F1 5.10 IAS 38 Intangible Assets

In this session we shall look at the definition of an intangible asset and how they should be recognized and measured initially and subsequently.

Intangible assets

IAS 38 Intangible Assets states that “an intangible asset is an identifiable non-monetary asset without physical substance.”

An asset is identifiable if it is either:

  1. Separable which means that it is capable of being separated or divided from the company and sold, transferred, licensed, rented or exchanged; e.g.
    1. A pharmaceutical company could sell its rights to a particular drug to another business
    2. A software company could license another company to use a piece of software in its products
  2. Arises from contractual or other legal rights; e.g.
    1. A company has purchased the goodwill of another business
    2. A company holds the copyright of a piece of music and can therefore legally restrict its use

Examples of intangible assets

Recognition criteria

Before an intangible asset can be recorded in a set of financial statements it must first meet the definition of an intangible asset (i.e. it is an identifiable non-monetary asset without physical substance). In addition, it will only be recognized if:

  1. It is probable that the expected future economic benefits (i.e. income or cost savings) will flow to the company; and
  2. The cost of the asset can be measured reliably

Internally generated goodwill, brands and similar items

Internally generated goodwill, brands, mastheads, publishing titles, customer lists and similar items shall not be recognised as intangible assets.


A publisher owns two newspapers. The first was purchased from a competitor and the amount spent buying its masthead (i.e. the name of the newspaper) was £2m. The second was created by the publisher who spent £1m on market research and design.

The publisher would be able to treat the £2m spent on buying the competitor’s masthead as an intangible asset but would have to treat the £1m spent on market research and design as this is an internally generated masthead.

Measuring intangible assets

An intangible asset shall be measured shall be measured initially at cost


Goji plc has purchased the patent rights to a piece of technology for £700,000, These patent rights are expected to generate royalties over the next 10 years.

Patent rights are an identifiable non-monetary asset without physical substance so it qualifies as an intangible asset. The rights would also entitle Goji plc to receive patent royalties so the company will receive future economic benefits from their ownership. Lastly, Goji plc is able to measure the cost at £700,000.

The £700,000 should therefore be recorded as an Intangible Asset in the company’s financial statements.

Internally generated assets: research & development

Companies often spend money developing new products or services, or new ways of working. In order to determine whether these costs meet the criteria for recognition as an intangible asset we should classify the costs as belonging to either:

  1. A research phase of the project; or as
  2. A development phase

IAS 38 tells us that research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Examples of research activities include:

  1. Activities aimed at obtaining new knowledge
  2. The search for, evaluation and final selection of applications of research findings or other knowledge
  3. The search for alternatives for materials, devices, products, processes, systems or services
  4. The formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems or services

IAS 38 defines development as 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 before the start of commercial production or use. Examples of development activities include:

  1. The design, construction and testing of pre-production or pre-use prototypes and models
  2. The design of tools, jogs, molds, and dies involving new technology
  3. The design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production
  4. The design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services

Development spending is therefore directly related to new products, services etc. that we expect to be used or sold in the future. It is far less clear that research spending will result in identifiable new products, services etc.

A software company has spent money on the projects listed below. Identify whether the money spent is likely to relate to the projects’ research or development stages.
a) £48,000 has been spent adding a new function into a piece of software. This includes the cost of testing that it does not cause any conflicts with other software and does not weaken its security. The software package is likely to be launched within six months.
b) £27,000 has been spent identifying how software can best take advantage of a new type of computer chip that has been launched recently. This new chip enables certain types of calculations to be processed significantly faster than other chips currently sold. The company believes that the new chip could have an effect on the way that software should be coded in the future.
Click here to reveal the answer

a) The costs belong to the development phase. It is clear that work relates to testing a product that will be launched within months

b) The costs belong to the research phase. At present, the company cannot say that it relates to a particular product and whilst the project may result in something that could be used at some point in the future, this is not clear or certain.

Treatment of Research and Development

Research spending should be treated as an expense in the Statement of Profit or Loss

Development spending should be treated as an intangible asset so long as certain criteria are met (if the criteria are not met, the costs would be treated as an expense).

Note that if a company cannot identify a particular cost being research or development, the company should treat that cost as an expense

Criteria for capitalizing development costs

There are six criteria that must be met in order to capitalize development costs. These can be considered in terms of the capability and intention to complete and use whatever is being developed as well the ability to measure its cost reliably and whether to company expects to benefit from the development. The criteria are summarized below.

A company that manufactures and sells hooks has spent £59,000 on the design and testing of a of a new type of hook for use by heavy engineering firms. The market for the new hooks is limited in size but the company believes that it can be sold in moderate numbers and will prove to be a profitable product.
The costs of £59,000 have been recorded using the company’s Management Costing System which apportions all costs according to the job or project that has incurred them.
The company plans for the hooks to be made available for sale within four months and whilst there are some technical issues that have yet to be resolved, these are relatively minor and the company does not expect them to cause any delays to the proposed launch date.
Explain whether the £59,000 costs should be capitalized as an intangible asset or be treated as an expense?
Click here to reveal the answer

The costs relate to design and testing and would therefore be considered as part of the product’s development. We will now consider whether the criteria for capitalising the costs as development have been met

  1. It seems clear from the scenario that the company has both the capability and intention to complete the product’s development
  2. It also clear that the company expects to launch the product and sell it to customers
  3. The company’s costing system is capable of measuring the cost of development reliably
  4. The product is expected to be profitable, so the company will benefit from its sale

The costs therefore meet the criteria and should therefore be capitalised.

A company has spent £520,000 developing a new product. The company originally intended selling the product once it had been completed but a competitor has recently started selling a more advanced product and the company has therefore dropped its plans to launch and sell the product.
How should the £520,000 be treated in the company’s financial statements?
Click here to reveal the answer

The company should treat the £520,000 of costs as an expense in its Statement of Profit or Loss. Whilst the cost relates to the development phase of the project it does not meet all the criteria for capitalization, specifically, there is no intention to complete and then sell the product.

Subsequent measurement of intangible assets

The way that a company will subsequently measure, or value, its intangible assets depends on whether the asset has a finite or an indefinite useful life.

Intangible assets with a finite useful life

A finite useful life means that the life is limited in terms of time or production levels and will end at some point. Examples of intangible assets with a finite useful life include: research & development, patent rights, player contracts and copyright.

Treatment of intangible assets with finite useful lives

An intangible asset with a finite useful life is amortised over its useful life starting when the asset becomes available for use. NB. [Amortisation is the same as depreciation but is charged on intangible, rather than tangible, assets]

Intangible assets are amortised using the straight-line method unless another method will better reflect the asset’s usage. The annual amortisation charge will therefore be calculated as Cost less Residual Value which is then divided by the asset’s Useful Life (in years).

We assume that an intangible asset’s residual value is £nil unless a third party has committed to purchase it at the end of its useful life or there is an active market in this type of asset which enables its likely value to be estimated.

A company has spent £14m on the development of a new drug which it expects to sell profitably over the next ten years. The company holds a patent on the drug with fifteen years left to run.
Calculate the annual amortisation charge
Click here to reveal the answer

Annual amortisation charge is £1.4m [i.e. (14-0)/10]

Cost is £14m, Residual Value is £nil, Useful life is 10 years (not 15 years as it will not be sold after 10)

A company has bought the right to the back catalogue of singer/songwriter Ptolemy Tempest for £25m. The company intends to sell the rights on in five years time for £12.5m (a market in these types of assets has developed considerably in recent years).
Calculate the annual amortisation charge
Click here to reveal the answer

Annual amortisation charge is £2.5m [i.e. (25.0-12.5)/5]

Cost is £25.0m, Residual Value is £12.5, Useful life is 5 years

Review of amortisation

Each financial period, the company should review the expected useful life of its intangible assets as well as the amortisation methods being used. If there have been any changes the company should recalculated its amortisation charges by dividing the carrying value less residual value by its remaining useful life.

At the start of a financial year, a company owned a patent with a cost of £330,000. This was being amortised at a rate of £27,500 a year and amortisation up to the start of the financial year amounted to £82,500. At the end of the financial year the directors review the patent and determine that its remaining useful life has fallen to four years at the end of which it will have no value.
Calculate the amortisation charge for the year.
Click here to reveal the answer
  1. The amortisation charge for the year is: £61,875 [i.e. (247,500-0)/4]
  2. Carrying value at the start of the year: £330,000 – £82,500; i.e. £247,500
  3. Residual value: £nil
  4. Remaining useful life

Intangible assets with an Indefinite useful life

An indefinite useful life means that there is no foreseeable limit to its life, so the company would not be able to estimate how long it might last. Examples of intangible assets include: purchased goodwill and purchased brands.

Treatment of intangible assets with indefinite useful lives

Intangible assets that have an indefinite useful life are not amortised. Instead their carrying value will be tested for any impairments. The tests will occur either annually or whenever there is an indication that an impairment has occured.

In addition, the company will review whether or not the useful life of the asset continues to be indefinite. If it has become finite the asset will then be amortised.

Some years ago, a company purchased a brand of gin for £125,000. The directors of the company have recently tested the brand for impairments and believe that its value has fallen to £50,000.
How will this fall in value be treated in the financial statements?
Click here to reveal the answer

The company will record an impairment loss of £75,000 in the expenses of the Statement of Profit or Loss. It will also reduce the value of the brand asset included in Intangible Assets in the Statement of Financial Position