The International Accounting Standard No. 38 (IAS 38) is a standard, issued by the International Accounting Standards Committee in September 1998, adopted by the International Accounting Standards Board in April 2001, and which has replaced IAS 9 (Research and Development Costs, issued in 1993), that sets outs the definition criteria to recognize and measure intangible assets and requires disclosures thereof.
What are intangible assets?
Intangible assets are non-physical assets that can be converted to cash by their worth value, such as intellectual property (patents, trademarks, copyrights, a mailing list of clients, among others), goodwill, brand recognition, computer software, etc.
However, goodwill acquired in a business transaction is accounted for under IFRS 3 (International Financial Reporting Standards 3) but outside the scope of IAS 38, whereas the internally generated goodwill is therein.
Being Coca Cola a big example of brand recognition, making it successful by the money produced by this.
Intangible assets are listed alongside physical/tangible assets on a balance sheet, affecting the cash flow significantly if there is a change in the former.
Criteria for initial recognition
According to the Standard, an intangible asset may be recognized by the company if, and only if:
- It is probable that the future economic benefits that have been attributed to it will flow to the entity.
- The cost of the intangible asset can be measured reliably.
These requirements apply both when the intangible asset has been acquired from third parties and has been generated internally. IAS 38 specifies that, when they have been generated internally, trademarks, newspaper or magazine mastheads, editorial labels or names, customer lists, or other similar items in substance should not be recognized in any case as assets. The same treatment should be applied to internally generated goodwill.
The objective of the Financial Audit
In a financial audit, the auditor’s objective and responsibility is to obtain sufficient audit evidence to evaluate whether management has been able to verify the basis of the agreements under which the intangible assets were initially valued and recorded in the accounts, considering their potential future benefits value. Likewise, to examine inherent risks and verify balances of the company. To evidence the accuracy and completeness of the accounting of income from the ownership of assets such as patents and determine these are useful expenditures for future periods.
Considerations when evaluating Intangible Assets
According to the standard, the probability criterion should be evaluated through reasonable and well-founded assumptions representing management’s best estimates and considering the economic conditions during the use of the asset.
For the initial recognition, the intangible asset is measured at cost. Subsequently, recognitions will measure such assets at cost less accumulated amortization and accumulated impairment losses.
The cost of an asset acquired separately includes:
- The acquisition price, the import duties, and non-recoverable taxes, after deducting trade discounts and rebates.
- Costs directly attributable to the preparation of the asset for its intended use.
Paragraph 28 of the standard provides some examples of costs directly attributable to initial recognition:
- Employee remuneration costs directly from bringing the asset to its intended use.
- Professional fees directly from bringing the asset to its working condition.
- The costs verifying the asset is properly working.
The recognition of costs in the carrying amount of an intangible asset will end when the asset is in the location and condition necessary to operate in the manner intended by management.
Accounting Amortization of Intangible Assets – IAS 38
IAS 38 classifies intangible assets into two categories:
- The finite, whose useful life is limited as legal/ licensing agreements, copyrights, patents, contracts, etc.
- The indefinite, whose useful life is unlimited as trademarks, brand names, franchises, goodwill, etc.
Let’s see what IAS 38 mentions in paragraph 88:
An entity shall assess the useful life of an intangible asset to determine if it is finite or indefinite. If finite, it shall assess the duration or number of productive or other similar units constituting its useful life. If indefinite, there is no foreseeable limit expected to generate net cash inflows to the entity, based on an analysis of all relevant factors.
In addition, only intangible assets acquired by purchase or any other transaction between related parties may be recorded in the amortization of the balance sheet, except those created by a company, nor have recorded book value.
Whereas tangible assets such as equity, a fixed asset, real estate, machinery, merchandise, and others, are subject to depreciation instead of amortization.
It is of utmost importance to evaluate whether the intangible asset is finite or indefinite to proceed with amortization.
Likewise, the accounting thereof is based on its useful life. An intangible asset with a finite useful life is amortized, while an intangible asset with an indefinite useful life is not.