In: Accounting
Assume you are the financial controller of a new established company. The CEO has asked your choice of accounting policy regarding the measurement of intangible assets at the time of recognition and after the acquisition.
Required:
State your choice of accounting policy regarding the measurement of intangible assets at the time of recognition and after the initial acquisition. Explain the reason (s) of your choice (s). You should provide comments regarding the choice of accounting method.
What is an intangible asset?
An intangible asset is a non-monetary asset which does not have a physical shape. It can be self-created or purchased. It is usually expected to be a source of revenue or other economic benefits/assets in future.
Features of intangible assets:
Following are the important features of intangible assets:
1. They are separately identifiable. Even without a physical shape, they can be attributed to a usable form.
2. They can be controlled by the entity that can use them to derive measurable benefits in future.
3. They are a source of future economic benefits in the form of revenue or reduction in costs.
Some common examples of intangible assets are patents, licenses, franchise agreements, computer software, databases, and marketing rights.
How do intangible assets arise?
Intangible assets can arise in any of the following ways:
1. By self-creation
2. By purchase
3. By an exchange of assets
4. By a business arrangement/acquistion
Accounting policy with respect to intangible assets:
The accounting treatment of intangible assets consists of the following aspects:
1. The first aspect is about the recognition of the intangible asset. Recognition of an intangible asset should be
based on two factors: the asset can be reasonably expected to produce a stream of future economic benefits for
the enterprise and the cost of the asset can be determined.
2. The second aspect is with respect to the valuation of the intangible asset subsequent to acquistion.
Initial recognition of an intangible asset:
An intangible asset that meets both the criteria for recognition is measured at cost and capitalised as an asset. If some expenditure is incurred on items that do not meet the recognition criteria, they are written off as expense in the period in which they are incurred. Thus, expenditures that add to the capability of the intangible asset to provide a future stream of benefits are included as the cost of the asset, whereas other related expenditures are written off as expense. For example, if a research and development project is underway to produce an asset, all research-related expenditure are treated as expense, whereas when the technical and financial feasibility of the asset are established, the development expenditure is capitalized.
Valuation after initial recognition/acquisition:
Once an intangible asset has been recognized, its carrying value should be evaluated at the end of each accounting period. The first step is to determine the useful life of the asset. For intangible assets with a definite useful life, the initial cost less the residual value should be amortized over the useful life of the asset. The method of amortization should be based on the pattern of benefits accruing from the asset. If such a pattern cannot be established, the straight-line method is adopted. An intangible asset with an indefinite useful life should be evaluated at the end of each accounting period to confirm the perpetual useful life. In case there is a change in this estimation, it can be stated that the useful life has changed to a definite time period and the asset should be treated accordingly.
If a market value or fair value is available for an intangible asset, it may be carried at this value after adjusting for amorization and impairment losses. An impairment is defined as a permanent reduction in the capability to produce the desired outcome or stream of benefits.