Guidance on Amortization of Intangible Assets

The accounting for an intangible asset is based on its useful life. An intangible asset with a finite useful life is amortised, and an intangible asset with an indefinite useful life is not.

What is the definition of Amortization ?

Amortization is the systematic allocation of the depreciable amount of an intangible asset over its useful life.

IAS 38 para. 97-106 rules the amortization of finite useful lives of intangible assets.

Paragraph 97 of IAS 38 states that the depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Amortization shall begin when the asset is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.

Amortization shall cease at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 and the date that the asset is derecognized.

The amortization method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. If that pattern cannot be determined reliably, the straight-line method shall be used.

The amortization charge for each period shall be recognized in profit or loss unless this or another Standard permits or requires it to be included in the carrying amount of another asset.

According to Para. 98, a variety of amortization methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the unit of production method. The method used is selected on the basis of the expected pattern of consumption of the expected future economic benefits embodied in the asset and is applied consistently from period to period, unless there is a change in the expected pattern of consumption of those future economic benefits.

Further, para. 99 of IAS 38 states that amortization is usually recognized in profit or loss. However, sometimes the future economic benefits embodied in an asset are absorbed in producing other assets. In this case, the amortization charge constitutes part of the cost of the other asset and is included in its carrying amount. For example, the amortization of intangible assets used in a production process is included in the carrying amount of inventories.

While para. 104 requires an entity to review the amortization period and method at least at each financial year-end.

If the expected useful life of the asset is different from previous estimates, the amortization period shall be changed accordingly. If there has been a change in the expected pattern of consumption of the future economic benefits embodied in the asset, the amortization method shall be changed to reflect the changed pattern. Such changes shall be accounted for as changes in accounting estimates in accordance with IAS 8.

During the life of an intangible asset, it may become apparent that the estimate of its useful life is inappropriate. For example, the recognition of an impairment loss may indicate that the amortization period needs to be changed.

Over time, the pattern of future economic benefits expected to flow to an entity from an intangible asset may change. For example, it may become apparent that a diminishing balance method or amortization is appropriate rather than a straight-line method. Another example is if use of the rights represented by a license is deferred pending action on other components of the business plan. In this case, economic benefits that flow from the asset may not be received until later periods (Hrd).

Source : IFRS as issued at 1 January 2010

Methods of adjusting ACCUMULATED DEPRECIATION at the date of REVALUATION

When an item of Property, Plant and Equipment is REVALUED, any accumulated depreciation at the date of the revaluation is treated in one of the following ways : (1) Restate accumulated depreciation proportionately with the change in the gross carrying amount of the asset (so that the carrying amount of the asset after revaluation equals its revalued amount); or (2) Eliminate the accumulated depreciation against the gross carrying amount of the asset (IAS 16 par. 35).

Example, Konin Corporation (KC) own buildings with a cost of USD200,000 and estimated useful life of five years. Accordingly, depreciation of USD40,000 per year is anticipated. After two years, KC obtains market information suggesting that a current fair value of the buildings is USD 300,000 and decided to write the building up to a fair value of USD300,000. There are two approaches to apply the revaluation model in IAS 38; the asset and accumulated depreciation can be “grossed up” to reflect the new fair value information, or the asset can be restated on a “net” basis. These two approaches are illustrated below. For both illustrations, the net carrying amount (book value or depreciated cost) immediately prior to the revaluation is USD120,000 (USD 200,000 - (2XUSD40,000)). The net upward revaluation is given by the difference between the fair value and net carrying value, or USD300,000 – USD120,000 = USD180,000.

Option 1. Applying the “gross up” approach, since the fair value after two years of the five-year useful life have already elapsed is found to be USD300,000, the gross fair value (gross carrying amount) must be 5/3 X USD300,000 = USD500,000. In order to have the net carrying value equal to the fair value after two years, the balance in accumulated depreciation needs to be USD200,000. Consequently, the buildings and accumulated depreciation accounts need to be restated upward as follows : buildings up USD300,000 (USD500,000 – USD200,000) and accumulated depreciation USD120,000 (USD200,000 – USD80,000). Alternatively, this revaluation could be accomplished by restating the buildings account and the accumulated depreciation account so that the ratio of net carrying amount to gross carrying amount is 60% (USD120,000/USD200.000) and the net carrying amount is USD300,000. New gross carrying amount is calculated USD300,000/60%=USD500,000.

The following journal entry illustrate the restatement of the accounts :

Buildings	300,000
Accumulated Depreciation		120,000
Other comprehensive income – gain on revaluation		180,000

And the following table illustrate the restatement of the accounts :

	Original cost		Revaluation		Total	%
Gross carrying amount	USD200,000	+	USD300,000	=	USD500,000	100
Accumulated Depreciation	80,000	+	120,000	=	200,000	40
Net carrying amount	USD120,000	+	USD180,000	=	USD300,000	60

After the revaluation, the carrying value of the building is USD300,000 (=USD500,000 – 200,000) and the ratio of net carrying amount to gross carrying amount is 60% (=USD300,000/USD500,000).

This method is often used when an asset is revalued by means of applying an index to determine its depreciated replacement cost.

Option 2. Applying the “netting” approach, KC would eliminate accumulated depreciation of USD80,000 and then increase the building account by USD180,000 so the net carrying amount is USD300,000 (=USD200,000 – USD80,000 + USD180,000). The journal entry as follow :

Acc. Depreciation	80,000
Buildings		80,000
Buildings	180,000
Other comprehensive income – gain on revaluation		180,000

This method is often used for buildings. In terms of total assets reported in the statement of financial position, option 2 has exactly the same effect as option 1.

However, many users of financial statements, including credit grantors and prospective investors, pay heed to the ratio of net property and equipment as a fraction of the related gross amounts. This is done to assess the relative age of the entity’s productive assets and, indirectly, to estimate the timing and amounts of cash needed for asset replacements. There is a significant diminution of information under the second method. Accordingly, the first approach described above, preserving the relationship between gross and net asset amounts after the revaluation, is recommended as the preferable alternative is the goal is meaningful financial reporting.

Source : WILEY – 2010 Interpretation and Application of IFRS, Barry J. Epstein and Eva K. Jermakowicz

Identifying the condition to recognise “Events after the Reporting Period”

IAS 10 Events after the Reporting Period replaces IAS 10 Events After the Balance Sheet Date (revised in 1999) and should be applied for annual periods beginning on or after 1 January 2005.

The main change from the previous version of IAS 10 was a limited clarification of par. 12 and 13. As revised, those paragraphs state that if an entity declares dividends after the reporting period, the entity shall not recognise those dividends as a liability at the end of the reporting period.

When an entity should recognise “Events after the Reporting Period” in the financial statements ?

IAS 10 par. 3 – 7 underlines several guidances regarding above question.

Par. 3 defines “Events after the Reporting Period” as those events, favourable and unfavourable, that occur between the end of the reporting period and the date when the financial statements are authorised for issue. Two types of events can be identified :

1. those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the reporting period); and
2. those that are indicative of conditions that arose after the reporting period (non-adjusting events after the reporting period).

The process involved in authorising the financial statements for issue will vary depending upon the management structure, statutory requirements and procedures followed in preparing and finalising the financial statements.

In some cases, an entity is required to submit its financial statements to its shareholders for approval after the financial statements have been issued. In such cases, the financial statements are authorised for issue on the date of issue, not the date when shareholders approve the financial statements.

Example, the management of an entity completes draft financial statements for the year to 31 December 20X1 on 28 February 20X2. On 18 March 20X2, the board of directors reviews the financial statements and authorises them for issue. The entity announces its profit and selected other financial information on 19 March 20X2. The financial statements are made available to shareholders and others on 1 April 20X2. The shareholders approve the financial statements at their annual meeting on 15 May 20X2 and the approved financial statements are then filed with a regulatory body on 17 May 20X2.

In this condition, the financial statements are authorised for issue on 18 March 20X2 (date of board authorisation for issue).

In some cases, the management of an entity is required to issue its financial statements to a supervisory board (made up solely of non-executives) for approval . In such cases, the financial statements are authorised for issue when the management authorises them for issue to the supervisory board.

Example, on 18 March 20X2, the management of an entity authorises financial statements for issue to its supervisory board. The supervisory board is made up solely of non-executives and may include representatives of employees and other outside interests. The supervisory board approves the financial statements on 26 March 20X2. The financial statements are made available to shareholders and others on 1 April 20X2. The shareholders approve the financial statements at their annual meeting on 15 May 20X2 and the financial statements are then filed with a regulatory body on 17 May 20X2.

In this condition, the financial statements are authorised for issue on 18 March 20X2 (date of management authorisation for issue to the supervisory board).

Events after the reporting period include all events up to the date when the financial statements are authorised for issue, even if those events occur after the public announcement of profit or of other selected financial information (Hrd). ***

Several main features of IAS 27 - Consolidated and Separate Financial Statements

The objective of IAS 27 is to enhance the relevance, reliability and comparability of the information that a parent entity provides in its separate financial statements and in its consolidated financial statements for a group of entities under its control.

The Standard specifies :

1. the circumstances in which an entity must consolidate the financial statements of another entity (being a subsidiary);
2. the accounting for changes in the level of ownership interest in a subsidiary;
3. the accounting for the loss of control of a subsidiary; and
4. the information that an entity must disclose to enable users of the financial statements to evaluate the nature of the relationship between the entity and its subsidiaries

Presentation of consolidated financial statements. A parent must consolidate its investments in subsidiaries. There is a limited exception available to some non-public entities. However, that exception does not relieve venture capital organisations, mutual funds, unit trusts and similar entities from consolidating their subsidiaries.

Consolidation procedures. A group must use uniform accounting policies for reporting like transactions and other events in similar circumstances. The consequences of transactions, and balances, between entities within the group must be eliminated.

Non-controlling interests. Non-controlling interests must be presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. Total comprehensive income must be attributed to the owners of the parent and to the non-controlling interests even if the results in the non-controlling interests having a deficit balance.

Changes in the ownership interests. Changes in a parent’s ownership interest in a subsidiary that do not result in the loss of control are accounted for within equity.

When an entity loses control of a subsidiary, it derecognises the assets and liabilities and related equity components of the former subsidiary. Any gain or loss is recognised in profit or loss. Any investment retained in the former subsidiary is measured at its fair value at the date when control is lost.

Separate financial statements. When an entity elects, or is required by local regulations, to present separate financial statements, investments in subsidiaries. jointly controlled entities and associates must be accounted for at cost or in accordance with IAS 39 Financial Instruments : Recognition and Measurement.

Disclosure. An entity must disclose information about the nature of the relationship between the parent entity and its subsidiaries (Hrd) ***

The Right Way to Classify A Lease

Definitions

A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.

A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.

An operating lease is a lease other than a finance lease.

Classification of Leases

The classification of a lease as either a finance lease or an operating lease is critical as significantly different accounting treatments are required for the different types of lease. The classification is based on the extent to which risks and rewards of ownership of the leased asset are transferred to the lessee or remain with the lessor. Risks include technological obsolescence, loss from idle capacity, and variations in return. Rewards include rights to sell the asset and gain from its capital value.

A lease is classified as a finance lease if it transfers substantially all the risks and rewards of ownership to the lessee. If it does not, then it is an operating lease. When classifying a lease, it is important to recognize the substance of the agreement and not just its legal form. The commercial reality is important. Conditions in the lease may indicate that an entity has only a limited exposure to the risks and benefits of the leased asset. However, the substance of the agreement may indicate otherwise. Situations that, individually or in combination, would usually lead to a lease being a finance lease include :

• transfer of ownership to the lessee by the end of the lease term
• the lessee has the option to purchase the asset at a price that is expected to be lower than its fair value such that the option is likely to be exercised
• the lease term is for a major part of the economic life of the asset, even if title to the asset is not transferred
• the present value of the minimum lease payments is equal to the substantially all of the fair value of the asset
• the leased assets are of a specialized nature such that only the lessee can use them without significant modification

Situations that, individually or in combination, could lead to a lease being a finance lease include :

• if the lessee can cancel the lease, and the lessor’s losses associated with cancellation are borne by the lessee
• gains or losses from changes in the fair value of the residual value of the asset accrue to the lessee
• the lessee has the option to continue the lease for a secondary term at substantially below market rent

It is evident from the descriptions that a large degree of judgment has to be exercised in classifying lease; many lease agreements are likely to demonstrate only a few of the situations listed, some of which are more persuasive that others. In all cases, the substance of the transaction needs to be properly analyzed and understood. Emphasis is placed on the risks that the lessor retains more than the benefits of ownership of the asset. If there is little or no related risk, then the agreement is likely to be a finance lease. If the lessor suffers the risk associated with a movement in the market price of the asset or the use of the asset, then the lease is usually an operating lease.

The purpose of the lease agreement may help the classification. If there is an option to cancel, and the lessee is likely to exercise such an option, then the lease is likely to be an operating lease (Hrd).

Source : IFRS Practical Implementation Guide and Workbook (2nd Edition) - Abbas Ali Mirza, Magnus Orrell & Graham J. Holt

Starting 1 July 2010, IASC Foundation will be known as IFRS Foundation

On 1 July 2010 the IASC Foundation will formally change its name to the IFRS Foundation. The change represents the next step in a process to simplify the names in use across the organisation announced following the conclusion of the Constitutional Review in 2010. The International Financial Reporting Interpretations Committee (IFRIC) and the Standards Advisory Council (SAC) have already been renamed as the IFRS Interpretations Committee and the IFRS Advisory Council, respectively.

The name of the International Accounting Standards Board (IASB) will remain unchanged.

Beyond the change in name, there are no other changes affecting the legal status of the Foundation, its structure or its operating terms and conditions.

Source : www.iasb.org