INTANGIBLE ASSETS (PAS No.

38)
OBJECTIVE OF PAS No. 38
To set down the recognition and measurement rules for intangible assets

SCOPE Excludes
1. Intangibles covered by other PASs 2. Financial assets (as defined under PAS 27, 28, 31, 32, and 39) 3. Mineral rights and expenditure on exploration, development and extraction of minerals, oil, natural gas and similar non-regenerative resources

INTANGIBLE ASSETS COVERED BY OTHER PASs

1. Those held for sale in ordinary course of business [Inventories (PAS 2)/Construction Contracts (PAS 11)] 2. Deferred tax assets (PAS 12) 3. Leases (PAS 17) 4. Those arising from employee benefits (PAS 19) 5. Goodwill arising in business combination (PFRS 3) 6. Deferred acquisition cost and intangible assets arising from an insurers contractual right under insurance contracts within the scope of PFRS 4 (Insurance Contracts) 7. Non-current intangible assets classified as held for sale under PFRS 5.

DEFINITION OF INTANGIBLE ASSET

Identifiable non-monetary asset without physical substance, controlled by the entity as a result of past event from which future economic benefits are expected to flow to the entity.

CHARACTERISTICS OF INTANGIBLE ASSET

1. Lacks physical substance 2. Used in business 3. Provides future economic benefit

CRITERIA IN THE DEFINITION

1. Identifiability a. Can be distinguished clearly There is a legal right that would make the intangible asset identifiable so that it is separable from the other assets of the enterprise. 2. Control power of the enterprise to obtain future economic benefits flowing from the intangible asset and restricts the access of others to those benefits. 3. Future economic benefits include: a. Revenue from the sale of produces or services Cost savings or other benefits resulting from the use of the asset by the entity.

INTANGIBLE ASSETS INCLUDE

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. Scientific or technical knowledge The design and implementation of new processes or systems; Licenses; Intellectual property; Market knowledge; Trademarks (including brand names and publishing); Computer software; Patents; Copyrights; Motion picture films; Customer lists; Mortgage servicing rights; Fishing licenses; Import quotas; Franchises; Customer or supplier relationships; Customer loyalty; Market share; and Marketing rights

Note: Not all the items, (eg. market shares, customer relationships and customer loyalty) described above meet the definition of an intangible asset, i.e. identifiability, control over a resource and existence of future economic benefits. If an item within the scope of this Standard does not meet the definition of an intangible asset, expenditure to acquire it or generate it internally is recognized as an expense when it is incurred. However, if the item is acquired in a business combination, it forms part of the goodwill recognized at the acquisition date. (PAS38, par. 10)

CATEGORIES OF INTANGIBLE ASSETS

1. Marketing related intangible assets used mainly in the marketing or promotion of products or services. Examples are trademarks or tradenames, newspaper mastheads, Internet domain names, and non-competition agreements. 2. Customer related intangible assets occur as a result of interactions with outside parties. Examples are customer lists, order or production backlogs, and both contractual and non-contractual customer relationships. 3. Artistic related intangible assets involve ownership rights to literary works, musical works, pictures, photographs, and video and audiovisual material. These ownership rights are protected by copyrights 4. Contract related intangible assets represent the value of rights that arise from contractual arrangements. Examples are franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts. 5. Technology related intangible assets relate to innovations or technological advances. Examples are patented technology and trade secrets. (Kieso, Fargher, Wise, Weygandt, Warfield 2008)

TWO TYPES
Identifiable 1. Acquired through purchase 2. Can be rented or sold separately 3. Examples are: Patent Copyright Franchise Trademark or brand name Leasehold or lease rights Computer software Fishing rights and other specific rights 1. 2. 3. 4. Unidentifiable It cannot be purchased, sold or rented separately. Inherent in a continuing business Can only be identified with the business as a whole Example is Goodwill

CRITERIA FOR RECOGNITION

1. Future economic benefits are probable 2. Cost can be reliably measured

INITIAL MEASUREMENT AT COST

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MODES OF ACQUISITION
A. Separate Acquisition 1. Cash basis purchase price, import duties and non-refundable purchase taxes after deducting trade and cash discounts and any directly attributable cost of preparing the asset for its intended use. Examples of directly attributable costs are: cost of employee benefits professional fees cost testing whether the asset is functioning properly 2. Deferred use cash price equivalent 3. Lump sum allocate using fair market values B. Acquisition as Part of Business Combination the cost of the intangible asset is its fair value (PFRS 3 Business Combination). PAS 38 does not refer to goodwill but to other intangible asset such as in-process research and development project of the acquiree if the project meets the definition of an intangible asset and its fair value can be measured reliably. If an intangible asset acquired in a business combination has a finite useful life, there is a rebuttable presumption that its fair value can be measured reliably. Par. 39 41 of PAS38 discusses the measurement of these fair values. Various measures of these fair values are possible: Quoted market prices in an active market. An active market is defined in par. 8 as one which has all the following conditions: a) The items traded within the market are homogeneous b) Willing buyers and sellers can normally be found at any time c) Prices are available to the public Where there is an active market, the fair value is determined by reference to quoted market prices. (It is expected that active markets will be rare for intangible assets). Recent transactions. Where there is no active market, reference must be made to other sources of information, such as recent transactions in the same or similar items. Measurement techniques. With the increasing importance of intangible assets, there has been a growing establishment of entities who specialize in measuring intangible assets, particularly brand names. These valuation firms measure the worth of intangible assets by using variations of present value techniques, and multiples of variables such as royalty rates. These methods should reflect current transactions and practices in the industry.

C. Acquisition by way of Government Grant (PAS 20) Intangible asset may be acquired free of charge, or for nominal consideration. Examples of this are airport landing rights, licenses to operate radio or TV stations, import licenses or quotas or rights to access other restricted resources. The intangible asset may be recorded initially, at 1. fair value (benchmark treatment) 2. at nominal amount (permitted treatment) plus any expenditure that is directly attributable to preparing the asset for its intended use. D. Exchange of assets 1. The intangible asset may be acquired in exchange for a non-monetary asset or a combination of monetary and non-monetary asset. It is measured at fair value unless the exchange is without commercial substance. 2. The cost of intangible asset is measured at the carrying amount of the asset given up if the exchange is without commercial substance. Note: An exchange transaction has commercial substance when: a) The cash flows of the asset received differ from the cash flows of the asset transferred and the difference is significant relative to the fair value of the assets exchanged. b) The entity specific value of the portion of the entitys operations affected by the transaction changes as a result of the exchange and the amount of change is significant relative to the fair value of the assets exchanged. Entity specific value is the present value of the cash flows an entity expects to arise from the continuing use of an asset and from its disposal at the end of its useful life. E. Internally Generated Intangible Assets - 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. Examples are 1. Cost of materials and services used in generating the intangible asset 2. Cost of employee benefits arising from the generation of the intangible asset 3. Fees to register a legal right 4. Amortization of patents and licenses that are used to generate the intangible asset.

Costs that are not included: a. selling, administrative and other general overhead, unless this can be directly attributed to preparing the asset for use. b. clearly identified inefficiencies and initial operating losses incurred before an asset achieves planned performance. c. expenditure on training staff to operate the asset. d. cost of internally generated brands, mastheads, publishing titles, customer lists and items similar in substance. e. cost of internally generated goodwill. Costs incurred internally to create intangibles are generally expensed as incurred (such as internally generated brands, mastheads, publishing titles, customer lists and items similar in substance). Thus, even though a company may incur substantial research costs to create an intangible, these costs are expensed Some people argue that with a purchased intangible, a reliable number for the cost of the intangible, can be determined; with internally developed intangibles, it is difficult to associate costs with specific intangible assets. Others argue that because of the underlying subjectivity relating to intangibles, a conservative approach should be followed that is, expense as incurred.

RECOGNITION AS AN EXPENSE
An expenditure on an intangible item that does not meet the recognition criteria for an intangible asset shall be expensed when incurred. However, if this item is acquired in purchase business combination, this expenditure shall form part of the amount attributed to goodwill at the date of acquisition. Examples of expenditures that shall be expensed when incurred include: a. Start up costs b. Training costs c. Advertising and promotional costs d. Business relocation or reorganization costs An expenditure on an intangible item that was initially recognized as an expense shall not be included as part of the cost of intangible asset at a later date. Prepayment can be recognized as an asset when payment for delivery of goods or services has been made in advance of the delivery of goods or the rendering of services.

SUBSEQUENT EXPENDITURES
1. As a general rule, subsequent expenditure should be recognized as an expense. 2. Subsequent expenditure may be capitalized if the following conditions are present. It will increase or enhance the amount of future economic benefits. It can be measured reliably. It can be attributed directly to the intangible asset. 3. An expenditure previously expensed should not be recognized as part of the cost of an intangible asset subsequently.

MEASUREMENT AFTER INITIAL RECOGNITION

Benchmark (Cost Model) 1. Cost less accumulated amortization and any impairment losses Allowed alternative (Revaluation Model) 1. Fair value less accumulated amortization and any impairment losses 2. Fair value Determine by reference to an active market The fair value is kept to date. Regular revaluation (annually) is made for intangible assets that have volatile fair values. Frequent revaluations are unnecessary for intangible assets with only insignificant movements in fair value. To be applied to all assets in class (unless no active market) 3. If no active market Carry at cost less accumulated amortization and impairment losses

USEFUL LIFE
A. Intangible Asset with Finite Useful Life: 1. The entity shall assess the length of, or number of production constituting the useful life. 2. Cost is amortized over its useful life or

3.

4. 5.

6. 7.

production units Amortization method used shall reflect the pattern in which the assets future economic benefits are expected to be consumed by the entity. If the pattern cannot be determined reliably, the straight-line method is used. Residual value is assumed to be zero unless there is a commitment by a third party to purchase the asset at the end of its useful life or there is an active market for the asset. The amortization period, amortization method, and residual value are reviewed at least at each financial year-end. A change in residual value and amortization method are accounted for as a change in accounting estimate in accordance with PAS 8.

B. Intangible Asset with Indefinite Useful Life (Goodwill): 1. Cost is not amortized 2. Intangible asset is tested for impairment annually and whenever there is an indication that the intangible asset may be impaired.

DISPOSAL/RETIREMENT
1. Intangible asset is derecognized on disposal or when no future economic benefits are expected from its use or disposal. 2. Gain or loss on disposal is the difference between the net disposal proceeds and the carrying amount of the asset. 3. The gain or loss is recorded in the Income Statement 4. Derecognition gains shall not be included in revenue but treated as other income. 5. Amortization of an intangible with a finite useful life does not cease when the asset becomes temporarily idle or is retired from active use.

AMORTIZATION
1. The process of allocating the cost of an intangible asset as expense over the expected useful life of the asset in a systematic and rational matter. 2. Pro-forma Entry Amortization of intangible asset Intangible asset xxx xxx

3. An Accumulated Amortization account may also be maintained. 4. Amortization should start when the asset is ready for use.

FACTORS TO CONSIDER IN ESTIMATING THE LIFE OF AN INTANGIBLE ASSET

1. Legal, regulatory, or contractual provisions that may limit the maximum useful life. 2. Provisions for renewal or extension that may alter a specified limit on useful life. 3. Effects of obsolescence, demand, and other economic factors that may reduce useful life.

DISCLOSURES
PAS 38 contains numerous disclosure requirements. Among them is a requirement for the financial statements to disclose the following for each class of intangible assets, distinguishing between internally generated intangible assets and other intangible assets: a. Whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortization rate used; b. The amortization methods used for intangible assets with finite useful lives; c. The gross carrying amount and any accumulated amortization (aggregated with accumulated impairment losses) at the beginning and end of the period; d. The line item(s) of the income statement in which any amortization of intangible assets is included; e. A reconciliation of the carrying amount at the beginning and end of the period showing: i.Additions, indicating separately those from internal development, those acquired separately, and those acquired through business combinations; ii.Retirements and disposals; iii.Increases or decreases during the period resulting from revaluations and from impairment losses recognized or reversed directly in equity; iv.Impairment losses recognized in the income statement during the period; v.Impairment losses reversed in the income statement during the period; vi.Any amortization recognized during the period. The financial statements are also to disclose: a. If an intangible asset is assessed as having an indefinite useful life; the carrying amount of that asset and the reasons supporting the assessment of an indefinite 9

useful life. In giving these reasons, the entity shall describe the factor(s) that played a significant role in determining that it has an indefinite useful life; b. A description, the carrying amount and remaining amortization period of any individual intangible asset that is material to the financial statement as a whole; c. For intangible assets acquired by way of government grant and initially recognized at fair value: i.The fair value initially recognized for these assets; ii.Their carrying amount; iii.Whether they are carried under the benchmark or the allowed alternative treatment for subsequent measurement; d. The existence and carrying amounts of intangible assets whose title is restricted and the carrying amounts of intangible assets pledged as security for liabilities; and e. The amount of contractual commitments for the acquisition of intangible assets. An entity shall disclose the aggregate amount of research and development expenditure recognized as an expense during the period.

PATENT
1. Definition: An exclusive right granted by the government to an inventor enabling him to control the manufacture, sale or other use of his invention for a specified period of time. 2. Invention any technical solution of a problem in any field of human activity, which is new, involves inventive step, and is industrially applicable. 3. Legal life is 20 years (in accordance with R.A. 8293, or the Intellectual Property Code of the Philippines, effective January 1, 1998) 4. Cost of patent If acquired purchase price plus incidental costs If internally developed - licensing and legal fees and other related fees in securing the patent. As a rule, Research and development costs should be expensed as incurred. Legal fees and other costs of successfully prosecuting or defending a patent should be expensed. Cost of unsuccessful litigation and the remaining cost of the patent should be written off as a loss.

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5. Amortization of patent The original cost is amortized over the legal or useful life whichever is shorter. Cost of a competitive patent that was acquired to protect an original patent should be amortized over the remaining life of the old patent. Cost of a related patent that extends the life of the old patent should be amortized over the extended life. The unamortized cost of the old patent should also be amortized over the extended life. If there is no extension of life, the new patent should be amortized over its own life, and the cost of the old patent is amortized over the remainder of its life.

COPYRIGHTS
1. A copyright is an exclusive right granted by the government to the author, composer or artist enabling him to publish, sell or otherwise benefit from his literary, musical or artistic work. 2. The cost assigned to copyright consists of all expenses incurred in the production of the work including those required to establish or obtain the right. 3. If the copyright is purchased the cost includes cash paid, and directly attributable cost necessary for its intended use. 4. The term of protection for copyrights is during the life of the author and for 50 years after his death. 5. It is difficult to estimate the useful life of a copyright 6. The cost of the copyright is written off against the revenue of the first printing.

TRADEMARK
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1. A trademark is a symbol, sign, slogan or name used to mark a product to distinguish it from other products. 2. Trademark is also known as trade name and brand name. 3. When a trademark is purchased, the cost includes the purchase price plus costs directly attributable to the acquisition. 4. When a trademark is internally developed, the cost includes expenditures required to establish it, including filing fees, registry fees, and other expenses incurred in securing the trademark such as design cost of the trademark. 5. The cost of successful litigation is an outright expense. 6. The legal life of trademark is 10 years and may be renewed for period of 10 years each. 7. Trademark may be considered as an intangible asset with an indefinite life. 8. The cost of a trademark is not amortized 9. The cost of a trademark is tested for impairment at least annually.

RESEARCH AND DEVELOPMENT COSTS DEFINITIONS

1. Research original and planned investigation undertaken with the prospect of gaining scientific or technical knowledge and understanding. 2. Development application of research findings to develop a product, service or process.

RESEARCH EXPENDITURE
1. Recognize as expense when incurred Rationale: At the research phase of a project, an entity cannot be certain 12

that future economic benefits will probably flow to the entity. DEVELOPMENT EXPENDITURE - capitalize development expenditure if able to demonstrate all of the following: 1. 2. 3. 4. 5. Technical feasibility (planning, design, coding and testing is established) Intention to complete and use or sell Ability to use or sell Ability to generate probable future economic benefits Availability of adequate technical, financial and other resources to complete development and to use of sell 6. Ability to measure attributable expenditure reliably during development Rationale: the probability of success may be more apparent. Note: 1. Consistent with accounting for intangible asset above, if an entity owns a research facility consisting of buildings, laboratories and equipment where R&D activities are conducted and that has alternative future uses (in other R&D projects or other uses), facility would be accounted for as a capitalized operational asset. The depreciation and other costs related to such research facilities are accounted for as an expense. However, if specific projects are identified as meeting the requirements for development phase activities being capitalized, then the direct costs on the particular projects could be capitalized as an intangible asset. These include the purchase of equipment and the cost of salaries for work on a particular development phase project. (Kieso, Fargher, Wise, Weygandt, Warfield 2008)

EXAMPLES OF ACTIVITIES THAT TYPICALLY WOULD BE INCLUDED IN RESEARCH

1. Laboratory research aimed at discovery of new knowledge 2. Searching for applications of new research findings or other knowledge 3. Conceptual formulation and design of possible product or process alternatives 4. Testing in search for, or evaluation of, product or process alternative.

EXAMPLES OF ACTIVITIES THAT TYPICALLY WOULD BE INCLUDED IN DEVELOPMENT

1. Design, construction, and testing of pre-production prototypes and model. 2. Design of tools, jigs, moulds, and dies involving new technology. 3. Design, construction, and testing of a pilot plant that is

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not of a scale economically feasible to the enterprise for commercial production. 4. Design, construction, and testing of a chosen alternative for new or improved product or process.

EXAMPLES OF ACTIVITIES THAT TYPICALLY WOULD NOT BE CONSIDERED RESEARCH OR DEVELOPMENT

1. Engineering follow-through in an early phase of commercial production 2. Quality control during commercial production, including routine testing of products 3. Trouble-shooting in connection with breakdowns during commercial production 4. Routine or periodic alterations to existing products, production lines to improve quality. 5. Manufacturing processes and other ongoing operations, even though such alternations may represent improvements. 6. Adaptation of an existing capability to a particular requirement or customers need as part of a continuing commercial activity. 7. Routine design of tools, jigs, moulds and dies 8. Activity, including design and construction engineering, related to the construction, relocation, rearrangement or start-up of facilities or equipment other than facilities or equipment whose sole use is for a particular research and development project.

ACQUIRED IN PROCESS RESEARCH AND DEVELOPMENT PROJECT

Arises when acquired separately or in a business combination. Recognized it as an asset at cost, even if a component is research. Subsequent expenditure on that project may be capitalized or expensed depending on the recognition criteria for an intangible asset. If the subsequent expenditure is research expenditure, recognize it as an expense. If the subsequent expenditure is development expenditure and it satisfies the recognition criteria for an asset, it is added to the carrying amount of the inprocess research and development project. Otherwise, the subsequent development expenditure is recognized as an expense.

COMPUTER SOFTWARE COSTS

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The main rules are:

1. All costs incurred in creating a computer software prior to establishing the technological feasibility should be expensed when incurred. 2. Technological feasibility is established when an enterprise has produced either a detailed program design or working model. 3. Cost incurred subsequent to establishing technological feasibility shall be capitalized. These costs include coding and testing and the cost to produce the product masters. 4. Cost incurred to actually produce the software from the master copy shall be charged as inventory.

AMORTIZATION OF CAPITALIZED SOFTWARE COSTS

1. The amortization method shall reflect the pattern in which the assets future economic benefits are expected to be consumed by the entity. 2. If such pattern cannot be determined reliably, the straight-line method is used.

CLASSIFICATION OF COMPUTER SOFTWARE

1. As a rule, computer software is classified as an intangible asset 2. Computer software purchased for resale should be treated as inventory 3. A computer software purchased as an operating system for the hardware or as an integral part of a computer-controlled machine tool that cannot operate without the specific software should be treated as property, plant, and equipment. 4. However, if the computer software is not an integral part of the related hardware, it is classified as an intangible asset.

GOODWILL
1. Definition: An intangible asset that is not specifically identifiable, has an indeterminate life, in inherent in a continuing business and relates to the enterprise as a whole. 2. Goodwill arises when the earnings of a business exceed normal earnings. 3. Factor leading to goodwill 15

 Good name Capable staff and personnel High credit standing Reputation for fair dealings Reputation for superior products Favorable location List of regular customers 4. Two kinds Developed goodwill generated internally; not recorded. Purchased goodwill paid for; arises when a business is sold.

MEASUREMENT
1. Specific attributes approach identifies specific attributes of goodwill and assigns values to this. 2. Indirect valuation approach excess of the amount paid over the fair market value of the net assets acquired. 3. Direct valuation approach based on the future earnings of a company. The following information are required: Normal rate of return rate of return which attracts investors in a particular industry. Fair value of net assets assets should be reported at current market value and liabilities at adjusted amounts. Estimated future earnings 3 to 5 years past earnings; exclude extraordinary items; should be based only on earnings arising from normal operations. Probable duration of excess earnings

DIRECT VALUATION METHODS

1. Purchase of average earnings Average earnings Less: Normal earnings (Rate x Net assets) Average excess earnings No. of years Goodwill 2. Capitalization of average excess earnings Average earnings Less: Normal earnings (Rate x Net Assets) Average excess earnings P P xxx xxx xxx P P P xxx xxx xxx x xxx

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Divide by capitalization rate Goodwill 3. Capitalization of average earnings Average earnings Divide by capitalization rate Net assets, including goodwill Less: Net assets excluding goodwill Goodwill 4. Present value method Average earnings Less: Normal earnings (Rate x Net Assets) Average excess earnings Multiply by present value factor Goodwill
May 2009

x% xxx

P P P

xxx x% xxx xxx xxx

P P P

xxx xxx xxx xxx xxx

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