GOODWILL AND INTANGIBLE ASSETS (ASPE 3064 AND IAS 38)

Definition and capitlization criteria

Non-monetary assets without physical substance that meets the following criteria;

• identifiable
  • can be separated, licensed, rented or sold from business; or
  • arises from legal or contractual right
• control
  • ability to obtain access to rights to gain benefits or restrict benefits to others
• future economic benefits

An intangible asset cab be recognized as an asset if;

• meets definition above (3 points)
• costs can be measured
• probable future economic benefits will flow to entity

Note that an asset could meet the definition criteria as an intangible if there is some form of future economic benefits even it is unlikely. But in that case, it meets the definition but not the recognition criteria as it must be probable for future economic benefits to flow to the entity. Generally the term probable just means more than 50% of occurring.

When determining which costs can be capitalized or expensed there are specific costs which must be expensed;

• Start-up costs
• Training activities
• Advertising and promotion
• Relocating or reorganizing part or all of an entity
• Internally generated brands, customer lists, publishing titles etc.

Internally Generated Assets (Research and Development)

ASPE 3064

All costs incurred in the research phase are to be expensed.

Examples of research activities are:

(a) activities aimed at obtaining new knowledge;

(b) the search for, evaluation and final selection of, applications of research findings or other knowledge;

(c) the search for alternatives for materials, devices, products, processes, systems or services; and

(d) the formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems or services.

In accounting for expenditures on internally generated intangible assets during the development phase, an entity shall make an accounting policy choice to either:

(a) expense such expenditures as incurred; or

(b) capitalize such expenditures as an intangible asset (provided the criteria are met).

 

This accounting policy choice shall be applied consistently to expenditures on all internal projects in the development phase. Under IFRS there is no policy choice; if it meets the development criteria it must be capitalized, but the criteria are identical.

 

An intangible asset arising from development (or from the development phase of an internal project) is recognized if, and only if, an entity can demonstrate all of the following:

(a) technical feasibility

(b) intention to complete

(c) ability to use or sell

(d) the availability of adequate technical, financial and other resources to complete

(e) ability to measure reliably costs

(f) how the intangible asset will generate probable future economic benefits

Examples of development activities are:

(a) the design, construction and testing of pre-production or pre-use prototypes and models;

(b) the design of tools, jigs, moulds and dies involving new technology;

(c) the design, construction and operation of a pilot plant that is not of a scale economically feasible for commercial production; and

(d) the design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services.

Specifically for internally generated intangible assets, costs that can be capitalized are; any directly attributable costs to create, produce and prepare the asset to be capable of operating as intended such as

• Materials and services
• Employee salaries
• Fees to register a legal right
• Amortization of patents and licenses used to generate intangible asset
• Interest costs (if entity choose policy to do so under ASPE, whereas IFRS requires it)

Examples of expenditures that are to be excluded for internally generated intangible assets are;

• Selling, admin and general overhead
• Identified inefficiencies and initial operating losses
• Training staff to operate the asset

Subsequent Recognition

ASPE 3064

Historical cost model only

Presented net of accumulated amortization for limited life intangible

Indefinite life intangibles are not amortized if it truly is indefinite life

IFRS 38

Choice between historical cost model and revaluation model (must be applied consistently for all assets in a particular class; i.e. all patents can be at cost and all licenses can be at revaluation model)

However the revaluation model is only available if an active market exists for that intangible. This is fair rare but some examples are taxi or fishing licenses that are frequently bought and sold. Just know that there are two options for IFRS. Same goes for amortization under IFRS; if indefinite life no amortization.

Useful Life of Intangible

You may need to determine the appropriate useful life of an intangible when the entity originally believes that it should be indefinite life.

You should consider

• the expected usage of the asset by the entity
• typical product life cycle for the asset
• public information on estimates of similar assets
• technological or commercial obsolescence
• expected actions by competitors or potential competitors
• period of control over the asset and legal limits on use of asset

Website Costs

Under ASPE there is no specific criteria for websites but they would fall under the general criteria for capitalization (identifiable, control, future benefit).

Under IFRS there is a specific SIC for website costs; SIC 32. This interpretation standard falls back to the general criteria for intangible assets but offers addition guidance as well. The main issue is whether a future economic benefit exists (criteria #3). It specifically states that if a website is used solely to promote or advertise products then it cannot be capitalized as it does not have a probable future economic benefit. However if the website can also take orders online then it can be established that a future economic benefit will result.

The treatment under ASPE and IFRS would then be the same for website costs, but just be aware that there is a SIC 38 under IFRS that deals specifically with website costs.

Final Thoughts

Could be tested on the capitalization criteria in terms of multiple choice or on a case. Another possible test question could be to calculate the costs that can be capitalized and/or expensed.

R&D criteria might be hard to memorize but I recommend copy and pasting from the handbook on a case. This makes it easy to apply each criteria to a case fact as you work your way through the criteria. For the CKE, perhaps try to remember examples of R&D activities in order to help you determine which activities should be capitalized or expensed.

Also on a case, you might need to assess the useful life of an intangible asset. Management may want to show it as an indefinite life intangible, but you likely should challenge this assertion if case facts lead to it. You might see things like “the average product life cycle of similar products is 3 years” or “the intangible asset will expire after 10 years”.

There is an increased chance of being tested on websites to keep up to date on IT advances. Apply the general rules, but remember that the website has to be able to take and place orders online (not just advertising products).

Revenue Recognition (ASPE 3400 & IAS 18)

Revenue Recognition on Sale of Goods

ASPE 3400

When performance is achieved provided that collection is reasonably assured.

Performance is achieved when

• Transferred significant risks and rewards of ownership; i.e.
  • All significant acts have been completed      
  • No continuing involvement in or control over the goods
  • Reasonable assurance regarding measurement of consideration and extent of returns

In general (for good or services) performance is achieved when all are met;

• Persuasive evidence of an arrangement exists
• Delivery has occurred or services have been rendered
• The seller’s price is fixed or determinable

IAS 18

Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits associated with the transaction will flow to the entity; (collectability)

(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

 

Notes

Under both frameworks the revenue recognition on sale of goods have almost identical criteria. An easy way to remember these can be from the acronym RCMP

 

Risks and rewards have been transferred (point A)

Continuing involvement (point B)

Measurable costs and revenue that can be measured reliably (point C + E)

Probable economic benefits will flow to entity (point D)

 

Revenue Recognition on Provision of Services

ASPE 3400

In the case of rendering of services and long-term contracts, performance shall be determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished.

Always use percentage of completion unless;

• Performance exists of a single act (in this case would use completed contract)
• Extent of progress cannot be measured reliably
• Consideration is not measurable

IAS 18

When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the end of the reporting period.

 

Always use percentage of completion unless;

• Outcome of contract cannot be measured reliably* (use cost recovery method)
• When specific act is much more significant and any other act (only measure after significant act is completed)

*The outcome of a transaction can be estimated reliably when all the following conditions are satisfied:

(a) the amount of revenue can be measured reliably;

(b) it is probable that the economic benefits associated with the transaction will flow to the entity;(collectability)

(c) the stage of completion of the transaction at the end of the reporting period can be measured reliably; and

(d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

 

Notes

Under ASPE, percentage of completion or completed contract method are not acceptable accounting policy choices –the method that relates the revenue to the work accomplished is to be used. Completed contract method is only appropriate when performance consist of the execution of a single act or when the enterprise cannot reasonably estimate the extent of progress toward completion. You are supposed to use percentage of completion first, and only if it is not appropriate then you can use completed contract; it is not a simple matter of choice.

Also note under IFRS that there is no CC as there is only POC and the cost recovery method. Under this method you simply recognize revenue up to the extent of costs incurred. Take a construction contract that spans over several years. If the outcome cannot be estimated reliably then you would only measure revenue up to the amount of costs incurred for that period. You would report $nil gross profits on that contract currently. Once the outcome can be estimated (near the end of the contract) you would treat as a change in accounting estimate at that time (accounted for prospectively).

 

Revenue Gross Versus Net

Revenue can be presented either gross with related costs or netted as one line item and it depends on if the entity is either a principle or agent.

 

Factors that indicate treatment of entity as principle (recording gross);

• Entity has primary responsibility for providing good or service being purchased
• Entity has inventory risk
• Entity bears credit risk
• Entity has ability to establish prices

 

Factors that indicate treatment of entity as agent (recording net);

• Amount to be received is fixed or predetermined
• Has no risk associated with sale (as noted above)

 

Conceptually this makes sense. If you do not bear any risk with the sale, why should you be able to present gross revenues then present all related expenses? Notice that the impact on net income is $nil between the two. So why do we care? What if management’s bonus is based on gross revenues? In this case they would more inclined to present revenue gross as this amount would be higher than just the net amount.

 Same under IFRS and ASPE

 

Multiple Deliverables

When a single transaction has multiple components the revenue recognition criteria should be applied to each component separately if it better reflects the substance of the transaction.

 

Take this example. You sell a machine to a customer for $1,000. As part of the sale you also include a maintenance contract that lasts for a year. At the sale the customer pays $1,100 for both the machine and the added maintenance contract. It would be inappropriate to recognize the full $1,100 immediately as performance may have been achieved on the machine sale but maybe not on the maintenance contract. Under this scenario it would likely be appropriate to measure revenue on the machine sale ($1,000) and defer and recognize the revenue on the maintenance contract on the percentage of completion basis using time to measure the progress.

Sometimes you will have to allocate the revenue to be recognized on multiple deliverable. You can use either relative fair values of a similar sale in a standalone transaction or you can use the residual method. Taking the example from above, you could use the residual method to allocate $100 to the maintenance contract after allocating $1,000 of the $1,100 to the machine.

There could be a scenario where you have the total purchase price of a machine and contract for $2,500 and you are given the prices or fair values of just the machine and the contract as a standalone value. Let’s say that to buy the machine alone would sell for $2,000 and the contract alone would sell for $1,000.

You might ask why would anyone do this; sell $3,000 of goods and services for $2,500. An entity might do this to bundle products in order to push new products that might not be otherwise bought.

Back to the example; to allocate the revenue in order to quantify which revenue can be recognized immediately and which can be deferred it should be based on the relative fair values. We know the total revenue to be recognized is $2,500 as this is what we actually receive. The fair value of the total package is $3,000 ($2,000 + $1,000). The machine makes up 66% of this and the contract is 33%. ($2,000 / $3,000 = 66% and $1,000 / $3,000 = 33%). Therefore by applying these percentages to the $2,500 will allocate revenue to each component. The immediate revenue to be recognized is then $1,667 to the machine and $833 to the contract which is deferred and recognized over life of contract.

Same under IFRS and ASPE.

 

Final Thoughts

Revenue recognition usually requires significant judgement. When are the “significant” acts completed or what is “managerial involvement”? It is hard to test judgement in a multiple choice question, but you can see expect to see a few questions on every exam. Usually they relate to calculating the amount of revenue to be recognized on a construction contract or a basic percentage of completion application.

However on a case exam, you will be hard pressed to find a final exam that doesn’t test revenue recognition. Because it requires judgement, they want to test you to know the handbook, apply the criteria then make a judgement and recommend how to treat. Almost always there are alternatives for revenue recognition, and as such is hard to test as a multiple choice.

I recommend knowing the revenue criteria for the CKE regardless as you will need to know these inside and out come time for case exams.