Deegan5e Sm Ch08

8/20/2019 Deegan5e Sm Ch08

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Chapter 8

Accounting for intangibles

8.1 This question has been asked to stimulate debate. Certainly, in recent times it would appear that a greater proportion of corporate assets are often found to be in assets that are classifiedas intangible, and hence there might be a case for having an accounting standard dedicated tointangible assets. But it is perhaps questionable that the rules applying to intangible assets areso different and stricter that the rules that appear to tangible assets. !or e"ample, is thereadequate #ustification for disallowing the recognition of intangible assets on the basis thatthey have been internally generated, particularly when such assets can subsequently berecognised by another party if there is a business acquisition. $nternally developed intangibles,such as brand names, publishing titles, distribution rights and so forth can have significantvalue and prohibiting their recognition from corporate balance sheets obviously hasimplications for the relevance of information being provided in balance sheets. %lso, why do

we restrict the revaluation of intangible assets to situations where there is an &active market'when such restrictions are not e"plicitly in place for tangible assets( There is also theconservative requirement that stipulates that once an intangible asset has been the sub#ect of an impairment loss then it cannot be reinstated even if information comes to light to suggestthat future economic benefits are deemed to be probable. This is not consistent with therequirements for tangible assets wherein tangible assets can be reinstated and it is also notconsistent with the recommendations of the %%)B !ramework. $t would appear that theregulators have provided limited #ustification for these differences.

8.* +aragraph - of %%)B 18 states/

0o intangible asset arising from research or from the research phase of an internal pro#ect2 shall be recognised. 3"penditure on research or on the research phase of aninternal pro#ect2 shall be recognised as an e"pense when it is incurred.

$n #ustifying this requirement, paragraph of %%)B 18 states/

$n the research phase of an internal pro#ect, an entity cannot demonstrate that anintangible asset e"ists that will generate probable future economic benefits. Therefore,this e"penditure is recognised as an e"pense when it is incurred.

4ence, the argument is that the ne"us between the e"penditure and the subsequent economic

benefits is too uncertain to allow an asset to be recognised for balance sheet purposes.Certainly, much research e"penditure would not lead to future economic benefits.

5ith the above being said, whilst a great deal of research might not lead to subsequenteconomic benefits, some will indeed, for profit6seeking entities this is the general reason theyare undertaking the research2. To have a &blanket rule' that all research must be written off asincurred does seem highly conservative. $nterestingly, under our former accounting standard%%)B 17112 there was a requirement that research be divided into basic research andapplied research, and sub#ect to certain tests for deferral that the deferred costs be e"pected&beyond reasonable doubt' to be recoverable2 the applied research could be deferred andcarried forward as an asset.

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8. $f an intangible asset is acquired separately, and not as part of a business acquisition and in a business combination, many assets would be acquired2, the costs of the intangible asset are toinclude the costs associated with acquiring the asset and preparing the asset for its intendeduse. %s paragraph *; of %%)B 18 states/

The cost of a separately acquired intangible asset comprises:

(a) its purchase price, including import duties and non-refundable purchase taxes,after deducting trade discounts and rebates; and

(b) any directly attributable cost of preparing the asset for its intended use

%%)B &Business Combinations' defines a business combination as &the bringing together of separate entities or businesses into one reporting entity'. +aragraph of %%)B 18 statesthat where intangible assets are acquired as part of a business combination, rather than as aseparate acquisition of an asset, the assets will initially be recognised at their &fair value'. Thiscan be contrasted with individual acquisitions of intangible assets, where they are recognised

at &cost'. +aragraph of %%)B 18 states/

!n accordance "ith AA#$ % Business Combinations , if an intangible asset isacquired in a business combination, the cost of that intangible asset is its fair &alue at the acquisition date The fair &alue of an intangible asset reflects mar'et expectations about the probability that the future economic benefits embodied inthe asset "ill flo" to the entity !n other "ords, the effect of probability is reflected in the fair &alue measurement of the intangible asset Therefore, the probabilityrecognition criterion in paragraph (a) is al"ays considered to be satisfied for intangible assets acquired in business combinations

The above requirement is interesting, particularly the statement that &the probability criterion isalways considered to be satisfied for intangible assets acquired in a business combination'. Thisseems to be a simplistic assumption and not in accord with the asset recognition criteria in the%%)B !ramework, which require consideration to be given to the probability of futureeconomic benefits being generated. $n the basis for conclusions that was released with $%) 8,the $%)B acknowledged the conflict. $t stated at paragraph 18 of &Basis for Conclusions to$%) 8' that/

The $oard obser&ed that this highlights a general inconsistency bet"een therecognition criteria for assets and liabilities in the Frame"or' ("hich states that anitem meeting the definition of an element should be recognised only if it is probable

that any future economic benefits associated "ith the item "ill flo" to or from theentity, and the item can be measured reliably) and the fair &alue measurementsrequired in, for example, a business combination *o"e&er, the $oard concluded that the role of probability as a criterion for recognition in the Frame"or' should be considered more generally as part of a forthcoming +oncepts proect

)o this apparent inconsistency will be addressed in future work. !or our purposes, however,we need to appreciate that different recognition criteria apply to intangible assets, dependingupon whether an intangible asset is acquired individually, or as part of a business

combination. $f an intangible asset is acquired as part of a business combination it is to berecognised at its fair value. 4owever, if it is acquired separately it is to be recognised at&cost'.

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5hat is also interesting is that if intangible assets are acquired as part of a businesscombination they can be recognised by the acquirer even though they might originally have

been internally generated. !or e"ample, if a publisher has developed a successful list of publishing titles internally they may not recognise the list as an asset, but if their organisationis acquired, the list of titles may in fact be recognised by the acquiring party. %s paragraph -

of %%)B 18 states/

Therefore, in accordance "ith this #tandard and AA#$ %, an acquirer recognises at the acquisition date separately from good"ill an intangible asset of the acquiree if the assets fair &alue can be measured reliably, irrespecti&e of "hether the asset had been recognised by the acquiree before the business combination

)o, although paragraph


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a2 the design, construction and testing of pre6production or pre6use prototypes andmodels?

b2 the design of tools, #igs, moulds and dies involving new technology?c2 the design, construction and operation of a pilot plant that is not of a scale

economically feasible for commercial production? and

d2 the design, construction and testing of a chosen alternative for new or improvedmaterials, devices, products, processes, systems or services.

8. $ssues associated with this question were also addressed in @uestion 8.1. Tangible assets arethose assets with physical substance, such as inventory. $ntangible assets are non6monetaryassets that do not have physical substance. 3"amples include patents, trademarks, brandnames and copyrights. :ifferent accounting treatments apply. $ntangible assets are onlyrecognised if they are purchased other than deferred development costs that can berecognised even if internally developed2, while there is no equivalent restriction onrecognising internally generated tangible assets. There are also restrictions on revaluingintangible assets for e"ample, the intangible assets must originally have been recognised at

cost and there must be an &active market' for the assets2. )ome people argue that differentrules are appropriate because of the additional uncertainty and difficulty of measuring thevalue of intangible assets. =thers argue that intangible assets are equally able to be measuredreliably and that the different rules create internal inconsistency in the financial statements andimpede comparisons between companies that purchase their intangible assets and companiesthat generate them internally. )tudents should be encouraged to discuss these points. :o theythink the accounting rules make sense and are #ustifiable in terms of issues associated withrelevance and reliability(

8.< The adoption of $!A) has resulted in several changes to the accounting requirements for research and development e"penditure. +reviously, both research specifically, &applied

research'2 and developments costs could be deferred sub#ect to certain tests for deferral.4owever, under %%)B 18 &$ntangible %ssets' only development e"penditure may bedeferred sub#ect to certain tests for deferral2. %ll e"penditure on research must be e"pensedin the period in which it is incurred.

+reviously, the recognition of research and development costs as an asset was only permittedunder %ustralian %ccounting )tandards to the e"tent that the deferred costs were recoverable&beyond reasonable doubt'. This was a more restrictive test than the &probability' criterionapplied in the Conceptual !ramework. The corresponding requirement in %%)B 18 is thatthe future economic benefits are &probable'. 4owever, for development costs to be deferred,%%)B 18 requires that/

• completion is technically feasible?

• the entity intends to complete the asset and use it or sell it?

• the entity is able to sell or use the asset? and

• there are adequate technical, financial and other resources available to complete

the development.

$t is questionable whether mandatory e"pensing of all research costs provides better representation of financial performance and position than an alternative position which allowsdeferral sub#ect to certain stringent tests. The accounting treatment for research costs doesnot distinguish between unsuccessful research and research for which future economic

benefits are probable. %ssets would be understated to the e"tent that research e"penditure

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satisfies the definition and recognition criteria of assets but is not able to be reported on the balance sheet.

8.; $dentifiable intangible assets would include such things as patents, trademarks, licences,research and development, brand names, mastheads and copyrights. They are considered

identifiable because they can typically be separately identified, valued and perhapsindividually sold.

nidentifiable intangible assets are those intangible assets that cannot be separately identifiedor separately sold, an e"ample of which is goodwill. oodwill relates to the benefitsgenerated through reputation, good employees, location, and so on. %s with most intangibleassets, %%)B 18 requires that goodwill shall only be recognised when it is purchased. Thisrestriction has been imposed on the basis of the uncertainty surrounding the value of internally generated goodwill. )tudents should be encouraged to consider the merit of thisrestriction.

oodwill cannot subsequently be revalued and is to be sub#ect to ongoing impairment testing.=ther intangibles can be revalued to the e"tent that they are initially acquired at cost and aslong as there is an &active market' for the asset.

8.8 %%)B &Business Combinations' defines goodwill as future economic benefits arising fromassets that are not capable of being individually identified and separately recognised.%ccording to paragraph 1 of %%)B , the acquirer shall, at the acquisition date/

a2 recognise goodwill acquired in a business combination as an asset? andb2 initially measure that goodwill at its cost, being the e"cess of the cost of the business

combination over the acquirer's interest in the net fair value of the identifiable assets,

liabilities and contingent liabilities.

8.> %s we know, &assets' are defined in the %%)B !ramework as a resource controlled by theentity as a result of past events and from which future economic benefits are e"pected to flowto the entity.

oodwill would seem to fit the definition. $t relates to future economic benefits fromunidentifiable assets. +ursuant to our accounting standards, goodwill is only recognised whenit is acquired, which would seem to provide the requirements of control.

nder the Conceptual !ramework, however, the recognition of an asset would not be

dependent upon the requirement that the future economic benefit be purchased, only that it be controlled. But for goodwill recognition pursuant to %%)B , it is only purchasedgoodwill that shall be disclosed. This is an inconsistency between the accounting standard andthe conceptual framework.

8.17 The requirement to amortise goodwill was not popular with some companies because theyconsidered that it placed them at a competitive disadvantage in international capital markets.%ustralian companies had to amortise acquired goodwill over *7 years while companies inother reporting regimes were able to amortise over -7 years or, in some cases, were notrequired to amortise goodwill at all. They argued that amortising goodwill made their companies look less profitable to investors. %nother concern was that companies that grew

by acquiring other companies had to incur ongoing amortisation e"penses, while companiesthat grew internally did not. The concern here was with reduced comparability.



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These arguments assume that users of financial statements are not capable of, or do not bother, ad#usting for the amortisation of goodwill in their assessment of the profitability andearning potential of companies when making investment decisions.

+%T may provide some insights into the opposition to mandatory amortisation of goodwill.

0ot having to amortise goodwill would increase reported profits and managementcompensation, to the e"tent that it is linked to accounting profit. !urther, debt covenants,such as a minimum interest cover, are affected by the amortisation of goodwill. Theamortisation e"pense reduces reported profit and interest cover, being the ratio of profit

before ta" and interest, to interest. $f no ad#ustment is made for the amortisation of goodwill,companies with acquired goodwill may be disadvantaged in debt markets.

8.11 %ccording to %%)B 18, research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. +aragraph -requires that no intangible asset arising from research or from the research phase of aninternal pro#ect2 shall be recognised. 3"penditure on research or on the research phase of an

internal pro#ect2 shall be recognised as an e"pense when it is incurred. +aragraph < of %%)B18 provides e"amples of research activities, and these include/

a2 activities aimed at obtaining new knowledge?b2 the search for, evaluation and final selection of, applications of research findings or

other knowledge?c2 the search for alternatives for materials, devices, products, processes, systems or

services? andd2 the formulation, design, evaluation and final selection of possible alternatives for new

or improved materials, devices, products, processes, systems or services.

%ccording to %%)B 18, development is the subsequent application of research findings or other knowledge to a plan or design for the production of new or substantially improvedmaterials, devices, products, processes, systems or services before the start of commercial

production or use. +aragraph ; of %%)B 18 provides that an intangible asset arising fromdevelopment or from the development phase of an internal pro#ect2 shall be recognised if,and only if, an entity can demonstrate all of the requirements within the paragraph.

$n considering the e"penditure undertaken within the question it would generally be acceptedthat the administrative costs parts a2 and b2 of the question2 would not be considered todirectly relate to the research and development activities and hence the costs would bewritten off as incurred. The costs that would be included as research activities, and hence also

written off as e"penses, would be/i2 that proportion of staff salaries that relates to the research activities that is, half of their salaries2?

ii2 half of the consulting fees? andiii2 the raw material used in the research phase of operations.

)ub#ect to the deferral requirements of paragraph ; of %%)B 18, the following costswould be considered to relate to the development phases and hence be shown as an asset/i2 the depreciation of the laboratory equipment? andii2 half of the consulting fees.

8.1* For:



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$t would be difficult to ob#ectively determine the value of goodwill in the absence of a markettransaction. That is, the reliability of the recorded amount may be questionable. !urther,management may be able to employ particular assumptions in order to provide them withtheir desired goodwill amount.

Against:%n obvious argument against is one of consistency. The firm can recognise and revalue someother forms of intangible assets that were acquired at a cost. )hould the fact that somethingwas not acquired at a cost be enough to prohibit its recognition(

!urther, it does seem a bit odd, and conceptually unsound, that the entity that generates thegoodwill cannot show the asset in its balance sheet, but as soon as the entity is taken over,the acquiring company can disclose the purchased goodwill. This would lead to recordedassets being understated in the acquired entity.

8.1 There could be various reasons for this. The covenants included within trust deeds are

written to protect the interests of the lenders and to allow the borrowing company to attractfunds at a lower cost than might otherwise be possible. % common restriction is one that is based on the debt-to-asset ratio. %ll things being equal, the higher the level of debtDrelativeto total assetsDthe greater the risk that lenders may not be repaid. $f ma"imum debt to assetconstraints are put in place to safeguard the interests of lenders then arguably the lenderswould only want to include assets that are readily saleable in any debt restrictions. $ntangibleassets could frequently have little or no value should an entity be in financial distress. !or e"ample, assets such as brand names, mastheads and goodwill could have limited value if anentity was in financial trouble in fact, the reason it is in trouble may be that the brand name isno longer valued, or that it has no remaining goodwill2. any intangibles may have limitedvalue to parties other than the borrowers. Aelative to tangible assets such as stock,

machinery, or land and buildings, intangible assets may be particularly difficult to sell.

8.1- a2 Aesearch emanating from the +ositive %ccounting Theory perspective would tend toindicate that management may very well change their e"penditure patterns if such anaccounting change took place. !rom a mechanistic perspective, if the profits for a

period were low, management may opt to delay such e"penditure to future periods. $f management was sub#ect to debt9equity constraints which were binding, they mayneed to defer e"penditure, or else be in technical default of a debt agreement. $f theyare seeking to attract additional debt capital, they may need to defer the e"penditure if they are sub#ect to restrictive interest coverage provisions. The propensity to elect notto undertake certain e"penditure as a result of a new accounting standard requiring

the e"penditure to be e"pensed might be e"acerbated if the manager is approachingretirement. %s all such actions will have cash flow consequences, they willconceivably affect firm value.

b2 $f the manager was rewarded primarily on the basis of accounting earnings then thatmanager might, if he or she is driven by &self6interest', trade off the personal benefitsassociated with incurring the e"penditure, with those that would be generated fromnot incurring the e"penditure. $ssues such as the implications on future earnings andthe present value of such earnings would need to be considered. The implications for the reputation of the manager and related income flows2 due to the discovery of opportunistic e"penditure strategies would also need to be considered.

c2 Consider Eewellen, Eoderer and artin 1>8;2, and :echow and )loan 1>>12. %manager approaching retirement will not necessarily bear the costs related to reducing

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current period discretionary e"penditures for e"ample, repairs and maintenance or research and development2. Their &horiFon' will be different to that of the owners.%dopting the &self6interest perspective' which is central to +ositive %ccountingTheory, if managers were rewarded strictly in terms of accounting profits then theymay be e"pected to minimise e"penditure on the discretionary items. !urther, as they

are leaving the mar'et for managers they will not bear the cost of any damage to their reputation.

$t would be sensible that when managers are approaching retirement, they no longer be rewarded strictly on the basis of accounting earnings. +erhaps a mi" of market6 based and accounting6based reward structures may be appropriate.

8.1 )ub#ect to certain tests for deferral, e"penditure on development activity can be deferred tofuture periods and disclosed as an asset. 3"penditure on research activities is to be written off as an e"pense as incurred. +aragraph > of %%)B 18 provides e"amples of developmentactivities. These are/

a2 the design, construction and testing of pre6production or pre6use prototypes andmodels?

b2 the design of tools, #igs, moulds and dies involving new technology?c2 the design, construction and operation of a pilot plant that is not of a scale

economically feasible for commercial production? andd2 the design, construction and testing of a chosen alternative for new or improved

materials, devices, products, processes, systems or services.

The G7 777 spent on developing a general understanding of water flow dynamics would beconsidered as research and would be written off as incurred.

The G7 777 spent on understanding what local surfers e"pect from a surfboard would beresearch and would be written off as incurred.

The G>7 777 spent on testing and refining a certain type of fin and the G1>7 777 spent on the prototype would be construed as development e"penditure and to the e"tent that thee"penditure satisfies the tests for deferral then the e"penditures will be capitalised.



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8.1< Fair value of consideration/Cash G;7 777+lant and equipment G*7 777Eand G77 777

G


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8.18 For:

• Conceivably, all assets apart from, say, some land2 have a limited useful life and hence,

some form of recognition of wear and tear, commercial or technical obsolescence wouldseem to be appropriate. !ailure to recognise such wear and tear will lead to

overstatement of the entity's profits, and to the e"tent that dividends are paid out of such profits, to an erosion of the capital base of the entity.

• 5ithout rules requiring amortisation, some managers might opportunistically elect not to

amortise the assets.

Against:

• $f amortisation is to be dependent upon valuations, valuations are costly. 5ill the

additional cost offset the benefits to account users(

• $s amortisation conceptually sound remember amortisation is an allocation of cost, rather

than an acknowledgment of changes in the value of an asset2( $n terms of the %%)B!ramework, e"penses relate to losses of future economic benefits. This is not strictly thesame as amortisation.

• se of a set period for amortisation ignores the fact that various forms of intangibles will

be different in nature and will not have the same useful life. $t is also not conceptuallysound to impose arbitrary ma"imums.

• +erhaps it is possible that a limited number of intangibles might provide economic

benefits indefinitely, in which case, for these limited instances, amortisation might not beappropriate.

8.1> The G*17 777 spent researching materials in *77; must be e"pensed as incurred as %%)B18 does not permit the capitalisation of research e"penditure.

To the e"tent that future economic benefits were deemed probable then the e"penditureincurred in developing the proto6type surfboard and registering the patent in *778 can becarried forward as an asset.

The advertising e"penditure incurred in *77> of G* *77 777 would be e"pensed as incurredas generally accepted accounting procedures preclude the carry forward of advertisinge"penditure.

5hilst coy would have development assets of G87 777 shown in its balance sheet thee"penditure incurred in *7782 it is clear that the development e"penditure will lead tosignificant economic benefits. % competitor has made a legally binding offer to acquire therights to produce the surfboard for a price of G17 millions. )o can we revalue the asset inthe light of this legally binding offer( 0o. The reason that we cannot revalue the asset is thatthere is a lack of an &active market' given the unique nature of the asset. This inability torevalue the asset has obvious implication for the usefulness of the information provided in the

balance sheet

8.*7 4ow they treated goodwill/

• 5rote it off against retained profits. $n this case it will never affect profits.

• Treated as an e"traordinary item, which does not affect profits from ordinary activities.



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$mplications of non6compliance/

• Complying with the goodwill standard would have implications for profits from ordinary

activities which e"cluded e"traordinary items2. $t should be noted that we no longer disclose e"traordinary items. anagement may believe that reported profits fromordinary activities are used by account users to assess company performance and hence,any reduction in such profits may have cost of capital implications for the firm.

• +rofits from ordinary activities may be used in various contracts which are already in

place. anagement may disagree perhaps with some #ustification2 with the arbitrary *7year ma"imum.

• anagement may also disagree with the rule that only purchased goodwill be brought to

account. They could believe that any reduction in the value of purchased goodwill is morethan offset by an increase in internally generated goodwill.

8.*1 a2 This is a very interesting issue and one that has generated numerous debates. $f wewere to believe that readers of financial statements mechanistically reacted toreported profits that is, bigger reported profits are better than smaller reported

profits regardless of the accounting methods used2, then we could accept such anargument. !urther, if we could tie in actual cash flow implications that relate to the%ccounting )tandard's requirement then we could also probably accept such anargument. 4owever, if we assume an efficient market, then we could argue thatreaders of the financial statements could understand that the reduced accounting

profit is simply due to the requirement to amortise goodwill. %s the goodwillamortisation will be separately disclosed, perhaps we could argue that thoseindividuals that think the %ccounting )tandard is &stupid' could simply add theamortisation back to reported profits to get a &sensible' profit figure( $t should beremembered that there is no longer a requirement within %ustralia to amortisegoodwill on a systematic basis. $nstead we now have a requirement that goodwill besub#ect to ongoing impairment testing.

b2 This part should be used to generate discussion amongst the students. Certainly therequirements that only purchased goodwill shall be recognised, that goodwillamortisation shall be restricted to *7 years, and that straight6line amortisation shall beused by all reporting entities, are possibly quite difficult to support from a logical or conceptual basis. %s indicated above, the requirements in relation to the amortisationof goodwill no longer e"ist.

c2 5hether involving a greater number of corporate e"ecutives in the standard6setting process will improve the final %ccounting )tandards is not clear. Certainly they should

be able to give some indication of the costs and benefits2 that particular accountingapproaches may generate for their organisations or industries. This is information thatshould be considered. 4owever, whether they would let their own vested interestsdictate their support for particular accounting practices would not always beapparent. %t the e"treme, it is also possible that introducing numerous corporatee"ecutives to the accounting standard6setting process may enable corporations to&capture' the regulation process.

8.** $ntangible assets that are considered to have a limited useful life are required to be amortisedover their useful lives in accordance with %%)B 18. +reviously, although %ccounting

$nterpretation 1 e"tended the depreciation requirements to intangible assets, the wording wasless prescriptive and many companies chose not to amortise intangible assets other than



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goodwill2 even though it was reasonable to e"pect that their useful life was limited. Theamortisation of intangible assets will reduce reported profit to the e"tent that companies didnot previously amortise the assets.

oodwill is no longer amortised, whereas the previous accounting standard required straight6

line amortisation over a period not e"ceeding *7 years. The new requirements will increasethe reported profit of companies that would have otherwise been required to amortisegoodwill. 4owever, when there is cause to recognise an impairment of goodwill it is likelythat the loss in a given year will be greater because the carrying amount of goodwill will bethe original cost, rather than the amortised cost. Thus, any impairment loss is recognised inthe period that it is incurred rather than being spread out over a number of years.

8.* This view would appear logical. $f something is deemed to be an asset , then it perhaps shouldnot matter what its origin is as long as the entity is deemed able to control the associatedeconomic benefits and those benefits are deemed to be &probable'. 5ithin %ustralia, and

pursuant to %%)B 18, we are not to recognise internally generated intangible assets for balance sheet purposes with some e"ceptions, for e"ample, development e"penditure2.4owever, we are permitted to recognise a variety of purchased intangible assets. %rguably,the requirement not to recognise a number of internally developed intangible assetsunderstates the &true' assets of a reporting entity

8.*- Conceivably, many %ustralian corporations were worried by the possibility of having tocomply with requirements similar to those in $%) 8. There could be a number of reasons for concern. They might not have agreed with the logic of the requirements and might ob#ect tothe arbitrary requirement relating to the ma"imum period of time for amortisation being *7years this *7 year rule did not ultimately become part of %%)B 182. This has been onesource of the many arguments against the %ustralian goodwill accounting standard thegoodwill standard has since been replaced by %%)B 18 and there is no longer a requirementto systematically amortise goodwill over *7 years2. There are also problems associated withtrying to &prove' there is an active market for an asset if there is a decision to revalue theasset this is a requirement of %%)B 182.

$%) 8 would, in many cases, lead to reduced profits and reduced assetsDtwo things thatmanagement would not favour. They might believe that the market would react negatively tothe reduction in reported profits and assets, which in itself might imply that they believe thatthe capital market will not understand that the reductions were simply brought about by amandated change in accounting method. +erhaps they believe that the media will focus on

subsequent intangible asset write downs with the implication that the assets had previously been over6valued. $t is also possible that changing our rules to comply with $!A) would leadto a reduction in the wealth of the managers perhaps they are being paid accounting6based

bonuses which do not make allowance for a change in how intangibles are accounted for2.There is also a possibility that the reduction in reported profits could cause a small number of organisations to default on particular earnings based requirements that might be includedwithin certain borrowing contracts.

=f course there may be some managers who welcome the developments. They might believethat if %ustralia is required to follow the same rules as are employed internationally then thismight make it easier for the organisations to attract foreign capitalDalthough there is verylittle evidence to support this view. %nother perceived benefit of the $%) 8 approach was

that it minimised the discretion available to management to manipulate their accounting

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results for e"ample, an upper limit is provided for the life of the assets and revaluations areonly permitted if an &active market' can be proved2.

Companies with a large amount of intangible assets might anticipate significant write6offswith the introduction of %%)B 18 due to the restrictions on the recognition of manyintangible assetsDparticularly those that have been internally developed. 4owever, for those

entities with few intangible assets other than goodwill, the introduction of %%)B 18 couldlead to higher profits as a result of the removal of the requirement to systematically amortisegoodwill over *7 years.

8.* Computer software could qualify as an intangible asset an identifiable non6monetary assetwithout physical substance2 to the e"tent it is e"pected to provide future economic benefits.+aragraph > of %%)B 18 includes computer software as one of the categories of assets thatwould commonly be classified as intangible. +aragraph > states/

.ntities frequently expend resources, or incur liabilities, on the acquisition,de&elopment, maintenance or enhancement of intangible resources such as scientific or technical 'no"ledge, design and implementation of ne" processes or systems, licences,intellectual property, mar'et 'no"ledge and trademar's (including brand names and

publishing titles) +ommon examples of items encompassed by these broad headings arecomputer soft"are, patents, copyrights, motion picture films, customer lists, mortgage

ser&icing rights, fishing licences, import quotas, franchises, customer or supplier relationships, customer loyalty, mar'et share and mar'eting rights

Computer software would be carried at cost less subsequent amortisation and impairmentlosses, however fair value valuation would be allowed if the software has an &active market'.

)ome assets have both tangible and intangible characteristics and #udgement might benecessary to determine whether the tangible or intangible element of the asset is mostsignificant. %s paragraph - of %%)B 18 states/

#ome intangible assets may be contained in or on a physical substance such as acompact disc (in the case of computer soft"are), legal documentation (in the case of alicence or patent) or film !n determining "hether an asset that incorporates bothintangible and tangible elements should be treated under AA#$ / 0roperty, 0lant and

.quipment or as an intangible asset under this #tandard, an entity uses udgement toassess "hich element is more significant For example, computer soft"are for acomputer-controlled machine tool that cannot operate "ithout that specific soft"are is

an integral part of the related hard"are and it is treated as property, plant and equipment The same applies to the operating system of a computer 1hen the soft"areis not an integral part of the related hard"are, computer soft"are is treated as anintangible asset

$f computer software is carried forward as an asset then there would be an e"pectation thatthe useful life of the asset would typically be relatively short in duration. %s paragraph >* of %%)B 18 states/

2i&en the history of rapid changes in technology, computer soft"are and many other intangible assets are susceptible to technological obsolescence Therefore, it is li'ely

that their useful life is short



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8.*< % ta"i licence would be considered to be an intangible asset and must be accounted for inaccordance with %%)B 18. $ntangible assets can be carried at cost less any accumulatedamortisation and accumulated impairment losses2 or at fair value by way of assetrevaluations. $ntangible assets can only be revalued to fair value to the e"tent that there is an&active market'. $f there is not an &active market' then the intangible asset must be carried at

cost. %n active market is defined in %%)B 18 as/ &a market e"hibiting all of the following/the items traded are homogeneous? willing buyers and sellers can normally be found? and prices are publicly available'.

%ccording to %%)B 18, an active market would not e"ist for most intangible assets becauseintangible assets are typically unique in nature. 4owever, the market for ta"i licenses wouldseem likely to satisfy the requirements associated with an &active market' and hencerevaluations to fair value would be permitted. $n this regard paragraph ;8 of %%)B 18states/

!t is uncommon for an acti&e mar'et "ith the characteristics described in paragraph 3

to exist for an intangible asset, although this may happen For example, in some urisdictions, an acti&e mar'et may exist for freely transferable taxi licences, fishing licences or production quotas *o"e&er, an acti&e mar'et cannot exist for brands,ne"spaper mastheads, music and film publishing rights, patents or trademar's, becauseeach such asset is unique Also, although intangible assets are bought and sold,contracts are negotiated bet"een indi&idual buyers and sellers, and transactions arerelati&ely infrequent For these reasons, the price paid for one asset may not pro&ide

sufficient e&idence of the fair &alue of another 4oreo&er, prices are often not a&ailableto the public

5here a revaluation is undertaken, %%)B 18 requires that the revaluations be made with

sufficient regularity to ensure at reporting date that the carrying value and the fair value of theintangible asset are not materially different.

8.*; $ntangible assets such as internally generated goodwill cannot be recognised by a reportingentity. 4owever, goodwill purchased through a business acquisition can be shown as an asset.$f an organisation did have certain licenses that were internally developed then they wouldneed to be written off given the general prohibition on recognising as assets any internallydeveloped intangible assets, other than those relating to development e"penditure.$n terms of Tweedie's comments about restricting the recognition of intangible assets untilHwe get smarterI, he is obviously placing a great deal more emphasis on reliability that onrelevance. $t does appear that current6day balance sheets are not terribly relevant to manydecisions given their e"clusion of many valuable intangible assets. )tudents should beencouraged to discuss this e"clusion and whether they agree with the stance taken byTweedie and the $%)B.

8.*8 $n theory, goodwill could be carried forward indefinitely, but only to the e"tent that thecarrying amount does not e"ceed the recoverable amount of the asset. =nce goodwill has

been recognised there is a requirement that it must be carried forward at cost lessaccumulated impairment losses.

8.*> a2 +atents should be recognised on the balance sheet at amortised cost. The revaluationsubsequent to acquisition would not be permitted there would not be an &activemarket' for such assets2.

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=f course, if companies did stop paying dividends, the spending power of millions of shareholders might changeDand this could have enormous economic implications. Butstudents should be asked whether they believe that companies would, as a result of the

proposals, no longer be able to pay dividends, or whether the argument has been provided bya group of e"ecutives roup of 1772 to simply support a position that would give them more

professional latitude in how they account for their intangible assets.%s it turned out, when %ustralia adopted $%) 8 although labelled %%)B 182 theinternational standard had been amended to recognise the fact that some intangible assetsmight indeed have indefinite lives, and to the e"tent such a contention can be supported, thenthere is no need to amortise the related assets although annual impairment testing would still

be e"pected2.

8.* !or many organisations, a great deal of their underlying value is based on the intangible assets

that they control. 4ence, it is a reasonable argument that financial statement readers should

be provided with knowledge about these assets if they are going to make informed decisions

about the organisations. !ailure to provide such information would undermine the relevance

of the reports. The argument that there is also a problem if we &allow' intangibles that do not

meet the asset recognition criteria to be recognised is a very strange one. $f the asset

recognition criteria cannot be met, then simply stated, the assets are not &allowed' to be

recognised in accordance with the %%)B !ramework and other generally accepted

accounting principles. The use of the word &allow' in this document released by the %%)B is

quite ine"plicable. The real dilemma for standard setters is to develop tests that can be

applied to determine if intangible assets meet the asset recognition criteria the recognition

criteria being that it is probable that the future economic benefits embodied in the asset will

eventuate and that the asset possesses a cost or other value that can be measured reliably2 particularly if they believe knowledge about intangible assets is important. =f course, there

will always be some professional #udgement involved.

The relationship between integrity and usefulness is fairly straight6forward. $f financial

statement users do not consider that particular accounting numbers have integrity which

could be assumed to mean that they are not reliable and9or ob#ective2 then they will not be

inclined to use the numbers in the various decisions they might make. That is, there would be

a positive relationship between integrity and usefulness.

%rguably a requirement that all intangible assets of a certain type are not to be recognised for

balance sheet purposes will undermine the usefulness of balance sheets. !inancial statement

readers will not be able to differentiate between those entities that have valuable intangible

assets and those that do not, because all intangible assets of a certain type will not be allowed

to be recognised. The trade6off between usefulness and integrity is similar to the trade6off

between relevance and reliability.

8. a2 The internally generated masthead may not be recognised at all. +aragraph


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.xpenditure on internally generated brands, mastheads, publishing titles, customer lists and items similar in substance cannot be distinguished from the cost of de&eloping the business as a "hole Therefore, such items are not recognised asintangible assets

b2 The publishing title may be recognised as an asset because it was purchased, however itcannot be revalued because there is no &active market' for the title. %n active market isa requirement for revaluations pursuant to %%)B 18. $n relation to active markets,

paragraph ;8 of %%)B 18 states that/

an acti&e mar'et cannot exist for brands, ne"spaper mastheads, music and film publishing rights, patents or trademar's, because each such asset isunique Also, although intangible assets are bought and sold, contracts arenegotiated bet"een indi&idual buyers and sellers, and transactions arerelati&ely infrequent For these reasons, the price paid for one asset may not

pro&ide sufficient e&idence of the fair &alue of another 4oreo&er, prices are

often not a&ailable to the public

c2 The franchise may be revalued to the fair value of G*77 777, being the observable price in an active market.

:r !ranchise G177 777 Cr Aevaluation Aeserve G177 777Being revaluation of franchise by G177 777

d2 The deferred development e"penditure may not be revalued.

8.- a2 G7 777 should be recognised as an e"pense. %ll G-7 777 of the research e"pendituremust be e"pensed. The development e"penditure of G17 777 must also be e"pensed in*77; because the pro#ect was not e"pected to generate future economic benefits.

b2 G1* 777 shall be treated as an e"pense as all research e"penditure must be e"pensed.

c2 *77;/ Gnil?*778/ G :r :evelopment 3"pense G< 777 Cr %ccumulated %mort. :eferred

:evelopment CostsG< 777

%mortisation of deferred developmentscostsDturnip pro#ect

*717 :r :evelopment 3"pense G1* 777 Cr %ccumulated %mort. :eferred

:evelopment CostsG1* 777

%mortisation of deferred developmentscostsDturnip pro#ect

*77>G

*717G

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:eferred :evelopment Cost

Deegan5e Sm Ch08

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Transcript of Deegan5e Sm Ch08