(a) (i) The existing Conceptual Framework for Financial Reporting (the Conceptual Framework) specifies three recognition criteria which apply for the recognition of all assets and liabilities:
(a) the item meets the definition of an asset or a liability;
(b) it is probable that any future economic benefit associated with the asset or liability will flow to or from the entity; and
(c) the asset or liability has a cost or value which can be measured reliably.
IAS^® 38 Intangible Assets requires an entity to recognise an intangible asset, if, and only if, it meets criteria (b) and (c) above. An intangible asset also has to be an identifiable non-monetary asset without physical substance.
This requirement applies whether an intangible asset is acquired externally or generated internally. The probability of future economic benefits must be based on reasonable and supportable assumptions about conditions which will exist over the life of the asset. The probability recognition criterion is always considered to be satisfied for intangible assets which are acquired separately or in a business combination. If the recognition criteria are not met, IAS 38 requires the expenditure to be expensed when it is incurred.
Existing IFRS Standards do not all apply the recognition criteria set out in the Conceptual Framework. Thus, the Exposure Draft proposes a new approach to recognition. It proposes that assets and liabilities should be recognised if such recognition provides users of financial statements with:
(a) relevant information about the asset or the liability and about any income, expenses or changes in equity;
(b) a faithful representation of the asset or the liability and of any income, expenses or changes in equity; and
(c) information which results in the benefits exceeding the cost of providing that information.
The International Accounting Standards Board (the Board) have tentatively decided that the revised Conceptual Framework should not prescribe a ‘probability criterion’, and thus not prohibit the recognition of assets or liabilities with a low probability of an inflow or outflow of economic benefits. Further, the Board feel that the revised Conceptual Framework should identify only two criteria for recognition, that is relevance and faithful representation. The need for benefits which exceed the costs should not be identified as a third distinct recognition criterion but the revised Conceptual Framework should explain that the benefits of information must be sufficient to justify the costs of providing that information.
(ii) Skizer should have assessed whether the recognition criteria in IAS 38 were met at the time the entity capitalised the intangible assets. If the recognition criteria were met, then it was not appropriate to derecognise the intangible assets. According to IAS 38, an intangible asset should be derecognised only on disposal or when no future economic benefits are expected from its use or disposal. If there were any doubts regarding the recoverability of the intangible asset, then Skizer should have assessed whether the intangible assets would be impaired. IAS 36 Impairment of Assets would be used to determine whether an intangible asset is impaired.
Further, the reclassification of intangible assets to research and development costs does not constitute a change in an accounting estimate. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors states that a change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or related expense, resulting from reassessing the expected future benefits and obligations associated with that asset or liability. However, if Skizer concludes that the intangible assets’ carrying amounts exceed their recoverable amounts, an impairment loss should be recognised. The costs of the stakes in the development projects can be determined and will not have been estimated.
If the recognition criteria were not met, then Skizer would have to recognise retrospectively a correction of an error, in accordance with IAS 8.
(iii) Gains arising from derecognition of an intangible asset cannot be presented as revenue as IAS 38 explicitly forbids it. There is no indication that Skizer’s business model is to sell development projects but, rather, it undertakes the development of new products in conjunction with third party entities. Skizer’s business model is to jointly develop a product, then leave the production to partners. As Skizer has recognised an intangible asset in accordance with IAS 38, and fully impaired the asset, it cannot argue that it has thereafter been held for sale in the ordinary course of business. Therefore, according to IAS 38, the gain from the derecognition of the intangible asset cannot be classified as revenue under IFRS 15 Revenue from Contracts with Customers but as a profit on the sale of the intangible asset.
(b) (i) Under IFRS 3 Business Combinations, acquired intangible assets must be recognised and measured at fair value if they are separable or arise from other contractual rights, irrespective of whether the acquiree had recognised the assets prior to the business combination occurring. This is because there should always be sufficient information to reliably measure the fair value of these assets. IFRS 3 requires all intangible assets acquired in a business combination to be treated in the same way in line with the requirements of IAS 38. IAS 38 requires intangible assets with finite lives to be amortised over their useful lives and intangible assets with indefinite lives to be subject to an annual impairment review in accordance with IAS 36.
However, it is unlikely that all intangible assets acquired in a business combination will be homogeneous and investors may feel that there are different types of intangible assets which may be acquired. For example, a patent may only last for a finite period of time and may be thought as having an identifiable future revenue stream. In this case, amortisation of the patent would be logical. However, there are other intangible assets which are gradually replaced by the purchasing entity’s own intangible assets, for example, customer lists, and it may make sense to account for these assets within goodwill. In such cases, investors may wish to reverse amortisation charges. In order to decide whether an amortisation charge makes sense, investors require greater detail about the nature of the identified intangible assets. IFRS Standards do not permit a different accounting treatment for this distinction.
IAS 38 requires an entity to choose either the cost model or the revaluation model for each class of intangible asset. Under the cost model, after initial recognition intangible assets should be carried at cost less accumulated amortisation and impairment losses. Under the revaluation model, intangible assets may be carried at a revalued amount, based on fair value, less any subsequent amortisation and impairment losses only if fair value can be determined by reference to an active market. Such active markets are not common for intangible assets. If an intangible asset is reported using the cost model, the reported figures for intangible assets such as trademarks may be understated when compared to their fair values. Based upon the principle above regarding the different types of intangible asset, it would make sense for different accounting treatments subsequent to initial recognition. Some intangible assets should be amortised over their useful lives but other intangible assets should be subject to an annual impairment review, in the same way as goodwill.
IAS 38 requires all research costs to be expensed with development costs being capitalised only after the technical and commercial feasibility of the asset for sale or use has been established. If an entity cannot distinguish the research phase of an internal project to create an intangible asset from the development phase, the entity treats the expenditure for that project as if it were incurred in the research phase only. There is some logic to the capitalisation of development expenditure as internally generated intangible assets but the problem for investors is disclosure in this area as companies do not have a consistent approach to capitalisation. It is often unclear from disclosures how the accounting policy in respect of research and development was applied and especially how research was distinguished from development expenditure. One of the issues is that the disclosure of relevant information is already contained within IFRS Standards but preparers are failing to comply with these requirements or the disclosure is insufficient.
Intangible asset disclosure can help analysts answer questions about the innovation capacity of companies and investors can use the disclosure to identify companies with intangible assets for development and commercialisation purposes.
(ii) Measuring the contribution of intangible assets to future cash flows is fundamental to integrated reporting and will help explain the gaps between the carrying amount, intrinsic and market equity value of an entity. As set out above, organisations are required to recognise intangible assets acquired in a business combination. Consequently, the intangible assets are only measured once for this purpose. However, organisations are likely to go further in their integrated report and disclose the change in value of an intangible asset as a result of any sustainable growth strategy or a specific initiative. It is therefore very useful to communicate the value of intangible assets in an integrated report. For example, an entity may decide to disclose its assessment of the increase in brand value as a result of a corporate social responsibility initiative.