UNIT 4 : INTANGIBLE ASSETS
Key unit competence: To be able to measure and record intangibleassets
Introductory activity
Coca cola, Microsoft and Google are examples of the products that have
given the world their best and they are biggest trade mark since their
registration. The good reputation built over the years was catalyzed by
innovation and advertisements in big tournaments or events streamlined
through world class media.
What do you think these trademarks are in their books of accounts?
a) Company’s name
b) Asset
c) Equityd) Revenue
4.1 Introduction
Learning Activity 4.1
Required: Analyze the above picture and answer the following questions:
1) What does the picture demonstrate?2) Is a computer software an intangible asset ? Justify your answer.
4.1.1 Objective and scope
• Objective
The objective of this Standard is to prescribe the accounting treatment
for intangible assets that are not dealt with specifically in another Standard.
This Standard requires an entity to recognize an intangible asset if, and only
if, specified criteria are met. The Standard also specifies how to measure
the carrying amount of intangible assets and requires specified disclosuresabout intangible assets
• Scope
This standard shall be applied in accounting for intangible assets
except:
i. Intangible assets that are within the scope of another standard
ii. Financial assets
iii. Recognition and measurement of exploration and evaluation assets
iv. Expenditure on the development and extraction of minerals, oil, natural gas
and similar non-regenerative resources.
Note: If another Standard prescribes the accounting for a specific type
of intangible asset, an entity applies that Standard instead of this Standard.
a) This Standard applies to, among other things, expenditure on
advertising, training, start-up, and research and development activities.
Research and development activities are directed to the development
of knowledge. Therefore, although these activities may result in an
asset with physical substance (e.g: a prototype), the physical element
of the asset is secondary to its intangible component, i.e the knowledgeembodied in it.
b) Rights held by a lessee under licensing agreements for items such as
motion picture films, video recordings, plays, manuscripts, patents and
copyrights are within the scope of this Standard
Intangible assets that contain physical subsistence
Some intangible assets may be contained in or on a physical substance such as
a compact disc (in the case of computer software), legal documentation (in thecase of a license or patent) or film.
In determining whether an asset that incorporates both intangible and tangible
elements should be treated under IAS 16 Property, Plant and Equipment or as
an intangible asset under this Standard, an entity uses judgement to assess
which element is more significant. For example, computer software for a
computer-controlled machine tool that cannot operate without that specific
software is an integral part of the related hardware and it is treated as property,
plant and equipment. The same applies to the operating system of a computer.
When the software is not an integral part of the related hardware, computersoftware is treated as an intangible asset.
4.1.2 Definition and criteria to recognize intangible assets
• Definition
The following terms are used in this Standard with the meanings specified therein
i. Intangible assets: Intangible assets are non-current assets with no
physical substance, but which can be recognized in the statement of
financial position if they meet certain criteria.
ii. Amortization: is the decrease in the value of intangible asset due to its
use.
iii. Asset: is a resource controlled by an entity as a result of past events and
from which future economic benefits are expected to flow to the entity.
iv. Carrying amount is the amount at which an asset is recognized in the
statement of financial position after deducting accumulated amortization
and accumulated impairment losses thereon.
v. Depreciable amount is the cost of an asset, or other amount substituted
for cost less its residual amount
vi. Research is the original and planned investigation undertaken with
the prospect of gaining new scientific or technical knowledge and
understanding.
vii. Development is the application of reach findings or other knowledge
to a plan or design for the production of the new or improved materials,
products or system before start of commercial production or use
viii. Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
measurement date
ix. Impairment loss: is the amount which the carrying amount of an asset
exceeds its recoverable amount
x. Residual value of intangible assets: is the estimated amount that an
entity would currently obtain from disposal of the asset, after deducting
the estimated costs of disposal.
xi. Useful life: Useful life is the period over which an asset is expected tobe available for use by an entity.
• Criteria necessary to recognize intangible assets
The intangible asset is recognized if the following three criteria are fully met
i. The intangible asset should be identifiable
Intangible asset is identifiable when
a) It is separable, i.e is capable of being 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, regardless of whether the entity intends to do so
b) 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
ii. Intangible asset is controlled by entity
An entity controls an intangible asset if the entity has the power to obtain the
future economic benefits flowing from the underlying resource and to restrict
the access of others to those benefits.
iii. Intangible asset has expected future economic benefits
An item can only be recognized as an intangible asset if economic benefits
are expected to flow in the future from ownership of the asset. This economic
benefit could be revenue from the sale of products or services, cost savings, orother benefits resulting from the use of that intangible asset by the entity.
4.1.3 Exchange of asset
How to determine value of the exchanged asset?
If one intangible asset is acquired by way of exchanged for another, the cost of
the intangible asset is measured at fair value unless:
• The exchange transaction lacks commercial substance i.e no way to
determine market value ; or
• The fair value of neither the asset received nor the asset given up can
reliably be measured.
If the acquired asset is not measured at fair value, its cost is measured atthe carrying amount of the asset given up.
Example
Kigali Education Board is government business enterprises that comply with
IFRS and IAS for reporting purpose.
On 01 January 2021, Kigali education board (KEB) decides to acquire Clients’
Management System (CMS) that will serve as client management information
system. With this system, the clients can register, request service, and pay
through the system. Despite the need of the system, the management had no
funds to finance it and they decided to exchange one of their motor vehicles into
this system. The cost of this given up motor vehicle was FRW 20 million while its
accumulated depreciation as of 01 January 2021 was FRW 4 million. Because
the system was new in Rwanda, Kigali Education Board failed to determinemarket value of that system.
Required: Determine the value that will be assigned to this Client Management
System in KEB’s books of account
Answer
IAS 38 provides that if the acquired asset through exchange is not measured
at fair value, its cost is measured at the carrying amount of the asset given up.
Therefore, the fact that Kigali Education Board failed to determine fair value
of the system, the carrying amount of the given-up asset which is now motor
vehicle will serve the basis to determine initial value of the system.
Therefore, the value to be assigned to this Client Management System is FRW
16 million deemed to be carrying amount of motor vehicle, computed as follows
FRW 20 million – FRW 4 million.
4.1.4 Types of intangible assets
• Goodwill
Goodwill is an intangible asset that arises when one company acquires another.
Things like the value of a company name and brand, customer loyalty, or even
good employee retention are examples of a goodwill asset. You can calculate a
rough estimate of a goodwill asset by using this formula:
Goodwill= P - (A - L)
P = Purchase price of the target company
A = Fair market value of assets
L = Fair market value of liabilities
Goodwill acquired always makes it on to a balance sheet and will show up on a
separate line than other intangible assets.
• Brand equity: This represents a well-recognized brand with ability
to boost profit of the company. With good brand, the customers are
willing to order and buy goods from you at highest price compared to
similar product in the same industry
• Intellectual properties: Example of intellectual properties
includes: Copyrights, patents, franchises.
• Licensing: This is another type of intangible assets whereby a company
could buy license to use formula or software to make sales
• Customer lists
A strong customer lists is an asset to the company that own it, because
this is a tool that can increase company’s profit
Application activity 4.1
Highland Ltd is a company that manufactures ink for big printers. During the
year that ended 31 December 2021, the company acquired multisystem
machine that will be used to produce the ink for new developed SPC360SN
card printer. The machine requires software to operate and the software
was successfully installed in the machine at cost of FRW 50 million. The
machine could not operate without that software.
The FRW 50 million cost incurred to buy software will be treated
as part of
a) IAS 38-Intangible assets
b) IAS 16-Property plant and Equipment
c) IFRS 16-Leased) None of the above
4.2 Measurement of Intangible asset
Learning Activity 4.2
4.2.1 Internally generated goodwill
In some cases, expenditure is incurred to generate future economic benefits, but
it does not result in the creation of an intangible asset that meets the recognition
criteria in this Standard. Such expenditure is often described as contributing to
internally generated goodwill. Internally generated goodwill is not recognized as
an asset because it is not an identifiable resource (ie it is not separable nor does
it arise from contractual or other legal rights) controlled by the entity that can be
measured reliably at cost.
How does internally generated goodwill arise?
In some instance, entity believes that the difference between fair value of entity’s
net assets and its carrying amount could represent goodwill.
However, that is wrong interpretation because the Differences between the fair
value of an entity and the carrying amount of its identifiable net assets at any time
may capture a range of factors that affect the fair value of the entity. Therefore,
such differences do not represent the cost of intangible assets controlled bythe entity
4.2.2 Initial measurement and subsequent measurement
• Initial measurement
Intangible assets are initially recognized at cost. This is either the purchase
price, or the internally generated cost (see research and development later in
this unit).
• Subsequent measurement
After initial recognition, the Standard allows two methods of valuation forintangible assets. The entity shall choose either:
i. Cost model and
ii. Revaluation model
The methods used for subsequent measurement of intangible assets areexplained below
a) Cost Model
This method applies when an intangible asset is carried at its cost, less any
accumulated amortization and less any accumulated impairment losses.
Computation of accumulated amortization is shown in learning outcome 4.2.3of this book.
b) Revaluation model
The revaluation model allows an intangible asset to be 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.
The standard states that there will not usually be an active market in an intangible
asset; therefore, the revaluation model will usually not be available. For example,
although copyrights, publishing rights and film rights can be sold, each has a
unique sale value. In such cases, revaluation to fair value would be inappropriate.
A fair value might be obtainable however for assets such as fishing rights orquotas or taxi cab licenses.
Treatment of Valuation surplus and deficit
Where an intangible asset is revalued upwards i.e fair value exceed carrying
amount, the amount of the revaluation should be credited directly to equityunder the heading of a revaluation surplus (other comprehensive income).
Example
The intangible asset that cost FRW 10 million was revalued on 31 December
2022 at FRW 8 million. The accumulated amortization at the date of revaluation
was FRW 4 million.
Required: Show how the above transaction will be treated in books of accounts
Answer: If the intangible asset is revalued, the first step you compute carrying
amount of the revalued intangible asset at revaluation date. The carrying amountin this case is, FRW 6 million
Where the carrying amount of an intangible asset is revalued downwards, the
amount of the downward revaluation should be recognized in profit or loss,
unless the asset has previously been revalued upwards in which case the
revaluation decrease should be first charged against any previous revaluation
surplus in respect of that asset.
Example: In our example above, let assume that the intangible asset was
revalued at FRW 5 million. Therefore, this implies revaluation decrease asrevalued amount falls short to carrying amount. The deficit is FRW 1 million
4.2.3 Useful life of intangible asset and amortization method
1. What is useful life of intangible asset
Useful life is the period over which an asset is expected to be available for use
by an entity
An entity should assess the useful life of an intangible asset, which may be finite
or indefinite. An intangible asset has an indefinite useful life when there is no
foreseeable limit to the period over which the asset is expected to generate net
cash inflows for the entity.
Many factors are considered in determining the useful life of an
intangible asset, including:
• Expected usage
• Typical product life cycles
• Technical, technological, commercial or other types of obsolescence
• The stability of the industry; expected actions by competitors
• The level of maintenance expenditure required
• Legal or similar limits on the use of the asset, such as the expiry dates
of related leases
2. Amortization of intangible assets
An intangible asset with a finite useful life should be amortized over its expected
useful life. Amortization is calculated in the same way as depreciation for tangible
assets.
When shall entity start and cease to compute amortization of intangible
asset?
Amortization should start when the asset is available for use while amortization
should cease at the earlier of the date the asset is classified as held for sale in
accordance with IFRS 5
The residual value of an intangible asset with a finite useful life is assumed to be
zero unless a third party is committed to buy the intangible asset at the end of
its useful life or unless there is an active market for that type of asset (so that its
expected residual value can be measured) and it is probable that there will be amarket for the asset at the end of its useful life
4.2.4 Intangible assets with indefinite useful lives
An intangible asset with an indefinite useful life should not be amortized. (IAS
36 requires that such asset is tested for impairment at least annually). However,
the appropriateness of deeming the useful life of the asset as indefinite should
be reviewed each year. If the useful life of the asset is deemed to be finite rather
than indefinite this may indicate that the asset may be impaired and it should betested for impairment.
4.2.5 Disposal/retirements of intangible assets
a) When to derecognize intangible asset in the accounts
An intangible asset shall be derecognized
• On disposal
• When no future economic benefits are expected from its use or disposal.
b) Treatment of gain or loss on disposal
The gain or loss arising from the derecognition of an intangible asset shall be
determined as the difference between the net disposal proceeds, if any, and
the carrying amount of the asset. It shall be recognized in profit or loss when theasset is derecognized.
Application activity 4.2
Mahoro supermarket has development expenditure of RWF5 million. Its
policy is to amortized development expenditure at 5% per annum using
straight line method. Accumulated amortization brought forward is
RWF500,000
What is the charge in the statement of profit or loss for the year’s
amortization?
a) FRW 250,000
b) FRW 225,000
c) FRW 500,000d) FRW 4,500,000
4.3 Internally generated intangible assets
Learning Activity 4.3
List some examples of activities that might be included in either research ordevelopment
4.3.1 Research and development cost
• Criteria to recognize internally developed intangible asset
To assess whether an internally generated intangible asset meets the criteria for
recognition, an entity classifies the generation of the asset into:
i. research phase; and
ii. development phase.
a. Research phase
Research activities by definition do not meet the criteria for recognition under
IAS 38. This is because, at the research stage of a project, it cannot be certain
that future economic benefits will probably flow to the entity from the project.
There is too much uncertainty about the likely success or otherwise of the
project. Research costs should therefore be written off as an expense as they
are incurred.
b. Development
Development costs may qualify for recognition as intangible assets provided
that the following strict criteria can be demonstrated.
– The technical feasibility of completing the intangible asset so that it will
be available for use or sale.
– Its intention to complete the intangible asset and use or sell it.
– Its ability to use or sell the intangible asset.
– There will be future economic benefits for the entity. The entity should
demonstrate the existence of a market for the output of the intangible
asset or the intangible asset itself or the usefulness of the intangible
asset to the business.
– The availability of technical, financial and other resources to complete
the development and to use or sell the intangible asset.
– Its ability to reliably measure the expenditure attributable to the intangibleasset during its development.
Note: If an entity cannot distinguish the research phase from the development
phase of an internal project to create an intangible asset, the entity treats the
expenditure on that project as if it were incurred in the research phase only.
• Cost of an internally generated intangible asset
The cost of an internally generated intangible asset is the sum of expenditure
incurred from the date when the intangible asset first meets the recognition
criteria. The IAS 38 prohibits reinstatement of expenditure previously recognizedas an expense.
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 of directly attributable costs are:
i. Costs of materials and services used or consumed in generating the
intangible asset;
ii. Costs of employee benefits (salaries-wages) arising from the generation
of the intangible asset;
iii. Fees to register a legal right; andiv. Amortization of patents and licenses that are used to generate the
intangible asset
The following are not components of the cost of an internally
generated intangible asset:
a) Selling, administrative and other general overhead expenditure unless
this expenditure can be directly attributed to preparing the asset for use
b) Identified inefficiencies and initial operating losses incurred before the
asset achieves planned performance; and
c) Expenditure on training staff to operate the asset.
• Recognition of an expense
Expenditure on an intangible item shall be recognized as an expense when it is
incurred unless:
i. It forms part of the cost of an intangible asset that meets the recognition
criteria
ii. The item is acquired in a business combination and cannot be recognized
as an intangible asset. If this is the case, it forms part of the amount
recognized as goodwill at the acquisition date
• Past expenses not to be recognized as an asset
Expenditure on an intangible item that was initially recognized as an expenseshall not be recognized as part of the cost of an intangible asset at a later date.
Learning Activity 4.3
Igicuruzwa Ltd is developing a new production process. During 2020,
expenditure incurred was RWF1,000,000 of which RWF900,000 was
incurred before 1 December 2020 and RWF100,000 between 1 December
2020 and 31 December 2020. Igicuruzwa Ltd can demonstrate that, at 1
December 2020, the production process met the criteria for recognition as
an intangible asset. The recoverable amount of the know-how embodied inthe process is estimated to be RWF500,000
Required: How should the expenditure be treated?
Skills Lab
Visit local business center and try to identify or choose one company/
business with a good reputation compared to others and discuss on how
that reputation will increase value of the business when its acquisition happen
End unit assessment
1. A business buys a patent for RWF50 million. It expects to use the
patent for the next ten years, after which it will be valueless.
Required: Calculate the amortization charge for each year and
show the double entry to record it.
2. What do you think intangible assets is?
a) Non-current asset
b) Current asset
c) Revenue expenditure
d) Deferred expenditure3. Explain the accounting treatment of internally generated goodwil