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Accounting for intangible assets

Intangible assets are assets that do not have a physical substance. These include patents, copyrights, franchises, etc.

Under IFRS, an identifiable intangible asset is one which:

  • can be separately identified from other assets,
  • is under the control of the company, and
  • is expected to generate economic benefits.

An identifiable intangible asset is recognized when it is probable that economic benefits will flow to the entity and the asset’s cost can be measured reliably. Goodwill, even though an intangible asset, is not an identifiable asset.

Acquired intangible assets

When a company acquires intangible assets in a transaction other than in a business combination, it recognizes them on the balance sheet at their cost just like a tangible fixed asset.

When a number of assets are acquired in a single transaction, the purchase price is allocated to them based on their fair values.

Understanding the type of intangible assets that a company acquires is useful in assessing a company’s strategy.

Internally-developed intangible assets

The cost of internally-developed intangible assets is generally (but not always) expensed. This creates a mismatch between the balance sheet of a company that develops intangible assets internally and the balance sheet of a company that acquires them.

The cost of internally-developed intangible assets is classified as cash flows from operating activities, but the cost of acquired intangible assets is categorized as investing cash outflow.

IFRS requires expenses incurred during the research phase to be expensed while those in the development phase (once the technical feasibility of the intangible asset has been determined) must be capitalized. US GAAP requires expensing-out of both research and development phase costs but requires capitalization of software development costs (whose accounting is similar to accounting for internally-developed intangible assets under IFRS, i.e. expense costs until technical feasibility is determined, and capitalize thereon).

Intangible assets acquired in business combinations

When intangible assets are acquired in a business combination, the purchase price is allocated to identifiable assets based on their fair value, and any excess is recognized as goodwill. Under the US GAAP, intangible assets acquired in business are recognized if (a) it arises from contractual or legal rights (such as patents, copyrights, etc.), or (b) if it can be separated from the acquired company.

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