The valuation of intangible assets is a tricky subject and hence is in most cases excluded from financial statements. Below we talk about the pre-requisites to be able to report the value of intangible assets on financial statements.
International Accounting Standard (IAS) 38, is the accounting standard that sets out the criteria for recognizing and measuring intangible assets.
Definition: “An intangible asset is an identifiable non-monetary asset without physical substance. Such an asset is identifiable when it is separable, or when it arises from contractual or other legal rights. Separable assets are those than can separately sold, transferred, licensed, etc. Examples of intangible assets include computer software, licenses, trademarks, patents, films, copyrights, import quotas and goodwill*.
Recognition on financial statements:
If the intangible has a fair value: Simply put, intangible assets can be recorded on financial statements only if they have been purchased or generated through a transaction, have a fair value assigned to them through comparison to an active market (in rare cases) or are commercially viable with a high likelihood to generate cashflows. For example, a purchased patent, software and even purchased goodwill*.
If the revenue generated from it is separable from the overall revenue: Internally generated assets such as internally generated brands, mastheads, publishing titles, customer lists and similar items cannot be reported on balance sheets as revenue generated by such assets cannot be singled out from the overall revenue, and neither do they have a fair value assigned to them through a recent transaction.
If it is developed internally – based on the development phase: Internally developed intangibles such as software and technology, can be measured and recognized on financial statements based on the development phase of the asset. If the development is in research stage, all expenses incurred will be charged to the income statement. It is only when the development has surpassed testing stage and meets certain conditions that qualifies as being commercially viable that all expenses incurred on it can be capitalized in the balance sheet and recorded at cost.
The accounting standard specifies: Expenditure for an intangible item is recognized as an expense, unless the item meets the definition of an intangible asset, and:
it is probable that there will be future economic benefits from the asset; and
the cost of the asset can be reliably measured.
Subsequent valuation of intangible assets: Intangible assets are measured initially at cost or fair value. After initial recognition, an entity usually measures an intangible asset at cost less accumulated amortisation. An intangible asset with a finite useful life is amortised and is subject to impairment testing. An intangible asset with an indefinite useful life is not amortised, but is tested annually for impairment. When an intangible asset is disposed of, the gain or loss on disposal is included in profit or loss.
* Goodwill acquired in a business combination is accounted for in accordance with IFRS 3 and is outside the scope of IAS 38. Internally generated goodwill is within the scope of IAS 38 but is not recognised as an asset because it is not an identifiable resource.