Slide 19.1
Chapter 19
R&D; Goodwill; Intangible
Assets and Brands
Slide 19.2
Main purpose
The main purpose of this chapter is consider
the accounting treatments of:

Research and development

Goodwill and intangible assets

Brands
Slide 19.3
Objectives
By the end of this chapter, you should be able to:
define and explain how to account for research
and development (R&D), goodwill and other
intangible assets;
comment critically on the IASB requirements in IAS
38 and IFRS 3;
account for development costs;
account for impairment;
prepare extract of the entries and disclosure of
these items in the statement of comprehensive
income and statement of financial position.
Slide 19.4
Intangibles
 An intangible asset is defined under IAS 38, as:
an identifiable non-monetary asset without physical
substance
 Intangibles include systems, licences,
intellectual property, market knowledge and
trademarks (including brand names and
publishing titles) – see p. 503 for more examples
 An intangible asset must be identifiable (para 12
IAS 38), and there must be control (para 13), as
well as the production of future economic
benefits and its cost can be reliably measured
(para 21) before it may be recognised
Slide 19.5
Intangibles
Initial recognition is at cost (para 24)
Two categories of intangible asset:
externally acquired or
internally generated .
Slide 19.6
Intangibles
 Externally acquired:
 Purchased from another party either separately
or as part of a business combination.
 If purchased separately, eg. buying rights to a
book before making it into a film, cost can be
established as
the purchase price and any other expenses associated
with readying the asset for its intended use.
plus any duties and non-refundable taxes
less any trade discounts or rebates (para 27)
Slide 19.7
Intangibles
 Buying the business of a competitor may include, for
example, the rights to copyrights, patents or mastheads.
 If these cannot be reliably measured or distinguished
from other assets, they become part of purchased
goodwill – the premium paid over and above the fair
value of tangible and identifiable intangible assets (para
10).
 Where the price paid for the intangible can be
distinguished from goodwill and the future economic
benefits that arise can be identified, the test of
identifiability is met and it can be recorded as a separate
asset (para 34) at fair value at the date of purchase
(para 33).
 This treatment differs from the separate purchase of an
intangible, which is recorded at cost.
Slide 19.8
Intangibles
 Goodwill is recognised as a separate intangible
asset, subject to an annual test for impairment.
 A gain on bargain purchase – negative goodwill
- (paid less than fair value) is taken to revenue.
 Where an identifiable intangible asset exists but
cannot be reliably measured, it is included as
part of goodwill. In such a case, there is a
requirement to describe each intangible asset
acquired in a business combination, and explain
why its fair value could not be reliably measured.
Slide 19.9
Intangibles – internally generated
 As the name suggests, these arise from the
activities of the business.
 Expenditure on internally developed brands,
mastheads (newspaper and magazine titles),
publishing titles, customer lists, and similar
cannot be distinguished from the cost of
developing the entity’s overall business.
 Such intangibles (including internally generated
goodwill) do not meet the definition of assets,
and shall not be recognised as intangible assets
(IAS 38, para 63).
Slide 19.10
Research defined
Research – original and planned
investigation undertaken with the prospect
of gaining new scientific or technical
knowledge and understanding i.e.
Obtaining new knowledge
Search for alternatives
 Materials
 Products
 Processes
Evaluation of alternatives.
Slide 19.11
IAS 38 – accounting treatment for
R&D
Research:
Expense in the year in which incurred
Not to be carried forward in statement of
financial position i.e research is not capitalised
or shown as an asset on the balance sheet
Slide 19.12
IAS 38 intangible assets
Development defined
 Application of research findings to a plan for production
of new or substantially improved
• Products
• Processes
• Systems
 Prior to commencement of commercial production.
Slide 19.13
Development costs comprise
Directly attributable costs
 Materials
 Labour
 Fees such as patents
Allocatable on a reasonable and consistent
basis
 Necessary and identifiable overheads
 Depreciation
 Insurance premiums, rent.
Slide 19.14
IAS 38 – development recognition criteria
Technical feasibility
Intention to complete and use or sell
Generate future economic benefits
 Existence of market for asset or output
Availability of adequate resources to complete
 Technical
 Financial
 Reliable measurement of costs possible
Expense if not recoverable from future
revenue. Otherwise, capitalise and show on
balance sheet.
Slide 19.15
Activities that are neither research
or development
Activities related to research and development, but
cannot be classified for the purposes of the standard
as R&D include:
Engineering followthrough in an early phase of
commercial production
Quality control during commercial production,
including routine testing
Troubleshooting in connection with breakdowns
during production
Routine efforts to improve the qualities of an
existing product.
Slide 19.16
Goodwill and intangible assets
The main requirements of IFRS 3 Business
Combinations and IAS 38 Intangible Assets are:
• Purchased goodwill and intangible assets should be
capitalised as assets
• Internally generated goodwill should not be
capitalised and
• Internally developed intangible assets should be
capitalised only where it is probable that future
economic benefits attributable to the asset will flow to
the enterprise and the cost of the asset can be
measured reliably
• Capitalised assets are subject to amortisation
and/impairment review.
Slide 19.17
Accounting for research & development
 Why does the accounting differ between research
and development?
 Research expenditure, whether pure or applied, cannot
meet the definition of assets.
 There is no probability of service potential or future
economic benefits arising as a direct result of the
expenditure. Accordingly, it meets the definition of
expense – consumption has occurred that has reduced
assets (or increased liabilities) and it can be reliably
measured.
 Development expenditure, when it passes the test
criteria, meets the definition of assets.
 In meeting the test it is probable that service potential or
future economic benefits will eventuate, and the cost or
other value can be reliably measured.
Slide 19.18
IFRS 3 business combinations
IFRS 3 Business Combinations states:
Goodwill is the difference between the cost of
acquisition and the acquirer’s interest in the
fair value of the identifiable assets, liabilities
and contingent liabilities acquired at the date
of the exchange transaction.
Purchased goodwill is based on
 Transaction with third party at arm’s length
Internally generated goodwill is based on
 Directors’ valuation of internal goodwill by valuing
 Business as a whole
 Separable assets.
Slide 19.19
Accounting treatment of goodwill
Purchased goodwill is recognised in the
statement of financial position as an asset
Amortisation prohibited
Annual impairment reviews
Inherent goodwill not normally recognised in
the accounts.
Slide 19.20
Economic consequence of writeoff/amortisation
ROCE
 Write-off reduces shareholders’ reserves and capital
employed
Gearing
 Write-off reduces shareholders’ reserves and so capital
employed
 How this affects investor decisions
 How this affects creditor decisions.
Slide 19.21
Negative goodwill – related to
expectation of losses and expenses
Arises when the amount paid for the purchase
is less than its fair value.
Credit income statement immediately.
Slide 19.22
Intangible assets – purchased
Separately purchased, included in goodwill
and with a finite life
 Capitalise as part of goodwill
Separately purchased and capable of reliable
measurement
 Capitalise separately from goodwill and amortise.
Slide 19.23
Intangible assets – internally
developed
 Capitalise – only if an enterprise can demonstrate all of the
following:
 the 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 use or
sell it;
 its ability to use or sell the intangible asset;
 how the intangible asset 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
 its ability to measure reliably the expenditure attributable
to the intangible asset during its development. (para 57)
Slide 19.24
Intangible assets – indefinite useful economic
life
 Intangible assets with indefinite useful lives must, at each annual
balance date compare carrying value against recoverable amount. If
the recoverable amount is less, then the impairment amount is written
off first to any related asset revaluation reserve and then as an
expense to the Income Statement.
 Where impairment losses recognised in prior periods no longer exist
or have decreased so that recoverable amount is now above carrying
amount, the previous impairment loss is unwound – first to any
amount expensed to the Income Statement and then to the
revaluation reserve, if one exists. The reversal must not result in the
asset’s carrying value exceeding that which would have resulted had
no prior impairment loss been recognised.
 Improve transparency
 Improve comparability.
Slide 19.25
Brand accounting
Include in statement of financial position to
pre-empt equity depletion caused by goodwill
write-offs or amortisation
Typically not amortised but subject to
impairment review.
Slide 19.26
Intellectual property – two categories
Industrial property
 Inventions
 Trademarks
 Designs
Copyright
 Literary and artistic works.
Slide 19.27
OECD definition of intellectual capital
The economic value of two categories of
intangible assets:

Organisational (structural) capital
– Software systems
– Supply chains

Human capital
– Internally – staff
– Externally – customers.
Slide 19.28
Discussion
Explain how primary ratios were distorted by
immediate write-off of goodwill against
reserves
Explain the criteria for recognising internally
generated intangible assets.
Slide 19.29
Discussion (Continued)
Explain why companies began to recognise
brands in their statement of financial positions
Explain the requirement at the year end with
respect to intangible assets with an indefinite
useful economic life
Why do you think companies were motivated
to measure intellectual capital?
Slide 19.30
Discussion (Continued)
What indications may there be that an
impairment review of an intangible asset is
necessary?
Explain the criteria to be satisfied for
development costs to be capitalised
Discuss why intellectual property has become
increasingly important.
Slide 19.31
Review questions
7.The Chloride 2005 Annual Report included the
following accounting policy for goodwill:
Goodwill is subject to review at the end of the
year of acquisition and at any other time when
the directors believe that impairment may have
occurred. Any impairment would be charged to
the profit and loss account in the period in
which the loss occurs
(a) Explain the indications that a review for
impairment is required
(b) Once there are indications of impairment,
how is impairment measured?
Slide 19.32
Review questions (Continued)
10.IFRS 3 has introduced a new concept into
accounting for purchased goodwill – annual
impairment testing, rather than amortisation.
Consider the effect of a change from
amortisation of goodwill (in IAS 22) to
impairment testing and no amortisation in IFRS
3, and in particular:
• The effect on the financial statements
• The effect on financial performance ratios.
•
Continued
…
Slide 19.33
Review questions (Continued)
Which method gives the fairest charge over time for the
value of the goodwill when a business is acquired
Whether impairment testing with no amortisation
complies with the IASC’s Framework for the Preparation
and Presentation of Financial Statements
The effect on the annual impairment or amortisation
charge and its timing
Why there has been a change from amortisation to
impairment testing – is this pandering to pressure from
the US FASB and/or listed companies?