Abstract
In an effort to converge Australian accounting standards with International standards, AASB 138, which is similar to IAS 38, has been introduced with effect from January 1, 2005. Intangibles have been defined as identifiable non-monetary assets that have no physical substance. Intangibles are required to be recognized only when it is probable that future economic benefits attributable to such assets will flow to the entity. Internally generated intangibles including goodwill are not required to be recognized.
Conservatism reflects when intangibles are required after initial recognition at fair value only under the circumstances of an active market, and such a market does not exist factually in the majority of cases. The motive of the standard is not to take risks of any type and intangibles are valued only conservatively. Amortization is not permitted and assets are judged from an impairment point of view. Moreover, AASB 138 is available for general purpose applications, and thus for special circumstances, entities will have to look for other pronouncements.
Introduction
The subject matter of recognition, measurement and reporting of intangibles has been reviewed in accordance with newly inserted accounting standard AASB 138, which is parallel to International accounting standard 38. It has been critically reviewed in the write-up that the approach of the standard is conservative. The standard does not contain any risk-taking features whether it is recognition or measurement or reporting of the intangibles. Conservatism has been imbibed in the standard to such an extent that internally-generated intangibles are stated not to be recognized, even though it may impact profitability during the periods of their occurrences. The write has also reviewed the requirement of a separate standard for intangibles.
Need for a separate standard for Intangibles
The applicability of AASB 138 has been restricted to general purpose financial reporting including reporting under Part 2M.3 of the Corporations Act. The provisions of this standard are not applicable to intangibles that are under the scope of other standards, like financial assets as defined under AASB 139, exploration and evaluation assets, minerals, oil, natural gas, and non-regenerative resources.
Earlier Australian Accounting Standard Board did not carry in particular one specific accounting standard that dealt with accounting and reporting of intangible assets. AASB 1011 was dealing with accounting and reporting of ‘research and development’, AASB 1013 and AAS 18 addressed ‘Goodwill’ accounting and reporting, AASB1015 dealt with the acquisition of assets accounting, and AASB 1041 was dealing with ‘revaluation of non-current assets’.
Thus individually solutions for accounting recognition, measurement, and reporting of intangible assets were available earlier in Australian accounting standards, but AASB 138 replaced all those scattered dealings with one consolidated standard available to all types of intangible assets to solve their accounting recognition, measurement, and reporting issues, though this effort is more of convergence efforts of Australian accounting standards with International accounting standards.
AASB 138 became applicable with effect from January 2005. Apparently, AASB 138 has been pronounced to sort out accounting recognition, measurement, and reporting problems of intangibles, but it would remain inapplicable to intangibles that are covered by other accounting standards. A list of such intangibles and applicable standards is as under:
- Intangibles held for sale in the ordinary course of business (AASB 102 and AASB 111),
- Deferred tax assets (AASB 112),
- Leases within the scope of AASB 117,
- Goodwill acquired in business combinations (AASB 3), and
- Intangibles classified as held for sale (AASB 5) (AASB 138 ‘Intangible Assets’ Summary, page no. 2)
The issue of whether it is necessary to have a separate accounting standard for intangible should be addressed from the following two points of view:
- Whether AASB 138 is in the best interest of the Australian economy, and
- Whether the cost of providing financial information as per AASB 138 exceeds the benefits derived by the financial statement users.
The best interests of the Australian economy are conserved only when the economy grows at a pace to provide opportunities to all at an internationally comparable level. For this purpose, various legislations are passed so that there is free and easy dissemination of information relating to investment growth. Financial statements are the real source of such information, and when such information is legally controlled, then investors and all other users of financial statements are bound to be benefitted. In fact, as per section 224 of Part 12 of ASIC Act, AASB and FRC are supposed to
- facilitate the accounting standards that require the provision of financial information that allows users to make and evaluate decisions about allocating scarce resources, assist directors to discharge their obligations in relation to financial reporting, is relevant to assessing performance, financial position, financing, and investment, is relevant and reliable, facilitate comparability and is readily understandable;
- facilitate the Australian economy by reducing the cost of capital, enabling Australian entities to compete effectively overseas and having accounting standards that are clearly stated and easy to understand; and
- maintain investor confidence in the Australian economy (including its capital markets).” (Year 2005 Impact Statement)
These objectives are the real force to introduce a separate accounting standard for intangibles. The above-stated objectives and requirements of investors and others will get accomplished only when information is provided effectively for different intangibles following directions from one standard and not from different accounting pronouncements that are scattered all over the arena. Different sources of information create complications for the users of financial statements, as directions in different pronouncements are not directed purely toward intangibles.
Australian economy needs the force of real investments to keep its growth compatible with international standards, and one of the ways is to adopt the path shown by International Accounting Standard Board. Accordingly convergence of Australian standards with International Accounting Standards is the best measure to assess the local Australian development through international parameters. Thus the emergence of AASB 138 as a separate accounting standard, which is similar to IAS 38, is a sort of blessing in disguise for the Australian economy to measure its performance as per current international parameters.
Conservatism in recognition and measurement and reporting of intangibles
The importance of intangible assets has been recognized a long time ago, but the recognition, measurement, and reporting of intangible has become a real issue with all those concerned. An intangible under AASB 138 is recognized only when it is probable that expected future economic benefits will accrue to the entity from its use, and further only if its costs are reliably measurable. It is believed that prior to the introduction of AASB 138, Australian accounting standards have been very restrictive in application for unidentifiable intangible assets like Goodwill and also those have been very flexible for identifiable intangibles.
That is to say conservatism in capitalization or expensing the spending on intangible existed when identification of those intangibles was doubtful or not possible. This conservatism has not changed even with the introduction of AASB 138.
Let us first understand the conservatism approach of accounting recognition, measurement, and reporting. Basically the conservatism in accounting is like taking into account the risks inherent in the business. It is due to this conservatism that probable loss contingencies are recognized while gain contingencies are not. Similarly applying the lower of cost or market concept to inventories is another application of conservatism.
Conservatism in accounting is basically an issue of verifiability. One can say conservatism is the asymmetry in the verification requirements for profits and losses. Wherever there is asymmetry of available information, accountants are cautious in reporting and this is called accounting conservatism. Are the provisions of AASB 138 plagued with pure conservatism? The matter needs a thorough investigation.
Investments in assets by entities are in order to make gains in business adventures. Also it is established that tangible assets like property, plant and equipment are well known to contribute towards the profits of the organization. On the other hand the contributions of intangibles always remain a mysterious factor. But now entities have started recognizing the contributions of intangible assets into the success and that is why accounting and reporting of intangibles is gaining importance as well.
Traditionally till the expenditures take some physical form those are not recognized as assets, even though future benefits may be expected to accrue from such expenditures. But now the parameters of recognition of expenditures as assets have changed. The expenditures that are expected to provide future economic benefits, even though such expenditure does not take physical shape, are being recognized as assets. For example expenditures those give rise to information technology, infrastructure, patents, trademarks and others.
A serious thinking of this changed scenario will provide the result that parameters to view the expenditures have been enlarged from identifiable assets to unidentifiable asset but the perspective to view expenditures has not changed. This exactly is the present position of AASB 138. Conservatism was there even in earlier pronouncement and it is still there in the approach of AASB 138.
When the benefits of expenditure or cost expires on its incurring, then those are written off to revenue during periods of their occurrences; but when expenditure or costs provide future benefits then those expenditures become assets even though they do not take any physical shape. The crux of the approach has remained the same as earlier but its perception has been enlarged from physical formation of expenditure to non- physical formation of expenditure. In other words conservatism in the approach of handling the expenditures or costs still exists.
AASB 138 provides very clear indications of presence of such conservatism. Take the case of provisions of AASB 138 that deal with research and development expenditure. The standard requires that research and development expenditure to be capitalized only when the following conditions are fulfilled:
- When it is possible technically to complete the asset for entity’s own use or outside sale.
- Adequate technical and financial resources are available with the entity to complete the development of assets for its own use or for sale to others.
- The entity intends to complete the assets for which expenditure is being made.
- The entity is in a position to sell or use the asset that will be created.
- The intangible assets will provide probable future economic benefits to the entity
- The expenditure that entity is incurring during development stage can be measured with reliability.
The above conditions to capitalize the research and development expenditure certainly provide an indication that the idea behind capitalization is to overcome all risks. This approach is no different from earlier approach of conservatism of Australian accounting standards. For example the entity may be financially in a position to complete the assets with technical accuracy, but there are no plans to use such intangible asset for manufacturing or other purposes of the entity and also assuming no market exists where under such intangible asset can be sold.
Under such circumstances the provisions of AASB 138 warrants not to capitalize such expenditure as probabilities to bring in economic benefits to the entity do not exist. The standard suggests to expense with such lay out for research and development and not take risk of capitalization. This incapacity of the standard to take risk is clearly a conservative approach of the standard, which was also reflected in earlier scattered Australian accounting standards applicable to intangibles. Accordingly the characteristics of conservatism very much exist in AASB 138 and that makes it traditional in its approach.
Under AASB 138 goodwill is not amortized but subjected to impairment tests in order to assess its fair value. Now, the concept of assessment of any asset for impairment purposes is itself based on the principle of conservatism and therefore AASB 138 is affected by conservatism at least to the extent of such assessment of goodwill.
Further, the standard AASB 138 requires an entity to select either cost model or a revaluation for the purposes of initial and later recognition of intangibles. The revaluation model, after initial recognition, carries intangibles at fair value at the date of revaluation less any impairment losses. Fair value is required to be determined under active market, and where there are no active markets then only the cost model is used.
It must be noted that ‘AASB 138 represents a significant change from the previous AGAAP (AASB 1041 Revaluation of non- current assets) In particular AASB 138 requires entities to value acquired intangible assets at original cost. Revaluation of acquired intangible assets is only permitted where revaluation is made with reference to an active market. Such markets rarely exist for intangibles. Most internally generated intangibles are not recognized at all under AASB 138. In contrast AASB 1041 allowed for the recognition of internally generated and acquired intangibles to be revalued without reference to an active market, so long as valuations were kept up to date.’ (Thin capitalization: Application of accounting standards, November 2006) Therefore, again the approach is conservative.
Investments in research & development, product development, and customer relationship management activities are normally undertaken by the entities in order to develop organizational processes. These efforts many a time result into technological and other innovations. Accordingly the emergences of such know from internal resources of the entity need recognition in shape of assets formation. But AASB 138 has very categorically barred these efforts to be treated as intangibles in any way. This approach of non recognition of internally generated intangibles is a definite contributor of conservatism in AASB 138. One can say that outlook might have changed on adoption of
International accounting standards but approach and treatment with intangibles have remained the same as was in AGAAP. The only additional difference in approach now is that AASB 138 is extra cautious and thus more conservative in its outlook.
Conservatism is again reflected from the treatment on following issues by AASB 138 those are different from the treatment adopted by earlier AGAAP:
- Intangibles resulting from business combinations are recognized only when there are existing intangible meeting the criteria of recognition prescribed under AASB 138
- Profitability is immediately impacted when internally generated intangibles, which are not recognized by AASB 138, are expensed with in the period of occurrences.
- Intangibles are not required to be revalued or judged for impairments unless there is an active market for those intangibles. This is clear cut escapism or accounting conservatism in face of diversities.
Moreover, active market as per this standard is the one where only homogeneous items are traded, buyers and sellers are found all the time, and prices are always known to concerned parties. This is a hypothetical market that rarely exists. The standard is taking us to an unbelievable world. The standard believes and directs that risks are not required to be taken for recognition, measurements and reporting of intangibles.
Conclusion
Though convergence with IAS has taken place but the accounting treatment of intangibles has not changed to a great extent. Rather the standard AASB 138 has clearly debarred the recognition of internally developed intangibles. The approach of the standard is very conservative and traditional. This standard certainly requires an intensive movement in its provisions to meet the requirements of modern business.
References
AASB 138 ‘Intangible Assets’ Summary, Scope. 2008, Page no. 2. Web.
Year 2005 Impact Statement, AASB 138 Intangible Assets, 2008, page 4. Web.
Thin capitalization: Application of accounting standards, International Tax and Treaties Division of the treasury Page No 7. Web.