Accounting for intangible assets and goodwill under IFRS
All European quoted companies will be required to prepare financial statements in accordance with International Financial Reporting Standards (IFRS) including International Accounting Standards (IAS) from 2005. Companies in a number of other jurisdictions, notably Australia, Canada and New Zealand, will also adopt IAS in a similar timeframe.
One standard, IFRS1 deals with the first time adoption of IFRS financial statements by companies. Three further standards will impact the accounting for intangible assets, namely IFRS3, Business Combinations, IAS36, Impairment of Assets, and IAS38, Intangible Assets. In general the International Accounting Standards Board is seeking convergence with accounting standards in use elsewhere, and especially with US standards. However some differences do remain.
All European quoted companies will be required to prepare financial statements in accordance with IFRS for 2005. In addition, companies are recommended to make information available to investors as early as possible. Companies also need to consider whether information about the impact of the change to IFRS may be considered price sensitive and subject to separate regulation
The transition steps are referenced to calendar years and these refer to the company's financial year commencing in that calendar year, so 2003 financial statements are those for the year ending on or after 31 December, 2003.
The first step in setting out a timetable for a company is to determine the transition date. This is the date as at which the company must first prepare an IFRS balance sheet. For a company with a reporting date of 31 December, the first annual financial statements to be prepared under IFRS are those to 31 December 2005. These statements require comparables for the year to 31 December 2004, also prepared on an IFRS basis. In order to prepare a profit and loss account for this year, an opening balance sheet at 1 January 2004, or in effect 31 December 2003, prepared under IFRS, is required. This company's transition date is therefore 31 December 2003. The full range of transition dates for companies of differing reporting dates runs from 31 December 2003 to 30 December 2004.
The key steps for the transition are:
1. 2003 financial statements
• A statement of plans and achievements for implementation of IAS and qualitative information about the major differences between present accounting policies and IAS.
2. Prepare an opening IFRS balance sheet at as the transition date.
3. 2004 financial statements
• 2004 financial statements will have to be restated to IFRS as comparatives for the 2005 financial statements.
• Companies are encouraged to publish the relevant quantified information as soon as it can be quantified in a sufficiently reliable manner, and at the latest with their 2005 financial statements.
4. 2005 interim financial statements
• Such interim financial statements as companies are required to publish should be prepared on an IFRS basis with comparatives for the corresponding period of 2004 prepared under the original accounting standards and restated to IFRS.
5. 2005 full year financial statements
• Should be prepared on an IFRS basis with comparatives for the corresponding period of 2004 prepared under the original accounting standards and restated to IFRS.
• If companies are required to publish two years of comparative data, for 2004 and 2003, the 2003 data does not have to be restated to IFRS.
The main area of concern will be in respect of intangible assets acquired as part of a business combination. Previous GAAP in many jurisdictions has given companies an option over recognition of acquired intangible assets. Most companies have chosen not to recognise acquired intangible assets separately, but have included them within goodwill. In general, companies making business combinations in future will have to recognise acquired intangible assets.
There is a series of tests for determining whether internally generated intangible assets should be recognised in the company's balance sheet. For all recognised intangible assets, a useful life must be estimated and the asset valued amortised over this life. Frequently it will be appropriate to allocate indefinite lives to certain intangible assets, in which case no amortisation is reiquired. The accounting treatment of goodwill will also change as amortisation will no longer be permitted. Annual impairment testing will be necessary to check that the carrying values of goodwill and intangible assets, particularly those deemed to have indefinite lives, are not overstated.
Acquired intangible assets
Intangible assets acquired in a business combination must be recognised separately from goodwill if:
• They are identifiable
• Their cost, based on fair value, can be measured reliably
The fair value can be based on:
• A quoted price in an active market
• The amount the entity would have paid in an arm's length transaction
• A calculated value using earnings multiples, the relief from royalty method or
discounted cash flows
Internally generated intangible assets
Internally generated intangible assets resulting from development expenditure must be recognised if certain conditions are met. The key conditions are that:
• The asset is identifiable
• Future economic benefits are probable
• The company has the intent and ability to complete the asset
The standards specifically exclude research expenditure and brands, mastheads and customer lists.
Goodwill is only recognised as a result of a business combination and represents the difference between the total purchase consideration and the total of the fair values of the acquired assets, including recognised intangible assets, and liabilities assumed. If the amount of goodwill is negative, that is the total fair value of acquired assets and liabilities is more than the purchase consideration, the excess must be recognised immediately as a profit.
Measurement after recognition
Companies may choose to value intangible assets at cost or at a revalued amount. Revaluations must be undertaken regularly, in effect annually, and increases in carrying value are taken to a revaluation surplus account. Companies may also choose an indefinite or a finite life for each asset. The useful life is deemed to be indefinite if there is no foreseeable time limit to future cash flows, and there is no amortisation charge to profits. For assets with a finite useful life, the cost is amortised over that life.
Goodwill is not amortised.
Goodwill, intangible assets with indefinite lives and those not yet in use must all be tested for impairment at least annually. Intangible assets with finite lives require a review for indications of any impairment, and tests as required. The test involves a comparison of the carrying value of the asset with its estimated recoverable amount. The recoverable amount is defined as the higher of the value less costs to sell and the value in use. The value in use is generally based on the discounted future cash flows from the asset. When the recoverable amount is found to be lower than the carrying value, the carrying value is reduced to the recoverable amount with a charge to profits. It is possible to reverse an impairment loss related to an intangible asset, but not for goodwill. Remaining differences between IAS and US GAAP Under US GAAP, there are very limited circumstances in which internally generated intangible assets are recognised and capitalised. This will have a significant impact on companies with material research and development expenditure, and who are quoted on a US stock exchange.
Prior business combinations
Companies have a choice on the treatment of business combinations which occurred prior to the company's transition date. They can restate earlier business combinations under IFRS3 to recognise acquired intangible assets. However, companies must apply IFRS3 consistently for every business combination after the earliest one and must also apply IAS 36, Impairment of Assets and IAS38, Intangible Assets. Alternatively they can elect not to restate earlier business combinations, leaving the values unchanged.