Intangible Assets and Impairment (IAS 38 and IAS 36)
Assets
Intangible Assets and Impairment (IAS 38 and IAS 36)
Syllabus tag: KASNEB CPA | Intermediate Level | CA23 Financial Reporting and Analysis | Topic 3 Intangible Assets and Impairment
Lesson objectives
By the end of this topic, you will be able to:
- Apply the recognition criteria for an intangible asset
- Distinguish research from development and apply the capitalisation criteria
- Explain why internally generated goodwill and brands may not be recognised
- Amortise a finite-life intangible and test an indefinite-life one
- Allocate an impairment loss within a cash-generating unit
Why this matters
For many modern businesses the most valuable things they own — a brand, a customer list, software they wrote themselves — appear nowhere on the balance sheet. Understanding why is as important as the arithmetic.
Recognition
An intangible asset is an identifiable, non-monetary asset without physical substance. Identifiable means either separable — capable of being sold on its own — or arising from contractual or legal rights.
It is recognised only where future economic benefits are probable and cost can be measured reliably.
Research and development
Research is original investigation to gain new knowledge. It is always expensed, because at that stage no economic benefit can be demonstrated.
Development is applying research findings to a plan for a new product or process. It must be capitalised — not may — once all six criteria are met:
- Technical feasibility of completing it
- Intention to complete and use or sell it
- Ability to use or sell it
- Probable future economic benefits
- Adequate resources to complete it
- Reliable measurement of the expenditure
A memory aid: PIRATE — Probable benefits, Intention, Resources, Ability, Technical feasibility, Expenditure measurable.
The date matters. Chui Ltd spent KES 14,400,000 on a project: 5,400,000 on research, 3,000,000 on development before the criteria were met, and 6,000,000 after.
| KES | |
|---|---|
| Research — expensed | 5,400,000 |
| Development before criteria met — expensed | 3,000,000 |
| Total expensed | 8,400,000 |
| Development capitalised | 6,000,000 |
Expenditure already expensed may never be reinstated as an asset once the criteria are later met. Only spending from that date forward is capitalised.
Amortised over a 5-year benefit period: 1,200,000 a year, giving a carrying amount after two years of KES 3,600,000.
Amortisation begins when the asset is available for use, not when development ends.
What may never be recognised
Internally generated goodwill, brands, mastheads, customer lists and similar items are prohibited, along with start-up costs, training, advertising and relocation.
The reason is that their cost cannot be distinguished from the cost of running the business as a whole. A company cannot say which portion of its marketing spend created the brand rather than sold this month's goods.
This produces an asymmetry worth stating plainly: a purchased brand appears as an asset because a price was paid for it, while an identical brand built up internally does not. It is not inconsistency for its own sake — one has a reliable cost and the other does not.
:::checkpoint A company has spent thirty years building a brand its directors value at KES 2 billion. A rival buys a similar brand for KES 1.8 billion and shows it as an asset. Explain to the directors why their brand cannot be recognised, and what would change if the company were itself acquired. :::
Finite and indefinite useful lives
Finite life — amortise over the useful life, and review the life and method at each year end.
Indefinite life — do not amortise. Instead test for impairment annually and whenever there is an indication of impairment.
Indefinite does not mean infinite. It means there is no foreseeable limit to the period over which the asset will generate cash. Goodwill acquired in a business combination always falls here — never amortised, always tested each year.
Impairment of a cash-generating unit
Many assets cannot be tested alone because they do not generate cash independently. They are tested as part of a cash-generating unit: the smallest group of assets producing largely independent cash inflows.
A CGU has goodwill of KES 4,000,000 and other assets of 20,000,000, so its carrying amount is 24,000,000. Its recoverable amount is 21,000,000.
Impairment loss = 24,000,000 − 21,000,000 = KES 3,000,000
The allocation order is fixed:
- First to goodwill, until it is exhausted
- Then to other assets pro rata by carrying amount
Here the whole 3,000,000 is written off goodwill, leaving 1,000,000 of goodwill and the other assets untouched.
Had the loss been 6,500,000, the first 4,000,000 would eliminate goodwill entirely and the remaining 2,500,000 would reduce the other assets to 17,500,000.
Goodwill absorbs the loss first because it is the least certain asset in the unit — it has no separate existence and cannot be sold on its own.
Reversal. An impairment of most assets may be reversed if circumstances improve. An impairment of goodwill may never be reversed, since any later recovery would be internally generated goodwill, which cannot be recognised.
:::checkpoint A CGU's goodwill was written down in full two years ago. Trading has since recovered strongly and the recoverable amount now exceeds the carrying amount. Explain what may and may not be reversed, and why the rule differs for goodwill. :::