Chapter 8

Accounting for intangibles

8.1

This question has been asked to stimulate debate. Certainly, in recent times it would appear
that a greater proportion of corporate assets are often found to be in assets that are classified
as intangible, and hence there might be a case for having an accounting standard dedicated to
intangible assets. But it is perhaps questionable that the rules applying to intangible assets are
so different and stricter that the rules that appear to tangible assets. For example, is there
adequate justification for disallowing the recognition of intangible assets on the basis that
they have been internally generated, particularly when such assets can subsequently be
recognised by another party if there is a business acquisition. Internally developed intangibles,
such as brand names, publishing titles, distribution rights and so forth can have significant
value and prohibiting their recognition from corporate balance sheets obviously has
implications for the relevance of information being provided in balance sheets. Also, why do
we restrict the revaluation of intangible assets to situations where there is an active market
when such restrictions are not explicitly in place for tangible assets? There is also the
conservative requirement that stipulates that once an intangible asset has been the subject of
an impairment loss then it cannot be reinstated even if information comes to light to suggest
that future economic benefits are deemed to be probable. This is not consistent with the
requirements for tangible assets wherein tangible assets can be reinstated and it is also not
consistent with the recommendations of the AASB Framework. It would appear that the
regulators have provided limited justification for these differences.

8.2

Paragraph 54 of AASB 138 states:

No intangible asset arising from research (or from the research phase of an internal
project) shall be recognised. Expenditure on research (or on the research phase of an
internal project) shall be recognised as an expense when it is incurred.
In justifying this requirement, paragraph 55 of AASB 138 states:
In the research phase of an internal project, an entity cannot demonstrate that an
intangible asset exists that will generate probable future economic benefits. Therefore,
this expenditure is recognised as an expense when it is incurred.
Hence, the argument is that the nexus between the expenditure and the subsequent economic
benefits is too uncertain to allow an asset to be recognised for balance sheet purposes.
Certainly, much research expenditure would not lead to future economic benefits.
With the above being said, whilst a great deal of research might not lead to subsequent
economic benefits, some will (indeed, for profit-seeking entities this is the general reason they
are undertaking the research). To have a blanket rule that all research must be written off as
incurred does seem highly conservative. Interestingly, under our former accounting standard
(AASB 1011) there was a requirement that research be divided into basic research and
applied research, and subject to certain tests for deferral (that the deferred costs be expected
beyond reasonable doubt to be recoverable) the applied research could be deferred and
carried forward as an asset.

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8.3

If an intangible asset is acquired separately, and not as part of a business acquisition (and in a
business combination, many assets would be acquired), the costs of the intangible asset are to
include the costs associated with acquiring the asset and preparing the asset for its intended
use. As paragraph 27 of AASB 138 states:
The cost of a separately acquired intangible asset comprises:
(a) its purchase price, including import duties and non-refundable purchase taxes,
after deducting trade discounts and rebates; and
(b) any directly attributable cost of preparing the asset for its intended use.
AASB 3 Business Combinations defines a business combination as the bringing together of
separate entities or businesses into one reporting entity. Paragraph 33 of AASB 138 states
that where intangible assets are acquired as part of a business combination, rather than as a
separate acquisition of an asset, the assets will initially be recognised at their fair value. This
can be contrasted with individual acquisitions of intangible assets, where they are recognised
at cost. Paragraph 33 of AASB 138 states:
In accordance with AASB 3 Business Combinations, if an intangible asset is
acquired in a business combination, the cost of that intangible asset is its fair
value at the acquisition date. The fair value of an intangible asset reflects market
expectations about the probability that the future economic benefits embodied in
the asset will flow to the entity. In other words, the effect of probability is reflected
in the fair value measurement of the intangible asset. Therefore, the probability
recognition criterion in paragraph 21(a) is always considered to be satisfied for
intangible assets acquired in business combinations.
The above requirement is interesting, particularly the statement that the probability criterion is
always considered to be satisfied for intangible assets acquired in a business combination. This
seems to be a simplistic assumption and not in accord with the asset recognition criteria in the
AASB Framework, which require consideration to be given to the probability of future
economic benefits being generated. In the basis for conclusions that was released with IAS 38,
the IASB acknowledged the conflict. It stated at paragraph 18 of Basis for Conclusions to
IAS 38 that:
The Board observed that this highlights a general inconsistency between the
recognition criteria for assets and liabilities in the Framework (which states that an
item meeting the definition of an element should be recognised only if it is probable
that any future economic benefits associated with the item will flow to or from the
entity, and the item can be measured reliably) and the fair value measurements
required in, for example, a business combination. However, the Board concluded
that the role of probability as a criterion for recognition in the Framework should
be considered more generally as part of a forthcoming Concepts project.

So this apparent inconsistency will be addressed in future work. For our purposes, however,
we need to appreciate that different recognition criteria apply to intangible assets, depending
upon whether an intangible asset is acquired individually, or as part of a business
combination. If an intangible asset is acquired as part of a business combination it is to be
recognised at its fair value. However, if it is acquired separately it is to be recognised at
cost.
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What is also interesting is that if intangible assets are acquired as part of a business
combination they can be recognised by the acquirer even though they might originally have
been internally generated. For example, if a publisher has developed a successful list of
publishing titles internally they may not recognise the list as an asset, but if their organisation
is acquired, the list of titles may in fact be recognised by the acquiring party. As paragraph 34
of AASB 138 states:
Therefore, in accordance with this Standard and AASB 3, an acquirer recognises at
the acquisition date separately from goodwill an intangible asset of the acquiree if
the assets fair value can be measured reliably, irrespective of whether the asset had
been recognised by the acquiree before the business combination.
So, although paragraph 63 of AASB 138 stipulates that certain intangible assets may not be
recognised if they have been internally developed, if an entity is acquired by another entity its
assets may be recognised. On why internally developed intangible assets cannot be recognised
within the original entity, paragraph 64 of AASB 138 states:
Expenditure on internally generated brands, mastheads, publishing titles, customer
lists and items similar in substance cannot be distinguished from the cost of
developing the business as a whole. Therefore, such items are not recognised as
intangible assets.
We are left to wonder how the case is conceptually different in a business combination. How
are we able to distinguish various intangible assets from goodwill when we acquire a business
when we are assumed to be unable to do so when developing such assets internally? Certainly
AASB 138 does appear to be vulnerable in a number of respects to criticism on logical
grounds. Moreover, some of its requirements seem to be inconsistent with others within the
standard.
8.4

AASB 138 Intangible Assets requires expenditure on research activities to be written off as
incurred. Paragraph 56 of AASB 138 provides examples of research activities. These
examples of research activities are:
(a)
(b)
(c)
(d)

activities aimed at obtaining new knowledge;

the search for, evaluation and final selection of, applications of research findings
or other knowledge;
the search for alternatives for materials, devices, products, processes, systems or
services; and
the formulation, design, evaluation and final selection of possible alternatives for
new or improved materials, devices, products, processes, systems or services.

By contrast and subject to requirements stipulated in paragraph 57 of AASB 138, expenditure

incurred in the development phases of operations can be deferred and disclosed as an asset.
As paragraph 58 of AASB 138 explains:
In the development phase of an internal project, an entity can, in some instances,
identify an intangible asset and demonstrate that the asset will generate probable future
economic benefits. This is because the development phase of a project is further
advanced than the research phase.
Paragraph 59 of AASB 138 provides examples of development activities, and these are:
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(a) the design, construction and testing of pre-production or pre-use prototypes and
models;
(b) the design of tools, jigs, moulds and dies involving new technology;
(c) the design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production; and
(d) the design, construction and testing of a chosen alternative for new or improved
materials, devices, products, processes, systems or services.
8.5

Issues associated with this question were also addressed in Question 8.1. Tangible assets are
those assets with physical substance, such as inventory. Intangible assets are non-monetary
assets that do not have physical substance. Examples include patents, trademarks, brand
names and copyrights. Different accounting treatments apply. Intangible assets are only
recognised if they are purchased (other than deferred development costs that can be
recognised even if internally developed), while there is no equivalent restriction on
recognising internally generated tangible assets. There are also restrictions on revaluing
intangible assets (for example, the intangible assets must originally have been recognised at
cost and there must be an active market for the assets). Some people argue that different
rules are appropriate because of the additional uncertainty and difficulty of measuring the
value of intangible assets. Others argue that intangible assets are equally able to be measured
reliably and that the different rules create internal inconsistency in the financial statements and
impede comparisons between companies that purchase their intangible assets and companies
that generate them internally. Students should be encouraged to discuss these points. Do they
think the accounting rules make sense and are justifiable in terms of issues associated with
relevance and reliability?

8.6

The adoption of IFRS has resulted in several changes to the accounting requirements for
research and development expenditure. Previously, both research (specifically, applied
research) and developments costs could be deferred subject to certain tests for deferral.
However, under AASB 138 Intangible Assets only development expenditure may be
deferred (subject to certain tests for deferral). All expenditure on research must be expensed
in the period in which it is incurred.
Previously, the recognition of research and development costs as an asset was only permitted
under Australian Accounting Standards to the extent that the deferred costs were recoverable
beyond reasonable doubt. This was a more restrictive test than the probability criterion
applied in the Conceptual Framework. The corresponding requirement in AASB 138 is that
the future economic benefits are probable. However, for development costs to be deferred,
AASB 138 requires that:

completion is technically feasible;

the entity intends to complete the asset and use it or sell it;
the entity is able to sell or use the asset; and
there are adequate technical, financial and other resources available to complete
the development.

It is questionable whether mandatory expensing of all research costs provides better

representation of financial performance and position than an alternative position which allows
deferral subject to certain stringent tests. The accounting treatment for research costs does
not distinguish between unsuccessful research and research for which future economic
benefits are probable. Assets would be understated to the extent that research expenditure

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satisfies the definition and recognition criteria of assets but is not able to be reported on the
balance sheet.
8.7

Identifiable intangible assets would include such things as patents, trademarks, licences,
research and development, brand names, mastheads and copyrights. They are considered
identifiable because they can typically be separately identified, valued and perhaps
individually sold.
Unidentifiable intangible assets are those intangible assets that cannot be separately identified
or separately sold, an example of which is goodwill. Goodwill relates to the benefits
generated through reputation, good employees, location, and so on. As with most intangible
assets, AASB 138 requires that goodwill shall only be recognised when it is purchased. This
restriction has been imposed on the basis of the uncertainty surrounding the value of
internally generated goodwill. Students should be encouraged to consider the merit of this
restriction.
Goodwill cannot subsequently be revalued and is to be subject to ongoing impairment testing.
Other intangibles can be revalued to the extent that they are initially acquired at cost and as
long as there is an active market for the asset.

8.8

AASB 3 Business Combinations defines goodwill as future economic benefits arising from
assets that are not capable of being individually identified and separately recognised.
According to paragraph 51 of AASB 3, the acquirer shall, at the acquisition date:
(a) recognise goodwill acquired in a business combination as an asset; and
(b) initially measure that goodwill at its cost, being the excess of the cost of the business
combination over the acquirers interest in the net fair value of the identifiable assets,
liabilities and contingent liabilities.

8.9

As we know, assets are defined in the AASB Framework as 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.
Goodwill would seem to fit the definition. It relates to future economic benefits from
unidentifiable assets. Pursuant to our accounting standards, goodwill is only recognised when
it is acquired, which would seem to provide the requirements of control.
Under the Conceptual Framework, however, the recognition of an asset would not be
dependent upon the requirement that the future economic benefit be purchased, only that it
be controlled. But for goodwill recognition pursuant to AASB 3, it is only purchased
goodwill that shall be disclosed. This is an inconsistency between the accounting standard and
the conceptual framework.

8.10

The requirement to amortise goodwill was not popular with some companies because they
considered that it placed them at a competitive disadvantage in international capital markets.
Australian companies had to amortise acquired goodwill over 20 years while companies in
other reporting regimes were able to amortise over 40 years or, in some cases, were not
required to amortise goodwill at all. They argued that amortising goodwill made their
companies look less profitable to investors. Another concern was that companies that grew
by acquiring other companies had to incur ongoing amortisation expenses, while companies
that grew internally did not. The concern here was with reduced comparability.

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These arguments assume that users of financial statements are not capable of, or do not
bother, adjusting for the amortisation of goodwill in their assessment of the profitability and
earning potential of companies when making investment decisions.
PAT may provide some insights into the opposition to mandatory amortisation of goodwill.
Not having to amortise goodwill would increase reported profits and management
compensation, to the extent that it is linked to accounting profit. Further, debt covenants,
such as a minimum interest cover, are affected by the amortisation of goodwill. The
amortisation expense reduces reported profit and interest cover, being the ratio of profit
before tax and interest, to interest. If no adjustment is made for the amortisation of goodwill,
companies with acquired goodwill may be disadvantaged in debt markets.
8.11

According to AASB 138, research is original and planned investigation undertaken with the
prospect of gaining new scientific or technical knowledge and understanding. Paragraph 54
requires that no intangible asset arising from research (or from the research phase of an
internal project) shall be recognised. Expenditure on research (or on the research phase of an
internal project) shall be recognised as an expense when it is incurred. Paragraph 56 of AASB
138 provides examples of research activities, and these include:
(a)
(b)
(c)
(d)

activities aimed at obtaining new knowledge;

the search for, evaluation and final selection of, applications of research findings or
other knowledge;
the search for alternatives for materials, devices, products, processes, systems or
services; and
the formulation, design, evaluation and final selection of possible alternatives for new
or improved materials, devices, products, processes, systems or services.

According to AASB 138, development is the subsequent 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 before the start of commercial
production or use. Paragraph 57 of AASB 138 provides that an intangible asset arising from
development (or from the development phase of an internal project) shall be recognised if,
and only if, an entity can demonstrate all of the requirements within the paragraph.
In considering the expenditure undertaken within the question it would generally be accepted
that the administrative costs (parts (a) and (b) of the question) would not be considered to
directly relate to the research and development activities and hence the costs would be
written off as incurred. The costs that would be included as research activities, and hence also
written off as expenses, would be:
(i)
that proportion of staff salaries that relates to the research activities (that is, half of
their salaries);
(ii) half of the consulting fees; and
(iii) the raw material used in the research phase of operations.
Subject to the deferral requirements of paragraph 57 of AASB 138, the following costs
would be considered to relate to the development phases and hence be shown as an asset:
(i)
the depreciation of the laboratory equipment; and
(ii)
half of the consulting fees.
8.12

For:

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It would be difficult to objectively determine the value of goodwill in the absence of a market
transaction. That is, the reliability of the recorded amount may be questionable. Further,
management may be able to employ particular assumptions in order to provide them with
their desired goodwill amount.
Against:
An obvious argument against is one of consistency. The firm can recognise and revalue some
other forms of intangible assets that were acquired at a cost. Should the fact that something
was not acquired at a cost be enough to prohibit its recognition?
Further, it does seem a bit odd, and conceptually unsound, that the entity that generates the
goodwill cannot show the asset in its balance sheet, but as soon as the entity is taken over,
the acquiring company can disclose the purchased goodwill. This would lead to recorded
assets being understated in the acquired entity.
8.13

There could be various reasons for this. The covenants included within trust deeds are
written to protect the interests of the lenders and to allow the borrowing company to attract
funds at a lower cost than might otherwise be possible. A common restriction is one that is
based on the debt-to-asset ratio. All things being equal, the higher the level of debtrelative
to total assetsthe greater the risk that lenders may not be repaid. If maximum debt to asset
constraints are put in place to safeguard the interests of lenders then arguably the lenders
would only want to include assets that are readily saleable in any debt restrictions. Intangible
assets could frequently have little or no value should an entity be in financial distress. For
example, assets such as brand names, mastheads and goodwill could have limited value if an
entity was in financial trouble (in fact, the reason it is in trouble may be that the brand name is
no longer valued, or that it has no remaining goodwill). Many intangibles may have limited
value to parties other than the borrowers. Relative to tangible assets such as stock,
machinery, or land and buildings, intangible assets may be particularly difficult to sell.

8.14

(a)

Research emanating from the Positive Accounting Theory perspective would tend to
indicate that management may very well change their expenditure patterns if such an
accounting change took place. From a mechanistic perspective, if the profits for a
period were low, management may opt to delay such expenditure to future periods. If
management was subject to debt/equity constraints which were binding, they may
need to defer expenditure, or else be in technical default of a debt agreement. If they
are seeking to attract additional debt capital, they may need to defer the expenditure if
they are subject to restrictive interest coverage provisions. The propensity to elect not
to undertake certain expenditure as a result of a new accounting standard requiring
the expenditure to be expensed might be exacerbated if the manager is approaching
retirement. As all such actions will have cash flow consequences, they will
conceivably affect firm value.

(b)

If the manager was rewarded primarily on the basis of accounting earnings then that
manager might, if he or she is driven by self-interest, trade off the personal benefits
associated with incurring the expenditure, with those that would be generated from
not incurring the expenditure. Issues such as the implications on future earnings and
the present value of such earnings would need to be considered. The implications for
the reputation of the manager (and related income flows) due to the discovery of
opportunistic expenditure strategies would also need to be considered.

(c)

Consider Lewellen, Loderer and Martin (1987), and Dechow and Sloan (1991). A
manager approaching retirement will not necessarily bear the costs related to reducing

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current period discretionary expenditures (for example, repairs and maintenance or

research and development). Their horizon will be different to that of the owners.
Adopting the self-interest perspective which is central to Positive Accounting
Theory, if managers were rewarded strictly in terms of accounting profits then they
may be expected to minimise expenditure on the discretionary items. Further, as they
are leaving the market for managers they will not bear the cost of any damage to their
reputation.
It would be sensible that when managers are approaching retirement, they no longer
be rewarded strictly on the basis of accounting earnings. Perhaps a mix of marketbased and accounting-based reward structures may be appropriate.
8.15

Subject to certain tests for deferral, expenditure on development activity can be deferred to
future periods and disclosed as an asset. Expenditure on research activities is to be written off
as an expense as incurred. Paragraph 59 of AASB 138 provides examples of development
activities. These are:
(a) the design, construction and testing of pre-production or pre-use prototypes and
models;
(b) the design of tools, jigs, moulds and dies involving new technology;
(c) the design, construction and operation of a pilot plant that is not of a scale
economically feasible for commercial production; and
(d) the design, construction and testing of a chosen alternative for new or improved
materials, devices, products, processes, systems or services.
The $50 000 spent on developing a general understanding of water flow dynamics would be
considered as research and would be written off as incurred.
The $30 000 spent on understanding what local surfers expect from a surfboard would be
research and would be written off as incurred.
The $90 000 spent on testing and refining a certain type of fin and the $190 000 spent on the
prototype would be construed as development expenditure and to the extent that the
expenditure satisfies the tests for deferral then the expenditures will be capitalised.

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8.16

Fair value of consideration:

Cash
Plant and equipment
Land
Plus legal fees
Fair value of net assets acquired:
Asset
Less Liabilities
Goodwill

8.17

(a)
Fair value of consideration:
Direct cost of acquisition
Legal costs
Fair value of net assets acquired:
Book value of net assets
Fair value of brand name
Fair value adjustment for land and
buildings
Goodwill

$70 000
$250 000
$300 000
$620 000
$35 000
$800 000
$300 000

$1 400 000
$70 000

$655 000
$500 000
$155 000

$1 470 000

$1 000 000
$50 000
$100 000

$1 150 000
$320 000

As can be seen from the above calculation, an adjustment was made for the fair value of the
brand name. The brand name was not shown on the balance sheet of the acquired company
(perhaps because it was internally developed). Paragraph 63 of AASB 138 states that
internally generated brands, mastheads, publishing titles, customer lists and items similar in
substance shall not be recognised as intangible assets. This is explained by paragraph 64
which states that expenditure on internally generated brands, mastheads, publishing titles,
customer lists and items similar in substance cannot be distinguished from the cost of
developing the business as a whole. Therefore, such items are not recognised as intangible
assets.
If the acquiring entity has clearly included a payment of $50 000 for the brand name (as part
of the total payment) and this is quite explicit in the purchase agreement, then the amount of
goodwill can be reduced to $320 000 and a $50 000 brand name could also be disclosed
within the balance sheet.
(b) Nat Ltd would have been prepared to pay for the goodwill because of the economic
benefits that the goodwill is expected to generate. Further, Nat Ltd must believe that it is
more efficient to acquire existing goodwill rather than trying to create the goodwill itself.
(c) Because only purchased goodwill is allowed to be disclosed in the financial reports, there
is a general prohibition on the subsequent revaluation of goodwill.

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8.18

For:

Conceivably, all assets (apart from, say, some land) have a limited useful life and hence,
some form of recognition of wear and tear, commercial or technical obsolescence would
seem to be appropriate. Failure to recognise such wear and tear will lead to
overstatement of the entitys profits, and to the extent that dividends are paid out of such
profits, to an erosion of the capital base of the entity.

Without rules requiring amortisation, some managers might opportunistically elect not to
amortise the assets.

Against:

8.19

If amortisation is to be dependent upon valuations, valuations are costly. Will the

additional cost offset the benefits to account users?

Is amortisation conceptually sound (remember amortisation is an allocation of cost, rather

than an acknowledgment of changes in the value of an asset)? In terms of the AASB
Framework, expenses relate to losses of future economic benefits. This is not strictly the
same as amortisation.

Use of a set period for amortisation ignores the fact that various forms of intangibles will
be different in nature and will not have the same useful life. It is also not conceptually
sound to impose arbitrary maximums.

Perhaps it is possible that a limited number of intangibles might provide economic

benefits indefinitely, in which case, for these limited instances, amortisation might not be
appropriate.

The $210 000 spent researching materials in 2007 must be expensed as incurred as AASB
138 does not permit the capitalisation of research expenditure.
To the extent that future economic benefits were deemed probable then the expenditure
incurred in developing the proto-type surfboard and registering the patent in 2008 can be
carried forward as an asset.
The advertising expenditure incurred in 2009 of $2 200 000 would be expensed as incurred
as generally accepted accounting procedures preclude the carry forward of advertising
expenditure.
Whilst McGoy would have development assets of $805 000 shown in its balance sheet (the
expenditure incurred in 2008) it is clear that the development expenditure will lead to
significant economic benefits. A competitor has made a legally binding offer to acquire the
rights to produce the surfboard for a price of $150 millions. So can we revalue the asset in
the light of this legally binding offer? No. The reason that we cannot revalue the asset is that
there is a lack of an active market given the unique nature of the asset. This inability to
revalue the asset has obvious implication for the usefulness of the information provided in the
balance sheet

8.20

How they treated goodwill:

Wrote it off against retained profits. In this case it will never affect profits.
Treated as an extraordinary item, which does not affect profits from ordinary activities.

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Implications of non-compliance:

8.21

8.22

Complying with the goodwill standard would have implications for profits from ordinary
activities (which excluded extraordinary items). It should be noted that we no longer
disclose extraordinary items. Management may believe that reported profits from
ordinary activities are used by account users to assess company performance and hence,
any reduction in such profits may have cost of capital implications for the firm.

Profits from ordinary activities may be used in various contracts which are already in
place. Management may disagree (perhaps with some justification) with the arbitrary 20
year maximum.

Management may also disagree with the rule that only purchased goodwill be brought to
account. They could believe that any reduction in the value of purchased goodwill is more
than offset by an increase in internally generated goodwill.

(a)

This is a very interesting issue and one that has generated numerous debates. If we
were to believe that readers of financial statements mechanistically reacted to
reported profits (that is, bigger reported profits are better than smaller reported
profits regardless of the accounting methods used), then we could accept such an
argument. Further, if we could tie in actual cash flow implications that relate to the
Accounting Standards requirement then we could also probably accept such an
argument. However, if we assume an efficient market, then we could argue that
readers of the financial statements could understand that the reduced accounting
profit is simply due to the requirement to amortise goodwill. As the goodwill
amortisation will be separately disclosed, perhaps we could argue that those
individuals that think the Accounting Standard is stupid could simply add the
amortisation back to reported profits to get a sensible profit figure? It should be
remembered that there is no longer a requirement within Australia to amortise
goodwill on a systematic basis. Instead we now have a requirement that goodwill be
subject to ongoing impairment testing.

(b)

This part should be used to generate discussion amongst the students. Certainly the
requirements that only purchased goodwill shall be recognised, that goodwill
amortisation shall be restricted to 20 years, and that straight-line amortisation shall be
used by all reporting entities, are possibly quite difficult to support from a logical or
conceptual basis. As indicated above, the requirements in relation to the amortisation
of goodwill no longer exist.

(c)

Whether involving a greater number of corporate executives in the standard-setting

process will improve the final Accounting Standards is not clear. Certainly they should
be able to give some indication of the costs (and benefits) that particular accounting
approaches may generate for their organisations or industries. This is information that
should be considered. However, whether they would let their own vested interests
dictate their support for particular accounting practices would not always be
apparent. At the extreme, it is also possible that introducing numerous corporate
executives to the accounting standard-setting process may enable corporations to
capture the regulation process.

Intangible assets that are considered to have a limited useful life are required to be amortised
over their useful lives in accordance with AASB 138. Previously, although Accounting
Interpretation 1 extended the depreciation requirements to intangible assets, the wording was
less prescriptive and many companies chose not to amortise intangible assets (other than

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goodwill) even though it was reasonable to expect that their useful life was limited. The
amortisation of intangible assets will reduce reported profit to the extent that companies did
not previously amortise the assets.
Goodwill is no longer amortised, whereas the previous accounting standard required straightline amortisation over a period not exceeding 20 years. The new requirements will increase
the reported profit of companies that would have otherwise been required to amortise
goodwill. However, when there is cause to recognise an impairment of goodwill it is likely
that the loss in a given year will be greater because the carrying amount of goodwill will be
the original cost, rather than the amortised cost. Thus, any impairment loss is recognised in
the period that it is incurred rather than being spread out over a number of years.
8.23

This view would appear logical. If something is deemed to be an asset, then it perhaps should
not matter what its origin is as long as the entity is deemed able to control the associated
economic benefits and those benefits are deemed to be probable. Within Australia, and
pursuant to AASB 138, we are not to recognise internally generated intangible assets for
balance sheet purposes (with some exceptions, for example, development expenditure).
However, we are permitted to recognise a variety of purchased intangible assets. Arguably,
the requirement not to recognise a number of internally developed intangible assets
understates the true assets of a reporting entity

8.24

Conceivably, many Australian corporations were worried by the possibility of having to

comply with requirements similar to those in IAS 38. There could be a number of reasons for
concern. They might not have agreed with the logic of the requirements and might object to
the arbitrary requirement relating to the maximum period of time for amortisation being 20
years (this 20 year rule did not ultimately become part of AASB 138). This has been one
source of the many arguments against the Australian goodwill accounting standard (the
goodwill standard has since been replaced by AASB 138 and there is no longer a requirement
to systematically amortise goodwill over 20 years). There are also problems associated with
trying to prove there is an active market for an asset if there is a decision to revalue the
asset (this is a requirement of AASB 138).
IAS 38 would, in many cases, lead to reduced profits and reduced assetstwo things that
management would not favour. They might believe that the market would react negatively to
the reduction in reported profits and assets, which in itself might imply that they believe that
the capital market will not understand that the reductions were simply brought about by a
mandated change in accounting method. Perhaps they believe that the media will focus on
subsequent intangible asset write downs with the implication that the assets had previously
been over-valued. It is also possible that changing our rules to comply with IFRS would lead
to a reduction in the wealth of the managers (perhaps they are being paid accounting-based
bonuses which do not make allowance for a change in how intangibles are accounted for).
There is also a possibility that the reduction in reported profits could cause a small number of
organisations to default on particular earnings based requirements that might be included
within certain borrowing contracts.
Of course there may be some managers who welcome the developments. They might believe
that if Australia is required to follow the same rules as are employed internationally then this
might make it easier for the organisations to attract foreign capitalalthough there is very
little evidence to support this view. Another perceived benefit of the IAS 38 approach was
that it minimised the discretion available to management to manipulate their accounting

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results (for example, an upper limit is provided for the life of the assets and revaluations are
only permitted if an active market can be proved).
Companies with a large amount of intangible assets might anticipate significant write-offs
with the introduction of AASB 138 due to the restrictions on the recognition of many
intangible assetsparticularly those that have been internally developed. However, for those
entities with few intangible assets other than goodwill, the introduction of AASB 138 could
lead to higher profits as a result of the removal of the requirement to systematically amortise
goodwill over 20 years.

8.25

Computer software could qualify as an intangible asset (an identifiable non-monetary asset
without physical substance) to the extent it is expected to provide future economic benefits.
Paragraph 9 of AASB 138 includes computer software as one of the categories of assets that
would commonly be classified as intangible. Paragraph 9 states:
Entities frequently expend resources, or incur liabilities, on the acquisition,
development, maintenance or enhancement of intangible resources such as scientific or
technical knowledge, design and implementation of new processes or systems, licences,
intellectual property, market knowledge and trademarks (including brand names and
publishing titles). Common examples of items encompassed by these broad headings are
computer software, patents, copyrights, motion picture films, customer lists, mortgage
servicing rights, fishing licences, import quotas, franchises, customer or supplier
relationships, customer loyalty, market share and marketing rights.
Computer software would be carried at cost less subsequent amortisation and impairment
losses, however fair value valuation would be allowed if the software has an active market.
Some assets have both tangible and intangible characteristics and judgement might be
necessary to determine whether the tangible or intangible element of the asset is most
significant. As paragraph 4 of AASB 138 states:
Some intangible assets may be contained in or on a physical substance such as a
compact disc (in the case of computer software), legal documentation (in the case of a
licence or patent) or film. In determining whether an asset that incorporates both
intangible and tangible elements should be treated under AASB 116 Property, Plant and
Equipment or as an intangible asset under this Standard, an entity uses judgement to
assess which element is more significant. For example, computer software for a
computer-controlled machine tool that cannot operate without that specific software is
an integral part of the related hardware and it is treated as property, plant and
equipment. The same applies to the operating system of a computer. When the software
is not an integral part of the related hardware, computer software is treated as an
intangible asset.
If computer software is carried forward as an asset then there would be an expectation that
the useful life of the asset would typically be relatively short in duration. As paragraph 92 of
AASB 138 states:
Given the history of rapid changes in technology, computer software and many other
intangible assets are susceptible to technological obsolescence. Therefore, it is likely
that their useful life is short.

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8.26

A taxi licence would be considered to be an intangible asset and must be accounted for in
accordance with AASB 138. Intangible assets can be carried at cost (less any accumulated
amortisation and accumulated impairment losses) or at fair value by way of asset
revaluations. Intangible assets can only be revalued to fair value to the extent that there is an
active market. If there is not an active market then the intangible asset must be carried at
cost. An active market is defined in AASB 138 as: a market exhibiting all of the following:
the items traded are homogeneous; willing buyers and sellers can normally be found; and
prices are publicly available.
According to AASB 138, an active market would not exist for most intangible assets because
intangible assets are typically unique in nature. However, the market for taxi licenses would
seem likely to satisfy the requirements associated with an active market and hence
revaluations to fair value would be permitted. In this regard paragraph 78 of AASB 138
states:
It is uncommon for an active market with the characteristics described in paragraph 8
to exist for an intangible asset, although this may happen. For example, in some
jurisdictions, an active market may exist for freely transferable taxi licences, fishing
licences or production quotas. However, an active market cannot exist for brands,
newspaper mastheads, music and film publishing rights, patents or trademarks, because
each such asset is unique. Also, although intangible assets are bought and sold,
contracts are negotiated between individual buyers and sellers, and transactions are
relatively infrequent. For these reasons, the price paid for one asset may not provide
sufficient evidence of the fair value of another. Moreover, prices are often not available
to the public.
Where a revaluation is undertaken, AASB 138 requires that the revaluations be made with
sufficient regularity to ensure at reporting date that the carrying value and the fair value of the
intangible asset are not materially different.

8.27

Intangible assets such as internally generated goodwill cannot be recognised by a reporting

entity. However, goodwill purchased through a business acquisition can be shown as an asset.
If an organisation did have certain licenses that were internally developed then they would
need to be written off given the general prohibition on recognising as assets any internally
developed intangible assets, other than those relating to development expenditure.
In terms of Tweedies comments about restricting the recognition of intangible assets until
we get smarter, he is obviously placing a great deal more emphasis on reliability that on
relevance. It does appear that current-day balance sheets are not terribly relevant to many
decisions given their exclusion of many valuable intangible assets. Students should be
encouraged to discuss this exclusion and whether they agree with the stance taken by
Tweedie and the IASB.

8.28

In theory, goodwill could be carried forward indefinitely, but only to the extent that the
carrying amount does not exceed the recoverable amount of the asset. Once goodwill has
been recognised there is a requirement that it must be carried forward at cost less
accumulated impairment losses.

8.29

(a)

Patents should be recognised on the balance sheet at amortised cost. The revaluation
subsequent to acquisition would not be permitted (there would not be an active
market for such assets).

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The trademarks should not be recognised, because the cost of the intangible asset was
expensed in a previous period (AASB 138, paragraph 71 requires that expenditure on
an intangible item that was initially recognised as an expense shall not be recognised as
part of the cost of an intangible asset at a later date).
Goodwill is recognised at cost subject to an impairment test. It is assumed there has
been no impairment.
The brand name may not be recognised because it is internally generated. Expenditure
on specified internally generated assets, such as brand names and customer lists, may
not be recognised as an asset because the costs incurred are considered
indistinguishable from expenditure incurred to develop the business as a whole.
The licence should be recognised and amortised. IP may choose between the cost and
fair value methods.
(b)
Carrying amount
Cost
Accum. Amort.
Fair Value

8.30

Patent
$60m
$80m
$20m
Not
applied

Trademark
Not applicable,
not recognised

Goodwill
$50m

Brand name
Not applicable, not
recognised

$50m
nil
Not
applied

Licence
$9m or $17m
$10m
$1m
$17m

Across time, the managers of a number of organisations have argued against amortising
particular intangible assets because they believed that the assets either maintained their value,
or actually increased in value across time. If the asset values do behave in this way, then it is
difficult to argue that they are depreciable and therefore need to be depreciated. If the reality
is that an assets ability to generate future economic benefits is not eroding then, conceptually,
no depreciation or amortisation should be charged.
However, for most assets it is hard to envisage that the useful life is indefinite. Further,
allowing managers to nominate that assets have indeterminate lives (and therefore perhaps
will not be depreciated) gives the managers a great deal of scope to avoid depreciating assets,
or allows them to depreciate the assets over very long lives. This might increase the ability of
the managers to manipulate accounting numbers to increase both assets and profits. However,
whether this threat of manipulation warrants fairly arbitrary requirements that require all
identifiable intangible assets to be amortised is quite a contentious point.

8.31

It is an interesting argument that mandating a particular amortisation requirement will lead to

significant economic impact. That is, if an accountant provides a particular debit and credit
entry then this in itself (without considering actual changes in operations) will have real
economic implications for the organisation and its shareholders. There is a generally accepted
principle that dividends should only be paid out of profits, so there is the possibility that
companies might pay less dividends if their profits fall. However, companies typically do not
pay all their profits out in the form of dividends anyway, so it is difficult to believe that the
dividend payment pollices would change across too many organisations. Further, one would
expect that business fundamentals and prospects would impact dividend payments, rather
than whether an accountant changes the way in which he or she accounts for a particular
asset.

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Of course, if companies did stop paying dividends, the spending power of millions of
shareholders might changeand this could have enormous economic implications. But
students should be asked whether they believe that companies would, as a result of the
proposals, no longer be able to pay dividends, or whether the argument has been provided by
a group of executives (Group of 100) to simply support a position that would give them more
professional latitude in how they account for their intangible assets.
As it turned out, when Australia adopted IAS 38 (although labelled AASB 138) the
international standard had been amended to recognise the fact that some intangible assets
might indeed have indefinite lives, and to the extent such a contention can be supported, then
there is no need to amortise the related assets (although annual impairment testing would still
be expected).
8.32

For many organisations, a great deal of their underlying value is based on the intangible assets
that they control. Hence, it is a reasonable argument that financial statement readers should
be provided with knowledge about these assets if they are going to make informed decisions
about the organisations. Failure to provide such information would undermine the relevance
of the reports. The argument that there is also a problem if we allow intangibles that do not
meet the asset recognition criteria to be recognised is a very strange one. If the asset
recognition criteria cannot be met, then simply stated, the assets are not allowed to be
recognised in accordance with the AASB Framework and other generally accepted
accounting principles. The use of the word allow in this document released by the AASB is
quite inexplicable. The real dilemma for standard setters is to develop tests that can be
applied to determine if intangible assets meet the asset recognition criteria (the recognition
criteria being that it is probable that the future economic benefits embodied in the asset will
eventuate and that the asset possesses a cost or other value that can be measured reliably)
particularly if they believe knowledge about intangible assets is important. Of course, there
will always be some professional judgement involved.
The relationship between integrity and usefulness is fairly straight-forward. If financial
statement users do not consider that particular accounting numbers have integrity (which
could be assumed to mean that they are not reliable and/or objective) then they will not be
inclined to use the numbers in the various decisions they might make. That is, there would be
a positive relationship between integrity and usefulness.
Arguably a requirement that all intangible assets of a certain type are not to be recognised for
balance sheet purposes will undermine the usefulness of balance sheets. Financial statement
readers will not be able to differentiate between those entities that have valuable intangible
assets and those that do not, because all intangible assets of a certain type will not be allowed
to be recognised. The trade-off between usefulness and integrity is similar to the trade-off
between relevance and reliability.

8.33

(a)
The internally generated masthead may not be recognised at all. Paragraph 63 of
AASB 138 states that internally generated brands, mastheads, publishing titles, customer lists
and items similar in substance shall not be recognised as intangible assets. In explaining this,
paragraph 64 states:

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Expenditure on internally generated brands, mastheads, publishing titles, customer

lists and items similar in substance cannot be distinguished from the cost of
developing the business as a whole. Therefore, such items are not recognised as
intangible assets.
(b)

The publishing title may be recognised as an asset because it was purchased, however it
cannot be revalued because there is no active market for the title. An active market is
a requirement for revaluations pursuant to AASB 138. In relation to active markets,
paragraph 78 of AASB 138 states that:
an active market cannot exist for brands, newspaper mastheads, music and
film publishing rights, patents or trademarks, because each such asset is
unique. Also, although intangible assets are bought and sold, contracts are
negotiated between individual buyers and sellers, and transactions are
relatively infrequent. For these reasons, the price paid for one asset may not
provide sufficient evidence of the fair value of another. Moreover, prices are
often not available to the public.

(c)

The franchise may be revalued to the fair value of $200 000, being the observable
price in an active market.

Dr Franchise
Cr Revaluation Reserve
Being revaluation of franchise by $100 000

$100 000
$100 000

(d) The deferred development expenditure may not be revalued.

8.34

(a)

$50 000 should be recognised as an expense. All $40 000 of the research expenditure
must be expensed. The development expenditure of $10 000 must also be expensed in
2007 because the project was not expected to generate future economic benefits.

(b)

$12 000 shall be treated as an expense as all research expenditure must be expensed.

(c)

2007: $nil;
2008: $60 000

(d)
2009

2010

Dr Development Expense
$6 000
Cr Accumulated Amort. Deferred
Development Costs
Amortisation of deferred developments
coststurnip project
Dr Development Expense
$12 000
Cr Accumulated Amort. Deferred
Development Costs
Amortisation of deferred developments
coststurnip project

$6 000

$12 000

2009
$
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$
817

Deferred Development Cost

Accumulated Amortisation
Carrying Amount
(e)

60 000
6 000
54 000

60 000
18 000
42 000

Carrying amount after amortisation in 2011 = $24 000 ($60 000 $36 000)
Impairment (assuming that the present value of using the development is the
recoverable amount, that is, the net realisable value of the project does not exceed
$15 000): Carrying amount > recoverable amount; recognise an impairment loss and
write the asset down to its recoverable amount.

2011

8.35

Dr Impairment Loss
$9 000
Cr Accumulated Impairment.
Deferred Development Costs
Impairment of deferred developments
coststurnip project

$9 000

(a)

This is a very interesting issue and is at the heart of why the FRC decided that
Australia should adopt IFRS. Would investors really be more inclined to invest in
Australia now that we have adopted IFRS than before? Which investors are we
talking about? If it is large institutional investors then wouldnt they have had the
ability to understand the differences between financial results and financial position
reported under IFRS and the former accounting standards issued within Australia?
Further, what about investors from the USthe US has not adopted IFRS so why
doesnt the argument apply to them? Is it because they are so big that they dont
depend upon international investment or is it because people are prepared to
understand the difference between IFRS and US GAAP?

(b)

Arguably, the requirement that many intangible assets, which are of value to reporting
entities, must be written off and not disclosed within the balance sheet will make the
financial statements less useful. Readers of financial statements will not be able to
differentiate between those with valuable intangibles and those without. Many people
believed the Australian approach was preferable as it facilitated the disclosure of
intangible assets, which can tend to be integral to the operations of an entity.

(c)

Because Australia has a strong tradition of developing sound accounting standards, it

would seem sensible for that expertise to be utilised when the IASB develops
accounting standards. Because the Australian economic environment is, in some
respects, different from other countries (for example, the reliance on the extractive
industries and agriculture), it would seem to make sense that on certain accounting
issues Australia should take the lead. It would not be a good outcome if Australia had
little or no impact on the development of IFRSalthough across time this might
become a reality. By effectively taking accounting standard setting out of the hands of
the AASB in Australia, as the actions of the FRC did, we have certainly lost a great
deal of control in determining the future of financial reporting within Australia.

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