Ind AS 38 : Summary of Identification and Recognition of Intangible Assets in Financial Reporting

Many companies are increasing big cost on intangible assets because of future economic benefits.

For example, companies pay salaries to software develops who are developing some sort of programme or a web based application.

Well, we have understood but how would we treat these costs in accounting?

It does not feel good treatment in accounting of above transaction if we put all salaries of these developers in profit or loss when they are incurred, because the company will be going to benefit from these expenses in the upcoming future.

One of the most frequent audit issues that I have faced during my auditing job was the dilemma:

Intangible asset or expense?

So let us go. In this article, you’ll be going to find the short snapshot of the main rules in INDAS 38 Intangible assets.

What assets are covered by INDAS 38?

This standard INDAS 38 shows the methods for accounting for all intangible assets except for the intangible assets covered by another standard.

What is excluded? Here you go: 

• Deferred tax assets – covered by INDAS 12 Income Taxes,
• Goodwill – covered by INDAS 103 Business Combinations,
• Intangible assets held for sale – covered by INDAS 105 Non-Current Assets Held For Sale and Discontinued Operations,
• Financial assets – covered by INDAS 32 Financial Instruments: Presentation and IFRS 9 Financial Instruments,
• Expenditures for development and extraction of minerals, oils, natural gas and other non-regenerative resources, etc.

What is an intangible asset?

An intangible asset is an identifiable untouchable and non-monetary asset which does not physical substance.

That’s the definition from INDAS 38, .

People can interpret the above definition in many different manner, just as they need and therefore, INDAS 38 contains a very good and clear guidance on how to apply it.

When can we identify an intangible asset?

Sometimes it can happen that your item is meeting all the criteria and has all characteristics of an intangible asset, but you still are not able to recognize it in your financial statements.

The reason for above as such could be that your item does not meet the identification and recognition criteria.

You can recognize an intangible asset only when: 

1. Future economic benefits from the asset are probable;
2. Cost can be measured reliably.

When an entity generates the asset internally…

When you are purchasing an item from someone else, it’s relatively easy to determine whether it’s an intangible asset or an expense.

Also, it’s more likely that the recognition criteria shall be met.

But, what about that situation when the entity is actually developing intangible assets itself?

Well, this area is really very complicated and tricky and that’s why INDAS 38 offers specific guidance for internally generated intangible assets.

Research

Research is investigating a fact that you undertake to obtain some information, knowledge or an understanding.

For example, you are analyzing different alternatives for your new designed software product. 

Or, you are examining the competitive products on the market, researching their features and trying to identifying their weaknesses in order to design better product in comparison to you competitor.

You are NOT allowed to capitalize any expenditure pertaining to research activity.

You need to charge it in profit or loss as expense as it is incurred.

And, let me warn you, that yes, all feasibility studies, evaluating whether the project is feasible or not, ARE research activity and required to be EXPENSED in profit or loss.

Yes,even in that case when you have incurred huge money for that activity.

This applies to both internal research and research conducted by the external provider, too.

Development

Development is usually done after the research phase.

At the development phase, you are actually planning or designing the new products, materials, processes, etc. – BEFORE the initiation of commercial production or use.

It is important to differentiate development and research, because yes, you CAN DEFINITELY CAPITALIZE the expenditures for the development phase.

But it’s not that simple.

You have to satisfy 6 criteria before you can capitalize these expenditures on development phase.

If you are preparing yourself for CA Final exam, then the great mnemonic to memorize these 6 criteria is PIRATE: 

1. Probable future economic benefits,
2. Intention to complete and use or sell the asset,
3. Resources adequate and available to complete and use or sell the asset,
4. Ability to use or sell the asset,
5. Technical feasibility,
6. Expenditures can be reliably measured.

Thank you very much to that unknown genius, to invent this mnemonic, I have used it at my own CA Final exam and it worked well!

You can capitalize the development expenditures only when all of the 6 criteria are satisfied – not before that.

Also, you can capitalize it prospectively only.

Just as an example, let’s suppose that you have incurred Rs. 5 000 for development in September 20X1 and further Rs 10 000 in October 20X1.

If you are satisfying all the 6 conditions in October 20X1, you can capitalize only Rs. 10 000 incurred in October. Expenditure of Rs. 5 000 from September must be charged to profit or loss.

Goodwill

Internally generated goodwill is NEVER capitalized.

You can only recognize the goodwill acquired at business combination, but that’s the different story to tell (INDAS 103).

Other internally generated intangible assets

Maybe you must have developed some other intangible assets, like brands, title, trademark, copyright or similar.

INDAS 38 prohibits TO CAPITALIZE these assets if generated internally, because it’s hard to measure their cost reliably.

Measurement of intangible assets initially?

The initial measurement of an intangible asset depends on how you have acquired the asset.

I have provided the summary version it in the following table:

How acquired?	How initially measured?
Separate purchase	Cost – see below
Internally generated	Directly attributable costs incurred after the asset first meet 6 PIRATE criteria – see above
As a part of business combination	Fair value at the acquisition date
By a government grant	Fair value or nominal amount + directly attributable expenditure
Within exchange of assets	Fair value; if not possible, then carrying amount of asset given up

Cost of separately acquired intangible asset

Cost of a separately acquired intangible asset consists of (INDAS 38): 

Its purchase price, plus import duties and non-refundable taxes, less discounts and rebates, 

Any directly attributable costs of preparing the asset for its intended use. 

What about the subsequent measurement?

Intangible assets are subsequently measured in a manner as property, plant and equipment in IND AS 16.

You can chose from 2 models of measuring cost: 

1. Cost model: The intangible asset is carried at its cost less accumulated amortization less any accumulated impairment loss.
2. Revaluation model: The intangible asset is recorded at its fair value at the revaluation date less accumulated amortization less any accumulated impairment loss.

Point to be noted that the revaluation model is not applied very frequently for intangible assets because it is difficult to identity an active market – which is rare.

And, you cannot apply the revaluation model for brands, mastheads, patents, trademarks and similar assets.

The reason is that these assets are very related to the user of intangible assets and very specific and unique and there’s no active market available.

I am not going to deal with journal entries of amortization and revaluations, because they are almost the same as in case of property, plant and equipment.

Amortization and useful life

Similarly as in case of property, plant and equipment, amortization is the allocation of depreciable amount of an intangible asset over its useful life.

Here, you need to take decision about: 

• How much the intangible asset to amortize, or what the depreciable amount is (cost – residual value),
• How long the intangible asset to amortize, or what’s the asset’s useful life, and
• How the intangible asset to amortize, or what amortization method you apply.

However, there’s one very specific about the amortization – it is the useful life of intangible assets acquired from others.

It is possible that Intangibles can have: 

• Finite useful life: In this case you can estimate the life of the asset up front, for example some License, or
• Indefinite useful life: There is no foreseeable limit to period over which the asset will generate cash flows, for example goodwill.

When you have an intangible asset with indefinite useful life, you do NOT need to amortize it.

Instead, you need to revise the asset’s useful life at the end of each financial year and require to identify the indicators of impairment.

Derecognization of intangible assets?

You should derecognize the intangible asset either: 

• When you dispose the asset, or
• When no more future economic benefits are expected to be availed from the asset

The gain or loss on derecognition of intangibles assets is calculated as:

• Net disposal proceeds, less
• Asset’s carrying amount

Gain or loss are always recognized in profit or loss.