as 26 – intangible assets - icai knowledge gateway asset (ia) • identifiable • non monetary...

AS 26 – Intangible Assets IPCC Paper 5, Chapter 2

CA Amit Kothari

Learning Objectives a • Applicability

b • Objective

c • Scope (Incl and Excl)

d • Monetary & Non Monetary asset

e • Asset & Intangible Asset

f • Definition criteria of IA

g • Recognition criteria of IA

h • Measurement of IA

i • Cost under different scenarios

j • Internally generated goodwill

k • Internally generated IA

l • Research Phase

m • Development Phase

n • Cost of Internally generated IA

o • Expenses on an Intangible item

p • Msmt post initial recognition

q • Amortization of IA

r • Impairment Losses

s • Disclosure Requirements

t • Transitional provisions

Applicability

Mandatory for all

enterprises

Refer to transitional provisions

Objective

To prescribe accounting treatment for IA that are not dealt with specifically in other AS’s

Scope Exclusions

Applied to all IA except those

covered by other AS’s

Leased assets (AS19),

Deferred Tax assets (AS22),

Goodwill on Amalgamation (AS14) & on Consolidation

(AS23)

IA held for sale in business (AS 2 or 7)

Financial assets (AS 30)

IA arising in insurance enterprises from contracts with policy holders

To mineral rights & expenditure on exploration, development & extraction of mineral oil, natural gas & similar non-regenerative resources

To accounting for share issue expenses and discount allowed on issue of shares

To expenditure in respect of termination benefits

Scope Exclusions

Applicable to

Advertising Exp Training

Start up cost R & D

Licensing Rights for films etc

Patents Copyrights

Scope Inclusions

Definitions

• Egs: Debtors, Loans and advances, Short term investments like cash equivalents

Monetary Assets: Money held and assets to be received in

fixed or determinable amounts of money.

• Egs: Fixed Assets and inventories

Non Monetary Assets: Assets other then monetary assets.

Definitions • The items traded within the

market are homogenous • Willing buyers and sellers can

normally be found at any time • Prices are available to the public.

Active Market: A market where the following 3 conditions exist

• It’s the amount by which the carrying amount of an asset exceeds its recoverable amount.

Impairment Losses

Intangible Asset (IA)

• Identifiable • Non

monetary asset

• Without physical substance

Intangible Asset: Its an Identifiable, non monetary asset without physical substance * held for use in the production or supply of goods or services, for rental to others, or for administrative purpose.

*Consider a broader angle and not in the strict sense [computer software, software stored on hard disk is considered as Intangible Assets]

Asset

• Resource • Control • Future eco

benefits

Asset: It is a resource, controlled by an enterprise as a result of past events

and from which future economic benefits are expected to flow to

the enterprise.

Asset - Resource, control, future economic benefits

Intangible Asset – Identifiable non monetary asset without physical substance held for use

Definition criteria for IA

Thus, to meet the definition of an Intangible Asset, it has to meet the following 3 conditions- a) Identifiability, b) Control over resources & c) Expectation of future economic benefits.

If an item does not meet conditions of Identifiability, control over resources and expectation of future economic benefits then it is recognized as an expense on intangible item.

Egs of IA and Intangible expense: Computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licenses, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketing rights, Goodwill.

Definition criteria for IA

Distinguished from goodwill

If the asset is separable

It can rent, sell, exchange or distribute the future economic benefits of the asset

Identifiability

If the enterprise has powers to obtain future economic benefits flowing from the asset and also can restrict the access of others to those benefits

Control would normally stem from legal rights that are enforceable in court of law

Control

Examples: Training, Portfolio of customers or Market share, Market and Technical knowledge

It includes revenue from

sale of products or services, cost savings or other benefits resulting from the use of

the asset

Future Economic Benefits

It is probable that the future

economic benefits that are attributable to the asset will flow to the enterprise

The cost of the asset can be measured reliably.

Recognition Criteria

Inta

ngib

le

Ass

et Definition

Identifiable

Control

Future Economic Benefits


Probability of future economic benefits

Cost measurement


An enterprise should assess the probability of future economic benefits using reasonable and supportable assumptions that represent best estimate of the set of economic conditions that will exist over the useful life of the asset.

An enterprise uses judgement to assess probability of the future economic benefits on the basis of the evidence available at the time of initial recognition, giving greater weight to external evidence.


• At Cost Initial Recognition:

• It should be recognized as an expense unless it is probable that the expense will enable the generation of future economic benefits in excess of its originally assessed standard of performance and the expense can be measured and attributed to the assets reliably (like AS 10)

Subsequent Expenditure:

Measurement of IA

Cost – Separate Acquisition Separate Acquisition

•The cost of IA comprises its purchase price including any import duties and other taxes, other than those subsequently recoverable by the enterprise from the taxing authorities, and any directly attributable expense for making the asset ready for it’s intended use. Any trade discounts and rebates are deducted in arriving at the cost.

Cost – Acquisition by Govt. Grant

By way of Govt. grant

• Principles of AS-12 have to be followed. • If acquired free of cost – nominal consideration • If acquired for nominal consideration – acquisition

cost • Any expenditure directly attributable to make the

asset ready for its intended use is included in the cost of asset.

• E.g. – Import license or quotas, license to operate radio or T. V. stations, airport landing rights, collection of toll rights etc.

Cost- Acquisition by exchange of asset

By exchange of assets

• Principles of AS-10 needs to be followed. If acquired in exchange of shares or other securities the IA is recorded at it’s fair value or the fair value of shares issued whichever is more evident. The similar principle can be applied for acquisition by way of exchange of other assets.

Acquisition as part of amalgamation • Applicable in case on Amalgamation in nature of

PURCHASE only • The PC is allocated to individual identifiable assets and

liabilities on the basis of their fair values. • Judgment is required to determine fair value of the IA. • Quoted market price, price of most recent similar

transactions, amount that enterprise would have paid in an arms length transactions, techniques like multiples of revenue or operating profit or discounting future cash flows can be used to estimate the Fair Value of intangible asset.

Cost – Acquired in Amalgamation


Acquisition as part of amalgamation • The transferee company can recognize an IA only if it

meets the recognition criteria even if that IA had not been recognized in the financial statement of the transferor.

• However if the fair value cannot be measured reliably then such asset is not recognized as a separate IA but is included in goodwill.

• Unless there is an active market for intangible asset the cost initially recognized for the intangible asset is restricted to an amount that does not create or increase any capital reserve arising at the date of amalgamation.

Case 1 Case 2 Net Payments 100 lacs Net Payments 100 lacs Net Assets (excluding IA)

120 lacs Net Assets (excluding IA)

90 lacs

Capital Reserve (at this stage excluding IA)

20 lacs Goodwill (at this stage excluding IA)

10 lacs

FV of IA 15 lacs FV of IA 15 lacs If there is an active market, IA recognised

15 lacs If there is an active market, IA recognised

15 lacs

Then Capital Reserve 35 lacs Then Capital reserve 5 lacs If there is no active market, IA recognised

NIL If there is no active market, IA recognised

10 lacs

Then Capital reserve 20 lacs Then Capital Reserve NIL


Unless there is an active market for IA its cost is restricted to an amount that does not create or increase any capital reserve.

Internally Generated Goodwill

• It should not be recognized as an asset. This is because it is not an identifiable resource, controlled by the enterprise that can be measured reliably at cost.

• Difference between market value of an enterprise and carrying amount of its net assets cannot be considered to represent the cost of intangible assets controlled by the enterprises.

Cost – Internally generated Goodwill

Internally Generated IA • It is difficult to assess whether an internally generated IA

qualifies for recognition. • It is also difficult to identify the point of time when there is

an identifiable asset that will generate probable future economic benefits.

• It is also difficult to measure the cost. • Therefore in addition to complying with the general

requirements for recognition & initial measurement, an enterprise applies certain other requirements also.

• To assess whether an internally generated IA meets the criteria for recognition, an enterprise classifies the generation of the asset into a Research Phase and a Development Phase.

Internally generated IA

• Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.

Research

No Intangible Asset arising from Research phase should be recognized.

Expenditure is to be recognized as an expense when incurred because in the research phase an enterprise cannot demonstrate that an intangible asset exists from which future economic benefits are probable.

Research Phase

Activities aimed at obtaining new knowledge;

The search for, evaluation and final selection of, applications of research findings or other knowledge;

The search for alternatives for materials, devices, products, processes, systems or services;

The formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems or services.

Examples of Research Activities

If an enterprise cannot distinguish the research phase from the development phase, the enterprise treats the expenditure incurred as if it were incurred in the research phase only.

Research v/s Development

• Application of research findings or other knowledge to plan or design for production of new material, devices, product, processes, systems or services prior to the commencement of commercial production or use.

Development

Development Phase

Design, construction and testing of pre-production or pre-use prototypes and models

Design of tools, jigs, moulds and dies involving new technology

Design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production

Design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services

Examples of Development Activities


Technical Feasibility of completing the IA

Intention to complete the IA and use or sell it

Ability to use or sell the IA

How the IA will generate probable future economic benefits

The availability of adequate technical, financial and other resources to complete the development and to use or sell IA

Ability to measure the expenses attributable to the IA during its development reliably

Certain internally generated IA

BRANDS MASTHEADS

PUBLISHING TITLES

CUSTOMER LISTS

Not recognized as IA

It is the sum of the expenses incurred from time to time

when the internally generated IA first

meets the recognition criteria.

Cost of an internally generated IA

Materials & Services

Salaries & Wages

Directly attributable Expenses

Overheads

Cost inclusions

Cost exclusions

Selling & Administrative

OH

Inefficiencies and Initial Operating

Losses

Expenditure on Training the

Staff

Expenses on an intangible ITEM should be recognized as an expense when it is incurred unless it forms part of the cost of an IA that meets the recognition criteria

Egs: Research cost, Start up cost, advertisement, training, relocating cost.

Expenses on Intangible items

Para 58 states that expenditure on an intangible item that was initially recognised as an expense by a reporting enterprise in previous annual financial statement or interim financial reports should not be recognised as part of the cost of an intangible asset at a latter date.

Past Expenses on Intangible items

After initial recognition, an IA should be carried at its cost less any

accumulated amortization and any accumulated

impairment losses.

Measurement post to Initial Recognition

•The depreciable amount of an IA should be allocated on a systematic basis over the best estimate of its useful life.

Depreciable amount

•There is rebuttable presumption that the useful life will not exceed 10 years from the date when the asset is available for use.

Useful Life

• Amortization should commence when the asset is available for use.

Amortization

Amortization Period – Para 63

AS 26 presumes that useful life of IA is unlikely to exceed 10 years.

There may be evidence that the useful life of IA will be longer than 10 years.

If control over the future economic benefits from an IA is achieved through legal rights that have been granted for a finite period, the useful life should not exceed this period unless those rights are renewable; and renewal is virtually certain.

Useful Life

There may be both economic and legal factors influencing the useful life of an IA. Economic factors determine the period over which future economic benefits will be generated; legal factors may restrict the period over which the enterprise controls access to these benefits. The useful life is the shorter of the periods determined by these factors.

Useful Life

Assumed to be Zero unless

There is a commitment by a third party to

purchase it or

There is an active market for the asset

and

It is probable that such a market will exist at the end

of the assets useful life.

Residual Value

Amortization Method

It should reflect the pattern in which the

economic benefits are consumed.

If that pattern cannot be determined reliably, the

SLM should be used.

The amortization charge should be recognized as

expense unless another AS permits or requires it to be

included in the carrying amount of another assets.

Eg. Amortization of IA used in a production process is included in carrying amount of

inventories.

Amortization Method

Am

ortiz

atio

n Pe

riod

The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is rebuttable presumption that the useful life will not exceed 10 years from the date when the asset is available for use. Amortisation should commence when the asset is available for use.

Resi

dual

Val

ue Assumed to be Zero

unless there is a commitment by a third party to purchase the asset at the end of the useful life or there is an active market for the asset and residual value can be determined by reference to that market and it is probable that such a market will exist at the end of the assets useful life.

Am

ortiz

atio

n M

etho

d It should reflect the pattern in which the economic benefits are consumed. If that pattern cannot be determined reliably, the SLM should be used. The amortization charge should be recognised as expense unless another AS permits or requires it to be included in the carrying amount of another assets. Eg. Amortization of intangible asset used in a production process is included in carrying amount of inventories.

Amortization of an IA

To be reviewed at least at each financial year end.

If expected useful life significantly different from previous estimates, amortization period should be changed accordingly.

If there has been a significant change in the expected pattern of economic benefits amortization method should be changed, to reflect the change pattern.

Review of Amortization Period and Method

Impairment Losses

An enterprise should estimate the recoverable amount (as per AS 28) of the following IA at least at each financial year even if there is no indication that the asset is impaired : • An IA that is not yet available for use. • IA that is amortized over a period

exceeding 10 years from the date when the asset is available for use.

An IA should be derecognized or disposed of when no future economic benefits are expected from its use.

Gains or losses i.e. the difference between the net disposal proceeds and the carrying amount of the asset is recognized as income or expense in the P/L A/c.

Retirements & Disposals

• Useful lives or amortization rates used. • Amortization methods • Gross carrying amount and

accumulated amortization at beginning and end

• Reconciliation of carrying amount at beginning and end showing additions, retirements and disposals, impairment losses recognized, impairment losses reversed, amortization, other changes.

For each class of IA ,

distinguishing between internally generated

and others –

Disclosure Requirements

The financial statements should disclose the amount of research and development expenditure recognized as an expense during the period.


If an IA is amortized over more than ten years, the reasons why it is presumed that the useful life will exceed ten years from the date when the asset is available for use.

A description, the carrying amount and remaining amortization period of any individual IA that is material to the financial statements of the enterprise as a whole

The existence and carrying amounts of IA whose title is restricted and the carrying amounts of IA pledged as security for liabilities;

The amount of commitments for the acquisition of IA.


v On the date of AS coming into effect, the enterprise is –

Para 99: Transitional Provisions

Not amortizing (or) amortizing over longer period

Period as per para 63 is over (i.e. 10 years)

Eliminate IA and adjust it against the opening balance of revenue reserves


Period as per para 63 is not over

Assume it was amortized as per AS 26 and adjust the IA and the revenue reserves

Amortizing over shorter period


No adjustment

Para 99: Transitional Provisions On the date of AS coming into effect, the enterprise is –


Period as per para 63 is over (i.e. 10 years)

Eliminate IA and adjust it against the opening balance of revenue reserves

For Example: An IA appears in the Balance sheet of A Ltd. at Rs. 10 lacs on 1/4/2003. This IA was acquired on 1st April 1990. A Ltd. has not amortized it. By applying para 63, A Ltd. would have amortized the IA over a period of 10 years ending on 31/3/2000. Since the amortization period as per para 63 is already over, the IA of 10 lacs would be eliminated with a corresponding adjustment in the opening balance of reserves on 1st April 2003.




Assume it was amortized as per AS 26 and adjust the IA and the revenue reserves

For Example: An IA appears in the Balance sheet of A Ltd. at Rs. 18 lacs on 1/4/2003. This IA was acquired on 1st April 2000 for Rs. 24 lacs. A Ltd. was amortizing it over 12 years on SLM Basis. By applying para 63, A Ltd. would have amortized the IA over a period of 10 years. On 1/4/2003, the remaining period as per the original policy is 9 years and as per para 63 is 7 years. Accordingly A Ltd. will have to restate the IA to 16.8 lacs being amortized as per AS 26 over 10 years, adjusting the difference to the revenue reserves.


Amortizing over shorter period


No adjustment

For Example: An IA appears in the Balance sheet of A Ltd. at Rs. 8 lacs on 1/4/2003. This IA was acquired on 1st April 2000. A Ltd. was amortizing it over a period of 5 years on SLM basis. By applying para 63, A Ltd. determines the amortization period to be 8 years. On 1st April 2003, the remaining period as per the original policy is 2 years and as per para 63 of AS 26 is 5 years. A Ltd. will have to amortize it over the remaining 2 years only.

A Ltd. is developing a new distribution system of its material and incurred the following costs on research and development.

Question

Year Phase/Expenses Amount

1999 Research 8 crores

2000 Research 10 crores

2001 Development 30 crores



On 31.12.2003 the A Ltd. identified the level of savings at Rs. 66 Crores over a period of 5 years. The new system met the criteria of asset recognition on 01.01.2001. Determine the amount which will be expensed and be capitalized as IA. System shall be available for use from 2004.

Answer

Research expense of Rs. 18cr. will be expensed off in the year in which they are incurred.

The asset recognition criteria is met on 01.01.2001 & system shall be available for use from 2004. Therefore, expenses for development for the year 2001, 2002, and 2003 can be capitalized as per AS-26.

However, the benefit of the system is only Rs. 66 crores. Therefore, the amount to be recorded as an IA is restricted to Rs. 66 crores. It shall be amortized over a period of 5 years.

Ideally the company should capitalize the present value of Rs. 66 crores at the cost of capital of the company.

A company with a turnover of Rs.250 crores and an annual advertising budget of Rs.2 crore had taken up the marketing of a new product.

It was estimated that the company would have a turnover of Rs. 25 crores from the new product.

The company had debited to its P/L A/c the total expense of Rs.2 crore incurred on extensive special initial advertisement campaign for the new product. Is the procedure adopted by the company correct?

Question

According to AS-26, expenses on an intangible item should be recognized as an expense when it is incurred unless it forms a part of the cost of an intangible asset.

In the given case, advertisement expenses of Rs. 2 crores for marketing a new product may provide future economic benefit to the enterprise by having a turnover of Rs.25crores, however no intangible asset is acquired or created that can be recognized.

Therefore, the accounting treatment by the company of debiting the entire expense to P/L A/c seems correct.

Solution

The Enterprise has paid Rs. 5 crores for the use of Know-how for a period of 4 years. The Enterprise estimates the production of mopeds as follows:

Question

Year No. of mopeds 1 25,000 2 50,000 3 75,000 4 1,00,000

How will the Enterprise amortise the Technical Know-how Fees as per AS- 26?

Whether this amortisation should be directly charged as an expense or should form part of Production Cost of the Mopeds?

Solution In the given case it seems significant amortization amount is being postponed to later years. However, if the estimates are the best evidence then we amortize it as mentioned above.

If the estimates of production cannot be determined reliably, it would be preferable to charge them off on SLM basis. AS-26 mentions that there will rarely, if ever, be persuasive evidence to support an amortization method for Intangible Assets that results in a lower amount of amortization than under the SLM.

In the given case, amortization expenses will be included as cost of inventory i.e. the production cost of mopeds.

AB Ltd. launched a project for producing product X in October 2009.

The company incurred Rs. 20 lacs towards R/D expenses upto 31st March 2011.

Due to prevailing market conditions, the management came to conclusion that the product cannot be manufactured and sold in the market for the next 10 years.

The management hence wants to defer the expenditure write off to future years. Advise the company as per the applicable AS.

Question

According to AS-26, expenses on an intangible item should be recognized as an expense when it is incurred.

An IA arising from development (or from the development phase of an internal project) should be recognized if, and only if, an enterprise can demonstrate all of the conditions specified in para 44 of the standard.

An IA (arising from development) should be derecognized when no future economic benefits are expected from its use.

Therefore, the managment cannot defer the expenditure written off to future years. Hence, the expenses amounting to Rs. 20 lakhs incurred on the research and development project has to be written off in the current year ending 31st March 2011.

Solution

NDA corporation is engaged in research on a new process design for its product. It had incurred an expenditure of Rs. 530 lakhs on research upto 31st March 2010.

The development of the process began on 1st April 2010 and development phase expenditure was Rs. 360 lakhs upto 31st March 2011 which satisfies assets recognition criteria.

From 1st April 2011, the company will implement the new process design which will result in after tax saving of Rs. 80 lakhs per annum for the next five years.

The cost of capital is 10%. What should be the accounting treatment

Question

Solution

Research expenditure: According to AS 26, the expenditure on research of new process design for its product Rs. 530 lakhs should be charged to the P/L A/c in the year in which it is incurred. It is presumed that the entire expenditure is incurred in the financial year 2009-10. Hence, it should be written off as an expenditure in that year itself.

The question states that the development phase expenditure amounting to Rs. 360 lakhs incurred upto 31st March 2011 meets asset recognition criteria.

Solution

Particulars Savings (after tax) for next 5 years 80 lakhs p.a.

Company’s cost of capital 10% Annuity factor 3.7908 Present value of net cash flows 303.26 lakhs

Solution The cost of an internally generated IA would be lower of cost of Rs. 360 lakhs or present value of future savings of Rs. 303.26 lakhs

Hence, cost of that asset will be Rs. 303.26 lakhs.

The difference of 56.74 lakhs(360 lakhs-303.26 lakhs) will be written off by the enterprise for the financial year 10-11.

The company can amortise Rs. 303.26 lakhs over a period of five years by charging Rs.60.65 lakhs per annum from the financial year 2011-2012 onwards.

Thank You Email: [email protected]

as 26 – intangible assets - icai knowledge gateway asset (ia) • identifiable • non monetary...

Documents