9 INTANGIBLE ASSETSPERSPECTIVE AND ISSUES

Long-lived assets are those that will provide economicbenefits to an enterprise for a number of future periods.Accounting standards regarding long-lived assets involvedetermination of the appropriate cost at which to recordthe assets initially, the amount at which to present theassets at subsequent reporting dates, and the appropriatemethod(s) to be used to allocate the cost or other recordedvalues over the periods being benefited. Underinternational accounting standards, while historical costis the defined benchmark treatment, revalued amounts mayalso be used for presenting long-lived assets in thestatement of financial position if certain conditions aremet.Long-lived assets are primarily operational in character,and they may be classified into two basic types: tangibleand intangible. Tangible assets have physical substance,while intangible assets either have no physical substance,or have a value that is not conveyed by what physicalsubstance they do have (e.g., the value of computersoftware is not reasonably measured with reference to thecost of the diskettes on which these are contained).The value of an intangible asset is a function of therights or privileges that its ownership conveys to thebusiness enterprise. Intangible assets can be furthercategorized as either1. Identifiable, or2. Unidentifiable (i.e., goodwill).Identifiable intangibles include patents, copyrights, brandnames, customer lists, trade names, and other specificrights that typically can be conveyed by an owner withoutnecessarily also transferring related physical assets.Goodwill, on the other hand, cannot be meaningfullytransferred to a new owner without also selling the otherassets and/or the operations of the business.Research and development costs are also addressed in thischapter. Formerly the subject of a separate internationalstandard (IAS 9), but more recently guided by the standardcovering all intangibles (IAS 38), research costs must beexpensed as incurred, whereas development costs, as defined

and subject to certain limitations, are to be classified asassets and amortized over the period to be benefited. The standard on impairment of assets (IAS 36) pertains toboth tangible and intangible long-lived assets. Thischapter will consider the implications of this standard forthe accounting for intangible assets. The matter ofgoodwill, an unidentifiable intangible asset deemed to bethe residual cost of a business combination accounted foras an acquisition, has been addressed by IAS 22 and iscovered in Chapter 11; accounting for all otherintangibles, addressed in IAS 38, is discussed in thischapter.As part of its twin projects considering revisions to thestandards on business combinations and related topics,which are now anticipated to result in new or revisedstandards no earlier than 2004, the IASB has been reviewingthe accounting for intangibles in general. The objectiveis for the accounting for acquired intangibles, includinggoodwill and in-process research and development, to bemade more consistent with that prescribed for intangiblesacquired by other means or internally generated by thereporting entity.With regard to goodwill (discussed in greater detail inChapter 11, Business Combinations and ConsolidatedFinancial Statements, it is expected that an acquirer willbe required, as of the acquisition date to 1. Recognize goodwill acquired in a business combinationas an asset; and2. Initially measure that goodwill at its cost, being theexcess of the cost of the business combination over theacquirer’s interest in the net fair value of theidentifiable assets, liabilities, and any contingentliabilities recognized.It is well established that goodwill acquired in a businesscombination represents a payment made by the acquirer inanticipation of future economic benefits from assets thatare not capable of being individually identified andseparately recognized. To the extent that the acquiree’sidentifiable assets, liabilities, or contingent liabilitiesdo not satisfy the criteria for separate recognition at theacquisition date, there is a resulting impact on the amountrecognized as goodwill. This is because goodwill is

measured as the residual cost of the business combinationafter recognizing the acquiree’s identifiable assets,liabilities, and contingent liabilities.Under the anticipated IAS revisions, subsequent to initialrecognition, the acquiring entity will be required tomeasure goodwill acquired in a business combination at costless any accumulated impairment losses. This willessentially replicate the approach adopted under US GAAP(SFAS 142), which is a stark departure from historicalpractice. Rather than being amortized over its estimatedeconomic life, goodwill acquired in a business combinationwill have to be tested for impairments annually, or morefrequently if events or changes in circumstance indicatethat it might be impaired, in accordance with IAS 36.Sources of IASIAS 36, 38 SIC 6, 32DEFINITIONS OF TERMSAmortization. In general, the systematic allocation of thecost of a long-term asset over its useful economic life;the term is also used specifically to define the allocationprocess for intangible assets.Carrying amount. The amount at which an asset is presentedon the balance sheet, which is its cost (or other allowablebasis), net of any accumulated depreciation and impairmentlosses.Cash generating unit. The smallest identifiable group ofassets that generates cash inflows from continuing use,largely independent of the cash inflows associated withother assets or groups of assets.Corporate assets. Assets, excluding goodwill, thatcontribute to future cash flows of both the cash generatingunit under review for impairment and other cash generatingunits.Cost. Amount of cash or cash equivalent paid or the fairvalue of other consideration given to acquire or constructan asset.Depreciable amount. Cost of an asset or the other amountthat has been substituted for cost, less the residual valueof the asset.Depreciation. Systematic and rational allocation of thedepreciable amount of an asset over its economic life.

Development. The application of research findings or otherknowledge to a plan or design for the production of new orsubstantially improved materials, devices, products,processes, systems, or services prior to commencement ofcommercial production or use. This should be distinguishedfrom research.Fair value. Amount that would be obtained for an asset inan arm’s-length exchange transaction between knowledgeablewilling parties.Goodwill. The excess of the cost of a business combinationaccounted for as an acquisition over the fair value of thenet assets thereof, to be amortized over its usefuleconomic life that, as a rebuttable presumption, is nogreater than twenty years.Impairment loss. The excess of the carrying amount of anasset over its recoverable amount.Intangible assets. Nonmonetary assets without physicalsubstance that are held for use in the production or supplyof goods or services or for rental to others, or foradministrative purposes, which are identifiable and arecontrolled by the enterprise as a result of past events,and from which future economic benefits are expected toflow.Monetary assets. Assets whose amounts are fixed in termsof units of currency. Examples are cash, accountsreceivable, and notes receivable.Net selling price. The amount which could be realized fromthe sale of an asset by means of an arm’s-lengthtransaction, less costs of disposal.Nonmonetary transactions. Exchanges and nonreciprocaltransfers that involve little or no monetary assets orliabilities.Nonreciprocal transfer. Transfer of assets or services inone direction, either from an enterprise to its owners oranother entity, or from owners or another entity to theenterprise. An enterprise’s reacquisition of itsoutstanding stock is a nonreciprocal transfer.Recoverable amount. The greater of an asset’s net sellingprice or its value in use.Research. The original and planned investigationundertaken with the prospect of gaining new scientific or

technical knowledge and understanding. This should bedistinguished from development.Residual value. Estimated amount expected to be obtainedon ultimate disposition of the asset after its useful lifehas ended, net of estimated costs of disposal.Useful life. Period over which an asset will be employedin a productive capacity, as measured either by the timeover which it is expected to be used, or the number ofproduction units expected to be obtained from the asset bythe enterprise.CONCEPTS, RULES, AND EXAMPLESBackgroundOver the years, the role of intangible assets has grownmore important for the operations and prosperity of manytypes of businesses, as the “knowledge-based” economybecomes more dominant. However, until recently, accountingstandards have tended to give scant attention to, or ignoreentirely, the appropriate means of reporting upon suchassets. As a consequence, practice has been exceptionallydiverse, with enterprises in nations whose standards hadnot addressed accounting for intangibles typically beingmuch more aggressive in capitalizing a range ofintangibles, including internally generated goodwill, vis-à-vis those entities operating under more strictly definedrules limiting cost deferral and requiring rapidamortization of those costs which could be deferred.Thus, in many countries it has been common practice todefer recognition of certain types of expenditures,including advertising costs and setup costs, the futurebenefits of which are very difficult to demonstrate. Inaddition, when intangibles such as “brand names” and“internally generated goodwill” have been capitalized,there has often been a great reluctance to amortize thecosts against earnings over a reasonable time horizon, onthe basis that these have either indefinite or infinitelives.While advocates for such practices have made the claim thatfuture benefits will flow from such expenditures (else, whyincur those costs?), experience has shown that thesedeferrals often result in a subsequent year in large “bigbath” write-offs. This pattern of foregone periodicexpense and sporadic charge-offs clearly impedes the

utility of financial statements for one of their primarypurposes, namely, the predicting of future economicperformance (both in terms of earnings and cash flows) ofthe reporting entity. While all can agree that predictingthe useful economic lives of certain intangibles isexceptionally challenging, the need to honor the matchingprinciple and to provide relevant information for use byinvestors, creditors and others has driven most standardsetters to impose rather stringent requirements on therecognition and measurement of intangible assets.International accounting standards first addressedaccounting for intangibles in a thorough way with IAS 38,which was promulgated after a rather long and contentiousgestation period that included the issuance of two ExposureDrafts. IAS 38 is a comprehensive standard whichsuperseded an earlier standard dealing solely with researchand development expenditures. It establishes recognitioncriteria, measurement bases, and disclosure requirementsfor intangible assets. The standard also prescribesimpairment testing for intangible assets, to be undertakenon a regular basis. This is to ensure that only assetshaving recoverable values are capitalized and carriedforward to future periods.It is interesting to note that in prescribing theamortization period, IAS 38 has ruled out the concept ofintangible assets having infinite or indefinite lives. Infact, by imposing additional burdens on those who wouldassign lives greater than twenty years to such assets, thestandard set a rather conservative approach to recognitionand measurement of intangibles. However, the IASB iscurrently weighing revisions that would remove therefutable presumption of a twenty-year maximum economiclife and would further acknowledge the existence ofindefinite-life intangibles, not subject to amortization atall (at least, until a finite life was determinable).These potential revisions are being pondered largely aspart of IASB’s effort to “converge” its standards, in thiscase to the recently revised US GAAP standards on businesscombinations and intangibles. If adopted, goodwill will nolonger be subject to amortization, but will have to beevaluated for impairment regularly, reversing the positiontaken by IAS 38. (See further discussion in Chapter 11.)

Also, by simultaneously withdrawing the existing standardon research and development costs (the former IAS 9) andrevising the standard on business combinations (IAS 22),the former IASC considerably streamlined and rationalizedthe accounting standards relating to accounting forintangible assets. As the rules presently exist,therefore, they do form a coherent and consistent set ofrequirements for the financial reporting on all suchassets.Scope of the standard. The standard applies to allenterprises. It prescribes the accounting treatment forintangible assets, including development costs. However,it does not apply to intangible assets covered by otherIAS; for instance, deferred tax assets covered under IAS12, leases that fall within the purview of IAS 17, goodwillarising on a business combination and dealt with by IAS 22,assets arising from employee benefits that are covered byIAS 19, and financial assets as defined by IAS 32 andcovered by IAS 27, 28, 31, and 39. This standard does notapply to intangible assets arising in insurance companiesfrom contracts with policyholders, nor to mineral rightsand the costs of exploration for, or development andextraction of, minerals, oil, natural gas, and similarnonregenerative resources. However, the standard doesapply to intangible assets that are used to develop ormaintain these activities.Identifiable intangible assets include patents, copyrights,licenses, customer lists, brand names, import quotas,computer software, leasehold improvements, marketingrights, and specialized know-how. These items have incommon the fact that there is little or no tangiblesubstance to them, they have an economic life of greaterthan one year, and they have a decline in utility over thatperiod which can be measured or reasonably assumed. Inmany but not all cases, the asset is separable; that is, itcould be sold or otherwise disposed of withoutsimultaneously disposing of or diminishing the value ofother assets held.Intangible assets are, by definition, assets that have nophysical substance. However, there may be instances whereintangibles also have some physical form. For example

• There may be tangible evidence of an asset’sexistence, such as a certificate indicating that a patenthad been granted, but this does constitute the assetitself;• Some intangible assets may be contained in or on aphysical substance such as a compact disc (in the case ofcomputer software); and • Identifiable assets that result from research anddevelopment activities are intangible assets because thetangible prototype or model is secondary to the knowledgethat is the primary outcome of those activities.In the case of assets that have both tangible andintangible elements, there may be some confusion aboutwhether to classify them as tangible or intangible assets.Considerable judgment is required in properly classifyingsuch assets as either intangible or tangible assets. As arule of thumb, the asset should be classified as either anintangible asset or a tangible asset based on the relativeor comparative dominance or significance of the tangible orthe intangible component (or element) of the asset. Forinstance, computer software that is not an integral part ofthe related hardware equipment is treated as software(i.e., as an intangible asset). Conversely, certaincomputer software, such as the operating system, that isessential and an integral part of a computer, is treated aspart of the hardware equipment (i.e., as property, plant,and equipment as opposed to an intangible asset).The concept embodied in this standard is somewhatcontroversial, and in some respects also vague and unclear,being subjective and open to interpretation. In variousattempts to explain this concept, different techniques havebeen used by commentators. Some have restricted themselvesto detailed examples, while others (perhaps exhibiting overenthusiasm to clarify the concept) have gone further, evenso far as to argue that IAS 38 draws a distinction betweenan “intangible asset” and an “intangible resource.” Inthis typology, the latter expression has been conceived ofa broader concept that includes intangible assets (asdefined by IAS 38), as well as other hypothetical assets.For example, intangible resources would include not onlyitems such as patents and copyrights (which would meet thequalifying criteria set forth for intangible assets in IAS

38), but also items such as customer lists and internallygenerated brands (which do not meet the definition ofintangible assets). While this may serve some usefulpurpose, the coining of a phrase such as “intangibleresources” (which is found neither in the IASC Frameworknor in IAS 38) to be used in distinction from the term“intangible asset,” is ill-advised. Given the fact thatIAS 38 (paragraph 7) has defined an asset as a “resource…controlled by the enterprise…”, the creation of alternativedefinitions and concepts is probably not appropriate.Recognition CriteriaIdentifiable intangible assets have much similarity totangible long-lived assets (property, plant, andequipment), and the accounting for them is accordingly verysimilar. The key criteria for determining whetherintangible assets are to be recognized are1. Whether the intangible asset has an identity separatefrom other aspects of the business enterprise;2. Whether the use of the intangible asset is controlledby the enterprise as a result of its past actions andevents;3. Whether future economic benefits can be expected toflow to the enterprise; and4. Whether the cost of the asset can be measuredreliably.Identifiability. As to the first issue, the principalconcern is to distinguish these intangibles from goodwillarising from a business combination, the accounting forwhich is addressed by IAS 22. Goodwill is the residualcost of a business acquisition that cannot be assignedeither to tangible assets, net of any liabilities assumed,or to identifiable intangibles. Unlike identifiableintangibles, goodwill cannot be separated from the assets(the physical as well as the identifiable intangible) itwas acquired with. Since goodwill cannot be severed andsold, its real value is often questioned and the periodover which it can be amortized is, accordingly, often madeas brief as possible. (But note that goodwill may become anonamortizing, impairment-tested asset under a revised orsuperseded IAS 22; see Chapter 11 for a discussion.)To capitalize the cost of an intangible asset other thangoodwill, it must have an independently observable

existence and a cost that can be assigned to it.Independently observable existence can be established ifthe enterprise can rent, sell, exchange, or distribute thefuture economic benefits from the assets without alsodisposing of other assets; that is, that an owner canconvey them without necessarily also transferring relatedphysical assets. Goodwill, on the other hand, cannot bemeaningfully transferred to a new owner without alsoselling other assets, and hence, will not meet therecognition criteria for intangible assets as defined byIAS 38.Identifiability can be demonstrated by a legal right overan asset or by the fact that the asset is separable fromthe rest of the business. It is worth noting that whileIAS 38 does not regard “separability” as an additionalrecognition criterion, some national standards (UK GAAP,for instance) still retain it as one of the qualifyingcriteria for recognition. At the time it adopted IAS 38,the IASC Board rejected the views of commentators on theantecedent Exposure Drafts who had advocated the inclusionof “separability” as an additional recognition criterion.In setting forth the basis for its conclusions, the Boardcited several reasons for this rejection. Among these,perhaps the most noteworthy is the following:…if a “separability” criterion was applicable to allintangible assets, many intangible assets (for example, alicense to operate a radio station) would not be shownseparately in the financial statements even if they meetthe (IASC) Framework’s definition of, and recognitioncriteria for, an asset.While not supportive of imposing separability as athreshold criterion for intangible assets, IASC supportedthe view that1. Demonstration of the separability of an asset canassist an enterprise in identifying an intangible asset;and2. The inability of an enterprise to demonstrate theseparability of an asset will make it harder to demonstratethat there is an identifiable intangible asset.Currently, IASB is embarked upon a thorough review ofaccounting for business combinations, a corollary of whichis the accounting for intangibles (including goodwill and

in-process research and development) acquired in suchcombinations. Based on deliberations to mid-2002, itappears that the existing philosophy for intangible assetrecognition will be essentially continued. A replacementfor IAS 22 will likely stipulate that intangible assetsacquired in a business combination should be recognizedseparately from goodwill if they arise as a result ofcontractual or legal rights or are separable from thebusiness. The existence of contractual or legal rights andseparability will not, however, form part of the definitionof an asset, but rather, will serve as indicators that anentity controls the future economic benefits embodied inthe item. It would appear, therefore, that neither ofthese characteristics are intended to be absoluterequirements, which would continue current practice in thisarea.Control. The provisions of IAS 38 require that anenterprise should be in a position to control the use ofthe intangible asset. Control implies the power to bothobtain future economic benefits from the asset as well asrestrict the access of others to those benefits. Normallyenterprises register patents, copyrights, etc. to ensureits control over an intangible asset. A patent gives theholder the exclusive right to use the underlying product orprocess without any interference or infringement fromothers. Intangible assets arising from technical knowledgeof staff, customer loyalty, long-term training benefits,etc., will have difficulty meeting this recognitioncriteria in spite of expected future economic benefits fromthem. This is due to the fact that the enterprise wouldfind it impossible to fully control these resources or toprevent others from controlling them.For instance, even if an enterprise incurs considerableexpenditure on training that will supposedly increase staffskills, the economic benefits from skilled staff cannot becontrolled, since trained employees could leave theircurrent employment and move on in their career to otheremployers. Hence, staff training expenditures, no matterhow material in amount, do not qualify as an intangibleasset. In other words, the practice of deferring trainingcosts based on the reasoning that future economic benefitsfrom enhanced staff skills will flow to the enterprise can

no longer be justified, after the promulgation of the IASon Intangible Assets. Other often-quoted examples ofexpenses that do not qualify as intangible assets based onthe criterion of control are market share, customerrelationships, customer loyalty (unless protected byenforceable legal rights), and portfolio of clients.Future economic benefits. Under IAS 38, it is mandatedthat an intangible asset be recognized only if it isprobable that future economic benefits specificallyassociated therewith will flow to the reporting entity, andthe cost of the asset can be measured reliably. Therecognition criteria for intangible assets are derived fromthe (IASC) Framework and are similar to the recognitioncriteria for tangible assets (property, plant, andequipment).The future economic benefits envisaged by the standard maytake the form of revenue from the sale of products orservices, cost savings, or other benefits resulting fromthe use of the intangible asset by the enterprise. A goodexample of other benefits resulting from the use of theintangible asset is the use by an enterprise of a secretformula (which the enterprise has protected legally) thatleads to reduced future production costs (as opposed toincreased future revenue).Measurement of Cost of IntangiblesThe conditions under which the intangible asset has beenacquired will determine the measurement of cost.The cost of an intangible asset acquired separately isdetermined in a manner largely analogous to that fortangible long-lived assets as described in Chapter 8.Thus, the cost comprises the purchase cost, including anytaxes and import duties, less any trade discounts andrebates, plus any directly attributable expendituresincurred in preparing the asset for its intended use.Directly attributable expenditures would include fullyloaded labor costs, thus including employee benefitsarising directly from bringing the asset to its workingcondition. It would also include professional fees andother costs.As with tangible assets, capitalization of costs ceases atthe point when the intangible asset is ready to be placedin service in the manner intended by management. Any costs

incurred in using or redeploying intangible assets areaccordingly to be excluded from the cost of those assets.Thus, any costs incurred while the asset is capable ofbeing used in the manner intended by management, but whileit has yet to be placed into service, would be expenses,not capitalized. Similarly, initial operating losses, suchas those incurred while demand for the asset’s productiveoutputs is being developed, cannot be capitalized. On theother hand, further expenditures made for the purpose ofimproving the asset’s level of performance would qualifyfor capitalization.Changes being made to IAS 38 as a consequence of the IASB’sImprovements Project will emphasize the fact that certainoperations may occur in connection with the development ofan intangible asset, but not be necessary in order to bringthe asset to the condition where it would be capable ofoperating in the manner intended by management. Theseincidental operations could occur either before or duringthe development activities. Because by definition suchoperations are not necessary to bring an asset to thecondition necessary for it to be capable of operating inthe manner intended by management, the income and relatedexpenses of incidental operations must be recognized in theoperating results for the current period, to be reported inthe respective classification of income and expense.Under IAS 38, a condition for the recognition of anintangible asset is that the cost of the asset can bemeasured reliably. The changes made to IAS 38 consequentto the IASB’s Improvements Project clarified that thereporting entity would be unable to determine reliably thefair value of an intangible asset when comparable markettransactions are infrequent and when alternative estimatesof fair value (e.g., those based on discounted cash flowprojections) cannot be calculated. Furthermore, the costof an intangible asset acquired in exchange for a similarasset would be measured at the carrying amount of the assetgiven up when the fair value of neither of the assetsexchanged could be easily determined reliably.In some situations, identifiable intangibles are acquiredas part of a business combination or other bulk purchasetransaction. According to the provisions of IAS 38, thecost of an intangible asset acquired as part of a business

combination is its fair value as at the date ofacquisition. If the intangible asset can be freely tradedin an active market, then the quoted market price is thebest measurement of cost. If the intangible asset has noactive market, then cost is determined based on the amountthat the enterprise would have paid for the asset in anarm’s-length transaction at the date of acquisition. Ifthe cost of an intangible asset acquired as part of abusiness combination cannot be measured reliably, then thatasset is not recognized, but rather, is included ingoodwill. Under US GAAP, the aggregate purchase cost is to beallocated to assets acquired and liabilities assumed. Ifone or more of the assets are intangibles, the extent ofjudgment required in the allocation process becomessomewhat greater than would otherwise be the case; inextreme situations it may be impossible to determine howmuch, if any, of the aggregate cost should be allocated tointangibles. It is most likely to be determinable when theintangibles were actually negotiated for in the transactionrather than being thrown in to the deal. Furthermore, ifthe allocation of the purchase price to individual assetsis accomplished by applying discounted present valuemeasures to future revenue streams, unless this sameprocess is usable with regard to the intangibles, it islikely that any unallocated purchase price will have to beassigned to goodwill.In some instances, intangible assets are obtained inexchange for equity instruments of the reporting entity.The revisions to IAS 38 will stipulate that under suchcircumstances the cost of the asset is the fair value ofthe equity instruments issued. Where the fair value forthe item received is more clearly evident than the fairvalue of the equity instruments issued, however, thatshould be used to measure its cost.In other situations, intangible assets may be acquired inexchange or part exchange for other dissimilar intangibleassets or other assets. Unless the “like-kind” exceptiondescribed in the following paragraph applies, the costs ofthe assets obtained are measured at the fair values of theassets given up, adjusted by the amount of any cash or cashequivalents transferred. However, if the fair values of

the assets received are more clearly evident than the fairvalues of the assets given up, those values are to be usedto measure the transaction. These procedures arepredicated upon the ability to reliably measure costs;absent this ability, as when comparable market transactionsare infrequent and alternative estimates of fair value(e.g., based on discounted cash flow projections) cannot becalculated, acquired assets would not be subject torecordation.The revisions to IAS 38 also will establish accountingprocedures for what is commonly known as a like-kindexchange. In such instances, the cost of an intangibleasset acquired is measured at the carrying amount of theasset given up when the fair value of neither of the assetsexchanged can be determined reliably.Internally generated goodwill is not recognized as anintangible asset because it fails to meet the recognitioncriteria of• Reliable measurement at cost, • Lack of an identity separate from other resources, and• Control by the reporting enterprise.In practice, accountants are usually confronted with thedesire to recognize internally generated goodwill based onthe premise that at a certain point in time the marketvalue of an enterprise exceeds the carrying value of itsidentifiable net assets. However, as IAS 38 categoricallypoints out, such differences cannot be considered torepresent the cost of intangible assets controlled by theenterprise, and hence, would not meet the criteria forrecognition (i.e., capitalization) of such an asset on thebooks of the enterprise.Intangibles acquired by means of government grants. If theintangible is acquired free of charge or by payment ofnominal consideration, as by means of a government grant(e.g., when the government grants the right to operate aradio station) or similar program, and assuming thebenchmark accounting treatment (historical cost) isemployed, obviously there will be little or no amountreflected as an asset. If the asset is important to thereporting entity’s operations, however, it must beadequately disclosed in the notes to the financialstatements. If the allowed alternative (fair value) method

is used, the fair value should be determined by referenceto an active market. However, given the probable lack ofan active market, since government grants are generally nottransferable, it is unlikely that this situation will beencountered. If an active market does not exist for thistype of an intangible asset, the enterprise must recognizethe asset at cost. Cost would include those that aredirectly attributable to preparing the asset for itsintended use.Intangibles Acquired through an Exchange of AssetsIf an intangible asset is acquired in exchange or partialexchange for a dissimilar intangible or other asset, thenthe cost of the asset is measured at its fair value. Thisamount is to be ascertained by reference to the fair valueof the asset received, which is equivalent to the fairvalue of the asset given up in the exchange, adjusted forany cash or cash equivalents transferred.If the exchange involves similar assets to be used by theenterprise in essentially the same manner and for the samepurpose as the item given up in the exchange, the exchangeis not deemed to be the culmination of an earnings process,and accordingly, no gain or loss is recognized. The newasset will be recorded at the carrying amount of the assetgiven up, adjusted for any cash or cash equivalent (oftencalled “boot”) given or received.Internally Generated Intangibles other than GoodwillIn many instances, intangibles are generated internally byan entity, rather than being acquired via a businesscombination or some other purchase transaction. Because ofthe nature of intangibles, the actual measurement of thecost (i.e., the initial amounts at which these could berecognized as assets) can prove to be rather challenging inpractice, and for that reason, historically there wassomewhat of a bias against recognition of internallygenerated intangible assets. However, a failure torecognize such assets would not only cause the entity’sbalance sheet to underreport its economic resources, butwould also result in a mismatching of income and expense inboth the period of expenditure and later periods when therelated benefits would be reaped. Accordingly, IAS 38provides that internally generated intangible assets,provided certain criteria are met, are to be capitalized

and amortized over the projected period of economicutility.Under the now-superseded IAS 9, it was established thatresearch costs were to be expensed as incurred, but thatdevelopment costs were to be deferred (i.e., capitalized)and expensed over the periods of expected benefit. IAS 38absorbed the guidance formerly found in IAS 9 and expandedit to cover other internally generated intangible assets.Thus, expenditures pertaining to the creation of intangibleassets are to be classified alternatively as beingindicative of, or analogous to, research activity ordevelopment activity. The former costs are expensed asincurred; the latter are capitalized, if future economicbenefits are reasonably likely to be received by thereporting entity. Per IAS 38,1. Costs incurred in the research phase are expensedimmediately; and2. If costs incurred in the development phase meet therecognition criteria for an intangible asset, such costsshould be capitalized. However, once costs have beenexpensed during the development phase, they cannot later becapitalized.In practice, distinguishing research-like expenditures fromdevelopment-like expenditures may not be easilyaccomplished. This would be especially true in the case ofintangibles for which the measurement of economic benefitscannot be performed in anything approximating a directmanner. Assets such as brand names, mastheads, andcustomer lists can prove quite resistant to such directobservation of value (although in many industries there arebenchmark monetary amounts commonly associated with suchitems, such as the oft-expressed notion that a customerlist in the securities brokerage business is worth $1,500per name, implying the amount of avoidable promotionalcosts each qualified name is worth).Thus, entities may incur certain expenditures in order toenhance brand names, such as engaging in image-advertisingcampaigns, but these costs will also have ancillarybenefits, such as promoting specific products that arebeing sold currently, and possibly even enhancing employeemorale and performance. While it may be argued that theexpenditures create or add to an intangible asset, as a

practical matter it would be difficult to determine whatportion of the expenditures relate to which achievement,and to ascertain how much, if any, of the cost may becapitalized as part of brand names. Thus, it is consideredto be unlikely that threshold criteria for recognition canbe met in such a case. For this reason the standard hasspecifically disallowed the capitalization of internallygenerated assets like brands, mastheads, publishing titles,customer lists, and items similar to these in substance.Apart from the prohibited items, however, IAS 38 permitsrecognition of internally created intangible assets to theextent the expenditures can be analogized to thedevelopment phase of a research and development program.Thus, internally developed patents, copyrights, trademarks,franchises, and other assets will be recognized at the costof creation, exclusive of costs which would be analogous toresearch, as further explained in the following paragraphs.When an internally generated intangible asset meets therecognition criteria, the cost is determined using the sameprinciples as for an acquired tangible asset. Thus, costcomprises all costs directly attributable to creating,producing, and preparing the asset for its intended use.IAS 38 closely follows IAS 16 with regard to elements ofcost that may be considered as part of the asset, and theneed to recognize the cash equivalent price when theacquisition transaction provides for deferred paymentterms. As with self-constructed tangible assets, elementsof profit must be eliminated from amounts capitalized, butincremental administrative and other overhead costs can beallocated to the intangible and included in the asset’scost. Initial operating losses, on the other hand, cannotbe deferred by being added to the cost of the intangible,but must be expensed as incurred.As noted above, the standard presents the concepts of theresearch phase and the development phase of a research anddevelopment project. IAS 38 mandates that the expenditureincurred during the research phase of an internal projectshould be recognized as an expense when incurred (asopposed to recognizing it as an intangible asset). Thestandard takes this view based on the premise that anenterprise cannot demonstrate that the expenditure incurredin the research phase will generate probable future

economic benefits, and consequently, that an intangibleasset exists (thus, such expenditure should be expensed).Examples of research activities include: activities aimedat obtaining new knowledge; the search for, evaluation, andfinal selection of applications of research findings; andthe search for and formulation of alternatives for new andimproved systems, etc.The standard recognizes that the development stage isfurther advanced than the research stage, and that anenterprise can possibly, in certain cases, identify anintangible asset and demonstrate that this asset willprobably generate future economic benefits for theorganization. Thus, the standard allows recognition of anintangible asset during the development phase, provided theenterprise can demonstrate all the following:• Technical feasibility of completing the intangibleasset so that it will be available for use or sale;• Its intention to complete the intangible asset andeither use it or sell it; • Its ability to use or sell the intangible asset;• The mechanism by which the intangible will generateprobable future economic benefits;• The availability of adequate technical, financial andother resources to complete the development and to use orsell the intangible asset; and• The entity’s ability to reliably measure theexpenditure attributable to the intangible asset during itsdevelopment.Examples of development activities include: the design andtesting of preproduction models; design of tools, jigs,molds, and dies; design of a pilot plant which is nototherwise commercially feasible; design and testing of apreferred alternative for new and improved systems, etc. Recognition of internally generated computer softwarecosts. The recognition of computer software costs posesseveral questions.1. In the case of a company developing software programsfor sale, should the costs incurred in developing thesoftware be expensed, or should the costs be capitalizedand amortized?

2. Is the treatment for developing software programsdifferent if the program is to be used for in-houseapplications only?3. In the case of purchased software, should the cost ofthe software be capitalized as a tangible asset or as anintangible asset, or should it be expensed fully andimmediately?In view of the current IAS on intangible assets, theposition can be clarified as follows:1. In the case of a software-developing company, thecosts incurred in the development of software programs areresearch and development costs. Accordingly, all expensesincurred in the research phase would be expensed. Thus,all expenses incurred until technological feasibility forthe product has been established should be expensed. Theenterprise would have to demonstrate technical feasibilityand probability of its commercial success. Technologicalfeasibility would be established if the enterprise hascompleted a detailed program design or working model. Theenterprise should have completed the planning, designing,coding, and testing activities and established that theproduct can be successfully produced. Apart from beingcapable of production, the enterprise should demonstratethat it has the intention and ability to use or sell theprogram. Action taken to obtain control over the programin the form of copyrights or patents would supportcapitalization of these costs. At this stage the softwareprogram would be able to meet the criteria ofidentifiability, control, and future economic benefits, andcan thus be capitalized and amortized as an intangibleasset.2. In the case of software internally developed for in-house use, for example, a payroll program developed by thereporting enterprise itself, the accounting approach wouldbe different. While the program developed may have someutility to the enterprise itself, it would be difficult todemonstrate how the program would generate future economicbenefits to the enterprise. Also, in the absence of anylegal rights to control the program or to prevent othersfrom using it, the recognition criteria would not be met.Further, the cost proposed to be capitalized should berecoverable. In view of the impairment test prescribed by

the standard, the carrying amount of the asset may not berecoverable and would accordingly have to be adjusted.Considering the above facts, such costs may need to beexpensed.3. In the case of purchased software, the treatment woulddiffer on a case-to-case basis. Software purchased forsale would be treated as inventory. However, software heldfor licensing or rental to others should be recognized asan intangible asset. On the other hand, cost of softwarepurchased by an enterprise for its own use and which isintegral to the hardware (because without that software theequipment cannot operate), would be treated as part of costof the hardware and capitalized as property, plant, orequipment. Thus, the cost of an operating system purchasedfor an in-house computer, or cost of software purchased forcomputer-controlled machine tool, are treated as part ofthe related hardware.Cost of other software programs should be treated asintangible assets (as opposed to being capitalized alongwith the related hardware), as they are not an integralpart of the hardware. For example, the cost of payroll orinventory software (purchased) may be treated as anintangible asset provided it meets the capitalizationcriteria under IAS 38 (in practice, the conservativeapproach would be to expense such costs as they areincurred, since their ability to generate future economicbenefits is always questionable).Costs Not Satisfying the IAS 38 Recognition CriteriaThe standard has specifically provided that expendituresincurred for nonmonetary intangible assets should berecognized as an expense unless1. It relates to an intangible asset dealt with inanother IAS;2. The cost forms part of the cost of an intangible assetthat meets the recognition criteria prescribed by IAS 38;or3. It is acquired in a business combination and cannot berecognized as an identifiable intangible asset. In thiscase, this expenditure should form part of the amountattributable to goodwill as at the date of acquisition.As a consequence of applying the above criteria, thefollowing costs are expensed as they are incurred:

• Research costs;• Preopening costs to open a new facility or business,and plant start-up costs incurred during a period prior tofull-scale production or operation, unless these costs arecapitalized as part of the cost of an item of property,plant, and equipment;• Organization costs such as legal and secretarialcosts, which are typically incurred in establishing a legalentity;• Training costs involved in operating a business or aproduct line;• Advertising and related costs;• Relocation, restructuring, and other costs involved inorganizing a business or product line;• Customer lists, brands, mastheads, and publishingtitles that are internally generated.Thus, the IASC has finally resolved the controversyregarding the potential deferral of costs like preoperatingexpenses. In the past, many enterprises have been known todefer setup costs and preoperating costs on the premisethat benefits from them flow to the enterprise over futureperiods as well. Due to the unequivocal stand taken by theIASC on this contentious issue, enterprises can no longerdefer such costs. Further, by adding the provisionrelating to annual impairment testing of all internallygenerated intangible assets being amortized (over a periodexceeding twenty years), the IASC has ensured that all suchcosts capitalized in the past would need to be adjusted forimpairment.The criteria for recognition of intangible assets asprovided in IAS 38 are rather stringent, and manyenterprises will find that expenditures either to acquireor to develop intangible assets will fail the test forcapitalization. In such instances, all these costs must beexpensed currently as incurred. Furthermore, onceexpensed, these costs cannot be resurrected and capitalizedin a later period, even if the conditions for suchtreatment are later met. This is not meant, however, topreclude correction of an error made in an earlier periodif the conditions for capitalization were met butinterpreted incorrectly by the reporting entity at thattime.)

Subsequently Incurred CostsUnder the provisions of IAS 38, the capitalization of anysubsequent costs incurred on intangible assets is difficultto justify. This is because the nature of an intangibleasset is such that, in many cases, it is not possible todetermine whether subsequent costs are likely to enhancethe specific economic benefits that will flow to theenterprise from those assets. Thus, subsequent costsincurred on an intangible asset should be recognized as anexpense when they are incurred unless1. It is probable that those costs will enable the assetto generate specifically attributable future economicbenefits in excess of its assessed standard of performanceimmediately prior to the incremental expenditure; and 2. Those costs can be measured reliably and attributed tothe asset reliably.Thus, if the above two criteria are met, any subsequentexpenditure on an intangible after its purchase or itscompletion should be capitalized along with its cost. Thefollowing example should help to illustrate this pointbetter.ExampleAn enterprise is developing a new product. Costs incurredby the R&D department in 2003 on the “research phase”amounted to $200,000. In 2004, technical and commercialfeasibility of the product was established. Costs incurredin 2004 were $20,000 personnel costs and $15,000 legal feesto register the patent. In 2005, the enterprise incurred$30,000 to successfully defend a legal suit to protect thepatent. The enterprise would account for these costs asfollows:• Research and development costs incurred in 2003,amounting to $200,000, should be expensed, as they do notmeet the recognition criteria for intangible assets. Thecosts do not result in an identifiable asset capable ofgenerating future economic benefits.• Personnel and legal costs incurred in 2004, amountingto $35,000, would be capitalized as patents. The companyhas established technical and commercial feasibility of theproduct, as well as obtained control over the use of theasset. The standard specifically prohibits thereinstatement of costs previously recognized as an expense.

Thus $200,000, recognized as an expense in the previousfinancial statements, cannot be reinstated and capitalized.• Legal costs of $30,000 incurred in 2005 to defend theenterprise in a patent lawsuit should be expensed. UnderUS GAAP, legal fees and other costs incurred insuccessfully defending a patent lawsuit can be capitalizedin the patents account, to the extent that value isevident, because such costs are incurred to establish thelegal rights of the owner of the patent. However, in viewof the stringent conditions imposed by IAS 38 concerningthe recognition of subsequent costs, the IASC seems to bein favor of the conservative approach of expensing suchcosts. Only such subsequent costs should be capitalizedwhich would enable the asset to generate future economicbenefits in excess of the originally assessed standards ofperformance. This represents, in most instances, a veryhigh, possibly insurmountable hurdle. Thus, legal costsincurred in connection with defending the patent, whichcould be considered as expenses incurred to maintain theasset at its originally assessed standard of performance,would not meet the recognition criteria under IAS 38. • Alternatively, if the enterprise were to lose thepatent lawsuit, then the useful life and the recoverableamount of the intangible asset would be in question. Theenterprise would be required to provide for any impairmentloss, and in all probability, even to fully write off the intangible asset. What is required must be determinedby the facts of the specific situation.Measurement subsequent to Initial RecognitionBenchmark treatment. After initial recognition, anintangible asset should be carried at its cost less anyaccumulated amortization and any accumulated impairmentlosses.Allowed alternative treatment—revaluation. As withtangible assets under IAS 16, the standard for intangiblespermits revaluation subsequent to original acquisition,with the asset being written up to fair value. Inasmuch asmost of the particulars of IAS 38 follow IAS 16 to theletter, and were described in detail in Chapter 8, thesewill not be repeated here. The unique features of IAS 38are as follows:

1. If the intangibles were not initially recognized(i.e., they were expensed rather than capitalized) it wouldnot be possible to later recognize them at fair value.2. Deriving fair value by applying a present valueconcept to projected cash flows (a technique that can beused in the case of tangible assets under IAS 16) is deemedto be too unreliable in the realm of intangibles, primarilybecause it would tend to commingle the impact ofidentifiable assets and goodwill. Accordingly, fair valueof an intangible asset should only be determined byreference to an active market in that type of intangibleasset. Active markets providing meaningful data are notexpected to exist for such unique assets as patents andtrademarks, and thus it is presumed that revaluation willnot be applied to these types of assets in the normalcourse of business. As a consequence, the IASC haseffectively restricted revaluation of intangible assets toonly freely tradable intangible assets.As with the rules pertaining to plant, property, andequipment under IAS 16, if some intangible assets in agiven class are subjected to revaluation, all the assets inthat class should be consistently accounted for unless fairvalue information is not or ceases to be available. Alsoin common with the requirements for tangible fixed assets,IAS 38 requires that revaluations be taken directly toequity through the use of a revaluation surplus account,except to the extent that previous impairments had beenrecognized by a charge against income.Example of revaluation of intangible assetsA patent right is acquired July 1, 2003, for $250,000;while it has a legal life of 15 years, due to rapidlychanging technology, management estimates a useful life ofonly 5 years. Straight-line amortization will be used. AtJanuary 1, 2004, management is uncertain that the processcan actually be made economically feasible, and decides towrite down the patent to an estimated market value of$75,000. Amortization will be taken over 3 years from thatpoint. On January 1, 2006, having perfected the relatedproduction process, the asset is now appraised at a soundvalue of $300,000. Furthermore, the estimated useful lifeis now believed to be 6 more years. The entries to reflectthese events are as follows:

7/1/03 Patent 250,000Cash, etc. 250,000

12/31/03 Amortization expense 25,000Patent 25,000

1/1/04 Loss from asset impairment 150,000Patent 150,000

12/31/04 Amortization expense 25,000Patent 25,000

12/31/05 Amortization expense 25,000Patent 25,000

1/1/06 Patent 275,000Gain on asset value recovery 100,000Revaluation surplus 175,000

Certain of the entries in the foregoing example will beexplained further. The entry at year-end 2003 is to recordamortization based on original cost, since there had beenno revaluations through that time; only a half-yearamortization is provided [($250,000/5) x ½]. On January 1,2004, the impairment is recorded by writing down the assetto the estimated value of $75,000, which necessitates a$150,000 charge to income (carrying value, $225,000, lessfair value, $75,000).In 2004 and 2005, amortization must be provided on the newlower value recorded at the beginning of 2004; furthermore,since the new estimated life was 3 years from January 2004,annual amortization will be $25,000.As of January 1, 2006, the carrying value of the patent is$25,000; had the January 2004 revaluation not been made,the carrying value would have been $125,000 ($250,000original cost, less 2.5 years amortization versus anoriginal estimated life of 5 years). The new appraisedvalue is $300,000, which will fully recover the earlierwrite-down and add even more asset value than theoriginally recognized cost. Under the guidance of IAS 38,the recovery of $100,000 that had been charged to expenseshould be taken into income; the excess will be credited tostockholders’ equity.Development costs pose a special problem in terms of theapplication of the allowed alternative method under IAS 38.The utilization of the allowed alternative method of

accounting for long-lived intangibles is only permissiblewhen stringent conditions are met concerning theavailability of fair value information. In general, itwill not be possible to obtain fair value data from activemarkets, as is required by IAS 38, and this is particularlytrue with regard to development costs. Accordingly, theexpectation is that the benchmark (historical cost) methodwill be almost universally applied for development costs.The use of the available alternative method for developmentcosts, while theoretically valid, is expected to be veryunusual in practice.Example of development cost capitalizationAssume that Creative, Incorporated incurs substantialresearch and development costs for the invention of newproducts, many of which are brought to market successfully.In particular, Creative has incurred costs during 2003amounting to $750,000, relative to a new manufacturingprocess. Of these costs, $600,000 were incurred prior toDecember 1, 2003. As of December 31, the viability of thenew process was still not known, although testing had beenconducted on December 1. In fact, results were notconclusively known until February 15, 2004, after another$75,000 in costs were incurred post–January 1. Creative,Incorporated’s financial statements for 2003 were issuedFebruary 10, 2004, and the full $750,000 in research anddevelopment costs were expensed, since it was not yet knownwhether a portion of these qualified as development costsunder IAS 38. When it is learned that feasibility had, infact, been shown as of December 1, Creative management asksto restore the $150,000 of post–December 1 costs as adevelopment asset. Under IAS 38 this is prohibited.However, the 2004 costs ($75,000 thus far) would qualifyfor capitalization, in all likelihood, based on the factsknown.If, however, it is determined that fair value informationderived from active markets is indeed available, and theenterprise desires to apply the allowed alternative(revaluation) method of accounting to development costs,then it will be necessary to perform revaluations on aregular basis, such that at any reporting date the carryingamounts are not materially different from the current fairvalues. From a mechanical perspective, the adjustment to

fair value can be accomplished either by “grossing up” thecost and the accumulated amortization accountsproportionally, or by netting the accumulated amortization,prerevaluation, against the asset account and thenrestating the asset to the net fair value as of therevaluation date. In either case, the net effect of theupward revaluation will be recorded in stockholders’ equityas revaluation surplus; the only exception would be when anupward revaluation is in effect a reversal of a previouslyrecognized impairment which was reported as a chargeagainst earnings or a revaluation decrease (reversal or ayet earlier upward adjustment) which was reflected inearnings.The accounting for revaluations is illustrated as follows:Example of accounting for revaluation of development costAssume Breakthrough, Inc. has accumulated development coststhat meet the criteria for capitalization at December 31,2003, amounting to $39,000. It is estimated that theuseful life of this intangible asset will be 6 years;accordingly, amortization of $6,500 per year isanticipated. Breakthrough uses the allowed alternativemethod of accounting for its long-lived tangible andintangible assets. At December 31, 2005, it obtains marketinformation regarding the then-current fair value of thisintangible asset, which suggests a current fair value ofthese development costs is $40,000; the estimated usefullife, however, has not changed. There are two ways toapply IAS 38: the asset and accumulated amortization can be“grossed up” to reflect the new fair value information, orthe asset can be restated on a “net” basis. These are bothillustrated below. For both illustrations, the book value(amortized cost) immediately prior to the revaluation is$39,000 – (2 x $6,500) = $26,000. The net upwardrevaluation is given by the difference between fair valueand book value, or $40,000 – $26,000 = $14,000.If the “gross up” method is used: Since the fair valueafter 2 years of the 6-year useful life have alreadyelapsed is found to be $40,000, the gross fair value mustbe 6/4 x $40,000 = $60,000. The entries to record thiswould be as follows:

Development cost (asset) 21,000

Accumulated amortization—development cost 7,000Revaluation surplus (stockholders’ equity) 14,000

If the “netting” method is used: Under this variant, theaccumulated amortization as of the date of the revaluationis eliminated against the asset account, which is thenadjusted to reflect the net fair value.

Accumulated amortization—development cost 13,000Development cost (asset) 13,000Development cost (asset) 14,000Revaluation surplus (stockholders’ equity) 14,000

Amortization PeriodAs with tangible assets subject to depreciation ordepletion, the cost (or revalued carrying amount) ofintangible assets is subject to rational and systematicamortization. Given that the useful economic life of manyintangibles would be difficult to assess, the rule is thata maximum twenty-year life is permissible, withamortization being over a shorter useful life if known.The only exceptions would occur in those instances wherethe legal right has a life of greater than twenty years andeither of the following conditions exists:1. The intangible has an existence that is not separablefrom a specific tangible asset, the useful life of whichcan be reliably determined to exceed twenty years, or2. There is an active secondary market for theintangible.The thrust of these requirements is to make the twenty-yearlife an upper limit for most intangibles.If there is persuasive evidence that the useful life of anintangible asset is longer than twenty years, then thetwenty-year presumption is rebutted and the enterprise must• Amortize the intangible asset over that longer period;• Estimate the recoverable amount of the intangibleasset at least annually in order to identify any impairmentloss; and • Disclose the reasons why the presumption has beenrebutted.Note that IAS 38 provides for amortization of allintangible assets; it does not subscribe to the view that

any intangible asset can possess an infinite life. Thethrust of these requirements is to make the twenty-yearlife an upper limit for most intangibles.If control over the future economic benefits from anintangible asset is achieved through legal rights for afinite period, then the useful life of the intangible assetshould not exceed the period of legal rights, unless thelegal rights are renewable and the renewal is a virtualcertainty. Thus, as a practical matter, the shorter legallife will set the upper limit for an amortization period inmost cases.The amortization method used should reflect the pattern inwhich the economic benefits of the asset are consumed bythe enterprise. Amortization should commence when theasset is available for use and the amortization charge foreach period should be recognized as an expense unless it isincluded in the carrying amount of another asset (e.g.,inventory). Intangible assets may be amortized by the samesystematic and rational methods that are used to depreciatetangible fixed assets. Thus, IAS 38 would seemingly permitstraight-line, diminishing balance, and units of productionmethods. If a method other than straight-line is used, itmust accurately mirror the expiration of the asset’seconomic service potential.Residual ValueTangible assets often have a positive residual value beforeconsidering the disposal costs because tangible assets cangenerally be sold for scrap, or possibly be transferred toanother user that has less need for or ability to affordnew assets of that type. Intangibles, on the other hand,lacking the physical attributes that would make scrap valuea meaningful concept, often have little or no residualworth. Accordingly, IAS 38 requires that a zero residualvalue be presumed unless an accurate measure of residual ispossible. Thus, the residual value is presumed to be zerounless• There is a commitment by a third party to purchase theasset at the end of its useful life; or • There is an active market for that type of intangibleasset, and residual value can be measured reliably byreference to that market and it is probable that such amarket will exist at the end of the useful life.

IAS 38, as revised by the consequential changes wrought bythe IASB Improvements Project, specifies that the residualvalue of an intangible asset is the estimated net amountthat the reporting entity currently expects to obtain fromdisposal of the asset at the end of its useful life, afterdeducting the estimated costs of disposal, if the assetwere of the age and in the condition expected at the end ofits estimated useful life. In other words, changes inprices or other variables over the expected period of useof the asset are not to be included in the estimatedresidual value, since this would result in the recognitionof estimated holding gains over the life of the asset (viareduced amortization that would be the consequence of ahigher estimated residual value).Residual value is to be assessed at each balance sheetdate. Any change to the estimated residual, other thanthat resulting from impairment (accounted for under IAS 36)is to be accounted for prospectively, only by varyingfuture periodic amortization. Similarly, any change inamortization method (e.g., from accelerated to straight-line) is dealt with as a change in estimate, again to bereflected only in future periodic charges for amortization.Periodic review of useful life assumptions and amortizationmethods employed. As for fixed assets accounted for inconformity with IAS 16, the newer standard on intangiblessuggests that the amortization period be reconsidered atthe end of each reporting period, and that the method ofamortization also be reviewed at similar intervals. Thereis the expectation that due to their nature intangibles aremore likely to require revisions to one or both of thesejudgments. In either case, a change would be accounted foras a change in estimate, affecting current and futureperiods’ reported earnings but not requiring restatement ofpreviously reported periods.Impairment LossesIAS 38 has provided that• Amortization of an asset should commence when theasset is available for use; and• The amortization period should not exceed twentyyears, although this presumption is rebuttable.In view of the above, some enterprises may be tempted to

• Capitalize intangible assets and defer amortizationfor long periods on the grounds that the assets are notavailable for use; and/or• Rebut the presumption of twenty-year life and amortizeassets over a longer period.To combat the risk that either of these strategies might beemployed, the standard provides that in addition to theuniversal provisions of IAS 36 (which require that therecoverable amount of an asset should be estimated whencertain indications of impairment exist, as described indetail in Chapter 8), IAS 38 requires that an enterpriseshould estimate the recoverable amount of the followingintangible assets at least at each financial year-end evenif there is no indication of impairment:1. Intangible assets that are not yet ready for use; and2. Other intangible assets that are amortized over aperiod exceeding twenty years from the date when the assetbecomes available for use.Apart from the special case of assets not yet in use, orbeing amortized over greater than twenty years, the majorcomplication arises in the context of goodwill. Unlikeother intangible assets that are individually identifiable,goodwill is amorphous and cannot exist, from a financialreporting perspective, apart from the tangible andidentifiable intangible assets with which it was acquired.Thus, a direct evaluation of the recoverable amount ofgoodwill is not actually feasible; accordingly, thestandard requires that goodwill be combined with otherassets which together define a cash generating unit, andthat an evaluation of any potential impairment (ifwarranted by the facts and circumstances) be conducted onan aggregate basis. A more detailed consideration ofgoodwill is presented in Chapter 11.The impairment of intangible assets other than goodwill(such as patents, copyrights, trade names, customer lists,and franchise rights) should be considered in precisely thesame way that long-lived tangible assets are dealt with.Carrying amounts must be compared to the greater of netselling price or value in use when there are indicationsthat an impairment may have been suffered. Reversals ofimpairment losses under defined conditions are alsorecognized. The effects of impairment recognitions and

reversals will be reflected in current period operatingresults, if the intangible assets in question are beingaccounted for in accordance with the benchmark method setforth in IAS 38 (i.e., at historical cost). On the otherhand, if the allowed alternative method (presentingintangible assets at revalued amounts) is followed,impairments will normally be charged to stockholders’equity to the extent that revaluation surplus exists, andonly to the extent that the loss exceeds previouslyrecognized valuation surplus will the impairment loss bereported as a charge against earnings. Recoveries arehandled consistent with the method by which impairmentswere reported, in a manner entirely analogous to theexplanation earlier in this chapter dealing withimpairments of plant, property, and equipment.Disposals of Intangible AssetsWith regard to questions of accounting for the dispositionof assets, the guidance of IAS 38 virtually mirrors that ofIAS 16. Gain or loss recognition will be for thedifference between carrying amount (net, if applicable, ofany remaining revaluation surplus) and the net proceedsfrom the sale. The amendment to IAS 38 made by the IASB’sImprovements Project observes that a disposal of anintangible asset may result from either a sale of the assetor by entering into a finance lease. The determination ofthe date of disposal of the intangible asset is made byapplying the criteria in IAS 18 for recognizing revenuefrom the sale of goods, or IAS 17 in the case of disposalby a sale and leaseback. As for other similartransactions, the consideration receivable on disposal ofan intangible asset is to be recognized initially at fairvalue. If payment for such an intangible asset isdeferred, the consideration received is recognizedinitially at the cash price equivalent, with any differencebetween the nominal amount of the consideration and thecash price equivalent to be recognized as interest revenueunder IAS 18, using the effective yield method.Website Development and Operating CostsWith the advent of the Internet and growing popularity of“e-commerce,” many businesses now have their own websites.Websites have become integral to doing business and may bedesigned either for external or internal access. Those

designed for external access are developed and maintainedfor the purposes of promotion and advertising of anentity’s products and services to their potentialconsumers. On the other hand, those developed for internalaccess may be used for displaying company policies andstoring customer details.With substantial costs being incurred by many entities forwebsite development and maintenance, the need foraccounting guidance became evident. The recentlypromulgated interpretation, SIC 32, concluded that suchcosts represent an internally generated intangible assetthat is subject to the requirements of IAS 38, and thatsuch costs should be recognized if, and only if, anenterprise can satisfy the requirements of IAS 38,paragraph 45. Therefore, website costs have been likenedto “development phase” (as opposed to “research phase”)costs.Thus the stringent qualifying conditions applicable to thedevelopment phase, such as “ability to generate futureeconomic benefits,” have to be met if such costs are to berecognized as an intangible asset. If an enterprise is notable to demonstrate how a website developed solely orprimarily for promoting and advertising its own productsand services will generate probable future economicbenefits, all expenditure on developing such a websiteshould be recognized as an expense when incurred.Any internal expenditure on development and operation ofthe website should be accounted for in accordance with IAS38. Comprehensive additional guidance is provided in theAppendix to the Interpretation and is summarized below.1. Planning stage expenditures, such as undertakingfeasibility studies, defining hardware and softwarespecifications, evaluating alternative products andsuppliers, and selecting preferences, should be expensed;2. Application and infrastructure development costspertaining to acquisition of tangible assets, such aspurchasing and developing hardware, should be dealt with inaccordance with IAS 16;3. Other application and infrastructure developmentcosts, such as obtaining a domain name, developingoperating software, developing code for the application,installing developed applications on the web server and

stress testing, should be expensed when incurred unless theconditions prescribed by IAS 38, paragraphs 19 and 45, aremet;4. Graphical design development costs, such as designingthe appearance of web pages, should be expensed whenincurred unless conditions prescribed by IAS 38, paragraphs19 and 45, are met;5. Content development costs, such as creating,purchasing, preparing, and uploading information on thewebsite before completion of the website’s developmentshould be expensed when incurred under IAS 38, paragraph57(c), to the extent content is developed to advertise andpromote an enterprise’s own products or services;otherwise, expensed when incurred, unless expenditure meetsconditions prescribed by IAS 38, paragraphs 19 and 45;6. Operating costs, such as updating graphics andrevising content, adding new functions, registering websitewith search engines, backing up data, reviewing securityaccess and analyzing usage of the website should beexpensed when incurred, unless in rare circumstances thesecosts meet the criteria prescribed in IAS 38, paragraph 60,in which case such expenditure is capitalized as a cost ofthe website; and7. Other costs, such as selling and administrativeoverhead (excluding expenditure which can be directlyattributed to preparation of website for use), initialoperating losses and inefficiencies incurred before thewebsite achieves planned performance, and training costs ofemployees to operate the website, should be expensed whenincurred.This interpretation became effective in March 2002. Theeffects of adopting this Interpretation was to be accountedfor using the transition provisions originally establishedby IAS 38. For instance, when a website does not meet therequirements of this SIC but was previously recognized asan asset, the item was to be derecognized at the date whenthis SIC becomes effective. If previously capitalizedcosts are written off due to the imposition of SIC 32, theexpense may be handled under either the benchmark oralternative treatments specified by IAS 8.Disclosure Requirements

The disclosure requirements set out in IAS 38 forintangible assets and those imposed by IAS 16 for property,plant, and equipment are very similar, and both demandextensive details to be disclosed in the financialstatement footnotes. Another marked similarity is theexemption from disclosing “comparative information” withrespect to the reconciliation of carrying amounts at thebeginning and end of the period. While this may bemisconstrued as a departure from the well-known principleof presenting all numerical information in comparativeform, it is worth noting that it is in line with theprovisions of IAS 1. IAS 1, paragraph 38, categoricallystates that “(u)nless an International Accounting Standardpermits or requires otherwise, comparative informationshould be disclosed in respect of the previous period forall numerical information in the financial statements….”(Another standard that contains a similar exemption fromdisclosure of comparative reconciliation information is IAS37—please refer to the relevant chapter of the book fordetails.)For each class of intangible assets (distinguishing betweeninternally generated and other intangible assets),disclosure is required of1. The amortization method(s) used;2. Useful lives or amortization rates used;3. The gross carrying amount and accumulated amortization(including accumulated impairment losses) at both thebeginning and end of the period;4. A reconciliation of the carrying amount at thebeginning and end of the period showing additions,retirements, disposals, acquisitions by means of businesscombinations, increases or decreases resulting fromrevaluations, reductions to recognize impairments, amountswritten back to recognize recoveries of prior impairments,amortization during the period, the net effect oftranslation of foreign entities’ financial statements, andany other material items; and5. The line item of the income statement in which theamortization charge of intangible assets is included. The standard explains the concept of “class of intangibleassets” as a “grouping of assets of similar nature and usein an enterprise’s operations.” Examples of intangible

assets that could be reported as separate classes (ofintangible assets) are1. Brand names;2. Licenses and franchises;3. Mastheads and publishing titles;4. Computer software;5. Copyrights, patents and other industrial propertyrights, service and operating right;6. Recipes, formulae, models, designs and prototypes; and7. Intangible assets under development.The above list is only illustrative in nature. Intangibleassets may be combined (or disaggregated) to report largerclasses (or smaller classes) of intangible assets if thisresults in more relevant information for financialstatement users.In addition, the financial statements should also disclosethe following:1. If the amortization period for any intangibles exceedstwenty years, the justification therefor;2. The nature, carrying amount, and remainingamortization period of any individual intangible asset thatis material to the financial statements of the enterpriseas a whole;3. For intangible assets acquired by way of a governmentgrant and initially recognized at fair value, the fairvalue initially recognized, their carrying amount, andwhether they are carried under the benchmark or allowedalternative treatment for subsequent measurement;4. Any restrictions on titles and any assets pledged assecurity for debt; and5. The amount of outstanding commitments for theacquisition of intangible assets.In addition, the financial statements should disclose theaggregate amount of research and development expenditurerecognized as an expense during the period.Examples of Financial Statement DisclosuresNovartis AGFor the Fiscal Year ending December 31, 2002Notes to the consolidated financial statementsIntangible assets. These are valued at their cost andreviewed periodically and adjusted for any diminution invalue as noted in the preceding paragraph. Any resulting

impairment loss is recorded in the income statement ingeneral overheads. In the case of business combinations,the excess of the purchase price over the fair value of netidentifiable assets is recorded as goodwill in the balancesheet. Goodwill, which is denominated in the localcurrency of the related acquisition, is amortized to incomethrough administration and general overheads on a straight-line basis over its useful life. The amortization periodis determined at the time of the acquisition, based uponthe particular circumstances, and ranges from five totwenty years. Goodwill relating to acquisitions arisingprior to January 1, 1995, has been fully written offagainst reserves.Management determines the estimated useful life of goodwillbased on its evaluation of the respective company at thetime of the acquisition, considering factors such asexisting market share, potential sales growth and otherfactors inherent in the acquired company.Other acquired intangible assets are written off on astraight-line basis over the following periods:

Trademarks 10 to 15 yearsProduct and marketing rights 5 to 20 yearsSoftware 3 yearsOthers 3 to 5 years

Trademarks are amortized on a straight-line basis over theestimated economic or legal life, whichever is shorter,while the history of the Group has been to amortize productrights over estimated useful lives of five to twenty years.The useful lives assigned to acquired product rights arebased on the maturity of the products and the estimatedeconomic benefit that such product rights can provide.Marketing rights are amortized over their useful livescommencing in the year in which the rights first generatesales.9. Intangible asset movements

Goodwill Product and marketing rightsTrademarksSoftware Other intangibles Totals

2002 2001(in CHF millions)Cost, January 1 2,736 4,222 614 85 333

7,990 6,508Consolidation changes 1 -- (11) 49 457 496 752Additions 937 51 13 5 65 1,071 696Disposals (7) (6) (6) (6) (17) (42) (42)Translation effects (399) (330) (95) (9)(58) (891) 76December 31 3,267 3,938 515 124 780 8,624

7,990

Accumulated amortizationJanuary 1 (442) (577) (132) (62) (229)

(1,442) (678)Consolidation charges (20) (50) (1) (42) (82) (195)

(16)Amortization charge (141) (286) (41) (16) (67)

(551) (564)Disposals 3 2 6 6 26 43 45Impairment charge (369) (102) (18) (6)(495) (216)Translation effects 94 53 25 5 9 186(13)December 31 (875) (960) (161) (109)

(349) (2,454) (1,442)

Net book value—December 312,392 2,978 354 15 431 6,170 6,548

The principal additions in both years were goodwill onacquisition and in 2001 pitavastatin marketing rights.In 2002, goodwill impairment charges were recorded of CHF369 million mainly related to the Pharmaceuticals divisionresearch and biotechnology activities of Genetic TherapyInc., Systemix Inc., Imutran Ltd., due to changes in theresearch and development strategy, and relating to theMedical Nutrition and OTC business units. The majority of

the product and marketing rights impairment related to aCHF 80 million charge to the pitavastatin rights (2001:CHF 216 million).Bayer AktingesellschaftYear ended December 31, 2002[18] Intangible assetsAcquired intangible assets other than goodwill arerecognized at cost and amortized by the straight-linemethod over a period of four to fifteen years, depending ontheir estimated useful lives. Write-downs are made forimpairment losses. Assets are written back if the reasonsfor previous years’ write-downs no longer apply.Goodwill, including that resulting from capitalconsolidation, is capitalized in accordance with IAS 22(Business Combinations) and amortized on a straight-linebasis over a maximum estimated useful life of twenty years.The value of goodwill is reassessed regularly based onimpairment indicators and written down if necessary. Incompliance with IAS 36 (Impairment of Assets), such write-downs of goodwill are measured by comparison to thediscounted cash flows expected to be generated by theassets to which the goodwill can be ascribed.Self-created intangible assets generally are notcapitalized.Certain development costs relating to the applicationdevelopment stage of internally developed software arecapitalized in the Group balance sheet. These costs areamortized over their useful life from the date they areplaced in service.Changes in intangible assets in 2002 were as follows:

Acquired concessions, industrial property rights,similar rights and assets, and licenses thereunder

Acquired goodwill

Advance payments

Total(€ million)

Gross carrying amounts, Dec. 31, 2001 5,240 1,39942 6,681

Exchange differences (529) (163) (4) (696)Changes in scope of consolidation 2 7 -- 9Acquisitions 3,057 2,267 -- 5,324Capital expenditures 363 -- 72 435Retirements (249) (204) (13) (466)Transfers 39 -- (39) --Gross carrying amounts, Dec. 31, 2002 7,923 3,306

58 11,287Accumulated amortization and write-downs, Dec. 31, 20011,243424--1,667Exchange differences (149) (43) -- (192)Changes in scope of consolidation -- -- -- --Amortization and write-downs in 2002 1,058 205 --

1,263of which write-downs (249) (11) (--) (260)Write-backs -- -- -- --Retirements (186) (144) -- (330)Transfers -- -- -- --Accumulated amortization and write-downs, Dec. 31, 20021,966 442--2,408Net carrying amounts, Dec. 31, 2002 5,957 2,864

58 8,879Net carrying amounts, Dec. 31, 2001 3,997 975

42 5,014

The exchange differences are the differences between thecarrying amounts at the beginning and the end of the yearthat result from translating foreign companies’ figures atthe respective different exchange rates and changes in

their assets during the year at the average rate for theyear.In 2002, as required by the newly implemented SFAS 142, theGroup ceased amortization of its goodwill recorded underIAS, its indefinite-lived intangible asset, the Bayer“Cross” and the pre-1995 goodwill recognized for US GAAPpurposes. The adjustment reverses the amortizationrecorded under IAS for the Group’s IAS goodwill of €11million.In-process research and developmentIAS does not consider that in-process research anddevelopment (IPR&D) is an intangible asset that can beseparated from goodwill. Under US GAAP it is considered tobe a separate asset that needs to be written offimmediately following an acquisition as the feasibility ofthe acquired research and development has not been fullytested and the technology has no alternative future use.During 2002, IPR&D has been identified for US GAAP purposesin connection with the Aventis CropScience and VisibleGenetics acquisitions. Fair value determinations were usedto establish €133 million of IPR&D for both acquisitions,which was expensed immediately. The independent appraisersused a discounted cash flow approach and relied uponinformation provided by Group management. The discountedcash flow approach uses the expected future net cash flows,discounted to their present value, to determine an asset’scurrent fair value.As a whole, the income booked for the reversal of theamortization of IPR&D recorded under IAS as a component ofother operating expense and selling expense amounted to €5million in 2002.