Intangible assets constitute a significant class of assets for companies that create value by managing intangibles (e.g. corporate identity, product brand and knowledge). They spend a significant amount of resources to create and maintain those assets internally. They also purchase intangible assets (e.g. brand) or acquire them in a business combination (e.g. goodwill). Contemporary accounting practices apply two different rules for the accounting of intangible assets: one for internally generated intangible assets and the other for acquired intangible assets. Acquired intangible assets are recognised in the balance sheet while internally generated intangible assets, other than software, are not recognised. This duality of rules impairs the comparability of financial statements of different companies.
The Indian Accounting Standards (AS) mandates amortisation of goodwill over a period not exceeding five years. It mandates amortisation of other intangible assets over a period not exceeding ten years, unless a longer useful life can be justified. IFRS classifies intangible assets into two groups: assets with a finite useful life and assets with an indefinite useful life. When the the management is unable to estimate the useful life of an intangible asset, it is classified as an intangible asset with an indefinite useful life. Examples are goodwill and brand. IFRS requires amortisation of an intangible asset with finite useful life over its estimated useful life. Amortisation of intangible assets with indefinite useful life is not permitted. They are tested for impairment annually.
An intangible asset cannot be tested for impairment individually. Therefore, the impairment test is carried out for a group of assets (called cash generating unit, in short CGU), which generate cash flows independently from other cash flows. For example, a business division to which the goodwill is allocated, or which holds a product brand is a CGU. The management estimates the present value (PV) of the cash flows (called ‘value in use’, in short VIU) that the division will generate over the remaining useful life of the central asset of the division and on disposal of assets. If the VIU is higher than the total of the book values of all the assets, it is assumed that none of the assets is impaired. If, VIU is lower than the aggregate book value, the management estimates the fair value less costs to sell (FVLCS) of the CGU. If FVLCL is higher than the book value,it is assumed that none of the assets is impaired. If the recoverable amount (higher of VIU and FVLCS) is lower than the aggregate book value of assets, an impairment loss is recognised. If, the impairment loss is lower than the amount of goodwill, the book value of the goodwill is reduced by the amount of the impairment loss. If, the impairment loss is higher than the book value of goodwill, first the goodwill is written off and then the balance amount of the impairment loss is allocated to other assets, including intangible assets.
The accounting rules prescribed by IFRS for accounting for intangible assets with indefinite useful life are theoretically superior to the Indian accounting practice. But, it is yet to be established that it improves the relevance of financial information. The methods of estimating VIU and FVLCS are highly judgemental, complex and costly. Similarly, estimation of the useful life of an asset with finite life is arbitrary because intangible assets are surrounded by higher level of uncertainties. Therefore, a rebuttable presumption about the useful life might be considered a prudent approach.
Whatever may be the accounting policy, analysts restructure financial statements. They treat expenditure on creating and maintaining intangible assets and as ‘expensed investment’ (e.g. expenditure on product promotion and R&D). They adjust the balance sheet and profit and loss account to recognise those expenditure as investment and to amortise them over an arbitrarily decided number of years. They restate goodwill in the balance sheet at an initial cost and re-adjust the reported profit by writing back amortised portion of the goodwill. These adjustments make return on investment (ROI) comparable across companies in the same industry. Each analyst sets rules for such adjustments according to his/her preference.
We need to debate that when we do not recognise valuable and important class of internal assets generated internally, whether we need a complex, costly, but theoretically elegant rules for a similar class of assets acquired from outside.
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Perhaps, we need a simple and easy to implement rules that can be defended within the over accounting structure. Companies should provide adequate information to enable analysts to make adjustments, which they consider necessary.
Researches have established that the valuation in the capital market does not depend on the accounting policy, provided the market understands the same.
E-mail: asish.bhattacharyya@gmail.com Affiliation: Chairperson, Riverside Management Academy www.riversidemanagement.in