Alternative for Intangible Assets - Coursework Example

Running header: Intangible Assets Student’s name: Instructor’s name: Subject code: Date of submission Introduction As world economies gradually transform from being manufacturing based to being service based, intangible assets continue increasingly becoming important economic resources for many organizations. In addition, intangible assets have increasingly become a significant portion of the organization’s assets acquired in many transactions. As such, their recognition and subsequent accounting has become increasingly important in today’s organization unlike before when users did not consider intangible assets as useful. However, the development of an accounting standard for intangible assets has been controversial despite taking a long time with some arguing that there is no one best way of accounting for intangible assets. Others see it vital for a uniform accounting treatment for intangible assets to be developed so that all organizations can reflect their true value. This paper critically evaluates the current accounting standard on intangible assets reporting with an aim of establishing whether it reflects the true value of intangible assets. In addition, the paper will propose an alternative for intangible assets recognition while establishing whether company’s’ management should be given more flexibility in intangible assets reporting. Intangible assets reporting, conceptual framework and accounting theory The IASB conceptual framework defines an asset as a resource that the entity controls resulting from past events and from which future economic benefits flow to the entity. This implies that for the asset to be recognized, the entity must be in control of it regardless of whether it owns it or not and whether it is an intangible asset or not. In other words, entities should use substance over form where economic substance of the transaction acquiring the asset takes precedence over its legal aspect in presenting a true and fair value (Accounting simplified.com, 2012). In addition, the inflow of economic benefits to the entity should be probable while its cost or value should be measured reliably if any asset including intangible assets can be recognized in the financial statements. This is also the criteria advocated for by AASB138, IAS38 among other recognized accounting standards. This being the case, the decision of whether there is any one best criteria for intangible assets recognition or organizations should be given some freedom in accounting for intangible assets is based on this criteria. While all the accounting standards seem to agree on the recognition criteria for externally acquired intangible assets, it is the internally generated intangibles that have caused recognition problems in most cases, they have been ignored for lack of association between their cost and future revenue, difficulties in ascertainment of their cost as well as focusing on reliability over relevance in disclosing asset information. However, due to the increasing proportion of the entity’s market value attributable to them, they are increasingly being viewed as important and hence the need for recognition. AASB 138: Intangible assets AASB138 is similar to IAS38 in most respects. The standard defines intangible assets as identifiable non monetary asset with no physical substance. Identifiable in this respect implies the asset is either separable and can be sold apart from the other assets of the entity or it arose from contractual or legal rights. This recognition criterion is in addition to there being probable future economic benefits attributable to it which flow from the entity while the assets costs can be reliably measured. AASB further clarifies that intangible assets arise either from self creation and hence internally generated by the entity, asset exchange, and business combination separate purchase or from a government grant (Aasb.gov.au, 2009). As such, intangible assets that arise from asset exchange are recognized at the fair value of acquired intangible asset or the asset exchanged whichever is greater. Separately purchased intangible assets’ probability of generating future benefits is considered to be satisfied as rational firms would only acquire assets when they are certain of making future benefits. As such, they are recognized at their cost price. Valuing of internally generated intangible assets is more difficult and is recognized in two phases. i.e. the research phase and the development phase. Research costs are considered disconnected with probable future revenues and hence are expensed. However, development costs can be capitalized in the balance sheet provided; i) it is technically feasible that the asset will be completed for use or sale ii) there is intent to complete the asset for use or sale iii) the entity will be able to use or sell the asset iv) the intangible asset will produce future benefits v) existence of technical and financial resources for completing the asset vi) the cost of the assets development are reliably measurable AASB138 further prohibits capitalization of costs of some internally generated intangible assets regardless of whether they meet the development criteria above. These includes expenditure on internally generated goodwill and brands, publishing titles, consumer lists, mastheads and other items similar in substance as they do not pass the separable asset test (Jade, 2005). However, the standard allows intangible assets that may not have been recognizable to be recognized incase of combinations as they are now treated as externally acquired intangibles. According to the standard, both externally acquired and the permitted internally generated intangibles are recognized initially at cost. However, for an intangible to qualify for revaluation, its fair value must be obtained with reference to an active market which is hard to come by (Wellington, 2008). AASB 138 also considers purchased brands, mastheads, patents and trademarks as unique intangibles and hence prohibits their revaluation. It should however be noted that intangible assets are revalued in similar manner to tangible assets. In this regard, an upward revaluation is an increase in balance sheet value and hence credited to the revaluation surplus part of the entity’s equity. Both AASB138 and IAS38 require that entities assess the useful life of their intangibles. As such, those with finite life should be amortized over their useful life. However, intangibles with indefinite lives should be assessed annually for impairment adjustments. Similar treatment should be accorded goodwill. However, the standard prohibits recognition of internally generated goodwill. Inadequacies of the current standard-AASB138 The current intangible assets accounting standard in no doubt has revolutionalized accounting for intangibles in Australia by offering consistency in financial reporting. However it has a lot of flaws which have led to such situations as the one witnessed in Fairfax media. As company’s like Fairfax media start derecognizing intangible assets previously capitalized but which are not allowed by AASB138 such as mastheads, this is having adverse effects on their financial positions. The standard does not require recognition of many intangibles thus reducing the reliability of financial statements (Mathews, 2010). This will call for entities to increasingly rely on non financial indicators (NFI) in making investment decisions as expensing intangibles leads to understatement of assets while reducing profits and hence the traditional financial statements can no longer be relied upon. In addition, the current standard only allows revaluation of intangible assets apart from goodwill when there is an active market for them which are not common. As such, it will be hard for such assets to be recorded at their fair value that is relevant to the users of financial statements. Finally, the requirement that research costs be expensed may discourage entities from undertaking expensive research as this may lead to low profits. Based on the above inadequacies therefore, AASB does not provide a criterion that can be used uniformly in preparing reliable financial statements (Steadman, 2006). As such, there is need for an alternative measurement base that will enhance recognition of the intangible assets by entities as explained below. Conclusion -Alternative measurement base and management role As discussed above, the current standard has a lot of flows thus leaving a lot of intangible assets unrecognized which has potential for giving misleading financial information. As such, the ideal measurement base should ensure that most intangible assets are recognized while only a few are expensed where necessary. The measurement base should recognize all intangible assets regardless of whether they are internally generated or externally acquired provided they pass the recognition criteria according to the conceptual framework. i.e. i) The entity must have control over the asset’s use ii) It has to be probable that the future economic benefits attributable to the asset will flow to the entity iii) The ability to measure the cost of the asset reliably (Sutton, 2004) Once an intangible asset fulfills the above criteria, it should be recognized regardless of whether it is internally or externally generated. This will have the effect of removing the strict limits imposed by AASB138 on intangibles recognition especially on internally generated ones. It should be noted that the argument that there lacks a relation between the cost of intangible assets and their related future revenues can also be applied to most plant and equipment as well as property assets and hence there is no reason why it should only be used to restrict recognition of internally generated intangibles only. Rather than applying a rule on internally generated assets, the management will have a free way in deciding what intangibles to recognize or not through applying of recognition and reliability criteria outlined above. By giving such a measurement base to the management and hence enhancing their freedom in accounting for intangibles, firms will be able to offer reliable information to its users at all times (Aden, 2010). This way, users will also find financial statements useful and use them in conjunction with non financial indicators (NFI) in making informed decisions. References: Jade, B2005, Intangibles: Management, measuring and recording, Washington DC, Brooklins institution Press. Accounting simplified.com, 2012, Recognition of assets, viewed 11 October2012, from http://accounting–simplified.com/assets-recognition.html Steadman, B2006, The boundaries of financial reporting and how to extend them, Journal of accounting research, vol.33, no.2, pp.353-86. Wellington, S2008, Business and financial reporting, Challenges from the new economy (Financial accounting series special report), Norwalk, Connecticut. Mathews, M2010, Potentially dysfunctional impacts of harmonizing accounting standards: International Accounting Journal, vol.21, no.6, pp.256-89. Sutton, T2004, Corporate financial accounting and reporting, Harlow, Prentice Hall. Aden, B2010, Value relevance of non financial information: The wireless communications industry, Journal of Accounting and Economics, vol.17, pp3-30 Aasb.gov.au, 2009, AASB138 Intangible assets, viewed 11 October 2012, from www.aasb.gov.au/.../AASB138_07-04_ERDRjun10_07-09.pd... Read More