RECOGNITION AND INITIAL MEASUREMENT OF AN INTANGIBLE ASSET An intangible asset should be recognised if, and only if: a. it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and b. the cost of the asset can be measured reliably. According to the AS-26,an enterprise should assess the probability of future economic benefits using reasonable and supportable assumptions that represent best estimate of the set of economic conditions that will exist over the useful life of the asset. Separate Acquisition 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 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. Example:11.18 Table 11.42 shows the balance sheet of ABC ltd. Table 11. 42 Balance Sheet Capital 50,000 Cash 50,000 Profit 35,000 Stock 25,000 Loans 50,000 Fixed Assets 60,000 135,000 135,000 35
ABC ltd acquires technical know-how from a Singapore company for 1000 Singapore Dollars ( 1 Singapore Dollar = Rs. 22). The company paid 12% duty on the purchase price and a legal fee of Rs.10,000 towards legal and consulting charges. Balance sheet after the acquisition of the know-how will be as follows: Table 11.43 Balance Sheet after acquiring know-how Capital 50,000 Cash 15,360 Profit 35,000 Stock 25,000 Know-how 34,640 Loans 50,000 Fixed Assets 60,000 Value of Know-how Purchase Price 22,000 Duty (12%) 2,640 Legal Fee 10,000 34,640 135,000 135,000 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 Accounting Standard (AS) 14: Accounting for Amalgamations. According to AS-14: under the purchase method, the transferee company accounts for the amalgamation either by incorporating the assets and liabilities at their existing carrying amounts or by allocating the consideration to individual identifiable assets and liabilities of the transferor company on the basis of their fair values at the date of amalgamation. The identifiable assets and liabilities may include assets and liabilities not recorded in the financial statements of the transferor company. Excess money is treated as goodwill. Such goodwill is amortised over a period not exceeding five years unless a somewhat longer period can be justified. Example:11.19 Following are the assets and sources of ABC ltd. and XYZ ltd. Table 11.44 Balance sheet of XYZ ltd Capital (10) 100,000 Reserves 150,000 10% Loans 200,000 450,000 Plant 200,000 Furniture 50,000 Cash 200,000 450,000 Table 11.45 Capital (10) 100,000 Reserves 50,000 10% Loans 200,000 350,000 Plant 200,000 Furniture 50,000 Stock 100,000 350,000 36
ABCltd was taken over by XYZ ltd. at the market price of Rs. 40 per share. ABC ltd had a knowhow with a market value of 100,000. Purchase Consideration = 10,000 *40 = 400,000 Market value of the assets = Plant (150,000)+ Furniture (20,000)+ Stock (250,000) + Know-how (100,000) = 520,000 Networth = Market value of assets Liabilities = 520,000-200,000 = 320,000 Goodwill = Purchase Consideration - Market Value of Net worth = 400,000-320,000 = 80,000 Table 11.46 Balance sheet of XYZ ltd (After Consolidation) Capital (10) 100,000 Plant 350,000 Reserves 150,000 Furniture 70,000 Loans 200,000 Stock 250,000 Know-how 100,000 10% Loans 400,000 Cash 0 Goodwill 80,000 850,000 850,000 Acquisition by way of a Government Grant According to AS-26, 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, Accounting for Fixed Assets. According to AS-10, When an asset is acquired in exchange for another asset, its cost is usually determined by reference to the fair market value of the consideration given. Similarly, when an asset is acquired in exchange for shares or other securities in the enterprise, it is usually recorded at its fair market value, or the fair market value of the securities issued, whichever is more clearly evident. 37
Example: 11.20 Table 11.47 shows the balance sheet of ABC ltd. Table 11.47 Capital (10) 100,000 Plant 200,000 Reserves 250,000 Furniture 50,000 10% Loans 200,000 Stock 100,000 Cash 200,000 550,000 550,000 ABC ltd. acquires a computer design from a small IT firm in consideration of its 1000 shares. The market value of its shares on the date of acquisition is Rs. 50. Balance sheet, if ABC issues shares to the IT firm, is shown by table 11.48. Table 11.48 Capital (10) 110,000 Plant 200,000 Reserves 250,000 Furniture 50,000 Share Premium 40,000 Software 50,000 10% Loans 200,000 Stock 100,000 Cash 200,000 600,000 600,000 Increase in Assets by 50,000 (Software) Increase of capital by 10,000 (1000 *10) Share premium of Rs 40,000 (1000 *40) Balance sheet if ABC purchases shares from the market and then transfers to the IT firm is shown by table 11.49. Table 11.49 Capital (10) 100,000 Plant 200,000 Reserves 250,000 Furniture 50,000 Software 50,000 10% Loans 200,000 Stock 100,000 Cash 150,000 550,000 550,000 Increase in Assets by 50,000 (Software) Decrease in cash by 50,000 No change in capital Internally generated goodwill should not be recognised as an asset. In some cases, expenditure is incurred to generate future economic benefits, but it does not result in the creation of an intangible asset that meets the recognition criteria in this Statement. Such expenditure is often described as contributing to 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. Table 11.50 shows the market value (MV) and book value (BV) of some of the selected Indian companies: 38
Table 11.50 BV and MV as on 31st March 2006 BV MV Oil & Natural Gas Corpn. Ltd. 5,609 70,130 Tata Consultancy Services Ltd. 6,897 68,483 Infosys Technologies Ltd. 45,154 98,819 Reliance Industries Ltd. 6,420 57,407 Wipro Ltd. 7,335 57,833 Bharti Airtel Ltd. 9,002 47,919 I T C Ltd. 2,305 38,877 Differences between the market value of an enterprise and the carrying amount of its identifiable net assets at any point in time may be due to a range of factors that affect the value of the enterprise. However, such differences cannot be considered to represent the cost of intangible assets controlled by the enterprise. Internally Generated Intangible Assets According to AS-26, to assess whether an internally generated intangible asset meets the criteria for recognition, an enterprise classifies the generation of the asset into: a research phase; and a development phase. Research Phase No intangible asset arising from research (or from the research phase of an internal project) should be recognised. Expenditure on research (or on the research phase of an internal project) should be recognised as an expense when it is incurred. Development Phase 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: a. the technical feasibility of completing the intangible asset so that it will be available for use or sale; b. its intention to complete the intangible asset and use or sell it; c. its ability to use or sell the intangible asset; d. 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; 39
e. 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. Cost of an Internally Generated Intangible Asset According to AS-26, 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. The cost includes, if applicable: a. expenditure on materials and services used or consumed in generating the intangible asset; b. the salaries, wages and other employment related costs of personnel directly engaged in generating the asset; c. any expenditure that is directly attributable to generating the asset, such as fees to register a legal right and the amortisation of patents and licences that are used to generate the asset; and d. overheads that are necessary to generate the asset and that can be allocated on a reasonable and consistent basis to the asset (for example, an allocation of the depreciation of fixed assets, insurance premium and rent). Allocations of overheads are made on bases similar to those used in allocating overheads to inventories (see AS 2, Valuation of Inventories). AS 16, Borrowing Costs, establishes criteria for the recognition of interest as a component of the cost of a qualifying asset. These criteria are also applied for the recognition of interest as a component of the cost of an internally generated intangible asset. Recognition of an Expense According to the AS-26, if an expenditure is incurred to provide future economic benefits to an enterprise, but no intangible asset or other asset is acquired or created that can be recognised. In these cases, the expenditure is recognised as an expense when it is incurred. a. expenditure on research is always recognised as an expense when it is incurred ; b. 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); c. expenditure on training activities; d. expenditure on advertising and promotional activities; and e. expenditure on relocating or re-organising part or all of an enterprise 40
Subsequent Expenditure According to the AS-26, 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. If these conditions are met, the subsequent expenditure should be added to the cost of the intangible asset. Example:11.21 ABC ltd. acquired a patent for Rs. 50,000 in the year 2005. During 2006 hired a consultant to use the patent to design a product using the patent. The consultant was paid a fee of Rs. 25,000. Money paid to the consultant will be treated as a revenue expense unless the company can prove it otherwise. 41