Audit and Technical Partner Leavitt Walmsley Associates Ltd
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Intangible assets: Get the details right

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This is the first in a series of technical articles examining some of the more complex areas of UK GAAP, starting with intangible assets.

13th Sep 2021
Audit and Technical Partner Leavitt Walmsley Associates Ltd
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Intangible assets other than goodwill are dealt with in FRS 102 ‘The Financial Reporting Standard applicable in the UK and Republic of Ireland’ in Section 18, Intangible Assets other than Goodwill, and in FRS 105 ‘The Financial Reporting Standard applicable to the Micro-entities Regime’ in Section 13, Intangible Assets other than Goodwill.

Intangible assets defined

Both FRS 102 and FRS 105 define an intangible asset as:

An identifiable non-monetary asset without physical substance. Such an asset is identifiable when:
  1. It is separable, ie capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or
  2. It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
An intangible asset must meet the definition of an asset and be identifiable. The definition of an asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

Hence, the intangible asset must be “controlled” by the entity, which means that economic benefit (ie cash or other forms of assets) will accrue to the entity as a result of its control over the intangible asset, and the entity also has control over what will eventually happen to that intangible asset.

The future economic benefits expected to flow to the entity as a result of the intangible asset are often in the form of cash. The definition of an asset in the glossaries to both FRS 102 and FRS 105 refer to economic benefits being “expected” to flow to the entity. While there is an inherent element of uncertainty in the term expected, it should be taken to mean that it is probable that economic benefit will flow to the entity (the term probable being defined as “more likely than not”).

The definition contains two sub-parts to it. An intangible asset must be:

  • separable; or
  • arise from contractual or other legal rights.

Separable

The term “separable” is a fundamental component of the definition of an intangible asset. It means that the intangible asset is capable of being separated or divided from the business itself and subsequently sold, transferred, licensed, rented or exchanged either individually or with a related contract without having to dispose of the entire business. This means that the intangible asset must be capable of being separated from goodwill.

Arise from contractual or other legal rights

An intangible asset can also arise from contractual or other legal rights. For example, a licence to operate a taxi cab in the UK must be acquired. While the licence would be an intangible asset which arises from legal rights, it may not necessarily be separable as there are circumstances when it could only be sold or transferred by also disposing of the underlying taxi business.

Intangible assets and business combinations

FRS 102, paragraph 18.8 states that an intangible asset that has been acquired in a business combination (for example when a parent company acquires a subsidiary) must be recognised separately from goodwill when all the following three conditions are satisfied:

  1. the recognition criteria set out in FRS 102, para 18.4 are met
  2. the intangible asset arises from contractual or other legal rights; and
  3. the intangible asset is separable.

FRS 102, para 18.8 provides an accounting policy choice. It allows an entity to separately recognise intangible assets from goodwill for which condition a) and only one of b) or c) above is met. However, this policy must then be applied to all intangible assets within that class of intangible asset and consistently to all business combinations. This means that if, for example, a parent acquires a subsidiary and separately recognises licences, then it must recognise all licences acquired in every subsequent business combination it undertakes.

Internally generated intangible assets

Internally generated intangible assets are dealt with under the research and development section of FRS 102 (paras 18.8A to 18.8K). Under FRS 102, an entity can choose to capitalise development expenditure or write it off to profit or loss, provided this accounting policy choice is applied consistently.

It is worth emphasising that under FRS 105, all development expenditure is written off to profit or loss when it is incurred; there is no option under FRS 105 to capitalise development expenditure.

There are certain types of expenditure which can never be capitalised and these are outlined in FRS 102, para 18.8C as follows:

  1. Internally generated brands, logos, publishing titles, customer lists and items similar in substance
  2. Start-up activities (ie start-up costs), which include establishment costs such as legal and secretarial costs incurred in establishing a legal entity, expenditure to open a new facility or business and expenditure for starting new operations or launching new products or processes
  3. Training activities
  4. Advertising and promotional activities – unless it meets the definition of inventories held for distribution at no or nominal consideration (see paragraph 13.4A))
  5. Relocating or reorganising part or all of an entity
  6. Internally generated goodwill.
Accounting standards prohibit the capitalisation of internally generated goodwill because it does not have a readily ascertainable market value from which a fair value can be derived and hence cannot qualify for recognition. This notion is accentuated by the placing of goodwill in FRS 102, Section 19 Business Combinations and Goodwill to recognise that goodwill only arises in a business combination.

Not all internally generated intangible assets will fail the recognition test. The generation of the intangible asset will be split into two stages:

  • the research stage; and
  • the development stage.

All research expenditure is written off to profit or loss. If there is any uncertainty as to whether expenditure has been incurred in the research phase or the development phase, FRS 102, para 18.8B requires the entity to treat the expenditure as if it were incurred in the research phase, so it will be  written off to profit or loss.

FRS 102, para 18.8G provides examples of research activities as follows (note, when an accounting standard provides examples, they should not be viewed as being comprehensive):

  1. Activities aimed at obtaining new knowledge
  2. The search for, evaluation and final selection of, applications of research findings and other knowledge
  3. The search for alternatives for materials, devices, products, processes, systems or services
  4. The formulation, design, evaluation and final selection of possible alternatives for new or improved material, devices, projects, processes, systems or services.
Under FRS 102, development expenditure can be capitalised (as an accounting policy choice) if, and only if, an entity can demonstrate all of the following:
  1. The technical feasibility of completing the intangible asset so that it will be available for use or sale
  2. Its intention to complete the intangible asset and use or sell it
  3. Its ability to use or sell the intangible asset
  4. How the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset
  6. Its ability to measure reliably the expenditure attributable to the intangible asset during its development.
As with research expenditure, FRS 102, para 18.8J provides examples of what it considers to be development activities as follows:
  1. The design, construction and testing of pre-production or pre-use prototypes and models.
  2. The design of tools, jigs, moulds and dies involving new technology.
  3. The design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production.
  4. The design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services.

Recognition and measurement

Intangible assets are initially recognised at cost. After initial recognition, an intangible asset can be measured under the cost model or the revaluation model. Under the cost model, the intangible asset is measured at cost less amortisation less accumulated impairment losses. This is the most common method for intangible assets in practice.

Under the revaluation model, an intangible asset is carried at a revalued amount which is its fair value at the date of the revaluation less subsequent amortisation and subsequent impairment losses. The revaluation model is not widely used for intangible assets because its use involves obtaining a fair value at the date of the revaluation and such a fair value can only be obtained from an active market. An “active market” is defined as:

A market in which all the following conditions exist:
  1. the items traded in the market are homogeneous
  2. willing buyers and sellers can normally be found at any time; and
  3. prices are available to the public.

Active markets are unlikely to exist for the majority of intangible assets and are usually confined to taxi licences, fishing and production quotas.

Where the revaluation model is applied because an active market exists for the intangible asset, FRS 102, para 18.18D requires revaluations to be carried out with sufficient regularity to ensure that the carrying amount of the asset does not differ materially from that which would be obtained using fair value at the balance sheet date. There are no specific timescales to carry out revaluations and this will be left to the entity’s judgement.

Amortisation

All intangible assets have finite useful lives under FRS 102 and FRS 105. It is not possible to assign an indefinite useful life to any intangible asset (and this is the same for goodwill). FRS 102, para 18.19 and FRS 105, para 13.9 state that where the intangible asset arises from contractual or other legal rights, its useful life cannot exceed the period of the contractual or other legal rights.

The useful life can be shorter depending on the period over which the entity expects to use the intangible asset. If the contractual or other legal rights are granted to the entity for a limited period of time, which can then be subsequently renewed, the useful life of the intangible asset should only include the renewal period if there is evidence to support renewal by the entity without significant cost.

Where management are unable to make a reliable estimate of the useful life of an intangible asset, the amortisation period cannot exceed 10 years (FRS 102, para 18.20). It can be shorter, but not longer.

Keep in mind that FRS 102, para 18.20 is clear where this amortisation cap is concerned. It says: “If, in exceptional cases…” Hence the 10-year cap is not a blanket maximum and there may be justifiable reasons why an intangible asset is being written off over a much longer, or indeed, shorter period. This is also the same for goodwill amortisation and intangible assets under FRS 105.

Conclusion

This article has considered some of the key aspects where intangible assets are concerned. Keep in mind the differences between FRS 102 and FRS 105, for example the lack of accounting policy options such as capitalisation of development costs in FRS 105, and the amortisation cap that will only be applied in exceptional cases.

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