START-UP Costs, how to record them ?

HOW to record Start-Up Costs arising from a new operation activities ? Should this type of cost be treated as Intangible Assets based on IAS 38 ?

Referring to IAS 38, the standard requires an entity to recognize an Intangible Asset, whether purchased or self-created (at cost), if, and only if :

1. it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
2. the cost of the asset can be measured reliably

An entity shall assess the probability of expected future economic benefits using reasonable and supportable assumptions that represent management’s best estimate of the set of economic conditions that will exist over the useful life of the asset.

Read also my previous post : Recognition Criteria of Intangible Asset

Paragraph 68 of IAS 38 states that expenditure on an intangible item shall be recognized as an EXPENSE when it is incurred unless :

1. it forms part of the cost of an intangible asset that meets the recognition criteria (as stated above)
2. the item is acquired in a business combination and cannot be recognized as an intangible asset. If this is the case, it forms part of the amount recognized as goodwill at the acquisition date.

Further, paragraph 69 gives examples of the types of cost that are indistinguishable from the costs of developing the business as a whole and that should, therefore, be EXPENSED when it is incurred. The kind of such costs are include :

1. expenditure on START-UP activities (ie START-UP COSTS), unless this expenditure is included in the cost of an item of property, plant and equipment in accordance with IAS 16. Start-up costs may consist of establishment costs such as legal and secretarial costs incurred in establishing a legal entity, expenditure to open a new facility or business (ie Pre-Opening Costs) or expenditures for starting new operations or launching new products or processes (ie Pre-Operating Costs);
2. expenditure on training activities;
3. expenditure on advertising and promotional activities (including mail order catalogues);
4. expenditure on relocating or reorganizing part or all of an entity.

From the above explanations, it is clear that START-UP Cost has to be EXPENSED as incurred.

Following is the illustrated example of Start-Up Cost excerpted from Intermediate Accounting - Kieso, Weygandt, Warfield :

U.S-based Hilo Beverage Company decides to construct a new plant in Brazil. This represents Hilo’s first entry into the Brazilian market. Hilo plans to introduce the company’s major U.S brands into Brazil, on a locally produced basis. The following costs might be involved :

1. Travel-related costs; costs related to employee salaries; and costs related to feasibility studies, accounting, tax, and government affairs
2. Training of local employees related to product, maintenance, computer systems, finance, and operations
3. Recruiting, organizing, and training related to establishing a distribution network

Hilo Beverage Company should EXPENSE all these start-up costs  as incurred.

The same accounting treatment as Start-Up Cost, the Initial Operating Losses incurred in the start-up of a business also may not be capitalized (HRD).

Determine the USEFUL LIVES of Intangible Assets

IAS 38 regarding Intangible Assets defines USEFUL LIFE as :

1. the period over which an asset is expected to be available for use by an entity; or
2. the number of production or similar units expected to be obtained from the asset by an entity

Further, IAS 38 requires an entity to assess whether the useful life of an intangible asset is FINITE or INDEFINITE and, if finite, the length of, or number of production or similar units constituting, that useful life. An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.

IAS 38 contains guidance on factors to be taken into account when estimating useful life of an intangible asset, which includes :

1. Expected usage by the entity of the asset and whether it could be managed efficiently by another management team;
2. The typical product life cycle for the asset and published information about useful lives of similar assets that are used in a similar way. This might include comparison with useful lives disclosed in the financial statements of companies that have a similar business using similar assets;
3. Technical, technological, commercial or other types of obsolescence;
4. The stability of the industry in which the asset operates and changes in market demand for the products or services from or related to the asset;
5. Expected actions by actual or potential competitors;
6. The level of maintenance required to maintain the asset’s operating capability and whether management intends to perform that level of maintenance;
7. The period for which the entity has control of the asset and any legal or similar limits on the asset’s use, including for example, expiry dates of leases or licences or geographical restrictions;
8. Whether the asset’s useful life is dependent on the useful life of other assets of the entity. For example, use of a trademark or brand may cease if production of the goods represented by the trademark or brand is discontinued.

An Intangible Asset that is determined to have an INDEFINITE USEFUL LIFE is not amortized. While, assets having a FINITE USEFUL LIFE must be amortized over the useful life, and this may be done in any of the usual ways (pro rata over time, over units of production, etc.). If control over the future economic benefits from an intangible asset is achieved through legal rights for a finite period, then the useful life of the intangible asset should not exceed the period of legal rights, unless the legal rights are renewable and the renewal is a virtual certainty. Thus, as a practical matter, the shorter legal life will set the upper limit for an amortization period in most cases.

There are illustrative examples in IAS 38 that cover assessing of the useful life of intangible assets, which include the Customer Lists, Patents, Copyrights, and also Renewable License Rights. Please refer to IAS 38 for further explanation.

The Useful Life of a finite life intangible asset should be reviewed at least at each financial year end. Changes in useful lives should be accounted for as changes in estimates in accordance with IAS 8.

Where an intangible asset is not being amortized because its useful life is considered to be indefinite, an entity should carry out a review in each accounting period to confirm whether or not events and circumstances still support the assumption of an indefinite life. If they don’t, the change from the indefinite to finite useful life should be accounted for as a change in estimate under IAS 8 (HRD).

Sources :

1. Manual of Accounting, IFRS 2014 – Vol.2 (PwC)
2. Wiley, 2013 Interpretation and Application of IFRS
3. www.ifrs.org