Capitalisation of expenditure ceases when the asset is in the condition necessary for it
to be capable of operating in the manner intended by management. [IAS 38.30]. This may
well be before the date on which it is brought into use.
If payment for an intangible asset is deferred beyond normal credit terms, its cost is the
cash price equivalent. The difference between this amount and the total payments is
recognised as interest expense over the period of credit unless it is capitalised in
accordance with IAS 23 – Borrowing Costs (see Chapter 21). [IAS 38.32].
4.3
Costs to be expensed
The following types of expenditure are not considered to be part of the cost of a
separately acquired intangible asset:
• costs of introducing a new product or service, including costs of advertising and
promotional activities;
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• costs of conducting business in a new location or with a new class of customer,
including costs of staff training;
• administration and other general overhead costs;
• costs incurred in using or redeploying an intangible asset;
• costs incurred while an asset capable of operating in the manner intended by
management has yet to be brought into use; and
• initial operating losses, such as those incurred while demand for the asset’s output
builds up. [IAS 38.29-30].
Accordingly, start-up costs, training costs, advertising and promotional activities, and
relocation or reorganisation costs should be expensed (see 7 below).
4.4
Income from incidental operations while an asset is being
developed
When an entity generates income while it is developing or constructing an asset, the
question arises as to whether this income should reduce the initial carrying value of the
asset being developed or be recognised in profit or loss. IAS 38 requires an entity to
consider whether the activity giving rise to income is necessary to bring the asset to the
condition necessary for it to be capable of operating in the manner intended by
management, or not. The income and related expenses of incidental operations (being
those not necessary to develop the asset for its intended use) should be recognised
immediately in profit or loss and included in their respective classifications of income
and expense. [IAS 38.31]. Such incidental operations can occur before or during the
development activities. The example below illustrates these requirements.
Example 17.3: Incidental operations
Entity A is pioneering a new process for the production of a certain type of chemical. Entity A will be able
to patent the new production process. During the development phase, A is selling quantities of the chemical
that are produced as a by-product of the development activities that are taking place. The expenditure incurred
comprises labour, raw materials, assembly costs, costs of equipment and professional fees.
The revenues and costs associated with the production and sale of the chemical are accounted for in profit or
loss for the period, while the development costs that meet the strict recognition criteria of IAS 38 are
recognised as an intangible asset. Development costs that fail the IAS 38 recognition test are also expensed.
As the above example suggests, identifying the revenue from incidental operations will
often be much easier than allocating costs to incidental operations. Furthermore, it will
often be challenging to determine when exactly a project moves from the development
phase into its start-up phase.
Whilst IAS 38 is not explicit on the matter, it follows that when the activity is determined
to be necessary to bring the intangible asset into its intended use, any income should be
deducted from the cost of the asset. (Note that IAS 16 mandates this treatment; see
Chapter 18 at 4.2.1). An example would be where income is generated from the sale of
samples produced during the testing of a new process or from the sale of a production
prototype. However, care must be taken to confirm whether the incidence of income
indicates that the intangible asset is ready for its intended use, in which case
capitalisation of costs would cease, revenue would be recognised in profit or loss and
the related costs of the activity would include a measure of amortisation of the asset.
1230 Chapter 17
4.5
Measurement of intangible assets acquired for contingent
consideration
Transactions involving contingent consideration are often very complex and payment
is dependent on a number of factors. In the absence of specific guidance in IAS 38,
entities trying to determine an appropriate accounting treatment are required not only
to understand the commercial complexities of the transaction itself, but also to negotiate
a variety of accounting principles and requirements.
Consider a relatively simple example where an entity acquires an intangible asset for
consideration comprising a combination of up-front payment, guaranteed instalments
for a number of years and additional amounts that vary according to future activity
(revenue, profit or number of units output).
Where the goods and services in question have been delivered, there is no doubt that
there is a financial liability under IFRS 9 – Financial Instruments. A contingent
obligation to deliver cash meets the definition of a financial liability (see Chapter 43).
However, where the purchaser can influence or control the crystallisation of the
contingent payments or they are wholly dependent on its future activities, the
circumstances are more difficult to interpret. Many consider that these arrangements
contain executory contracts that are only accounted for when one of the contracting
parties performs.
Further complications arise when the terms of the agreement indicate that a future
payment relates to the completion of a separate performance obligation, or the delivery
of intangible rights in addition to those conferred by the exchange of the original asset.
In practice there are two general approaches. One includes the fair value of all contingent
payments in the initial measurement of the asset. The other excludes executory payments
from initial measurement. Under both approaches, contingent payments are either
capitalised when incurred if they meet the definition of an asset, or expensed as incurred.
Between July 2013 and March 2016, the Interpretations Committee discussed
accounting for contingent consideration but ultimately concluded that the issue was too
broad for the Committee to address and referred it back to the Board. In May 2016, the
IASB tentatively agreed that this issue would be included in the research pipeline
between 2017 and 2021.1 In February 2018, the Board decided that the IASB staff should
carry out work to determine how broad the research project should be.2
Until this matter is resolved, an entity should adopt and apply a consistent accounting
policy to initial recognition and subsequent costs. For intangible assets, these
approaches are illustrated in the following example. Note that this example does not
include a number of common contingent payments, e.g. those related to usage or
revenue, or non-floating rate cha
nges in finance costs.
Example 17.4: Contingent consideration relating to a football player’s
registration
Entity A is a football club which signs a new player on a 4 year contract. In securing the registration of the
new player, Entity A agrees to make the following payments to the player’s former club:
• €5.5 million on completion of the transfer;
• €2.8 million on the first anniversary of the transfer;
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• €1 million as soon as the player has made 25 appearances for the club;
• €0.2 million when the player is first selected to play for his country; and
• 25% of the gross proceeds from any onward sale of the player before the expiry of the initial contract term.
It is determined that the expenditure meets the definition of an intangible asset because it allows Entity A to
negotiate a playing contract with the footballer that covers 4 seasons and prevents other clubs from using that
player’s services over that time. How does Entity A determine the cost of the player registration?
View 1 – All of the above payments are contractual and a financial liability arises under IFRS 9 as soon as
that player signs for the club. Accordingly, the cost of the intangible asset comprises the initial payment of
€5.5 million, plus an amount representing the present value of the €2.8 million payable in one year and an
amount to reflect the fair value of the other contingent payments (most likely determined using some kind of
probability-weighted estimation technique).
View 2 – The contractual terms requiring a payment of €1 million on the player achieving 25 appearances for
the club and another payment of 25% of the gross proceeds from any onward sale of the player are not
liabilities of Entity A at the inception of the contract, as there is no obligation on the part of Entity A to use
the player in more than 24 fixtures or to sell the player before the end of the 4 year contract term. Accordingly,
these elements of the contract are excluded from the initial cost of the intangible asset and are not recognised
until the obligating event occurs. However, the element that is contingent on the player being selected to play
for his country is not within the entity’s control and is included in the initial measurement of cost.
An entity taking view 2 would not include the appearance payment or the share of sale proceeds within the
cost of the intangible asset, even when the related obligation is eventually recognised. The entity would most
likely regard the €1 million appearance payment as an expense on the grounds that this is subsequent
expenditure that does not qualify for recognition as an intangible asset (see 3.3 above).
4.6
Acquisition by way of government grant
An intangible asset may sometimes be acquired free of charge, or for nominal
consideration, by way of a government grant. Governments frequently allocate airport-
landing rights, licences to operate radio or television stations, emission rights (see 11.2
below), import licences or quotas, or rights to access other restricted resources.
[IAS 38.44].
Government grants should be accounted for under IAS 20 – Accounting for
Government Grants and Disclosure of Government Assistance – which permits initial
recognition of intangible assets received either at fair value or a nominal amount.
[IAS 20.23].
This represents an accounting policy choice for an entity that should be applied
consistently to all intangible assets acquired by way of a government grant.
It may not be possible to measure reliably the fair value of all of the permits allocated
by governments because they may have been allocated for no consideration, may not
be transferable and may only be bought and sold as part of a business. Some of the issues
surrounding the determination of fair value in the absence of an active market are
considered in Chapter 14. Other allocated permits such as milk quotas are freely traded
and therefore do have a readily ascertainable fair value.
4.7
Exchanges of assets
Asset exchanges are transactions that have challenged standard-setters for many
years. An entity might swap certain intangible assets that it does not require or is no
longer allowed to use for those of a counterparty that has other surplus assets. For
example, it is not uncommon for airlines and media groups to exchange landing slots
1232 Chapter 17
and newspaper titles, respectively, to meet demands of competition authorities. The
question arises whether such transactions should be recorded at cost or fair value,
which would give rise to a gain in the circumstances where the fair value of the
incoming asset exceeds the carrying amount of the outgoing one. Equally, it is
possible that a transaction could be arranged with no real commercial substance,
solely to boost apparent profits.
Three separate International Accounting Standards contain virtually identical guidance
on accounting for exchanges of assets: IAS 16 (see Chapter 18), IAS 40 – Investment
Property (see Chapter 19) and IAS 38.
4.7.1
Measurement of assets exchanged
In the context of asset exchanges, the standard contains guidance on the reliable
determination of fair values in the circumstances where market values do not exist. Note
that while fair value is defined by reference to IFRS 13 (see Chapter 14), the
requirements in this section are specific to asset exchanges in IAS 38.
IAS 38 requires all acquisitions of intangible assets in exchange for non-monetary assets,
or a combination of monetary and non-monetary assets, to be measured at fair value.
The acquired intangible asset is measured at fair value unless: [IAS 38.45]
(a) the exchange transaction lacks commercial substance; or
(b) the fair value of neither the asset received nor the asset given up is reliably measurable.
The acquired asset is measured in this way even if an entity cannot immediately
derecognise the asset given up. If an entity is able to reliably determine the fair value of
either the asset received or the asset given up, then it uses the fair value of the asset
given up to measure cost unless the fair value of the asset received is more clearly
evident. [IAS 38.47]. If the fair value of neither the asset given up, nor the asset received
can be measured reliably the acquired intangible asset is measured at the carrying
amount of the asset given up. [IAS 38.45].
In this context the fair value of an intangible asset is reliably measurable if the variability
in the range of reasonable fair value measurements is not significant for that asset or the
probabilities of the various estimates within the range can be reasonably assessed and
used when measuring fair value. [IAS 38.47].
4.7.2 Commercial
substance
A gain or loss is only recognised on an exchange of non-monetary assets if the
transaction is determined to have commercial substance. Otherwise, the acquired asset
is measured at the cost of the asset given up. [IAS 38.45].
The commercial substance test for asset exchanges was put in place to prevent gains
being recognised in income when the transaction had no discernible effect on the
entity’s economics. [IAS 16.BC21]. The commercial substance of a
n exchange is
determined by forecasting and comparing the future cash flows expected to be
generated by the incoming and outgoing assets. Commercial substance means that there
must be a significant difference between the two forecasts. An exchange transaction has
commercial substance if: [IAS 38.46]
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(a) the configuration (i.e. risk, timing and amount) of the cash flows of the asset received
differs from the configuration of the cash flows of the asset transferred; or
(b) the entity-specific value of the portion of the entity’s operations affected by the
transaction changes as a result of the exchange; and
(c) the difference in (a) or (b) is significant relative to the fair value of the assets exchanged.
IAS 38 defines the entity-specific value of an intangible asset as the present value of
the cash flows an entity expects to arise from its continuing use and from its disposal
at the end of its useful life. [IAS 38.8]. In determining whether an exchange transaction
has commercial substance, the entity-specific value of the portion of the entity’s
operations affected by the transaction should reflect post-tax cash flows. [IAS 38.46].
This is different to the calculation of an asset’s value in use under IAS 36 (see
Chapter 20), as it uses a post-tax discount rate based on the entity’s own risks rather
than IAS 36, which requires use of the pre-tax rate that the market would apply to a
similar asset.
The standard acknowledges that the result of this analysis might be clear without having
to perform detailed calculations. [IAS 38.46].
5
ACQUISITION AS PART OF A BUSINESS COMBINATION
The requirements of IFRS 3 apply to intangible assets acquired in a business
combination. The recognition and initial measurement requirements are discussed in
detail in Chapter 9 and a summary is given below. The emphasis in IFRS 3 is that, in
effect, it does not matter whether assets meeting the definition of an intangible asset
have to be combined with other intangible assets, incorporated into the carrying value
of a complementary item of property, plant and equipment with a similar useful life or
included in the assessment of the fair value of a related liability. The important
requirement is that the intangible asset is recognised separately from goodwill.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 243
