Question

A. What is the difference between internally generated intangible assets and those generated through external transactions? Discuss with EXAMPLES OF EACH.

B. Do you think recognizing internally generated intangible assets leads to incorrect reporting of intangible assets? Give an EXAMPLE to support your answer.

Answer 1

(A) Solution:

Internally generated intangible assets:

- The intangible assets which are generated internally by the organisation are covered under this category of intangibles.

-The process of generating an intangible asset is divided into a research phase and a development phase. No intangible assets arising from the research phase may be recognised. Intangible assets arising from the development phase are recognised when the entity can demonstrate:

• its technical feasibility;
• its intention to complete the developments;
• its ability to use or sell the intangible asset;
• how the intangible asset will generate probable future economic benefits (for example, the existence of a market for the output of the intangible asset or for the intangible asset itself);
• the availability of resources to complete the development; and
• its ability to measure the attributable expenditure reliably.

Any expenditure written off during the research or development phase cannot subsequently be capitalised if the project meets the criteria for recognition at a later date.

The costs relating to many internally generated intangible items cannot be capitalised and are expensed as incurred. This includes research, start-up and advertising costs. Expenditure on internally generated brands, mastheads, customer lists, publishing titles and goodwill are not recognised as intangible assets.

Development costs paid to an external party – example

Company A pays Company B, an external party, to develop an asset that would meet the requirements of IAS 38 for recognition as an internally generated intangible asset in Company A’s financial statements. Company B is performing only development work; all the associated research has already been performed, and the costs expensed, by Company A.

Company A should recognise an internally generated intangible asset for these development costs under IAS 38. Whether Company A incurs the costs directly via an internal development function or outsources the development process to an external party does not influence how Company A should account for the asset in its financial statements.

Externally generated Intangible asset

- The externally generated intangible assets are also known as purchased intangible assets. These are intangible which are purchased by us and sold by others.

- Examples of purchased intangible assets include purchased goodwill, purchased brand recognition, purchased copyrights, purchased patents, purchased trademarks, and purchased customer lists.

Goodwill purchased - Example

Company A acquired Company B and paid a total consideration of $ 10 million whereas the Company B total assets fair value were only $ 8 million. So question arises why $ 2 million extra paid for the company B acquisition, So the answer is it is for the brand value i.e Goodwill of Company B which is now purchased by Company A.

(B) Solution:

Yes, recognizing internally generated intangible assets leads to incorrect reporting of intangible assets because the many of the expenses are expensed out in profit and loss account before meeting the criteria for the recognition of the intangible asset and also the cost recorded of the development phase till final phase is less as compared to the fair market value of the product which is developed. Futher, the amount recognised of internally generated asset is less reliable then the externally purchased intangible asset.

Example:

Company A wanted to develop a Special Vaccine to cure a new Virus. It started its research phase and spent $ 10 million and then development phase beginned and recognition critera got met for intangible asset and spent another $ 30 million and later in started trial and the vaccine was successful. Spent $ 10 million on marketing and other expenses. After it got launched its fair market value was $ 100 million. So in this whole only $ 30 million would be recorded as intangible asset as the rognizing criteria got met. $ 10 million each spent on research was expensed off to profit and loss account. So the intangible asset value on balance sheet is only  $ 30 million from the total amount spent of  $ 50 million. These figures shows some inconsistency among the cost spent and cost recognised as intangible asset. Further, the fair market value is $ 100 million wheres in books of accounts it is only $ 30 million. This figures also created a question about correct reporting of internal generated assets. This case was understatment of value of intangible asset. The opposite case of overstatment of value of intangible assets can also be there. So cost recorded of internally generated intangibe assets are considered less reliable and thus leads to inaccurate reporting of intangible assets.