Accounting Standard (AS) 26: Intangible Asset
The objective of AS 26 is to prescribe the accounting treatment for intangible assets that are not dealt with specifically in another Accounting Standard.
AS 26 should be applied by all enterprises in accounting for intangible assets, except:
- Intangible assets that are covered by another Accounting Standard. For example, AS 26 does not apply to:
- Intangible assets held by an enterprise for sale in the ordinary course of business (AS 2 and AS 7)
- Deferred tax assets (AS 22)
- Leases that fall within the scope of AS 19
- Goodwill arising on an amalgamation (AS 14 (Revised)) and goodwill arising on consolidation (AS 21 (Revised))
- Financial assets
- Mineral rights and expenditure on the exploration for, or development and extraction of, minerals, oil, natural gas and similar non-regenerative resources and
- Intangible assets arising in insurance enterprises from contracts with policyholders.
However, AS 26 applies to other intangible assets used (such as computer software), and other expenditure (such as start-up costs), in extractive industries or by insurance enterprises.
AS 26 also applies to:
- expenditure on advertising, training, start – up cost
- Research and development activities
- Right under licensing agreements for items such as motion picture films, video recordings, plays, manuscripts
- Patents, copyrights and trademarks
An asset is a resource:
- Controlled by an enterprise as a result of past events and
- From which future economic benefits are expected to flow to the enterprise.
Monetary assets are money held and assets to be received in fixed or determinable amounts of money.
Non-monetary assets are assets other than monetary assets.
Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its useful life.
Depreciable amount is the cost of an asset less its residual value.
Useful life is either:
- the period of time over which an asset is expected to be used by the enterprise; or
- the number of production or similar units expected to be obtained from the asset by the enterprise.
An active market is a market where all the following conditions exist:
- The items traded within the market are homogeneous.
- Willing buyers and sellers can normally be found at any time and
- Prices are available to the public.
An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
Carrying amount is the amount at which an asset is recognised in the balance sheet, net of any accumulated amortisation and accumulated impairment losses thereon.
An intangible asset is
- an identifiable
- non-monetary asset
- without physical substance
- held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
The definition of an intangible asset requires that an intangible asset be identifiable. To be identifiable, it is necessary that the intangible asset is clearly distinguished from goodwill.
An intangible asset can be clearly distinguished from goodwill if the asset is separable. An asset is separable if the enterprise could rent, sell, exchange or distribute the specific future economic benefits attributable to the asset without also disposing of future economic benefits that flow from other assets used in the same revenue earning activity.
An enterprise controls an asset if the enterprise has the power to obtain the future economic benefits flowing from the underlying resource and also can restrict the access of others to those benefits. The capacity of an enterprise to control the future economic benefits from an intangible asset would normally stem from legal rights that are enforceable in a court of law.
However, legal enforceability of a right is not a necessary condition for control since an enterprise may be able to control the future economic benefits in some other way.
Future Economic Benefits
The future economic benefits flowing from an intangible asset may include revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the asset by the enterprise. For example, the use of intellectual property in a production process may reduce future production costs rather than increase future revenues.
Recognition and Initial Measurement of an Intangible Asset
The recognition of an item as an intangible asset requires an enterprise to demonstrate that the item meets the definition of an intangible asset and recognition criteria set out as below:
- It is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
- The cost of the asset can be measured reliably.
An intangible asset should be measured initially at cost.
If an intangible asset is acquired separately, the cost of the intangible asset can usually be measured reliably. This is particularly so when the purchase consideration is in the form of cash or other monetary assets.
The Cost of an Intangible Asset
The cost of an intangible asset comprises
- its purchase price, including any import duties and other taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), and
- any directly attributable expenditure on making the asset ready for its intended use.
- Directly attributable expenditure includes, for example, professional fees for legal services. Any trade discounts and rebates are deducted in arriving at the cost.
If an intangible asset is acquired in exchange for shares or other securities of the reporting enterprise, the asset is recorded at its fair value, or the fair value of the securities issued, whichever is more clearly evident.
Acquisition as part of an Amalgamation
An intangible asset acquired in an amalgamation in the nature of purchase is accounted for in accordance with AS 14 (Revised). In accordance with AS 26:
- A transferee recognises an intangible asset that meets the recognition criteria, even if that intangible asset had not been recognised in the financial statements of the transferor and
- If the cost (i.e. fair value) of an intangible asset acquired as part of an amalgamation in the nature of purchase cannot be measured reliably, that asset is not recognised as a separate intangible asset but is included in goodwill.
Acquisition by way of a Government Grant
In some cases, an intangible asset may be acquired free of charge, or for nominal consideration, by way of a government grant. This may occur when a government transfers or allocates to an enterprise intangible assets such as airport landing rights, licences to operate radio or television stations, import licences or quotas or rights to access other restricted resources.
AS 12, requires that government grants in the form of non-monetary assets, given at a concessional rate should be accounted for on the basis of their acquisition cost. Accordingly, intangible asset acquired free of charge, or for nominal consideration, by way of government grant is recognised at a nominal value or at the acquisition cost, as appropriate; any expenditure that is directly attributable to making the asset ready for its intended use is also included in the cost of the asset.
Exchanges of Assets
An intangible asset may be acquired in exchange or part exchange for another asset. In such a case, the cost of the asset acquired is determined in accordance with the principles laid down in this regard in AS 10.
Internally Generated Goodwill
Internally generated goodwill is not recognised as an asset because it is not an identifiable resource controlled by the enterprise that can be measured reliably at cost.
Internally Generated Intangible Assets
To assess whether an internally generated intangible asset meets the criteria for recognition, an enterprise classifies the generation of the asset into following phases:
- Research Phase
- Development Phase
Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
No intangible asset arising from research or from the research phase should be recognised. Expenditure on research or on the research phase should be recognised as an expense when it is incurred.
Examples of research activities are:
- Activities aimed at obtaining new knowledge.
- The search for, evaluation and final selection of, applications of research findings or other knowledge.
- The search for alternatives for materials, devices, products, processes, systems or services;
- The formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems or services.
Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services prior to the commencement of commercial production or use.
An intangible asset arising from development (or from the development phase of an internal project) should be recognised if, and only if, an enterprise can demonstrate all of the following:
- The technical feasibility of completing the intangible asset so that it will be available for use or sale.
- Its intention to complete the intangible asset and use or sell it.
- Its ability to use or sell the intangible asset.
- How the intangible asset will generate probable future economic benefits. Among other things, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
- The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset and
- Its ability to measure the expenditure attributable to the intangible asset during its development reliably.
Examples of development activities are:
- The design, construction and testing of pre-production or pre-use prototypes and models.
- The design of tools, jigs, moulds and dies involving new technology.
- The design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production and
- The design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services.
Cost of an Internally Generated Intangible Asset
The cost of an internally generated intangible asset is the sum of expenditure incurred from the time when the intangible asset first meets the recognition criteria.
Reinstatement of expenditure recognised as an expense in previous annual financial statements or interim financial reports is prohibited.
The cost of an internally generated intangible asset comprises all expenditure that can be directly attributed, or allocated on a reasonable and consistent basis, to creating, producing and making the asset ready for its intended use from the time when the intangible asset first meets the recognition.
Recognition of an Expense
Expenditure on an intangible item should be recognised as an expense when it is incurred unless:
- It forms part of the cost of an intangible asset that meets the recognition criteria or
- The item is acquired in an amalgamation in the nature of purchase and cannot be recognised as an intangible asset. It forms part of the amount attributed to goodwill (capital reserve) at the date of acquisition.
Examples of other expenditure that is recognised as an expense when it is incurred include:
- expenditure on start-up activities (start-up costs), unless this expenditure is included in the cost of an item of fixed asset under AS 10. Start-up costs may consist of preliminary expenses incurred in establishing a legal entity such as legal and secretarial costs, expenditure to open a new facility or business (pre-opening costs) or expenditures for commencing new operations or launching new products or processes (pre-operating costs);
- expenditure on training activities;
- expenditure on advertising and promotional activities; and
- expenditure on relocating or re-organising part or all of an enterprise.
Expenses recognised as expenses cannot be reclassified as cost of intangible asset in later years.
Subsequent expenditure on an intangible asset after its purchase or its completion should be recognised as an expense when it is incurred unless:
- It is probable that the expenditure will enable the asset to generate future economic benefits in excess of its originally assessed standard of performance and
- The expenditure can be measured and attributed to the asset reliably.
Measurement Subsequent to Initial Recognition
After initial recognition, an intangible asset should be carried
- at its cost
- less any accumulated amortization; and
- any accumulated impairment losses.
Amortise the intangible asset over the best estimate of its useful life.
AS 26 adopts a presumption that the useful life of an intangible asset is unlikely to exceed 10 years.
In case the above presumption is rebutted, entity
- Amortises over higher useful life,
- Estimates the recoverable amount of the intangible asset at least annually in order to identify any impairment loss and
- Discloses the reasons why the presumption is rebutted and the factors that played a significant role in determining the useful life of the asset.
A variety of amortisation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life.
These methods include the straight-line method, the diminishing balance method and the unit of production method. The method used for an asset is selected based on the expected pattern of consumption of economic benefits and is consistently applied from period to period, unless there is a change in the expected pattern of consumption of economic benefits to be derived from that asset.
There will rarely, if ever, be persuasive evidence to support an amortisation method for intangible assets that results in a lower amount of accumulated amortisation than under the straight-line method.
Residual value is the amount, which an enterprise expects to obtain for an asset at the end of its useful life after deducting the expected costs of disposal.
The residual value of an intangible asset should be assumed to be zero unless:
- There is a commitment by a third party to purchase the asset at the end of its useful life or
- There is an active market for the asset and
- Residual value can be determined by reference to that market and
- It is probable that such a market will exist at the end of the asset’s useful life.
Review of Amortisation Period and Amortisation Method
The amortisation period and the amortisation method should be reviewed at least at each financial year end. If the expected useful life of the asset is significantly different from previous estimates, the amortisation period should be changed accordingly. If there has been a significant change in the expected pattern of economic benefits from the asset, the amortisation method should be changed to reflect the changed pattern. Such changes should be accounted for in accordance with AS 5.
Retirements and Disposals
An intangible asset should be derecognised (eliminated from the balance sheet) if
- disposed or
- when no future economic benefits are expected from its use and subsequent disposal.
Gains or losses arising from the retirement or disposal of an intangible asset should be determined as the difference between the net disposal proceeds and the carrying amount of the asset and should be recognised as income or expense in the statement of profit and loss.
The financial statements should disclose the following for each class of intangible assets, distinguishing between internally generated intangible assets and other intangible assets:
- The useful lives or the amortisation rates used.
- The amortisation methods used.
The gross carrying amount and the accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period.
A reconciliation of the carrying amount at the beginning and end of the period showing:
- Additions, indicating separately those from internal development and through amalgamation.
- Retirements and disposals.
- Impairment losses recognised in the statement of profit and loss during the period.
- Impairment losses reversed in the statement of profit and loss during the period.
- Amortisation recognised during the period and
- Other changes in the carrying amount during the period.
The financial statements should also disclose:
- If an intangible asset is amortised over more than ten years, the reasons why it is presumed that the useful life of an intangible asset will exceed ten years from the date when the asset is available for use. In giving these reasons, the enterprise should describe the factor(s) that played a significant role in determining the useful life of the asset.
- A description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial statements of the enterprise as a whole.
- The existence and carrying amounts of intangible assets whose title is restricted and the carrying amounts of intangible assets pledged as security for liabilities and
- The amount of commitments for the acquisition of intangible assets.
- The financial statements should disclose the aggregate amount of research and development expenditure recognised as an expense during the period.