PAS 38 Intangible Assets Study Guide

Overview and Definition of Intangible Assets (PAS 38)

  • Learning Objectives:

    • Definition of Intangible Assets
    • Recognition Criteria
    • Initial Measurement
    • Subsequent Measurement
    • Classifications
    • Impairment and Derecognition

  • Definition of Intangible Assets:

    • An intangible asset is defined as an identifiable nonmonetary asset without physical substance.
    • PAS 38 explicitly states that "the intangible asset must be controlled by the entity as a result of past event and from which future economic benefits are expected to flow to the entity."

  • Essential Elements of Intangible Assets:

    • Identifiability: The asset can be distinguished clearly from other assets.
    • Control: The power to obtain future economic benefits and restrict others from accessing them.
    • Future Economic Benefits: Economic inflows resulting from the asset's use.

  • Identifiability Criteria:

    • An asset satisfies the identifiability criterion if it meets either of the following conditions:
    • Separability: The asset can be separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability.
    • Contractual or Legal Rights: The asset arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

  • Control:

    • Defined as the power of the entity to obtain the future economic benefits flowing from the underlying intangible asset and to restrict the access of others to those benefits.
    • Simply stated, the entity can enjoy the economic benefits while preventing external parties from gaining access to those same benefits.

  • Future Economic Benefits:

    • May include:
    • Revenue generated from the sale of products or services.
    • Cost savings achieved through internal operational efficiencies.
    • Other benefits resulting directly from the entity's utilization of the asset.

  • Examples of Intangible Assets:

    • Identifiable Intangible Assets:
    • Patent
    • Copyright
    • Franchise
    • Trademark or brand name
    • Customer list
    • Computer software
    • Broadcasting license, airline right, and fishing right
    • Unidentifiable Intangible Asset:
    • Goodwill

Recognition Criteria for Intangible Assets

  • An intangible asset shall be recognized if, and only if, the following two conditions are present:
    • It is probable that expected future economic benefits attributable to the asset will flow to the entity.
    • The cost of the intangible asset can be measured reliably.

Initial Measurement of Intangible Assets

  • General Rule:

    • Intangible assets are initially measured at COST.

  • Modes of Acquisition and Cost Determination:

    • Separate Acquisition:
    • Cost comprises:
      • Purchase price, including import duties and nonrefundable purchase taxes, after deducting trade discounts and rebates.
      • Any directly attributable costs of preparing the asset for its intended use.
    • Acquisition as Part of a Business Combination:
    • The cost of the intangible asset is based on its fair value at the date of acquisition.
    • Acquisition by Way of a Government Grant:
    • An intangible asset acquired via government grant may initially be recorded at either:
      • Fair value of the asset.
      • Nominal amount or zero, plus any expenditure directly attributable to preparing the asset for its intended use.
    • Acquisition by Exchange:
    • Exchange with Commercial Substance: Measured at the fair value of the asset given up, adjusted by any cash paid or received.
    • Exchange Lacking Commercial Substance: Measured at the carrying amount of the asset given up, adjusted by any cash paid or received.
    • Acquisition by Self-Creation or Internal Generation:
    • The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management.

  • Explicit Non-Recognition Provision (PAS 38, Paragraph 63):

    • PAS 38, paragraph 63, explicitly provides that "internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognized as intangible assets."
    • These expenditures cannot be distinguished separately from the cost of developing the business as a whole.
    • Such items are viewed as components of internally generated goodwill.
    • Consequently, all expenditures on internally generated brands, mastheads, publishing titles, customer lists, and similar items shall be recognized as an expense when incurred.

Classification of Intangible Assets by Useful Life

  • Definite Life vs. Indefinite Life:
    • Definite Life:
    • Definition: The asset has a limited or finite useful life over which economic benefits are expected to be generated.
    • Accounting Treatment: Subject to systematic amortization over its useful life.
    • Typical Examples: Patent, copyright, franchise with a fixed term, computer software, customer list, and finite license.
    • Indefinite Life:
    • Definition: There is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.
    • Accounting Treatment: Not amortized; evaluated for impairment annually or whenever indicators of impairment arise.
    • Typical Examples: Goodwill, trademark, and perpetual franchise.

Subsequent Measurement Models

  • An entity shall select either the Cost Model or the Revaluation Model as its accounting policy:

  • Cost Model:

    • Carried at cost, less any accumulated amortization and any accumulated impairment losses.

  • Revaluation Model:

    • Carried at a revalued amount, which is its fair value at the date of revaluation, less any subsequent accumulated amortization and any subsequent accumulated impairment losses.
    • Fair value must be determined by reference to an active market.
    • An intangible asset can only be carried under the revaluation model if an active market exists for that specific asset.

Amortization and Impairment

  • Amortization:

    • Definition: The systematic allocation of the amortizable amount of an intangible asset over its useful life.
    • Amortizable Amount Formula:     Cost−Residual Value=Amortizable amount\text{Cost} - \text{Residual Value} = \text{Amortizable amount}
    • Journal Entry to Record Amortization:
    • Debit: Amortization expense
    • Credit: Accumulated amortization
    • Amortization Method:
    • Shall reflect the pattern in which the entity expects to consume the asset's future economic benefits.
    • If that pattern cannot be determined reliably, the straight-line method shall be used.

  • Useful Life Assessment:

    • Why useful life must be assessed:
    • Finite Useful Life: The asset is amortized.
    • Indefinite Useful Life: The asset is not amortized.

  • Impairment Testing Requirements:

    • Finite Useful Life: Tested for impairment whenever there is an indication of impairment at the end of the reporting period.
    • Indefinite Useful Life: Tested for impairment at least annually, and whenever there is an indication that the asset may be impaired.

  • Residual Value Rules:

    • The residual value of an intangible asset with a finite useful life is presumed to be zero, except in the following cases:
    • A third party has made a commitment to purchase the asset at the end of its useful life.
    • There is an active market for the asset such that the residual value can be determined by reference to that market, and it is probable that such a market will exist at the end of the asset's useful life.

  • Review of Amortization Period, Method, and Residual Value:

    • The amortization period, amortization method, and residual value shall be reviewed at least at each financial year-end.
    • Any significant changes in expectations are accounted for as changes in accounting estimates and applied prospectively.

Derecognition

  • An intangible asset shall be derecognized (eliminated from the statement of financial position):

    • On disposal of the asset.
    • When no future economic benefits are expected from its use or disposal.

  • Gain or Loss Calculation:   Net Disposal Proceeds−Carrying amount of the asset=Gain/Loss\text{Net Disposal Proceeds} - \text{Carrying amount of the asset} = \text{Gain/Loss}

Specific Identifiable Intangible Assets

  • Patent:

    • Category: Technology-Based Intangible Asset.
    • Definition: An exclusive right granted by the government to an inventor enabling control over the manufacture, sale, or other use of an invention for a specified period.
    • Legal Life: 20 years20\,\text{years} in accordance with R.A. No. 8293.
    • Cost Determination:
    • Purchased Patent: Includes purchase price, import duties, nonrefundable purchase taxes, and directly attributable costs of preparing the asset for intended use.
    • Internally Developed Patent: Includes licensing fees, legal fees, and administrative expenses incurred in securing the patent rights.
    • Cost of Litigation:
    • Legal fees and other expenses incurred in successfully prosecuting or defending a patent litigation shall be recognized as an expense.
    • If the litigation is unsuccessful, the legal costs and any remaining unamortized cost of the patent shall be written off immediately as a loss.
    • Amortization Rules for Patent:
    • Internally Developed Patent: Amortized over its legal life (20 years20\,\text{years}) or useful life, whichever is shorter.
    • Acquired Patent: Amortized over its remaining legal life or useful life, whichever is shorter.
    • Competitive Patent (acquired to protect an original patent): Amortized over the remaining life of the original patent.
    • Related Patent (acquired to extend the life of an old patent): The cost of the related patent plus any unamortized cost of the old patent are amortized over the extended life. If there is no extension of life, the new patent is amortized over its own useful life, and the unamortized cost of the old patent continues to be amortized over its remaining life.

  • Trademark:

    • Category: Market-Related Intangible Asset.
    • Definition: A symbol, sign, slogan, or name used to mark a product to distinguish it from competitors. The terms trademark, trade name, and brand name are used interchangeably.
    • Legal Life: 10 years10\,\text{years}, renewable indefinitely for additional periods of 10 years10\,\text{years} each.
    • Cost Determination:
    • Purchased Trademark: Purchase price plus directly attributable acquisition costs.
    • Internally Developed Trademark: Expenditures required to establish it, such as filing fees, registry fees, design costs, and legal fees in securing the rights.

  • Copyright:

    • Category: Artistic-Related Intangible Asset.
    • Definition: An exclusive right granted by the government to an author, composer, or artist to publish, sell, or benefit from literary, musical, or artistic works.
    • Legal Life / Term of Protection: Extended during the author's lifetime plus 50 years50\,\text{years} after death.
    • Cost Determination:
    • Purchased Copyright: Cash paid plus directly attributable costs necessary for intended use.
    • Internally Produced Copyright: All expenses incurred in producing the work and establishing/obtaining the legal right.

  • Franchise:

    • Category: Contract-Based Intangible Asset.
    • Definition: A business license granting permission to sell a company's goods or use its brand name under a franchise agreement between a franchisor and a franchisee.
    • Agreement Types:
    • Between government and a private entity/individual.
    • Between private entities/individuals.
    • Cost and Fee Structures:
    • Initial Franchise Fee: Lump-sum payment for costs necessary for intended use (e.g., acquisition expenses, legal fees); capitalized as the cost of the franchise.
    • Periodic Franchise Fee: Continuous periodic payments made to the franchisor; recognized as outright operating expense when incurred.
    • Amortization Rules:
    • Definite Useful Life: Amortized over the useful life or definite franchise period, whichever is shorter.
    • Indefinite Useful Life: Not amortized; evaluated for impairment at least annually.

  • Customer List:

    • Database containing customer names, contact details, transaction histories, and demographic statistics.
    • Capitalized only if separately acquired or acquired via business combination; internally generated customer lists must be expensed.

  • Organization Cost:

    • Costs incurred in forming or organizing a corporation (e.g., startup legal and secretarial costs).
    • PAS 38 requires startup costs to be recognized as an expense when incurred.

  • Computer Software:

    • Definition: A collection of instructions, data, and programs instructing computer hardware on executing specific tasks.
    • Classification Rules:
    • Software Purchased for Resale: Classified as Inventory.
    • Software Integral to Hardware: Software purchased as an integral part of computer-controlled machinery (which cannot operate without it) is classified as Property, Plant, and Equipment (PPE).
    • Software Non-Integral to Hardware: Classified as an Intangible Asset.

  Types of Computer Software

  • Amortization and Impairment of Computer Software:
    • Amortized over its useful life using a pattern that reflects expected benefit consumption (or straight-line method if pattern is not reliably determinable).
    • Tested for impairment whenever an indication of impairment exists at the end of the reporting period.

Research and Development Costs

  • Research Activities:

    • Definition: Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
    • Examples:
    • Laboratory research aimed at obtaining or discovering new knowledge.
    • Searching for applications of research findings or other knowledge.
    • Conceptual formulation and design of possible product or process alternatives.
    • Testing in search for product or process alternatives.
    • Accounting Treatment: All expenditure on research or on the research phase of an internal project shall be expensed when incurred due to high uncertainty surrounding economic failure or success.

  • Development Activities:

    • Definition: The application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services prior to commercial production or use.
    • Examples:
    • Design, construction, and testing of preproduction prototypes and models.
    • Design of tools, jigs, molds, and dies involving new technology.
    • Design, construction, and operation of a pilot plant that is not of a scale economically feasible for commercial production.
    • Design, construction, and testing of a chosen alternative for new or improved products or processes.
    • Accounting Treatment: Development costs are capitalized as an intangible asset if, and only if, the entity can demonstrate ALL six strict recognition criteria.

  • Criteria for Capitalizing Development Costs:

    • Technical feasibility of completing the intangible asset so that it will be available for use or sale (demonstrated by producing a model/prototype).
    • Intention to complete the intangible asset and use or sell it.
    • Ability to use or sell the intangible asset.
    • How the intangible asset will generate probable future economic benefits.
    • Availability of adequate technical, financial, and other resources to complete development and to use or sell the asset.
    • Ability to measure reliably the expenditure attributable to the intangible asset during its development.

  • Summary of Project Phases:

    • Research Phase: Expensed immediately when incurred.
    • Development Phase: Capitalized as an intangible asset if all six recognition criteria are satisfied; otherwise expensed.
    • Commercial Production Phase: Expensed.

  • Activities Excluded from R&D (Operating Expenditures):

    • Engineering follow-through during an early phase of commercial production.
    • Quality control during commercial production, including routine testing.
    • Troubleshooting equipment breakdowns during commercial production.

Goodwill

  • Nature of Goodwill:

    • Represents future economic benefits arising from unidentifiable assets acquired in a business combination.
    • Arises when an entity earns profit above normal return due to good name, capable personnel, high credit standing, reputation for fair dealing, product quality, favorable location, and customer loyalty.
    • Characteristics: Not specifically identifiable, indeterminate useful life, inherent in a continuing business, and relates to the business as an entire entity.

  • Recognition of Goodwill:

    • Internally Generated Goodwill: Shall NOT be recognized as an asset.
    • Purchased Goodwill: Recognized as an asset because it is acquired and paid for through a business combination.

  • Measurement Approaches for Purchased Goodwill:

    • 1. Residual Approach:

    • Goodwill is measured as the excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired.

    • Calculation Example:

      • An entity acquires an ongoing business for P9,000,000\text{P}9,000,000 cash.
      • Identifiable Assets at Fair Value:
      • Cash: P500,000\text{P}500,000
      • Accounts receivable: P1,500,000\text{P}1,500,000
      • Inventory: P2,500,000\text{P}2,500,000
      • Property, Plant, and Equipment (PPE): P4,000,000\text{P}4,000,000
      • Patent: P1,300,000\text{P}1,300,000
      • Total Fair Value of Assets = P9,800,000\text{P}9,800,000
      • Liabilities Assumed at Fair Value:
      • Accounts payable: P1,600,000\text{P}1,600,000
      • Notes payable: P1,000,000\text{P}1,000,000
      • Accrued liabilities: P200,000\text{P}200,000
      • Total Fair Value of Liabilities = P2,800,000\text{P}2,800,000
      • Net Identifiable Assets = P9,800,000−P2,800,000=P7,000,000\text{P}9,800,000 - \text{P}2,800,000 = \text{P}7,000,000
      • Purchase Price = P9,000,000\text{P}9,000,000
      • Goodwill = P9,000,000−P7,000,000=P2,000,000\text{P}9,000,000 - \text{P}7,000,000 = \text{P}2,000,000

    • 2. Direct Approach:

    • Measures goodwill based on future earnings above normal levels.

    • Requires information on:

      • Normal rate of return in the industry.
      • Fair value of net identifiable assets.
      • Expected future normal earnings.
      • Duration of excess earnings.

    • Data Example:

      • Net assets (excluding goodwill): P7,500,000\text{P}7,500,000
      • Normal rate of return in industry: 12%12\%
      • Past 5-year earnings record:
      • 2017: P950,000\text{P}950,000
      • 2018: P974,000\text{P}974,000
      • 2019: P950,000\text{P}950,000
      • 2020: P1,075,000\text{P}1,075,000
      • 2021: P1,050,000\text{P}1,050,000
      • Total 5-year earnings = P5,000,000\text{P}5,000,000
      • Average annual earnings: P5,000,0005=P1,000,000\frac{\text{P}5,000,000}{5} = \text{P}1,000,000