Accounting and Appraisal of Intangible Assets

Professor Lali Chagelishvili

According to the international accounting standards, an intangible asset is an identifiable non-monetary asset that does not have a physical form and an enterprise has the right to use it in the process of production or supplying (of goods or services), to lease or use it for administrative purposes.

In accordance with the explanation, an intangible asset should meet the following three conditions:
– As an asset, it should be controllable by the enterprise;
– It should make economic profit;
– It should be identifiable.
An enterprise controls the asset if it has the right, based on the given resource, to receive the future economic profit and, at the same time, if it can restrain others from using this asset.
The economic profit that will be received from intangible assets in future includes the avail received from selling of goods/services, saving of expenses or other profit is a result of these assets’ use.
Identifiability of an intangible asset demands its distinguishing from goodwill. Goodwill, which originates as a result of merger of enterprises, represents a fee paid in expectation of a future economic profit. The future economic profit may be a result of combination of an identifiable asset with an asset that is not liable to individual recognition, but a buyer is ready to pay for it. We can clearly distinguish an intangible asset from goodwill if its singling out is possible. In this case singling out implies individual use of an asset. The ability of singling out should not be understood as an obligatory condition of identifiability, since identification of an asset may take place in a different way as well.
Proceeding from business accounting of intangible assets, their classification according to groups is necessary.
The class of intangible assets is a group of assets that homogeneous in accordance with their character and their use at the enterprise. International Accounting Standard 38 envisages the following groups of intangible assets:
a) Brand; b) Names of periodicals and publications; c) Computer software support; d) License and franchising; e) Copyright, patent and the right to industrial property; f) Recipe, formula, model, design and prototype; g) An intangible asset being processed.
Thus, intangible assets are non-monetary assets having no physical substance that cannot be referred to either fixed assets or goodwill.
Appraisal of intangible assets
The principles of recognition f intangible assets do not differ from the principle of recognition of other non-monetary assets. In particular, intangible assets should be recognized if:
– it is expected that the future economic profit related to this asset will be received by the enterprise;
– the asset’s cost can be surely appraised.
Intangible asset can enter the enterprise in different ways. The enterprise can either buy it, receive it as a state grant or create it by itself. In any case, an intangible asset, which meets the aforementioned recognition criteria, should be first appraised by its prime cost.
The prime cost of an intangible asset is the sum that was paid for its obtaining in the process of purchasing or production in the form of money means, their equivalent or some other real cost of compensation. The prime cost of an intangible asset includes its purchasing price, customs taxes and returnable taxes, as well as direct expenses related to preparation of an asset for use. No price discounting or privileges are included in the prime cost. If an asset is purchased on credit, then requirements of other standards related to recognition of interest are taken into account with the purpose of establishing its prime cost. A paid interest can be recognized as expense and will have no effect on the prime cost of the intangible asset, but in case of using of an alternative approach to recognition of the interest on loan, capitalization of the interest will take place and, correspondingly, increasing of the prime cost by the sum of the interest.
Example – The enterprise purchased an intangible asset for 25 000 GEL. It paid 118 GEL, including VAT – 18 GEL, for notarizing the purchase of the asset. Paying of the assets cost will take place within a period of one year from the moment of purchase. The enterprise will pay 12% in connection with payment by installments. If the enterprise does not pay interest capitalization on loan, then the prime cost of the purchased intangible asset will be 25 100 (25 000 + 100) GEL, and in case of interest capitalization – 28 100 (25 000 + 3 000 + 100) GEL.
If purchasing of an intangible asset takes place in exchange for a share of the accountable enterprise, the prime cost of the purchased asset represents the real cost of the issued share which is equal to the real cost of the asset.
An intangible asset can be also purchased by means of exchanging for another intangible asset or by partial exchange. In this case, with the purpose of establishing of the prime cost, it is necessary to determine how similar are the intangible assets participating in the exchange. If the intangible assets participating in the exchange are not similar or an intangible asset will be taken in exchange for another asset, then the prime cost of the purchased asset is equal to the real cost of the asset handed over in exchange for it, which is corrected by any money means or their equivalent participating in the exchange.
Example – The enterprise handed over a construction having a real cost of 30 000 GEL in exchange for an intangible asset, and received 2 000 GEL together with the intangible asset. The prime cost of the intangible asset received by means of the exchange makes up 28 000 (30 000 – 2 000). If the enterprise had had to pay 1 500 GEL together with the construction, the prime cost of the intangible asset would have made up 31 500 (30 000 + 1 500) GEL.
If an intangible asset is received in exchange for a similar asset (which has the same purpose in the same field of activities) and the assets participating in the exchange have a similar cost, then the cost of the newly received asset is determined by the book value of the handed over asset. The real cost of the received asset may be evidence of a loss as a result of depreciation of the handed over asset. In this kind of situation, the loss suffered as a result of depreciation of the handed over asset will be recognized, and the remaining book value will be referred to the referred asset. An enterprise can get an intangible asset from the state free of charge or at nominal cost. For instance, the right to flying to an airport, a license for television and radio broadcasting, import quota or access to other limited resources. International Accounting Standard 20 “Business accounting of state grants and reflection of state aid in explanatory enclosures of financial accounting” should be used with the purpose of their recognition and appraisal at the enterprise. As it is indicated by the standard, in this case a non-monetary asset should be appraised at real cost, correspondingly, both a grant and an asset should be shown in accordance with real cost. There is an alternative method as well, in accordance with which reflection of a grant and a non-monetary asset takes place at nominal cost (International Accounting Standard 20, Paragraph 23). Thus, an enterprise has the right of choice in recognition of an intangible asset. It can reflect it either at real or nominal cost. In reflecting at nominal cost, it is necessary that all the expenses that are needed for the intangible asset’s preparation for purposeful use should be added to the nominal cost.
We have touched upon the cases when an intangible asset is received either by means of buying or exchanging for another asset. Getting of an intangible asset by means of merger of enterprises is not ruled out either. In merger of enterprises, which is considered as a purchase, it is necessary to take into account how surely it is possible to appraise the real cost of the intangible asset with the purpose of its separate recognition. Dependability of the appraisal is assured by quotation of the asset on the active market, to what extent the current price represents the average market price.
Active market is a market on which the following conditions are secured:
– Items that are sold on the market should be homogenous;
– Buyers and sellers wishing to make a deal can be found any time;
º% The are prices that are available for the society (International Accounting Standard 38, Paragraph 7).
Intangible assets will be inside the enterprise as well. Their recognition and appraisal is based on special rules. From the viewpoint of recognition, establishing of their criteria is important, which is often difficult. The difficulty is stipulated by the fact that it is not easy to establish if the asset is an identifiable one and how exactly it is possible to establish its prime cost, since sometimes it is impossible differentiate between the expenses for creation of an intangible asset, prime cost of internally produced goodwill and other daily expenses.
Creation of an asset is divided into research and development phases with the purpose of determination of the recognition criterion of an intangible asset created at the enterprise.
As far as the research phase is concerned, the standard requires no intangible asset created as a result of research should be recognized. The research expenses should be recognized upon incurring (International Accounting Standard 38, Paragraph 44).
An intangible asset created in implementation of an internal project during the development phase should be recognized only if the enterprise can:
– technically implement the completion of the intangible asset so that its use or selling could be possible;
– intend to complete the intangible asset and use or sell it;
– show its ability or sell the intangible asset;
– determine how the intangible asset will create economic profit, at the same time, the enterprise should show the result of the intangible asset or the existence of the intangible asset’s market, or profitability of the intangible asset if its internal use is envisaged;
– Availability of technical, financial and other resources sufficient for processing and use, or selling of the intangible asset;
– Ability to surely appraise the expenses related to creation of the intangible asset;
Standards envisage that the expenses related to creation of some intangible assets cannot be differentiated from the expenses related to the enterprise’s merger and bans recognition of an intangible asset created by means of this kind of expenses. International Accounting Standard 38 explains that a brand created at the enterprise, a periodical’s name, the right to recurring issue and similar articles should not be recognized in the form of an intangible asset (Paragraph 51, 52).
In connection with recognition of an intangible asset, it is important to know that some expenses are incurred for provision of the enterprise’s future economic profit, but no creation or purchasing of any asset takes place. However, the incurred expenses make an illusion of creation of an intangible asset. In this case the expense will not be recognized as an asset, except for the case when they form the prime cost of the intangible asset that is liable to recognition, or in the case when an intangible asset is obtained by means of enterprises’ merger that represents a purchase and cannot be recognized as an intangible asset. In the first case the expenditure is referred to expenses upon incurring, while in the second case it makes up goodwill’s prime cost. The example of expenses liable to recognition as expenditure:
– expenses related to setting in operation (establishment costs, expenses preceding the enabling), from expenses related to launching of a new operation, a new kind of product or processes (preproject expenses);
– expenses relater to personnel’s training;
– expenses related to advertisement or promotion of products;
– expenses related to changing of location of an enterprise or its part (International Accounting Standard 38, Paragraph 57).
A liable to recognition intangible asset created at the enterprise should be appraised at prime cost. An interest paid on loan can also be referred to prime cost of an intangible asset created at the enterprise if it is directly related to creation of the asset, and the enterprise uses an alternative method of accounting of the interest paid on the loan. International Accounting Standard 23 allows capitalization of loan’s interest in relation to particular assets.
Example – The enterprise decided to launch production of a new product and for this purpose it incurred research expenses in the amount of 4 000 GEL. Based on the effectiveness of the result obtained from the research, the enterprise continues to inculcate in practice the obtained knowledge. From the day of completion of the research the intangible asset meets the recognition criterion. With the purpose of development, the enterprise borrowed 6 000 GEL from a bank for a period of one year, at annual interest rate of 15%. It spent 4 000 GEL worth of materials for making samples of the new product. It set the salary in the amount of 1 000 for the employees working on making of the sample product. The corresponding social transfers make up 310 GEL. In the existing situation the enterprise will recognize 4 000 GEL as research expenses, while the remaining expenditure – as an intangible asset. The prime cost of the intangible asset will be its development expenditure that was incurred from the day of meeting of the recognition criterion, which makes up 5 310 (4 000 + 1 000 + 310) GEL. However, if the enterprise’s accounting policy envisages capitalization of the loan’s interest, then the interest on loan in the amount of 900 GEL will be added to 5 300 GEL and the intangible asset will be shown in the amount of 6 210 GEL.
Trade, administrative and other general overhead expenses does not refer to the prime cost of internal production’s intangible assets, except for the expenses are directly related to creation of an intangible asset; as well as the loss suffered prior to obtaining of the planned indicators of the asset and the expenses related to training of the personnel intended for the asset’s exploitation.
The expenses incurred for an intangible asset, which were initially recognized in the previous year’s or intermediate accounts as an expenditure, cannot be later referred to the prime cost of an intangible asset.