General rules

An item should be recognised in the financial statements as an intangible asset if it meets the definition of an intangible asset and it meets the recognition criteria.

The key characteristics of an intangible asset are that it:

• is a resource controlled by the entity from which the entity expects to derive future economic benefits;
• lacks physical substance;
• is identifiable to be distinguished from goodwill.

An entity controls an asset if it has the power to obtain the future economic benefits from an underlying resource and to restrict the access of others to those benefits. Control is usually evidenced by legally enforceable contractual or other rights, such as legal title or a licence. It is more challenging to demonstrate control in the absence of legal rights. The entity might be able to control the asset in some other way (for example, control over the benefits of know-how could be attained through secrecy).

Customer relationships Customer relationships are a type of intangible asset where it might be difficult to establish control over expected future economic benefits. Control could be evidenced if customer relationships are contractual (for example, where a sales contract specifies the customer’s name and address, the goods to be supplied and agreed contract periods). However, there is usually insufficient control over the expected economic benefits from a customer relationship. Evidence of control for non-contractual relationships could be sufficient only where there are exchange transactions for the same or similar non-contractual customer relationships (other than as part of a business combination). Any such exchange transactions would also provide evidence that the relationships were separable. Exchange transactions for non-contractual customer relationships are rare in practice.

How should payments for cloud computing arrangements be treated? Companies might enter into cloud computing arrangements. This could include software as a service, infrastructure as a service, or other hosting arrangements. In such contracts the buying company generally does not obtain a software licence or have a right to take possession of the software or infrastructure. Rather, the software remains on the seller’s hardware, and the buyer would normally only access the software or seller’s infrastructure via an internet connection. Typically, in these situations the buyer acquires a service and has no rights to control the use over any identified assets. Amounts paid by the buyer to the seller would be an operating expense. Advance payments for such services would be capitalised as a prepayment. The buyer might incur additional implementation costs to adapt its systems to use the service. These costs can usually be capitalised if they meet the criteria of development activities. If a licence was acquired, whether as part of a cloud computing arrangement or not, associated licence costs would be capitalised as an intangible asset.

Classification and measurement of cryptocurrencies and other cryptographic assets A single, generally accepted framework for the classification of cryptographic assets does not currently exist. There is consequently no generally applied definition of a cryptographic asset. This reflects the broad variety of features and bespoke nature of the transaction in practice. However, based on our current observations, there are some characteristics that can be used to classify cryptographic assets into similar types. We believe that similar types of cryptographic asset should be accounted for in a similar way. Cryptocurrencies At the June 2019 IFRS Interpretations Committee (IC) meeting, the IC issued an agenda decision that discusses how IFRS standards apply to holdings of cryptocurrencies. For the purpose of the agenda decision, the IC considered cryptocurrency to have the following characteristics: a. a digital or virtual currency recorded on a distributed ledger that uses cryptography for security; b. is not issued by a jurisdictional authority or other party; and c. does not give rise to a contract between the holder and another party. The IC concluded that cryptocurrencies held for sale in the ordinary course of business fall within the scope of IAS 2. Where IAS 2 is not applicable, an entity should apply IAS 38. In reaching this decision, it was noted that a cryptocurrency is not cash, because cryptocurrencies are not used as a medium of exchange (that is, they are not used in the exchange of goods or services) or as a monetary unit in pricing goods or services to such an extent that it would be the basis for which all transactions are measured or recognised in the financial statements. Since cryptocurrencies are not cash, do not provide a contractual right to receive cash or exchange for other financial assets, and are not an equity instrument in another entity, cryptocurrencies are also not financial assets. An entity that acts as a broker-trader of cryptocurrencies should consider the guidance in IAS 2, and it might be required to measure cryptocurrency inventory at fair value less costs to sell. Entities that sell cryptocurrency in the ordinary course of business, but are not broker-traders, would record cryptocurrency at the lower of cost and net realisable value. Other entities that account for cryptocurrencies under IAS 38 should establish an accounting policy to record their cryptocurrency holdings under the cost or revaluation models. If recorded under the cost model, an entity would need to assess for impairment in accordance with IAS 36. The chart below summarises the different possible classifications and their associated measurement considerations: Applicable standard Initial measurement Subsequent measurement Movements in carrying amount Inventory (IAS 2) – Other Cost Lower of cost and net realisable value Movements above cost – N/A Movements below cost – profit and loss Inventory (IAS 2) – Commodity broker trader exception Cost Fair value less costs to sell Profit and loss Intangible assets (IAS 38) – Revaluation model (accounting policy choice but requires existence of active market) Cost Fair value less accumulated amortisation and impairment *   Movements above cost – Other comprehensive income Movements below cost – profit and loss Intangible assets (IAS 38) – Cost model Cost Cost less any accumulated amortisation and impairment* Movements above cost – N/A Movements below cost – profit and loss     * In most cases, no amortisation is expected for cryptocurrencies Cryptographic assets other than cryptocurrencies A similar thought process will apply for considering the accounting for cryptographic assets other than cryptocurrencies. These cryptographic assets include security tokens, asset-backed tokens and utility tokens. The specific terms of each cryptographic asset might be unique, so it is important to carefully consider its features in applying IFRS standards. As with cryptocurrencies, other types of cryptographic assets would unlikely be considered cash under IFRS. However, certain types of crypto token might give the holder the right to cash or a financial asset (such as an equity interest in an entity). In this case, the cryptographic asset might meet the definition of a financial asset under IAS 32, and entities would be required to follow the guidance in IFRS 9 for measurement. An entity that holds cryptographic assets in the ordinary course of business might consider these assets to be inventory. Similar to cryptocurrencies, the measurement of these assets would depend on whether the entity should apply the broker-trader guidance in IAS 2. However, if an entity holds crypto tokens for investment purposes (that is, capital appreciation) over an extended period of time, it would likely not meet the definition of inventory. Some cryptographic assets provide the holder with the right to future goods or services. These tokens are, in effect, the prepayment for a future good or service, and the accounting might be similar to other prepaid assets. Other types of cryptographic asset, often called ‘asset-backed tokens’, might give the holder the right to an underlying asset. If these tokens give the holder the right to this underlying asset, the accounting will likely be driven by the nature of the underlying asset and relevant accounting standard. Cryptographic assets held on behalf of others Cryptographic assets might also be held by an entity on behalf of its customers. Some examples are entities that operate a trading platform that allows its customers to exchange different cryptographic assets or exchange fiat currency for cryptographic assets, and entities that offer custodian services for their customers’ cryptographic assets. A key accounting question is whether such holdings of cryptographic assets should be recorded on or off the entity’s balance sheet. There is no IFRS that directly provides guidance on whether an entity’s holdings of cryptographic assets on behalf of others should be presented on its balance sheet. We believe that such entities should consider the general guidance in IAS 8, ‘Accounting Policies, Changes in Accounting Estimates and Errors’, in developing a policy for such assets. In determining whether an asset and a liability should be recognised on the balance sheet of the entity holding the cryptographic assets on behalf of its customers, an entity considers: ·        Whether it has the right (explicit or implicit) to ‘borrow’ the cryptographic assets to use for its own purposes. If the entity has such a right, it would seem that the definition of an asset is met. ·        The rights of customers to cryptographic assets held on their behalf if the entity is liquidated. In particular, if customers would have the status of unsecured creditors, with no preferential claim on the cryptographic assets held by the entity on their behalf, this is a strong indicator that the cryptographic assets and the corresponding liability should be recognised on the balance sheet, because the Framework definition of a liability would seem to be met. Initial coin offerings An initial coin offering (ICO) is a form of fundraising that harnesses the power of cryptographic assets and blockchain-based trading. An ICO allocates tokens instead of shares to investors/subscribers. These ICO tokens typically do not represent an ownership interest in the entity, but they often provide access to a platform (if and when developed) and can often be treated as a cryptocurrency. The population of ICO tokens in an ICO is generally at a fixed amount. Each ICO is bespoke and will have unique terms and conditions. It is critical for issuers to review the whitepaper or underlying documents accompanying the ICO token issuance to understand what exactly is being offered to investors/subscribers, because this will be important in determining which accounting standard applies to the ICO.

An entity usually has insufficient control over the expected future economic benefits derived from its workforce for the workforce to be recognised as an intangible asset.

Sign-up bonuses paid to new employees An entity is involved in retail banking. The bank’s strategy is to diversify its services and expand its customer base. Management plans to establish an investment banking division. The bank is aware that it will need to recruit high-profile employees to attract new business quickly. The bank has made offers of employment to ten individuals. These offers have been accepted. The contracts are for a five-year period and include substantial sign-on bonuses, without any clawback if the employee leaves during the term of the contract. The bank would like to recognise an intangible asset in respect the sign-on payments. The sign-on payment cannot be recognised as an intangible asset and should be expensed when incurred. The sign-on payment has not established a right to a future benefit over which the bank has control. The new employees could leave during the contract period. An intangible asset might be recognised if there was an enforceable non-compete clause in the contract, depriving competitors from using this employee.

Capitalisation of periodic licence fees on purchase of an intangible asset – example In 20X0, Entity A, a telecoms operator, is granted a licence from a national authority for a fixed period commencing 1 January 20X2. The purchase of the licence is deemed to be an executed transaction and the definition of and recognition criteria for an intangible asset in IAS 38, respectively, are met. Entity A is required to pay an up-front fee for the licence and, in addition, from 20X2 onwards Entity A will be required to pay a fixed fee on a quarterly basis irrespective of whether the licence is used. The obligation to pay the quarterly licence fees will remain constant over the whole licence period and is non-cancellable. Entity A is permitted to sell the licence, in which case the buyer would be expected to take on the obligation for the quarterly fees, but permission from the national authority would be required for any such transaction. The quarterly licence fees should be accounted for as part of the cost of the intangible asset when the asset is acquired. The total cost of the licence will be the up-front payment plus the present value of the quarterly fees over the licence period. The definition of cost (see above) refers to ‘the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition’. In the circumstances described, Entity A has incurred an obligation for the quarterly licence fees at the date of acquisition. This obligation is part of the consideration given and meets the definition of a financial liability in accordance with IAS 32 because it constitutes a contractual obligation to deliver cash that Entity A cannot avoid unconditionally. Any subsequent sale of the licence to a third party would involve both that party and the national authority agreeing to the transfer of that obligation and would result in derecognition of the liability only when Entity A is legally released from primary responsibility for payment. Consequently, the obligation to make quarterly licence fee payments is reflected when measuring the cost of the intangible asset (as part of the fair value of consideration given) and also gives rise to a financial liability that is initially measured at fair value in accordance with IFRS 9 (or, for entities that have not yet adopted IFRS 9, IAS 39). As discussed, amortisation of the cost of the licence should commence at the date the licence is available for use (i.e., 1 January 20X2), with the effect of discounting on the quarterly licence fee payments treated).

Future economic benefits might include revenue from the sale of goods or the provision of services, cost savings, or other benefits derived by the entity from the use of the asset.

Some intangible assets might be contained in or on a physical substance, such as on a compact disc (computer software) or in legal documentation (licence or patent). The physical and non-physical elements might be incapable of separation in these instances, and judgement is required to determine which element is the more significant. The asset should be treated as an intangible asset if the intangible element is the more significant.

Categorising an asset as tangible or intangible It might be challenging to categorise an asset as tangible or intangible. An intangible asset is often contained in or on a physical substance. Examples are a compact disc that contains computer software, legal documentation that evidences a patent or a licence, a building to which a trading licence attaches, a DVD containing a film recording, or a computer system containing a database. If, for example, a machine cannot operate without a particular piece of software, the software is regarded as an integral part of the machine and is treated as a tangible asset. By contrast, where a tangible asset is incidental to an intangible asset, both the tangible and intangible elements are treated as an intangible asset. This would include situations where the tangible asset is merely a means of containing the software or other intangible asset and has no other use (for example, the compact disc on which software is contained). There might also be situations where, although the tangible and intangible elements cannot operate independently of each other, their costs are each significant. It might be appropriate to account for each element separately. For example, a database might be contained on expensive computer hardware, and the costs of the hardware might be separately identifiable from those of the database. Each element might have a different useful life (for example, the hardware might become obsolete and the database might be transferred to another computer system). It is appropriate, in this situation, to account separately for the two components of the computer database, classifying the hardware as tangible and the database itself as intangible, because they are both significant components.

Development costs paid to an external party – example Company A pays Company B, an external party, to develop an asset that would meet the requirements of IAS 38 for recognition as an internally generated intangible asset in Company A’s financial statements. Company B is performing only development work; all the associated research has already been performed, and the costs expensed, by Company A. Company A should recognise an internally generated intangible asset for these development costs under IAS 38. Whether Company A incurs the costs directly via an internal development function or outsources the development process to an external party does not influence how Company A should account for the asset in its financial statements. Therefore, because the expenditure meets the requirements for the recognition of an internally generated intangible asset under IAS 38, Company A should recognise the asset as an internally generated intangible asset in its financial statements. If the asset being developed did not meet the requirements for recognition of an internally generated intangible asset under IAS 38, the costs would be considered research expenditures and would be expensed as incurred. Similarly, if Company B were paid by Company A to perform both research and development activities, the research element would be expensed as incurred, but the development element would be capitalised provided that it met the requirements of IAS 38.

An intangible asset is identifiable when it:

• is separable (that is, it 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, asset or liability); or
• arises from contractual or other legal rights, regardless of whether the rights are transferable or separable from the entity or from other rights and obligations.

Identifiability of an asset Intangible assets that can be separated and sold, individually or with another asset, are deemed to meet the criterion of identifiability. Assets that arise from contractual or legal rights are also identifiable, even if they cannot be separated from the business. For example, in some jurisdictions, some licences within the business might not be transferable, except when the business is being sold as a whole. An asset might not, on its own, be separable or arise from contractual or legal rights. However, if there are exchange transactions in such assets (such as the sale of a portfolio of non-contractual customer relationships), they are deemed to meet the criterion of identifiability. Exchange transactions in the same or similar assets would provide evidence that the entity had control and that the item was separable.

Capitalisation of supplies purchased during the research phase – example Entity A is developing a new pharmaceutical product, Product X. The project is still at the research phase and the criteria in IAS 38 for recognition of an intangible development-phase asset have not yet been met. Consequently, costs of the project are currently expensed when incurred. To manufacture Product X for the purpose of feasibility testing, Entity A needs to purchase a raw material, Supply Y. It purchases a large volume of Supply Y, sufficient for all planned feasibility testing, so as to take advantage of bulk-buying discounts. If at any point during the feasibility testing process Entity A decides not to proceed with the development of Product X, it will be able to sell the remaining Supply Y in the market. Supply Y should be recognised as a current asset in Entity A’s statement of financial position provided that its carrying amount can be recovered by alternative means if the research project is abandoned. Supply Y should be initially recognised at cost, subsequently measured at the lower of cost and recoverable amount, and expensed as it is consumed. Prior to the decision to proceed with commercial production of Product X, Supply Y does not meet the definition of inventories (under paragraph 6 of IAS 2); nor does it meet the definition of property, plant and equipment (under paragraph 6 of IAS 16). Nevertheless, it does meet the definition of an asset in the Conceptual Framework, i.e., it is “a present economic resource controlled by the entity as a result of past events”. Note that if Entity A does not have alternative means to recover the carrying amount of Supply Y (whether by re-sale in the market or otherwise) in the event that the research project is abandoned, the criteria for recognition as an asset are not met and the cost should be recognised as an expense upon purchase of Supply Y.

Maps of distribution network that cannot be sold or exchanged An entity is involved in telecommunications and has an extensive distribution network that requires maintenance. Management maintains maps of the distribution system that enable maintenance crews to identify and locate the assets that form the system. The entity incurred substantial costs in developing these maps. The maps could not be sold or exchanged, as they are only of value to the entity. The entity would like to recognise an asset in respect of the expected future economic benefits to be derived from the maps. Management has control over the intellectual property that the maps represent, although the maps are not separable. The maps are protected by copyright. The intellectual property arises from contractual or legal rights, and the criterion of identifiability is met. Economic benefits might flow from the savings in maintenance costs that the entity will experience from having access to the maps. The costs incurred to develop the maps could be recognised as an internally generated intangible asset, provided that all the criteria for capitalisation as development expenditure have been met.

The recognition criteria for an intangible asset are:

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

What are ‘probable economic benefit’? ‘Probable’, as used in ‘probable economic benefit’, is not defined in IAS 38. The standard does not give any greater detail on how the expected future economic benefits should be assessed. Management should develop an accounting policy for intangible assets and, as a part of this accounting policy, it should determine what is ‘probable economic benefit’. Management should consider likelihood of success and the amount of expected economic benefits. IAS 37 defines ‘probable’ as ‘more likely than not’. This definition could be used when considering what is probable for the purpose of interpreting the likelihood of success. If management considers it more likely than not that the expected future economic benefits will flow to the entity, and this can be substantiated, this part of the criterion would be met.

An entity should assess the probability of expected future economic benefits using reasonable and supportable assumptions. These assumptions should represent management’s best estimate of the set of economic conditions that will exist over the asset’s useful life. In assessing future economic benefits, the entity could use cash flow models.

Judgement is required in assessing the degree of certainty to attach to the flow of economic benefits expected from the asset’s use based on evidence available at the date of initial recognition. Management should place greater reliance on external evidence.

External evidence The reference in IAS 38 to the need to give greater weight to external evidence is important. Exchange transactions are referred to throughout the standard as providing evidence of the separability of intangible assets. Exchange transactions might also provide external evidence of the expected future economic benefits. Other external evidence might include industry forecasts, market and competitor analysis provided by external experts, as well as general information on expected inflation and country growth rates.

If the asset will generate economic benefits only when combined with other assets, the IAS 36 concept of cash generating units should be applied.

An entity might obtain an intangible asset in a number of ways:

• by separate acquisition for monetary or other consideration;
• as part of a business combination;
• by exchange for other non-monetary assets;
• by way of government grant; or by developing or generating the asset internally.

The criteria for recognition are applied differently in each of these situations. The extent and reliability of the evidence available to the entity, in determining whether the criteria are met, vary depending on which situation is involved. For example, in each of the first three situations listed above, there is an exchange transaction, which gives evidence that economic benefits are likely to flow to the entity.

Subsequent expenditure on an internally generated intangible asset under development for use in a cash-generating unit when impairment indicators are identified If an impairment indicator has been identified in respect of an internally generated intangible asset that is currently being developed for internal use as part of a cash-generating unit (and for which IAS 38’s criteria for recognition of an internally generated intangible asset have been met), but no impairment loss has been recognised because the recoverable amount of the cash-generating unit as a whole is greater than its carrying amount, the entity should generally include subsequent expenditure in the cost of the intangible asset. Usually, an entity will only continue with such a development project if it expects the future benefits from completing the project to exceed the additional costs that will need to be incurred (even though those benefits may not be sufficient also to cover costs already incurred, i.e., ‘sunk’ costs). When the future benefits are expected to exceed the additional costs, it is appropriate to capitalise the subsequent costs in accordance with the requirements of IAS 38. If, exceptionally, an entity decides to continue with a development project even though it does not expect the future benefits from completing the project to exceed the additional costs that will need to be incurred, then the entity will need to consider carefully whether the fourth criterion in IAS 38 (probability of future economic benefits) is met. If it is not, subsequent expenditure should be recognised as an expense.

Subsequent expenditure on an internally generated intangible asset under development for use in a cash-generating unit when impairment indicators are identified – example Entity R is developing computer software for use in its business. On 1 January 20X1, the criteria for recognition as an internally generated intangible asset are met and expenditure on the development incurred after that date is included in the cost of the asset. Budgeted total expenditure to completion of the project at the end of 20X3 is CU3 million and the incremental benefits to be derived from the software are expected to be approximately CU5 million. At 31 December 20X1, the intangible asset is tested for impairment as required by IAS 36, but no impairment loss is identified. At 31 May 20X2, the carrying amount of the intangible asset is CU1.5 million. In June 20X2, estimates of the additional costs to complete the project are increased to CU4.5 million (i.e., total project costs of CU6 million). (Note that this is not as a result of operating inefficiencies or error.) A decision is taken to proceed with the project because the expected incremental benefits (CU5 million) are still in excess of the costs not yet incurred (CU4.5 million). However, the directors consider that this is an indication of impairment and that the recoverable amount of the software should be estimated. The software does not generate independent cash flows, and its fair value less costs of disposal is estimated to be lower than its carrying amount; accordingly, the software asset is tested for impairment as part of its cash-generating unit. The recoverable amount of the cash-generating unit as a whole is determined to be CU100 million and its carrying amount is CU75 million; therefore, no impairment loss is recognised. As additional expenditure is incurred on completion of the software development, Entity R should continue to include that expenditure in the cost of the software asset in accordance with IAS 38. In addition, although the total costs are significantly in excess of the original budget, and are expected to exceed the incremental benefits that will be generated by the software, no impairment loss is required to be recognised unless the carrying amount of the cash-generating unit as a whole exceeds its recoverable amount.

Evaluating whether overheads are ‘directly attributable costs’ – example Company A is developing a product in premises used solely for the product’s development. The criteria in IAS 38 for the recognition of an intangible asset arising from the development activities have been met. Company A expects to continue to use the premises after the product’s development is completed. IAS 38 states that “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”. Premises costs are more likely to fall under IAS 38, which states that selling, administrative and other general overhead costs are not part of the cost of an internally generated intangible asset “unless this expenditure can be directly attributed to preparing the asset for use”. Whether such costs can be considered ‘directly attributable’ is a matter of judgement in the particular circumstances. However, to qualify as directly attributable, it would be expected that the costs would have been avoided had the entity not engaged in the development activities. Therefore, in the circumstances described, if the premises are rented, it may be possible to demonstrate that the rental costs are directly attributable costs if they would not have been incurred had the entity not engaged in the development activities. For example, Company A might be able to demonstrate that: it did not rent the premises until commencement of the development activities; and had it not engaged in the development activities, it would not have rented the premises until a later date for use in other activities. Alternatively, if the development activities take place in a property owned by Company A, prior to commencing those activities, Company A would need to demonstrate that the costs of the building (or portion of the building) in which the development activities are carried out would have been avoided, such as in one of the following scenarios: the building (or portion of the building) is separately identifiable and could have been separately subleased if not used for the development activities; or the building (or portion of the building) would have been used to house other activities for which Company A has rented additional premises.

Cost of carbon offsets created by a certified carbon emission reduction project – wind farm An entity is constructing a wind farm in a developing country that it intends to use in the production of electricity and, therefore, is accounted for as property, plant and equipment. The project has been certified as a carbon emission reduction project and the entity receives carbon offsets upon completion of the construction phase of the project. The entity will cease to receive carbon offsets in relation to the wind farm once construction is complete. If the carbon offsets are ‘created’ (i.e., through the construction of the wind farm) with the intention of selling them in the ordinary course of business, they are classified as inventory. Otherwise, they are classified as intangible assets. The carbon offsets are initially recognised at cost. Applying, by analogy, the principle in IAS 16, the cost of the carbon offset is determined applying the measurement requirements of IAS 2. Because the carbon offsets are obtained upon completion of the construction of the wind farm, the costs incurred in the construction of the wind farm could be allocated between the construction and the ’creation’ of the associated carbon offset, based on the relative fair value of wind farm and the carbon offsets on that date. This allocation method will also be appropriate if the carbon offsets are accounted for as intangible assets.

Cost of carbon offsets created by a certified carbon emission reduction project – ‘green’ fuel An entity produces biofuel made from used cooking oil. Production of the biofuel has been certified as a carbon emission reduction project and the entity receives carbon offsets as the production of the biofuel is completed. The entity sells the biofuel either in its pure form or blended with carbon-based fuel. The carbon offsets obtained as a consequence of the biofuel production can be sold with the biofuel, sold separately, or used by the entity to offset its own carbon emissions. The entity should account for the production of the biofuel and the carbon offsets as separate assets. The biofuel meets the definition of inventory because it is held for sale in the ordinary course of business. The carbon offsets are inventory if the entity intends to sell them in the ordinary course of business or intangible assets otherwise. The biofuel and the carbon offsets are initially recognised at cost. When a production process results in more than one product being produced simultaneously, and the costs of conversion of each product are not separately identifiable, the total production cost is allocated between the products on a rational and consistent basis. Because the carbon offsets are obtained on completion of the biofuel, the allocation could be based on the relative sales value of the biofuel and the carbon offsets on completion of production. This allocation method will also be appropriate if the carbon offsets are accounted for as intangible assets. Whilst IAS 2 does not contemplate any exception to the requirement to allocate costs to the separate products, this requirement may not have a significant impact if the entity always sells biofuel with carbon offsets and satisfies its performance obligations in respect of the sale of each product at the same time. However, the entity will also need to consider the requirements of IAS 2 to disclose the carrying amount of inventory in classifications that are appropriate to the entity.

Research and development activities performed under contract for others When an entity carries out research and development activities for others, the substance of the arrangement dictates the accounting treatment of the research and development expenditure for both entities. If the entity carrying out the research and development activities will control any asset that is developed, it should account for the expenditure on the research and development activities in accordance with IAS 38. If the entity carrying out the research and development activities will not retain control of any asset that is developed, it should account for its activities in accordance with IFRS 15. The following factors may indicate that control of any asset developed is retained by the entity carrying out the activities: the entity conducting the research and development activities will retain full rights to any intellectual property that is developed; the entity conducting the research and development activities will only receive payment from the other entity if the outcome of the research and development activities is successful (i.e., the outcome meets criteria specified by that other entity); the entity conducting the research and development activities is contractually obliged to repay any of the funds provided by the other entity, regardless of the outcome of the research and development activities; or even though the contract does not require the entity conducting the research and development activities to repay any of the funds provided by the other entity, repayment could be required at the option of the other entity or the surrounding conditions indicate that repayment is probable.

Applying recognition criteria to externally acquired assets

The probability recognition criterion is always assumed to be met for separately acquired intangible assets. The price paid reflects expectations about the probability that the future economic benefits of the asset will flow to the entity. The greater the price paid, the higher the expectations of future economic benefits to be derived from the asset. A business combination is an exchange transaction.

Probability criterion for assets acquired in an exchange transaction The probability recognition criterion is deemed to be satisfied for intangible assets acquired in exchange for a non-monetary asset, as in the acquisition for monetary consideration. The asset acquired in a nonmonetary exchange is measured at fair value of the consideration given, and the fair value reflects expectations about the probability of future economic benefits flowing to the entity.

Reliable measurement criterion for assets acquired in a business combination A business combination is an exchange transaction. The price paid in a business combination reflects expectations about the future economic benefits expected from the acquired business as a whole. It does not directly reflect expectations about individual assets acquired as part of the combination.

Reliable measurement criterion for assets acquired by way of government grant Intangible assets might be acquired free of charge, or for nominal consideration (for example, by way of a government grant). Assets that might be acquired through government grant include airport landing rights, emission rights, radio or television station operating licences, import licences and quotas. Assets such as these can be recognised at cost (being nil or nominal value) or at fair value. If the entity chooses to recognise these assets at fair value, management needs to assess whether the grant at fair value could be recognised. For this, there should be reasonable assurance that the entity will comply with the conditions attached to the grant. There is no exchange transaction where an intangible asset is acquired by way of a government grant. No reference is made in IAS 38 to the application of the recognition criteria for intangible assets acquired by way of a government grant. However, IAS 20 states that a non-monetary grant at fair value is not recognised until there is reasonable assurance that the entity will comply with the conditions attaching to it and the grant will be received. Receipt of a grant does not, of itself, provide conclusive evidence that the conditions attaching to the grant have been or will be met.

Internally generated intangible assets

It might be challenging to determine whether an internally generated intangible asset qualifies for recognition because:

• there is uncertainty that the intangible asset will generate expected future economic benefits; and
  • it might not be possible to determine the asset’s cost reliably or distinguish the costs attributable to such an asset from costs of maintaining or increasing the entity’s internally generated goodwill or the costs of carrying out the entity’s day-to-day operations.

Research and development costs which cannot be attributed to a specific product A major supplier that produces confectionery has two lines of business: chocolates and candies. The chocolates unit comprises five brands, and the candies unit has three brands. Management is continually seeking to innovate and attract new customers. It incurs expenditure related to research and development of new products, such as investigation of customer preferences, design of variations to current products and designs of new products. Research and development expenditure of C1 million for the chocolate’s unit, and C1.6 million for the candy’s unit, was incurred during the year. The expenditure cannot be allocated to any specific product, but it can be associated with a line of business. The research and development costs should not be capitalised as an internally generated intangible asset. An intangible asset must be identifiable and attributable to a specific product or project in order to meet the recognition criteria for an intangible asset. Management should be able to identify the future economic benefits that will flow from each separate intangible asset that it recognises. It is not possible to meet the recognition criteria for an intangible asset if management is unable to identify the individual product or project.

Research and development

The process of generating an intangible asset is divided into a research phase and a development phase.

If the two phases are indistinguishable, all the expenditure on the asset should be attributed to the research phase.

‘Research’ is defined as “… original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding”. ‘Development’ is defined as “… 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”.

Research phase

Examples of research activities include:

• Activities aimed at obtaining new knowledge.

• Searching for suitable applications of research findings or other knowledge, evaluating the applications and making a final selection of suitable applications.

• Searching for alternatives for materials, devices, products, processes, systems or services.

Research activities An example of an activity aimed at obtaining new knowledge is biotechnology research into how the presence of particular genes might affect the incidence of particular illnesses in humans. An example of searching for suitable applications of research findings is determining whether the discovery of the effect of a particular interaction of chemicals might be used in developing a treatment for a particular disease, using criteria that include the treatment’s likely effectiveness, cost and the alternative existing treatments available. An example of searching for alternatives for materials and processes is seeking alternatives that are more ecologically friendly as part of an entity’s efforts to improve its corporate social responsibility. Research is defined as related to scientific or technical knowledge. The same accounting treatment of expensing the costs as incurred would apply to other forms of enquiry, such as market or customer research.

Expenditure on the research phase of an internal project should be expensed as incurred. No intangible asset arising from research, or from the research phase of an internal project, can be recognised.

An entity is unable to demonstrate that there will be future economic benefits during the research phase. The absence of probability of future economic benefits means that the expenditure does not meet the definition of an intangible asset, nor does it meet the criteria for recognition.

Intangible assets used in a research and development project An entity might purchase patents and other rights over processes that are used in a research and development project. These rights would qualify for recognition as separately acquired intangible assets, even though they are used in the research activity. The ‘future economic benefits’ criterion is assumed to be automatically satisfied in the separate acquisition of an intangible asset.

Research projects that are acquired as part of a business combination are treated differently. In such cases, an asset will usually be recognised.

Research project acquired in a business combination Research and development projects acquired separately or as part of a business combination are recognised as intangible assets if they can be reliably measured. This results in the recognition of many such assets at an earlier stage than if they were internally generated assets. Example Entity A has incurred C100,000 of research expenditure on a project to develop a new type of fuel and has expensed these costs. Entity B purchases the research project, including certain patents that have been registered by entity A, for C150,000 and recognises an intangible asset. Subsequently, entity B incurs C200,000 of expenditure on completing the research phase and decides to develop the product commercially. It incurs a further C300,000 of costs in bringing the product to a stage where the conditions for recognising development costs as an internally generated intangible asset are met. Further costs of C1 million are incurred in bringing the product into a condition where it is ready for use in the manner that management intends. Marketing costs and initial losses of C200,000 are incurred before the product reaches widespread distribution. What costs can entity B capitalise? ·        Entity B recognises C150,000 as the cost of the acquired research project. ·        The subsequent research costs of C200,000 are expensed as incurred. ·        The subsequent development costs incurred of C300,000 do not meet the conditions for recognition and are expensed as incurred. ·        Further development costs of C1 million must be recognised, because they meet the conditions for recognition as an intangible asset. The previously written-off development costs are not reinstated. ·        The marketing costs and initial losses of C200,000 are expensed as incurred. The intangible asset’s carrying amount, when production and sale of the product commences, is C1,150,000.

Development phase

Examples of development activities include:

• Designing, constructing and testing pre-production or pre-use prototypes and models.
• Designing tools, jigs, moulds and dies involving new technology.
• Designing, constructing and operating a pilot plant that is not of a scale that is economically capable of commercial production.
• Designing, constructing and testing a selected alternative for new or improved materials, devices, products, processes, systems or services.

The future economic benefits might become more apparent as a project progresses into the development stage. The development phase of a project is more advanced than the research phase. An entity can, in some instances, identify an intangible asset in the development phase.

Unit of account for capitalisation of research and development expenses Research and development projects should be capitalised at the project level for purposes of recognition, measurement and amortisation or subsequent impairment testing.

An intangible asset arising from development, or from the development phase of an internal project, should be recognised if an entity can demonstrate all of the following:

1. The technical feasibility of completing the intangible asset so that it will be available for use or sale.

1. Its intention to complete the intangible asset and use or sell it.
2. Its ability to use the intangible asset or to sell it.
3. The way in which the intangible asset will generate probable future economic benefits. Among other factors, the entity must be able to demonstrate the existence of a market for the intangible asset’s output or for the intangible asset itself; or, if the asset is to be used internally, it must be able to demonstrate the usefulness of the intangible asset.
4. The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.

1. Its ability to measure reliably the expenditure attributable to the intangible asset during its development.

Application of recognition criteria to each stage of the product life cycle Management should consider the product life cycle and then apply the recognition criteria listed in IAS 38 at each stage of that cycle, as illustrated below. Consider the development of a new technology to be used in a manufacturing plant. The process could be split into the following stages: 1. Identify a need for/benefit of new technology. 2. Commission a project to investigate the new technology. 3. Investigate other technologies available in the market. 4. Investigate competitors’ use of other technologies. 5. Commission the design of alternative types of new technology and get input from the manufacturing floor for feasibility. 6. Prepare a shortlist of alternatives from commissioning stage and prepare costing. 7. Prepare a budget for the new technology and agree to the shortlist and the replacement of technology. 8. Send the shortlist to line managers for input and list three alternatives based on feedback. 9. Present the final three to the board for final selection. 10. Finalise a development plan for the final selection. 11. Develop new technology. 12. Test new technology. 13. Train staff on new technology. 14. Roll out new technology to the production line. The recognition criteria should be considered at each stage to determine when the criteria have been met in full. From that point onwards, the entity should capitalise all directly attributable costs. Stage 5: Criteria (a) and (c) have been met, because the feasibility of completing the intangible asset for use and the entity’s ability to use it have been confirmed. Stage 7: Criteria (a), (c), (d) and (e) have been met at the end of this stage, because a budget has been produced, it has been agreed to proceed with replacing the technology, and adequate resources exist to complete the development. Stage 10: All the criteria have been met at this stage, because, in addition to the above, the board has approved the project (evidence of intention to complete the asset – criterion (b)), and the development plan, based on the budgets, evidences the ability to measure the expenditure reliably (criterion (f)).

Considering the nature of the business and the nature of the products being developed until the application of IFRS 15 Many entities incur significant expenditure on development. The amount that is recognised as an intangible asset varies considerably, depending on the nature of the business and the nature of the products that are being developed. Consider, for example: ·        An entity whose business is long-term contracting, where its business involves developing major computer systems for customers. Contract terms might provide for the entity to be reimbursed for development costs of the product or system as part of the contract price. These development costs would not generally be accounted for under IAS 38, but as part of the cost of the contract under IAS 11. ·        Another entity might make products for sale generally, such as cars. That entity might incur significant expenditure on development of new models. Provided the recognition criteria were met, the entity would capitalise the development costs incurred after the criteria were met and thus might carry significant amounts of development costs as an intangible asset. Regulatory requirements are an important factor in restricting the ability of an entity to meet the recognition criteria in certain industries such as pharmaceuticals. However, the existence of such restrictions might have less impact in other industries. For example, the need for a new type of train to meet safety laws is, in itself, unlikely to prohibit an entity from concluding that it is probable that future economic benefits will flow to the entity. A train is an established form of transport, not a completely new product. Defects in design could be rectified to meet safety requirements. A failure to meet regulatory requirements with a completely new product, on the contrary, could mean that the entire project fails.

Application of recognition criteria in the pharmaceutical industry An entity involved in developing new drugs or vaccines might incur significant research and development costs and might reach a stage at which it is very confident that the product will be successful. There is no definitive starting point for capitalising such internal development costs. Management must use its judgement, based on the facts and circumstances of each project. The release of a new drug is strictly controlled by legislation and has to pass a number of clinical trials before it can be marketed. The entity is not normally able to capitalise development expenditure before obtaining regulatory authority for final approval of the drug. This is because it is not able to demonstrate the technical feasibility of completing the project before this stage. These entities might have to expense all research and development expenditure until the technical feasibility of the products could be demonstrated. However, a strong indication that an entity has met the recognition criteria in IAS 38 arises when it files its submission to the regulatory authority for final approval. It is strong evidence that the technical feasibility of completing the project is proven, this being the most difficult criterion to demonstrate.

Considering the nature of the business and the nature of the products being developed after the application of IFRS 15 Many entities incur significant expenditure on development. The amount that is recognised as an intangible asset varies considerably, depending on the nature of the business and the nature of the products that are being developed. Consider, for example, an entity whose business is long-term contracting, which involves developing major computer systems for customers. Contract terms might provide that the development activities for the product or system are part of the performance obligation. These development costs would not generally be accounted for under IAS 38, but as part of satisfying the performance obligation(s) under IFRS 15. However, if the development activities are not part of the performance obligation(s), but nonetheless are explicitly chargeable to the customer (for example, because the knowledge is used when satisfying the performance obligation(s), without being part of it itself), it should be analysed whether the guidance on costs to fulfil a contract (IFRS 15) or IAS 38 is applicable. Another entity might make products for sale generally, such as cars. That entity might incur significant expenditure on development of new models. Provided the recognition criteria were met, the entity would capitalise the development costs incurred after the criteria were met and thus might carry significant amounts of development costs as an intangible asset. Regulatory requirements are an important factor in restricting the ability of an entity to meet the recognition criteria in certain industries such as pharmaceuticals. However, the existence of such restrictions might have less impact in other industries. For example, the need for a new type of train to meet safety laws is, in itself, unlikely to prohibit an entity from concluding that it is probable that future economic benefits will flow to the entity. A train is an established form of transport, not a completely new product. Defects in design could be rectified to meet safety requirements. A failure to meet regulatory requirements with a completely new product, on the contrary, could mean that the entire project fails.

Reliable measurement criterion for customer lists developed internally and customer lists acquired as part of a business combination Entity A has been in the market for many years and has built a list of customers with which it currently transacts. This list is large and complete in terms of information about the customers. Management considers that the list has a significant value. Entity A acquires a medium-sized competitor that also has a large customer list, with information such as name, address, contacts and average purchase amount. This customer list has a value, and management could sell it to third parties. Its fair value can be measured reliably and there are no substantive legal reasons that preclude client information from being exchanged or traded. Entity A would like to recognise intangible assets in respect of the customer lists above, as both are resources controlled by the entity from which the entity expects to derive future economic benefit. Entity A should recognise the customer list acquired in the business combination as an intangible asset, provided its fair value can be reliably measured. The ability to sell the list or to exchange it provides evidence that it is separable from the goodwill arising in the acquisition. Entity A cannot, however, recognise an intangible asset for the internally generated customer list, despite the fact that it clearly has satisfied the control criterion. IAS 38 specifically prohibits recognising internally generated intangible assets, other than development expenditure that meets the conditions in the standard for recognition. This is because the cost of the list cannot be distinguished from the cost of developing the business as a whole.

Expenses incurred before a project meets the criteria for recognition as an intangible asset must be expensed as incurred. Previously written-off costs cannot be reinstated as part of the intangible asset if the project has reached the stage at which an asset must be recognised.

How could the introduction of a new product or system affect the future economic benefits from an existing product or system? A new product or system might replace or make obsolete an existing product or system owned by an entity. The entity should reassess the benefits from products or systems that are replaced or which are affected in other ways by the new product or system. The planned replacement might well be an impairment indicator under IAS 36. A new product might result in an impairment of existing assets or reduce the useful lives of the existing asset. An example is the introduction of digital technology that replaces analogue technology.

Costs incurred under the REACH (registration, evaluation, authorisation and restriction of chemicals) EU legislation The REACH legislation requires the registration of existing and new chemicals and substances by manufacturers, importers and downstream users. This legislation also requires authorisation of substances of very high concern (according to the list published by the European Chemicals Agency). The entity is not permitted to manufacture or import a chemical that is not registered and cannot use a substance that is not authorised. Registration and authorisation fees meet the definition of an intangible asset and could be capitalised, provided the costs incurred are directly attributable (that is, can be distinguished from the day-to-day costs of running the business) to registration or authorisation and are reliably measurable. Jurisdictions other than the EU have already developed or are in the process of developing regulations relating to similar environmental issues. Similar costs incurred, as required by legislation in these jurisdictions, can also be capitalised as an intangible asset. Similarly, discretionary costs incurred by an entity to obtain a certification mark (defined in the Appendix to IFRS 3 as being “used to certify the geographical origin or other characteristics of a good or service”, such as British Standards recognition) can be capitalised as an intangible asset if the recognition criteria are met. If the entity considers that it is probable that future economic benefits will flow from the asset to the entity (through increased sales), the cost of acquiring the specific certification can be recognised as an intangible asset if it is protected legally or through registration.

Expenditure which cannot be capitalised as internally generated intangible assets

The criteria for recognising internally generated intangible assets cannot be satisfied for some types of intangible asset. These include internally generated brands, mastheads, publishing titles, customer lists and items that are similar in substance. It is extremely difficult to distinguish the costs of such items from the costs of developing the business as a whole. The standard prohibits recognition of those items as intangible assets.

Customer loyalty scheme A supermarket is one of three large supermarket chains that dominate the market. Competition in the market is intense, resulting in low product margins. The supermarket has launched a customer loyalty scheme in an effort to boost its market share. Customers who sign up for this scheme are issued loyalty cards that they can use to earn redeemable points based on the value of their purchases. Points can be redeemed against future purchases or to obtain prizes. The supermarket wishes to capitalise the cost of establishing the scheme as an intangible asset. The expenditure on the scheme cannot be distinguished from the cost of developing the business as a whole. The customer loyalty scheme is internally generated, and so it cannot be recognised as an intangible asset.

Internally generated items acquired in a business combination that should not be recognised as intangible assets IFRS 3 contains a list of items acquired in a business combination that meet the definition of intangible assets and which are recognised as such, separately from goodwill, if their fair values can be reliably measured. The following are items that should not be recognised as intangible assets in a business combination: ·        Customer service capability: An entity’s customer service capability does not meet the identifiability criterion for separate recognition as an intangible asset. An entity’s customer service capability is dependent on its employees, which do not represent a resource controlled by the entity. ·        A customer base which is a group of customers not identifiable to the entity, such as the walk-in customers of a retailer: The walk-in customer base of a retailer does not meet the identifiability criterion for separate recognition as an intangible asset. The absence of contractual or legal rights, plus the inability of the retailer to identify or contact the customer, means that the entity has insufficient control over the economic benefits that it expects to derive from the customers. ·        Presence in geographic markets or locations: Presence in geographic markets or locations does not meet the identifiability criterion for separate recognition as an intangible asset. There is nothing to prevent other third parties from entering the geographic markets or locations, so the entity is not in a position to control the benefits associated with a specific location or geographic market. ·        Non-union status or strong labour relations: Non-union status or strong labour relations do not meet the identifiability criterion for separate recognition as an intangible asset. Although an entity might be able to identify future economic benefits from non-union status (such as reduced employee administrative and salary costs), employees do not represent a resource controlled by the entity. ·        On-going training or recruiting programmes: Expenditure on training costs should be expensed as incurred, because these costs are indistinguishable from the costs of developing the business as a whole. The entity might be able to identify incremental staff skills leading to future economic benefits from on-going training and recruiting programmes; however, employees do not represent a resource controlled by an entity, so the entity cannot recognise a separate intangible asset. ·        Outstanding credit ratings or access to capital markets: Outstanding credit ratings or access to capital markets do not meet the identifiability criterion for separate recognition as an intangible asset. Credit ratings or a company’s creditworthiness are not protected by contractual or legal rights. The entity has insufficient control over any economic benefits that it expects to derive as a result of favourable credit ratings/access to a capital market. Favourable credit ratings or access to a capital market are also not separable, because they cannot be sold to a third party. ·        Favourable government relations: Favourable government relations do not meet the identifiability criterion for separate recognition as an intangible asset. The government does not represent a resource that is controlled by the entity. It is common practice, in certain jurisdictions, for entities to actively lobby government, which might result in certain economic benefits flowing to the company. ·        Assembled workforce: The assembled workforce does not meet the identifiability criterion for separate recognition as an intangible asset. The benefits arising from an assembled workforce cannot be controlled by an entity, since the entity cannot prevent a change in the composition of the workforce.

Examples of the types of cost that are indistinguishable from the costs of developing the business as a whole and that should be expensed include:

• Start-up costs, unless such costs are included in the cost of a tangible fixed asset under IAS 16.

• Costs that should be expensed as incurred include preliminary expenses of establishing a legal entity, expenditure on opening a new facility or business (pre-opening costs), and expenditure on starting up a new operation or launching a new product or process.
• Training costs.
• Advertising and promotion costs, including mail order catalogues.
• Relocation expenses.

• Re-organisation costs for all or part of an entity.

Treatment of advertising expenditure and catalogues Expenditure that does not meet the recognition criteria includes the general day-to-day expenditure on maintaining the business, such as wages and salaries, maintenance, advertising expenditure and catalogues. Advertising and promotional activities enhance or create brands or customer relationships, which in turn generate revenues. Goods or services acquired to be used in advertising or promotional activities have no other purpose. The only benefit of those goods or services is to develop brands or customer relationships, which in turn generate revenues. Internally generated brands and customer relationships are not recognised as intangible assets. An entity should not recognise an asset in respect of an advertisement that it has not yet published. The only economic benefits that might flow to the entity as a result of publishing the advertisement are the same as those that might flow to the entity as a result of the brand or customer relationship that it would enhance or create. The entity should not recognise as an asset goods or services that it had received in respect of its future advertising or promotional activities. The primary objective of mail order catalogues is to advertise goods to customers rather than to give rise to a distribution network. Mail order catalogues are an example of advertising activities and cannot be capitalised.

Internally generated goodwill is not recognised as an asset, because it is not an identifiable resource – that is, it is not separable and it does not arise from contractual or other legal rights that are controlled by the entity and that are reliably measurable.

Market capitalisation exceeding net assets’ value There might be a difference, sometimes large, between the market capitalisation of an entity and its net asset value. Such a difference can represent a wide variety of factors affecting the value of an entity, including management expertise or reputation, internally generated brand value, growth in acquired brand values carried at cost, and bid speculation. However, such differences do not represent identifiable intangible assets controlled by the entity.

Assets acquired in a business combination

An acquirer recognises an intangible asset of the acquiree, irrespective of whether the asset had been recognised by the acquiree before the business combination.

It is always assumed that the probability recognition criterion is met for intangible assets acquired in a business combination. The fair value of an intangible asset reflects market participants’ expectations at the acquisition date about the probability that the expected future economic benefits embodied in the asset will flow to the entity.

The reliable measurement criterion will always be met for intangible assets acquired in a business combination. If an asset acquired is separable or arises from contractual rights, sufficient information exists to reliably measure the fair value of the asset.

An in-process research and development project of the acquiree should be recognised if the project:

• meets the definition of an asset; and
• is identifiable (that is, it is separable or arises from contractual or other legal rights).

Intangible assets that generally meet the criteria for separate recognition The table below includes a list of intangible assets by major category and identifies whether the asset would typically meet the contractual-legal criterion or the separability criterion. An intangible asset might meet both identifiable criteria. However, the exhibit highlights the primary criterion under which the specific intangible asset would be recognised. The list is not intended to be all-inclusive. Other acquired intangible assets might also meet the criteria for recognition apart from goodwill. Intangible asset Contractual-legal criterion Separability criterion Marketing-related ■ Trademarks, trade names ✓ ■ Service marks, collective marks, certification marks ✓ ■ Trade dress (unique colour, shape, or package design) ✓ ■ Newspaper mastheads ✓ ■ Internet domain names ✓ ■ Non-competition agreements ✓ Customer-related ■ Customer lists ✓ ■ Order or production backlog ✓ ■ Customer contracts and related customer relationships ✓ ■ Non-contractual customer relationships ✓ Artistic-related ■ Plays, operas, ballets ✓ ■ Books, magazines, newspapers, other literary works ✓ ■ Musical works, such as compositions, song lyrics, advertising jingles ✓ ■ Pictures, photographs ✓ ■ Video and audio-visual material, including motion pictures, music videos, television programmes ✓ Contract-based ■ Licensing, royalty, standstill agreements ✓ ■ Advertising, construction, management, service or supply contracts ✓  ■ Construction permits ✓ ■ Franchise agreements ✓ ■ Operating and broadcast rights ✓ ■ Use rights, such as drilling, water, air, mineral, timber cutting, and route authorities ✓ ■ Servicing contracts (for example, mortgage servicing contracts) ✓ ■ Employment contracts ✓ Technology-based ■ Patented technology ✓ ■ Research and development ✓ ■ Computer software and mask works ✓ ■ Unpatented technology ✓ ■ Databases, including title plants ✓ ■ Trade secrets, such as secret formulae, processes, recipes ✓ ✓ Indicates the primary criterion under which the specific intangible asset would typically be recognised.

Marketing-related intangible assets Marketing-related intangible assets are primarily used in the marketing or promotion of products or services. They are typically protected through legal means and generally meet the contractual-legal criterion for recognition separately as an intangible asset if acquired separately or in business combination. Trademarks, trade names and other marks are often registered with governmental agencies or are unregistered, but otherwise protected. Whether registered or unregistered, but otherwise protected, trademarks, trade names and other marks have some legal protection and would meet the contractual-legal criterion. If trademarks or other marks are not protected legally, but there is evidence of similar sales or exchanges, the trademarks or other marks would meet the separability criterion. A brand is the term often used for a group of assets associated with a trademark or trade name. An acquirer can recognise a group of complementary assets, such as a brand, as a single asset apart from goodwill if the assets have similar useful lives and either the contractual-legal or the separable criterion is met. Trade dress refers to the unique colour, shape or packaging of a product. If protected legally, the trade dress meets the contractual-legal criterion. If the trade dress is not legally protected, but there is evidence of similar sales, or if the trade dress is sold in conjunction with a related asset, such as a trademark, it would meet the separability criterion. Newspaper mastheads are generally protected through legal rights, similar to a trademark, and would meet the contractual-legal criterion. If not protected legally, a company would look at whether exchanges or sales of mastheads occur, to determine if the separability criterion is met. Internet domain names are unique names used to identify a particular internet site or internet address. These domain names are usually registered and would meet the contractual-legal criterion. Non-competition (‘non-compete’) agreements are legal arrangements that generally prohibit a person or business from competing with a company in a certain market for a specified period of time. An acquiree might have pre-existing non-compete agreements in place at the time of the acquisition. Those agreements would meet the contractual-legal criterion and represent an acquired asset that would be recognised as part of the business combination. The terms, conditions and enforceability of noncompete agreements might affect the fair value assigned to the intangible asset, but they would not affect its recognition. Other payments made to former employees, that might be described as non-compete payments, might actually be compensation for services in the post-combination period and should be scrutinised.

Customer-related intangible assets Customer-related intangible assets include, but are not limited to: i)               customer contracts and related customer relationships, ii)                non-contractual customer relationships, iii)              customer lists, and iv)              order or production backlog. The relationships that an acquiree has with its customers might encompass more than one type of intangible asset (for example, customer contract and related customer relationship, customer list, and backlog). The inter-relationship of various types of intangible assets related to the same customer can pose challenges in recognising and measuring customer-related intangible assets. The values ascribed to other intangible assets, such as brand names and trademarks, might also impact the valuation of customer-related intangible assets. Further, because the useful lives and the pattern in which the economic benefits of the assets are consumed might differ, it might be necessary to separately recognise intangible assets that encompass a single customer relationship.

Contract-based intangible assets Contract-based intangible assets represent the value of rights that arise from contractual arrangements. Customer contracts are one type of contract-based intangible asset. Contract-based intangible assets include: (i)               licensing, royalty and standstill agreements; (ii)              advertising, construction, management, service or supply contracts; (iii)            construction permits; (iv)            franchise agreements; (v)              operating and broadcast rights; (vi)            contracts to service financial assets; (vii)           employment contracts; (viii)          use rights; and (ix)             lease agreements if applying IAS 17. Contracts whose terms are considered at-the-money, as well as contracts in which the terms are favourable relative to market, might also give rise to contract-based intangible assets. If the contract’s terms are unfavourable relative to market, the acquirer recognises a liability assumed in the business combination.

Customer-related intangible assets: customer award or loyalty programmes In assessing the recognition and measurement of any intangible assets related to a customer award or loyalty programme, careful consideration should be given. The range of terms and conditions associated with these programmes might vary. Customer award or loyalty programmes might create a relationship between the acquiree and the customer. Such programmes might enhance the value of a customer-related intangible asset. These programmes are expected to meet the term ‘contractual’ because the parties have agreed to certain terms and conditions, or they have had a previous contractual relationship, or both. In addition to evaluating the need to recognise and measure a customer-related intangible asset for these programmes, the acquirer must separately evaluate the need to recognise and measure any assumed liabilities related to these programmes on the acquisition date.

Customer-related intangible assets: customer contracts and related customer relationships A customer relationship exists between a company and its customer if (i)               the company has information about, and regular contact with, the customer, and (ii)              the customer has the ability to make direct contact with the company. If the entity has a practice of establishing relationships with its customers through contracts, the customer relationship would meet the contractual-legal criterion for separate recognition as an intangible asset, even if no contract (for example, purchase order or sales order) is in place on the acquisition date. A practice of regular contact by sales or service representatives might also give rise to a customer relationship. A customer relationship might indicate the existence of an intangible asset that should be recognised if it meets the contractual-legal or separable criterion. Example 1 – Cancellable and non-cancellable customer contracts An acquired business is a manufacturer of commercial machinery and related aftermarket parts and components. The acquiree’s commercial machines, which comprise approximately 70% of its sales, are sold through contracts that are non-cancellable. Its aftermarket parts and components, which comprise the remaining 30% of the acquiree’s sales, are also sold through contracts. However, the customers can cancel the contracts at any time. The acquiree has a practice of establishing contractual relationships with its customers for the sale of commercial machinery and the sale of aftermarket parts and components. The ability of those customers that purchase aftermarket parts and components to cancel their contracts at any time would factor into the measurement of the intangible asset, but would not affect whether the contractual-legal criterion has been met from a recognition perspective. Example 2 – Potential contracts being negotiated at the acquisition date An acquiree is negotiating contracts with a number of new customers at the acquisition date for which the substantive terms, such as pricing, product specifications and other key terms, have not yet been agreed to by both parties. Although the acquirer might consider these prospective contracts to be valuable, potential contracts with new customers do not meet the contractual-legal criterion, because there is no contractual or legal right associated with them at the acquisition date. Potential contracts also do not meet the separability criterion, because they are not capable of being sold, transferred or exchanged and are not separable from the acquired business. The value of these potential contracts is subsumed into goodwill. Changes to the status of the potential contracts subsequent to the acquisition date would not result in a reclassification of goodwill to an intangible asset.

Customer-related intangible assets: ‘overlapping customers’ An acquirer might have relationships with the same customers as the acquiree (sometimes referred to as ‘overlapping customers’). If the customer relationship meets the contractual-legal or separable criterion, an intangible asset should be recognised for the customer relationships of the acquiree, even though the acquirer might have relationships with those same customers. The valuation of such relationships might depend on a number of factors, including whether market participants would benefit from those same relationships.

Customer-related intangible assets: noncontractual customer relationships Non-contractual customer relationships do not meet the contractual-legal criterion. However, there might be circumstances in which these relationships can be sold or otherwise exchanged without selling the acquired business, thereby meeting the separability criterion. If a noncontractual customer relationship meets the separability criterion, the relationship is recognised as an intangible asset. Evidence of separability of a non-contractual customer relationship includes exchange transactions for the same or similar type of asset. These transactions do not need to occur frequently for a non-contractual customer relationship to be recognised as an intangible asset apart from goodwill. Instead, recognition depends on whether the non-contractual customer relationship is capable of being separated and sold, transferred, etc. Non-contractual relationships that are not separately recognised, such as customer bases, market share and unidentifiable ‘walk-in’ customers, should be included as part of goodwill.

Customer-related intangible assets: customer lists A customer list represents a list of known, identifiable customers that contains information about those customers, such as name and contact information. A customer list might also be in the form of a database that includes other information about the customers (for example, order history and demographic information). A customer list does not usually arise from contractual or other legal rights, and it typically does not meet the contractual-legal criterion. However, customer lists are often leased or exchanged. Therefore, a customer list acquired in a business combination normally meets the separability criterion. An acquired customer list does not meet the separability criterion if the terms of confidentiality or other agreements prohibit an acquiree from leasing or otherwise exchanging information about its customers.

Customer-related intangible assets: customer bases A customer base represents a group of customers that are not known or identifiable (for example, persons who purchase newspapers from a news stand or customers of a fast-food franchise or petrol station). A customer base might also be described as ‘walk-in’ customers. A customer base might constitute a customer list if information is obtained about the various customers. A customer base is generally not recognised separately as an intangible asset, because it does not arise from contractual or legal rights and is not separable.

Customer-related intangible assets: order or production backlog Order or production backlog arises from unfulfilled purchase or sales order contracts and might be significant in certain industries, such as manufacturing or construction. The order or production backlog acquired in a business combination meets the contractual-legal criterion and could be recognised separately as an intangible asset, even if the purchase or sales order contracts are cancellable. However, the fact that contracts are cancellable might affect the measurement of the fair value of the associated intangible asset. Example – Identification of customer-related intangible assets due to purchase orders Entity M is acquired in a business combination by entity Y and has the following two customers: ·        Customer A is a recurring customer that transacts with entity M through purchase orders, of which certain purchase orders are outstanding at the acquisition date. ·        Customer B is a recurring customer that transacts with entity M through purchase orders, but there are no purchase orders outstanding at the acquisition date. Entity Y assesses the various components of the overall customer relationship that might exist for the acquired customers. Entity Y will recognise an intangible asset(s) for customers A and B based on the contractual-legal criterion. The customer relationship with customer A meets the contractual-legal criterion, because there is a contract or agreement in place at the acquisition date. Customer B’s customer relationship also meets the contractual-legal criterion, because there is a history of entity M using purchase orders with this customer, even though there are no purchase orders outstanding on the acquisition date.

Artistic-related intangible assets Artistic-related intangible assets are creative assets that are typically protected by copyrights or other contractual and legal means. Artistic related intangible assets are recognised separately if they arise from contractual or legal rights, such as copyrights. Artistic related intangible assets include: (i)               plays, operas, ballets; (ii)              books, magazines, newspapers, other literary works; (iii)            musical works, such as compositions, song lyrics, advertising jingles; (iv)            pictures, photographs; and (v)              video and audio-visual material, including motion pictures or films, music videos and television programmes. Copyrights can be assigned or licensed, in part, to others. A copyright protected intangible asset and related assignments or licence agreements can be recognised as a single complementary asset, as long as the component assets have similar useful lives.

Contract-based intangible assets: favourable and unfavourable contract terms Intangible assets or liabilities might be recognised for certain contracts whose terms are favourable or unfavourable to current market terms. The terms of a contract should be compared to market prices at the date of acquisition, to determine whether an intangible asset or liability should be recognised. An intangible asset is recognised if the terms of an acquired contract are favourable relative to market prices. A liability is recognised if the terms of the acquired contract are unfavourable relative to market prices. A significant area of judgement in measuring favourable and unfavourable contracts is whether contract renewal or extension terms should be included. The following factors should be taken into account when considering whether to include renewals or extensions: ·        Whether the renewals or extensions are discretionary, without the need to renegotiate key terms, or are within the control of the acquiree. Renewals or extensions that are within the control of the acquiree are likely to be included if the terms are favourable to the acquirer. ·        Whether the renewals or extensions provide economic benefit to the holder of the renewal right. The holder of a renewal right, either the acquiree or the counterparty, is likely to act in their best interest. ·        Whether there are any other factors indicating that a contract might or might not be renewed (for example, the renewal history). Each arrangement is recognised and measured separately. The resulting amounts for favourable and unfavourable contracts are not offset. The fair value of an intangible asset or liability associated with favourable and unfavourable contract terms would generally be determined based on present-value techniques. The difference between the contract price and the current market price for the remaining contractual term, including any expected renewals, would be calculated and then discounted to arrive at a net present-value amount. The fair value of the intangible asset or liability would then be amortised over the remaining contract term, including renewals (if applicable). Example 1 – Favourable purchase contract Entity N acquires entity O in a business combination. Entity O purchases electricity through a purchase contract, which is in year 3 of a five-year arrangement. At the end of the original term, entity O has the option, at its sole discretion, to extend the purchase contract for another five years. The annual cost of electricity under the original contract is C80 per year, and the annual cost for the five-year extension period is C110 per year. The current annual market price for electricity at the acquisition date is C200. Market rates are expected to remain stable in the future. Entity N does not account for the contract as a derivative. Entity O’s purchase contract for electricity is favourable. Both the original contract and extension terms allow entity O to purchase electricity at amounts below the current market price. Entity N is likely to exercise the option and extend the contract for a further five years. Example 2 – Unfavourable purchase contract Assuming the same facts above, except that the current annual market price for electricity at the acquisition date is C50 per year, and market rates are not expected to change in the future. Entity O’s purchase contract is unfavourable. Both the original contract and extension terms require it to pay amounts in excess of the current annual market price of C50 in this situation. Entity N should recognise and measure a liability for the two years remaining under the original contract term. The extension term would not be considered in measuring the unfavourable contract, because entity N can choose not to extend the contract. At-the-money contracts should be evaluated for any intangible assets that might need to be separately recognised. At-the-money contract terms reflect market terms at the date of acquisition. The contract might have value for which market participants would be willing to pay a premium for the contract, because it provides future economic benefits. An entity should consider other qualitative reasons or characteristics, such as: (i)               the uniqueness or scarcity of the contract or leased asset, (ii)              the unique characteristics of the contract, (iii)            the efforts, to date, that a seller has expended to obtain and fulfil the contract, or (iv)            the potential for future contract renewals or extensions. The existence of these characteristics might make the contract more valuable, resulting in market participants being willing to pay a premium for the contract. Leases of airport gates and customer contracts in the home security industry are examples of at-the-money contracts that are bought or sold in observable exchange transactions and have resulted in the recognition of separate intangible assets.

Contract-based intangible assets: contracts to service financial assets Contracts to service financial assets should be recognised as separate intangible assets if: (i)               the underlying financial assets (for example, receivables) are sold or securitised and the servicing contract is retained by the seller; or (ii)              the servicing contract is separately purchased or assumed. A separate intangible asset cannot be recognised if these criteria are not met, even though servicing is inherent in all financial assets. Contracts to service financial assets might include: ·        collecting principal, interest and escrow payments from borrowers; ·        paying taxes and insurance from escrowed funds; ·        monitoring delinquencies; ·        executing foreclosure; ·        temporarily investing funds pending distribution; ·        remitting fees to guarantors, trustees and others providing services; and ·        accounting for and remitting principal and interest payments to the holders of beneficial interests in the financial assets. If mortgage loans, credit card receivables or other financial assets are acquired in a business combination alongside the contract to service those assets, neither of the above criteria has been met and the servicing rights will not be recognised as a separate intangible asset. However, the servicing rights are included in the measurement of the fair value of the underlying mortgage loans, credit card receivables or other financial assets.

Contract-based intangible assets: employment contracts Employment contracts might, rarely, result in contract-based intangible assets or liabilities. An employment contract might be above or below market, in the same way as a servicing contract. The recognition of employment contract intangible assets and liabilities is rare in practice; because employees can choose to leave employment with relatively short notice periods, employment contracts are usually not enforced and it is difficult to substantiate market compensation for specific employees. An exception might be when a professional sports team is acquired. The player contracts might well give rise to employment contract intangible assets and liabilities. The athletes are often working under professional restrictions, such that they cannot leave their contracted teams at will and play with another team to maintain their professional standing. Player contracts might also be separable, in that they are often the subject of observable market transactions. Pre-existing employment contracts in the acquired business might also contain non-competition clauses. These noncompetition clauses might have value and should be assessed separately as intangible assets when such contracts are part of a business combination.

Contract-based intangible assets: use rights Use rights, such as drilling, water, air, mineral, timber cutting and route authorities’ rights, are contract-based intangible assets. Use rights are unique, in that they might have characteristics of both tangible and intangible assets. Use rights should be recognised at fair value based on their nature as either a tangible or an intangible asset.

Contract-based intangible assets: lease agreements under IAS 17 The table below summarises the typical items to consider in the recognition of assets and liabilities associated with lease arrangements in a business combination. Lease classification Items to consider Acquired entity is a lessee in an operating lease. ·        Favourable or unfavourable rental rates. ·        Premium paid for certain at-the-money contracts. ·        Purchase or renewal options. ·        Leasehold improvements owned. Acquired entity is a lessee in a finance lease. ·        Property under finance lease (recognised at an amount equal to the fair value of the underlying property if ownership is reasonably certain to transfer to the lessee). ·        Property under finance lease (recognised at an amount equal to the fair value of the leasehold interest if ownership is not reasonably certain to transfer to the lessee). ·        Leasehold improvements owned. ·        Lease obligation recognised for remaining lease payments. Acquired entity is lessor in an operating lease. ·        Leased asset (including tenant improvements) recognised, taking lease terms into account. ·        Customer (or tenant) relationships. Acquired entity is lessor in a finance lease. ·        Financial asset that represents its remaining investment in the lease (measured in accordance with IAS 17) is recognised. ·        Customer (or tenant) relationships. A lease agreement represents an arrangement in which one party obtains the right to use an asset from another party for a period of time, in exchange for the payment of consideration. Lease arrangements that exist at the acquisition date could result in the recognition of various assets and liabilities, including separate intangible assets based on the contractual- legal criterion. The type of lease (for example, operating versus finance) and whether the acquiree is the lessee or the lessor to the lease will impact the various assets and liabilities that might be recognised in a business combination. An intangible asset or liability might be recognised if the acquiree is the lessee in an operating lease, and the rental rates for the lease contract are favourable or unfavourable compared to market terms of leases for the same or similar items at the acquisition date. There might also be value associated with an at-the-money lease contract, depending on the nature of the leased asset. Other assets might be identifiable if the terms of the lease contain purchase or renewal options. Lastly, leasehold improvements of the acquired entity would be recognised as tangible assets on the acquisition date at their fair value. No separate intangible asset or liability would typically be recognised for the lease contract terms if the acquiree is a lessee in a finance lease. Any value inherent in the lease (that is, fair value associated with favourable or unfavourable rental rents, renewal or purchase options, or in-place leases) is typically reflected in the amount assigned to the finance lease asset and the finance lease obligation. The asset subject to the lease would be recognised at its fair value, as encumbered by the existing lease, if the acquiree is a lessor in an operating lease. A separate intangible asset or liability associated with the favourable or unfavourable terms, and any value associated with ‘in-place’ leases, would not be separately recognised, but are included in the value of the leased asset. However, it might be appropriate to amortise separately the amounts related to favourable or unfavourable lease terms. The acquired entity might also be a lessor in a lease other than an operating lease, such as a direct finance or sales-type lease. The acquirer recognises and measures a financial asset that represents its remaining investment in the lease. Such investment would be recognised in accordance with IAS 17, based on the nature of the lease arrangement, and would typically include any value associated with the existing in-place lease. Assets and liabilities that arise from leases assumed in a business combination are measured at their fair value on the acquisition date. The classification of a lease determined at inception should not be changed as a result of a business combination, unless the provisions of the lease are modified. The determination of the lease term is a key assumption in establishing the classification of a lease at the inception of the contract. For example, including a renewal option in the lease term at inception might affect the initial lease classification. Example – Recognisable intangible and tangible assets related to leases acquired in a business combination Entity A, the lessor of a commercial office building subject to various operating leases, was acquired by entity G in 20X0. Entity A owns a building fully leased by third parties, with leases extending until 20X9. Some of the leases are at above-market rates and others are at below market rates at the acquisition date. All of the leases are classified as operating leases, as determined by the acquiree at lease inception. Entity G would consider the following in recognising and measuring the assets and liabilities, if applicable, associated with the lease arrangements: Building – A tangible asset would be recognised and measured at fair value, taking into account the terms of the leases in place at the acquisition date. The acquirer does not recognise separate intangible assets or liabilities related to the favourable/unfavourable leases or for the value of in-place leases. However, it might be appropriate to identify and depreciate separately the amounts related to favourable or unfavourable lease terms relative to market terms in accordance with IAS 16. Customer (tenant) relationships – An intangible asset could be recognised, if applicable, for the value associated with the existing customer (tenant) base at the acquisition date. Such value might include expected renewals, expansion of leased space, etc.

Technology-based intangible assets Technology-based intangible assets generally represent innovations on products or services, but can also include collections of information held electronically. Patented technology is protected legally and meets the contractual-legal criterion for separate recognition as intangible assets. Unpatented technology is typically not protected by legal or contractual means and does not meet the contractual-legal criterion. Unpatented technology, however, is often sold in conjunction with other intangible assets, such as trade names or secret formulae. As it is often sold with a related asset, the unpatented technology would generally meet the separability criterion. A trade secret is information, including a formula, pattern, recipe, compilation, programme, device, method, technique or process, that derives independent economic value from not being generally known and is the subject of reasonable efforts to maintain its secrecy. If the future economic benefits from a trade secret acquired in a business combination are legally protected, that asset would meet the contractual-legal criterion. Even if not legally protected, trade secrets acquired in a business combination are likely to be identifiable based on meeting the separability criterion. An asset would be recognised if the trade secrets could be sold or licensed to others, even if sales are infrequent or if the acquirer has no intention of selling or licensing them. Mask works are software permanently stored on read-only memory chips. Mask works, computer software and programme formats are often protected legally, through patent, copyright or other legal means. If they are protected legally, they meet the contractual-legal criterion. If they are not protected through legal or contractual means, these types of assets might still meet the separability criterion if there is evidence of sales or exchanges of the same or similar types of assets. Databases are collections of information, typically stored electronically. Sometimes, databases that include original works of authorship can be protected by legal means, such as copyrights; and, if they are so protected, they meet the contractual-legal criterion. More frequently, databases are information collected through the normal operations of the business, such as customer information, scientific data or credit information. Databases, similar to customer lists, are often sold or leased to others and meet the separability criterion.

Complementary intangible assets and grouping of other intangible assets Separate intangible assets might work together or complement each other. An acquirer might wish to group these complementary intangible assets together for the purpose of measuring their initial fair value at the acquisition date and for subsequent amortisation and impairment testing. An example is a brand or brand names. Only limited grouping is permitted under IFRS. A brand is a general marketing term that refers to a group of complementary intangible assets, such as a trademark and its related trade name, formula, recipe and technology. If the assets that make up that group meet the standard’s identifiable criteria for separate recognition and have similar useful lives, an acquirer can recognise them as a single intangible asset. An acquirer could also recognise other groups of complementary intangible assets as a single asset. This conclusion might also be applied to other assets for which the underlying component assets have similar useful lives. Examples of assets that could be recognised as a single asset if the useful lives are similar include: ·        A nuclear power plant and the licence to operate the plant. ·        A copyright intangible asset and any related assignments or licence agreements. ·        A seaport and any related permits or licences to operate it. ·        A series of easements that support a gas pipeline. ·        The acquirer identifies the component assets and determines each component asset’s useful life to evaluate whether such lives are similar.

Contract based intangible assets: lease agreements under IFRS 16 The table below summarises the typical items to consider in the recognition of assets and liabilities associated with lease arrangements in a business combination: Lease classification Items to consider Acquired entity is a lessee. ·        Account for the lease as a new lease at the acquisition date according to IFRS 16. ·        Lease obligation recognised for remaining lease payments. ·        Measure right-of-use asset at the amount of the lease liability adjusted to reflect favourable or unfavourable rental rates. Acquired entity is a lessor in an operating lease. ·        Leased asset (including tenant improvements) recognised, taking lease terms into account. ·        Customer (or tenant) relationships. Acquired entity is a lessor in a finance lease. ·        Receivable that represents its remaining net investment in the lease (measured in accordance with IFRS 3) is recognised. ·        Customer (or tenant) relationships. A lease agreement represents a contract or a part of a contract that conveys the right to use an asset for a period of time in exchange for consideration. Lease arrangements that exist at the acquisition date could result in the recognition of various assets and liabilities, including separate intangible assets based on the contractual-legal criterion. The type of lease (for example, operating versus finance) and whether the acquiree is the lessee or the lessor under the lease will impact the various assets and liabilities that might be recognised in a business combination. Acquiree is lessee The acquirer recognises right-of-use assets and lease liabilities for leases identified in accordance with IFRS 16 unless the lease ends within 12 months of the acquisition date or the underlying asset is of low value in accordance with IFRS 16. The acquirer measures the lease liability at the present value of the remaining lease payments as if the acquired lease were a new lease at the acquisition date. The acquirer shall measure the right-of use asset at the same amount as the lease liability, adjusted to reflect favourable or unfavourable terms of the lease when compared with market terms. Acquiree is lessor The acquirer measures the acquisition date fair value of assets of the lessor that are subject to operating leases based on the terms of the lease. A separate intangible asset or liability associated with the favourable or unfavourable terms, and any value associated with ‘in place’ leases, is recognised, but it is included in the value of the leased asset. However, it might be appropriate to amortise separately the amounts related to favourable or unfavourable lease terms. The acquired entity might also be a lessor in a finance lease. The acquirer recognises and measures a receivable that represent its remaining net investment in the lease. Such investment would be recognised in accordance with IFRS 3, based on the terms of the lease arrangement. Assets and liabilities that arise from leases assumed in a business combination where the acquiree is the lessor are measured at their fair value on the acquisition date. The classification of a lease determined at inception should not be changed as a result of a business combination, unless the provisions of the lease are modified. The determination of the lease term is a key assumption in establishing the classification of a lease at the inception of the contract. For example, including a renewal option in the lease term at inception might affect the initial lease classification.

Accounting for costs related to compliance with REACH REACH regulation – background The Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH) regulation requires commercial users of chemical substances in the European Union (EU) to perform studies demonstrating the properties of each of the substances they use or sell and to pay a one-time fee to register each of the chemical substances. The registration process (the performance of the studies and the one-time registration fee) is required for all chemical substances already in use and those that will be developed. If the registration process is not followed for a substance, a commercial user cannot market that chemical substance or the products containing the substance. In addition, the REACH regulation allows studies performed by one commercial user to be sold to other users as a means of sharing costs among users. In the July 2009 edition of IFRIC Update, the IFRIC (now the IFRS Interpretations Committee) declined to provide guidance on the appropriate accounting for the costs of complying with the REACH regulation. The IFRIC noted that IAS 38 includes definitions and recognition criteria for intangible assets that provide guidance to enable entities to account for the costs of complying with the REACH regulation. As discussed in the following paragraphs, the appropriate accounting for the costs of the registration process depends on whether the costs incurred relate to chemical substances (and products made with such substances) already in commercial use when the REACH regulation came into effect or to new substances (and new products made with such substances) developed after the effective date of the REACH regulation. Existing chemical substances and existing products made with chemical substances The preferred treatment is to recognise the REACH costs relating to existing chemical substances and products in profit or loss as incurred because those costs do not add value to the entity’s business but rather enable the entity to continue its operations. However, because there is no clear guidance on the issue, it would also be acceptable to recognise an intangible asset arising from the costs incurred to comply with the REACH regulation, provided that the recognition criteria of IAS 38 are met. This is because the costs incurred under REACH result in an entity obtaining identifiable rights for the commercial use of a specific substance that are necessary to earn benefits from that substance or the product that embodies the substance. The accounting policy adopted should be disclosed and applied consistently. New chemical substances and new products made with chemical substances The REACH costs are necessary for the development of new chemical substances (or new products) and their commercial use. Therefore, if the recognition criteria in IAS 38 are met, an intangible asset should be recognised arising from the costs incurred to comply with the REACH regulation. Income from sale of the studies In either case, any income received from the sale of the studies should be recognised in profit or loss as ‘other income’ because it is incidental to the development of the studies.

Recognition of expenses relating to goods acquired solely for advertising and promotional activities – example Entity A operates in the pharmaceutical industry and acquires goods (such as refrigerators, air conditioners and watches) to distribute free of charge to doctors as part of its promotional activities. Entity A does not enter into agreements with the doctors (either for the sale of pharmaceuticals or otherwise) that create enforceable rights and obligations in relation to those goods. As a result, the distribution of these goods is not within the scope of IFRS 15. At its reporting date, Entity A holds a stock of these goods, which were acquired solely for use in advertising or promotional activities and have no other purpose for Entity A. Entity A should not recognise these undistributed goods as an asset in its statement of financial position. Expenditure solely in respect of advertising or promotional activities is, as required by IAS 38:69, recognised as an expense when it is incurred. In the case of a supply of goods, this is specified as the point at which an entity has a right to access those goods. In explaining these requirements, IAS 38 states that goods “acquired to be used to undertake advertising or promotional activities have no other purpose than to undertake those activities. In other words, the only benefit of those goods or services [for the entity] is to develop or create brands or customer relationships, which in turn generate revenues”. However, applying IAS 38, the entity does not recognise internally generated brands or relationships as assets. As a result, in the specific circumstances under consideration (i.e. the goods being acquired solely for promotional purposes and providing no other benefit to Entity A), the cost of the goods acquired is recognised as an expense when Entity A has a right to access those goods; no asset is recognised for goods purchased but not yet distributed to doctors. This arrangement can be contrasted with, for example, the circumstances described in which goods are intended for use in research activities (the costs of which are, similar to promotional activities, expensed as incurred) but might instead be sold in the market. Reference: IFRIC Update, September 2017.

Initial measurement

Intangible assets should be measured on initial recognition at cost.

Cost is defined as the amount of cash or cash equivalents paid, or the fair value of other consideration given, to acquire an asset at the time of its acquisition or construction. Alternatively, where applicable, cost is the amount attributed to that asset when initially recognised in accordance with the specific requirements of other IFRSs, such as IFRS 2.

Measurement of separately acquired intangible assets

The cost of a separately acquired intangible asset (including in-process research and development projects) can usually be reliably measured. This is particularly so for assets acquired for cash.

The cost of a separately acquired intangible asset comprises:

• the purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and
• any directly attributable cost of preparing the asset for its intended use.

Directly attributable costs include, but are not limited to:

• The cost of employee benefits, as defined in IAS 19, that arise directly from bringing the asset into its working condition.

• Professional fees.

• Costs of testing whether the asset is working properly.

Is the guidance on directly attributable costs applicable to separately acquired assets? The directly attributable costs are more likely to arise where an intangible asset is internally generated, rather than acquired separately. An intangible asset that is acquired separately might sometimes still require expenditure to bring it into working condition, so the guidance on directly attributable costs might be relevant in these circumstances.

Expenditures that are not part of the cost of an intangible asset include:

• The cost of introducing a new product or service, including advertising costs and promotional activities.
• Costs of conducting business in a new location or with a new class of customer, including training costs.
• Administration and other general overheads.

Capitalisation of eligible costs should cease when the asset is capable of operating in the manner intended by management. Costs of using the asset or for redeploying it to other uses or another location are not capitalised. Such costs include any that are incurred while an asset is capable of operating in the manner intended by management and any initial operating losses, such as those that might be incurred while demand builds up for the asset’s output.

Some activities occur in the course of developing an intangible asset that are not necessary to bring the asset to its intended working condition. Income and expenditure relating to such non-essential incidental operations should not be capitalised, but should be expensed instead.

Treatment of variable or contingent consideration for the purchase of intangible assets

An entity might acquire an intangible asset for an initial payment plus agreed additional payments contingent on future events, outcomes or the ultimate sale of the acquired asset at a threshold price. The entity will usually be contractually or statutorily obliged to make the additional payment if the future event or condition occurs. This is often described as variable or contingent consideration for an asset. The accounting for contingent consideration of an asset has been discussed by the IFRS IC. The IC determined that this issue is too broad, and it did not add the issue to its agenda. The IC suggested that the IASB should address this issue comprehensively.

First it has to be analysed carefully if the future payment is related to the cost of the asset or not. If it is determined that the future payment is related to the cost of the asset, there is diversity in practice in accounting for contingent consideration of an asset, with two approaches observed. The first is a cost accumulation model, whereby contingent consideration is not considered on initial recognition of the asset, but is added to the cost of the asset initial recorder added, when incurred, or when a related liability is remeasured for changes in cash flows. The second approach is a financial liability model, whereby the estimate future amounts payable for contingent consideration are recorded on initial recognition of the asset with a corresponding liability. Any remeasurements of the related liability and any additional payments are either recognised in the income statement or capitalised. The cost accumulation model is much more common in practice. Both approaches to accounting for contingent consideration are acceptable. This is a policy choice that should be applied consistently to all similar transactions and appropriately disclosed.

Deferred payment terms

If payment for an intangible asset is deferred beyond normal credit terms, the asset’s cost is its cash price equivalent, which is the discounted amount.

The difference between the discounted amount and the total payment is treated as interest payable over the period of credit, unless it meets the conditions for capitalisation set out in IAS 23.

Assets acquired for shares

The cost of an intangible asset acquired for shares is measured under IFRS 2. The goods or services received in exchange for shares should be measured at fair value of those goods or services. There is a rebuttable presumption that, for transactions with parties other than employees, fair value can be reliably measured. However, where the fair value of the goods or services cannot be reliably measured, the entity should measure fair value indirectly by reference to the fair value of the equity instruments granted.

Shares issued as consideration for an intangible asset An entity issues 100,000 ordinary C1 shares for the acquisition of an intangible asset comprising certain rights. Similar intangible assets are regularly exchanged in cash transactions, and the entity has been offered a similar asset for a cash price of C300,000. This is consistent with prices paid in similar transactions. The price of the entity’s ordinary shares at the date of the transaction is C2.95. At what value should the intangible asset be recognised initially? The asset should be recognised at the fair value of the rights acquired. The existence of exchange transactions and cash prices for similar assets means that the fair value of the rights can be determined reliably at C300,000. The asset is recorded at this amount. If the fair value of the rights had not been reliably measurable, the asset would be recorded at C295,000, being the fair value of the equity instruments issued.

Assets acquired in exchange for non-monetary assets

An intangible asset acquired in exchange for a non-monetary asset, or for a combination of non-monetary and monetary assets, should be recognised initially at its fair value, unless:

• the exchange transaction has no commercial substance; or
• the fair value of neither the asset received nor the asset given up can be reliably measured.

Exchange of patents Entity A is the holder of a patent with a carrying amount of C3,000. Entity A agreed to exchange its patent for that of entity B. The fair value of entity A’s patent has been assessed by both parties at C5,000. Entity B’s patent cannot be measured reliably. No additional monetary or non-monetary consideration has been included in the exchange. Entity A will record its acquired patent at a cost of C5,000. The asset’s fair value that can be measured reliably is used by both parties as the value of the consideration if the fair value of the other asset cannot be measured reliably. A gain arises on the transaction of C2,000 and is recognised by entity A in the income statement. This amount is the difference between the carrying amount of entity A’s original patent (C3,000) and the fair value of the patent given up (C5,000). Patents are inherently unique, and so the exchange has commercial substance.

Consideration comprises a combination of non-monetary and monetary assets The fair value is adjusted by the amount of the monetary assets (for example, cash) given or received where the consideration received or given comprises a combination of non-monetary and monetary assets. An entity exchanges the rights to distribute a product in Japan that have a carrying amount of C1 million (but a fair value of C1.2 million) for C500,000 cash and the rights to distribute the same product in Europe which are fair valued at C700,000. The cash of C500,000 is effectively the difference between the fair value of the exchanged assets (C1.2 million – C700,000). The European distribution rights are recorded at C700,000, which is equivalent to the fair value of the Japanese rights of C1.2 million less the cash received of C500,000. A gain of C200,000 arises on the transaction and is recognised in the income statement.

The decision as to whether a transaction has commercial substance depends on the extent to which the entity’s future cash flows are expected to change as a result of the transaction. ‘Configuration of the cash flows’ means the risk, timing and amount of the cash flows. An exchange transaction has commercial substance if:

• the configuration of the cash flows of the asset received differs from the configuration of the cash flows of the asset given up; or
• the entity-specific value of the part of the entity’s operations affected by the transaction changes as a result of the exchange, and the difference in either case is significant relative to the fair value of the assets exchanged.

Exchange of research and development project for the marketing rights An entity might exchange a research and development project for the rights to market a patented product. The cash flows from the developed product are different in configuration from those of the research and development project (for example, no further cash outflow for development expenditures). The exchange has commercial substance.

‘Entity-specific value’ is defined as “… 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 or expects to incur when settling a liability”.

Entity-specific value versus value in use Entity-specific value is different from ‘value in use’, which is defined in IAS 36 as “… the present value of the future cash flows expected to be derived from an asset or cash-generating unit”. One of the most significant differences is that entity-specific value is determined using post-tax cash flows, and value in use is measured using pre-tax cash flows.

Exchange of telephone licences An entity provides fixed telephone services, operating under a licence acquired from the government five years ago. The entity is required, by the 7th year, to reach service coverage of at least 67% of a specific area under the licence terms. Failure to achieve it will result in a penalty payment and possible licence cancellation. Currently, the entity has only achieved 31% coverage. The government is offering new licences, under which both fixed and mobile services can be provided, to new entrants. No minimum coverage is required. Existing operators are entitled to exchange their licences for the new ones. Although management does not intend to expand into mobile phone services, it has decided to exchange its licence. The exchange transaction is considered to have commercial substance. It is unlikely that the minimum required coverage ratio under the existing licence would be met by the entity. It would then incur a penalty payment and could have its licence cancelled. There is a change in the entity specific value of the part of the entity’s operations affected by the transaction as a result of the exchange. The fact that the entity does not intend to expand its operations into mobile phone services under the new fixed/mobile licence is irrelevant.

The outcome of the cash flow analysis might be clear without the entity having to perform detailed calculations.

Gain or loss on exchange transaction No gain or loss is recognised on the exchange transaction if the entity is in the same position as it was before the transaction and no material change has taken place in its net assets. The cost of the new asset is the carrying amount of the asset given up. However, the fair value of the asset received might provide evidence of either a gain or an impairment in the asset given up. The exchange has commercial substance if the value of the asset received is different. In this case, the asset acquired should be recorded at fair value. A loss on disposal should be recognised if the value of the asset acquired is less than that given up.

The absence of market transactions does not mean fair value cannot be established. The fair value of either the asset given up or the asset received can still be reliably measured if:

• the range of reasonable estimates of fair value does not vary significantly (that is, the range is reasonably narrow); or
• the range of reasonable estimates is not narrow, but the probabilities of the various estimates within the range can be reasonably assessed and used in estimating fair values.

Where both the fair value of the asset given up and the fair value of the asset received can be estimated with equal reliability, the fair value of the asset given up is used to measure the cost of the asset received.

Government grants

An intangible asset might sometimes be acquired for free or for a nominal amount by way of a government grant. Examples include allocations of airport landing rights and import quotas. Intangible assets such as these can be recognised at either fair value or nominal value. This is an accounting policy choice under IAS 20. Any expenditure incurred by the entity that is directly attributable to preparing the asset for its intended use is also included in the initial measurement of the intangible asset. If the entity chooses to recognise the asset at fair value, that fair value is determined using an appropriate method. Government grants are dealt with in IAS 20.

Cost of donated assets

An asset might, in unusual circumstances, be acquired by an entity through donation or contribution for no consideration and no issuance of shares. There is no specific guidance in IFRS for this type of transaction. The entity should develop an accounting policy and apply it consistently. There are two approaches generally observed in practice: assets are recognised at fair value when the entity obtains control of the asset; or they are recognised at nil value.

Measurement of internally generated intangible assets

The cost of an internally generated intangible asset that meets the recognition criteria is the sum of directly attributable expenditure incurred to create, produce and prepare the asset so that it is capable of operating in the manner intended by management.

Examples of directly attributable costs are:

• Costs of materials and services used or consumed in generating the intangible asset.

• Cost of employee benefits (as defined in IAS 19) that arise directly from the generation of the asset.
• Fees paid to register a legal right, such as patent registration fees.
• Amortisation of patents and licences that are used in generating the asset.
• Borrowing costs, to the extent that they are eligible for capitalisation as part of the cost.

• Borrowing costs are dealt with by IAS 23.

What employee benefit costs can be capitalised? Employee benefits are defined as all forms of consideration given by an entity in exchange for service rendered by employees. The types of benefit include: ·        Short-term employee benefits, such as wages, salaries and social security contributions, paid annual leave and paid sick leave, profit-sharing and annual bonuses, and non-monetary benefits such as medical care, housing and free or subsidised goods or services. ·        Post-employment benefits, such as pensions, other retirement benefits, post-employment life insurance and post-employment medical care. ·        Other long-term employment benefits, including long-service leave or sabbatical leave, jubilee or other long-service benefits, long-term disability benefit and deferred bonuses or profit-sharing and other deferred compensation. ·        Termination benefits. The costs of an employee share scheme, social security costs and entity pension contributions might be considered to be directly attributable costs. These costs are directly attributable if they are incurred in bringing an asset to the condition necessary for it to operate in the manner intended by management. The cost of employee benefits arising directly from bringing the asset into its working condition do not need to be incremental. An employee does not need to be specifically hired to prepare the asset for intended use, for the employee benefit costs to be capitalised. It is sufficient that the employee has incurred time working on the relevant project. Termination benefits will rarely, if ever, be relevant for capitalisation. They are provided to employees who, by definition, are leaving or have left and are unlikely to be contributing to the development of an asset.

The cost of testing whether an item is functioning properly is a directly attributable cost of a separately acquired intangible asset. Testing costs would also be a valid cost for an internally generated intangible asset.

Only the costs that are directly attributable to generating the intangible asset can be capitalised. General costs of the operation that are not ‘directly attributable’, and are not components of the cost of an internally generated intangible asset, are as follows:

• Selling, administration and other general overhead costs, unless they can be directly attributed to preparing the asset for use.

• Inefficiencies and initial operating losses are incurred before the asset achieves planned performance.

• Training costs for staff that will operate the asset.

Promotion costs and operating losses related to entity database An entity has developed a database of names and addresses of professional people who reach their 25th birthdays between the years 2014 and 2020. Management intends to exploit this by selling the information to suppliers of life enhancement products and solutions for junior executives. The entity is incurring costs of promoting the database to vendors of such solutions, such as adventure holiday companies. It is also incurring losses, because there are substantial administrative costs and no income as yet. Can it capitalise the promotion costs and the operating losses, because the database cannot work as intended by management unless a customer base is first established? The promotional costs are not eligible for capitalisation as part of the cost of the intangible asset. The database is already capable of operating in the manner intended by management (that is, it can provide the information that management wishes to exploit). Building up a customer base is not essential to the working of the database, although it is essential to ensuring that the future economic benefits expected from the asset are achieved. The start-up losses are also not eligible for capitalisation, because they are not directly attributable costs of generating the database.

The capitalisation of costs stops when the asset “is capable of operating in the manner intended by management”. An asset might be internally generated (constructed) and could operate in that manner immediately, but it is not brought into use. Costs incurred while the asset is standing idle cannot be capitalised.

Period when staff costs could be capitalised Staff costs in the development phase of a project might meet the capitalisation criteria. However, once the development project is completed, if the staff then commence work on another research project, their costs can no longer be capitalised.

Initial operating losses, such as those that might be incurred while demand for an item’s output builds up, should not be capitalised.

Website costs

A website that is developed for internal or external access is an internally generated intangible asset under IAS 38. SIC-32 provides further guidance on this topic. The costs must satisfy the recognition criteria in IAS 38 for intangible assets to qualify for recognition as an asset.

A website capable of generating revenues, including direct revenues from e-commerce, will satisfy the requirement of future probable economic benefit. The website itself might contain the product that is being sold (such as information), and access might be provided by way of registration for a fee. A website that is developed solely to promote or advertise an entity’s products or services would not meet the recognition criteria. All expenditure is expensed as incurred.

The costs incurred at each stage in developing the site must be evaluated to determine whether they should be expensed as incurred or capitalised. SIC-32 includes a detailed appendix that describes the nature of expenditure that can be incurred at each of the stages and the appropriate accounting treatment.