Subsequent expenditures

The nature of many intangible assets is that there are often no additions to the asset or replacements of parts of it. Most subsequent expenditure is likely to be incurred to maintain the asset and will not usually meet the criteria for recognition as an asset. It is often difficult to attribute subsequent expenditure to a particular intangible asset rather than to the business as a whole. Most subsequent expenditure will be expensed as incurred. Subsequent expenditure on brands, mastheads, publishing titles, customer lists and items that are similar in substance is always expensed as incurred. This applies whether the asset was originally acquired or internally generated.

Subsequent costs on acquired intangibles for research and development projects follows the guidance in IAS 38 for internally generated intangible assets. This means that the subsequent expenditure is accounted for as follows: Subsequent research expenditure is expensed as incurred. Subsequent development expenditure is expensed if it does not satisfy the conditions for recognition as an asset. Subsequent development expenditure that does satisfy the conditions for recognition as an asset is added to the carrying amount of the intangible asset.

Introduction to the cost model and the revaluation model

An entity can adopt either the cost model or the revaluation model as its accounting policy after initial recognition. The revaluation model can only be adopted if the intangible assets are traded in an active market, so it is not frequently used. The policy should be applied to the whole of a class of intangible assets and not merely to individual assets within a class, unless there is no active market for an individual asset.

The cost model requires that, after initial recognition, intangible assets should be carried at cost less accumulated amortisation and impairment losses.

The revaluation model requires that, after initial recognition, intangible assets should be carried at fair value, determined by reference to an active market. Revaluations should be carried out with sufficient regularity that the carrying amount of the asset does not differ materially from that which would be determined using fair value at the balance sheet date.

Revaluation not permitted in the absence of an active market – example Over the past two years, a group has developed various items of computer software to be used internally and/or to be sold to prospective buyers. In accordance with IAS 38, the group capitalised the development costs incurred during the development phase and recognised an intangible asset of CU1 million. After the reporting date, the group began discussions with a third party for the sale of the subsidiary that owns the software, or the sale of that subsidiary’s assets. The selling price under negotiation is much higher than the carrying amount of the subsidiary’s assets (which mainly relate to the internally generated intangible asset and other computer equipment). The group is not permitted to revalue its internally generated intangible asset because no active market exists. Although the entity has entered into sale negotiations, this is not sufficient to indicate an active market. If an active market, as defined, genuinely existed, the price for which the asset could be sold would be publicly available and would not be a matter for negotiation. Indeed, IAS 38 indicates that the fact that there is a sale agreement between an entity and a buyer does not provide evidence of an active market.

Classes of intangible assets

An entity can adopt classes of assets that meet the following definition: “A grouping of assets of a similar nature and use in an entity’s operations”.

Other than ruling out classes of assets determined on a geographical basis, this definition is reasonably flexible. An entity can adopt meaningful classes that are appropriate to its business. Most companies have a few broadly drawn classes of intangible assets. Examples of classes of intangible assets are:

• Brand names.
• Mastheads and publishing titles.
• Licences and franchises.
• Copyrights, patents and other industrial property rights, service and operating rights.
• Recipes, formulae, models, designs and prototypes.
• Intangible assets under development.
• Emission rights.

Items in this list might be further analysed or combined if that would give more relevant information to users of the financial statements.

Further categories of intangible assets Further categories (resulting from aggregation or disaggregation of items in the list) that might sometimes be treated as separate classes of intangible asset include: ·        Website and application development costs. ·        Computer software. ·        Databases. ·        Aircraft landing rights. ·        Picture or music libraries. ·        Mobile phone licences.

Application of revaluation model

The revaluation model can be applied to measure an intangible asset only after the asset’s initial recognition and measurement at cost. The method cannot be used at initial recognition to record an intangible asset at a value other than cost. The method cannot be applied to intangible assets that have not previously been recognised as intangible assets.

Licences that have not previously been recognised as intangible assets Over the years, an entity might have accumulated, for nominal consideration, a number of licences of a kind that are traded on an active market. The entity has not recognised an intangible asset, because the licences were individually immaterial when acquired. Market prices for such licences have recently risen significantly, and the value of the licences held by the entity has substantially increased. The entity is, however, prohibited by IAS 38 from applying the revaluation model to the licences, because they have not previously been recognised as an asset.

The revaluation model can also be applied to an asset that was acquired by way of government grant and measured, on initial recognition, at a nominal amount. The nominal amount could be nil if the asset was received free of charge.

The active market might cease to exist and the revalued asset’s fair value could no longer be determined by reference to an active market. The carrying amount should be frozen at the revalued amount at the date of the last valuation. That carrying amount is then amortised and impaired in the normal way. The previous revaluation surplus is not reversed when the measurement by reference to an active market is no longer possible.

The absence of an active market might be an indication of impairment that would require an impairment test to be performed.

If, subsequently, it becomes possible to value the asset again by reference to an active market, the asset should be revalued from that date in accordance with the revaluation model applied to the class of which it is part.

The only valuation basis permitted is fair value determined by reference to an active market. The definition of active market is included in IFRS 13. An active market exists for only a few types of intangible asset, and the revaluation model can only be used where such a market exists. In some jurisdictions, an active market might exist for freely transferable taxi licences, fishing licences or production quotas. An example might be emission rights for which there is an active market.

Could the revaluation model be used for websites? A website would normally be carried at cost less amortisation. The revaluation model permitted by IAS 38 would not apply. Website addresses are unique and there is no active market for websites.

An active market cannot exist for brands, newspaper mastheads, music and film rights, patents or trademarks, because each such asset is unique. Although such unique intangibles can be bought and sold, the prices are negotiated between individual buyers and sellers rather than being quoted on an active market. Such purchase and sale transactions are relatively infrequent. The price paid for an asset in one transaction might not be a good guide to the fair value of another asset.

Purchase and sale of a cigarette brand name The purchase and sale of a cigarette brand name is an example of when the price paid is not a reliable measure of the fair value of other cigarette brands. The asset is unique and there is no active market.

Frequency of revaluations

Valuations should remain up to date to be meaningful. Revaluations should be made with sufficient regularity that the carrying amount does not differ materially from fair value at the balance sheet date.

The frequency of revaluations depends on movements in the fair value of intangibles. Market prices for some intangibles might suffer significant and volatile movements, such that annual valuations are needed. Market prices should be relatively easy to obtain and annual revaluations would be straightforward. Intangibles with relatively stable market prices might not require such frequent valuations.

Treatment of accumulated amortisation under revaluation model

The carrying amount of an asset is adjusted to the revalued amount when this intangible asset is revalued. The asset is treated in one of the following ways at the date of the revaluation: The gross carrying amount is adjusted in a manner that is consistent with the revaluation of the carrying amount of the asset (for example, the gross carrying amount might be restated by reference to observable market data, or it might be restated proportionately to the change in the carrying amount). The accumulated amortisation at the date of the revaluation is adjusted to equal the difference between the gross carrying amount and the carrying amount of the asset after taking into account accumulated impairment losses. The accumulated amortisation is eliminated against the gross carrying amount of the asset.

The amount of the adjustment of accumulated amortisation forms part of the increase or decrease in the carrying amount that is accounted for as part of the gain or loss on revaluation.

Revaluation gains

A revaluation increase should be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus, unless it reverses a revaluation decrease on the same asset previously recognised as an expense. Reversals of previous revaluation decreases are credited to profit or loss to the extent that the decrease was recognised as an expense.

The revaluation surplus included in equity can be transferred directly to retained earnings when the surplus is realised (where the asset is retired or disposed of).

Some of the surplus can also be transferred directly to retained earnings as the asset is used by the entity (that is, as the surplus is realised). The amount transferred is the difference between amortisation based on the revalued carrying amount of the asset and amortisation based on the asset’s original cost. This amount can be transferred directly from revaluation surplus to retained earnings (reserves transfer).

Revaluation loss

A revaluation decrease should be recognised in profit or loss. If there is a credit balance in the revaluation surplus on the same asset, the decrease should be recognised in other comprehensive income. The decrease in other comprehensive income also decreases the amount accumulated in equity under the heading of revaluation reserve.

Amortisation

Amortisation is defined as “the systematic allocation of the depreciable amount of an intangible asset over its useful life”. The depreciable amount is defined as the asset’s “cost, or other amount substituted for cost, less its residual value”.

Amortisation applies to all intangible assets, whether held at cost or fair value, except intangible assets with indefinite useful lives.

Amortisation should begin as soon as an asset is available for use – that is, when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.

Initial adoption of revaluation basis When an entity which previously applied the cost model in IAS 38 initially adopts a policy to measure intangible assets using the revaluation model, this represents a change in accounting policy. However, IAS 8 specifies that the change is to be dealt with as a revaluation rather than as a prior period adjustment. Consequently, the valuation uplift or write-down occurring on the initial adoption of the revaluation basis is recognised in other comprehensive income (and accumulated in the revaluation surplus) or profit or loss, as appropriate, in accordance with the requirements of IAS 38. Prior period amounts are not restated. This is a practical and helpful exception from the general rules for changes in accounting policies, which means that it will not be necessary to obtain valuations at the end of earlier reporting periods. One consequence of the approach, however, is that the amount of amortisation included in profit or loss for the current and prior periods may not be comparable, because they are based on revaluation and on cost, respectively. If the impact is significant, the entity will need to consider whether additional disclosure should be provided in the notes to the financial statements.

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Date of commencement of amortisation of an intangible asset It is important to distinguish the date an asset is available for use from the date on which it is actually brought into use. Amortisation will commence from the former. For example, operators usually are required to purchase a telecom licence prior to the provision of services in a particular location or prior to the provision of certain types of services (e.g., 4G services). Because telecom licences normally are granted for a specified period of time, the cost of the licence has to be amortised over the best estimate of its useful life. The operator is generally required to build and commission its network before it can earn revenues from the use of its licence. The ability to receive economic benefits from the licence is linked directly to the ability to use the network; therefore, the licence is only available for use when the network is in place. Consequently, amortisation of the licence should commence at the date the network is available for use (i.e., it is in the location and condition necessary for it to be capable of operating in the manner intended by management). In some countries, the full network may not be operational in the entire targeted areas until a certain date. However, as soon as one area (one connection) is in place and working, the amortisation of the licence should commence. In most instances, the amortisation of the licence should begin before the full commercial launch.

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Amortisation of product distribution rights An entity acquires licences and trademarks, including product distribution rights, on 1 January 20X0. The licences and product distribution rights still require some regulatory approval at this date. On 1 March 20X0, the entity receives regulatory approval to distribute the products. Management proposes that amortisation of these rights begins on 1 March 20X0. The amortisation will commence when the intangibles are available for use. The amortisation of an acquired intangible can be delayed only to the point at which the intangible asset becomes available for use. The acquired rights will be consumed over a period from 1 March 20X0, and so they should be amortised over that period.

Amortisation should stop at the earlier of the date when the intangible asset is derecognised and the date when it is classified as held for sale under IFRS 5. An intangible asset is classified as held for sale in accordance with IFRS 5 when it meets the conditions in that standard for such classification.

Amortisation does not stop when an asset is retained but no longer used, unless it has been fully amortised or classified as held for sale under IFRS 5.

An intangible asset with an indefinite useful life should not be amortised.

Useful lives – finite and indefinite

Useful life is defined as:

• the period over which an asset is expected to be available for use by an entity; or
• the number of production or similar units expected to be obtained from the asset by an entity.

Determining the useful life of an intangible asset – general

The subsequent accounting for an intangible asset is determined on the basis of its useful life. If the useful life of the asset is determined to be finite, the asset is amortised over that useful life. If the useful life of the asset is determined to be indefinite, the asset is not amortised. IAS 38 provides a significant amount of guidance to assist in this determination.

Finite or indefinite useful life?

Entities are required to assess whether the useful life of an intangible asset is finite or indefinite and, if finite, the length of, or number of production or similar units constituting, that useful life.

An intangible asset should be regarded as having an indefinite useful life when, based on all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. Therefore, if management has the intention and the ability to maintain an intangible asset so that there is no foreseeable limit on the period over which the asset is expected to generate net cash inflows for the entity, the asset is regarded as having an indefinite useful life.

Note that the term ‘indefinite’ does not mean ‘infinite’. There does not need to be an expectation that the cash inflows generated by the asset will go on forever – simply that, at the date of assessment, there is no foreseeable point at which the cash inflows will cease.

If there is a foreseeable limit to the period over which net cash inflows are expected to flow to the entity, the asset is regarded as having a finite life.

The assessment as to whether an intangible asset has an indefinite useful life is clearly crucial for the purposes of the subsequent accounting treatment for the intangible asset. IAS 38 provides a number of illustrative examples for this determination.

Factors for consideration in determining useful life

The useful life of an intangible asset is either:

• the period over which the asset is expected to be available for use by the entity; or
• the number of production or similar units expected to be obtained from the asset by an entity.

Factors to consider in estimating the useful life of an intangible asset include:

• the expected usage of the asset by the entity and whether the asset could be efficiently managed by another management team;
• typical product life cycles for the asset and public information on estimates of useful lives of similar types of assets that are used in a similar way;
• technical, technological, commercial or other types of obsolescence;
• the stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset;
• expected actions by competitors or potential competitors;
• the level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity’s ability and intent to reach such a level;
• the period of control over the asset, and legal or similar limits on the use of the asset, such as the expiry dates of related leases; and
• whether the useful life of the asset is dependent on the useful life of other assets of the entity.

The useful life of an intangible asset reflects only that level of future maintenance expenditure required to maintain the asset at its standard of performance assessed at the time of estimating the asset’s useful life, and the entity’s ability and intention to reach such a level. A conclusion that the useful life of an intangible asset is indefinite should not depend on planned future expenditure in excess of that required to maintain the asset at that standard of performance.

IAS 38 notes that, given the history of rapid changes in technology, computer software and many other intangible assets are susceptible to technological obsolescence. Therefore, it will often be the case that their useful lives will be short. Expected future reductions in the selling price of an item that was produced using an intangible asset could indicate the expectation of technological or commercial obsolescence of the asset which, in turn, might reflect a reduction of the future economic benefits embodied in the asset.

Uncertainty may lead to estimating the useful life of an intangible asset on a prudent basis; however, it is not appropriate to choose a useful life that is unrealistically short.

Assets arising from contractual or other legal rights

Control over the future economic benefits from an intangible asset is often achieved through legal rights that have been granted for a finite period. Under most circumstances, the estimated useful life of the intangible asset is the shorter of the period of the legal rights and the period over which economic benefits are expected to be generated.

In some cases, however, the legal rights may be renewable. The question then arises as to whether it is appropriate to assume that the legal rights will be extended. IAS 38 stipulates that the useful life of an intangible asset should include the renewal period(s) only if there is evidence to support renewal by the entity without significant cost. The following factors are listed which indicate that an entity would be able to renew the contractual or other legal rights without significant cost:

• there is evidence (possibly based on past experience) that the legal rights will be renewed. If renewal is contingent upon the consent of a third party, this includes evidence that the third party will give its consent;
• there is evidence that the conditions necessary to obtain the renewal of the legal right (if any) will be satisfied; and
• the cost to the entity of renewal is not significant when compared with the future economic benefits expected to flow to the entity from renewal.

If the cost of renewal is significant when compared with the future economic benefits expected to flow to the entity from renewal, the ‘renewal’ represents, in substance, the acquisition of a new intangible asset at the renewal date.

The useful life of a reacquired right recognised as an intangible asset in a business combination is the remaining contractual period of the contract in which the right was granted, and does not include renewal periods.

Determining the useful life of an intangible asset that arises from contractual or other legal rights – example Entity T acquires a licence under a contract which grants it rights to economic benefits for a five-year term. The contract provides that the licence may be renewed at the end of the initial five-year term at Entity T’s instigation for a further period of three years without significant cost. The contract does not allow for any further renewals. There is evidence that the grantor routinely agrees to second and subsequent renewals on substantially the same terms as the previous contract, and generally declines to renew only when the licensee has not met its obligations under the contract. The licence should not be determined to have an indefinite useful life on the basis that Entity T can expect to be able to renew it indefinitely. Given that the renewal period of three years can be achieved without significant cost, the maximum useful life of the intangible asset is eight years (assuming that Entity T expects to use the asset for the entire licence period). IAS 38 states that the “useful life of an intangible asset that arises from contractual or other legal rights shall not exceed the period of the contractual or other legal rights”. Although IAS 38:94 subsequently discusses the possibility of an extended useful life in circumstances when the contractual or other legal rights are conveyed for a limited term that can be renewed without significant cost, it is only appropriate to include such renewal periods in the useful life of the intangible asset when the possibility for renewal is specifically included or contemplated in the contractual or other legal rights.

Examples illustrating the determination of the useful life of an intangible asset

The illustrative examples accompanying IAS 38 guide the determination of the useful life of an asset by the Standard. Each example details the specific facts and circumstances surrounding the determination of the asset’s useful life. The following table summarises the key determinants for each example. Readers should refer to the text of the Standard, however, to obtain a full understanding of each of the circumstances and the factors assessed in each scenario.

Subsequent reassessment of useful life

Whether an intangible asset is determined to have a finite useful life, or an indefinite useful life, IAS 38 requires that the initial determination be reviewed at least annually.

Factors that may affect the determination of the remaining useful life of an intangible asset The determination of useful life for each intangible asset requires a comprehensive consideration of all pertinent factors surrounding the assets. Subsequent to the initial determination of useful life, entities must establish sufficient procedures to identify and evaluate appropriately those events or circumstances that, if occurring after, or changed from, the initial determination, may affect the remaining useful life. Some events or circumstances will represent both discrete and readily identifiable events to which the entity should respond (e.g., a change in regulation). Other events or circumstances may develop more gradually over time but, nevertheless, must be monitored and given appropriate consideration by the entity (e.g., obsolescence, competition and demand). Given the varying nature of the intangible assets, and each entity’s unique background and circumstances, procedures employed by entities to evaluate useful lives of intangible assets are expected to vary.

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What periods are covered by useful life? Useful life includes any period following acquisition when the asset is capable of operating in the manner intended by management, but has not yet been brought into use. The end of the asset’s useful life is not necessarily the end of its economic life. The economic life is the period during which the asset produces economic benefits, no matter who is using it at the time. The useful life is the period when the asset is used by the entity. If the entity buys an asset for C100 that has an economic life of ten years, but the entity intends to use the asset for only six years, the useful life that the entity assigns to the asset will be six years and not ten years. It would then be necessary to estimate the residual value at the end of six years.

Management should assess whether an intangible asset’s useful life is finite or indefinite. An intangible asset should be regarded as having an indefinite useful life if, based on all the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.

IAS 38 contains guidance on factors to be taken into account when estimating useful lives, which include:

• Expected usage by the entity of the asset and whether it could be managed efficiently by another management team.

• The typical product life cycle for the asset and published information about useful lives of similar assets that are used similarly.
• Technical, technological, commercial or other types of obsolescence.
• The stability of the industry in which the asset operates, and changes in market demand for the products or services from or related to the asset.
• Expected actions by actual or potential competitors.
• The level of maintenance required to maintain the asset’s operating capability, and whether management intends to perform that level of maintenance.
• The period for which the entity has control of the asset and any legal or similar limits on the asset’s use.

• Whether the asset’s useful life is dependent on the useful life of other assets of the entity.

Other factors to consider when estimating useful life of an asset Management considers many factors in determining the useful life of asset. The following are examples related to factors listed: ·        Typical product life cycle for the asset. This could be done via comparison with useful lives disclosed in the financial statements of companies that have a similar business using similar assets. ·        The level of maintenance required to maintain the asset’s operating capability. An example might be spending on advertising required to maintain the value of a trademark. ·        The period for which the entity has control of the asset. This could include expiry dates of leases or licences or geographical restrictions. ·        Whether the asset’s useful life is dependent on the useful life of other assets of the entity. For example, use of a trademark or brand might cease if production of the goods represented by the trademark or brand is discontinued. Type Factors Expectation of useful life Noncompete agreement Terms of the arrangement, including restrictions of enforceability of the agreement Finite useful life limited by the period over which the benefits from the agreement are derived. Customer list Nature of the customer information, how easily it could be obtained from other sources, and period over which the benefits are derived Relatively short. The best estimate of the period over which the benefits are derived should be used.   Legal rights that require renewal Evidence that renewal will be obtained In the absence of evidence that legal rights will be renewed, useful life cannot be extended after expiry of rights.

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Useful life of intangible assets that the acquirer does not intend to use or intends to use differently than other market participants An intangible asset acquired in a business combination that the acquirer does not intend to actively use, but does intend to prevent others from using, is commonly referred to as a ‘defensive asset’ or a ‘locked-up asset’. The asset is likely to be contributing to an increase in the cash flows of other assets owned by the acquirer. An intangible asset that the acquirer does not intend to use, and does not intend to prevent others from using, is not a defensive asset.  Distinguishing defensive intangible assets from intangible assets (Example 1) Entity A, a consumer products manufacturer, acquires an entity that sells a product that competes with one of entity A’s existing products. Entity A plans to discontinue the sale of the competing product within the next six months. Entity A will maintain the rights to the trade name, at minimal cost, to prevent a competitor from using it. Entity A’s existing product’s market share is expected to increase. Entity A does not have any current plans to re-introduce the acquired trade name in the future. The trade name meets the definition of a defensive intangible asset, because entity A does not intend to actively use the acquired trade name, but intends to hold the rights to the trade name to prevent its competitors from using it. Useful life of a trade name should be the period during which entity A intends to hold the rights to the trade name.  Distinguishing defensive intangible assets from intangible assets (Example 2) Entity A acquires a business, and one of the assets acquired is billing software developed by the acquiree for its own use. Entity A plans to discontinue use of the internally developed billing software after a six-month transition period. Entity A determines that a market participant would use the billing software, along with other assets in the asset group, for its full remaining economic life. Entity A does not intend to use the asset in a way that is its highest and best use. Entity A does not believe that the software could be sold to a third party without the other assets acquired. Entity A is not holding the internally developed software to prevent its competitors from using it. The internally developed software asset does not meet the definition of a defensive intangible asset. This limits the period over which the internally developed software is available for use by entity A to six months.

Many types of intangible assets, including computer software and websites, are susceptible to technological obsolescence from rapid changes in technology. Their useful lives are likely to be finite and relatively short.

Uncertainty justifies estimating useful lives on a prudent basis, but it does not justify choosing a life that is unrealistically short.

Useful lives are usually determined by reference to time periods, except for those assets, such as mineral resources, that are clearly consumed through use. Economic and legal factors may influence the useful life of an intangible asset. Economic factors determine the period over which future economic benefits will be received by the entity. The useful lives of certain intangible assets are restricted by the period for which contractual or other legal rights are held. The useful life of such assets is the shorter of the periods determined by economic factors and contractual or other legal factors.

Legal life of copyright in excess of the economic life An entity acquires a copyright that has a remaining legal life of 50 years. The entity determines that the copyright has an economic life of only 30 years (that is, it will only generate economic benefits for 30 years). The entity must amortise the copyright over 30 years. Useful economic life is defined as the period over which the entity is expected to use the asset, and this is limited to 30 years. The entity will not use the asset after 30 years and must derecognise it at the point when no future economic benefits are expected from its use.

Contractual or legal rights are often granted for a finite period. The useful life of the related intangible asset can extend beyond that period only if the legal rights are renewable and there is evidence to support renewal by the entity without significant cost.

Evidence that supports renewal without significant cost is as follows:

• Evidence, possibly based on experience, that the contractual or legal rights will be renewed. This includes evidence that, where the consent of a third party is required, such consent will be forthcoming.
• Evidence that any conditions necessary to obtain renewal will be satisfied.
• Evidence that the cost to the entity of renewal is not significant compared to the future economic benefits that are expected to flow to the entity from renewal.

Renewal cost that is significant in comparison to the future economic benefits expected to flow to the entity is, in substance, the cost of acquiring a new intangible asset at the renewal date.

How to account for the carrying amount of the replaced asset and for the renewal cost? The carrying amount of the replaced intangible asset should be fully amortised by the renewal date, and the renewal cost is then capitalised as a new intangible asset if the recognition criteria are met.

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Assured renewal of broadcasting licence An entity has acquired a broadcasting licence that expires in five years’ time. The licence is renewable at little cost and has already been renewed twice in the past. There are no factors to suggest that the licence will not be renewed again, and the entity intends to do so. The licence is expected to contribute indefinitely to the entity’s cash flows. The intangible asset’s useful life is treated as indefinite and the licence would not be amortised. An intangible asset with a limited legal life can be treated as indefinite if it can be renewed by the entity without substantial cost and such renewal is expected.

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Broadcasting licence with no assurance of renewal An entity has acquired a broadcasting licence that expires in five years’ time. The renewal of the licence is not assured or even probable. The broadcasting authority has decided that, in future, it will auction the licences when they come up for renewal, rather than renew them automatically. The broadcasting authority made its decision when the licence had three years to run. The licence is amortised over the remaining three years, because renewal is uncertain and so is the cost of renewal.

The useful life of reacquired rights (for example, franchise rights previously granted by the acquirer to the acquiree) in a business combination is the remaining contractual period for which the right was granted and should not include renewal periods.

‘Indefinite’ is not the same as ‘infinite’ (that is, limitless in extent). The useful life of an intangible asset reflects only the level of future maintenance (and management’s ability and intention to carry out such maintenance) that is necessary to preserve the asset’s operating capability as assessed when initially estimating the asset’s useful life. The estimation of useful life does not take into account any planned future expenditure in excess of that which is required to maintain the asset’s operating capability.

Other considerations in determining indefinite useful life Indefinite is not the same as infinite (limitless in extent). Indefinite means that there is no foreseeable limit on the period of time over which it is expected to contribute to the cash flows of the reporting entity. An indefinite life for an intangible asset will generally require a business, industry and products with a track record of stability and high barriers to market entry. Added to this is the commitment of management to continue to invest for the long term to extend the period over which the intangible asset is expected to continue to provide economic benefits. Indefinite lives might be justified for established brands that have demonstrated their ability to survive changes. Finite lives might be appropriate for other brands that are relatively new, that depend on an individual’s reputation (such as a movie star) or that operate in more volatile sectors, where they are more likely to be affected by changes in fashions or technology.

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Useful life of a customer relationship Entity A acquired entity B, which operates a TV channel. Entity B negotiates the sale of air time directly with advertisers, who are mostly big companies. Advertising contracts are negotiated annually, and management considers it likely that the relationships will continue indefinitely. Entity A’s management proposes to recognise customer relationships as intangible assets and assign the relationships an indefinite useful life. An indefinite useful life is attributed to an asset when there is no foreseeable limit to the period over which the asset is expected to generate cash inflows. It is unlikely that customer relationships have indefinite useful lives, because ownership of the customers might change, strategies might change and further competitors might enter entity B’s market. Management should consider all the relevant factors, such as historical experience, contracts periods, competitors and life cycle, to determine the useful life of the customer relationships. The useful life of the customer relationships is expected to be finite and should be estimated considering all relevant factors (as described above).

Review of useful life assessment

The useful life of a finite-life intangible asset should be reviewed at least at each financial year end. Changes in useful lives should be accounted for as changes in estimates in accordance with IAS 8.

A change in estimate is accounted for prospectively, with the effect of the change being recognised in the current and future periods.

Indefinite-lived intangible assets should be reviewed annually, to confirm whether or not events and circumstances still support the assumption of an indefinite life. If they do not, the change from the indefinite to finite useful life should be accounted for as a change in estimate under IAS 8, as set out in the preceding paragraph.

A change from an indefinite to a finite useful life is an impairment indicator under IAS 36. If the useful life is changed from indefinite to finite, the entity must carry out an impairment test under IAS 36 and charge any shortfall between recoverable amount and carrying amount as an impairment loss.

Change of useful life of trademark from indefinite to finite A trademark was acquired several years ago and has been treated as having an indefinite useful life. Management had expected to continue the related business indefinitely, and all the other conditions for treatment as an intangible asset with an indefinite useful life had been met. However, management has now taken the decision to discontinue the business over the next four years. The intangible asset should be amortised over the remaining four years during which it will be used by the entity. If the assessment of an intangible asset’s useful life changes from indefinite to finite, the asset should be amortised over that remaining finite useful life. The asset must also be tested for impairment on a change from indefinite to finite useful life.

Residual value

Residual value is defined as “the estimated amount that an entity would currently obtain from the asset’s disposal, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life”.

The residual value of an intangible asset with a finite useful life is assumed to be zero, unless:

• a third party has committed to purchase the asset at the end of its useful life; or

• there is an active market for the intangible asset, and:

• residual value can be determined by reference to that market; and the market is likely to exist at the end of the asset’s useful life.

Useful life of a patent with committed residual value Entity A acquires a patent whose economic life is 15 years. Entity A expects to use the patent for five years and intends to sell it after five years to entity B. Entity B has committed to buy the patent for 60% of the cost to entity A. Entity A amortises the depreciable amount of the intangible asset over five years, which is the useful life to entity A. The depreciable amount is 40% of the asset’s cost, because the residual value is 60%. The depreciable amount is the amount to be amortised (that is, the cost less residual value). A third party has committed to buy the asset after five years, so the assumption of nil residual value can be rebutted.

A residual value of greater than zero assumes that an entity will not use the asset for the whole of its economic (as opposed to useful) life.

The residual value is determined assuming an asset has reached the end of its useful life and has been operated in a similar manner to the actual asset under consideration.

Factors to consider in determining residual value Residual value is based on current prices at the date when the estimate of residual value is made. The value does not take account of expected future inflation after the date when the estimate is made. If a third party has committed to buy the asset at the end of its useful life, its residual value would be the amount payable by the third party, adjusted to exclude future inflation.

Residual values should be reviewed at least at each financial year end. Changes in residual values should be accounted for as changes in estimates in accordance with IAS 8.

Residual values might increase to an amount equal to or greater than the intangible asset’s carrying amount. The amortisation charge would be nil, unless and until the residual value falls below the carrying amount.

When could residual value change occur? This situation will only occur if one of the two exceptions to the ‘residual value assumed to be zero’ rule applies: ·        a third party has committed to purchase the asset at the end of its useful life; or ·        residual value can be determined by reference to an active market for the intangible asset, and this market is likely to exist at the end of the asset’s useful life. The likelihood of no amortisation for a finite-lived intangible asset is remote.

Amortisation methods

There are a variety of amortisation methods, including the straight-line method, the diminishing balance method and the unit of production method.

The method of amortisation that is used should reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. If that pattern cannot be determined reliably, the straight-line method of amortisation must be used.

Selection of amortisation method The amortisation method is selected on the basis of the expected pattern of consumption of future economic benefits from an intangible asset. The straight-line method will often be the most appropriate method to use if the consumption of future economic benefits is through the passage of time (for example, patents and licences that operate for a fixed number of years). The unit of production method is likely to be the most appropriate method if the consumption of future economic benefits is through usage or production (for example, when minerals are extracted). The amortisation method used depends on the entity’s expectation of consumption of economic benefits from the asset and the entity’s ability to reliably measure the asset’s expected usage or production. The default method will be the straight-line method if the pattern of consumption cannot be reliably determined.

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Application of straight-line method The straight-line method of amortisation involves allocating an asset’s cost or revalued amount, less its residual value, over the asset’s useful life so as to charge each accounting period on a systematic basis. Each period is charged with the same amount, unless the useful life or the residual value changes.

There is a rebuttable presumption that the amortisation method cannot be based on the revenue generated by an activity that includes the use of an intangible asset. The revenue generated typically reflects factors that are not directly linked to the consumption of the economic benefits embodied in the intangible asset. For example, revenue is affected by other inputs and processes, selling activities and changes in sales volumes and prices. The price component of revenue might be affected by inflation, which has no bearing on the way in which an asset is consumed.

The presumption that a revenue-based method of amortisation is inappropriate might be rebutted if:

• the intangible asset is expressed as a measure of revenue; or
• a high correlation between revenue and the consumption of the intangible asset’s economic benefits can be demonstrated.

Predominant limiting factor inherent in the intangible asset An entity could look to the predominant limiting factor inherent in the intangible asset in determining an appropriate amortisation method. Use of an intangible asset might be limited to a certain period of time or to a certain number of units produced. However, the predominant limiting factor might be determined to be revenue. For example, an entity might have the right to operate a toll road until a fixed total revenue amount is generated from cumulative tolls charged. Given that revenue is the predominant limiting factor, the revenue to be generated might be an appropriate basis for amortising the intangible asset.

Review of amortisation period

At least at each financial year end, the amortisation periods for intangible assets with finite lives should be reviewed. If the expected useful life of the asset is different from previous estimates, the amortisation period should be adjusted accordingly. Any such change is accounted for as a change in estimate in accordance with IAS 8, by adjusting current and future periods.

When the annual review of the amortisation period of a previously-amortised intangible asset results in a determination that the asset has an indefinite useful life:

• it should be tested for impairment;
• it should no longer be amortised, but should be accounted for in the same manner as other intangible assets that are not subject to amortisation; and
• previous amortisation of that asset is not reversed.

Amortisation method should reflect expected consumption of economic benefits

IAS 38 requires that the entity should select an amortisation method that reflects the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.

Alternative methods of apportioning amortisation

There are several methods of apportioning amortisation over the anticipated useful life of the asset; those most commonly employed are the straight-line method and the reducing balance (diminishing balance) method.

Identification of the predominant limiting factor inherent in an intangible asset

In choosing an appropriate amortisation method, the Board suggests that an entity could determine the predominant limiting factor that is inherent in the intangible asset. For example, the contract that sets out the entity’s rights over its use of an intangible asset might specify the entity’s use of the intangible asset as a predetermined period of time, as a number of units produced or as a fixed total amount of revenue to be generated.

The identification of such a predominant limiting factor could serve as the starting point for the identification of an appropriate amortisation method; however, the underlying requirement is to select a method that is based on the expected pattern of consumption of economic benefits.

The concept of a ‘predominant limiting factor’ (essentially, the measurement used to determine when the rights embodied in an asset expire) is used in the specification of an exception to IAS 38’s general presumption against revenue-based amortisation methods; however, the concept is equally useful in other circumstances as an aid to the identification of the pattern of consumption of the economic benefits of an intangible asset.

Amortisation on a straight-line basis if the expected pattern of economic benefits cannot be determined reliably

In some circumstances, it may not be possible to determine reliably the expected pattern of consumption of future economic benefits. In such circumstances, use of the straight-line method is mandatory.

Change in amortisation method

At least at the end of each financial year, the amortisation methods for intangible assets with finite useful lives should be reviewed. If there has been a change in the expected pattern of consumption of the future economic benefits embodied in an asset, the amortisation method should be changed to reflect the changed pattern. Any such change is accounted for as a change in estimate in accordance with IAS 8, by adjusting current and future periods.

Amortisation method based on revenue

Rebuttable presumption against revenue-based amortisation methods

There is a rebuttable presumption that an amortisation method based on the revenue generated by an activity that includes the use of an intangible asset is inappropriate.

Such methods are generally considered to be inappropriate because the revenue generated by an activity that includes the use of an intangible asset typically reflects factors that are not directly linked to the consumption of the economic benefits embodied in the intangible asset. For example, revenue is affected by other inputs and processes, selling activities and changes in sales volumes and prices. The price component of revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed.

Rebuttal of the presumption against revenue-based amortisation

IAS 38’s general presumption that the use of revenue-based amortisation methods is inappropriate can be overcome only in two specific circumstances:

• when the intangible asset is expressed as a measure of revenue, as described in IAS 38 (see below); or
• when it can be demonstrated that revenue and the consumption of the economic benefits of the intangible asset are highly correlated.

When the predominant limiting factor inherent in an intangible asset is a revenue threshold, the revenue to be generated can be an appropriate basis for amortisation, provided that the contract specifies a fixed total amount of revenue to be generated on which amortisation is to be determined.

The Board concluded that it may be appropriate to use a revenue-based amortisation method when the right embodied by an intangible asset is expressed as a total amount of revenue to be generated (rather than time, for example), so that the generation of revenue is the measurement used to determine when the right expires. In such circumstances, the pattern of consumption of future economic benefits that is embodied in the intangible asset is defined by reference to the total revenue earned as a proportion of the contractual maximum and, consequently, the amount of revenue generated contractually reflects the consumption of the benefits that are embodied in the asset.

Note, however, that another basis may be more appropriate if it more closely reflects the expected pattern of consumption of economic benefits.

These exceptions have not been permitted in the equivalent provisions in IAS 16 because the Board believes that the circumstances in which a revenue-based amortisation method for intangible assets is acceptable are not likely to arise in respect of items of property, plant and equipment.

IAS 38 identifies two examples in which the predominant limiting factor inherent in an intangible asset is the achievement of a revenue threshold.

• An entity acquires a concession to explore and extract gold from a gold mine and the expiry of the contract is based on a fixed amount of total revenue to be generated from the extraction (e.g., the contract allows the extraction of gold from the mine until total cumulative revenue from the sale of gold reaches CU2 billion) and is not based on time or on the amount of gold extracted.
• A right to operate a toll road is based on a fixed total amount of revenue to be generated from cumulative tolls charged (e.g., the contract allows operation of the toll road until the cumulative amount of tolls generated from operating the road reaches CU100 million).

Intangible asset used in multiple activities to provide multiple revenue streams

In the course of its deliberations on revenue-based amortisation methods, the Board also analysed situations in which an intangible asset is used in multiple activities to provide multiple revenue streams (e.g. the producer of a motion picture uses the intellectual property embodied in the film to generate cash flows through exhibiting the film in theatres, licensing the rights to characters to manufacturers of toys and other goods, selling DVDs or digital copies of the film and licensing broadcast rights to television broadcasters). It had been suggested (1) that the application of the units of production method in such circumstances is not practicable, because the units of production are not homogenous, and (2) that a revenue-based method of amortisation might be more appropriate because revenue might be considered a common denominator to reflect a suitable proxy of the pattern of consumption of all the benefits received from the multiple activities in which the intellectual property could be used.

The Board acknowledged that determining an appropriate amortisation method in circumstances when an intangible asset is used in multiple activities and generates multiple cash flow streams in different markets, requires judgement. Although no explicit guidance was developed, the Board referred to the possibility that an intangible asset could be componentised for amortisation purposes in circumstances in which the asset is used to generate multiple cash flow streams.

Change in amortisation method

The amortisation method should be applied consistently from period to period, unless there is a change in the expected pattern of consumption of those future economic benefits. The amortisation method for an intangible asset with a finite useful life should be reviewed at least each financial year end. Changes in the method used should be accounted for as a change in accounting estimate under IAS 8.

How likely is a change in the expected pattern of consumption of future economic benefits? It is unlikely that the pattern of consumption of an intangible asset would vary significantly over its useful life, and so changes in method should be rare. Example – Expected pattern of consumption of future economic benefits from a patent An entity has recently developed a drug through to production. It has patented the drug for a ten-year period. In those ten years, the entity is the sole seller of the drug. It expects that it will take two years to build market share. Sales will decline towards the end of the patent life, because generic companies might attack the patent. The patent provides exclusivity and premium cash flows over a ten-year period. The economic benefits are consumed rateably over time. The limiting factor of the patent is time. Whether the drug is a blockbuster and exceeds expectations or just breaks even, the patent’s economic benefit will still be consumed equally over time. Straight-line amortisation appropriately reflects the consumption of economic benefits.

Amortisation charges should be recognised as an expense, unless they are permitted or required by IAS 38 or another standard to be included in the carrying amount of another asset.

The amortisation charges relating to the intangible asset might be included in the cost of inventories or property, plant and equipment. The amortisation charge might qualify for inclusion in the cost of another asset if the intangible asset is used in producing that other asset.

Other methods of amortisation and the application of the rules relating to residual values and useful lives Examples of other methods of amortisation and depreciation, and of the application of the rules relating to residual values and useful lives, are contained in chapter 22 para 94 on property, plant and equipment. Those examples might also be relevant to intangible assets in most situations.

Subsequent accounting for intangible assets with indefinite useful lives

Entities are not permitted to amortise intangible assets that have been assessed as having an indefinite useful life. Rather, in accordance with the requirements of IAS 36, such assets are tested for impairment by comparing their recoverable amounts with their carrying amounts once a year, at a minimum. An additional impairment test is required whenever there is an indication that an intangible asset may be impaired.

If an asset has been assessed as having an indefinite useful life, resulting in the asset not being amortised in accordance with IAS 38, that assessment is revisited each period to determine whether events and circumstances continue to support an indefinite useful life for that asset. If not, the change in the indefinite life assessment is accounted for as a change in accounting estimate in accordance with IAS 8.

When the useful life of an intangible asset is reassessed as finite rather than indefinite, this is an indicator that the asset may be impaired. Accordingly, the asset is tested for impairment by comparing its recoverable amount, determined in accordance with IAS 36, with its carrying amount, and recognising any excess of the carrying amount over the recoverable amount as an impairment loss.

Following the annual reassessment of the useful life of an intangible asset previously considered to have an indefinite useful life:

• if the intangible asset still has an indefinite useful life, it should be tested for impairment in accordance with the requirements of IAS 36; and
• if the intangible asset is determined to have a finite useful life, it should be tested for impairment, and should be amortised over its estimated remaining useful life and accounted for in the same manner as other intangible assets that are subject to amortisation, including further impairment testing when indicators of impairment exist.

Impairment

Impairment of intangible assets is dealt with by IAS 36. An entity should assess at each reporting date whether there is any indication that an intangible asset is impaired. If such an indication exists, the entity should estimate the asset’s recoverable amount. The asset should be written down to its recoverable amount.

Expected future reductions in the selling price of an item that was produced using an intangible asset could indicate the expectation of technological or commercial obsolescence of the asset; this, in turn, might reflect a reduction of the future economic benefits embodied in the asset.

Indefinite-life intangible assets are tested for impairment annually, whether or not there is any indication of impairment.

Intangible assets used in research and development activities are classified as indefinite-lived (not available for use) assets until completion or abandonment. In subsequent periods, the intangible assets would be subject to annual impairment testing.

A change in the estimate of an intangible asset’s useful life from indefinite to finite is an indication of impairment and an impairment test is required at that point.

Impairment indicators If the asset is no longer used because no future economic benefits are expected from it or if an asset is temporarily unused, this would be an indication of impairment for the relevant cash-generating unit, and an impairment review should be carried out.