MODULE 4 – Intangible Assets

2.1 Definition, Recognition, Measurement, Derecognition & Disclosures

2.1.1 Definition and Nature

IAS 38 defines intangible assets as an identifiable non-monetary asset without physical substance.
An asset is a resource that is controlled by the entity as a result of past events (for example, purchase
or self-creation) and from which future economic benefits (inflows of cash or other assets) are
expected.
An intangible asset is:
 An identifiable nonmonetary asset without physical substance.
i. It is separable, capable of being separated from the entity by transfer, sale, licensed,
rented or exchange.
ii. It arises from contractual or legal rights, meaning it is a right granted by contract or by
operation of law
 Must be controlled by the entity as a result of a past event and from which future economic
benefits are expected to flow to the entity.
For example, a copyright on musical compositions and soundtracks cannot be used by others
without benefiting the composer of royalties, and the same compositions cannot be used by
third parties for the purpose of obtaining economic benefits without violating a contractual or
legal right.
Control is a power to obtain future economic benefits from the asset while preventing others
from enjoying the same.

2.1.2 Recognition Criteria

IAS 38 requires an entity to recognise an intangible asset, whether purchased or self-created
(at cost) if, and only if:
 it is probable that the future economic benefits that are attributable to the asset will flow to
the entity;
 and the cost of the asset can be measured reliably.
This requirement applies whether an intangible asset is acquired externally or generated internally.

If an intangible item does not meet both the definition of and the criteria for recognition as an
intangible asset, IAS 38 requires the expenditure on this item to be recognised as an expense when it
is incurred. [IAS 38.68]

2.1.3 Initial Measurement

Intangible assets are initially measured at cost. The cost of an intangible asset depends on the
following modes of acquisition:
A. Separate Acquisition
i. Cash. If acquired separately and in the form of cash, the cost includes:
 the purchase price
 import duties and non-refundable purchase taxes
 directly attributable costs after deducting trade discounts and rebates.

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 Directly attributable costs are costs related to bringing the asset to its working condition and will
include:
 Costs of employee benefits such as incentives and additional compensation.
 Professional fees
 Cost of testing whether the asset is functioning properly.
ii. Deferred terms. If term of payment is beyond normal credit terms:
The cost is the cash price equivalent. The difference between the cash price equivalent and
total payments is recognized as interest expense over the credit period.
The following costs are not capitalizable as intangible assets:
 Advertising and promotional activities for introducing a new product.
 Staff training, and other costs of operating in a new location or new class of customers.
 Administrative and general overhead costs.
 Idle costs such as maintenance costs, on assets which are ready for intended use but has
yet been brought into use.
 Initial operating losses.

B. Acquisition as part of Business Combination

If an intangible asset is acquired in a business combination, the cost of the intangible asset is
based on its fair value on the date of acquisition.
If there is an active market, the quoted market price which is usually the current bid price provides
the most reliable estimate of fair value.
If there is no active market, the fair value of the intangible asset is equal to the amount which
would be paid by the entity for the asset in an arm’s length transaction between knowledgeable
and willing parties.
This will be discussed further in another course from the Accountancy Program – ABUSCOM

C. Acquisition by way of a government grant

In accordance with PAS 20, the intangible asset acquired by way of government grant may be
initially recorded at either:
 Fair value
 Nominal amount or zero, plus any expenditure that is directly attributable to preparing the
asset for its intended use.
See: Government Grants on Unit 1.2. of this module

D. Acquisition by exchange
The cost of an item of an intangible asset acquired in exchange for a nonmonetary asset or a
combination of monetary and nonmonetary asset is measured at fair value, unless the exchange
transaction lacks commercial substance (PAS 16).
See: Exchange transactions in Modes of acquisition of Unit 1.1.4

E. Acquisition by self-creation or internal generation

The cost of an internally generated intangible asset comprises all directly attributable costs
necessary to create, produce and prepare the asset to be capable of operating it in the manner
intended by management.

Examples of directly attributable costs are:

 Cost of materials and services used or consumed in generating the intangible asset.
 Costs of employee benefits arising from the generation of the intangible asset.
 Fees to register a legal right.
 Amortization of patents and licenses that are used to generate the intangible asset.
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 PAS 38 explicitly provides that “internally generated brands, mastheads, publishing titles,
customer lists and items similar in substance shall not be recognized as intangible assets”.

The following are not capitalizable for internally generated intangible assets:
 Selling and administrative expenses.
 Initial operating loss and inefficiencies
 Training costs for staff operating the asset.
Costs that are recognized as expense and not capitalized at initial recognition:
1. Start-up Costs
2. Training costs
3. Advertising and promotional costs
4. Business relocation and reorganization costs
5. Selling and administrative costs
6. Initial operating losses

2.1.4 Subsequent Measurement

In determining measurement subsequent to acquisition, cost model and revaluation models allowed:
 Cost Model – carried at cost less any accumulated amortization and any accumulated
impairment loss. [IAS 38.74]
 Revaluation Model – carried at revalued amount (Fair value less any subsequent amortization
and any subsequent accumulated impairment loss).
Intangible assets may be carried at a revalued amount (based on fair value) less any subsequent
amortization and impairment losses only if fair value can be determined by reference to an
active market. [IAS 38.75] Such active markets are expected to be uncommon for intangible
assets. [IAS 38.78]
Under the revaluation model, revaluation increases are recognised in other comprehensive
income and accumulated in the "revaluation surplus" within equity except to the extent that
they reverse a revaluation decrease previously recognised in profit and loss. If the revalued
intangible asset has a finite life and is, therefore, being amortised (see below) the revalued
amount is amortised. [IAS 38.85]
Subsequent expenditures incurred on an intangible asset shall be recognized as expense. Generally,
these expenditures are of a maintenance nature. However, the subsequent expenditure may be
capitalized or added to the cost of intangible assets if they meet the recognition criteria for intangible
assets as discussed in 2.1.2 Recognition Criteria.

2.1.5 Amortization
Amortization is the process of expensing the cost of an intangible asset over the projected life of the
asset. It measures the consumption of the value of an intangible asset over the period of its productive
life. Amortization is calculated in a similar manner to depreciation, which is used for tangible assets,
and depletion, which is used for natural resources.
Amortization matches recognition of expensing the cost of the intangible assets to the revenues they
generate in a period, this is referred to as matching-principle
For example, assume you acquired a patent that allowed you to use a blueprint of a machinery
invented by a third party for a term of 5 years. Initially, the cost of the patent will be capitalized as an
asset. This cost however is allocated for a 5-year use, in that, by the end of the 5th year, we will no
longer be allowed to use the patent. The payment for the patent therefore was in essence, a rental of
the patent for 5 years, and must be expensed or amortized over the period of use.

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However, not all intangible assets are subjected to amortization, as they may be classified as:

i. Indefinite life: no foreseeable limit to the period over which the asset is expected to generate
net cash inflows for the entity. Intangible assets with indefinite life are not amortized over their
useful life but is subjected to impairment testing at least annually. An impairment loss shall be
recognized if the recoverable amount is less than the carrying amount.

ii. Finite life. Intangible assets with a limited period of benefit to the entity. These assets are
amortized over their useful life and subjected to impairment testing at least annually.

The cost less residual value of an intangible asset with a finite useful life should be amortised on
a systematic basis over that life: [IAS 38.97]
 The amortization method should reflect the pattern of benefits.
 If the pattern cannot be determined reliably, amortise by the straight-line method.
 The amortisation charge is recognised in profit or loss unless another IFRS requires that it
be included in the cost of another asset.
 The amortisation period should be reviewed at least annually.
 The residual value of an intangible asset is presumed to be zero, except when a third party
is committed to buy the asset at the end of its useful life or if there is an active market for
the asset.

2.1.6 Derecognition
An intangible asset is derecognized or removed from the financial statements when:
a. It is disposed
b. When no future economic benefit can be expected from its use or disposal.
A gain or loss may arise from the disposal of intangible assets, which is the difference between the net
disposal proceeds and the carrying amount of the asset. In this case the gain or loss from derecognition
will be presented as “other income”.

2.1.7 Required Disclosures

For each class of intangible asset, disclose:
i. useful life or amortization rate
ii. amortization method
iii. gross carrying amount
iv. accumulated amortisation and impairment losses
v. line items in the income statement in which amortization is included
vi. reconciliation of the carrying amount at the beginning and the end of the period showing:
 additions (business combinations separately) & retirements and other disposals
 assets held for sale
 amortizations, revaluations, impairments & reversals of impairments
 foreign exchange differences & other changes
vii. basis for determining that an intangible asset has an indefinite life
viii. description and carrying amount of individually material intangible assets
ix. certain special disclosures about intangible assets acquired by way of government grants
x. information about intangible assets whose title is restricted
xi. contractual commitments to acquire intangible assets
Additional disclosures are required about:
i. intangible assets carried at revalued amounts [IAS 38.124]
ii. the amount of research and development expenditure recognized as an expense in the current
period [IAS 38.126]

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2.2 Identifiable Intangible Assets

2.2.1 Common Identifiable Intangible Assets Defined

i. Patent
A patent is the granting of a property right by a sovereign authority to an inventor.
This grant provides the inventor exclusive rights to the patented process, design, or invention
for a designated period in exchange for a comprehensive disclosure of the invention.

ii. Trademark
A trademark is a recognizable insignia, phrase, word, or symbol that denotes a specific product
and legally differentiates it from all other products of its kind.
A trademark exclusively identifies a product as belonging to a specific company and recognizes
the company's ownership of the brand.
A trademark can be a corporate logo, a slogan, a brand, or simply the name of a product.

iii. Copyright
Copyright refers to the legal right of the owner of intellectual property. In simpler terms,
copyright is the right to copy.
This means that the original creators of products and anyone they give authorization to are the
only ones with the exclusive right to reproduce the work.

iv. Franchise
When a business wants to increase its market share or increase its geographical reach at a low
cost, it may create a franchise for its product and brand name.
A franchise is a joint venture between a franchisor and a franchisee. The franchisor is the
original or existing business that sells the right to use its name and idea. The franchisee is the
individual who buys into the original company by purchasing the right to sell the franchisor's
goods or services under the existing business model and trademark.

v. License
A license is an official document that gives you permission to own, do, or use something and is
issued by a licensing authority for a certain number of years or period of time.

vi. Customer list

A list of previous buyers from a company. The company maintains a customer list in order to
continue the business relationship. That is, companies use customer lists to keep up with
buyers and to promote customer loyalty.

vii. Computer Software

A computer software used in business operations or in production for sale and licensed
product.

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 2.2.2 Patent
A patent is an exclusive right granted by the government to an inventor enabling him to control the
manufacture, sale or other use of his invention for a specified period of time.
The legal life of patent is 20 years from the date of filing the application, as stated in the “Intellectual
Property Code”.
Meaning, after the patent is recognized by the government the inventor has 20 years of exclusive
control over the patent. He can decide on the manufacture or sale of products created using the
designs from his invention registered as his patent. Another option could be, he may also decide to sell
the patent itself if he deems necessary.

A company generally has two ways of obtaining a patent, they may conduct a research and development
in order to create their own patent also referred to as internal development or they can seek to acquire
a patent from another entity.

Cost of Patent
i. Separate acquisition
o Purchase price
o Import duties
o Non-refundable purchase taxes
o Directly attributable costs in preparing the asset for its intended use
ii. Internally developed
o cost of licensing
o legal fees in securing the patent rights
o development cost after technological feasibility has been established

Technological feasibility is when an invention is functioning in its intended purpose. Development

costs after technological feasibility are improvements to the design that can either benefit the
efficiency or functionality of the invention.
Legal fees and other costs of successfully prosecuting or defending a patent shall be expensed. If the
litigation is unsuccessful, the legal costs and the remaining cost of the patent shall be written off as
loss.

Amortization of Patent Cost

Original Patent
i. amortized over the legal life or useful life, whichever is shorter.

Competitive Patent
i. acquired to protect an original patent.
ii. amortized over the remaining life of the old patent.

Related Patent
i. acquired in order to extend the life of the old patent.
ii. amortized over the extended life.
iii. if there were no extension in life, amortized over its own life and the cost of the old patent is to
be amortized over the remainder of its life.

A competitive patent as the description suggests, is a patent owned by a competitor entity, the
competitive patent in a way affects how our patent performs in terms of production and/or sales.
Acquiring the competitive patent will benefit us by mitigating or eliminating this threat to our patent
and as a consequence the acquisition of that patent is a form of protecting the original patent.

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A related patent can be a similar patent that in some ways, is a better version from the original patent.
The reason for acquiring a related patent is to preserve a patent that may be expiring or to protect a
patent from being obsolete.

Illustration: Separate acquisition of Patent (a)

Dolores Inc. acquired a patent on January 1, 2020. The patent had a remaining legal life of 10 years.
The company had the following expenditures related to the separate acquisition of a patent and in
placing it into operation.
Purchase price P 10,000,000
Business relocation costs 510,000
Employee benefits from acquisition of patent 200,000
Employee training costs to construct 850,000
Professional fees related to acquisition 1,500,000
Selling and administrative costs 1,080,000
Import duties 2,150,000
Advertising and promotional cost 380,000
Non-refundable purchase taxes 150,000

Requirements:
1. What costs can we capitalize for the patent on January 1, 2020?
2. What amount of expense will be recorded on January 1, 2020?
3. Prepare the necessary entries related to the patent in 2020.

Requirement 1:

Purchase price P 10,000,000

Employee benefits from acquisition of patent 200,000
Professional fees related to acquisition 1,500,000
Import duties 2,150,000
Non-refundable purchase taxes 150,000

Cost of Patent P 14,000,000

Requirement 2:

Business relocation costs P 510,000

Employee training costs to construct 850,000
Selling and administrative costs 1,080,000
Advertising and promotional cost 380,000

Costs that are expensed P 2,820,000

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Requirement 3:

Patent P 14,000,000
Cash P 14,000,000
To record patent acquisition

Relocation expense P 510,000

Training expense 850,000
Selling and administrative costs 1,080,000
Advertising and promotional cost 380,000
Cash P 2,820,000
To record various expenses

Amortization of patent P 1,400,000

Patent P 1,400,000
To record patent amortization

Illustration: Separate acquisition of Patent (b)

i. Dovahkiin Co. spent development cost of P500,000 for a patent and paid 2,000,000 for its
licensing including legal fees and costs of blueprints, drawings and models in presenting it
to regulatory agencies for patent application. The patent was granted on January 1, 2020
The company intends to use the patent for its entire legal life of 20 years.

ii. On January 1, 2022, Dovahkiin Co successfully defended a lawsuit from Miraak Co. for
accusations of patent infringement. Legal fees of P200,000 to attorneys for the service were
paid on the same date.

iii. On January 1, 2023, the company secured the original patent by acquiring a competing
patent for P900,000. The competing patent will only be useful for the remaining legal life of
the original patent, 18 years.

iv. On December 31, 2024 a design fault causing incidents of the battery of the product to
explode when charging. This forced the regulatory agencies to deliver revocation of the
patent and all the related products were recalled from the market for reengineering. The
incidents rendered the patent unusable.

Requirement: Prepare the necessary journal entries.

Solution:
i. Journal entries for 2020
Research and development expense P 500,000
Cash P 500,000
To record patent development.

Patent P 2,000,000
Cash P 2,000,000
To record patent cost.

Amortization of Patent* P 100,000

Patent P 100,000
To record patent amortization.
*(P2,000,000 / 20 years)

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 Journal entries for 2021
Amortization of Patent P 100,000
Patent P 100,000
To record patent amortization.

ii. Journal entries for 2022

Legal expenses P 200,000
Cash P 200,000
To record legal fees.

Amortization of Patent P 100,000

Patent P 100,000
To record patent amortization.

iii. Journal entries for 2023

Patent P 900,000
Cash P 900,000
To record competing patent.

Amortization of patent** P 150,000

Patent P 100,000
To record amortization.

Original patent (2,000,000 – 200,000) P 1,800,000

Competing patent 900,000
Carrying amount 2,700,000
Remaining life ÷ 18 years
Amortization for 2023** P 150,000

iv. Journal entries for 2024

Amortization of patent P 150,000
Patent P 100,000
To record patent amortization.

Patent write-off*** P 2,400,000

Patent P 2,400,000
To record derecognition.

***(2,700,000 – 300,000)
Patent write-off is classified as other expenses

The patent is derecognized on December 31, 2024 because we can no longer expect any future
economic benefit from it. If we continue to make products using its design we would be
operating illegally and that may cause more problems for the company.

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 2.2.3 Trademark
A symbol, sign, slogan or name used to mark a product to distinguish it from other products, by nature
trademarks are market-related intangible assets.

The effects of trademark are evident in several markets, for example, products, because of popularity
of the brand name can be priced significantly higher than other similar products from different
companies of a different brand name. Companies can benefit from a well-positioned trademark this
way. Examples: Apple iPhones, Samsung Phones, Louis Vuitton, Rolex

There are two ways a company can obtain a trademark:

 the easier one is by purchasing the rights of a third-party trademark to sell their products bearing
their trademark;
 and the second one is by internal development.

Cost of Trademark
i. If purchased – the purchase price plus directly attributable costs are capitalized as cost of the
trademark.
ii. If internally developed – the cost includes expenditures required to establish it, including filing
fees, registry fees and other expenses incurred in securing the trademark such as design cost of
the trademark.

If the trademark is successfully prosecuted or defended, the same principle from patent applies to
litigation cost. That is, outright expense, because such cost is simply intended to maintain the
intangible asset rather than to increase the economic benefit.
Amortization of Trademark
A trademark may be classified as intangible asset with either indefinite life or definite life.
A. Indefinite Life
The legal life of a trademark is 10 years as stated in R.A. No. 8293 or the Intellectual Property Code
of the Philippines.
However, considering that a trademark can be renewed for periods of 10 years each with little to
no additional costs, the renewal process becomes almost automatic for most entities. This allows a
company to account for trademarks as an intangible asset with indefinite useful life.
Accordingly, the cost of the trademark is not amortized but still subject to impairment testing at
least annually similar to other non-current assets.

Illustration: Accounting for Trademarks with indefinite life.

Aela Co. developed and registered a trademark which they intended to renew indefinitely. The
trademark will be appropriately accounted for as having indefinite life. Aela incurred the following
costs in development and registration:
Filing Fees P 50,000
Design costs 10,000
Promotional costs 100,000
Administrative costs 75,000

Requirement: Prepare the necessary journal entries.

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 The journal entries to record the transactions:

Trademark P 60,000
Cash P 60,000
To record trademark cost.

Advertising expense P 100,000

Administrative expense 75,000
Cash P 175,000
To record various expense

At least annually the trademark will be tested for impairment.

B. Finite Life
In the event that the entity deems that the trademark will have limited useful life or has no
intention to renew a currently registered trademark, the trademark shall be amortized based on its
remaining useful life.

Illustration: Accounting for Trademarks with finite life.

On January 1, 2020, Hadvar Co. acquired a registered a trademark for P1,000,000 with a remaining
legal life of 4 years. The trademark will be appropriately accounted for as having finite life.
The journal entries in 2020:
Trademark P 1,000,000
Cash P 1,000,000
To record trademark acquisition.

Amortization of Trademark P 250,000

Trademark P 250,000
To record amortization.

At least annually the trademark will be tested for impairment.

2.2.4 Copyright
A copyright is an artistic-related intangible asset that is an exclusive right granted by the government
to the author, composer or artist enabling him to publish, sell or otherwise benefit from his literary,
musical or artistic work.

Cost of Copyright
A copyright can be related to a self-produced piece of art or purchased.
Included in self-produced copyright costs are all expenses incurred in the production of the work
including those required to establish or obtain the right.
The cost of a purchased copyright includes the cash paid, and directly attributable cost necessary for
its intended use.

Amortization of copyright
Theoretically, the cost of the copyright shall be amortized over the useful life. In practice, it is often
difficult to estimate the useful life of the copyright (lifetime of the author plus 50 years after death).

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Commonly, it is advisable to write off the cost of the copyright against the revenue of first printing.
Meaning, the capitalized cost of the copyright can be treated as fully amortized after the sale of the
first printing or distribution of the piece of art.

2.2.5 Franchise
A franchise is a contract-based intangible asset that consists of an agreement between one party called
the franchisor who grants certain rights to another party called the franchisee.
The franchise may be :
i. Between a government and private entity. A government agency granting a private entity
permission to use public property in performing the services. This usually involves rights to use
public properties like use of streets and highways for a bus line, public land for electric lines.
ii. Between private entities. If a franchise is between two private entities, the franchisee acquires
the right to use the trademark, patent and process of the franchisor.
Examples are the right to operate a business under the tradename of “Jollibee” and use their
operating processes, or to acquire an exclusive right to distribute or sell a particular brand
product like “bench/”,”Rolex”.
The franchisee may be granted the right for a definite period or indefinite period.
Cost of Franchise
The cost includes:
 lump sum payments for the acquisition of the franchise also known as initial franchise fee.
 legal expenses incurred in connection with the acquisition of the right.
The franchise agreement may require the franchisee to make periodic payments to the franchisor. Such
payment is considered as expense and is known as periodic franchise fee.

Amortization or Impairment of Franchise

 If franchise is granted for a definite period – amortized over the useful life or definite period
whichever is shorter.
 If franchise is granted indefinitely – not subject to amortization but tested for impairment
annually.

Illustration: Accounting for Franchise rights (a)

On January 1, 2020, Bellator Company acquired a 10 year franchise to operate a 7 Eleven store by
paying an initial franchise fee of P2,000,000 which includes use of their trademark, training staff
and preparations for initial operations. The franchise contract also provides for Bellator to pay a 5%
periodic franchise fee based on gross sales, Bellator pays at the end of each year. The 7 Eleven
outlet operated by Bellator Company reported 15,000,000 sales for the year 2020.
Requirement: Prepare the necessary journal entries in the books of the franchisee, Bellator
Company to record the above events.

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 The journal entries to record the transactions:

Franchise P 2,000,000
Cash P 2,000,000
To record franchise acquisition.

Franchise fee expense (5% x 15,000,000) P 750,000

Cash P 750,000
To record franchise fee expense.

Amortization of franchise P 200,000

Franchise (2,000,000 / 10 years) P 200,000
To record franchise amortization.

In this case, the “Franchise” intangible asset is recorded by the franchisee (Bellator Company),
representing the right to operate an outlet of 7 Eleven.

Franchise accounting is more elaborately discussed in ASTRANS of the Accountancy program

In most cases the initial franchise fee is a substantially large sum of money and would be paid in
installments on an interest bearing or non-interest bearing note:

Illustration: Accounting for Franchise rights (b)

On January 1, 2020, Volition Company acquired a 20 year franchise to operate a McDonalds food
chain signing a contract for an initial franchise fee of P30,000,000 which includes rights to sell their
products and services, use of their trademark, training staff, supplies, advertising and initial
operations assistance.
The initial fee was payable 10,000,000 cash and the remaining balance is in a 10% promissory note
of 4 equal installments every December 31 starting in 2020.
The franchise contract also provides for Volition to pay a 7% periodic franchise fee based on gross
sales, Volition pays at the end of each year. The McDonalds outlet operated by Volition Company
reported P25,000,000 sales for the year 2020.

Prepare the necessary journal entries in 2020 on the books of the franchisee (Volition Company).

Franchise P 30,000,000
Cash P 10,000,000
Notes payable 20,000,000
To record franchise acquisition.

Franchise fee expense – (7% x 25,000,000) P 1,750,000

Cash P 1,750,000
To record franchise fee expense.

Amortization of franchise P 1,500,000

Franchise (30,000,000 / 20 years) P 1,500,000
To record franchise amortization.

Notes payable (20,000,000 / 4 years) P 5,000,000

Interest expense (20,000,000 x 10%) 2,000,000

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 Cash P 7,000,000
To record instalment payment on NP.

2.2.6 Other Intangible Assets

Broadcasting license
A license granting the licensee permission to use a portion of the radio frequency spectrum in a given
geographical area for broadcasting purposes.
A broadcasting license may be accounted for as an intangible asset with finite life or indefinite life
depending on the business intent of the entity. This is because it may be renewed indefinitely at little
cost.
When accounted for as an intangible asset with finite life, the broadcasting license is amortized over
its useful life or until its expiration whichever is shorter.
When accounted for as intangible asset with indefinite life, the broadcasting license is not amortized
but tested for impairment at least annually and whenever there is an indication of impairment.

Airline Rights
Airline rights or route authority pertains to the right given to an entity to use air transport route and
operate as an airline company. Such license to operate may be renewed indefinitely, provided that the
renewing entity has complied with applicable rules and regulations surrounding renewal.
Airline rights as an intangible asset may be accounted for as having finite or indefinite life depending
on the business intent of the entity.

Customer List
Literally means a list of customers, including contact information, order history and other valuable
business intel that an entity could make use of for purposes such as marketing, product offering or
direct selling.
PAS 38, paragraph 63 however does not allow recognition as an intangible asset an internally
generated customer list.
A customer list can only be considered as an intangible asset when acquired, and shall be amortized
over its useful life.
The customer list shall also be reviewed for any indication of impairment at least annually.
The recognition of customer list as an intangible asset has been a subject for debate as the purchase of
a list does not automatically afford you of the customer’s loyalty. Without any doubt, customers
cannot be forced to buy from the entity and the customer will still choose their preferred suppliers for
their needs.

Computer Software
Costs incurred in developing a computer software after technological feasibility can be capitalized as
an intangible asset.
Costs incurred in creating a computer software before technological feasibility are expensed as
incurred.
Technological feasibility is established when the entity has produced a detailed program design of the
program or there is already a working model for the program.
Capitalizable costs for computer softwares are:

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  Cost of coding and testing
 Cost of product masters
A computer software shall be amortized over its useful life reflecting the pattern in which the future
economic benefits are expected to be consumed, if such pattern cannot be determined reliably the
straight line method will be applied. Similar to other intangible assets, a computer software must also
be assessed for impairment at least annually or whenever there is an indication of impairment.

2.3 Unidentifiable Intangible Asset – Goodwill

2.3.1 Nature and Definition

Goodwill arises when earnings exceed normal earnings by reason of good name, capable staff and
personnel, high credit standing, reputation for fair dealings, reputation for superior products, favorable
location and a list of regular customers.
Goodwill is created by a good relationship between an entity and its customers by:
 Reputation or word of mouth for high standard services and quality products.
 Good customer service & relationship
 Customer satisfaction as to staff competency, personality and their attitude towards work.
Goodwill is an unidentifiable intangible asset. As opposed to patents, copyright or trademark, goodwill
cannot be acquired, sold, leased or otherwise transferred to another entity as a standalone asset.

2.3.2 Recognition Criteria

Internally generated goodwill.

Any company can claim that they are the best in the business, that their staff are far more competent
than any among the competition or that the customers in the market regard them as the number one
choice that they are the best in town and they stand atop other brands.
This impression is what we can call “homegrown” internally developed goodwill. While these claims
may be true to life, such internally generated goodwill cannot be recognized as an intangible asset as
provided by IAS 38, paragraph 48.

Purchased goodwill
When an entity acquires an existing business, it will have acquired not only the net tangible assets but
also the good name of the company, the customer satisfaction towards that company and the staff
that are already in place. In other words the buyer company will be acquiring the goodwill that is
embedded with the company being acquired.
(A seller business claiming to have goodwill will ask the buyer to pay for such goodwill)
Meaning it can only arise from acquisition of a business, which is covered in much detail in IFRS 3
business combinations and IFRS 10 consolidated financial statements. The principles in business
combination supports, IAS 28 in stating that the amount of goodwill capitalized cannot exceed the
amount paid.
Only purchased goodwill can be recognized as an intangible asset.
Goodwill will be recorded by an entity who acquired another entity.

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 2.3.3 Measurement
The measurement of goodwill is a result of fixing the acquisition cost in a business combination
agreement between acquirer-company and acquiree-company. In other words, the goodwill capitalized
by the acquirer company will depend on fixing the price between purchaser and seller companies.
There are two approaches that may be followed by acquirer and acquiree company in agreeing on the
valuation of goodwill:
i. Residual Approach – The excess of the purchase price over the net tangible and identifiable assets
is considered goodwill.

Illustration: Goodwill computation under Residual Approach.

Adelair Corp. acquired the net assets of Dublig Company on January 1, 2020 by paying
P2,500,000 cash. The following information pertains to financial data of Dublig Co. on the date
of acquisition:
Book Value Fair Value
Total assets P 2,500,000 P 3,000,000
Total liabilities ( 1,200,000) ( 1,200,000)
Net assets P 1,300,000 P 1,800,000

Requirement:
What amount of goodwill under the residual approach will be capitalized by Adelair Corp?

Solution:
Acquisition cost P 2,500,000
Fair value of net assets ( 1,800,000)
Goodwill P 700,000

The journal entry to record the acquisition on the books of Adelair:

Various assets* P 3,000,000
Goodwill 700,000
Various liabilities** P 1,200,000
Cash 2,500,000
To record the business combination.

*The asset accounts to be debited will be the actual assets received (AR, Inventory, PPE)
**The liability accounts to be credited are the actually assumed liabilities (AP, NP, Loans payable,
Bonds payable etc.)

Adelair Corp will account for the assets and liabilities exchanged in a business combination at fair
value. This principle will be further elaborated in IFRS 3 discussed in the course ABUSCOM of the
Accountancy Program.

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ii. Direct Approach – Direct computation of goodwill is based earnings projection of the entity being
acquired. That is, if the entity has the potential based on projected future income to earn above
industry average, it can be a reliable basis of the recognition and measurement of goodwill.

Direct approach goodwill is measured on the basis of the future earnings of the entity by:
a) Purchase of average excess earnings
b) Capitalization of average excess earnings
c) Capitalization of average earnings
d) Present value method

Illustration: Goodwill computation under the Direct approach

Bento Corp. is in the process of negotiations for the acquisition of the net assets of Klaudia Co.
Both parties agreed to decide on the acquisition cost by measuring goodwill under the direct
approach.
Klaudia has the following data available for the computation of goodwill:
Net assets 8,000,000
Normal rate of return 12%

Past earnings for 5 years preceding the sale:

2016 P 1,050,000
2017 1,075,000
2018 1,050,000
2019 1,175,000
2020 1,150,000
5,500,000
Average earnings of th 5-year period (5,500,000/5) P 1,100,000

Requirements: Compute goodwill under each of the four methods

1. Purchase of average excess earnings
2. Capitalization of average excess earnings at 25%.
3. Capitalization of average earnings at 10%.
4. Present value method.

Requirement 1: If both parties agree on purchase of average excess earnings:

Average earnings P1,100,000
Normal earnings (8,000,000 x 12%) ( 960,000)
Average excess earnings 140,000
Goodwill (140,000 x 5 years) P 700,000

Normal rate of return is the ordinary amount of net income from the use of existing assets. For
example, at 12% return, a P100.00 asset invested will normally contribute P12.00 to the total
net income. (P100.00 x 12%)

Requirement 2: If both parties agree on a 25% capitalization of average excess earnings:

Average excess earnings 140,000
Divided by capitalization rate 25%
Goodwill P 560,000

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 Requirement 3: If both parties agree on a 10% capitalization of average earnings:
Average earnings 1,100,000
Divided by capitalization rate 10%
Net assets with goodwill 11,000,000
Less: net assets without goodwill 8,000,000
Goodwill P 2,000,000

Requirement 4: Present value method

Average excess earnings 140,000
Multiplied by the present value of an
ordinary annuity of 1 for 5 years at 12% 3.605
Goodwill P 504,700

Note that any of the four methods are generally acceptable practices and may be used in calculating
goodwill and is entirely dependent on the agreement of both parties.
Goodwill is not subject to amortization but tested annually for impairment.

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2.4 Research and Development Cost

2.4.1 Nature and Definition

To assess whether an internally generated intangible asset meets the criteria for recognition, an entity
must classify the generation of the asset into research phase and development phase. (PAS 38,
paragraph 52)
Research is original and planned investigation undertaken with the prospect of gaining scientific or
technical knowledge and understanding.
 Aimed at discovering new knowledge
 Searching for application of research findings and other knowledge
 Testing in search for product or process alternative
Development is the application of the research findings or other knowledge to a plan or design.
 Design, construction and testing of preproduction prototype and model.
 Design of tools, jigs, molds and dies involving new technology.
 Design, construction and operation of a pilot plant that is not a scale economically feasible to
the entity for commercial production. (Levelling up the current processes and capacity)
 Design, construction and testing of a chosen alternative for new or improved product or
process
If an entity cannot distinguish the research phase from the development phase, the entity treats the
expenditure as if it were incurred in the research phase only. (PAS 38, paragraph 53)
Research and development activities are events that occur before the beginning of commercial
production of the products or processes being researched. Activities that take place after commercial
production are not research and development phases.

2.4.2 Recognition Criteria

 Research Costs are expensed as incurred.
 Development Cost may qualify as intangible asset if all the following are met:
i. The completion of intangible asset is technically feasible.
ii. There is an intention to complete the intangible asset and use or sell it.
iii. There is the ability to use or sell the intangible asset.
iv. The intangible asset will generate probable future economic benefits.
v. There is the availability of resources or funding to complete development and to use or
sell the asset.
vi. There is the availability to measure reliably the expenditure attributable to the
intangible asset during its development.
Acquired in-process research and development project. An exception to the recognition as expense of
research costs is when, an entity acquires Research & Development projects from another entity.
Acquired R&D is recognized as an asset at cost, even if a component is research.

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Illustration: Accounting for Research and development
Uraraka Corp. invested in a research and development project for the creation of a new patent that
is intended to improve the efficiency and operational capacity of its products. During the year 2020
the following expenditures were incurred and paid in cash:
Construction and testing of pre-production prototype. P 1,300,000
Costs for discovering a new design for the product 900,000
Research and development project of Tenya Company
acquired by Uraraka Corp. 500,000

Requirement:
The necessary journal entry for the expenditures during the year.
Research and development expense P 900,000
Patent 1,800,000
Cash 2,700,000
To record research and development.

The patent account will not be amortized until completion of research and development and the
eventual approval of patent application by regulatory agencies.

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