04 May 2020
Entities holding significant intangible assets may find that changes in strategy or reductions in forecast revenues due to coronavirus will not only provide evidence of impairment but will also reduce the ability of the entity to meet the recognition criteria of intangible assets. This could mean an increase in costs being expensed to the P&L with knock on consequences for performance related pay, bonuses and covenants.
What does FRS 102 say?
The recognition criteria for intangible assets is (FRS 102.18.4):
- it must be probable that the expected future economic benefits attributable to the asset will flow to the entity; and
- the cost or value of the asset can be measured reliably.
For intangible assets acquired in a business combination, additional conditions to those above are required to be satisfied i.e.,:
- the intangible asset arises from contractual or other legal rights; and
- the intangible asset is separable (i.e., capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged either individually or together with a related contract, asset or liability).
An entity should initially measure the asset at cost.
- For internally generated intangible assets, the cost is the sum of the directly attributable expenditure incurred from when the asset first meets the recognition criteria. If an intangible asset is acquired through a business combination, then the cost is the fair value at the acquisition date.
Subsequent measurement, including impairment
Entities have a choice to subsequently measure the intangible assets recognised using either the cost or revaluation model (providing that there is an active market for the asset) (FRS 102.18.18).
An asset held under the cost model is measured at cost less accumulated amortisation and any impairment losses.
The article on impairment of assets explains how and when an entity reviews the carrying amount of its assets (i.e., assess at each reporting date whether there are any indicators of impairment), how it determines the recoverable amount of an asset, and when it recognises or reverses an impairment loss. (FRS 102.18.25)
Holding an intangible asset at valuation is rare given the limited active markets available for many intangible assets, and so commentary in this article is limited to a reminder on booking the increase or decrease:
- Any increases in an asset’s value as a result of a revaluation is taken to other comprehensive income and accumulated in equity.
- Any decrease in an asset’s valuation is firstly taken to other comprehensive income to reverse previously recognised gains. To the extent that the devaluation exceeds previous revaluation gains, the excess shall be recognised in profit or loss.
Practical impact and interpretation for preparers
The requirement for future economic benefits to flow to the entity may now mean that many costs do not meet the recognition criteria to be capitalised as intangible assets. The assessment of future cash flows must be made over the useful life of the asset, using reasonable and supportable assumptions and a degree of judgement must be used to assess the certainty attached to the flow of the economic benefits.
Internally generated R&D costs which were previously capitalised (such as staff costs for the development of intangible assets) may now not meet the requirement for recognition, meaning that entities will see an increase in the level of R&D expenditure being expensed to the P&L. In addition, if costs relating to a certain project no longer meet the requirement for capitalisation, then this is an indicator of impairment for the costs previously recognised as an intangible asset.
Costs expensed because they do not meet the requirement for capitalisation may not be recognised at a later date as part of a cost of an intangible asset (FRS 102.18.17).
Changes in entity strategy may result in the automatic impairment of some intangible assets. For example, a decision not to progress with a certain product, or revenue stream as a result of coronavirus may result in an impairment of any purchased brands, patents, trademarks or other recognised intangibles relating to these specific plans.
Under FRS 102, all intangible assets are considered to have a finite useful life. When considering an asset’s useful life, renewal periods can be included if to renew would not incur significant costs. The impact of coronavirus may mean that there are reductions to the useful lives of intangible assets, especially if it becomes unlikely that an entity will renew its contractual or legal rights. As a result, any accelerated amortisation is required to be taken to the P&L on a prospective basis.
Where an entity has a policy of capitalising borrowing costs, any delays to the development of an asset may mean that the capitalisation of borrowing costs may need to be suspended and instead expensed to the P&L.
- Entities must consider whether there are any indicators of impairment of their intangible assets.
- Entities should assess their internal processes for capitalising internally generated expenditure to ensure that only costs meeting the recognition criteria are capitalised as intangible assets. Costs for consideration include:
- Staff costs where staff have been unable to perform work on the intangible asset in question. If these costs are automatically journaled as an intangible asset each month, management may need to make a manual journal to move the costs to the P&L for the period in which there was no development.
- Management should suspend the capitalisation of directly attributable borrowing costs during a period in which no development of the asset in taking place.
- Any additional materials or costs (such as legal costs), incurred as a result of delays to development, should be assessed to ensure that they meet the criteria for recognition.
- Entities should review the useful lives of the intangible asset, including the consideration of any renewal periods included in the estimates, to ensure that they remain appropriate in light of the current economic environment.
- For entities with significant R&D an increase in costs being charged to P&L may affect performance related pay, bonuses, share options and covenants, and so these should all be reviewed.