9 intangible assets

9 INTANGIBLE ASSETS
PERSPECTIVE AND ISSUES

Long-lived assets are those that will provide economic
benefits to an enterprise for a number of future periods.
Accounting standards regarding long-lived assets involve
determination of the appropriate cost at which to record
the assets initially, the amount at which to present the
assets at subsequent reporting dates, and the appropriate
method(s) to be used to allocate the cost or other recorded
values over the periods being benefited. Under
international accounting standards, while historical cost is
the defined benchmark treatment, revalued amounts may
also be used for presenting long-lived assets in the
statement of financial position if certain conditions are
met.
Long-lived assets are primarily operational in character,
and they may be classified into two basic types: tangible
and intangible. Tangible assets have physical substance,
while intangible assets either have no physical substance,
or have a value that is not conveyed by what physical
substance they do have (e.g., the value of computer
software is not reasonably measured with reference to the
cost of the diskettes on which these are contained).
The value of an intangible asset is a function of the rights
or privileges that its ownership conveys to the business
enterprise. Intangible assets can be further categorized as
either
1. Identifiable, or
2. Unidentifiable (i.e., goodwill).
Identifiable intangibles include patents, copyrights, brand
names, customer lists, trade names, and other specific
rights that typically can be conveyed by an owner without

necessarily also transferring related physical assets.
Goodwill, on the other hand, cannot be meaningfully
transferred to a new owner without also selling the other
assets and/or the operations of the business.
Research and development costs are also addressed in this
chapter. Formerly the subject of a separate international
standard (IAS 9), but more recently guided by the standard
covering all intangibles (IAS 38), research costs must be
expensed as incurred, whereas development costs, as
defined and subject to certain limitations, are to be
classified as assets and amortized over the period to be
benefited.
The standard on impairment of assets (IAS 36) pertains to
both tangible and intangible long-lived assets. This
chapter will consider the implications of this standard for
the accounting for intangible assets. The matter of
goodwill, an unidentifiable intangible asset deemed to be
the residual cost of a business combination accounted for
as an acquisition, has been addressed by IAS 22 and is
covered in Chapter 11; accounting for all other
intangibles, addressed in IAS 38, is discussed in this
chapter.
As part of its twin projects considering revisions to the
standards on business combinations and related topics,
which are now anticipated to result in new or revised
standards no earlier than 2004, the IASB has been
reviewing the accounting for intangibles in general. The
objective is for the accounting for acquired intangibles,
including goodwill and in-process research and
development, to be made more consistent with that
prescribed for intangibles acquired by other means or
internally generated by the reporting entity.

With regard to goodwill (discussed in greater detail in
Chapter 11, Business Combinations and Consolidated
Financial Statements, it is expected that an acquirer will be
required, as of the acquisition date to
1. Recognize goodwill acquired in a business
combination as an asset; and
2. Initially measure that goodwill at its cost, being the
excess of the cost of the business combination over the
acquirer’s interest in the net fair value of the identifiable
assets, liabilities, and any contingent liabilities recognized.
It is well established that goodwill acquired in a business
combination represents a payment made by the acquirer in
anticipation of future economic benefits from assets that
are not capable of being individually identified and
separately recognized. To the extent that the acquiree’s
identifiable assets, liabilities, or contingent liabilities do
not satisfy the criteria for separate recognition at the
acquisition date, there is a resulting impact on the amount
recognized as goodwill. This is because goodwill is
measured as the residual cost of the business combination
after recognizing the acquiree’s identifiable assets,
liabilities, and contingent liabilities.
Under the anticipated IAS revisions, subsequent to initial
recognition, the acquiring entity will be required to
measure goodwill acquired in a business combination at
cost less any accumulated impairment losses. This will
essentially replicate the approach adopted under US
GAAP (SFAS 142), which is a stark departure from
historical practice. Rather than being amortized over its
estimated economic life, goodwill acquired in a business
combination will have to be tested for impairments
annually, or more frequently if events or changes in

circumstance indicate that it might be impaired, in
accordance with IAS 36.
Sources of IAS
IAS 36, 38 SIC 6, 32
DEFINITIONS OF TERMS
Amortization. In general, the systematic allocation of the
cost of a long-term asset over its useful economic life; the
term is also used specifically to define the allocation
process for intangible assets.
Carrying amount. The amount at which an asset is
presented on the balance sheet, which is its cost (or other
allowable basis), net of any accumulated depreciation and
impairment losses.
Cash generating unit. The smallest identifiable group of
assets that generates cash inflows from continuing use,
largely independent of the cash inflows associated with
other assets or groups of assets.
Corporate assets. Assets, excluding goodwill, that
contribute to future cash flows of both the cash generating
unit under review for impairment and other cash
generating units.
Cost. Amount of cash or cash equivalent paid or the fair
value of other consideration given to acquire or construct
an asset.
Depreciable amount. Cost of an asset or the other amount
that has been substituted for cost, less the residual value of
the asset.
Depreciation. Systematic and rational allocation of the
depreciable amount of an asset over its economic life.
Development. 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 prior to

commencement of commercial production or use. This
should be distinguished from research.
Fair value. Amount that would be obtained for an asset in
an arm’s-length exchange transaction between
knowledgeable willing parties.
Goodwill. The excess of the cost of a business
combination accounted for as an acquisition over the fair
value of the net assets thereof, to be amortized over its
useful economic life that, as a rebuttable presumption, is
no greater than twenty years.
Impairment loss. The excess of the carrying amount of an
asset over its recoverable amount.
Intangible assets. Nonmonetary assets without physical
substance that are held for use in the production or supply
of goods or services or for rental to others, or for
administrative purposes, which are identifiable and are
controlled by the enterprise as a result of past events, and
from which future economic benefits are expected to flow.
Monetary assets. Assets whose amounts are fixed in terms
of units of currency. Examples are cash, accounts
receivable, and notes receivable.
Net selling price. The amount which could be realized
from the sale of an asset by means of an arm’s-length
transaction, less costs of disposal.
Nonmonetary transactions. Exchanges and nonreciprocal
transfers that involve little or no monetary assets or
liabilities.
Nonreciprocal transfer. Transfer of assets or services in
one direction, either from an enterprise to its owners or
another entity, or from owners or another entity to the
enterprise. An enterprise’s reacquisition of its outstanding
stock is a nonreciprocal transfer.

Recoverable amount. The greater of an asset’s net selling
price or its value in use.
Research. The original and planned investigation
undertaken with the prospect of gaining new scientific or
technical knowledge and understanding. This should be
distinguished from development.
Residual value. Estimated amount expected to be
obtained on ultimate disposition of the asset after its useful
life has ended, net of estimated costs of disposal.
Useful life. Period over which an asset will be employed
in a productive capacity, as measured either by the time
over which it is expected to be used, or the number of
production units expected to be obtained from the asset by
the enterprise.
CONCEPTS, RULES, AND EXAMPLES
Background
Over the years, the role of intangible assets has grown
more important for the operations and prosperity of many
types of businesses, as the “knowledge-based” economy
becomes more dominant. However, until recently,
accounting standards have tended to give scant attention
to, or ignore entirely, the appropriate means of reporting
upon such assets. As a consequence, practice has been
exceptionally diverse, with enterprises in nations whose
standards had not addressed accounting for intangibles
typically being much more aggressive in capitalizing a
range of intangibles, including internally generated
goodwill, vis-à-vis those entities operating under more
strictly defined rules limiting cost deferral and requiring
rapid amortization of those costs which could be deferred.
Thus, in many countries it has been common practice to
defer recognition of certain types of expenditures,
including advertising costs and setup costs, the future

benefits of which are very difficult to demonstrate. In
addition, when intangibles such as “brand names” and
“internally generated goodwill” have been capitalized,
there has often been a great reluctance to amortize the
costs against earnings over a reasonable time horizon, on
the basis that these have either indefinite or infinite lives.
While advocates for such practices have made the claim
that future benefits will flow from such expenditures (else,
why incur those costs?), experience has shown that these
deferrals often result in a subsequent year in large “big
bath” write-offs. This pattern of foregone periodic
expense and sporadic charge-offs clearly impedes the
utility of financial statements for one of their primary
purposes, namely, the predicting of future economic
performance (both in terms of earnings and cash flows) of
the reporting entity. While all can agree that predicting
the useful economic lives of certain intangibles is
exceptionally challenging, the need to honor the matching
principle and to provide relevant information for use by
investors, creditors and others has driven most standard
setters to impose rather stringent requirements on the
recognition and measurement of intangible assets.
International accounting standards first addressed
accounting for intangibles in a thorough way with IAS 38,
which was promulgated after a rather long and contentious
gestation period that included the issuance of two
Exposure Drafts. IAS 38 is a comprehensive standard
which superseded an earlier standard dealing solely with
research and development expenditures. It establishes
recognition criteria, measurement bases, and disclosure
requirements for intangible assets. The standard also
prescribes impairment testing for intangible assets, to be
undertaken on a regular basis. This is to ensure that only

assets having recoverable values are capitalized and
carried forward to future periods.
It is interesting to note that in prescribing the amortization
period, IAS 38 has ruled out the concept of intangible
assets having infinite or indefinite lives. In fact, by
imposing additional burdens on those who would assign
lives greater than twenty years to such assets, the standard
set a rather conservative approach to recognition and
measurement of intangibles. However, the IASB is
currently weighing revisions that would remove the
refutable presumption of a twenty-year maximum
economic life and would further acknowledge the
existence of indefinite-life intangibles, not subject to
amortization at all (at least, until a finite life was
determinable). These potential revisions are being
pondered largely as part of IASB’s effort to “converge” its
standards, in this case to the recently revised US GAAP
standards on business combinations and intangibles. If
adopted, goodwill will no longer be subject to
amortization, but will have to be evaluated for impairment
regularly, reversing the position taken by IAS 38. (See
further discussion in Chapter 11.)
Also, by simultaneously withdrawing the existing standard
on research and development costs (the former IAS 9) and
revising the standard on business combinations (IAS 22),
the former IASC considerably streamlined and
rationalized the accounting standards relating to
accounting for intangible assets. As the rules presently
exist, therefore, they do form a coherent and consistent set
of requirements for the financial reporting on all such
assets.
Scope of the standard. The standard applies to all
enterprises. It prescribes the accounting treatment for

intangible assets, including development costs. However,
it does not apply to intangible assets covered by other IAS;
for instance, deferred tax assets covered under IAS 12,
leases that fall within the purview of IAS 17, goodwill
arising on a business combination and dealt with by IAS
22, assets arising from employee benefits that are covered
by IAS 19, and financial assets as defined by IAS 32 and
covered by IAS 27, 28, 31, and 39. This standard does not
apply to intangible assets arising in insurance companies
from contracts with policyholders, nor to mineral rights
and the costs of exploration for, or development and
extraction of, minerals, oil, natural gas, and similar
nonregenerative resources. However, the standard does
apply to intangible assets that are used to develop or
maintain these activities.
Identifiable intangible assets include patents, copyrights,
licenses, customer lists, brand names, import quotas,
computer software, leasehold improvements, marketing
rights, and specialized know-how. These items have in
common the fact that there is little or no tangible
substance to them, they have an economic life of greater
than one year, and they have a decline in utility over that
period which can be measured or reasonably assumed. In
many but not all cases, the asset is separable; that is, it
could be sold or otherwise disposed of without
simultaneously disposing of or diminishing the value of
other assets held.
Intangible assets are, by definition, assets that have no
physical substance. However, there may be instances
where intangibles also have some physical form. For
example

• There may be tangible evidence of an asset’s
existence, such as a certificate indicating that a patent had
been granted, but this does constitute the asset itself;
• Some intangible assets may be contained in or on a
physical substance such as a compact disc (in the case of
computer software); and
• Identifiable assets that result from research and
development activities are intangible assets because the
tangible prototype or model is secondary to the knowledge
that is the primary outcome of those activities.
In the case of assets that have both tangible and intangible
elements, there may be some confusion about whether to
classify them as tangible or intangible assets.
Considerable judgment is required in properly classifying
such assets as either intangible or tangible assets. As a
rule of thumb, the asset should be classified as either an
intangible asset or a tangible asset based on the relative or
comparative dominance or significance of the tangible or
the intangible component (or element) of the asset. For
instance, computer software that is not an integral part of
the related hardware equipment is treated as software (i.e.,
as an intangible asset). Conversely, certain computer
software, such as the operating system, that is essential
and an integral part of a computer, is treated as part of the
hardware equipment (i.e., as property, plant, and
equipment as opposed to an intangible asset).
The concept embodied in this standard is somewhat
controversial, and in some respects also vague and
unclear, being subjective and open to interpretation. In
various attempts to explain this concept, different
techniques have been used by commentators. Some have
restricted themselves to detailed examples, while others
(perhaps exhibiting over enthusiasm to clarify the concept)

have gone further, even so far as to argue that IAS 38
draws a distinction between an “intangible asset” and an
“intangible resource.” In this typology, the latter
expression has been conceived of a broader concept that
includes intangible assets (as defined by IAS 38), as well
as other hypothetical assets. For example, intangible
resources would include not only items such as patents
and copyrights (which would meet the qualifying criteria
set forth for intangible assets in IAS 38), but also items
such as customer lists and internally generated brands
(which do not meet the definition of intangible assets).
While this may serve some useful purpose, the coining of
a phrase such as “intangible resources” (which is found
neither in the IASC Framework nor in IAS 38) to be used
in distinction from the term “intangible asset,” is ill-
advised. Given the fact that IAS 38 (paragraph 7) has
defined an asset as a “resource…controlled by the
enterprise…”, the creation of alternative definitions and
concepts is probably not appropriate.
Recognition Criteria
Identifiable intangible assets have much similarity to
tangible long-lived assets (property, plant, and
equipment), and the accounting for them is accordingly
very similar. The key criteria for determining whether
intangible assets are to be recognized are
1. Whether the intangible asset has an identity separate
from other aspects of the business enterprise;
2. Whether the use of the intangible asset is controlled
by the enterprise as a result of its past actions and events;
3. Whether future economic benefits can be expected to
flow to the enterprise; and
4. Whether the cost of the asset can be measured
reliably.

Identifiability. As to the first issue, the principal concern
is to distinguish these intangibles from goodwill arising
from a business combination, the accounting for which is
addressed by IAS 22. Goodwill is the residual cost of a
business acquisition that cannot be assigned either to
tangible assets, net of any liabilities assumed, or to
identifiable intangibles. Unlike identifiable intangibles,
goodwill cannot be separated from the assets (the physical
as well as the identifiable intangible) it was acquired with.
Since goodwill cannot be severed and sold, its real value is
often questioned and the period over which it can be
amortized is, accordingly, often made as brief as possible.
(But note that goodwill may become a nonamortizing,
impairment-tested asset under a revised or superseded IAS
22; see Chapter 11 for a discussion.)
To capitalize the cost of an intangible asset other than
goodwill, it must have an independently observable
existence and a cost that can be assigned to it.
Independently observable existence can be established if
the enterprise can rent, sell, exchange, or distribute the
future economic benefits from the assets without also
disposing of other assets; that is, that an owner can convey
them without necessarily also transferring related physical
assets. Goodwill, on the other hand, cannot be
meaningfully transferred to a new owner without also
selling other assets, and hence, will not meet the
recognition criteria for intangible assets as defined by IAS
38.
Identifiability can be demonstrated by a legal right over an
asset or by the fact that the asset is separable from the rest
of the business. It is worth noting that while IAS 38 does
not regard “separability” as an additional recognition
criterion, some national standards (UK GAAP, for

instance) still retain it as one of the qualifying criteria for
recognition. At the time it adopted IAS 38, the IASC
Board rejected the views of commentators on the
antecedent Exposure Drafts who had advocated the
inclusion of “separability” as an additional recognition
criterion. In setting forth the basis for its conclusions, the
Board cited several reasons for this rejection. Among
these, perhaps the most noteworthy is the following:
…if a “separability” criterion was applicable to all
intangible assets, many intangible assets (for example, a
license to operate a radio station) would not be shown
separately in the financial statements even if they meet the
(IASC) Framework’s definition of, and recognition criteria
for, an asset.
While not supportive of imposing separability as a
threshold criterion for intangible assets, IASC supported
the view that
1. Demonstration of the separability of an asset can
assist an enterprise in identifying an intangible asset; and
2. The inability of an enterprise to demonstrate the
separability of an asset will make it harder to demonstrate
that there is an identifiable intangible asset.
Currently, IASB is embarked upon a thorough review of
accounting for business combinations, a corollary of
which is the accounting for intangibles (including
goodwill and in-process research and development)
acquired in such combinations. Based on deliberations to
mid-2002, it appears that the existing philosophy for
intangible asset recognition will be essentially continued.
A replacement for IAS 22 will likely stipulate that
intangible assets acquired in a business combination
should be recognized separately from goodwill if they
arise as a result of contractual or legal rights or are

separable from the business. The existence of contractual
or legal rights and separability will not, however, form
part of the definition of an asset, but rather, will serve as
indicators that an entity controls the future economic
benefits embodied in the item. It would appear, therefore,
that neither of these characteristics are intended to be
absolute requirements, which would continue current
practice in this area.
Control. The provisions of IAS 38 require that an
enterprise should be in a position to control the use of the
intangible asset. Control implies the power to both obtain
future economic benefits from the asset as well as restrict
the access of others to those benefits. Normally
enterprises register patents, copyrights, etc. to ensure its
control over an intangible asset. A patent gives the holder
the exclusive right to use the underlying product or
process without any interference or infringement from
others. Intangible assets arising from technical knowledge
of staff, customer loyalty, long-term training benefits, etc.,
will have difficulty meeting this recognition criteria in
spite of expected future economic benefits from them.
This is due to the fact that the enterprise would find it
impossible to fully control these resources or to prevent
others from controlling them.
For instance, even if an enterprise incurs considerable
expenditure on training that will supposedly increase staff
skills, the economic benefits from skilled staff cannot be
controlled, since trained employees could leave their
current employment and move on in their career to other
employers. Hence, staff training expenditures, no matter
how material in amount, do not qualify as an intangible
asset. In other words, the practice of deferring training
costs based on the reasoning that future economic benefits

from enhanced staff skills will flow to the enterprise can
no longer be justified, after the promulgation of the IAS
on Intangible Assets. Other often-quoted examples of
expenses that do not qualify as intangible assets based on
the criterion of control are market share, customer
relationships, customer loyalty (unless protected by
enforceable legal rights), and portfolio of clients.
Future economic benefits. Under IAS 38, it is mandated
that an intangible asset be recognized only if it is probable
that future economic benefits specifically associated
therewith will flow to the reporting entity, and the cost of
the asset can be measured reliably. The recognition
criteria for intangible assets are derived from the (IASC)
Framework and are similar to the recognition criteria for
tangible assets (property, plant, and equipment).
The future economic benefits envisaged by the standard
may take the form of revenue from the sale of products or
services, cost savings, or other benefits resulting from the
use of the intangible asset by the enterprise. A good
example of other benefits resulting from the use of the
intangible asset is the use by an enterprise of a secret
formula (which the enterprise has protected legally) that
leads to reduced future production costs (as opposed to
increased future revenue).
Measurement of Cost of Intangibles
The conditions under which the intangible asset has been
acquired will determine the measurement of cost.
The cost of an intangible asset acquired separately is
determined in a manner largely analogous to that for
tangible long-lived assets as described in Chapter 8. Thus,
the cost comprises the purchase cost, including any taxes
and import duties, less any trade discounts and rebates,
plus any directly attributable expenditures incurred in

preparing the asset for its intended use. Directly
attributable expenditures would include fully loaded labor
costs, thus including employee benefits arising directly
from bringing the asset to its working condition. It would
also include professional fees and other costs.
As with tangible assets, capitalization of costs ceases at
the point when the intangible asset is ready to be placed in
service in the manner intended by management. Any costs
incurred in using or redeploying intangible assets are
accordingly to be excluded from the cost of those assets.
Thus, any costs incurred while the asset is capable of
being used in the manner intended by management, but
while it has yet to be placed into service, would be
expenses, not capitalized. Similarly, initial operating
losses, such as those incurred while demand for the asset’s
productive outputs is being developed, cannot be
capitalized. On the other hand, further expenditures made
for the purpose of improving the asset’s level of
performance would qualify for capitalization.
Changes being made to IAS 38 as a consequence of the
IASB’s Improvements Project will emphasize the fact that
certain operations may occur in connection with the
development of an intangible asset, but not be necessary in
order to bring the asset to the condition where it would be
capable of operating in the manner intended by
management. These incidental operations could occur
either before or during the development activities.
Because by definition such operations are not necessary to
bring an asset to the condition necessary for it to be
capable of operating in the manner intended by
management, the income and related expenses of
incidental operations must be recognized in the operating

results for the current period, to be reported in the
respective classification of income and expense.
Under IAS 38, a condition for the recognition of an
intangible asset is that the cost of the asset can be
measured reliably. The changes made to IAS 38
consequent to the IASB’s Improvements Project clarified
that the reporting entity would be unable to determine
reliably the fair value of an intangible asset when
comparable market transactions are infrequent and when
alternative estimates of fair value (e.g., those based on
discounted cash flow projections) cannot be calculated.
Furthermore, the cost of an intangible asset acquired in
exchange for a similar asset would be measured at the
carrying amount of the asset given up when the fair value
of neither of the assets exchanged could be easily
determined reliably.
In some situations, identifiable intangibles are acquired as
part of a business combination or other bulk purchase
transaction. According to the provisions of IAS 38, the
cost of an intangible asset acquired as part of a business
combination is its fair value as at the date of acquisition.
If the intangible asset can be freely traded in an active
market, then the quoted market price is the best
measurement of cost. If the intangible asset has no active
market, then cost is determined based on the amount that
the enterprise would have paid for the asset in an arm’s-
length transaction at the date of acquisition. If the cost of
an intangible asset acquired as part of a business
combination cannot be measured reliably, then that asset is
not recognized, but rather, is included in goodwill.
Under US GAAP, the aggregate purchase cost is to be
allocated to assets acquired and liabilities assumed. If one
or more of the assets are intangibles, the extent of

judgment required in the allocation process becomes
somewhat greater than would otherwise be the case; in
extreme situations it may be impossible to determine how
much, if any, of the aggregate cost should be allocated to
intangibles. It is most likely to be determinable when the
intangibles were actually negotiated for in the transaction
rather than being thrown in to the deal. Furthermore, if
the allocation of the purchase price to individual assets is
accomplished by applying discounted present value
measures to future revenue streams, unless this same
process is usable with regard to the intangibles, it is likely
that any unallocated purchase price will have to be
assigned to goodwill.
In some instances, intangible assets are obtained in
exchange for equity instruments of the reporting entity.
The revisions to IAS 38 will stipulate that under such
circumstances the cost of the asset is the fair value of the
equity instruments issued. Where the fair value for the
item received is more clearly evident than the fair value of
the equity instruments issued, however, that should be
used to measure its cost.
In other situations, intangible assets may be acquired in
exchange or part exchange for other dissimilar intangible
assets or other assets. Unless the “like-kind” exception
described in the following paragraph applies, the costs of
the assets obtained are measured at the fair values of the
assets given up, adjusted by the amount of any cash or
cash equivalents transferred. However, if the fair values
of the assets received are more clearly evident than the fair
values of the assets given up, those values are to be used
to measure the transaction. These procedures are
predicated upon the ability to reliably measure costs;
absent this ability, as when comparable market

transactions are infrequent and alternative estimates of fair
value (e.g., based on discounted cash flow projections)
cannot be calculated, acquired assets would not be subject
to recordation.
The revisions to IAS 38 also will establish accounting
procedures for what is commonly known as a like-kind
exchange. In such instances, the cost of an intangible
asset acquired is measured at the carrying amount of the
asset given up when the fair value of neither of the assets
exchanged can be determined reliably.
Internally generated goodwill is not recognized as an
intangible asset because it fails to meet the recognition
criteria 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 the
desire to recognize internally generated goodwill based on
the premise that at a certain point in time the market value
of an enterprise exceeds the carrying value of its
identifiable net assets. However, as IAS 38 categorically
points out, such differences cannot be considered to
represent the cost of intangible assets controlled by the
enterprise, and hence, would not meet the criteria for
recognition (i.e., capitalization) of such an asset on the
books of the enterprise.
Intangibles acquired by means of government grants. If
the intangible is acquired free of charge or by payment of
nominal consideration, as by means of a government grant
(e.g., when the government grants the right to operate a
radio station) or similar program, and assuming the
benchmark accounting treatment (historical cost) is
employed, obviously there will be little or no amount

reflected as an asset. If the asset is important to the
reporting entity’s operations, however, it must be
adequately disclosed in the notes to the financial
statements. If the allowed alternative (fair value) method
is used, the fair value should be determined by reference
to an active market. However, given the probable lack of
an active market, since government grants are generally
not transferable, it is unlikely that this situation will be
encountered. If an active market does not exist for this
type of an intangible asset, the enterprise must recognize
the asset at cost. Cost would include those that are
directly attributable to preparing the asset for its intended
use.
Intangibles Acquired through an Exchange of Assets
If an intangible asset is acquired in exchange or partial
exchange for a dissimilar intangible or other asset, then the
cost of the asset is measured at its fair value. This amount
is to be ascertained by reference to the fair value of the
asset received, which is equivalent to the fair value of the
asset given up in the exchange, adjusted for any cash or
cash equivalents transferred.
If the exchange involves similar assets to be used by the
enterprise in essentially the same manner and for the same
purpose as the item given up in the exchange, the
exchange is not deemed to be the culmination of an
earnings process, and accordingly, no gain or loss is
recognized. The new asset will be recorded at the carrying
amount of the asset given up, adjusted for any cash or cash
equivalent (often called “boot”) given or received.
Internally Generated Intangibles other than Goodwill
In many instances, intangibles are generated internally by
an entity, rather than being acquired via a business
combination or some other purchase transaction. Because

of the nature of intangibles, the actual measurement of the
cost (i.e., the initial amounts at which these could be
recognized as assets) can prove to be rather challenging in
practice, and for that reason, historically there was
somewhat of a bias against recognition of internally
generated intangible assets. However, a failure to
recognize such assets would not only cause the entity’s
balance sheet to underreport its economic resources, but
would also result in a mismatching of income and expense
in both the period of expenditure and later periods when
the related benefits would be reaped. Accordingly, IAS 38
provides that internally generated intangible assets,
provided certain criteria are met, are to be capitalized and
amortized over the projected period of economic utility.
Under the now-superseded IAS 9, it was established that
research costs were to be expensed as incurred, but that
development costs were to be deferred (i.e., capitalized)
and expensed over the periods of expected benefit. IAS
38 absorbed the guidance formerly found in IAS 9 and
expanded it to cover other internally generated intangible
assets. Thus, expenditures pertaining to the creation of
intangible assets are to be classified alternatively as being
indicative of, or analogous to, research activity or
development activity. The former costs are expensed as
incurred; the latter are capitalized, if future economic
benefits are reasonably likely to be received by the
reporting entity. Per IAS 38,
1. Costs incurred in the research phase are expensed
immediately; and
2. If costs incurred in the development phase meet the
recognition criteria for an intangible asset, such costs
should be capitalized. However, once costs have been

expensed during the development phase, they cannot later
be capitalized.
In practice, distinguishing research-like expenditures from
development-like expenditures may not be easily
accomplished. This would be especially true in the case of
intangibles for which the measurement of economic
benefits cannot be performed in anything approximating a
direct manner. Assets such as brand names, mastheads,
and customer lists can prove quite resistant to such direct
observation of value (although in many industries there are
benchmark monetary amounts commonly associated with
such items, such as the oft-expressed notion that a
customer list in the securities brokerage business is worth
$1,500 per name, implying the amount of avoidable
promotional costs each qualified name is worth).
Thus, entities may incur certain expenditures in order to
enhance brand names, such as engaging in image-
advertising campaigns, but these costs will also have
ancillary benefits, such as promoting specific products that
are being sold currently, and possibly even enhancing
employee morale and performance. While it may be
argued that the expenditures create or add to an intangible
asset, as a practical matter it would be difficult to
determine what portion of the expenditures relate to which
achievement, and to ascertain how much, if any, of the
cost may be capitalized as part of brand names. Thus, it is
considered to be unlikely that threshold criteria for
recognition can be met in such a case. For this reason the
standard has specifically disallowed the capitalization of
internally generated assets like brands, mastheads,
publishing titles, customer lists, and items similar to these
in substance.

Apart from the prohibited items, however, IAS 38 permits
recognition of internally created intangible assets to the
extent the expenditures can be analogized to the
development phase of a research and development
program. Thus, internally developed patents, copyrights,
trademarks, franchises, and other assets will be recognized
at the cost of creation, exclusive of costs which would be
analogous to research, as further explained in the
following paragraphs.
When an internally generated intangible asset meets the
recognition criteria, the cost is determined using the same
principles as for an acquired tangible asset. Thus, cost
comprises 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 of
cost that may be considered as part of the asset, and the
need to recognize the cash equivalent price when the
acquisition transaction provides for deferred payment
terms. As with self-constructed tangible assets, elements
of profit must be eliminated from amounts capitalized, but
incremental administrative and other overhead costs can
be allocated to the intangible and included in the asset’s
cost. Initial operating losses, on the other hand, cannot be
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 the
research phase and the development phase of a research
and development project. IAS 38 mandates that the
expenditure incurred during the research phase of an
internal project should be recognized as an expense when
incurred (as opposed to recognizing it as an intangible
asset). The standard takes this view based on the premise
that an enterprise cannot demonstrate that the expenditure

incurred in the research phase will generate probable
future economic benefits, and consequently, that an
intangible asset exists (thus, such expenditure should be
expensed). Examples of research activities include:
activities aimed at obtaining new knowledge; the search
for, evaluation, and final selection of applications of
research findings; and the search for and formulation of
alternatives for new and improved systems, etc.
The standard recognizes that the development stage is
further advanced than the research stage, and that an
enterprise can possibly, in certain cases, identify an
intangible asset and demonstrate that this asset will
probably generate future economic benefits for the
organization. Thus, the standard allows recognition of an
intangible asset during the development phase, provided
the enterprise can demonstrate all the following:
• Technical feasibility of completing the intangible
asset so that it will be available for use or sale;
• Its intention to complete the intangible asset and
either use it or sell it;
• Its ability to use or sell the intangible asset;
• The mechanism by which the intangible will generate
probable future economic benefits;
• The availability of adequate technical, financial and
other resources to complete the development and to use or
sell the intangible asset; and
• The entity’s ability to reliably measure the
expenditure attributable to the intangible asset during its
development.
Examples of development activities include: the design
and testing of preproduction models; design of tools, jigs,
molds, and dies; design of a pilot plant which is not

otherwise commercially feasible; design and testing of a
preferred alternative for new and improved systems, etc.
Recognition of internally generated computer software
costs. The recognition of computer software costs poses
several questions.
1. In the case of a company developing software
programs for sale, should the costs incurred in developing
the software be expensed, or should the costs be
capitalized and amortized?
2. Is the treatment for developing software programs
different if the program is to be used for in-house
applications only?
3. In the case of purchased software, should the cost of
the software be capitalized as a tangible asset or as an
intangible asset, or should it be expensed fully and
immediately?
In view of the current IAS on intangible assets, the
position can be clarified as follows:
1. In the case of a software-developing company, the
costs incurred in the development of software programs
are research and development costs. Accordingly, all
expenses incurred in the research phase would be
expensed. Thus, all expenses incurred until technological
feasibility for the product has been established should be
expensed. The enterprise would have to demonstrate
technical feasibility and probability of its commercial
success. Technological feasibility would be established if
the enterprise has completed a detailed program design or
working model. The enterprise should have completed the
planning, designing, coding, and testing activities and
established that the product can be successfully produced.
Apart from being capable of production, the enterprise
should demonstrate that it has the intention and ability to

use or sell the program. Action taken to obtain control
over the program in the form of copyrights or patents
would support capitalization of these costs. At this stage
the software program would be able to meet the criteria of
identifiability, control, and future economic benefits, and
can thus be capitalized and amortized as an intangible
asset.
2. In the case of software internally developed for in-
house use, for example, a payroll program developed by
the reporting enterprise itself, the accounting approach
would be different. While the program developed may
have some utility to the enterprise itself, it would be
difficult to demonstrate how the program would generate
future economic benefits to the enterprise. Also, in the
absence of any legal rights to control the program or to
prevent others from using it, the recognition criteria would
not be met. Further, the cost proposed to be capitalized
should be recoverable. In view of the impairment test
prescribed by the standard, the carrying amount of the
asset may not be recoverable and would accordingly have
to be adjusted. Considering the above facts, such costs
may need to be expensed.
3. In the case of purchased software, the treatment
would differ on a case-to-case basis. Software purchased
for sale would be treated as inventory. However, software
held for licensing or rental to others should be recognized
as an intangible asset. On the other hand, cost of software
purchased by an enterprise for its own use and which is
integral to the hardware (because without that software the
equipment cannot operate), would be treated as part of
cost of the hardware and capitalized as property, plant, or
equipment. Thus, the cost of an operating system
purchased for an in-house computer, or cost of software

purchased for computer-controlled machine tool, are
treated as part of the related hardware.
Cost of other software programs should be treated as
intangible assets (as opposed to being capitalized along
with the related hardware), as they are not an integral part
of the hardware. For example, the cost of payroll or
inventory software (purchased) may be treated as an
intangible asset provided it meets the capitalization criteria
under IAS 38 (in practice, the conservative approach
would be to expense such costs as they are incurred, since
their ability to generate future economic benefits is always
questionable).
Costs Not Satisfying the IAS 38 Recognition Criteria
The standard has specifically provided that expenditures
incurred for nonmonetary intangible assets should be
recognized as an expense unless
1. It relates to an intangible asset dealt with in another
IAS;
2. The cost forms part of the cost of an intangible asset
that meets the recognition criteria prescribed by IAS 38; or
3. It is acquired in a business combination and cannot be
recognized as an identifiable intangible asset. In this case,
this expenditure should form part of the amount
attributable to goodwill as at the date of acquisition.
As a consequence of applying the above criteria, the
following 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 to
full-scale production or operation, unless these costs are
capitalized as part of the cost of an item of property, plant,
and equipment;

• Organization costs such as legal and secretarial costs,
which are typically incurred in establishing a legal entity;
• Training costs involved in operating a business or a
product line;
• Advertising and related costs;
• Relocation, restructuring, and other costs involved in
organizing a business or product line;
• Customer lists, brands, mastheads, and publishing
titles that are internally generated.
Thus, the IASC has finally resolved the controversy
regarding the potential deferral of costs like preoperating
expenses. In the past, many enterprises have been known
to defer setup costs and preoperating costs on the premise
that benefits from them flow to the enterprise over future
periods as well. Due to the unequivocal stand taken by the
IASC on this contentious issue, enterprises can no longer
defer such costs. Further, by adding the provision relating
to annual impairment testing of all internally generated
intangible assets being amortized (over a period exceeding
twenty years), the IASC has ensured that all such costs
capitalized in the past would need to be adjusted for
impairment.
The criteria for recognition of intangible assets as
provided in IAS 38 are rather stringent, and many
enterprises will find that expenditures either to acquire or
to develop intangible assets will fail the test for
capitalization. In such instances, all these costs must be
expensed currently as incurred. Furthermore, once
expensed, these costs cannot be resurrected and capitalized
in a later period, even if the conditions for such treatment
are later met. This is not meant, however, to preclude
correction of an error made in an earlier period if the

conditions for capitalization were met but interpreted
incorrectly by the reporting entity at that time.)
Subsequently Incurred Costs
Under the provisions of IAS 38, the capitalization of any
subsequent costs incurred on intangible assets is difficult
to justify. This is because the nature of an intangible asset
is such that, in many cases, it is not possible to determine
whether subsequent costs are likely to enhance the specific
economic benefits that will flow to the enterprise from
those assets. Thus, subsequent costs incurred on an
intangible asset should be recognized as an expense when
they are incurred unless
1. It is probable that those costs will enable the asset to
generate specifically attributable future economic benefits
in excess of its assessed standard of performance
immediately prior to the incremental expenditure; and
2. Those costs can be measured reliably and attributed
to the asset reliably.
Thus, if the above two criteria are met, any subsequent
expenditure on an intangible after its purchase or its
completion should be capitalized along with its cost. The
following example should help to illustrate this point
better.
Example
An enterprise is developing a new product. Costs incurred
by the R&D department in 2003 on the “research phase”
amounted to $200,000. In 2004, technical and commercial
feasibility of the product was established. Costs incurred
in 2004 were $20,000 personnel costs and $15,000 legal
fees to register the patent. In 2005, the enterprise incurred
$30,000 to successfully defend a legal suit to protect the
patent. The enterprise would account for these costs as
follows:

• Research and development costs incurred in 2003,
amounting to $200,000, should be expensed, as they do
not meet the recognition criteria for intangible assets. The
costs do not result in an identifiable asset capable of
generating future economic benefits.
• Personnel and legal costs incurred in 2004,
amounting to $35,000, would be capitalized as patents.
The company has established technical and commercial
feasibility of the product, as well as obtained control over
the use of the asset. The standard specifically prohibits
the reinstatement of costs previously recognized as an
expense. Thus $200,000, recognized as an expense in the
previous financial statements, cannot be reinstated and
capitalized.
• Legal costs of $30,000 incurred in 2005 to defend the
enterprise in a patent lawsuit should be expensed. Under
US GAAP, legal fees and other costs incurred in
successfully defending a patent lawsuit can be capitalized
in the patents account, to the extent that value is evident,
because such costs are incurred to establish the legal rights
of the owner of the patent. However, in view of the
stringent conditions imposed by IAS 38 concerning the
recognition of subsequent costs, the IASC seems to be in
favor of the conservative approach of expensing such
costs. Only such subsequent costs should be capitalized
which would enable the asset to generate future economic
benefits in excess of the originally assessed standards of
performance. This represents, in most instances, a very
high, possibly insurmountable hurdle. Thus, legal costs
incurred in connection with defending the patent, which
could be considered as expenses incurred to maintain the
asset at its originally assessed standard of performance,
would not meet the recognition criteria under IAS 38.

• Alternatively, if the enterprise were to lose the patent
lawsuit, then the useful life and the recoverable amount of
the intangible asset would be in question. The enterprise
would be required to provide for any impairment loss, and
in all probability, even to fully write off
the intangible asset. What is required must be determined
by the facts of the specific situation.
Measurement subsequent to Initial Recognition
Benchmark treatment. After initial recognition, an
intangible asset should be carried at its cost less any
accumulated amortization and any accumulated
impairment losses.
Allowed alternative treatment—revaluation. As with
tangible assets under IAS 16, the standard for intangibles
permits revaluation subsequent to original acquisition,
with the asset being written up to fair value. Inasmuch as
most of the particulars of IAS 38 follow IAS 16 to the
letter, and were described in detail in Chapter 8, these will
not be repeated here. The unique features of IAS 38 are as
follows:
1. If the intangibles were not initially recognized (i.e.,
they were expensed rather than capitalized) it would not
be possible to later recognize them at fair value.
2. Deriving fair value by applying a present value
concept to projected cash flows (a technique that can be
used in the case of tangible assets under IAS 16) is
deemed to be too unreliable in the realm of intangibles,
primarily because it would tend to commingle the impact
of identifiable assets and goodwill. Accordingly, fair
value of an intangible asset should only be determined by
reference to an active market in that type of intangible
asset. Active markets providing meaningful data are not
expected to exist for such unique assets as patents and

trademarks, and thus it is presumed that revaluation will
not be applied to these types of assets in the normal course
of business. As a consequence, the IASC has effectively
restricted revaluation of intangible assets to only freely
tradable intangible assets.
As with the rules pertaining to plant, property, and
equipment under IAS 16, if some intangible assets in a
given class are subjected to revaluation, all the assets in
that class should be consistently accounted for unless fair
value information is not or ceases to be available. Also in
common with the requirements for tangible fixed assets,
IAS 38 requires that revaluations be taken directly to
equity through the use of a revaluation surplus account,
except to the extent that previous impairments had been
recognized by a charge against income.
Example of revaluation of intangible assets
A patent right is acquired July 1, 2003, for $250,000;
while it has a legal life of 15 years, due to rapidly
changing technology, management estimates a useful life
of only 5 years. Straight-line amortization will be used.
At January 1, 2004, management is uncertain that the
process can actually be made economically feasible, and
decides to write down the patent to an estimated market
value of $75,000. Amortization will be taken over 3 years
from that point. On January 1, 2006, having perfected the
related production process, the asset is now appraised at a
sound value of $300,000. Furthermore, the estimated
useful life is now believed to be 6 more years. The entries
to reflect these events are as follows:

7/1/03 Patent 250,000
Cash, etc. 250,000
12/31/03 Amortization expense 25,000

Patent 25,000
1/1/04 Loss from asset impairment 150,000
Patent 150,000
Patent 25,000
Patent 25,000
1/1/06 Patent 275,000
Gain on asset value recovery 100,000
Revaluation surplus 175,000

Certain of the entries in the foregoing example will be
explained further. The entry at year-end 2003 is to record
amortization based on original cost, since there had been
no revaluations through that time; only a half-year
amortization is provided [($250,000/5) x ½]. On January
1, 2004, the impairment is recorded by writing down the
asset to the estimated value of $75,000, which necessitates
a $150,000 charge to income (carrying value, $225,000,
less fair value, $75,000).
In 2004 and 2005, amortization must be provided on the
new lower 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 ($250,000
original cost, less 2.5 years amortization versus an original
estimated life of 5 years). The new appraised value is
$300,000, which will fully recover the earlier write-down
and add even more asset value than the originally
recognized cost. Under the guidance of IAS 38, the
recovery of $100,000 that had been charged to expense

should be taken into income; the excess will be credited to
stockholders’ equity.
Development costs pose a special problem in terms of the
application of the allowed alternative method under IAS
38. The utilization of the allowed alternative method of
accounting for long-lived intangibles is only permissible
when stringent conditions are met concerning the
availability of fair value information. In general, it will
not be possible to obtain fair value data from active
markets, as is required by IAS 38, and this is particularly
true with regard to development costs. Accordingly, the
expectation is that the benchmark (historical cost) method
will be almost universally applied for development costs.
The use of the available alternative method for
development costs, while theoretically valid, is expected
to be very unusual in practice.
Example of development cost capitalization
Assume that Creative, Incorporated incurs substantial
research and development costs for the invention of new
products, many of which are brought to market
successfully. In particular, Creative has incurred costs
during 2003 amounting to $750,000, relative to a new
manufacturing process. Of these costs, $600,000 were
incurred prior to December 1, 2003. As of December 31,
the viability of the new process was still not known,
although testing had been conducted on December 1. In
fact, results were not conclusively known until February
15, 2004, after another $75,000 in costs were incurred
post–January 1. Creative, Incorporated’s financial
statements for 2003 were issued February 10, 2004, and
the full $750,000 in research and development costs were
expensed, since it was not yet known whether a portion of
these qualified as development costs under IAS 38. When

it is learned that feasibility had, in fact, been shown as of
December 1, Creative management asks to restore the
$150,000 of post–December 1 costs as a development
asset. Under IAS 38 this is prohibited. However, the
2004 costs ($75,000 thus far) would qualify for
capitalization, in all likelihood, based on the facts known.
If, however, it is determined that fair value information
derived from active markets is indeed available, and the
enterprise desires to apply the allowed alternative
(revaluation) method of accounting to development costs,
then it will be necessary to perform revaluations on a
regular basis, such that at any reporting date the carrying
amounts are not materially different from the current fair
values. From a mechanical perspective, the adjustment to
fair value can be accomplished either by “grossing up” the
cost and the accumulated amortization accounts
proportionally, or by netting the accumulated
amortization, prerevaluation, against the asset account and
then restating the asset to the net fair value as of the
revaluation date. In either case, the net effect of the
upward revaluation will be recorded in stockholders’
equity as revaluation surplus; the only exception would be
when an upward revaluation is in effect a reversal of a
previously recognized impairment which was reported as a
charge against earnings or a revaluation decrease (reversal
or a yet earlier upward adjustment) which was reflected in
earnings.
The accounting for revaluations is illustrated as follows:
Example of accounting for revaluation of development
cost
Assume Breakthrough, Inc. has accumulated development
costs that meet the criteria for capitalization at December
31, 2003, amounting to $39,000. It is estimated that the

useful life of this intangible asset will be 6 years;
accordingly, amortization of $6,500 per year is
anticipated. Breakthrough uses the allowed alternative
method of accounting for its long-lived tangible and
intangible assets. At December 31, 2005, it obtains
market information regarding the then-current fair value of
this intangible asset, which suggests a current fair value of
these development costs is $40,000; the estimated useful
life, however, has not changed. There are two ways to
apply IAS 38: the asset and accumulated amortization can
be “grossed up” to reflect the new fair value information,
or the asset can be restated on a “net” basis. These are
both illustrated 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
upward revaluation is given by the difference between fair
value and book value, or $40,000 – $26,000 = $14,000.
If the “gross up” method is used: Since the fair value after
2 years of the 6-year useful life have already elapsed is
found to be $40,000, the gross fair value must be 6/4 x
$40,000 = $60,000. The entries to record this would be as
follows:

Development cost (asset) 21,000
Accumulated amortization—development cost
7,000
Revaluation surplus (stockholders’ equity) 14,000

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

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

Amortization Period
As with tangible assets subject to depreciation or
depletion, the cost (or revalued carrying amount) of
intangible assets is subject to rational and systematic
amortization. Given that the useful economic life of many
intangibles would be difficult to assess, the rule is that a
maximum twenty-year life is permissible, with
amortization being over a shorter useful life if known.
The only exceptions would occur in those instances where
the legal right has a life of greater than twenty years and
either of the following conditions exists:
1. The intangible has an existence that is not separable
from a specific tangible asset, the useful life of which can
be reliably determined to exceed twenty years, or
2. There is an active secondary market for the
intangible.
The thrust of these requirements is to make the twenty-
year life an upper limit for most intangibles.
If there is persuasive evidence that the useful life of an
intangible asset is longer than twenty years, then the
twenty-year presumption is rebutted and the enterprise
must
• Amortize the intangible asset over that longer period;
• Estimate the recoverable amount of the intangible
asset at least annually in order to identify any impairment
loss; and
• Disclose the reasons why the presumption has been
rebutted.

Note that IAS 38 provides for amortization of all
intangible assets; it does not subscribe to the view that any
intangible asset can possess an infinite life. The thrust of
these requirements is to make the twenty-year life an
upper limit for most intangibles.
If control over the future economic benefits from an
intangible asset is achieved through legal rights for a finite
period, then the useful life of the intangible asset should
not exceed the period of legal rights, unless the legal rights
are renewable and the renewal is a virtual certainty. Thus,
as a practical matter, the shorter legal life will set the
upper limit for an amortization period in most cases.
The amortization method used should reflect the pattern in
which the economic benefits of the asset are consumed by
the enterprise. Amortization should commence when the
asset is available for use and the amortization charge for
each period should be recognized as an expense unless it is
included in the carrying amount of another asset (e.g.,
inventory). Intangible assets may be amortized by the
same systematic and rational methods that are used to
depreciate tangible fixed assets. Thus, IAS 38 would
seemingly permit straight-line, diminishing balance, and
units of production methods. If a method other than
straight-line is used, it must accurately mirror the
expiration of the asset’s economic service potential.
Residual Value
Tangible assets often have a positive residual value before
considering the disposal costs because tangible assets can
generally be sold for scrap, or possibly be transferred to
another user that has less need for or ability to afford new
assets of that type. Intangibles, on the other hand, lacking
the physical attributes that would make scrap value a
meaningful concept, often have little or no residual worth.

Accordingly, IAS 38 requires that a zero residual value be
presumed unless an accurate measure of residual is
possible. Thus, the residual value is presumed to be zero
unless
• There is a commitment by a third party to purchase
the asset at the end of its useful life; or
• There is an active market for that type of intangible
asset, and residual value can be measured reliably by
reference to that market and it is probable that such a
market will exist at the end of the useful life.
IAS 38, as revised by the consequential changes wrought
by the IASB Improvements Project, specifies that the
residual value of an intangible asset is the estimated net
amount that the reporting entity currently expects to obtain
from disposal of the asset at the end of its useful life, after
deducting the estimated costs of disposal, if the asset were
of the age and in the condition expected at the end of its
estimated useful life. In other words, changes in prices or
other variables over the expected period of use of the asset
are not to be included in the estimated residual value,
since this would result in the recognition of estimated
holding gains over the life of the asset (via reduced
amortization that would be the consequence of a higher
estimated residual value).
Residual value is to be assessed at each balance sheet date.
Any change to the estimated residual, other than that
resulting from impairment (accounted for under IAS 36) is
to be accounted for prospectively, only by varying future
periodic amortization. Similarly, any change in
amortization method (e.g., from accelerated to straight-
line) is dealt with as a change in estimate, again to be
reflected only in future periodic charges for amortization.

Periodic review of useful life assumptions and
amortization methods employed. As for fixed assets
accounted for in conformity with IAS 16, the newer
standard on intangibles suggests that the amortization
period be reconsidered at the end of each reporting period,
and that the method of amortization also be reviewed at
similar intervals. There is the expectation that due to their
nature intangibles are more likely to require revisions to
one or both of these judgments. In either case, a change
would be accounted for as a change in estimate, affecting
current and future periods’ reported earnings but not
requiring restatement of previously reported periods.
Impairment Losses
IAS 38 has provided that
• Amortization of an asset should commence when the
asset is available for use; and
• The amortization period should not exceed twenty
years, although this presumption is rebuttable.
In view of the above, some enterprises may be tempted to
• Capitalize intangible assets and defer amortization for
long periods on the grounds that the assets are not
available for use; and/or
• Rebut the presumption of twenty-year life and
amortize assets over a longer period.
To combat the risk that either of these strategies might be
employed, the standard provides that in addition to the
universal provisions of IAS 36 (which require that the
recoverable amount of an asset should be estimated when
certain indications of impairment exist, as described in
detail in Chapter 8), IAS 38 requires that an enterprise
should estimate the recoverable amount of the following
intangible assets at least at each financial year-end even if
there is no indication of impairment:

1. Intangible assets that are not yet ready for use; and
2. Other intangible assets that are amortized over a
period exceeding twenty years from the date when the
asset becomes available for use.
Apart from the special case of assets not yet in use, or
being amortized over greater than twenty years, the major
complication arises in the context of goodwill. Unlike
other intangible assets that are individually identifiable,
goodwill is amorphous and cannot exist, from a financial
reporting perspective, apart from the tangible and
identifiable intangible assets with which it was acquired.
Thus, a direct evaluation of the recoverable amount of
goodwill is not actually feasible; accordingly, the standard
requires that goodwill be combined with other assets
which together define a cash generating unit, and that an
evaluation of any potential impairment (if warranted by
the facts and circumstances) be conducted on an aggregate
basis. A more detailed consideration of goodwill 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 the
same way that long-lived tangible assets are dealt with.
Carrying amounts must be compared to the greater of net
selling price or value in use when there are indications that
an impairment may have been suffered. Reversals of
impairment losses under defined conditions are also
recognized. The effects of impairment recognitions and
reversals will be reflected in current period operating
results, if the intangible assets in question are being
accounted for in accordance with the benchmark method
set forth in IAS 38 (i.e., at historical cost). On the other
hand, if the allowed alternative method (presenting

intangible assets at revalued amounts) is followed,
impairments will normally be charged to stockholders’
equity to the extent that revaluation surplus exists, and
only to the extent that the loss exceeds previously
recognized valuation surplus will the impairment loss be
reported as a charge against earnings. Recoveries are
handled consistent with the method by which impairments
were reported, in a manner entirely analogous to the
explanation earlier in this chapter dealing with
impairments of plant, property, and equipment.
Disposals of Intangible Assets
With regard to questions of accounting for the disposition
of assets, the guidance of IAS 38 virtually mirrors that of
IAS 16. Gain or loss recognition will be for the difference
between carrying amount (net, if applicable, of any
remaining revaluation surplus) and the net proceeds from
the sale. The amendment to IAS 38 made by the IASB’s
Improvements Project observes that a disposal of an
intangible asset may result from either a sale of the asset
or by entering into a finance lease. The determination of
the date of disposal of the intangible asset is made by
applying the criteria in IAS 18 for recognizing revenue
from the sale of goods, or IAS 17 in the case of disposal
by a sale and leaseback. As for other similar transactions,
the consideration receivable on disposal of an intangible
asset is to be recognized initially at fair value. If payment
for such an intangible asset is deferred, the consideration
received is recognized initially at the cash price
equivalent, with any difference between the nominal
amount of the consideration and the cash price equivalent
to be recognized as interest revenue under IAS 18, using
the effective yield method.
Website Development and Operating Costs

With 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 be designed either for external or
internal access. Those designed for external access are
developed and maintained for the purposes of promotion
and advertising of an entity’s products and services to
their potential consumers. On the other hand, those
developed for internal access may be used for displaying
company policies and storing customer details.
With substantial costs being incurred by many entities for
website development and maintenance, the need for
accounting guidance became evident. The recently
promulgated interpretation, SIC 32, concluded that such
costs represent an internally generated intangible asset that
is subject to the requirements of IAS 38, and that such
costs should be recognized if, and only if, an enterprise
can satisfy the requirements of IAS 38, paragraph 45.
Therefore, website costs have been likened to
“development phase” (as opposed to “research phase”)
costs.
Thus the stringent qualifying conditions applicable to the
development phase, such as “ability to generate future
economic benefits,” have to be met if such costs are to be
recognized as an intangible asset. If an enterprise is not
able to demonstrate how a website developed solely or
primarily for promoting and advertising its own products
and services will generate probable future economic
benefits, all expenditure on developing such a website
should be recognized as an expense when incurred.
Any internal expenditure on development and operation of
the website should be accounted for in accordance with
IAS 38. Comprehensive additional guidance is provided

in the Appendix to the Interpretation and is summarized
below.
1. Planning stage expenditures, such as undertaking
feasibility studies, defining hardware and software
specifications, evaluating alternative products and
suppliers, and selecting preferences, should be expensed;
2. Application and infrastructure development costs
pertaining to acquisition of tangible assets, such as
purchasing and developing hardware, should be dealt with
in accordance with IAS 16;
3. Other application and infrastructure development
costs, such as obtaining a domain name, developing
operating software, developing code for the application,
installing developed applications on the web server and
stress testing, should be expensed when incurred unless
the conditions prescribed by IAS 38, paragraphs 19 and
45, are met;
4. Graphical design development costs, such as
designing the appearance of web pages, should be
expensed when incurred unless conditions prescribed by
IAS 38, paragraphs 19 and 45, are met;
5. Content development costs, such as creating,
purchasing, preparing, and uploading information on the
website before completion of the website’s development
should be expensed when incurred under IAS 38,
paragraph 57(c), to the extent content is developed to
advertise and promote an enterprise’s own products or
services; otherwise, expensed when incurred, unless
expenditure meets conditions prescribed by IAS 38,
paragraphs 19 and 45;
6. Operating costs, such as updating graphics and
revising content, adding new functions, registering website
with search engines, backing up data, reviewing security

access and analyzing usage of the website should be
expensed when incurred, unless in rare circumstances
these costs meet the criteria prescribed in IAS 38,
paragraph 60, in which case such expenditure is
capitalized as a cost of the website; and
7. Other costs, such as selling and administrative
overhead (excluding expenditure which can be directly
attributed to preparation of website for use), initial
operating losses and inefficiencies incurred before the
website achieves planned performance, and training costs
of employees to operate the website, should be expensed
when incurred.
This interpretation became effective in March 2002. The
effects of adopting this Interpretation was to be accounted
for using the transition provisions originally established by
IAS 38. For instance, when a website does not meet the
requirements of this SIC but was previously recognized as
an asset, the item was to be derecognized at the date when
this SIC becomes effective. If previously capitalized costs
are written off due to the imposition of SIC 32, the
expense may be handled under either the benchmark or
alternative treatments specified by IAS 8.
Disclosure Requirements
The disclosure requirements set out in IAS 38 for
intangible assets and those imposed by IAS 16 for
property, plant, and equipment are very similar, and both
demand extensive details to be disclosed in the financial
statement footnotes. Another marked similarity is the
exemption from disclosing “comparative information”
with respect to the reconciliation of carrying amounts at
the beginning and end of the period. While this may be
misconstrued as a departure from the well-known
principle of presenting all numerical information in

comparative form, it is worth noting that it is in line with
the provisions of IAS 1. IAS 1, paragraph 38,
categorically states that “(u)nless an International
Accounting Standard permits or requires otherwise,
comparative information should be disclosed in respect of
the previous period for all numerical information in the
financial statements….” (Another standard that contains a
similar exemption from disclosure of comparative
reconciliation information is IAS 37—please refer to the
relevant chapter of the book for details.)
For each class of intangible assets (distinguishing between
internally generated and other intangible assets),
disclosure is required of
1. 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 the beginning and end of the period;
4. A reconciliation of the carrying amount at the
beginning and end of the period showing additions,
retirements, disposals, acquisitions by means of business
combinations, increases or decreases resulting from
revaluations, reductions to recognize impairments,
amounts written back to recognize recoveries of prior
impairments, amortization during the period, the net effect
of translation of foreign entities’ financial statements, and
any other material items; and
5. The line item of the income statement in which the
amortization charge of intangible assets is included.
The standard explains the concept of “class of intangible
assets” as a “grouping of assets of similar nature and use
in an enterprise’s operations.” Examples of intangible

assets that could be reported as separate classes (of
intangible assets) are
1. Brand names;
2. Licenses and franchises;
3. Mastheads and publishing titles;
4. Computer software;
5. Copyrights, patents and other industrial property
rights, service and operating right;
6. Recipes, formulae, models, designs and prototypes;
and
7. Intangible assets under development.
The above list is only illustrative in nature. Intangible
assets may be combined (or disaggregated) to report larger
classes (or smaller classes) of intangible assets if this
results in more relevant information for financial
statement users.
In addition, the financial statements should also disclose
the following:
1. If the amortization period for any intangibles exceeds
twenty years, the justification therefor;
2. The nature, carrying amount, and remaining
amortization period of any individual intangible asset that
is material to the financial statements of the enterprise as a
whole;
3. For intangible assets acquired by way of a
government grant and initially recognized at fair value, the
fair value initially recognized, their carrying amount, and
whether they are carried under the benchmark or allowed
alternative treatment for subsequent measurement;
4. Any restrictions on titles and any assets pledged as
security for debt; and
5. The amount of outstanding commitments for the
acquisition of intangible assets.

In addition, the financial statements should disclose the
aggregate amount of research and development
expenditure recognized as an expense during the period.
Examples of Financial Statement Disclosures
Novartis AG
For the Fiscal Year ending December 31, 2002
Notes to the consolidated financial statements
Intangible assets. These are valued at their cost and
reviewed periodically and adjusted for any diminution in
value as noted in the preceding paragraph. Any resulting
impairment loss is recorded in the income statement in
general overheads. In the case of business combinations,
the excess of the purchase price over the fair value of net
identifiable assets is recorded as goodwill in the balance
sheet. Goodwill, which is denominated in the local
currency of the related acquisition, is amortized to income
through administration and general overheads on a
straight-line basis over its useful life. The amortization
period is determined at the time of the acquisition, based
upon the particular circumstances, and ranges from five to
twenty years. Goodwill relating to acquisitions arising
prior to January 1, 1995, has been fully written off against
reserves.
Management determines the estimated useful life of
goodwill based on its evaluation of the respective
company at the time of the acquisition, considering factors
such as existing market share, potential sales growth and
other factors inherent in the acquired company.
Other acquired intangible assets are written off on a
straight-line basis over the following periods:

Trademarks 10 to 15 years
Product and marketing rights 5 to 20 years

Software 3 years
Others 3 to 5 years

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

Goodwill Product and marketing rights
Trademarks
Software Other intangibles Totals
2002 2001
(in CHF millions)
Cost, January 1 2,736 4,222 614 85 333
7,990 6,508
Consolidation changes 1 -- (11) 49 457 496 752
Additions 937 51 13 5 65 1,071 696
Disposals(7) (6) (6) (6) (17) (42) (42)
Translation effects (399) (330) (95) (9) (58)
(891) 76
December 31 3,267 3,938 515 124 780 8,624
7,990

Accumulated amortization
January 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)
Disposals3 2 6 6 26 43 45
Impairment 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 31
2,392 2,978 354 15 431 6,170 6,548

The principal additions in both years were goodwill on
acquisition and in 2001 pitavastatin marketing rights.
In 2002, goodwill impairment charges were recorded of
CHF 369 million mainly related to the Pharmaceuticals
division research and biotechnology activities of Genetic
Therapy Inc., Systemix Inc., Imutran Ltd., due to changes
in the research and development strategy, and relating to
the Medical Nutrition and OTC business units. The
majority of the product and marketing rights impairment
related to a CHF 80 million charge to the pitavastatin
rights (2001: CHF 216 million).
Bayer Aktingesellschaft
Year ended December 31, 2002

[18] Intangible assets
Acquired intangible assets other than goodwill are
recognized at cost and amortized by the straight-line
method over a period of four to fifteen years, depending
on their estimated useful lives. Write-downs are made for
impairment losses. Assets are written back if the reasons
for previous years’ write-downs no longer apply.
Goodwill, including that resulting from capital
consolidation, is capitalized in accordance with IAS 22
(Business Combinations) and amortized on a straight-line
basis over a maximum estimated useful life of twenty
years. The value of goodwill is reassessed regularly based
on impairment indicators and written down if necessary.
In compliance with IAS 36 (Impairment of Assets), such
write-downs of goodwill are measured by comparison to
the discounted cash flows expected to be generated by the
assets to which the goodwill can be ascribed.
Self-created intangible assets generally are not capitalized.
Certain development costs relating to the application
development stage of internally developed software are
capitalized in the Group balance sheet. These costs are
amortized over their useful life from the date they are
placed 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, 20015,240 1,399
42 6,681
Exchange differences (529) (163) (4) (696)
Changes in scope of consolidation2 7 -- 9
Acquisitions 3,057 2,267 -- 5,324
Capital expenditures 363 -- 72 435
Retirements (249) (204) (13) (466)
Transfers 39 -- (39) --
Gross carrying amounts, Dec. 31, 20027,923 3,306
58 11,287
Accumulated amortization and write-downs, Dec. 31,
2001
1,243
424
--
1,667
Exchange differences (149) (43) -- (192)
Changes in scope of consolidation-- -- -- --
Amortization and write-downs in 2002 1,058 205 --
1,263
of which write-downs (249) (11) (--) (260)
Write-backs -- -- -- --
Retirements (186) (144) -- (330)
Transfers -- -- -- --

Accumulated amortization and write-downs, Dec. 31,
2002
1,966
442
--
2,408
Net carrying amounts, Dec. 31, 2002 5,957 2,864
58 8,879
Net carrying amounts, Dec. 31, 2001 3,997 975
42 5,014

The exchange differences are the differences between the
carrying amounts at the beginning and the end of the year
that result from translating foreign companies’ figures at
the respective different exchange rates and changes in
their assets during the year at the average rate for the year.
In 2002, as required by the newly implemented SFAS 142,
the Group ceased amortization of its goodwill recorded
under IAS, its indefinite-lived intangible asset, the Bayer
“Cross” and the pre-1995 goodwill recognized for US
GAAP purposes. The adjustment reverses the
amortization recorded under IAS for the Group’s IAS
goodwill of €11 million.
In-process research and development
IAS does not consider that in-process research and
development (IPR&D) is an intangible asset that can be
separated from goodwill. Under US GAAP it is
considered to be a separate asset that needs to be written
off immediately following an acquisition as the feasibility
of the acquired research and development has not been
fully tested and the technology has no alternative future
use.

During 2002, IPR&D has been identified for US GAAP
purposes in connection with the Aventis CropScience and
Visible Genetics acquisitions. Fair value determinations
were used to establish €133 million of IPR&D for both
acquisitions, which was expensed immediately. The
independent appraisers used a discounted cash flow
approach and relied upon information provided by Group
management. The discounted cash flow approach uses the
expected future net cash flows, discounted to their present
value, to determine an asset’s current fair value.
As a whole, the income booked for the reversal of the
amortization of IPR&D recorded under IAS as a
component of other operating expense and selling expense
amounted to €5 million in 2002.

9 intangible assets

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