from legal rights (e.g. restraint of trade agreements). Without such rights it
is difficult to demonstrate control. Bitterfontein plc’s marketing practices and flair are known to competitors
and accordingly could be replicated.
Hence, Bitterfontein plc should:
• Write off all costs capitalised to date; and
• Expense all such costs as incurred from now on
IAS 38 Intangible assets
Annual improvements 2007
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December 12, 2008
ANNUAL IMPROVEMENTS 2007
1. Kandinsky Medical recently completed a major study comparing its Alzheimer's drug to
competing drugs. The results of the study were highly favourable and Kandinsky has invested in a
significant new marketing campaign. The campaign will be launched at the January 20X5 International
Alzheimer's Conference. Kandinsky has also paid for direct‐to‐customer (DTC) television advertising which
will appear in February 20X. Related DTC internet advertising will likewise begin in February, and will be
paid based on 'click‐through' to its Alzheimer's site (PWC, Pharma, 78).
How should the marketing campaign costs incurred be treated in its December 20X4 financial
statements ?
Advertising and promotional expenditure should be treated as an expense when incurred. All costs to
develop and to produce the marketing campaign and related materials, including the television
advertisement, internet advertisement and website, should be expensed immediately. Amounts paid to
television broadcast providers should be accounted for as a prepayment and expensed when the
advertisement airs in 20X5. Costs for hits to the company’s internet site should be expensed based upon
the click‐through rate in 20X5.
2. Goya Laboratories is eager to increase knowledge of its new generic pain medication within
hospitals. Accordingly, Goya's sales force distributes free samples of the pain medication during sales calls
and at certain hospital conventions. Additionally, Goya runs a special promotion where hospitals get 13
tablets for the price of 12 (PWC, Pharma, 80).
How should management classify, and account for, the costs of free samples distributed in order to
promote a product ?
The cost of product distributed for free and not associated with any sale transaction should be classified as
marketing expenses. Goya should account for the sample products given away at conventions and during
sales calls as marketing expenses. The product costs should be recognized as marketing expense when the
product is packaged as sample product. The cost of the incremental 13th tablet sold under the special
promotion should be classified as cost of goods sold, as it is related to the overall sales transaction and is
not a free sample.
IFRIC 12 – Service concession arrangements
Scope
Instituut van de Bedrijfsrevisoren 34
December 12, 2008
IFRIC 12 – SERVICE CONCESSION ARRANGEMENTS
SCOPE
Decide for the following scenarios whether IFRIC 12 should be applied or not
1. A construction company has an agreement with the French government to construct a tunnel
through a mountain. The tunnel is constructed on land of the French government, which means that the
French government is the legal owner of the tunnel. During a period of 15 years the company will collect
toll from drivers using the tunnel. The fare is limited to €5 by the French government. During the 15
year‐period the tunnel must be maintained by the construction company. After this period the
government will take over the maintenance.
Proposed solution: this agreement falls within the scope of IFRIC 12: transportation is considered a public
service. The service is regulated, and the residual interest in the asset, which is considered significant, is
controlled by the grantor. The company recognizes an intangible asset.
2. A power company builds a power plant. It contracts a power purchase agreement with the local
government. Through the agreement it is obliged to generate energy for the adjacent city. The
government will pay a fixed capacity payment to the company, if the plant is available, regardless of it
being dispatched. At the end of the 15‐year agreement, the power company can manage its plant at its
sole discretion. The power plant has a useful life of 30 years.
Proposed solution: this agreement does not fall within the scope of IFRIC 12: even though energy
generation is considered a public service, the residual interest in the asset, which is considered significant,
is controlled by the project company.
3. A power company builds a power plant. It contracts a power purchase agreement with the local
government. Through the agreement it is obliged to generate energy for the adjacent city. The
government will pay a fixed capacity payment to the company, if the plant is available, regardless of it
being dispatched. At the end of the 25‐year agreement, the power company can manage its plant at its
sole discretion. The power plant has a useful life of 30 years.
Proposed solution: this agreement falls within the scope of IFRIC 12: energy generation is considered a
public service, the service is regulated, and the residual interest in the asset is considered insignificant. The
company recognizes a financial asset.
4. A power company builds a power plant. It contracts a power purchase agreement with the local
government. Through the agreement it is obliged to generate energy for the adjacent city. The users will
pay a fixed price per MW acquired to the company. At the end of the 25‐year agreement, the power
company can manage its plant at its sole discretion. The power plant has a useful life of 30 years.
Proposed solution: this agreement falls within the scope of IFRIC 12: energy generation is considered a
public service, the service is regulated, and the residual interest in the asset is considered insignificant. The
company recognizes an intangible asset.
IFRIC 12 – Service concession arrangements
Scope
Instituut van de Bedrijfsrevisoren 35
December 12, 2008
5. A power company builds a power plant. It contracts a power purchase agreement with the local
government. Through the agreement it is obliged to generate energy for the adjacent city. The users will
pay a fixed price per MW acquired to the company. At the end of the 15‐year agreement, the power
company can manage its plant at its sole discretion. The power plant has a useful life of 30 years.
Proposed solution: this agreement does not fall within the scope of IFRIC 12: even though energy
generation is considered a public service, the residual interest in the asset, which is considered significant,
is controlled by the project company.
IFRIC 12 – Service concession arrangements
Financial asset/intangible asset
Instituut van de Bedrijfsrevisoren 36
December 12, 2008
FINANCIAL ASSET/INTANGIBLE ASSET
Decide for the following scenarios whether a financial asset or an intangible asset should be recognized
1. A waste incineration company has an agreement with the Belgian government to construct and
operate a waste incineration oven. The company can use this oven to treat any waste collected by the
Belgian municipalities for a period of 20 years. The price paid by the municipalities for waste incineration
is fixed by the government and is reviewed every year. After 20 years, the oven will become the property
of the Belgian government.
Intangible asset since the waste incineration company receives a right (a license) to charge the
municipalities for the use of the incineration oven. The amounts are contingent on the extent that the
municipalities use the service.
2. A privately owned hospital that has an arrangement with the Swiss government to construct,
maintain, and operate a division for AIDS patients for 20 years. Under the arrangement, the hospital is
paid by the patients for care but if patients cannot afford to pay for the care the Swiss government
reimburses the hospital. The payments should at least cover the cost of the infrastructure, the
maintenance of the infrastructure and the variable costs of the care. In addition, if there are not
sufficient payments by the patients to cover the fixed cost of the hospital, the government will
compensate for those costs. At the end of the concession period the infrastructure either reverts to the
government or the concession is renewed.
Financial asset since the hospital has an unconditional right to receive cash from the government if the
patients do not pay, or receipts from the patients are insufficient to cover costs.
3. A construction company has an agreement with grantor Spain to construct a road and maintain
and operate the road for twelve years. Under the contract, the company will be paid an annual amount,
with the total to be paid over the arrangement being equal to 70% of the total costs to be incurred. The
company will be able to charge users a toll, which is capped by the grantor.
Bifurcated model: The company will have to account separately for each component of the consideration.
It will recognize a financial asset and an intangible asset measured initially at the fair values of the
considerations received or receivable. The consideration to be received from the grantor will lead to a
financial asset. The excess of the costs incurred over the financial asset should be recognized as an
intangible asset
IFRIC 12 – Service concession arrangements
Accounting for service concession arrangements
Instituut van de Bedrijfsrevisoren 37
December 12, 2008
ACCOUNTING FOR SERVICE CONCESSION ARRANGEMENTS
Arrangement terms:
Cost of construction: 100
Profit on construction: 10
Cash flows over life: 200
A. Financial Asset Model
Assume that the interest revenue to be recognized over the life of the contract (based on the effective interest
rate method in accordance with IAS 39 – Financial Instruments: Recognition and Measurement) is 10.
During construction:
Dr Financial asset 110
Cr Revenue 110
Dr Cost of construction 100
Cr Cash 100
In accordance with IAS 39, the entity recognizes a financial asset at the fair value of the construction and
recognizes the cost of the construction. Revenue of 110, costs of 100 and a profit of 10 is thus recognized
during the construction.
During operational phase:
Dr Financial asset 10
Cr Finance revenue 10
Dr Financial asset 80
Cr Revenue 80
Dr Cash 200
Cr Financial asset 200
Total revenue over the life of the contract: 200
Total cash flows over the life of the contract: 200
Over the life of the construction period the financial asset is measured using the effective interest method. In
this example, the finance revenue recognized under this method is 10. The excess of the total cash flows over
the life of the contract (200) over the carrying amount of the financial asset (110+10=120), is recognized as
revenue (80). When cash is received the financial asset is credited. Total Revenue of 90 is therefore
recognized during the operational phase. (NB: This is a simplified example. Concession arrangements will
normally also incorporate significant running costs during the life of the concession).
B. Intangible Asset Model
During construction:
Dr Construction costs 100
IFRIC 12 – Service concession arrangements
Accounting for service concession arrangements
Instituut van de Bedrijfsrevisoren 38
December 12, 2008
Cr Cash 100
Dr Intangible asset 110
Cr Revenue 110
During the construction, the cost of the construction services provided is recognized as work in process and
then a subsequent exchange transaction of construction WIP for an intangible asset is recognized at the fair
value of the constructions services provided. This gives revenue of 110, costs of 100 and a profit of 10 during
the construction.
During operational phase:
Dr Amortization expense 110
Cr Intangible asset 110
Dr Cash 200
Cr Revenue 200
Total revenue over the life of the contract: 310
Total cash flows over the life of the contract: 200
During the life of the concession the intangible asset is amortized and the cash flows are recognized as
revenue. This means that during the operational phase of the service concession arrangement 110 of
concession costs are recognized and 200 of revenue is recognized. This leads to a profit of 90 during the
operational phase of the contract.
C. Bifurcated Model
Additional information: Cash flows guaranteed by the government are 60, which is 54% of the fair value of the
construction. Assume that the interest revenue that should be recognized over the life of the contract (based
on the effective interest rate in accordance with IAS 39 – Financial Instruments: Recognition and
Measurement) is 6.
During construction:
Dr Receivable 60
Cr Revenue 60
A financial asset of 60, equal to the cash flows guaranteed by the government, is recognized as construction
services are provided.
Dr Cost (exp) 54
Dr Construction WIP 46
Cr Cash 100
Since the government guarantees 54% of the fair value of the construction, a cost of 54 related to the financial
asset is recognized during the course of construction in the income statement. The remaining part of the
construction costs (100‐54=46) are considered to be costs that are related to acquisition of the intangible
asset.
Dr Intangible asset 50
Cr Revenue 50
IFRIC 12 – Service concession arrangements
Accounting for service concession arrangements
Instituut van de Bedrijfsrevisoren 39
December 12, 2008
An intangible asset is recognized for the difference between the fair value of the construction (110) and the
value of the financial asset (60).
Dr Cost of sales 46
Cr WIP 46
The construction cost related to the construction of the intangible asset is recognized as cost of sales. During
the construction the entity recognizes revenue of 110, costs of 100 and profit of 10.
During operational phase:
Dr Financial asset 6
Cr Finance revenue 6
The financial asset is measured in accordance with the effective interest method.
Dr Amortization expense 50
Cr Intangible asset 50
The intangible asset is amortized.
Dr Cash 200
Cr Revenue 134
Cr Financial asset 66
The cash received is split between revenue and the reduction of the receivable (60+6).
During the operational phase of the contract the entity recognizes revenue of 140, costs of 50 and profit of 90.
Total revenue over the life of the contract: 250
Total cash flows over the life of the contract: 200