 Hello and welcome to the session. This is Professor Farhad and this session we're going to be looking at Intangible IAS 38. This topic is covered in international accounting as well as the CPA exam. Please connect with me on LinkedIn. If you don't have a LinkedIn account, make sure you create one. It's very important for your professional image and network ability. YouTube is where I house all my lectures, over 1500 accounting, auditing and tax lectures. If you subscribe, make sure you do so this way you're up to date. Share the channel, like the videos, put them in the playlist, let the world know about them. If you're benefiting, it means other people might benefit as well. This is my Instagram account. This is my accounting, my Facebook account. I do have some accounting lectures premium on Gumroad and this is my website. So let's talk about Intangibles. What are Intangible Assets? Let's take a look at the definition. How does IAS defines Intangible? It's an asset. It's identifiable. Make sure you know what identifiable is because we're going to be looking later on for assets that you cannot identify. Identify means you can point to it. You can say this is the value right there. You can put a name on it. Non-monetary asset without a physical substance. So it's not money. It's not financial asset and it does not have physical substance. You cannot touch it. You cannot basically see it. It's very important to remember it's health for use. So what does it mean health for use? You are using it in the production of your goods or services. So it's not something for decoration purposes. It's used to help you sell your product or rental to others or administrative purposes. So basically it's health for use, not health for investments, not health for decoration. Now Intangibles are very important part of our economy, at least in the U.S. And this is astonishing in my opinion. There was a study made in 2015 and find out that Intangible account for more than 85% of the economic value of the S&P company. So on average, think of it this way. For example, if we have a company, 85% of that company value coming, its economic value is coming from its Intangibles. So Intangible represent a tremendous value for each company. So it's very important that we understand how Intangibles work. Think of Alphabet, the parent company of Google, Apple, Facebook. Think about all those tech services that they provide. Most of them are Intangibles. Example include patent, especially tech patent. For example, the way you swipe your fingers to change the page on your phone. There was a big fight between Apple and Samsung. Who created that finger swiping? It's a patent. So in technology, you have many patents and that's why it's a big issue. And that's why it's a huge value for tech companies. Brands, trademark, trade names. This is what I'm talking about. The Coca-Cola sign, the Nike, Apple, Microsoft. As soon as you see those trademarks and trade names, you would recognize them. Those are company brand and company invest billions of dollars to make sure their product is known. And this is part of their Intangible. Copyrights and various operating rights, such as the right to broadcast. Franchise or licenses, if you want to start a McDonald's, well, you have to pay McDonald's a franchise fee. Well, that's an Intangible. You pay for the right to use the name of McDonald's as well as others. Now Intangible must be controlled by the enterprise. In other words, employees cannot be considered Intangible asset. That's very important because technically you cannot control your employees. Your employees can leave any time. They might be the most important asset, but they are not asset from an accounting perspective. They're not Intangible asset. Now, how do we account for Intangibles? Well, we can purchase the Intangible like we can go to another company and say, would you like to sell your patent? Would you like me? Can I have the right to use your software? You're buying, you're buying an Intangible. So purchased Intangibles are pretty straightforward. They are measured at cost. Pretty straightforward, but when you buy an asset, you measure it at cost. Now we have to understand that the useful life of an Intangible asset is assessed. So once you have an asset, you have to determine, does it have a finite or indefinite life? Finite life or indefinite life? Simply put, will this asset serve you for three years? Or with this asset, once you buy it, it's going to serve you forever. Serve your business. That makes a difference. And it's very important to understand that certain assets will have a finite life and other assets will have unlimited or indefinite life. Finite useful assets, finite useful life Intangible assets is amortized. And this is important. So if you have an asset and it's going to last you three years, an Intangible asset, for example, you bought a customer list and you could use it for three years, then you have to amortize, you have to expense the cost of the asset over three years. On a systematic basis over its useful life. Now, the residual value is assumed to be zero. When I was in practice, and as far as I know, most of the time, the residual value is zero. Now, the residual value can be considered something. We can assign a value to the residual value. And what's the residual value just in case you don't know what the residual value is? The residual value is simply put, after you use this asset for three years, are you going to get anything for it? Usually it's zero. You don't get anything for it unless a third party had agreed to purchase the asset at the end of its useful life. Well, if that's the case, then you have to take into residual value, take it into account when you compute amortization. And if there's also an active market for asset from which a residual value can be estimated, this is very rare for an Intangible asset. So generally speaking, you can skip those and assume the residual value is zero unless you are giving specific information. So an Intangible asset is deemed to have an indefinite life. So if it has an indefinite life, when there's no foreseeable limit to the period over which it's expected to generate future cash flow for the entity. Simply put, you buy the right to use this asset and that right is permanent in perpetuity forever. Well, if that's the case, then you have an Intangible asset with indefinite life. Now, those Intangible assets with indefinite life, there's no amortization. We don't amortize them. Simply put, when you amortize something, you amortize something over its useful life. Well, if it has an indefinite life, then how are you going to amortize something that's going to live forever in theory? If the useful life of an Intangible is indefinite, no amortization should be taking until the life is determined to be definite unless you change your mind. They said, you know what? It's no longer going to serve me forever. It's going to serve me only for the remaining eight years or seven years or three years. Good news is about IAS38 accounting treatment are consistent with USGAP for finite and indefinite life. So they agree on how they define finite and indefinite life or unlimited. I usually call it unlimited. Let's talk about Intangible asset acquired in a business combination. What is that? It's when you buy another company. When you buy another company, you buy older assets and older liabilities. Guess what? Intangible asset is an asset. So when you buy a company, you might buy their Intangible asset. That's one thing pretty straightforward. But what could be also the case? There could be some Intangible assets for the company that you purchase that the company don't have on the books. Let me just give you a real kind of visual of it. So let's assume you're buying a company and you're buying their assets. So this is their assets and this is the liabilities slash equity. So they're going to have older assets listed and some of their assets might be Intangibles. So they might have a patent. Let's say they might have a franchise. You're buying it and they have a franchise license for a company. So you're buying the company and you know on the books they have a franchise. What also you could be paying for is a patent that they develop internally. So when they develop it internally and you're going to see later, they did not put all the amount that they invested in that patent on the books. But now you're buying the company. Now what you're going to do, you're going to assign a dollar amount to that patent. So what's going to happen when you acquire the company, you're going to buy the franchise that's listed on the books. Then you're going to say I also bought your patent. That's not on your books. That I see that has a value that can be separately identifiable value that I'm going to buy. And I'll show you an example shortly when VW Volkswagen bought Porsche. So under IAS 38 and US GAAP, identifiable intangibles such as patent, brand and customer list acquired in a business combination should be recognized as asset apart from goodwill at their fair value. So simply put, you buy an asset and those assets include goodwill. I'm sorry, they include patent, they include brands, name, they include customers, they include intangible assets and you can identify them pretty straightforward. You buy them and you put them and you list them at the fair market value at your company books. That's pretty straightforward. What also should happen and this is the part where students kind of get a little bit confused. The acquiring company, the company that's buying the other company should recognize these intangible as assets even if they are not recognized as asset by the inquiry. So let's assume company A buying company B. Company A bought company B. Well, guess what? Company B might have a patent that's not on their books because they internally generated it. It was never on, so they did not capitalize the cost. It means it's not an asset. Well, company A said, I bought company B and the reason I bought you is because you have that patent, although it's not on your books because from an accounting perspective, you cannot add it to your books. I'm going to have to recognize it. So although the company that you're purchasing does not have the asset, the intangible asset on the books, as long as you can say the intangible asset is there, you can identify it, you can separate it from other assets, then it's an asset. If any of these criteria are not met, the intangible is not recognized as a separate asset, but instead it's included in Goodwill. If you don't know what Goodwill is, we're going to talk about Goodwill later. Goodwill is value on the company that you cannot identify. You cannot identify as a physical asset or as an intangible asset, tangible or intangible. So it's something you are paying for. That's not a tangible asset. That's not an intangible asset, which is, let's call it, you are paying for, there must be a reason, but you cannot specifically identify the reason or you cannot quantify the reason. Maybe you are buying the company because of their location. You're paying extra for the company for their location. Well, their location, you cannot have the location on the balance sheet and you cannot say, well, the location is an intangible asset. So what you do, anything that you paid above the fair market value of the identifiable, tangible and intangible asset is Goodwill. So Goodwill is anything that you paid extra for that cannot be identified either as a tangible or intangible, which we'll talk about Goodwill in the next session. Now, if you're interested in Goodwill, go to my intermediate accounting. I have a lot of lectures about Goodwill from a U.S. perspective. Also, the intangible asset must be classified as finite or indefinite life. Basically, it does not have a limited life. Let me show you an example of what I meant by saying you would buy when you buy a company. So for example, Volkswagen identified three major classes of intangible asset when they bought Porsches. So Volkswagen bought Porsches. I'm sure you heard of Volkswagen, the car company. So what they did is identified three assets, Porsche brand name, technology and customer supplier's relationship. Now, we have to understand that Porsche's brand name, this asset here, which is worth almost billions of dollars. I believe 13 billion, if my memory is right. Porsche never had that asset on their books because your brand name is something that was created over the years and you could not capitalize. So Porsche could not capitalize their brand name. But when VW bought them said, look, your brand name alone is worth 13 billion. I know you don't have it on your balance sheet. Now I'm going to have it on my balance sheet because I'm paying for it. Therefore, this was a new asset that they created, not they created. They can identify separately. Customer and supplier relationship. That's another asset. Porsche, they have an excellent relationship with their customers. It's worth a lot and with their suppliers. Now, Porsche could not say, well, let's debit an asset called customer relationship and let's debit an asset called supplier relationship. You cannot just make up phantom assets. Although the value exists, you cannot, you cannot, Porsche could not, could not record those assets. But when VW paid for Porsche, they told them, look, we are paying for you because you have a good customer relationship. You have a good supplier relationship. Therefore, we're paying for this asset. Therefore, we're going to just make up this number. This asset is worth 2 billion. So what they did, they created new assets in a sense, not they created them. Now they identified them as separate asset and they, and they record them at their fair market value when they bought the company. Okay. Hopefully this makes sense. Otherwise, go to my, go to my intermediate accounting goodwill and intangible asset. Let's talk about internally generated goodwill. There's no such thing really internally generated goodwill. When we talk about internally generated goodwill, we're really talking about how do we treat research and development or an or RND. So RND is research and development. Why? Because when a company create a new patent, what they do is they go through a lot of work, a lot of internal work and research and development until they come up with a new discovery that's considered an intangible asset. So what is research? Research is the search for a new knowledge. You're looking to find something new and development is when you take this knowledge and you, and you apply the knowledge into a product, into a commercially viable product. So research is when you do the research, you do the work, you search for the knowledge and at some point you will start to create a product that says the development stage. So this is what RND. So usually RND lead to some sort of an intangible. Okay. Now you have to understand that the standard required that all are expenditure, all research expenditure. So the R is expensed as incurred. Okay. So as you, as you, as you incur research, you expense it. And the concept behind this is pretty straightforward. When you, when, when you are incurring, when you are incurring millions or billions of dollars to find a new product. There is no, no guarantee you're going to find a product, a viable, viable product at the end. And for something to be considered an asset, it has to have a probable future benefit. And when you're doing your research, I mean, pharmaceutical companies, they spend billions and billions of dollars B with billions. Then they throw all this money away because they never come up with a viable product. So what we say is all research costs or research expenditure is expensed. So it's not capital wise. Well, development costs, the D should be generally expense in a project early in its early stages. When there is likely to be a substantial uncertainty about its technical feasibility or commercial substance. Although you'll start to develop the product early in its stages. If there's any, if there's a high likelihood, substantial doubt, a lot of uncertainty about the technical feasibility or commercial use. So simply put, you're starting to develop, to develop this product, but really you're not sure if it's going to come to life. It's going to, it's going to bear fruit. Well, what's going to happen then, once you start with developing, once you start, once you reach a certain stage. And this is where the US gap and IFRS differed a little bit. So under IFRS, the key difference between IS and US gap applies to the project later stages. When do they consider the project has been as feasible? It's already ready to be used. Specifically, the standard mandate that development expenditure be capitalized as development costs when the enterprise can demonstrate all the followings. Under IAS, you have to demonstrate six criteria and all the criteria. Not one, you have to demonstrate all six criteria in order to be able to capitalize to treat the expenditure as a development development cost. The first one is you have to show the technical feasibility of completing the intangible assets. So it will be available either for use. You're going to use it or you're going to sell it. Can you show that there is a technical feasibility that you're going to complete the project? Can you show us your intention to complete the intangible asset and use it or sell it? So you have to show it's viable, it's going to work, and you have the intention. That's not good enough. You want to show us your ability. Your ability either to sell it or to use it. It means are you going to really going to sell it? Are you really going to use it? Do you have the ability to do so? Also you have to show how the intangible will generate probable future economic benefit. Show us. Now you have it. Show us how does it benefit your company? Maybe it's a noble product, but it doesn't really benefit the company. So the enterprise should demonstrate the existence of a market. Is there a market for it? Is there people looking for that type of product? Or are you going to be using it for your own production? Is it going to help you somehow? Also you have to show that you have the availability of adequate technical, financial, and other resources to complete the project. Either to eat the salad or to use it internally. Do you have the resources to complete the project that you are undertaking? Okay. So basically those, the first five criteria's, okay, they want to show that you do have future use for the product. You have the ability, the technical ability, and the financial ability to complete something that's going to benefit you in the future. The six criteria is the ability to measure the expenditure attributed to the intangible asset during its development. Can you reliably measure the expenditure? Simply put, are you keeping track of the money invested in that project? If this is a separate intangible, show me, show me that this is, that this is separate from anything else. So you're not investing this money for the whole company, for the brand name of the company. Show me that the money that you are investing is specifically for this product. Are you measuring the cost? Okay. You assigned two or three engineers or four engineers. Okay. You assigned them a lab. Could you show me that this lab and those engineers are specifically working on this intangible asset? Okay. In other words, if they're working on general work, then they might be benefiting the brand name of the company, which is that's not really an intangible. You cannot, you cannot capitalize your brand name if you are working on it. Okay. So that's what we have the, those six elements. So the first one is to show that you have a future economic benefit. The six criteria actually serve two purposes. First, you want to make sure that the company is keeping track of the asset separately of that project separately. And also it wanted this allowed the recognition of internally marketing intangible, such as brand, customer list, math heads and publishing titles. So simply put, so the, the work that you are working for, it's not for the whole company. It's for that specific asset. Okay. Expenditure to create or enhance these intangibles like, you know, marketing intangibles, marketing intangibles is impossible because they are not distinguishable from the cost of developing the business as a whole. So simply put, once you talk, once we say we are doing something for marketing, you have to be very specific. What do we mean by marketing? Okay. Is it one specific asset that you are marketing? You are creating an intangible for? Or is it marketing for the whole company? Because marketing cost is always expense cost. The standard prohibit the capitalization of expenditure on advertising, which is marketing and corporate training for similar reasons. So when you advertise, when you advertise your product, when you train your employees, those are considered in a sense marketing cost. Marketing cost is expense. And because of those, you have to have that six criteria, that that intangible is its own. It's going to live on its own. Okay. It stands by itself. Now what happened if those six criteria are not met? Simply put, we expense the expenditure. It's as simple as that. Okay. Now development cost capitalized as internally generated can only be treated as having finite useful life. So any asset that you internally generate, it can only have a finite useful life. It means it needs to be amortized. It means you have to have a starting date. And the starting date is when the asset is available for sale, if you're creating the asset to sell it, or when you are starting to use it in your business. This is when you start to amortize the asset. Okay. Let's take a look at some examples of internally generated intangibles. Like what are some of the expenses? Okay. Development cost insists because that's internally generated intangibles. Cost directly attributed to the development activities. And cost that can be reasonably allocated. So any cost that's directly, for example, you bought a lab just for that product. Well, guess what? That's cost directly attributed. You bought a building that's cost directly attributable. Also, you could attribute personnel cost. You assign people. They may not be working there full time, not all their time. Maybe they're working 20 hours a week. Well, guess what? That 20 hours a week should be allocated that cost. Material and service cost. Any material, any service cost. Depreciation of property, plant and equipment used in that project. Overhead cost. Amortization of patent and licenses. Any cost that's reasonably allocated to that project can be considered part of the internally generated intangible, which is part of the development cost. Because now you are capitalizing this development cost. Okay. So it's very similar, really, to when you are producing inventory, labor, material and overhead, basically the same concept. Okay. Notice the cost, because the cost of some, but not all development costs will deferred, will be, because the cost of some, but not all development costs will be deferred, will be deferred as asset. It's necessary to accumulate costs for each development cost as of it were, work and process as a separate project. So what's going to happen? You might have many work and process that are considered internally generated intangibles. So you don't combine all those together. Each internally generated intangible should have its own project, its own work and process. Keep track of it separately. Okay. Now, bear in mind, while the above categories are common to R&D activities, these activities produce different product and services that differ substantially from industry to industry. So let's consider development cost could differ from industry to industry, from industry to industry, depending on what business you are in. For example, if we look at a company like Tata Motors, which produces cars and trucks. It's an Indian company and owns Jaguar and Land Rover. They capitalize development costs on, this is what they say, a new vehicle platform, engines and transmission. This is their development cost. So as they incur new vehicle platform when they have a new design for the vehicle, new engines, new transmission, that's called development cost. On the other hand, if we look at Burslin, which is a German company, the largest media company, they capitalize software and website development. That's what they capitalize. That's their development cost because it's a different business than Tata Motors. Well, if we look at Minor International, which is in Thailand, they own the Pizza Company, one of the Southeast Asia largest restaurant chain. What did they develop? They developed test new food items for the restaurant menu. This is part of their development cost. Or if you look at Sanofi, which is a French company, it's a pharmaceutical company, they capitalize cost for the second generation improvement of drugs that has already received regulatory approval for geographical extension of the drugs that have already been approved in a major market. So what do they capitalize as development cost? Well, once they want a second generation of drug improvement. So they have a drug, it's already been on the market. Now they are enhancing the drug. The second generation, that's development cost. So each company, the way they, what's development cost for company A will be totally different than company B, so on and so forth, depending on your industry, depending on your product, depending on your services. Let's take a look at an example to see how this all work from a general entry perspective. Let's look at S company. S company incurred cost of developed specific product for a customer year one amounting to 300,000. Of that amount, 250 incurred up to the point where the technical feasibility of the product demonstrated and other recognition criteria were met. So they spent 300,000, 250, until they have some sort of a feasibility. So what's going to happen is they incur 300,000 in cash, payable, they incur, you know, money or they're going to pay it later. 250 was expensed. Why? Because they needed to spend 250 until they get to the feasibility. Once they got to the feasibility, they started to capitalize this 50,000. What they did is of the 300,000, of the 300,000, 250 is capitalized. Now they have some sort of a feasibility for this project. In year two, the company incurred an additional 300,000 in cost and developed in the product. Now the product reached feasibility, all costs incurred as part of the development cost. So we debit development cost, 350, and credit cash, payable, whatever we incurred. Okay? This is year two. Now notice the product itself is FYI. Now they have a product that's worth 350,000. It's an asset. It's called development cost. Now they have an asset worth 350, 50 year one, 350 year two. The product was available for sale starting year three. And the first shipment to the customer occurred mid-February, year three. The sales of the product are expected to continue for four years. This is how long it's going to last them. At which time it's expected their replacement product will need to be developed. To simply put, they developed the product and they spent 350,000 and that product is going to serve them four years. The total number of units expected to be produced over the product four year economic life, they expect to produce 2 million units. The number of units expected to produce in year three 800,000. So they expect to produce 2 million in total. In year one, they expected to produce 800,000 and there is no residual value for this product. The residual value is zero. Now what we need to do since this product is we're selling this product year three, what do we have to do? Now we have to amortize the product because we know it's four year product. It has to have a definite life. Remember, internally generated, intangible will have to have a definite life. Therefore, they have to be amortized. Well, if they have to be amortized, one way to do it is we say, well, in year one, we spent 350,000. How much of it are we going to amortize? One way to do it is to do a straight line divided by four, okay? Or the other way to do it is to say, well, it's called the units of production. We produce 800,000 units out of 2 million expected to be produced, which is that's 40%. We multiply this by 350 for year one. In year two, we'll determine how many we produced divided by 200,000 so on and so forth. So, amortizing the development cost began on January 2nd, year three because this is when it became available for sale. And company determined that the unit of production best reflect the pattern on which the economic benefit are consumed. So they're going to use the units of production. So they use the units of production. They spent 350. They produce 800,000 of 2 million, which is 800 divided by 2 million equal to 40%. So 350 times 40%, year one, they will amortize 140,000. Now year two, let's assume they produced a million unit in year two, Rf2 million, we're not going to change the total. That's 50%, we'll take 50% times 350, and this will be the amortization amount for year two. Let's assume they cannot predict the number of units they can produce. They cannot predict under those circumstances you cannot predict, you just use the straight line. What's the straight line? Take 350,000 divided by four years equal to 87,500. So you amortize the asset for 87,500 every year. Also intangible asset, they have effect on the income statement, the balance sheet as well as the cash flow statement. What's the effect on the income statement? Well, if you're capitalizing your expenditure, it's going to delay expenses. What does that mean? If it's going to delay expenses, it's going to inflate your profit relative to full expensing system. So if you're not expensing the profit, if you're not expensing your R&D now, you're capitalizing it, well, it's going to increase your profit. And that's why a lot of German companies because they have a growing R&D program, capitalization inflated their reported profit. Why? Because they are not expensing it. They are treating those expenditure as R&D. They're treating those expenditure as intangible assets. Now on the balance sheet, obviously it's obvious if you're capitalizing, it's going to inflate your asset. Why? Because you have more assets and it's going to increase your assets. And it's going to delay, again, it's going to delay recognizing the expenses which in turn will inflate your equity or will inflate your profit and profit will inflate your equity. Now, because R&D expenditure are fully tax deductible in Germany as they are in most countries, German companies record the third tax liability because they take the expense now and in future years they don't have expenses. So that's going to create a deferred tax liability for the timing difference because they're going to have to recognize the expense later for IFRS. From a cash flow statement perspective, an enterprise's capital expenditure or CAPEX consists of its investment in a new PP&E as well as new intangible asset. Now, once you take the decision to capitalize R&D expenditure, you would reclassify this as CAPEX outflow. So what's going to happen is this. When you are spending, you remember, you have R&D. Everything you put in R is expense. It's part of your operating. Once it gets to the D, now it becomes considered CAPEX. It's part of your capital expenditure. Okay? This change, when you move from R to D, move the expenditure from the operating to the investing section. Now, this is important because CAPEX and operating cash flow are two of the financial world most important metrics. The simple locational shift can heavily influence an analyst's assessment. So once you see a company having a lot of R and now they move the R to the D, it means they move it to CAPEX. Why? Because from the cash flow statement, I can see those expenditure moved. It means now they have something in process that's starting to become viable. Okay? Revaluation model, the IAS 38, intangible assets, allowed the use of revaluation model, which is actually very similar to IAS 16 for intangible asset with finite life, finite life. But only if the intangible has a price that's available on an active market, which is very rarely. You would rarely have, I mean it doesn't mean it doesn't exist. I'm going to show you some example. But if you have an intangible assets, intangible assets, they rarely have a market value in an active market. So revaluation is a little bit difficult. But for some, it's good. Example of intangible asset that may be priced on an active market, taxi license. For example, if you want to operate a taxi in New York, there is a market price for the taxi license. Efficient license, the same thing. Production quotas. If a company chooses the revaluation model, the asset fair value must be assessed on a regular basis. Basically, IAS 16 applies here. Okay? And any increase in the fair value is credited to a revaluation surplus. It goes into all CI. It goes into equity. Okay? Expect to the extent it reversed previously, record the decrease, report it directly in their income. So basically, same thing as IAS 16. Okay? Impairment of intangible asset, even though they are subject to amortization, finite life intangibles also must be tested for impairment. Again, similar to IAS 16. So what's going to happen is, although they are amortized, they are still subject to, still subject to impairment testing. Now, goodwill and intangible asset with indefinite life. So if you have a goodwill and intangible asset with indefinite life, okay? They must be reviewed. Those, they have to be tested for impairment, whether there is an indicator or not, because they have an indefinite life. You're not amortizing them. With the definite life, you just wait for the indicator, like IAS 16. Okay? So IAS 16, impairment of IAS 36, impairment of assets, allow the reversal of impairment losses on intangible asset under special circumstances. Special circumstances you can do it. You cannot reverse any losses taken on goodwill. Okay? Hopefully this session gave you an idea about IAS 38, which deals with intangibles. If you happen to visit my website for additional lectures, please consider donating. If you're studying for your CPA exam, as always, study hard. It's worth it. Good luck.