IAS 38: Intangible Assets — Explained in Simple Terms

IAS 38 is the accounting standard that deals with intangible assets.

Intangible assets are non-physical, identifiable resources that a company owns, which can generate future economic benefits. Unlike physical assets like buildings or machinery, intangible assets include things like patents, trademarks, or software that you can’t touch or see but are still valuable to the business.

What is an Intangible Asset?

An intangible asset must meet certain criteria:

Identifiable: It should be something you can separate from the rest of the business, such as a patent or customer list.
Control: The company should have control over it, meaning they can benefit from it and prevent others from doing so.
Future Economic Benefit: It should have the potential to bring future revenue or savings.

Some common examples of intangible assets are:

Patents (exclusive rights to a specific invention)
Trademarks (logos or brand names that are registered)
Copyrights (ownership of artistic or literary work)
Software (that’s been developed or bought)

When Can You Recognize an Intangible Asset?

Not everything can be recognized as an intangible asset. There are two main situations where a company can recognize intangible assets:

If it is purchased: For example, if a company buys a patent from another business, they can list it as an intangible asset.
If it is internally developed: For instance, software that is developed in-house can be recognized as an intangible asset, but only after certain criteria are met. During the research phase (early stages), you cannot recognize it as an asset. Only in the development phase (when the product is almost ready for sale or use), can you record it as an asset.

Example:

A company buys a patent for ₦10 million from another company. This is recognized as an intangible asset and appears on the balance sheet.
The same company also spends ₦3 million to develop its software. In the research stage, the costs are not recognized as an asset. However, once the software enters the development stage, where it’s clear the software will be used or sold, the development costs can be recognized as an intangible asset.

Amortization of Intangible Assets

Unlike physical assets, intangible assets don’t wear out but their useful life may reduce over time. Amortization is the process of gradually expensing the value of an intangible asset over its useful life.

For example:

If a company buys a software license for ₦5 million, with a useful life of 5 years, the company would amortize (expense) ₦1 million per year.

Finite vs. Indefinite Life Intangible Assets

Finite life: Most intangible assets have a finite useful life, meaning you know how long the asset will generate value. These are amortized over that period. For instance, a 10-year patent is amortized over 10 years.
Indefinite life: Some intangible assets have an indefinite life, meaning there’s no foreseeable end to their benefit, like trademarks or brands that are well-maintained. These are not amortized but are tested for impairment annually, to check if they are still as valuable as before.

What about Goodwill?

Goodwill is a special type of intangible asset but it’s not included under IAS 38. Instead, goodwill is dealt with under IFRS 3 (Business Combinations). Goodwill arises only when one company buys another company for more than the fair value of its net identifiable assets (both tangible and intangible).

Example of Goodwill: Let’s say Company A buys Company B for ₦50 million. The fair value of Company B’s net assets (including its buildings, patents, and trademarks) is ₦40 million. The extra ₦10 million that Company A paid is recorded as goodwill.

Key Differences between Goodwill and Other Intangible Assets:

Recognition: Goodwill only arises through the acquisition of a business, whereas intangible assets can be either purchased separately or developed in-house.
Identification: Goodwill is not separable from the business; you can’t sell goodwill by itself. But other intangible assets like patents or trademarks can be sold independently.
Amortization: Goodwill is not amortized, but is tested for impairment annually. Other intangible assets with a finite life are amortized over their useful life.

Internal and External Intangible Assets

Internal: These are assets developed within the company, like software or internally created brands. Internal costs are often harder to recognize, especially in the early research stages.
External: These are intangible assets purchased from outside, such as buying a trademark or acquiring a customer list. External assets are easier to recognize, as there’s a clear cost attached.

Practical Example:

Let’s say a technology company in Nigeria, TechSoft Ltd, develops a new software that is unique and proprietary. In the first year, TechSoft spends ₦5 million researching the idea, and another ₦10 million developing it into a market-ready product. During the research phase, the ₦5 million cannot be listed as an asset; it’s an expense. However, once development is underway, the ₦10 million is recognized as an intangible asset on TechSoft’s balance sheet.

Additionally, TechSoft buys a patent for ₦8 million from another company. This patent is also listed as an intangible asset.

Testing for Impairment

Sometimes, intangible assets can lose value. Impairment testing ensures that the assets are not overvalued on the balance sheet. For assets with an indefinite life (like goodwill or some trademarks), impairment tests are done yearly.

If the company finds that the asset’s value has decreased, they reduce its value on the balance sheet and recognize a loss.

Learn more about impairment testing. Read IAS 36 here.

Summary

IAS 38 covers intangible assets like patents, trademarks, and software.
Intangible assets can be internally developed or purchased.
To be recognized, they must be identifiable, controlled, and provide future economic benefits.
Intangible assets with a finite life are amortized; those with an indefinite life are not.
Goodwill is a separate concept and arises from the acquisition of a business; it’s not amortized but is tested for impairment.