Intermediate Accounting — Intangible Assets and Investment Property: Capitalizing Development and the Fair Value Model

This chapter covers two kinds of non-financial assets that either have no physical form or are not used directly in operations. Intangible assets are governed by K-IFRS 1038 (IAS 38) and investment property by K-IFRS 1040 (IAS 40). In both standards the core questions are “may it be recognized as an asset?” and “at what amount is it carried afterwards?“

1. Definition and recognition of intangible assets

An intangible asset is an identifiable non-monetary asset without physical substance. It must have three features.

Identifiability: it is separable (can be sold or licensed) or arises from contractual or legal rights.
Control: the entity can obtain the future economic benefits and restrict others’ access to them. Skilled staff or customer relationships are not controlled without legal protection or contracts.
Future economic benefits: benefits flow in through revenue or cost savings.

It is recognized only if the inflow of benefits is probable and cost can be measured reliably. Internally generated brands, mastheads, customer lists and internally generated goodwill are not recognized, because their cost cannot be distinguished from the cost of developing the business as a whole.

2. Research phase and development phase

Internal projects are split into a research phase and a development phase.

Research phase: activities to obtain new knowledge or search for alternatives. Expensed as incurred.
Development phase: applying research findings to the design of new products or processes. Once all six criteria below are demonstrated, expenditure from that point is recognized as an asset (development costs).

Six criteria for capitalizing development costs
Criterion	What must be demonstrated
Technical feasibility	The intangible asset can be completed for use or sale
Intention	The entity intends to complete it and use or sell it
Ability	The entity is able to use or sell it
How benefits arise	A market exists, or its usefulness if used internally can be shown
Resources	Adequate technical and financial resources to complete it are available
Measurement	Expenditure in the development phase can be measured reliably

If the two phases cannot be distinguished, everything is treated as research. Amounts expensed before the criteria were met are not reinstated even if the criteria are met later.

A. Worked example

In 20X1 company P spent ₩3 million in the research phase and ₩5 million in the development phase of a new-drug project. Of the development spending, ₩3.5 million was incurred after 1 July, when all six criteria were demonstrated. The 20X1 expense is $300 + 150 = 450$ (₩10,000), i.e. ₩4.5 million, and the development cost asset is ₩3.5 million. Development costs are amortized from when the asset is available for use; amortizing straight-line over five years from 1 January 20X2 gives ₩700,000 a year.

3. Useful life: finite and indefinite

Intangible assets with finite useful lives: amortized over the useful life, usually with a residual value of zero; straight-line if the pattern of consumption cannot be determined reliably.
Intangible assets with indefinite useful lives: assets with no foreseeable limit to the period of benefits (trademarks renewable at little cost, some broadcasting licences) are not amortized. Instead they are tested for impairment annually and whenever there is an indication, and whether the indefinite-life assessment still holds is reviewed each period.

“Indefinite” does not mean “infinite”. If a trademark with an indefinite life can be used for only ten more years because a competing product appears, it becomes finite-lived from that point and amortization begins. This is a change in estimate, and an impairment test is performed before the change.

4. Investment property

Investment property is land or buildings held to earn rentals or for capital appreciation. Property used in producing goods or for administration (owner-occupied) or held for sale in the ordinary course of business (inventory) is not investment property. If part of a building is leased out and part owner-occupied, the parts are accounted for separately only if they could be sold or leased separately; otherwise the whole is investment property only if the owner-occupied portion is insignificant.

A. Cost model and fair value model

One model is chosen and applied to all investment property.

20X1 treatment of a rental building (cost ₩20 million, useful life 20 years; unit: ₩10,000)
Model	Depreciation	Closing measurement	Effect on profit
Cost model	100	1,900 (fair value disclosed in the notes)	−100
Fair value model (closing fair value 2,150)	None	2,150	+150 (fair value gain)

Gain or loss under the fair value model

\text{Fair value gain or loss} = \text{Closing fair value} - \text{Opening carrying amount}

Changes in fair value are recognized in profit or loss, not in other comprehensive income. This is the biggest difference from the revaluation model for property, plant and equipment.

B. Transfers

When use changes, the property is transferred between categories. When a company using the fair value model transfers owner-occupied property to investment property, it depreciates the asset as PP&E up to the transfer date and treats the difference between carrying amount and fair value at that date in the same way as a revaluation of PP&E (increases to OCI). Conversely, when investment property becomes owner-occupied, fair value at the transfer date becomes its new cost. For inventory transferred to investment property under the fair value model, the difference goes to profit or loss.

Check your understanding

Company Q uses the fair value model. It bought a rental building for ₩50 million at the beginning of 20X1; fair value was ₩47 million at the end of 20X1 and ₩52 million at the end of 20X2. On 1 July 20X2 it began using the building as its head office; fair value that day was ₩51 million and the remaining useful life 25 years (no residual value). What is the effect on profit in 20X1 and 20X2?

In 20X1 the ₩3 million fall in fair value is recognized as a loss. In 20X2, the rise in fair value to the transfer date of 1 July, $5{,}100 - 4{,}700 = 400$ (₩10,000), i.e. ₩4 million, is recognized as a gain, and ₩51 million becomes the new cost of the PP&E. Depreciation for the following six months is $5{,}100 / 25 \times 6/12 = 102$ , i.e. ₩1.02 million. The ₩52 million fair value at the end of 20X2 is not reflected if the PP&E is under the cost model. The effect on 20X2 profit is an increase of $400 - 102 = 298$ , i.e. ₩2.98 million.

References

Korea Accounting Standards Board, K-IFRS 1038 Intangible Assets
Korea Accounting Standards Board, K-IFRS 1040 Investment Property
Financial Supervisory Service, Supervisory guidelines on accounting for development costs of pharmaceutical and biotech companies (2018)