Intangible Assets

What is Intangible Asset?

An intangible asset is one of the important standards of ‘The International Financial Reporting Standards (IFRS). It is referred to as ‘IAS 38 - Intangible Assets.’ IASB, the UK accounting body, developed this standard.

An Intangible asset, as the term signifies, is a separable asset with non-monetary value and without physical substance. 

Quoting the definition formed by IFRS, these assets are “identifiable, non-monetary assets without a physical substance.” Examples of these assets include –

• Internally generated goodwill, 
• Patent
• Copyrights
• Trademarks, and many more.

These assets tend to arise due to contractual agreements or legal rights. Although goodwill is a part of these assets, it is specifically the internally generated goodwill rather than the one gained due to the business combination.

IAS 38 - Intangible Assets was developed in April 2001 by the International Accounting Standards Board (IASB). It was initially established in September 1998 by the International Accounting Standards Committee. 

This standard was formed to replace IAS 9 - Research & Development costs in 1993. IAS 9 - Research & Development was formed to replace an older version known as Accounting for Research and Development Activities - July 1978.

Examples of Intangible Assets

Some examples of intangible assets include: 

1. Goodwill
Goodwill represents the premium paid for acquiring a business entity over its net tangible assets. It arises from factors such as brand reputation, customer relationships, employee morale, and proprietary technology.

2. Patents
Patents are exclusive rights granted by a government to an inventor, giving them the sole authority to use, manufacture, or sell their invention for a specified period, typically 20 years.

3. Copyrights
Copyrights grant exclusive rights to the creator of original artistic, literary, or musical works, allowing them to reproduce, distribute, and display their work for a limited period, typically the creator's lifetime plus 70 years.

4. Trademarks
Trademarks are symbols, names, phrases, logos, or designs that distinguish and identify the source of goods or services provided by a business entity.

5. Franchise Agreements
Franchise agreements grant the right to use a company's business model, brand name, and operating systems in exchange for ongoing fees or royalties.

Franchises allow businesses to expand rapidly without significant capital investment and leverage the brand recognition and operational expertise of the franchisor.

Identifiable Vs. Unidentifiable Assets

Recognition Criteria

As per IAS 38 - these assets are recorded at cost. Therefore, two criteria need to be met to recognize an asset as an Intangible asset - IAS 38. 

1. The entity must control assets

As a result of past events, the asset must be in control of the entity. In terms of control, the asset must completely own the entity due to purchase or acquisition. In addition, the firm must have the legal rights to use this asset. 

For example, the legal right to use copyrights. However, it is quite complex to achieve or prove the ownership of an asset because many firms tend to capitalize costs of staff training or customer loyalty. This does not qualify for ownership as a firm does not control the staff.

The reason for not recognizing staff training as an intangible asset or control and ownership is that although the skills are an asset for the company, they cannot control the staff decisions, e.g., A staff member resigning takes with them the skills they have acquired from the training.

2. The entity expects future economic benefits to flow

An asset qualifies as an intangible asset if the resource generated from it is likely to provide the entity with future economic benefits. For example, an entity purchasing goodwill can result in plausible future economic benefits for the firm.

The cost is amortized once the asset starts generating commercial benefits.

Accounting Treatment of Intangible Assets

Intangible assets are a critical component of a company's balance sheet, representing non-physical resources with economic value. Here are some of the points highlighting this:

1. Recognition Criteria
Intangible assets are recognized if it is probable that future economic benefits will flow to the entity and the cost of the asset can be measured reliably.

2. Initial Recognition
Intangible assets are initially recognized at cost. This includes all directly attributable costs necessary to bring the asset to its working condition for its intended use.

For internally generated intangible assets, such as research and development costs, recognition is limited. Generally, these costs are expensed as incurred unless specific criteria are met for capitalization.

3. Subsequent Measurement
After initial recognition, intangible assets are carried at cost less any accumulated amortization and accumulated impairment losses.

If an intangible asset has a finite useful life, it is systematically amortized over its useful life. Amortization reflects the consumption of economic benefits associated with the asset over time.

4. Impairment Testing
Intangible assets are assessed for impairment whenever there is an indication that the asset may be impaired. This includes both tangible and intangible indicators of impairment.

If the carrying amount of the intangible asset exceeds its recoverable amount, the asset is written down to its recoverable amount, resulting in an impairment loss.

5. Disposal
Upon disposal or derecognition of an intangible asset, any gain or loss arising from the disposal is recognized in the statement of profit or loss.

The carrying amount of the asset is removed from the balance sheet, and any related accumulated amortization or impairment losses are also derecognized.

6. Disclosure
Entities are required to disclose significant information about their intangible assets in the financial statements, including the nature, carrying amount, useful life, and amortization method of each class of intangible assets.

Conclusion

Intangible assets play a significant role in the financial reporting landscape, as governed by IAS 38 under the International Financial Reporting Standards (IFRS).

These assets, devoid of physical substance yet possessing identifiable value, encompass a wide array of items such as patents, copyrights, and trademarks.

The categorization of intangible assets into identifiable and unidentifiable forms underscores their diverse nature, with identifiable assets being separable and independently valued, while unidentifiable assets, like goodwill, are inherently tied to the business itself.

The accounting treatment of intangible assets, particularly the distinction between research and development costs, underscores the necessity for accurate and consistent reporting practices.

While research costs are expensed as incurred, development costs are capitalized if they meet the PIRATE criteria.

This nuanced approach to accounting for intangible assets ensures that only assets meeting stringent criteria are recognized, promoting transparency and reliability in financial reporting practices.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Assets Under Management (AUM)
• IFRS Standards
• Impaired Asset
• Trading Assets
• Underlying Profit