Ind AS 38 - Intangible Assets

Under Ind AS 38, an entity determines the useful life of an intangible asset by considering various factors to assess the period over which the asset is expected to contribute to the entity's economic benefits. These factors include:

1. Expected usage of the asset: How the entity intends to use the asset.
2. Product life cycles: Typical product life cycles for the asset and public information about estimates of useful lives of similar assets.
3. Technical, technological, commercial, or other obsolescence: The rate at which the asset is expected to become obsolete.
4. Stability of the industry: The stability of the industry in which the asset operates and changes in market demand for the products or services output from the asset.
5. Expected actions of competitors: The expected actions of competitors or potential competitors.
6. Level of maintenance expenditure: The level of maintenance expenditure required to obtain the expected future economic benefits from the asset and the entity’s ability and intention to reach such a level.
7. Legal or similar limits: Legal or contractual provisions that may limit the useful life, such as expiry dates for licences or patents.

An intangible asset is considered to have an indefinite useful life when, based on an analysis of all relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. This does not mean the asset will last forever, but rather that its useful life is not limited by factors like obsolescence or contractual terms.

Implications of an Indefinite Useful Life:

• No Amortisation: Intangible assets with an indefinite useful life are not amortised. This is a key distinction from assets with finite useful lives.
• Annual Impairment Testing: Instead of amortisation, an intangible asset with an indefinite useful life must be tested for impairment annually, or more frequently if there is an indication that the asset may be impaired. This involves comparing the asset's recoverable amount (the higher of its fair value less costs to sell and its value in use) with its carrying amount. This annual impairment test is crucial to ensure the asset is not carried at an amount exceeding its recoverable amount.
• Reassessment of Useful Life: The useful life of an intangible asset that is not being amortised must be reviewed each reporting period to determine whether events and circumstances continue to support an indefinite useful life assessment. If the assessment changes from indefinite to finite, the asset is then amortised prospectively over its newly determined finite useful life.

Under Ind AS 38, an entity can choose either the cost model or the revaluation model as its accounting policy for subsequent measurement of intangible assets. However, the revaluation model is subject to stringent conditions and cannot be applied to 'all' intangible assets indiscriminately.

Conditions for applying the Revaluation Model:

1. Active Market: An intangible asset can be revalued only if there is an active market for that asset. An active market is defined as a market where transactions for the asset occur with sufficient frequency and volume to provide pricing information on an ongoing basis. This condition severely restricts the applicability of the revaluation model, as active markets rarely exist for most intangible assets (e.g., brands, patents, software) due to their unique nature. Active markets are more common for certain types of intangible assets like freely tradable production quotas or taxi licences.
2. Class of Assets: If an intangible asset is revalued, all other assets in its class must also be revalued, unless there is no active market for those assets. A 'class of intangible assets' is a grouping of assets of a similar nature and use in an entity's operations.
3. Regularity of Revaluations: Revaluations must be carried out with sufficient regularity to ensure that the carrying amount does not differ materially from its fair value at the end of the reporting period.

Implications of choosing the Revaluation Model:

• Revaluation Surplus: When an intangible asset's carrying amount is increased as a result of a revaluation, the increase is recognised in Other Comprehensive Income (OCI) and accumulated in equity under the heading 'Revaluation Surplus', unless it reverses a revaluation decrease of the same asset previously recognised in profit or loss.
• Revaluation Decrease: A revaluation decrease is recognised in profit or loss. However, to the extent that it reverses a revaluation increase for the same asset previously recognised in OCI, the decrease is recognised in OCI and reduces the revaluation surplus.
• Amortisation: The revalued amount is then amortised over the asset's remaining useful life. The amortisation charge will be higher if the revalued amount is higher than the cost.
• Derecognition: When a revalued intangible asset is derecognised, any revaluation surplus relating to that asset included in equity may be transferred directly to retained earnings. This transfer is not made through profit or loss.

Due to the rarity of active markets for most intangible assets, the revaluation model is seldom applied in practice for a wide range of intangible assets, making the cost model the predominant choice for subsequent measurement.

Yes, the revaluation model is permitted for intangible assets under Ind AS 38, but only if there is an active market for that specific type of intangible asset. An active market is a market where all the following conditions exist: (a) the items traded in the market are homogeneous; (b) willing buyers and sellers can normally be found at any time; and (c) prices are available to the public. Due to the unique nature of most intangible assets, active markets for them are rare (e.g., certain types of production quotas or taxi licences). If the revaluation model is applied, all other assets in that class must also be revalued, unless there is no active market for those assets. Revaluations must be made with sufficient regularity to ensure that the carrying amount does not differ materially from its fair value at the end of the reporting period. Revaluation increases are credited to 'Other Comprehensive Income' (OCI) and accumulated in a 'Revaluation Surplus' within equity, unless they reverse a revaluation decrease of the same asset previously recognised in profit or loss. Revaluation decreases are recognised in profit or loss, unless they reverse a revaluation increase of the same asset previously recognised in OCI.

Ind AS 38 mandates a clear distinction between the research phase and the development phase for R&D costs. Costs incurred during the research phase are expensed as incurred. This is because, at the research stage, an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. Examples include activities aimed at obtaining new knowledge or searching for alternatives. Costs incurred during the development phase can be capitalised as an intangible asset only if the entity can demonstrate all six specific criteria outlined in Ind AS 38. These criteria ensure that the asset is technically feasible, intended for use/sale, capable of generating future economic benefits, and that the costs can be reliably measured. If any of these criteria are not met, development costs must also be expensed. Once an expense is recognised for R&D costs, it cannot be subsequently reinstated as an asset.

Ind AS 38, 'Intangible Assets', mandates a clear distinction between the research phase and the development phase for internally generated intangible assets. Costs incurred during the research phase are expensed as incurred because, at this stage, an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. This phase involves original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Examples include activities aimed at obtaining new knowledge, searching for alternatives, or formulating and designing possible new or improved products or processes.

In contrast, the development phase is more advanced and involves 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. Costs incurred during the development phase can be capitalised as an intangible asset only if an entity can demonstrate all of the following six criteria (often remembered by the acronym PIRATE):

1. Probable future economic benefits: The technical feasibility of completing the intangible asset so that it will be available for use or sale.
2. Intention: Its intention to complete the intangible asset and use or sell it.
3. Resources: Its ability to use or sell the intangible asset.
4. Availability of technical, financial, and other resources to complete the development and to use or sell the intangible asset.
5. Technical feasibility: The ability to measure reliably the expenditure attributable to the intangible asset during its development.
6. Expenditure reliability: How the intangible asset will generate probable future economic benefits (e.g., the existence of a market for the intangible asset or the output it produces, or if it is for internal use, the usefulness of the intangible asset).

If an entity cannot distinguish the research phase from the development phase, it treats all expenditure on that project as if it were incurred in the research phase, meaning it is expensed as incurred.

The treatment of costs incurred in developing software for internal use under Ind AS 38 follows the same principles as for other internally generated intangible assets, particularly the distinction between research and development phases.

1. Preliminary Project Stage (Research Phase):
Costs incurred during the preliminary project stage, which is analogous to the research phase, are generally expensed as incurred. These costs typically include activities such as: conceptual formulation of alternatives, evaluation of alternatives, determination of existence of needed technology, and final selection of alternatives. At this stage, the entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits.

2. Application Development Stage (Development Phase):
Costs incurred during the application development stage, analogous to the development phase, can be capitalised as an intangible asset if, and only if, the entity can demonstrate all six recognition criteria (PIRATE) specified in Ind AS 38. For internal-use software, these criteria translate to:

• Probable future economic benefits: The technical feasibility of completing the software so that it will be available for use.
• Intention: Its intention to complete the software and use it.
• Resources: Its ability to use the software.
• Availability of technical, financial, and other resources to complete the development and to use the software.
• Technical feasibility: The ability to measure reliably the expenditure attributable to the software during its development.
• Expenditure reliability: How the software will generate probable future economic benefits (i.e., its usefulness for internal operations).

Capitalisable costs during this stage typically include: external direct costs of materials and services (e.g., consultants' fees), payroll costs for employees directly involved in the development, and costs of testing the software.

3. Post-Implementation Stage:
Costs incurred after the software is ready for its intended use (e.g., training costs, data conversion costs, maintenance costs) are generally expensed as incurred. Enhancements or upgrades that meet the capitalization criteria for development costs would be capitalised as additions to the existing software asset.

Subsequent Measurement: Once capitalised, the software asset is subsequently measured using either the cost model or the revaluation model (though an active market for internal-use software is highly unlikely, making the cost model the practical choice). It must be amortised over its estimated finite useful life and tested for impairment in accordance with Ind AS 36, 'Impairment of Assets'.

An intangible asset with an indefinite useful life is not amortized. Instead, it is tested for impairment annually and whenever there is an indication that it may be impaired.

Internally generated goodwill is not recognized as an asset because it is not an identifiable resource controlled by the entity that can be measured reliably at cost.

Under Ind AS 38, an intangible asset is recognised if, and only if: (a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and (b) the cost of the asset can be measured reliably. Additionally, an intangible asset must be identifiable, meaning it is either separable (capable of being separated and sold, transferred, licensed, rented or exchanged individually) or arises from contractual or other legal rights. The key difference from PPE (covered by Ind AS 16) is the lack of physical substance. While both require probable future economic benefits and reliable measurement of cost, PPE also requires the item to be held for use in the production or supply of goods or services, for rental to others, or for administrative purposes, and expected to be used for more than one period. The 'identifiability' criterion is unique to intangible assets to distinguish them from goodwill.

Ind AS 38 mandates comprehensive disclosures to enable users of financial statements to understand the investments in intangible assets and the changes in those investments. For examination purposes, CA students should focus on the following key disclosure requirements:

1. General Disclosures for each class of Intangible Assets:

• Whether the useful lives are finite or indefinite.
• The useful lives or the amortisation rates used.
• The amortisation methods used for intangible assets with finite useful lives.
• The gross carrying amount and the accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period.
• A reconciliation of the carrying amount at the beginning and end of the period showing:
  • Additions, indicating separately those from internal development, those acquired separately, and those acquired through business combinations.
  • Disposals and assets classified as held for sale.
  • Amortisation during the period.
  • Impairment losses recognised or reversed during the period.
  • Net exchange differences arising on translation of financial statements from the functional currency into a different presentation currency.
  • Other changes.

2. Specific Disclosures:

• Intangible assets with indefinite useful lives: The carrying amount of each material intangible asset with an indefinite useful life and the reasons supporting the assessment of an indefinite useful life. In giving these reasons, the entity shall describe the factors that played a significant role in determining that the asset has an indefinite useful life.
• Intangible assets acquired through government grants: The fair value initially recognised for intangible assets acquired free of charge or for a nominal consideration by way of government grant.
• Intangible assets under revaluation model: For intangible assets carried at revalued amounts, the following must be disclosed:
  • The effective date of the revaluation.
  • The carrying amount of revalued intangible assets by class.
  • The carrying amount that would have been recognised had the revaluation model not been used.
  • The revaluation surplus, indicating the change during the period and any restrictions on the distribution of the balance to shareholders.
• Contractual commitments: The amount of contractual commitments for the acquisition of intangible assets.
• Expenditure on research and development: The aggregate amount of expenditure on research and development recognised as an expense during the period.

These disclosures provide critical insights into an entity's intangible asset base and its accounting policies, which are vital for financial statement analysis.

Ind AS 38 requires extensive disclosures to provide users of financial statements with information about the intangible assets. Key disclosures include: (a) whether the useful lives are finite or indefinite; (b) the useful lives or the amortisation rates used; (c) the amortisation methods used; (d) the gross carrying amount and accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period; (e) a reconciliation of the carrying amount at the beginning and end of the period showing additions, disposals, amortisation, impairment losses, revaluations, and other changes; (f) for individually material intangible assets, a description, the carrying amount, and the remaining amortisation period; (g) the amount of research and development expenditure recognised as an expense during the period; (h) information about intangible assets whose title is restricted or pledged as security; and (i) contractual commitments for the acquisition of intangible assets.

The accounting treatment differs significantly. For an externally acquired intangible asset, it is generally recognised at cost if it meets the recognition criteria (identifiability, control, future economic benefits, reliable measurement of cost). The cost typically includes the purchase price and directly attributable costs. For internally generated intangible assets, Ind AS 38 imposes stricter criteria to distinguish between the research phase and the development phase. Costs incurred in the research phase are expensed as incurred because an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits. Costs incurred in the development phase can be capitalised as an intangible asset only if all six specific criteria are met: (a) technical feasibility of completing the intangible asset; (b) intention to complete and use or sell the asset; (c) ability to use or sell the asset; (d) how the intangible asset will generate probable future economic benefits; (e) availability of adequate technical, financial and other resources; and (f) ability to measure reliably the expenditure attributable to the asset during its development.

An intangible asset with a finite useful life is amortized systematically over its useful life. Amortization begins when the asset is available for use and ceases at the earlier of the date the asset is classified as held for sale (or included in a disposal group classified as held for sale) or the date it is derecognised. The amortization method should reflect the pattern in which the asset's future economic benefits are expected to be consumed. The useful life and amortization method are reviewed at least at each financial year-end. An intangible asset with an indefinite useful life is not amortized. Instead, it is tested for impairment annually, or more frequently if there is an indication that the asset may be impaired. All intangible assets (both finite and indefinite useful life) are subject to impairment testing under Ind AS 36, 'Impairment of Assets', whenever there is an indication that the asset may be impaired. For indefinite useful life intangibles, the annual impairment test is mandatory even without impairment indicators.

Expenditure on research (or on the research phase of an internal project) is recognized as an expense when it is incurred. An intangible asset arising from the development phase is recognized if, and only if, the entity can demonstrate technical feasibility, intention to complete, ability to use or sell, generation of probable future economic benefits, availability of resources, and ability to measure the expenditure reliably.

Ind AS 38 applies to a wide range of intangible assets. For software, if externally acquired, it's recognised at cost. If internally developed, it follows the R&D criteria (research costs expensed, development costs capitalised if criteria met). Patents are typically recognised if acquired (at cost) or if they arise from capitalised development costs. Internally generated patents, where only research costs are involved, would not be recognised. Brands, mastheads, publishing titles, and customer lists that are internally generated are explicitly prohibited from recognition as intangible assets under Ind AS 38, as the cost cannot be reliably measured and attributed to the asset. However, if these are acquired in a business combination, they would be recognised at fair value. The crucial distinction is with goodwill. Goodwill arising from a business combination is specifically excluded from the scope of Ind AS 38. It is accounted for under Ind AS 103 'Business Combinations' and subsequently tested for impairment under Ind AS 36 'Impairment of Assets'. Goodwill is not an identifiable asset; it represents future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.