4.1 Intangible Assets, Research and Development, and Goodwill

Intangible Assets, Research and Development, and Goodwill

Intangible assets carry two FAR items and reappear in business combinations. This section applies PAS 38: the identifiability, control, and future-benefit tests, the different ways intangibles are acquired, the research-versus-development split for internally generated assets, and subsequent measurement for finite-life assets, indefinite-life assets, and goodwill.

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1. PAS 38: Definition and Identifiability Criteria

Under PAS 38 paragraph 8, an intangible asset is an identifiable non-monetary asset without physical substance. Three critical definitional criteria must be satisfied:

1. Identifiability: An intangible asset is identifiable if it either:
   • Is separable (capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, asset, or liability); OR
   • 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.
2. Control: The entity possesses the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits (e.g., through legal rights, copyright, or patent protection).
3. Future Economic Benefits: Revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the asset.

General Recognition Criteria

An intangible asset is recognized if, and only if:

1. It is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
2. The cost of the asset can be measured reliably.

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2. Initial Recognition Modes

• Separate Acquisition: Initial cost comprises purchase price (including import duties and non-refundable purchase taxes) plus any directly attributable cost of preparing the asset for its intended use (e.g., professional legal fees, testing costs). Trade discounts and rebates are deducted.
• Acquisition as Part of a Business Combination (PFRS 3): All identifiable intangible assets acquired in a business combination are recognized at their fair value at the acquisition date, regardless of whether the acquiree had previously recognized them (e.g., in-process R&D, unpatented technology, customer relationships).
• Government Grants (PAS 20): Recognized initially at fair value or at a nominal amount plus direct preparation expenditures.
• Exchange of Non-Monetary Assets: Measured at fair value unless the transaction lacks commercial substance or the fair value of neither asset received nor asset given up is reliably measurable (in which case carrying amount of asset given up is used).

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3. Internally Generated Intangibles: Research vs. Development Phase

PAS 38 strictly differentiates between the research phase and the development phase for internally generated intangible assets:

[ Research Phase ]                     [ Development Phase ]
Strictly Expensed in P&L ------------> Capitalized ONLY IF all 6 PIRATA Criteria Met
(Cannot be capitalized)                (Prior research costs cannot be reinstated)

A. Research Phase (Strict Expense Rule)

Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. All research costs must be recognized as an expense in profit or loss when incurred. No research cost can ever be capitalized.

Examples of Research Activities:

• Activities aimed at obtaining new knowledge;
• The search for, evaluation, and final selection of applications of research findings;
• The search for alternatives for materials, devices, products, processes, systems, or services;
• The formulation, design, evaluation, and final selection of possible alternatives for new or improved materials, devices, products, processes, systems, or services.

B. Development Phase (The 6 Capitalization Criteria)

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 commercial production or use.

Development expenditures can be capitalized if, and only if, the entity demonstrates all six of the following criteria (mnemonic: PIRATA):

1. P - Probable Future Economic Benefits: How the intangible asset will generate probable future economic benefits (e.g., existence of a commercial market or internal usefulness);
2. I - Intention to Complete: The entity's intention to complete the intangible asset and use or sell it;
3. R - Resources Available: The availability of adequate technical, financial, and other resources to complete the development and to use or sell the asset;
4. A - Ability to Use or Sell: The entity's operational ability to use or sell the intangible asset;
5. T - Technical Feasibility: The technical feasibility of completing the intangible asset so that it will be available for use or sale;
6. A - Ability to Measure Reliably: The ability to measure reliably the expenditure attributable to the intangible asset during its development.

Strict Prohibitions and the Reinstatement Ban

• Internally Generated Brands, Mastheads, Publishing Titles, Customer Lists: Under PAS 38 paragraph 63, expenditures on internally generated brands, mastheads, publishing titles, customer lists, and items similar in substance cannot be recognized as intangible assets. These expenditures cannot be distinguished from the cost of developing the business as a whole.
• Internally Generated Goodwill: Prohibited from recognition as an asset under any circumstances.
• Ban on Reinstatement: Expenditure on an intangible item that was initially recognized as an expense in prior annual financial statements or interim reports shall not be recognized as part of the cost of an intangible asset at a later date (PAS 38 paragraph 71).

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4. Subsequent Measurement: Finite vs. Indefinite Useful Life

Accounting for Changes: A change from an indefinite useful life assessment to a finite useful life is accounted for as a change in an accounting estimate under PAS 8, applied prospectively.

Goodwill Impairment Mechanics

Goodwill acquired in a business combination represents future economic benefits arising from other assets acquired that are not individually identified and separately recognized. Under PFRS 3 and PAS 36, goodwill is never amortized. Instead, it is allocated to cash-generating units and tested for impairment at least annually. Once recognized, an impairment loss on goodwill can never be reversed in subsequent periods.