3.4 Intangible Non-Current Assets & Research & Development (IAS 38)

Definition of Intangible Assets

Under IAS 38, an intangible asset is an identifiable, non-monetary asset without physical substance. To be recognized in the financial statements, the item must meet three core criteria:

1. Identifiability: It is separable (capable of being sold, transferred, or licensed) or arises from contractual/legal rights.
2. Control: The entity must have the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits.
3. Future Economic Benefits: It must be probable that economic benefits will flow to the entity, and the cost can be measured reliably.

Common examples of purchased intangible assets include patents, copyrights, trademarks, licenses, quotas, and specialized computer software.

Internally Generated Goodwill

Goodwill represents the future economic benefits arising from assets that are not capable of being individually identified and separately recognized (such as a strong brand reputation, skilled workforce, or good customer relations).

CRITICAL RULE: Internally generated goodwill must NEVER be recognized as an asset. Because it is not identifiable, not separable, and its cost cannot be measured reliably, it fails the recognition criteria. Only purchased goodwill (arising upon the acquisition of another business) may be recognized as an intangible asset.

Similarly, internally generated brands, mastheads, publishing titles, and customer lists must not be recognized as intangible assets.

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Research and Development Expenditure (IAS 38)

A major area of testing in the ACCA FA exam is the accounting treatment of Research and Development (R&D) costs generated internally by a company trying to innovate a new product or process.

IAS 38 splits these activities into two distinct phases: the Research Phase and the Development Phase.

1. The Research Phase

Research is defined as original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. At this stage, the entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits.

Accounting Treatment: All expenditure incurred in the research phase must be expensed immediately to the Statement of Profit or Loss as it is incurred. It can never be capitalized, and if a project moves forward, you cannot retrospectively capitalize past research costs.

2. The Development Phase

Development is 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 before the start of commercial production or use.

Accounting Treatment: Expenditure incurred in the development phase MUST be capitalized as an intangible asset (often called 'Deferred Development Expenditure') if, and only if, the entity can demonstrate all six of the strict PIRATE criteria:

• P - Probable future economic benefits: The project will be profitable or useful.
• I - Intention to complete: Management intends to complete the asset and use or sell it.
• R - Resources available: Adequate technical, financial, and other resources are available to complete the project.
• A - Ability to use or sell: The entity has the means to use the asset internally or sell it.
• T - Technical feasibility: The project is technically sound and capable of being completed.
• E - Expenditure reliably measurable: The costs attributable to the development phase can be tracked and measured reliably.

If even one of these criteria is missing, the development costs must be treated like research and expensed to the P&L immediately.

Worked Example: Omega Co spends the following on a new product project during the year ending 31 December:

• Jan to March: $50,000 on initial laboratory research and market feasibility studies.
• April to June: $60,000 developing a prototype. However, financing was uncertain, and technical feasibility was not confirmed until 1 July.
• July to December: $120,000 finalizing the prototype for mass production. Management confirmed all PIRATE criteria were met as of 1 July.

Accounting Treatment:

• The $50,000 research costs are expensed.
• The $60,000 development costs from April-June are expensed because the PIRATE criteria (specifically technical feasibility and resources) were not yet met.
• The $120,000 development costs from July-December must be capitalized as an intangible asset on the SOFP.

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Amortization and Impairment of Intangible Assets

Once an intangible asset is capitalized, it is subject to rules very similar to the depreciation of tangible assets, but the terminology changes to Amortization.

• Finite Useful Life: If an intangible asset (like a 10-year patent or capitalized development costs) has a finite useful life, its capitalized cost must be amortized over that life, usually on a straight-line basis. Amortization begins when the asset is available for use (e.g., when commercial production begins).
• Indefinite Useful Life: If an asset has an indefinite useful life, it is not amortized. Instead, it must be tested annually for impairment.

Accounting Entry for Amortization: Debit: Amortization Expense (Statement of Profit or Loss) Credit: Accumulated Amortization (Statement of Financial Position)