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Unformatted text preview: Unit 4
Intangible Assets (HKAS 38) 1 Intangible Assets
WHAT ARE THEY? Goodwill Brands Trademarks / Patents / Licences Development costs 2 Intangible Assets
WHY ARE THEY IMPORTANT? Growing gap between the book values of companies and their market capitalisation
U Innovation U Employees U Organisational 3 Intangible Assets - Goodwill
PCCW Ltd – 31 December 2003 Goodwill Trade marks HK$ 933m HK$ 1,262m 4 Why Does Goodwill Arise? Superior earnings power Efficient or talented employees Regional monopoly Good location Strong product lines or brands Access to technology Loyal customer base
5 Intangible Assets - Brands
Diageo plc – 30 June 2004 Brands Shareholders Funds £3,945m £3,692m 6 What is a Brand?
U Recognised name U Product or range of products U Established market position U Marketing and specialist know-how
7 Recognition of Brands
U The title is clear U Brand earnings are separately identifiable U The brand could be sold separately from the business
U The brand achieves earnings in excess of unbranded products
8 Intangible Assets - Trademarks / Licences
Coca Cola Company – 31 December 2003 Trademarks US$ 1,979m HutchisonWhampoa – 31 December 2003 Telecom licences HK$ 97,926m
9 Intangible Assets - Development Costs
Rolls Royce plc – 31 December 2003 Engineering development £43m BP plc – 31 December 2003 Exploration expenditureUS$ 5,630m
10 Intangible Assets - Development Costs Application of research knowledge to a plan or design for the production of new products, materials or processes prior to the commencement of commercial production or use involved can be large
11 Amounts Intangible Assets - Employees
Manchester United – 31 July 2004 Players’ Registration Fees (with contracts) £78m 12 Intangible Assets An intangible asset is an identifiable non-monetary asset without physical substance.
U e.g. scientific or technical knowledge, design of new systems, licenses, intellectual property, brands, trademarks, patents, motion picture films, franchises, etc. General characteristics:
U No physical existence U Expect to benefit the company for more than one year U High degree of uncertainty relating to the value of future economic benefits to be derived U Difficult to identify specific revenues arising from the use of particular intangible asset U Difficult to determine the costs in some cases
13 Definition 3 Criteria to qualify for an intangible asset :
U Identifiability; U Control over a resource; and U Future economic benefits Identifiability
U An asset meets identifiability criterion when it is: Separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged ; or Arises from contractual or other legal rights
14 Definition Control
U Power to obtain future economic benefits from the intangible asset U Power to prevent the others to those benefits U As a result, intangible items like staff talents, customer loyalty or technical knowledge, do not meet this criterion, unless they are protected by legal rights e.g. copyrights Future economic benefits
U Revenue from sale of products and services U Cost savings U Other benefits resulting from the use of the intangible asset e.g. royalty fees 15 Goodwill Intangible asset has to be distinguished from goodwill which represents, in a business combination, a payment made by the acquirer in anticipation of future economic benefits arising from assets that are not capable of being individually identified and separately recognised i.e. the difference between the cost of an acquired entity and the aggregate of the fair values of its identifiable assets and liabilities
Thorn EMI plc acquisition of Virgin Music Group Limited 1992/93 £m Cost of Acquisition 593.0 Fair value of net assets acquired 14.1 Goodwill 578.9
17 Goodwill Characteristics Cannot be realised or sold separately No relationship to any costs incurred Impossible to value reliably the individual factors that may contribute to it Wide fluctuations due to internal and external circumstances Assessment highly subjective, unique to valuer at point in time
18 Scope HKAS 38 does not apply to intangible assets that are within the scope of other standards:
U Financial assets under HKAS 39 U Exploration assets of mineral resources and other non-regenerative resources under HKFRS 6 19 Recognition The recognition of an item as an intangible asset requires that the item meets :
U The definitions of an intangible asset; and U The recognition criteria Recognition Criteria :
U it is probably that expected future economic benefits will flow to the entity U The cost of the asset can be measured reliably If an intangible item does not meet both the above definition and recognition criteria, the expenditure on this item should be recognized as an expense when it is incurred Expenses that have been written off previously cannot be restated as intangible asset subsequently 20 Recognition of Internally Generated Intangible Assets – R&D Costs Can comprise the sum of all directly attributed costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by management. U e.g. material costs, employment costs, patents and licenses, etc. Should meet general recognition criteria, plus further requirements to classify the costs into 2 phases: U Research phase, and U Development phase ( a more advanced phase than research phase) 21 Recognition of Internally Generated Intangible Assets – R&D Costs Research phase:
U “Research” is defined as original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Research costs should be recognized as an expense when it is incurred because the company cannot demonstrate that research expenditure will definitely generate future economic benefits.
22 U Recognition of Internally Generated Intangible Assets – R&D Costs Development phase:
U U “Development” is defined as the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. Development costs incurred could be capitalised as an intangible asset if an enterprise can demonstrate the following:
23 Recognition of Internally Generated Intangible Assets – R&D Costs The technical feasibility of completing the intangible asset. Its intention to complete the intangible asset. Its ability to use and sell the intangible asset. The intangible asset will generate future economic benefits. The ability to measure the expenditure attributable to the intangible asset reliably. The availability of adequate technical, financial and other resources to complete the development of the intangible asset. 24 Issues of Recognition However, internally generated intangibles like brands, publishing titles, customer lists etc. are unlikely to be recognized as intangible assets because most expenditure incurred cannot be distinguished from cost of developing the business as a whole. Also, training of a team of skilled staff may help to generate F.E.B., but the firm may not have sufficient control over the staff, e.g. resignation of staff, in order to recognise the training costs as intangible assets But, if the firm purchased or acquired intangibles externally e.g. purchased a brand name, publishing title or patent at a price, then the amount paid can be recognised as intangible asset.
25 Initial Measurement An intangible asset should be measured initially at cost :
U For externally acquired intangible asset : the cost comprises its purchase price and any directly attributable expenditure on preparing the asset for its intended use e.g. professional fees etc. the sum of expenditure (materials, salaries and directly attributable overhead) incurred from the day when the asset first meets the recognition criteria. U For internally generated intangible asset : the cost comprises U For intangible assets acquired in business combination : the intangibles acquired, regardless of whether they had been previously recognised by the acquiree, should be recognised separately from the goodwill if their fair values can be reliably measured e.g. brand etc. 26 Example 1 AB Ltd. is developing a new production process. For the year ended 31/12/2005, expenditure incurred was $1m, of which $900k was incurred before 1/11/2005 and $100k was incurred between 1/11/2005 and 31/12/2005. The entity was able to demonstrate that at 1/11/2005, the production process met the criteria for the recognition as an intangible asset. The recoverable amount of the know-how embodied in the process was estimated to be $250k. Answer : as at 31/12/2005, intangible asset = $100k (in B/S) & expenses (in P/L) = $900k
27 Subsequent Measurement After initial recognition, an intangible asset can be measured under one of the two models below :
U Cost model (or Benchmark treatment) : Carrying amount / NBV = cost - accumulated amortisation (if any) - accumulated impairment losses (if any); or U Revaluation model (or Alternative treatment) : Carrying amount / NBV = revalued amount - subsequent accumulated amortisation (if any) - subsequent accumulated impairment losses (if any) this model is permitted if, and only if, fair value can be determined by reference to an active market; and revaluations must be made with sufficient regularity such that the carrying amount does not differ materially from its fair value at the balance date 28 Subsequent Measurement Accounting treatment on: U Revaluation surplus and deficit U Realization of revaluation reserve U Calculation of gain or loss on disposal U All of the above are same as P.P.E. 29 Estimation of Useful Life and Amortisation An enterprise shall assess whether the useful life of an intangible asset is finite or indefinite – If indefinite useful life : Amortisation not required If finite useful life : Apply amortisation The useful life of an intangible asset reflects only that level of future maintenance expenditure required to maintain the asset at its standard of performance assessed at the time of estimating the asset’s useful life, and the enterprise’s ability and intention to reach such a level. The useful life of an intangible asset that arises from contractual or other legal rights should not exceed the period of those rights, but may be shorter depending on the period over which the enterprise expects to use the asset.
30 Indefinite Useful Life
U Indefinite Useful Life
No foreseeable limit to the period over which the asset is expected to generate net cash inflows for the enterprise.
On annual basis, need to review for impairment and determine whether events and circumstances continue to support an indefinite useful life.
31 Finite Useful Life Finite Useful Life - Amortisation
U The amortisation amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Amortisation shall begin when the asset is available for use. U Amortisation method used should reflect the pattern of future economic benefits generated from the asset. If that pattern cannot be determined reliably, the straight line method should be used. U The amortisation period and amortisation method should be reviewed at the end of each accounting period.
32 Finite Useful Life Finite Useful Life - Residual Value
U Assumed to be zero unless there is commitment by a third party to purchase the asset at the end of its useful life or there is an active market for the asset. Finite Useful Life – Other Considerations
U If the useful life of an intangible asset was achieved through legal or contractual rights, then its useful life should not exceed the period of those rights, unless the rights were renewable and the renewal was virtually certain.
33 Example 2 Assume that DE Ltd. has capitalised $12m development costs as an intangible asset as at 31/12/2001. DE Ltd. expects the net profit from the sale of the new product developed to be approx. $15m, of which 50% will be earned in 2002, 30% in 2003, and 20% in 2004. Answer : the development costs should be amortised such that $6m(50%) will be charged to 2002 P/L, $3.6m(30%) to 2003 P/L, and $2.4m(20%) to 2004 P/L
34 Impairment All intangible assets (whether with finite or indefinite useful lives) are subjected to impairment test :
U For finite intangible asset : whenever there is an indication that the asset may be impaired U For infinite intangible asset : at least once a year; and also whenever there is an indication that the asset may be impaired
35 Example 3 Assume that LM Ltd. has capitalised $15m development costs as an intangible asset as at 31/12/2001. LM Ltd. expects the recoverable amount from the sale of new product to be approx. $20m and the amount is to be earned evenly from 2002 to 2006. At 1/1/2003 (after the amortisation charge of $3m for 2002 has been made, and when the unamortised amount therefore stands at $12m), it is expected that, due to changes in the market conditions, the recoverable amount in the future will only be $10m (to be earned evenly from 2003 to 2006). Answer : the written-down amount = $12m - $10m = $2m; and the new amortisation charge from 2003 onwards = $10m / 4 yr = $2.5m/yr 36 2002 Example 3
2003 2004 12,000,000 7,500,000 2005 2006 Opening balance 15,000,000 5,000,000 2,500,000 Impairment p (2,000,000) p p p Adjusted balance 15,000,000 10,000,000 7,500,000 5,000,000 2,500,000 Amortisation (3,000,000) (2,500,000) (2,500,000) (2,500,000) (2,500,000) Carrying amount / NBV 12,000,000 7,500,000 5,000,000 2,500,000 - 37 Example 4 Refer to back Eg. 3, assume that at 1/1/2005 (when the unamortised amount stands at $5m), it is expected that, due to changes in the market conditions, the original forecasted recoverable amount of $20m is achievable, and that $4m is expected to be earned in each of the year 2005 and 2006. Answer : the write-down of $2m in 2003 should be written back; and $1m amortisation undercharged in 2003 & 2004 should be reinstated
38 2002 Example 4
2003 2004 12,000,000 (2,000,000) 7,500,000 2005 2006 Opening balance Impairment 15,000,000 5,000,000 3,000,000 Write back impairment 2,000,000 Reinstate amortisation Adjusted balance Amortisation Carrying amount / NBV p 15,000,000 (3,000,000) 12,000,000 p 10,000,000 (2,500,000) 7,500,000 p 7,500,000 (2,500,000) 5,000,000 (1,000,000) 6,000,000 (3,000,000) 3,000,000 p 3,000,000 (3,000,000) - 39 Disposal of Intangible Assets The gain or loss arising from the disposal of investment property is the difference between the net disposal proceeds and the carrying amount gains or losses should be recognised in the income statement in the period of disposal
40 All Intangible Assets – Summary Recognition of I.A. Non-current Assets in F/S Finite Useful Life (with amortization) Indefinite Useful Life (no amortization) Must satisfy the recognition criteria, and there are additional requirements for internally generated I.A. i.e. R & D costs 41 Readings:
U AFA: Chapter 14 U Ref: HKAS 38 U Source: Hui, W.F., and Ng, P.H. (2008). Accounting in Hong Kong. SCOPE. 42 ...
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