The below mentioned article provides an overview on the Valuation of Intangible Assets:- 1. Meaning of Intangible Asset 2. Process of Valuation of Intangible Assets 3. Recognition and Initial Measurement 4. Separate Acquisition 5. Acquisition by Way of a Government Grant 6. Cost of an Internally Generated 7. Recognition of an Expense 8. Amortization 9. Impairment Losses 10. Retirements and Disposals.
- Meaning of Intangible Asset
- Process of Valuation of Intangible Assets
- Recognition and Initial Measurement of Intangible Assets
- Separate Acquisition of Intangible Assets
- Acquisition of Intangible Assets by Way of a Government Grant
- Cost of an Internally Generated Intangible Asset
- Recognition of an Expense on Intangible Asset
- Amortization of Intangible Asset
- Impairment Losses on Intangible Asset
- Retirements and Disposals of Intangible Asset
1. Meaning of Intangible Asset:
According to the Accounting Standard (AS) 26 ‘Intangible Assets’ issued by the Institute of Chartered Accountants of India, an intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
An asset is a resource:
(a) Rolled by an enterprise as a result of past events; and
(b) From which future economic benefits are expected to flow to the enterprise. Monetary assets are money held and assets to be received in fixed or determinable amounts of money. Non-monetary assets are assets other than monetary assets.
An intangible asset must have:
(ii) Control over a resource; and
(iii) Expectation of future economic benefits flowing to be enterprise.
Enterprises often spend resources or incur liabilities on the acquisition, development, maintenance or enhancement of intangible resources such as scientific or technical knowledge, design and implementation of new processes or systems, licences, intellectual property, market knowledge and trademarks (including brand names and publishing titles).
Computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketing rights are common examples of items encompassed by these broad headings. Goodwill is another example of an item of intangible nature which either arises on acquisition or is internally generated.
Many items described in the above paragraph will not meet the definition of an intangible asset, that is, identifiability, control over a resource and expectation of future economic benefits flowing to the enterprise. Expenditure to acquire such an item or to generate it internally is recognised as an expense when it is incurred.
However, if the item is acquired in an amalgamation in the nature of purchase, it forms part of the goodwill recognised at the date of amalgamation.
In some cases, intangible assets may be contained in or on a physical substance such as a compact disk (in the case of computer software), legal documentation (in the case of a licence or patent) or film (in the case of motion pictures).
But where the cost of the physical substance containing the intangible asset is not significant, the physical substance containing an intangible asset, though tangible in nature, is treated as a part of the intangible asset containing in or on it.
Sometimes, an asset may incorporate both intangible and tangible elements that are, in practice, inseparable. In such cases, judgement is required to asses as to which element is prominent in determining whether such an asset should be treated as fixed asset or an intangible asset.
An intangible asset must be identifiable. It must be distinguished from goodwill. Goodwill arising on an amalgamation in the nature of purchase represents a payment made by the purchaser in anticipation of future economic benefits.
An intangible asset can be clearly distinguished from goodwill if the asset is separable. An asset is separable if the enterprise could rent, sell, exchange or distribute the specific future economic benefits attributable to the asset without also disposing of future economic benefits that flow from other assets used in the same revenue earning activity. However, reparability is not a necessary condition for identifiability since an enterprise may be able to identify an asset in some other way.
An enterprise controls an asset if it has the power to obtain the future economic benefits flowing from the underlying resource and also can restrict the access of others to those benefits. Market and technical knowledge may give rise to future economic benefits.
An enterprise controls those benefits if, for example, the knowledge is protected by legal rights such as copyrights, or a restraint of trade agreement, where permitted. The future economic benefits flowing from an intangible asset may include revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the asset by the enterprise.
2. Process of Valuation of Intangible Assets:
Valuation of intangible assets is a complex exercise. The non-physical form of intangible assets makes it difficult to identify the future economic benefits that the enterprise can expect to derive from the intangible assets.
Many intangible assets do not have alternative use and cannot be broken down into components or parts for resale. Further, intangible assets normally do not have an active market. Many times, they are not separable from the business and hence it becomes difficult to value them separately from the business.
There are three approaches used in valuing intangible assets:
(i) Cost approach,
(ii) Market value approach and
(iii) Economic value approach.
The value has to select the approach after considering a number of factors like credibility, objectivity, relevance and practicality. The information’ available will also affect the selection. In cost approach, expenditure incurred in developing the asset is aggregated. If the asset has been purchased recently, its purchase price may be taken to be the cost.
In market value approach, valuation is made by reference to transactions involving similar assets that have taken place recently in similar markets. The approach is possible if there is the existence of an active market of comparable intangible assets and adequate information in respect of transactions that have taken place recently is available.
Economic value approach is based on the cash flows or earnings attributable to those assets and the capitalisation thereof, at an appropriate discount rate or multiple. The value has to identify the cash flows-earnings directly associated with the intangible assets like the cash flows arising from the exploitation of a patent or copyright, licensing of an intangible asset etc.
It is possible only if cash flows from the intangible asset are identifiable from the management accounts and budgets, forecasts or plans of the enterprise.
3. Recognition and Initial Measurement of Intangible Assets:
An intangible asset should be recognised if, and only if,
(a) It is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
(b) The cost of the asset can be measured reliably.
4. Separate Acquisition of Intangible Assets:
If an intangible asset is acquired separately, the cost of the intangible asset can usually be measured reliably. The cost comprises its purchase price, including any import duties and other taxes and any directly attributable expenditure on making the asset ready for its intended use. Directly attributable expenditure includes, for example, professional fees for legal services.
Any trade discounts and rebates are deducted in arriving at the cost. If an intangible asset is acquired in exchange for shares or other securities of the reporting enterprise, the asset is recorded at its fair value , or the fair value of the securities issued, whichever is more clearly evident.
Acquisition of Intangible Assets as part of an Amalgamation:
An intangible asset acquired in an amalgamation in the nature of purchase is accounted for in accordance with Accounting Standard (AS) 14 – Accounting for Amalgamations. Judgement is required to determine whether the cost (i.e. fair value) of an intangible asset acquired in an amalgamation can be measured with sufficient reliability for the purpose of separate recognition.
Quoted market prices in an active market provide the most reliable measurement of fair value. If no active market exists for an asset; its cost reflects the amount that the enterprise would have paid, at the date of the acquisition, for the asset in an arm’s length transaction between knowledgeable and willing parties, based on the best information available.
Certain enterprises that are regularly involved in the purchase and sale of unique intangible assets have developed techniques for estimating their fair values indirectly. These techniques include applying multiples reflecting current market transactions to certain indicators driving the profitability of the asset, such as revenue, market shares, operating profit etc.; or discounting estimated future net cash flows from the assets.
In amalgamation in the nature of purchase, a transferee recognises an intangible asset that meets the recognition criteria, even if that intangible asset had not been recognised in the financial statements of the transferor.
If the cost (i.e., fair value) of an intangible asset acquired cannot be measured reliably, that asset is not recognised as a separate intangible asset but is included in goodwill. Further, unless there is an active market for an intangible asset acquired, the cost initially recognised for the intangible asset is restricted to an amount that does not create or increase any capital reserve arising at the date of the amalgamation.
5. Acquisition of Intangible Assets by Way of a Government Grant:
An intangible asset may be acquired free of charge or for nominal consideration, by way of a government grant. This may happen when a government transfers or allocates to an enterprise intangible assets such as airport landing rights, licences to operate radio or television stations, import licences or quotas or rights to access other restricted resources.
Such an intangible asset is recognised at a nominal value or at the acquisition cost, as appropriate. Any expenditure that is directly attributable to making the asset ready for its intended use is also included in the cost of the asset.
Internally Generated Intangible Asset:
First of all, it should be remembered that internally generated goodwill should not be recognised as an asset.
To assess whether an internally generated intangible asset meets the criteria for recognition, an enterprise should classify the generation into (a) research phase and (b) development phase. If it is not possible to distinguish the research phase from the development phase, the enterprise should treat the entire expenditure as having been spent on research phase.
No intangible asset arising from research (or from the research phase of an internal project) should be recognised; such expenditure should be treated as an expense when it is incurred. Examples of research activities are activities aimed at obtaining new knowledge and the search for alternatives for materials, devices, products, processes, systems or services etc.
An intangible asset arising from development (or from the development phase of an internal project) should be recognised if, and only if, an enterprise can demonstrate all of the following:
(a) The technical feasibility of completing the intangible asset so that it will be available for use or sale,
(b) Its intention to complete the intangible asset and use or sell it,
(c) Its ability to use or sell the intangible asset
(d) How the intangible asset will generate probable future economic benefits. For example, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or if it is to used internally, the usefulness of the intangible asset.
(e) The availability of adequate technical, financial or other resources to complete the development and to use or sell the intangible asset, and
(f) Its ability to measure the expenditure attributable to the intangible asset during its development reliably.
Examples of development activities are:
(a) The design, construction and testing of pre-production or pre-use prototypes and models.
(b) The design of tools, jigs, moulds and dies involving new technology,
(c) The design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production, and
(d) The design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services.
Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance should not be recognised as intangible assets.
6. Cost of an Internally Generated Intangible Asset:
The cost of an internally generated intangible asset is the sum of expenditure incurred from the time when the intangible asset first meets the recognition criteria. Reinstatement of expenditure recognised as an expense in previous annual financial statements or interim financial reports is prohibited.
The cost of an internally generated intangible asset comprises of all expenditure that can be directly attributed or allocated on a reasonable and consistent basis to creating, producing and making the asset ready for its intended use.
The cost includes, if applicable:
(a) Expenditure on materials and services used or consumed in generating the intangible asset;
(b) The salaries, wages and other employment related cost of personnel directly engaged in generating the asset;
(c) Any expenditure that is directly attributable to generating the asset, such as fees to register a legal right and the amortization of patents and licences that are used to generate the asset; and
(d) Overheads that are necessary to generate the asset and that can be allocated on a reasonable and consistent basis to the asset (for example an allocation of the depreciation of fixed assets, insurance premium and rent).
Allocations of overheads are made on bases similar to those used in allocating overheads to inventories. AS 16, Borrowing Costs, establishes criteria for the recognition of interest as a component of the cost of a qualifying asset. These criteria are also applied for the recognition of interest as a component of the cost of an internally generated intangible asset.
The following are not components of the cost of an internally generated intangible asset:
(a) selling, administrative and other general overheads unless the expenditure can be directly attributed to making the asset ready for use.
(b) clearly identified inefficiencies and initial operating loss incurred before an asset achieves planned performance; and
(c) expenditure on training the staff to operate the asset.
7. Recognition of an Expense on Intangible Asset:
Expenditure on an intangible item should be recognised as an expense when it is incurred unless.
(a) it forms part of the cost of an intangible asset that meets the recognition criteria;
(b) the item is acquired in an amalgamation in the nature of purchase and cannot be recognised as an intangible asset. In this case, this expenditure (included in the cost of acquisition) should form part of the amount attributed to goodwill (capital reserve) at the date of acquisition.
In some cases, expenditure is incurred to provide future economic benefits to an enterprise, but no intangible asset or other asset is acquired or created that can be recognised. In these cases, the expenditure is recognised as an expense when it is incurred. Expenditure on research is always as an expense when it is incurred.
A few other examples are:
(a) expenditure on start-up activities i.e., start-up costs, unless this expenditure is included in the cost of a fixed asset. Start-up costs may consist of preliminary expenses incurred in establishing a legal entity;
(b) expenditure on training activities;
(c) expenditure on advertising and promotional activities; and
(d) expenditure on relocating or recognising part or all of an enterprise.
Subsequent Expenditure on Intangible Assets:
Subsequent expenditure on an intangible asset after its purchase or its completion should be recognised as an expense when it is incurred unless:
(a) It is probable that the expenditure will enable the asset to generate future economic benefits in excess of its originally assessed standard of economic performance; and
(b) The expenditure can be measured; and attributed to the asset reliably.
If the abovementioned conditions are fulfilled, the subsequent expenditure should be added to the cost of the intangible asset.
After initial recognition, an intangible asset should be carried at its cost less any accumulated amortization and any accumulated impairment losses.
The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life.
There is a rebuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use. The cost of the asset less any residual value is allocated over the useful life as an expense following a systematic method.
The amortization method should reflect the pattern in which the asset’s economic benefits are consumed by the enterprise. If that pattern cannot be determined reliably, straight line method should be used.
Sometimes, the economic benefits embodied in an asset are absorbed by the enterprise in producing other assets. In such cases, the amortization charge forms part of the cost of the other asset. For example, the amortization of intangible assets used in a production process is included in the carrying amount of inventories.
The residual value of an intangible asset should be assumed to be zero unless:
(a) There is a commitment by a third party to purchase the asset at the end of its useful life, or
(b) There is an active market for the asset and
(c) Residual value can be determined by reference to that market, and
(D) It is probable that such a market will exist at the end of the asset’s useful life.
Review of Amortisation Period and Amortisation Method:
The amortisation period and the amortisation method should be reviewed at least at each financial year end. If the expected useful life is significantly different, the amortisation period should be changed accordingly.
Similarly, if there has been a significant change in the expected pattern of economic benefits from the asset, the amortisation method should be changed to reflect the changed pattern. Such changes should be accounted for in accordance with AS-5, Net Profit or Loss for the Period; Prior Period Items and Changes in Accounting Policies.
9. Impairment Losses on Intangible Asset:
To determine whether an intangible asset is impaired, an enterprise applies Accounting Standard on Impairment of Assets which explains how an enterprise reviews the carrying amount of its assets, how it determines the recoverable amount of an asset and when it recognises or reverses an impairment loss.
If an impairment loss occurs before the end of the first annual accounting period commencing after acquisition for an intangible asset acquired in an amalgamation in the nature of purchase, the impairment loss is recognised as an adjustment to both the amount assigned to the intangible asset and the goodwill (capital reserve) recognised at the date of the amalgamation, provided the loss does not relate to specific events or changes in circumstances occurring after the date of acquisition.
An enterprise should estimate the recoverable amount of the following intangible assets at least at each financial year and even if there is no indication that the asset is impaired:
(a) an intangible asset that is not yet available for use; and
(b) an intangible asset that is amortized over a period exceeding ten years from the date when the asset is available for use.
10. Retirements and Disposals of Intangible Asset:
An intangible asset should be derecognized (eliminated from the balance sheet) on disposal or when no future economic benefits are expected from its use and subsequent disposal. Gains or losses arising from the retirement or disposal of an intangible asset should be recognised as income or expense, as the case may be, in the income statement of the accounting year in which the retirement or disposal takes place.