Ind AS 38, Intangible Assets, Important Questions with Solutions for CA Final Financial Reporting May & Nov 2021 Exams
Question 1 –
A Ltd. intends to open a new retail store in a new location in the next few weeks. It has spent a substantial sum on a series of television advertisements to promote this new store. It has paid for advertisements costing Rs.8,00,000 before 31st March, 2018. Rs.7,00,000 of this sum relates to advertisements shown before 31st March, 2018 and Rs.1,00,000 to advertisements shown in April, 2018. Since 31st March, 2018, A Ltd. has paid for further advertisements costing Rs.4,00,000. The accountant charged all these costs as expenses in the year to 31 March 2018. However, CFO of A Ltd. does not want to charge Rs. 12,00,000 against 2017-2018 profits. He believes that these costs can be carried forward as intangible assets because the company’s market research indicates that this new store is likely to be highly successful.
Examine and justify the treatment of these costs of Rs. 12,00,000 in the financial statements for the year ended 31st March, 2018 as per Ind AS.
Solution –
Ind AS 38 specifically prohibits recognising advertising expenditure as an intangible asset. Irrespective of success probability in future, such expenses have to be recognized in profit or loss. Therefore, the treatment given by the accountant is correct since such costs should be recognised as expenses.
However, the costs should be recognised on an accruals basis.
Therefore, of the advertisements paid for before 31st March, 2018, Rs. 7,00,000 would be recognised as an expense and Rs. 1,00,000 as a pre-payment in the year ended 31st March 2018.
Rs. 4,00,000 cost of advertisements paid for since 31st March, 2018 would be charged as expenses in the year ended 31st March, 2019.
Question 2 –
X Ltd. is engaged is developing computer software. The expenditures incurred by X Ltd. in pursuance of its development of software is given below:
- Paid Rs. 2,00,000 towards salaries of the program designers.
- Incurred Rs. 5,00,000 towards other cost of completion of program design.
- Incurred Rs. 2,00,000 towards cost of coding and establishing technical feasibility.
- Paid Rs. 7,00,000 for other direct cost after establishment of technical feasibility.
- Incurred Rs. 2,00,000 towards other testing costs.
- Cost of producing product masters for training material is Rs. 3,00,000.
- A focus group of other software developers was invited to a conference for the introduction of this new software. Cost of the conference aggregated to Rs. 70,000.
- On March 15, 20X0, the development phase was completed and a cash flow budget was prepared.
Net profit for the year was estimated to be equal Rs. 40,00,000. How X Ltd. should account for the above-mentioned cost?
Solution –
Costs incurred in creating computer software, should be charged to research & development expenses when incurred until technical feasibility/asset recognition criteria have been established for the product. Here, technical feasibility is established after completion of detailed program design.
In this case, Rs. 9,00,000 (salary cost of Rs. 2,00,000, program design cost of Rs. 5,00,000 and coding and technical feasibility cost of Rs. 2,00,000) would be recorded as expense.
Cost incurred from the point of technical feasibility are capitalised as software costs. But the conference cost of Rs. 70,000 would be expensed off.
In this situation, direct cost after establishment of technical feasibility of Rs. 7,00,000, testing cost of Rs. 2,00,000 and cost of producing product masters for training material of Rs. 3,00,000 will be capitalised.
The cost of software capitalised is = Rs. (7,00,000 + 2,00,000 + 3,00,000) = Rs. 12,00,000.
Question 3 –
Sun Ltd acquired a software from Earth Ltd. in exchange for a telecommunication license. The telecommunication license is carried at Rs. 5,00,000 in the books of Sun Ltd. The Software is carried at Rs. 10,000 in the books of the Earth Ltd which is not the fair value.
Advise journal entries in the following situations in the books of Sun Ltd and Earth Ltd:-
- Fair value of software is Rs. 5,20,000 and fair value of telecommunication license is Rs. 5,00,000.
- Fair Value of Software is not measureable. However similar Telecommunication license is transacted by another company at Rs. 4,90,000.
- Neither Fair Value of Software nor Telecommunication license could be reliably measured.
Solution –
|
Rs. in ‘000 |
||||||
| Situation | Sun Ltd. |
Earth Ltd. |
||||
| 1 | Software | 500 | Telecommunication license | 520 | ||
|
To Telecommunication license |
500 |
To Software |
10 | |||
|
To Profit on Exchange |
Nil |
To Profit on Exchange |
510 | |||
| 2 | Software | 490 | Telecommunication license | 490 | ||
| Loss on Exchange | 10 | To Software | 10 | |||
|
To Telecommunication license |
500 | To Profit on Exchange | 480 | |||
| Note: The company may first recognise Impairment loss and then pass an entry. The effect is the same as impairment loss will also be charged to Income Statement. | ||||||
| 3 | Software | 500 | Telecommunication license | 10 | ||
|
To Telecommunication license |
500 |
To Software |
10 | |||
Question 4 –
As part of its business expansion strategy, KK Ltd. is in process of setting up a pharma intermediates business which is at very initial stage. For this purpose, KK Ltd. has acquired on 1st April, 2018, 100% shares of ABR Ltd. that manufactures pharma intermediates. The purchase consideration for the same was by way of a share exchange valued at Rs.35 crores. The fair value of ABR Ltd.’s net assets was Rs.15 crores, but does not include:
(i) A patent owned by ABR Ltd. for an established successful intermediate drug that has a remaining life of 8 years. A consultant has estimated the value of this patent to be Rs.10 crores. However, the outcome of clinical trials for the same are awaited. If the trials are successful, the value of the drug would fetch the estimated Rs.15 crores.
(ii) ABR Ltd. has developed and patented a new drug which has been approved for clinical use. The cost of developing the drug was Rs.12 crores. Based on early assessment of its sales success, the valuer has estimated its market value at Rs.20 crores.
(iii) ABR Ltd.’s manufacturing facilities have received a favourable inspection by a government department. As a result of this, the Company has been granted an exclusive five-year license to manufacture and distribute a new vaccine. Although the license has no direct cost to the Company, its directors believe that obtaining the license is a valuable asset which assures guaranteed sales and the value for the same is estimated at Rs.10 crores.
KK Ltd. has requested you to suggest the accounting treatment of the above transaction under applicable Ind AS.
Solution –
As per para 13 of Ind AS 103 ‘Business Combination’, the acquirer’s application of the recognition principle and conditions may result in recognising some assets and liabilities that the acquiree had not previously recognised as assets and liabilities in its financial statements. This may be the case when the asset is developed by the entity internally and charged the related costs to expense.
Based on the above, the company can recognise following Intangible assets while determining Goodwill / Bargain Purchase for the transaction:
(i) Patent owned by ABR Ltd.: The patent owned will be recognised at fair value by KK Ltd. even though it was not recognised by ABR Ltd. in its financial statements. The patent will be amortised over the remaining useful life of the asset i.e. 8 years. Since the company is awaiting the outcome of the trials, the value of the patent cannot be estimated at Rs.15 crore and the extra Rs.5 crore should only be disclosed as a Contingent Asset and not recognised.
(ii) Patent internally developed by ABR Ltd.: lnd AS 38 ‘Intangible Assets’, after initial recognition, an intangible asset shall be carried at revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. For the purpose of revaluations under this Standard, fair value shall be determined by reference to an active market.
From the information given in the question, it appears that there is no active market for patents since the fair value is based on early assessment of its sale success. Hence it is suggested to use the cost model and recognise the patent at the actual development cost of Rs.12 crore.
(iii) Grant of Licence to ABR Ltd. by the Government: As regards to the five-year license, Ind AS 38 requires to recognize grant asset at fair value. KK Ltd. can recognize both the asset (license) and the grant at Rs.10 crore to be amortised over 5 years.
Hence the revised working would be as follows:
| Fair value of net assets of ABR Ltd. | Rs.15 crore |
| Add: Patent (10 + 12) | Rs.22 crore |
| Add: License | Rs.10 crore |
| Less: Grant for License | (Rs.10 crore) |
| Rs.37 crores | |
| Purchase Consideration | Rs.35 crores |
| Bargain purchase | Rs.2 crore |
Question 5 –
Mercury Ltd is preparing its accounts for the year ended 31 March 20X2 and is unsure about how to treat the following items.
- The company completed a grand marketing and advertising campaign costing Rs. 4.8 Lakh. The finance director had authorised this campaign on the basis that it would create Rs. 8 lakh of additional profits over the next three years.
- A new product was developed during the year. The expenditure totalled Rs. 3 lakh of which Rs. 1.5 lakh was incurred prior to 30 September 20X1, the date on which it became clear that the product was technically viable. The new product will be launched in the next four months and its recoverable amount is estimated at Rs. 1.4 lakh.
- Staff participated in a training programme which cost the company Rs. 5 lakh. The training organisation had made a presentation to the directors of the company outlining that incremental profits to the business over the next twelve months would be Rs. 7 lakh.
What amounts should appear as intangible assets in accordance with Ind AS 38 in Mercury’s balance sheet as on 31 March 20X2?
Solution –
The treatment in Mercury’s financials as at 31 March 20X2 will be as follows:
- Marketing and advertising campaign: no intangible asset will be recognised, because it is not possible to identify future economic benefits that are attributable only due to this campaign. All of the expenditure should be expensed in the statement of profit and loss.
- New product: development expenditure appearing in the balance sheet will be valued at Rs. 1.5 lakh. The expenditure prior to the date on which the product becomes technically feasible is recognised in the statement of profit and loss.
- Training programme: no asset will be recognised, because there is no control of the company over the staff and when staff leaves the benefits of the training, whatever they may be, also departs.
Question 6 –
X Ltd. acquired a patent right of manufacturing drug from Y Ltd. In exchange X Ltd. gives its intellectual property right to Y Ltd. Current market value of the patent and intellectual property rights are Rs. 20,00,000 and Rs. 18,00,000 respectively. At what value patent right should be initially recognised in the books of X Ltd. in following two situations?
(a) X Ltd. did not pay any cash to Y Ltd.
(b) X Ltd. pays Rs. 2,00,000 to Y Ltd.
Solution –
If an entity is able to determine reliably the fair value of either the asset received or the asset given up, then the fair value of the asset given up is used to measure cost unless the fair value of the asset received is more clearly evident.
The transaction at the fair value of the asset received adjusted for any cash received or paid. Therefore in case (a) patent is measured at Rs. 18,00,000, in case (b) it is measured at Rs. 20,00,000 (18,00,000 + 2,00,000).
Question 7 –
One of the senior engineers at XYZ has been working on a process to improve manufacturing efficiency and, consequently, reduce manufacturing costs. This is a major project and has the full support of XYZʼs board of directors. The senior engineer believes that the cost reductions will exceed the project costs within twenty four months of their implementation. Regulatory testing and health and safety approval was obtained on 1 June 20X5. This removed uncertainties concerning the project, which was finally completed on 20 April 20X6. Costs of Rs.18,00,000, incurred during the year till 31st March 20X6, have been recognized as an intangible asset. An offer of Rs.7,80,000 for the new developed technology has been received by potential buyer but it has been rejected by XYZ. Utkarsh believes that the project will be a major success and has the potential to save the company Rs.12,00,000 in perpetuity. Director of research at XYZ, Neha, who is a qualified electronic engineer, is seriously concerned about the long term prospects of the new process and she is of the opinion that competitors would have developed new technology at some time which would require to replace the new process within four years. She estimates that the present value of future cost savings will be Rs.9,60,000 over this period. After that, she thinks that there is no certainty about its future. What would be the appropriate accounting treatment of aforesaid issue?
Solution –
Ind AS 38 ‘Intangible Assets’ requires an intangible asset to be recognised if, and only if, certain criteria are met. Regulatory approval on 1 June 20X5 was the last criterion to be met, the other criteria have been met as follows:
- Intention to complete the asset is apparent as it is a major project with full support from board
- Finance is available as resources are focused on project
- Costs can be reliably measured
- Benefits are expected to exceed costs – (in 2 years)
Amount of Rs. 15,00,000 (Rs. 18,00,000 x 10/12) should be capitalised in the Balance sheet of year ending 20X5-20X6 representing expenditure since 1 June 20X5.
The expenditure incurred prior to 1 June 20X5 which is Rs. 3,00,000 (2/12 x Rs. 18,00,000) should be recognised as an expense, retrospective recognition of expense as an asset is not allowed.
Ind AS 36 ‘Impairment of assets’ requires an intangible asset not yet available for use to be tested for impairment annually.
Cash flow of Rs. 12,00,000 in perpetuity would clearly have a present value in excess of Rs. 12,00,000 and hence there would be no impairment. However, the research director is technically qualified, so impairment tests should be based on her estimate of a four-year remaining life and so present value of the future cost savings of Rs. 9,60,000 should be considered in that case.
Rs. 9,60,000 is greater than the offer received (fair value less costs to sell) of Rs. 7,80,000 and so Rs. 9,60,000 should be used as the recoverable amount.
So, the carrying amount should be consequently reduced to Rs. 9,60,000.
Calculation of Impairment loss:
| Particulars | Amount Rs. |
| Carrying amount (Restated) | 15,00,000 |
| Less: Recoverable amount | 9,60,000 |
| Impairment loss | 5,40,000 |
Impairment loss of Rs. 5,40,000 is to be recognised in the profit and loss for the year 20X5-20X6.
Necessary adjusting entry to correct books of account will be:
| Rs. | Rs. | |
| Operating expenses- Development expenditure Dr. | 3,00,000 |
8,40,000 |
| Operating expenses–Impairment loss of intangible assets Dr. | 5,40,000 | |
| To Intangible assets – Development expenditure |
Question 8 –
Expenditure on a new production process in 20X1-20X2:
| 1st April to 31st December | 2,700 |
| 1st January to 31st March | 900 |
| 3,600 |
The production process met the intangible asset recognition criteria for development on 1st January, 20X2. The amount estimated to be recoverable from the process is Rs. 1,000.
Expenditure incurred for development of the process in FY 20X2-20X3 is Rs. 6,000. Asset was brought into use on 31st March, 20X3 and is expected to be useful for 6 years.
What is the carrying amount of the intangible asset at 31st March, 20X2 and 31st March, 20X3. Also determine the charge to profit or loss for 20X1-20X2?
At 31st March, 20X4, the amount estimated to be recoverable from the process is Rs. 5,000.
What is the carrying amount of the intangible asset at 31st March, 20X4 and the charge to profit or loss for 20X3-20X4?
Solution
| 1) Expenditure to be transferred to profit or loss in 20X1-20X2 | Rs. |
| Total Expenditure | 3,600 |
| Less: Expenditure during development phase | (900) |
| Expenditure to be transferred to profit or loss | 2,700 |
| 2) Carrying amount of intangible asset on 31st March, 20X2 | |
| Expenditure during Development Phase will be capitalized | Rs. 900 |
| (Recoverable amount is higher being Rs. 1,000, hence no impairment) | |
| 3) Carrying amount of intangible asset on 31st March, 20X3 | Rs. |
| Carrying amount of intangible asset on 31st March, 20X2 | 900 |
| Add: Further expenditure during development phase | 6,000 |
| Total capital expenditure on development phase | 6,900 |
| 4) Expenditure to be charged to profit or loss in 20X3-20X4 | Rs. |
| Opening balance of Intangible Asset | 6,900 |
| Add: Amotisation for the year (6,900 / 6) | (1,150) |
| Carrying amount of intangible asset | 5,750 |
| Less: Recoverable Amount | (5,000) |
| Amount charged to profit or loss (Impairment Loss) | 750 |
| 5) Carrying Amount of Intangible Asset on 31st March, 20X4 | |
| Value of Intangible Asset will be recoverable amount i.e. Rs. 5,000 |
Question 9 –
A Ltd. intends to open a new retail store in a new location in the next few weeks. It has spent a substantial sum on a series of television advertisements to promote this new store. It has paid for advertisements costing Rs. 8,00,000 before 31st March, 2018. Rs. 7,00,000 of this sum relates to advertisements shown before 31st March, 2018 and Rs. 1,00,000 to advertisements shown in April, 2018. Since 31st March, 2018, A Ltd. has paid for further advertisements costing Rs. 4,00,000. The accountant charged all these costs as expenses in the year to 31 March 2018. However, CFO of A Ltd. does not want to charge Rs.12,00,000 against 2017-2018 profits. He believes that these costs can be carried forward as intangible assets because the company’s market research indicates that this new store is likely to be highly successful.
Examine and justify the treatment of these costs of Rs. 12,00,000 in the financial statements for the year ended 31st March, 2018 as per Ind AS.
Solution –
Ind AS 38 specifically prohibits recognising advertising expenditure as an intangible asset. Irrespective of success probability in future, such expenses have to be recognized in profit or loss. Therefore, the treatment given by the accountant is correct since such costs should be recognised as expenses.
However, the costs should be recognised on an accruals basis.
Therefore, of the advertisements paid for before 31st March, 2018, Rs. 7,00,000 would be recognised as an expense and Rs. 1,00,000 as a pre-payment in the year ended 31st March 2018.
Rs. 4,00,000 cost of advertisements paid for since 31st March, 2018 would be charged as expenses in the year ended 31st March, 2019.