Ifrs for Techn Com Closing the Gaap

ELECTRONICS, SOFTWARE & SERVICES

IFRS for Technology Companies: Closing the GAAP R&D Activities and Related Intangible Assets

KPMG LLP

© 2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. 080810

Contents

Executive Summary 1

What R&D Expenditures Should Be Recognized 4 As an Asset?

Definitions of Intangible Asset 4

Capitalization Criteria 6

Specific Application Issues 15

Subsequent Expenditures 20

Considerations for Subsequent Measurement 22 of Intangibles

Useful Life and Amortization 22

Impairment 25

Retirements and Disposals 26

First Time Adoption Considerations 27

Closing Comments 28

KPMG Can Help 29

Appendix A: Summary of Accounting for 30 Intangible Assets

Appendix B: Summary of IFRS Compared to 32 U.S. GAAP – Expenditures for R&D and Related Intangibles

Appendix C: IFRS Accounting Disclosures for 35 R&D and Related Intangible Assets

Appendix D: Technical References 36

Note: Throughout this document “KPMG” [“we,” “our,” and “us”] refers to KPMG International, a Swiss cooperative, and/or to any one or more of the member firms of the KPMG network of inde-pendent firms affiliated with KPMG International. KPMG International provides no client services.


Conversion to International Financial Reporting Standards (IFRS) from U.S. generally accepted accounting principles (U.S. GAAP) is more than just an accounting exercise. For many technology companies it can significantly affect the financial reporting for research and development expenditures. Where IFRS is likely to have the biggest impact is its requirement to capitalize development costs that meet certain criteria. Executives in the sector need an early understanding of the potential ways in which conversion to IFRS may affect their accounting policies, people, processes, information systems, and controls.

Executive Summary

Innovation is critical to the current and future success of most technology companies.

To stay competitive, many of those companies expend significant effort and resources

on research and development (R&D) for new or enhanced products, processes, and

services, and to protect and monetize intellectual property.

The financial reporting of R&D costs in the technology industry has been a focus of man-

agement, investors, regulators, analysts, valuation professionals, and auditors given the

pivotal importance of R&D to technology company valuations and the considerable costs

incurred to acquire or internally develop intellectual property. The debate has focused on

how to measure and account for R&D expenditures, including when to capitalize expen-

ditures as an asset and when to recognize capitalized costs as an expense.

The accounting for costs incurred to develop or obtain intangibles depends on how the

intangible was acquired, such as through a business combination, purchase or licens-

ing of individual assets or a group of assets from a third party, or internal develop-

ment. Under U.S. GAAP, in-process R&D (IPR&D) acquired in a business combination

accounted for in accordance with FASB Statement 141R, Business Combinations is

capitalized at fair value in the acquirer’s balance sheet and accounted for as an indefinite-

lived intangible until the project is completed or abandoned. The Emerging Issues Task

Force1 (EITF) tentatively concluded at its March 2009 meeting that expenditures to

acquire IPR&D outside of a business combination (i.e., an asset acquisition) also should

be capitalized and accounted for in the same manner as an asset acquired in a busi-

ness combination. In contrast, internal expenditures for R&D, including post-acquisition

expenditures for IPR&D, are expensed as incurred under U.S. GAAP. Limited excep-

tions to the expense treatment are provided for software and website development

costs once a project meets specific capitalization criteria.2 Therefore, for non-software

technology companies, most R&D costs are expensed as incurred under U.S. GAAP.

1 EITF 09-2, Research and Development Assets Acquired in an Asset Acquisition. For the current status of the tentative consensus reached on EITF 09-2, see the FASB website at www.fasb.org.2 The criteria depend on whether the software is being developed for internal use pursuant to Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, or developed for sale pursuant to FASB Statement 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.

http://www.fasb.org

I F R S F O R T E C H N O L O G Y C O M P A N I E S : C L O S I N G T H E G A A P 2


Thought Leadership from KPMG

International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) com-prise a set of accounting standards now used as the basis for financial reporting by listed companies in more than 100 countries. Global use of a single set of high-quality financial reporting standards has the potential to facilitate greater comparability of financial information among international competitors, elimi-nate dual reporting by subsidiaries in foreign localities, allow easier expan-sion into foreign markets, increase the mobility of finance professionals, and provide easier access to worldwide capi-tal markets. Many notable economies including Brazil, China, Japan, and India have committed to adopting IFRS in the coming years, and others are considering adoption. The United States is currently considering whether to adopt IFRS and, if so, how best to do it.

R&D Activities and Related Intangible Assets is the second3 publication in the KPMG thought leadership series IFRS for Technology Companies: Closing the GAAP. The series provides background and updates on the unfolding IFRS–U.S. GAAP convergence efforts from a regu-latory and standard setter perspective, discusses how IFRS compares to U.S. GAAP in key accounting areas for tech-nology companies, and shares views on how transition may affect business processes, systems, and people. Our primary focus here is on R&D and related intangibles.

3 In IFRS for Technology Companies: Closing the GAAP?, August 2008, KPMG provides a transition overview and examines potential differences in the treatment of rev-enue recognition issues.

Until such time as the U.S. commits to the adoption of IFRS (see “SEC ‘Roadmap’ to

IFRS” sidebar), convergence efforts between the International Accounting Standards

Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) are aimed at

reducing IFRS –U.S. GAAP differences.

Similarities and Differences

IFRS and U.S. GAAP accounting for R&D expenditures are similar in some respects and

different in others. For example, expenditures for research are expensed as incurred

under both. In practice, however, some companies that have transitioned to IFRS from

U.S. GAAP have encountered differences in the accounting for development costs,

resulting in differences in the accounting for internally developed intangibles. Another

difference is that IFRS contains general principles that apply to the recognition of all inter-

nally developed intangible assets. When the capitalization criteria are met, IFRS requires

capitalization of expenditures associated with “development” activities. In contrast,

under U.S. GAAP internally developed intangibles generally do not qualify for recognition

as an asset. The specific accounting, however, can depend, for instance, on whether:

(1) the internal development activities relate to software or non-software products and

solutions, and (2), if software, whether the software is intended for internal use or for sale.

As a result, industries such as the automotive sector and manufacturers of comput-

ers, software-enabled electronic devices, and other complex equipment where the

late stages of the product-development cycle are cost intensive, often find that under

IFRS significant product-development costs can or must be capitalized, whereas under

U.S. GAAP those amounts would be expensed. Conversely, companies developing

software for internal use may find that more costs are capitalized under U.S. GAAP

than under IFRS. Other IFRS vs. U.S. GAAP differences are more subtle, such as the

explicit definitions of research and development, which may affect a determination to

capitalize costs.

Given the differences between IFRS and U.S. GAAP, technology companies adopting

IFRS should include sufficient time and resources in their transition plan to permit a

comprehensive review of their R&D accounting practices. The plan should incorporate

accounting policy, people, process, and systems perspectives. Convergence activities

may include:

• Training R&D personnel to delineate between research and development as defined in IFRS

• Identifying practical operational milestones within the R&D process to determine when it is appropriate under IFRS to capitalize development costs if such costs could be significant prior to general release of the product

• Implementing time-tracking and costing systems and related processes at an R&D-project level if needed to ensure that development costs to be capitalized can be measured reliably

• Establishing appropriate controls for approvals, accurate data input, and transfers between R&D systems and the general ledger

3R & D A C T I V I T I E S A N D R E L A T E D I N T A N G I B L E A S S E T S


• Determining the appropriate level of detail and time period required for forecasts used in asset-recoverability assessments and periodic estimated useful-life reviews for recognized intangible assets

• Ensuring consistent policies and processes, as appropriate, where multiple R&D centers are used around the world

• Evaluating the need for new or enhanced disclosures of company policies for accounting for R&D expenditures

• Determining the development costs that should be capitalized as of the date of transition to IFRS.

Achieving the above may require new or modified systems and processes. Companies

may have to overcome cultural resistance in situations where R&D and engineering

teams: (1) have not previously tracked R&D time and costs at the project level (costs

often are tracked in no more detail than at the department level); and (2) now have to

implement a more formal process and internal controls including documenting project-

development stages and approvals. The change management issues for people,

processes, and systems in this area point to the need to gain an early understanding

of how IFRS may affect the accounting for R&D expenditures and whether the differ-

ences can be consequential to the company’s financial statements. Experience in juris-

dictions that have adopted IFRS indicates that determining the IFRS opening balance

sheet capitalized amounts of historical R&D projects is facilitated if IFRS-compliant

information for R&D projects is accumulated prior to transition. That period could range

from under a year to several years, depending on the length of the product life cycle

and the magnitude of costs capitalized under IFRS.

Effects on Earnings

Although more costs associated with R&D and related intangible assets may be capi-

talized under IFRS than under U.S. GAAP, the corresponding effect on a technology

company’s ongoing earnings is less clear and will depend on specific circumstances,

including whether:

• Significant capitalizable costs are incurred between the dates when the R&D project meets the capitalization criteria and when the results of the project become available for its intended purposes.

• The amount and timing of cost capitalization changes significantly from period to period due to variability in capitalizable expenditures incurred on internal R&D proj-ects or acquisitions of related intangible assets from third parties. For example, there often is more predictability in costs capitalized under IFRS in mature industries where the product-development roadmap is relatively stable and the product mix does not change significantly over time.

• The period and pattern of economic benefit to be obtained from capitalized intangible assets and whether the amortization methodology over the asset’s useful life is straight-line or some other attribution methodology.

• Impairments or dispositions of intangible assets are frequent or intermittent.

SEC “Roadmap” to IFRS

In November 2008, the U.S. Securities and Exchange Commission (SEC) issued for public comment a proposed “roadmap,”4 which – if approved as proposed – would establish a process and timetable for the potential three-year phase-in of mandatory use of IFRS by U.S. public companies, beginning with large accelerated filers for years ending on or after December 15, 2014. The roadmap is conditional on progress toward “milestones” that would demonstrate improvements in both the infrastructure of international standard set-ting and the preparation of the U.S. financial reporting community to prepare and use IFRS financial statements. The proposed roadmap contemplates that if the condi-tional milestones are satisfactorily achieved by 2011, the SEC could then consider rule-making to phase in requirements for U.S. public companies to use IFRS as issued by the IASB in the preparation of their finan-cial statements to be filed with the SEC. Under the roadmap proposal, some large U.S. public companies that operate within an “IFRS industry” would be permitted to begin using IFRS as soon as their financial statements for periods ending on or after December 15, 2009. At present, it appears highly unlikely that such a proposal will be adopted for 2009 reporting periods.

4 SEC Release No. 33-8982, Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers, available at www.sec.gov. The public comment period ended on April 20, 2009.

http://www.sec.gov



Other Considerations

By-product benefits of IFRS compliance, with its more-robust documentation and time/

cost reporting at the R&D project level, include an improved ability to assess the return

on investment for individual R&D projects. The increased documentation often needed

to support a position for capitalizing or expensing R&D costs also has the potential to

provide tax advisors and tax authorities with improved information with which to evalu-

ate the eligibility of expenditures for R&D-related tax credits.

While a variety of issues are relevant to the technology industry in accounting for

expenditures related to intangible assets, this publication of IFRS for Technology

Companies: Closing the GAAP focuses on R&D expenditures, which are particularly

key to the sector. Three significant questions that need to be addressed for R&D

expenditures are:

• What costs should be capitalized rather than expensed as incurred?

• For capitalized costs, when and how should the asset be amortized?

• How should impairment be assessed?

What R&D Expenditures Should Be Recognized As an Asset?

Given the commercial importance of

innovation to technology companies,

the question of when to recognize R&D

expenditures as an asset is a significant

one. For start-up companies or compa-

nies that incur significant costs when

internally developing intellectual property,

knowing what expenditures related to

R&D should be recognized as an asset

rather than expensed as incurred can

have a significant impact on key financial

performance measures.

Although IFRS and U.S. GAAP define intan-

gible assets similarly, they differ in how

they define the terms research and devel-

opment; on the criteria they require to be

met to capitalize R&D costs; and on what

costs should be capitalized. These differ-

ences may affect the amount and timing of

cost recognition for expenditures on R&D

and can affect key financial metrics.

Definitions of Intangible Asset

International Accounting Standard (IAS)

38 Intangible Assets defines an intangible

asset as an identifiable non-monetary

asset without physical substance. To be

recognized as an intangible asset, the

item should lack physical substance, be

non-monetary, be identifiable, be con-

trolled by the entity, and provide probable

future economic benefits that will flow to

the entity.

Under U.S. GAAP, FAS 142, Goodwill and

Other Intangible Assets, an intangible

asset is defined as “an asset (other than

financial assets and goodwill) that lacks

physical substance.” The definition is

similar to that of IFRS.

Unlike U.S. GAAP, IFRS has one standard

that applies to all expenditures related to

intangible assets and therefore has one

model related to internally developed

intangible assets. In contrast, U.S. GAAP

has the general requirement that internally

developed intangible assets are not capital-

ized, but it then has a number of specific

standards that require capitalization of cer-

tain costs related to internal development

of intangible assets. Similar to U.S. GAAP,

IFRS has general concepts of “identifiabil-

ity” and “control by the entity,” which are

among the requirements for capitalization

of costs under IFRS (next page).



Identifiability

The quality of being “identifiable” is

required to distinguish an intangible

asset from internally generated or

acquired “goodwill.” An item is identifi-

able if it either:

• Is separable, i.e., is capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, iden-tifiable asset, or liability, regardless of whether the entity intends to do so, or

• Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

The identifiability criterion is key to determining whether identifiable intan-gible assets have been acquired in a business combination. IFRS 3 (2008) Business Combinations provides illustra-tive examples of items that generally meet the definition of an intangible asset and qualify for recognition as separate intangibles in a business combination. Those examples are generally consistent with similar examples provided under FAS 141R and include intangibles such as acquired IPR&D (see page 18), patents, and other protection for intellectual prop-erty. Unpatented technology that does not arise from contractual or legal rights can qualify for recognition as an intangible asset in a business combination provided it is separable.

Control by the Entity to Which Probable Future Economic Benefits Will Flow

Here are examples of the characteristics

of control and probable future economic

benefits:

• Control: An entity has the power to obtain “future economic benefits” from the underlying resource and can restrict the access of others to those benefits. The entity’s ability to control future economic benefits from the intangible asset normally would stem from legal

rights enforceable in a court of law. For example, technical knowledge may pro-vide an entity the ability to control future economic benefits if the entity develops customized software for which a patent or copyright is registered.

In the absence of legal rights, it is more difficult to demonstrate control. However, legal enforceability of a right is not a necessary condition for con-trol, because an entity may be able to control future economic benefits in another way. Control also could be sup-ported where: (1) there is a legal duty of employees to maintain confidentiality for unpatented software development results, and (2) the entity believes that its right to proprietary intellectual prop-erty could be legally defended if chal-lenged. The know-how of employees who operate the software, however, does not meet the control criteria, as staff can leave at any time.

• Probable future economic benefits will flow to the entity: Economic benefits can arise in a number of different ways. When assessing how an intangible asset will generate probable future eco-nomic benefits, the entity should dem-onstrate the existence of a potential market for the intangible asset’s output or for the intangible asset itself; or, if it is to be used internally, the intangible asset’s usefulness in support of other operations or administrative activities. Economic benefits obtained from the market can include income from the sale, rental, or licensing of products and services and intellectual property. Economic benefits from internal use include cost savings from efficiency gains or other benefits derived from the company’s use of the intangible asset. For example, intellectual property used in a manufacturing process might reduce future production costs rather than increase future revenues.

An entity should base its expectation of probable future economic benefits on reasonable and supportable assump-tions that represent management’s best estimate of the economic conditions



5 Refer to KPMG’s publication, Accounting for Business Combinations – 141R (May 2009) for considerations in valuing acquired intangible assets under U.S. GAAP.

that will exist over the useful life of the asset. The entity uses judgment based on evidence available at the time of ini-tial recognition to assess the probability attached to the flow of future economic benefits attributable to the use of the asset, giving greater weight to external evidence.

Capitalization Criteria

Under IAS 38, an item meeting the defini-

tion of an intangible asset is recognized,

initially at cost, if the future economic

benefits are probable and the costs of the

asset can be measured reliably.

Intangible assets can be obtained through:

(1) a business combination; (2) an asset

acquisition; or (3) internal development.

Although not discussed in this paper, intan-

gible assets also can be acquired through

a non-monetary exchange of assets or via

a government grant. While the definition of

an intangible asset does not depend on the

manner of acquisition, how an intangible

item is obtained will affect how it is initially

recognized and measured. IAS 38 contains

additional capitalization hurdles that apply

to internally generated intangibles.

Intangible Assets Acquired from Third Parties

Technology companies frequently acquire

businesses or purchase the rights to

own or use intellectual property, such as

IPR&D projects or patents for the out-

come of R&D. When acquired either in a

business combination or an asset acquisi-

tion, an intangible asset is recognized if it

meets either the contractual/legal or the

separability criteria.

The “cost” of an intangible asset acquired

in a business combination is its fair value

at the acquisition date excluding transac-

tion costs. There is an assumption the fair

value of such intangible assets can always

be measured reliably. The acquiree’s

original cost or acquisition-date carrying

amount of the intangible asset (such as

for a perpetual software license or patent)

may not be a meaningful indicator of its

current fair value. Valuation techniques

may need to be applied if no active market

benchmarks exist for the asset.5

The cost of an intangible asset acquired

in an asset acquisition is its purchase

price which includes any transaction costs.

If an intangible asset is acquired with a

group of assets in a transaction that is not

a business combination, then its cost will

be measured on a relative fair value basis.

Intangible Assets Acquired in a Separate Asset Acquisition – Considerations

When acquiring an intangible asset from

third parties, there are specific application

considerations and practice issues that

can arise.

• IPR&D: Under IFRS, IPR&D would be recognized whether the IPR&D was acquired in a business combination or an asset acquisition. Under U.S. GAAP currently, IPR&D acquired in an asset acquisition would be expensed unless it had an alternative future use. However, the EITF has reached a tentative con-clusion on Issue 09-2 that, if finalized, would revise U.S. GAAP to require capitalization of IPR&D in an asset acquisition as well as in a business combination.

• Advance payments to third parties: If advance payments are made to third par-ties for services such as outsourced R&D prior to when the costs would qualify for capitalization under IAS 38, the costs would be recorded as a prepaid asset (rather than an intangible asset) if prob-able economic benefits are expected to flow to the entity. Once the related services are performed, the costs are re-evaluated for capitalization under IAS 38.



This is consistent with U.S. GAAP guid-ance under EITF 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities.

• Extended or variable payment terms: IAS 38 requires the cost of the asset to be measured at its cash equivalent amount. Therefore when payments to acquire an intangible are deferred the cost is measured as the present value of the future payments. The dif-ference between this amount and the total payments is recognized as interest expense over the period of the effective financing, unless it meets the criteria for capitalization in accordance with IAS 23 Borrowing Costs.

The measurement of cost is more complicated when the consideration to be paid for an intangible asset is wholly or partly variable, a payment structure not uncommon in technol-ogy industry arrangements to license or purchase intellectual property from others. Consider the following scenario under IFRS:

ABC Ltd. obtained a five-year license that allowed it to embed encryption software technology owned by XYZ Inc. into its own original equipment manu-facturer (OEM) product. ABC agrees to pay a minimum of $2 million, 25 percent of which is due at the outset of the licensing arrangement, and the remain-ing 75 percent of which is due one year later. In addition to this minimum payment, ABC also agrees to pay to XYZ 10 percent of the future revenues generated by the licensed technology. ABC estimates the revenues generated by the technology at $30 million for each of the following five years. In our view, under IAS 38 the cost of ABC’s intangible asset (the license) should be determined on the basis of the agreed minimum payments, i.e., $500,000 plus the present value of $1.5 million.

The revenue-based payments are treated in the same way as contin-gent rent under IAS 17 Leases and therefore are not included in the cost of the license. Instead, any additional payments would be expensed as the related sales occur.

Under U.S. GAAP, a separately acquired

intangible is measured at fair value rather

than at cost. Because a market partici-

pant may incorporate into the estimate of

future cash flows the possibility of having

to make future revenue-based variable

payments, the U.S. GAAP measurement

of the intangible asset could differ from

the IFRS amount.

Internally Generated Intangible Assets

Internally generated intangibles are sub-

ject to additional capitalization criteria

in IAS 38 that expand on the general

recognition criteria for intangible assets.

These additional criteria are used to

assess whether costs associated with

the development of internally generated

intangibles have resulted in an identifi-

able asset expected to generate future

economic benefits, and whether the cost

of that asset can be distinguished from

the entity’s expenditures to maintain or

enhance internally generated goodwill

related to the ongoing operations.

For internally generated intangibles,

expenditures are eligible for capitalization

only if they occur during the develop-

ment phase of a project. Similar to U.S.

GAAP, IFRS requires all costs incurred

during the research phase of a project to

be expensed as incurred, on the premise

that probable economic benefits cannot

be demonstrated during this phase. It

is thus important under IFRS to distin-

guish between activities constituting

“research” and “development.”

8


IFRS U.S. GAAP

Research IAS 38 defines research as “original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.”

(IAS 38, par. 8)

Research activities include:

• Activities aimed at obtaining new knowledge

• The search for, evaluation of, and final selection of, applications of research findings or other knowledge

• The search for alternatives for materials, devices, products, processes, systems, or services

• The formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, prod-ucts, processes, systems, or services.

FAS 2, Accounting for Research and Development Costs, defines research as a “planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be use-ful in developing a new product or service (hereinafter “product”) or new process or technique (hereinafter “process”) or in bringing about a significant improvement to an existing product or process.” (FAS 2, par. 8)

Because FAS 2 does not distinguish between the accounting for research and the accounting for development, it does not provide examples of research separate from examples of development.

Development IAS 38 defines development as “the applica-tion of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial pro-

duction or use.” (IAS 38, par. 8)

Development activities include:

• The design, construction, and testing of pre-production or pre-use prototypes and models

• The design of tools, jigs, molds, and dies involving new technology

• The design, construction, and operation of a pilot plant that is not of a scale economi-cally feasible for commercial production

• The design, construction, and testing of a chosen alternative for new or improved materials, devices, products, processes, systems, or services.

FAS 2 defines development as “the transla-tion of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use.” It includes the conceptual formulation, design, and testing of product alternatives, construction of prototypes, and operation of pilot plants. It does not include routine or periodic alterations to existing products, production lines, manufacturing processes, and other ongoing operations even though those alterations may represent improvements and it does not include market research or market testing activities.” (FAS 2, par. 8)





The table at left compares definitions of

research and development under IFRS

and U.S. GAAP

While the definitions of research and

development are similar under IFRS and

U.S. GAAP, the precise language differs.

It is therefore possible that differences

may arise in practice in how companies

categorize expenditures between the

research and development phases of

internal projects. Companies transition-

ing to IFRS may need to train R&D and

finance personnel in how to delineate

between research and development

activities using IFRS definitions, to ensure

that activities are classified consistently

across projects.

Under both IFRS and U.S. GAAP, expen-

ditures incurred during the research phase

of a project are expensed as incurred.

Under IFRS, during the development phase

of a project, costs are capitalized from the

date the entity can demonstrate that all of

the following criteria have been met:

Technical feasibility:

• The entity can demonstrate the technical feasibility of completing the intangible asset so that it will be available for use or sale.

Commercial feasibility:

• The entity has the intention to complete the intangible asset and use it or sell it.

• The entity has the ability to use or sell the intangible asset.

• The entity can demonstrate how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.

• The entity has available adequate tech-nical, financial, and other resources to complete development and use or sell the intangible asset.

Measurability of development costs:

• The entity has the ability to measure reliably the expenditures attributable to the intangible asset during its develop-ment phase.

These criteria cumulatively identify

instances where the advanced stage of

development activities support, through

consideration of technical and commercial

feasibility, an assertion that the intangible

will generate probable future economic

benefits. Once this occurs, provided that

directly attributable costs can be mea-

sured reliably, costs are capitalized until

the intangible is ready for its intended use

or the project no longer meets the capital-

ization criteria.



The following diagram summarizes the accounting for internally generated R&D costs:

Developmentphase

Researchphase Not determinable

Capitalization criteriafulfilled?

Capitalize as intangible asset

Expense as incurred

No Yes

Application of Technical Feasibility Criterion

For many technology companies, estab-

lishing the “technical feasibility” of com-

pleting the intangible so that it will be

available for use often will be the key mile-

stone for assessing when the capitalization

criteria are met. Although IAS 38 uses the

term technical feasibility, it neither defines

the term nor expresses how the criterion

is satisfied. Because technical feasibility

is not defined in IAS 38 or elsewhere in

IFRS, differences may arise in practice

(both across industries and for companies

within an industry sector) with respect to

how the technical feasibility criterion is

evaluated. However, based on the activi-

ties IAS 38 describes as “research” and

“development,” technical feasibility is

likely to be subsequent to (1) the comple-

tion of all significant planning activities

(including details of the intended design of

the product/process), and (2), where sig-

nificant high risk development issues exist

that call into question whether the prod-

uct/process can be completed to meet its

planned design, when the project develop-

ment has reached the point of establishing

product/process specifications and related

testing to support that these issues have

been resolved. However, unlike FASB

Statement 86, Accounting for the Costs of

Computer Software to Be Sold, Leased,

or Otherwise Marketed, it would not nec-

essarily require completion of a working

model or detailed program design.

Identifying operational milestones that

demonstrate technical feasibility often

requires judgment and the input of the

product R&D team and engineers. In

practice, evidence of the point during

the development cycle when technical

feasibility is established for a specific

project may depend on the uniqueness

or complexity of the product or process.

For example, technical feasibility may be

established earlier in the development

cycle of a new product generated through

adding new features or functionality to an

existing core product or product family.



Product or process development involv-

ing new innovation or sophistication may

require more extensive work to integrate

with existing products and platforms,

pushing back the point in the develop-

ment cycle when technical feasibility is

established.

To ensure consistency in application,

documentation of the stages in the devel-

opment cycle and internal company policy

guidelines that specify when technical

feasibility is established are particularly

important when R&D is performed across

separate teams or where R&D centers

exist in multiple jurisdictions.

Application of Other Commercial Feasibility–Related Criteria

In assessing whether an intangible asset

will generate probable future economic

benefits, the company should dem-

onstrate the existence of a market for

the intangible asset or its output if it is

intended to generate or be used in a

marketable product or process; or, if it

is to be used internally, the usefulness

of the intangible asset to the company.

When carrying out such an assessment,

IAS 38 points to the principles of IAS 36

Impairment of Assets. If the asset will

generate economic benefits only in con-

junction with other assets, the concept of

cash-generating units should be used in

the assessment. While IAS 36 is beyond

the scope of this document, companies

evaluating probable economic benefits

should be familiar with its guidance on

the identification of cash-generating units.

Although probable is not defined in rela-

tion to intangibles, it does not mean that

a project must be certain of success

prior to capitalization of development

costs. For example, a developer of cel-

lular phones should not expense all

development costs as incurred because

there is a possibility that new software

intended for the new phone might not be

approved for sale by relevant authorities

such as the U.S. Federal Communications

Commission. An assessment of the

process or product’s likelihood of suc-

cess should support a conclusion about

whether a positive outcome is or is not

probable. If so, the company should con-

clude that this criterion for capitalization

of the related development costs is met.

The financial, technical, and other resources

essential to complete the development

need not be secured at the onset of

the project. Companies may be able

to demonstrate their ability to secure

such resources through business plans

and external financing plans for which

potential customers, investors, and lend-

ers have expressed interest. Market

research studies and budgets also may

serve to demonstrate that capitalization

criteria are met. The existence of plans

showing the availability of resources to

complete a project is especially impor-

tant where: (1) an early-stage technology

company does not have sufficient inter-

nal resources or financing at inception,

(2) unique skill sets may be needed to

work on the project, or (3) emerging

markets may need to be penetrated.



Ability to Reliably Measure Costs Associated with Development

The final capitalization criterion for an

internally generated intangible is the abil-

ity to reliably measure the costs incurred

during its development. This does not

mean that project costs must be captured

throughout the entire project, only once

the other criteria for capitalization for

development costs are met. Also, being

able to reliably measure development

costs does not mean an entity has to

be able to estimate what the total costs

of the project will be. It would be highly

unlikely that when all other capitalization

criteria are met the inability to measure

costs reliably would preclude capitaliza-

tion, as companies would be expected

to have processes in place that would

capture relevant costs. See next page for

a discussion of types of costs required to

be measured and related practical opera-

tional issues.

Summary of Capitalization Considerations

The general IFRS principles for capi-

talization of expenditures for internally

generated intangibles apply to all inter-

nally developed intangibles, including

intellectual property developed for sale

and other technology developed for sale

and internal use. However, IAS 38 does

preclude capitalization of internally gener-

ated brands, mastheads, publishing titles,

customer lists, and similar items. It also

precludes capitalization of advertising and

promotional costs.

Little specific implementation guidance

exists under IFRS about when capitaliza-

tion of development costs should occur,

particularly for technical feasibility. The

determination depends very much on the

industry sector and the specific facts and

circumstances of the reporting entity.

Managers and executives responsible

for R&D and other development projects

typically require an evaluation of the

probability of success and the potential

economic outcomes at various points

(or gates) during the project life cycle.

At each gate, business decisions may

be made about whether to continue the

project. These reviews may be useful for

assessing whether technical and com-

mercial feasibility have been established.

Some industries, such as the automotive

sector, may have a large amount of their

annual product development expenditures

capitalized under IAS 38 in late-stage devel-

opment areas (for example, construction

of prototypes, customer testing, and pilot

plants, which are cost-intensive). Other

industries, such as the technology sector,

often find it is not until relatively late in

developing a product, process, or service

that the recognition criteria for internally

generated intangibles are met, resulting in

only a small amount of total invested proj-

ect expenditures being capitalized.



6 U.S. GAAP allows for capitalization of certain costs associated with direct-response advertising, which is not permitted under IFRS.

Which costs of developing internally generated intangible assets are capitalized?

Once the criteria for capitalization of

internally generated intangibles are met,

the next question is what expenditures

should be capitalized. Under IAS 38, the

cost of an internally generated intangible

asset comprises all directly attributable

costs necessary to create, produce, and

prepare the asset to be capable of operat-

ing in the manner intended by manage-

ment. These principles are consistent

with the IFRS treatment of property,

plant, and equipment. The capitalized cost

is the sum of these expenditures from

the date when the intangible asset first

meets the recognition criteria through

the date the asset becomes available

for its intended use. The costs need not

be external or incremental in order to be

directly attributable.

Examples of directly attributable costs

specifically identified in IAS 38 are:

• Costs of materials and services used or consumed in generating the intangible asset

• Costs of employee benefits, including share-based payments, arising from the generation of the intangible asset

• Fees to register a legal right

• Amortization of patents and licenses that are used to generate the intangible asset.

Directly attributable overhead costs are

capitalized as part of an intangible asset

as well. Examples of these are the alloca-

tion of overhead costs (for example, facili-

ties and utilities) directly related to R&D

activities. IAS 23 also specifies criteria

for the capitalization of interest as an ele-

ment of the cost of an internally gener-

ated asset.

IAS 38 also identifies certain costs that

are not considered directly attributable to

the creation of the intangible asset:

• Selling, administrative, and other gen-eral overhead expenditure, unless this expenditure can be directly attributed to preparing the asset for use

• Identified inefficiencies and initial oper-ating losses incurred before the asset achieves planned performance

• Expenditure on training staff to operate the asset.

Other costs that are not included in the

cost of an intangible asset (whether it

was generated internally or acquired

separately) include:

• Costs incurred after an intangible asset is capable of operating in the manner intended by management even though it has not yet been put into use

• Start-up costs, unless they qualify for recognition as part of property, plant, and equipment

• Advertising and promotional costs, even if they directly relate to the introduction of new products or services6

• Costs associated with market research and feasibility studies for the project

• Costs associated with relocating, reor-ganizing, or redeploying assets.



In general, FAS 142 prohibits capitaliza-

tion of costs for internally developed

intangibles. However, U.S. GAAP con-

tains specific requirements for capitaliza-

tion of costs related to certain intangibles

(see page 15). Because R&D costs are

expensed as incurred under U.S. GAAP

unless the costs fall within the scope of

other specific literature, many companies

reporting under U.S. GAAP will not have

existing policies, information systems,

and processes for determining when

the IAS 38 capitalization criteria are met

and for reliably accumulating the directly

attributable costs in an IAS 38-compliant

manner. For many companies, R&D costs

can be identified at a department level

but systems may not be in place to track

and measure these costs at a project

level. Implementing time-tracking and

costing systems and related processes

at the project level to accumulate devel-

opment costs eligible for capitalization

can be exacting. Project cost-tracking

systems and processes should be robust

enough to:

• Identify operational milestones within the R&D process to confirm trig-ger events requiring capitalization of development costs under IFRS on a timely basis if the subsequent directly attributable costs could be more than insignificant prior to the available-for-general-release/internal-use dates of the intangible asset

• Allow for separate identification of expenditures incurred before and after the trigger date for capitalization

• Distinguish between costs for activities meeting the definition of development activities from those related to research and other activities where these activi-ties could overlap once the criteria for capitalization of development costs have been met

• Capture expenditures related to intan-gibles qualifying for capitalization sepa-rately from those that do not once the capitalization criteria have been met.

Appropriate controls should be estab-

lished for the approval and accuracy of

information inputs, including time by proj-

ect and personnel for project activities,

allocation rates used for personnel-related

costs and directly attributable overhead,

operational project milestone attainment,

and transfers between the R&D systems

and the general ledger. Because these

functions may involve training personnel

on new or modified systems and pro-

cesses, the change management effort

may be significant, especially if the R&D/

engineering group is not accustomed to

internal controls and related documenta-

tion of activities. By-product benefits of

improved ability to track the return on

investment in R&D projects and claim

R&D tax credits in the appropriate juris-

diction may help motivation, although

ultimately ensuring IFRS compliance is a

corporate necessity.



7 The guidance in SIC-32 does not apply to costs to develop or operate a website or related software for sale to another company, costs to purchase or develop hardware to support the website, or costs to determine the initial recognition of a leased website asset.

Specific Application Issues

This section discusses certain topics

where U.S. GAAP contains guidance

on intangibles relevant to the technol-

ogy sector. Guidance under U.S. GAAP

may be a useful reference point where it

does not conflict with IFRS. We encour-

age technology companies to evaluate

whether continued use of U.S. GAAP

policies would be IFRS-compliant and

appropriate for them.

Internal-Use Software

Under IAS 38, outlays for software devel-

oped for use internally by the company are

accounted for under the general principles

for internally generated intangible assets

or, for purchased software, the general

requirements for separately acquired intan-

gible assets discussed earlier. Unlike IFRS,

U.S. GAAP contains specific requirements

for the accounting for the development of

internal-use software. Under SOP 98-1,

Accounting for the Costs of Computer

Software Developed or Obtained for

Internal Use, certain costs incurred for

internal-use software that is acquired, inter-

nally developed, or modified solely to meet

the company’s needs are capitalized during

the application development stage.

The three stages of software develop-

ment under SOP 98-1 are the preliminary

project stage, application development

stage, and post-implementation/operation

stage. Costs during the preliminary proj-

ect stage and the post-implementation

stage are expensed as incurred. Certain

costs incurred during the application

development stage are capitalized under

U.S. GAAP, and that stage may occur

sooner in the cycle than when the capital-

ization criteria under IAS 38 are met. For

example, IFRS limits capitalization only to

development-related activities, and then

only after specific capitalization criteria

are satisfied (see page 9). Consequently

capitalization for internal-use software

projects may begin earlier under U.S.

GAAP compared to IFRS.

Additionally, SOP 98-1 specifies the capital-

ization of: (1) external direct costs of mate-

rials and services consumed in developing

or obtaining internal-use software, (2) pay-

roll and payroll-related costs for employees

who devote time to the internal-use soft-

ware development, and (3) interest cost

in accordance with FASB Statement 34,

Capitalization of Interest Cost. Accordingly,

technology companies transitioning to IFRS

from U.S. GAAP may need to update their

internal policies for the capitalization of

internal-use software to reflect IFRS defini-

tions, capitalization criteria, and allowed

directly attributable costs to ensure IAS 38

compliance.

Website Development Costs

Accounting for website development costs

is one area of intangibles for which IFRS

provides specific guidance in SIC-32

Intangible Assets – Web Site Costs. SIC-32

indicates that a company’s own website7

that arises from internal development and

is for internal or external use is an internally

generated intangible asset subject to IAS

38 (provided the website is not used solely

or primarily for advertising or promotional

purposes). Accordingly, the cost of an inter-

nally developed website used by the com-

pany in its business would be capitalized as

an intangible asset if it satisfies the IAS 38

capitalization criteria. SIC-32 describes dis-

tinct phases of website creation and how

IFRS would apply to the costs incurred dur-

ing these phases.

Website Development Costs

Stage/nature of expenditure Accounting treatment

Planning• Undertaking feasibility studies• Defining objectives and specifications• Evaluating alternative products and suppliers• Selecting preferences

Recognize as an expense when incurred.

Application and infrastructure development• Purchasing or developing hardware• Obtaining a domain name• Purchasing or developing operating software

(for example, operating system and server software)

• Developing code for the application• Installing developed applications on the

web server• Stress testing

Apply the requirements of IAS 16.

Capitalize if the criteria for capitalizing devel-opment costs are met; this applies equally to internal and external costs. The costs of developing content for advertising or promo-tional purposes are expensed as incurred.

Graphical design development• Designing the appearance (for example,

layout and color) of web pagesCapitalize if the criteria for capitalizing devel-opment costs are met; this applies equally to internal and external costs. The costs of developing content for advertising or promo-tional purposes are expensed as incurred.

Content development• Creating, purchasing, preparing (for ex-

ample, creating links and identifying tags), and uploading information, either textual or graphical in nature, on the website before the completion of the website’s development. Examples of content include information about an entity, products or services offered for sale, and topics that subscribers access

Capitalize if the criteria for capitalizing devel-opment costs are met; this applies equally to internal and external costs. The costs of developing content for advertising or promo-tional purposes are expensed as incurred.

Operating• Updating graphics and revising content• Adding new functions, features, and content• Registering the website with search

engines• Backing up data• Reviewing security access• Analyzing usage of the website

Assess whether it meets the definition of an intangible asset and the recognition criteria, in which case the expenditure is recognized in the carrying amount of the website asset (also consider guidance on subsequent measurement).

Other• Selling, administrative, and other general

overhead expenditure that is not directly attributable to preparing the website for use to operate in the manner intended by management

• Clearly identified inefficiencies and initial operating losses incurred before the web-site achieves planned performance [e.g. false start testing]

• Training employees to operate the website

Recognize as an expense when incurred.



R & D A C T I V I T I E S A N D R E L A T E D I N T A N G I B L E A S S E T S 17

Internal Use Software

Type of Expenditure Stage of Project Accounting Treatment

• Identify need/benefit of the new software technology. Research Recognize expense as incurred.

• Gain technical knowledge (i.e. investigate technologies in market; determine whether project is feasible).

Research Recognize expense as incurred.

• Conceptual formulation and possible technology alternatives. Research Recognize expense as incurred.

• Design of alternatives and determine technical feasibility of software.

Development Recognize expense as incurred, since not all criteria will have been met.8

• Management prepares presentation to Board for final selec-tions of new technology, including budget.

Development Recognize expense as incurred.

• Board approves one alternative for the new technology and approves the budget.

Development Recognize expense as incurred. Criteria (a), (b), (c), (d) & (e) have been met since technology and budget has been approved by the board. However, assume criterion (f), the ability to measure costs reliably, has not been met at this stage.8

• Develop the software and acquire the hardware necessary to operate the software.

Development Capitalize directly attributable software development costs. All the criteria have been met at this stage.8 Capitalize hardware costs in accordance with IAS 16.

• Test the new software. Development Capitalize directly attributable costs.

• Train manufacturing facility staff on how to use the software. Production Recognize expense as incurred since does not meet the definition of an intangible asset.

• Debug the software and improve functionality. Production Recognize expense as incurred since does not meet the definition of an intangible asset.

• Ongoing management the minor functionality improvements of the software.

Production Recognize expense as incurred since does not meet the definition of an intangible asset.

8 Company would capitalize costs in the development stage if all the following criteria are met: (a) technical feasibility, (b) intention to complete the intangible asset and use or sell it, (c) ability to use or sell the intangible asset exists, (d) how the intangible asset will generate probable future economic benefits is known, (e) there is availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible, and (f) ability to measure reliably the expenditure attributable to the intangible asset during the development exists. Also see page 9.


Under U.S. GAAP, EITF 00-2, Accounting for Website Development Costs, provides

specific accounting guidance on the application of SOP 98-1 to website development

costs. Classification of the stages of website development and operation under EITF

00-2 roughly correlate to those in SIC-32. Costs incurred during the planning and oper-

ating stages are expensed as incurred. For websites developed for the company’s

own internal or external use, the website development costs are subject to the same

capitalization criteria as internal-use software in SOP 98-1. Therefore, costs incurred in

the application and infrastructure development stage are capitalized. EITF 00-2 provides

more detailed guidance on the activities deemed to be within the application develop-

ment stage so differences in practice from IFRS may occur.

Companies transitioning to IFRS from U.S. GAAP should review their policies for

accounting for website costs to understand the differences in definitions and capi-

talization criteria to ensure that their approach to the accounting for website costs is

adjusted as appropriate to comply with IFRS.

Software Developed for Sale

Under IAS 38, costs of software developed for sale are accounted for following

the general principles for all internally generated intangible assets. U.S. GAAP con-

tains specific requirements for software developed to be sold, leased, or otherwise

marketed. Under FAS 86, costs incurred internally in creating a computer software



product to be sold, leased, or otherwise

marketed as a separate product or as part

of a product or process are considered

R&D costs that are expensed as incurred

until “technological feasibility” has been

established. Technological feasibility is

established upon completion of a detailed

program and product design or – in the

absence of the former – completion of a

working model whose consistency with

the product design has been confirmed

through testing. Thereafter, all software

development/production costs incurred

up to the point that the product is avail-

able for general release to customers

are capitalized.

Establishing “technical feasibility” for

completing a project for use under IFRS

may be similar to but is not necessarily the

same as the requirements that establish

“technological feasibility” for software to

be sold under FAS 86. IFRS does not con-

tain guidance for what constitutes “tech-

nical feasibility,” and some technology

companies under IFRS – in particular soft-

ware companies that previously reported

under U.S. GAAP – have looked to FAS 86

and related implementation guidance as a

useful starting point to assess when tech-

nical feasibility has been reached under

IFRS. For example, consider a product

with multiple modules that are not sepa-

rately saleable. The U.S. GAAP implemen-

tation guidance says that technological

feasibility would need to be demonstrated

for the entire product (all modules linked

together – not on a module by module

basis) prior to capitalization.

In practice under U.S. GAAP, many soft-

ware companies have concluded that

technological feasibility under the FAS

86 criteria occurs so late in the product

development life cycle that costs incurred

between the point of technological fea-

sibility and the general release of the

software are not significant. Because

IFRS does not require a detailed program

design or working model to be completed

prior to establishing technical feasibility,

companies may find that development

costs should be capitalized sooner under

IFRS. Non-software technology com-

panies reporting under IFRS may have

significant amounts of capitalized devel-

opment costs. In practice, IFRS-reporting

entities have identified milestones within

their R&D processes to indicate when

technical feasibility has been achieved.

Judgment is required to assess whether

technical feasibility exists because the

IFRS criteria apply to all development

costs for internally generated intangibles

rather than just to software developed

for sale, which means differences from

U.S. GAAP may arise. Each entity should

evaluate the criteria against its internal

processes and circumstances to define

the appropriate policy.

Intangibles Including IPR&D Acquired in a Business Combination

Under IAS 38 and IFRS 3 as well as

FAS 141R, an acquirer recognizes an

intangible asset at the acquisition date

if such assets meet either the legal/

contractual or separability criteria dis-

cussed earlier. Intangibles recognized in

a business combination are measured

at fair value in the acquisition account-

ing. Acquired IPR&D projects of the

acquiree, irrespective of whether the

acquiree had recognized the asset

before the business combination, also

are recognized as separately identifiable

intangible assets if they are identifi-

able. At the acquisition date the asset is

capitalized as an intangible asset not yet

ready for use (IFRS) or indefinite-lived

intangible (U.S. GAAP) and is amortized

when it is available for use (when it is in

the location and condition necessary to

be capable of operating in the manner

intended by management).



Determining whether IPR&D qualifies

for recognition as part of the acquisition

accounting calls for consideration of sev-

eral factors discussed below. If the proj-

ect does not qualify as IPR&D, another

identifiable intangible asset could exist

that requires recognition (such as an R&D

project that is complete).

Factors to consider in determining

whether an IPR&D asset exists are:

• Is the IPR&D project incomplete? For a specific IPR&D project of an acquired company to give rise to an IPR&D asset, the project should be incomplete, and the acquirer’s interest must include control over the probable future eco-nomic benefits. At some point before commercialization and possibly before the end of development or the pre-production stage, the R&D project will no longer be considered incomplete. The evaluation of incompleteness applies to the entire IPR&D project and related individual subprojects. Software under development that is to be sold or leased is not considered incomplete if the project has reached technological feasibility as of the acquisition date. An incomplete project may be indicated if: (1) more than de minimus future costs are expected to be incurred, and (2) additional steps (or milestones) are required to overcome the remaining risks or to obtain regulatory approvals.

• Does the IPR&D project have sub-stance? An IPR&D asset must have substance, meaning that the acquiree performed a more than insignificant effort that: (1) meets the definition of R&D, and (2) results in the creation of value. There are four phases of a project’s life cycle that might be help-ful in determining when a project has substance or whether it has been completed. In the earlier phases, “substance” evolves and is deemed

to exist when it can be demonstrated, while in the later phases the project gradually reaches the point when it is no longer considered incomplete. The four phases of a project’s life cycle that have been applied in practice are:

(1) Conceptualization. This phase entails coming up with an idea, thought, new knowledge, or plan for a new product, service, or process, or for a significant improvement to an existing product, ser-vice, or process. It may represent a deci-sion by a company to focus its research activities within certain core competen-cies. Management might make an initial assessment of the potential market, cost, and technical issues for ideas, thoughts, or plans to determine whether the ideas can be developed to produce an economic benefit.

(2) Applied research. This phase rep-resents a planned search or critical investigation aimed at the discovery of additional knowledge in hopes that it will be useful in defining a new product, service, or process that will yield eco-nomic benefits, or significantly improve an existing product, service, or process that will yield economic benefits. Work during this phase assesses the feasibil-ity of successfully completing the proj-ect and the commercial viability of the resulting product, service, or process.

(3) Development. This phase represents the translation of research findings or other knowledge into a detailed plan or design for a new product, service, or process, or for a significant improve-ment to an existing product, service, or process, and carrying out development efforts pursuant to the plan.

(4) Pre-production. This phase repre-sents the business activities necessary to commercialize the asset resulting from R&D activities for the enterprise’s economic benefit.



We believe that identification of these

stages frames a threshold for asserting

that sufficient work has been done for

IPR&D to be separately identified. If the

threshold is not met (i.e., no more than

insignificant efforts have occurred to this

point), the value otherwise attributable to

IPR&D would be subsumed into goodwill

unless it meets the general recognition

criteria for intangible assets. For example,

if at the date of the acquisition an R&D

project had been only conceptualized

and the acquiree had not expended a

more than insignificant effort in R&D

activities to advance existing knowledge

and technology toward the project objec-

tive, the project would be deemed to lack

substance and would not be recognized

as an IPR&D asset. Alternatively, if the

acquiree’s IPR&D project has reached

a stage where it would be expected to

have value to a market participant, it most

likely would meet the definition of an

asset and therefore qualify for recogni-

tion by the acquirer at the acquisition

date. We would not expect differences in

this area to arise between IFRS and U.S.

GAAP in the initial capitalization of IPR&D

acquired in a business combination.

Subsequent Expenditures

Subsequent expenditures are expendi-

tures incurred after: (1) the initial recogni-

tion of an acquired intangible asset, or (2)

after an internally generated intangible

asset is available for its intended use.

Subsequent expenditures that add to,

replace part of, or service an intangible

asset are recognized as part of the intan-

gible asset if an entity can demonstrate

the item meets both (a) the definition of

an intangible asset and (b) the general

recognition criteria for intangible assets.

Subsequent costs that may be capitaliz-

able under IAS 38 are limited to only

those related to development activities

for projects that substantially improve

existing materials, devices, products, pro-

cesses, systems, or services.

The general recognition criteria for

internally generated intangible assets

also apply to subsequent expenditures

on IPR&D projects and other intangible

assets acquired separately or as part

of a business combination. Whereas

capitalization after acquisition is limited

to “development” costs that meet all

criteria applicable to internally generated

intangibles, the initially capitalized cost

of the related IPR&D acquired in a busi-

ness combination is based on its fair

value at the acquisition date.

Typically, a subsequent expenditure would

be recognized in the carrying amount of

an existing intangible asset only in rela-

tion to the development aspect of an

acquired IPR&D asset. This is because it

is difficult to definitively attribute subse-

quent expenditures directly to a particular

intangible asset rather than to the business

as a whole. Most subsequent expenditures

on intangibles other than acquired IPR&D

are more likely the cost to maintain the

expected future economic benefits embod-

ied in the existing intangible asset rather

than expenditures that meet the definition

of an intangible asset and the initial capital-

ization criteria (for example, by increasing

the expected future economic benefits

embodied in the existing intangible asset).

Exceptions to the general presumption

that subsequent expenditures are related

to maintaining economic benefits include:

• Acquired IPR&D projects where the company is continuing the development work associated with the IPR&D project and the subsequent expenditures meet the capitalization criteria in IAS 38

• Subsequent expenditures for software or hardware upgrades that give rise to an asset in their own right. This might be the case, for example, when expen-ditures appreciably improve an existing product or service through significantly enhancing its features and functionality.



U.S. GAAP provides specific guidance on

the accounting for subsequent expendi-

tures where intangible assets have been

recognized in the areas of internal-use

software and software to be sold or mar-

keted to others:

• SOP 98-1 indicates that if internal-use software is modified for internal use only and provides additional functional-ity, the modifications are considered a separate project. Eligible costs incurred during the application develop-ment stage are capitalized, and other costs are expensed. Whether these costs would be capitalized under IFRS depends on whether an entity can dem-onstrate that costs incurred during the application development phase under SOP 98-1 meet all the IAS 38 capitaliza-tion criteria (i.e., technical feasibility, probable future benefits, costs are mea-sured reliably).

• If the subsequent expenditure is a soft-ware product enhancement for the mar-ketplace, U.S. GAAP requires that costs incurred be charged to R&D expense until the technological feasibility of the enhancement is established. The defini-tion of “product enhancement” under FAS 86 speaks to measures expected to significantly improve the market-ability of software product or extend its life. The glossary in AICPA Statement of Position 97-2, Software Revenue Recognition (SOP 97-2) contains similar guidance in its definition of upgrade/enhancement. These definitions con-trast with activities to improve existing products through routine maintenance and minor enhancement or warranty activities, such as “right-of-dot” soft-ware updates and patches to keep system software current with related hardware or to fix “bugs.”

In different segments of the technology industry, however, the terms product update/upgrade/enhancement may con-note different levels of packaging or improvement and therefore entity-specific

facts and circumstances should be considered. The development of prod-uct enhancements (as defined under FAS 86) or upgrade/enhancements (as defined under SOP 97-2) may be an area where subsequent expenditures could meet the intangible asset recognition criteria under IFRS providing all IFRS recognition criteria for internally gener-ated intangibles have been met.

The implementation guidance to FAS 86 also suggests that technological feasi-bility may be more readily established for a significant enhancement to an existing product than it would be for a new product, for example where: (1) an enhancement adds only one function to a successful product and requires only minor modification to the original product’s detailed program design to establish technological feasibility, and (2) software is being ported (made avail-able to a different piece of hardware) and may not require a new detailed pro-gram design. In that case, technological feasibility of the enhancement could be established once high-risk develop-ment issues have been resolved. These examples may be a useful starting point in helping entities reporting under IFRS to assess when technical feasibil-ity has been reached. Irrespective of complexity, entities will want to assess whether the enhancements do, in fact, significantly increase the functionality of the existing product/process in order to qualify for capitalization.

Because of such potential differences,

companies would be well-advised to

review and update their policies and pro-

cedures regarding subsequent expendi-

tures on intangible assets if required.


9 Intangible assets may be revalued only in situations where there is an active market for the intangible asset. This situation occurs only rarely in practice, so this measurement alternative is not addressed in this publication.


Considerations for Subsequent Measurement of Intangibles

Under both IFRS and U.S. GAAP, an intan-

gible asset, after its initial recognition and

measurement, is subsequently recorded

at cost less accumulated amortization and

impairment charges, except in the infre-

quent situations where IFRS allows for an

intangible asset to be revalued.9 Similar

to U.S. GAAP, a number of issues arise

subsequent to the initial recognition of the

intangible asset including determining:

• Whether the intangible asset has a finite or indefinite useful life

• For intangible assets with a finite use-ful life, the amortization period and the appropriate amortization methodology

• For all intangible assets, whether an impairment exists and the accounting for retirements and disposals.

Useful Life and Amortization

“Finite-” or “indefinite-lived” intangible

asset: Under IFRS, an intangible asset is

an indefinite-lived asset when analysis

of all relevant factors suggests there

is no foreseeable limit to the period in

which the asset is expected to generate

net cash inflows to the entity. Like U.S.

GAAP, intangible assets with indefinite

useful lives are not amortized and are

subject to impairment testing at least

annually.

R & D A C T I V I T I E S A N D R E L A T E D I N T A N G I B L E A S S E T S


23

IFRSMany factors are considered in determining the useful life of an intangible asset, including:

• T he expected usage of the asset by the entity and whether the asset could be managed efficiently by another management team

• T ypical product life cycles for the asset and public information on estimates of useful lives of similar assets that are used in a similar way

• T echnical, technological, commer-cial, or other type of obsolescence

• The stability of the industry in which the asset operates and changes in the market demand for the products or services output from the asset

• Expected actions by competitors or potential competitors

• T he level of maintenance expendi-ture required to obtain the expected future economic benefits from the asset and the entity’s ability and intention to reach such a level

• T he period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases

• Whether the useful life of the asset is dependent on the useful lives of other assets of the entity.

(IAS 38, par. 90)

U.S. GAAPThe estimate of the useful life of an intangible asset to an entity shall be based on all pertinent factors, including:

• The expected use of the asset by the entity

• The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate

• Any legal, regulatory, or contrac-tual provisions that may limit the useful life

• T he entity’s own historical experi-ence in renewing or extending simi-lar arrangements (consistent with the intended use of the asset by the entity), regardless of whether those arrangements have explicit renewal or extension provisions. In the absence of that experience, the entity should consider the assump-tions that market participants would use about renewal or extension (consistent with the highest and best use of the asset by market participants), adjusted for entity-specific factors

• The effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environ-ment, and expected changes in distribution channels)

• The level of maintenance expendi-tures required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the car-rying amount of the asset may sug-gest a very limited useful life).

(FAS 142, par. 11 as modified by FSP FAS 142-3, Determination of the Useful Life of Intangible Assets)

Considerations in assessing the useful life

of intangible assets: IFRS and U.S. GAAP

require that various factors be considered

when assessing the useful life of an

intangible asset (a comparison of these

factors is shown in the table at right).

The factors under IFRS and U.S. GAAP

are similar but not identical, so it is pos-

sible to reach different conclusions about

whether an intangible asset is indefinite-

lived. However, it would be unusual for a

technology-based intangible asset to have

an indefinite useful life under IFRS given

evolving technologies and/or limitations on

contractual or legal rights (as with patents,

for example). A potential non-technology-

based intangible asset that could have an

indefinite useful life, however, would be

a long-established brand name in a stable

market with significant barriers to entry,

where the company expects to have avail-

able resources to continue maintaining the

brand. Consistent with U.S. GAAP, IFRS

requires an annual review of indefinite-

lived intangibles to determine whether

the classification of an intangible asset as

finite- or indefinite-lived is appropriate over

time, as circumstances related to the clas-

sification may change.

Method and Period of Amortization for Intangible Assets with Finite Useful Lives

IFRS and U.S. GAAP require that intan-

gible assets with finite useful lives be

amortized on a systematic basis over

their useful lives and that the method

of amortization reflect the pattern of

consumption of economic benefits.

A variety of methods may be used,

including the straight-line method, the

diminishing-balance method, and the

units-of-production method. IAS 38 does

not specify a method of amortization,

and the straight-line method, diminish-

ing (or reducing) balance method, and

units-of-production method are cited as

possible approaches. If the pattern over



which economic benefits are expected

to be consumed cannot be determined

reliably, then the straight-line method is

used. Valuations performed to measure

the fair value of an intangible asset that

uses an income approach also may be

useful when assessing a pattern and/or

period of economic consumption, such

as where projected future cash flows are

used to value acquired IPR&D. Changes

in circumstances after the valuation date

need to be considered.

U.S. GAAP specifies an amortization

approach for certain types of intangible

assets. For example, FAS 86 requires

that capitalized software development

costs (after technological feasibility is

established) be amortized using the

greater of (1) straight-line over the

remaining economic life of the prod-

uct or (2) proportionate to revenues.

Because IFRS requires consideration of

the pattern of benefits in determining

the amortization method, companies

should not automatically assume that

application of the U.S. GAAP require-

ments would be appropriate under IFRS.

Under IAS 38 amortization commences

when the intangible asset is available for

use, i.e., when it is in the location and

condition necessary to be capable of

operating in the manner intended by man-

agement. Amortization ceases when the

asset is derecognized or when it is clas-

sified as held for sale in accordance with

IFRS 5 Non-current Assets Held For Sale

and Discontinued Operations.

Classification of Amortization

Under IFRS, the classification of amor-

tization charges for intangible assets

with a finite useful life is based on the

intended purpose of the asset. If the

intangible is used in the production of

another asset (for example, inventory),

the amortization charge is included in the

cost of that asset. Otherwise, amortiza-

tion is recognized as an expense. For

internal-use intangibles, amortization of

capitalized development costs is classi-

fied according to the expense category

(nature or function) that benefits from

the related intangible asset.

U.S. GAAP is similar to IFRS with respect

to classification of amortization charges, but

provides additional guidance. U.S. GAAP

requires that amortization related to devel-

opment costs for software to be sold or

marketed to others be classified within cost

of sales or a similar expense category.

For technology companies that capitalize

product development costs under IFRS

that previously were expensed within

R&D under U.S. GAAP, differences in the

timing and classification (such as cost of

sales in some cases) of cost recognition

may affect key performance indicators

such as gross margin. It is important to

consider the impact on budgeting/fore-

casting, external reporting, and perfor-

mance metrics.



Impairment

Technology-related intangible assets are

particularly susceptible to changing mar-

ket forces that can affect the recoverabil-

ity of capitalized amounts. The guidance

in IAS 36 Impairment of Assets explains

when and how an IFRS entity reviews

the carrying amount of its assets, how

it determines the recoverable amount

of the asset, and when it recognizes or

reverses an impairment loss.

IAS 36 requires that indefinite-lived

intangible assets and intangible assets

not yet available for use be tested for

impairment whenever there is an indi-

cation that the related assets may be

impaired, and irrespective of such indica-

tion, at least annually. Intangible assets

being amortized are tested for impair-

ment only when there is an indication of

impairment (a trigger event). These trig-

ger events are similar to U.S. GAAP.

In-service intangible assets often don’t

generate independent cash inflows but

instead are used with other assets of the

entity within a larger cash-generating unit.

Under IFRS, this lowest independently

cash-generating category of assets is

called a cash-generating unit (CGU), a

concept broadly similar but not identical

to that of an “asset group” under FAS

144, Accounting for the Impairment or

Disposal of Long-Lived Assets. Because

FAS 144 uses undiscounted cash flows

as a “screen” to determine whether an

impairment exists, entities may find they

have an impairment sooner under IAS 36.

Under IAS 36, at each reporting date an

entity assesses whether an indication

exists that a previously recognized impair-

ment loss has reversed. If such indication

exists and the recoverable amount of the

impaired asset or CGU has subsequently

increased, then generally the impairment

loss is reversed. The maximum amount

of the reversal is the lower of (1) the

amount necessary to bring the carrying

amount of the asset up to its recoverable

amount and (2) the amount necessary

to restore the assets of the CGU to their

pre-impairment carrying amounts less

subsequent amortization that would have

been recognized. Therefore, entities will

need to track not only the recognized

amount of the intangible asset (net of

accumulated amortization and impairment)

but also what the carrying amount would

have been had the impairment not been

recognized so as to limit the recovery to

that amount.

IFRS requires that indefinite-lived intan-

gibles be evaluated for impairment annu-

ally, but generally within the CGU. U.S.

GAAP requires that such assets be evalu-

ated independently each year to deter-

mine whether they are impaired. As a

consequence, acquired IPR&D assets and

other capitalized internal development

costs for incomplete projects not yet

available for use may end up with differ-

ent impairment conclusions under IFRS.



Retirements and Disposals

Under IFRS, when an intangible asset

is either (1) disposed of, or (2) no future

economic benefit is expected from its

use or disposal, the asset is derecognized

and the resulting gain or loss is the differ-

ence between the proceeds and the car-

rying amount of the intangible asset.

If an intangible asset is disposed of, the

IAS 18 Revenue criteria for recognizing

revenue from the sale of goods should

be applied to determine the date of

disposal. Consideration received for the

disposal is initially recorded at fair value,

which may involve discounting deferred

payments. If so, interest expense would

subsequently be recorded to reflect the

effective interest yield on the receivable.

Amortization of an intangible asset with a

finite useful life does not cease when the

intangible asset is no longer used unless

the asset has been fully amortized, has

been derecognized, or is classified as

held for sale. Non-current assets held for

sale are presented separately from other

assets in the balance sheet and are not

amortized or depreciated.

An intangible asset is only derecognized

prior to disposal when no future economic

benefits are expected from either its future

use or disposal. A reduction in expected

economic benefits is dealt with through

impairment assessments and write-downs

without derecognizing the asset. This dif-

ferentiation is important given that under

IFRS impairment charges can be later

reversed in some cases, whereas costs of

a derecognized intangible expensed would

not be reinstated regardless of changed

circumstances since the asset is deemed

to no longer exist.

• Scenario 1: Company A is developing proprietary data-warehouse software for internal use through 20X7 with expenditures totaling $500,000 capital-ized during the development phase. In 20X8, prior to completion of the software, the company purchases and implements a new enterprise resource planning system that contains data-warehousing functionality equivalent to the in-process proprietary software. The proprietary database is determined to have no future economic benefits (no sales value and no alternative use). Therefore, in 20X8, the capitalized software-development intangible asset should be derecognized with a loss of $500,000 recognized in profit or loss.

• Scenario 2: Consider the same fact set as Scenario 1, above, except that the company estimates that the fair value of the in-process database is $100,000. Also, for purposes of this illustration, assume the criteria for a “held for sale” classification are not met, the company does not plan to sell the database, and there are no cash inflows directly attributable to the database. Under this approach, the intangible asset would be tested for impairment at the CGU level and any impairment loss would be rec-ognized in accordance with IAS 36.

Assuming the initially capitalized costs also

were eligible for capitalization under SOP

98-1, the concepts and calculations above

are consistent with U.S. GAAP except that

in Scenario 2, the impairment test pursuant

to FAS 144 would use an undiscounted

cash flow screen, rather than a recoverable

amount as required under IAS 36.



First Time Adoption Considerations

IFRS contains a specific standard, IFRS 1

First-time Adoption of International

Accounting Standards that sets out

requirements on the first time adop-

tion of IFRS. IFRS 1 contains a general

requirement that all existing IFRS be

adopted through retrospective applica-

tion. However, IFRS 1 has certain man-

datory and elective “reliefs” from that

requirement. For multinational technology

companies with subsidiaries that have

transitioned to IFRS for local statutory

reporting, each entity that prepares finan-

cial statements (each reporting entity)

is a first time adopter in its separate or

sub-consolidated financial statements.

Therefore the accounting policies adopted

in the parent’s consolidated financial

statements are not constrained by IFRS

policies adopted by subsidiaries that have

previously transitioned to IFRS. However,

because IFRS generally requires that

accounting policies be applied consis-

tently throughout the organization, com-

panies will want to be cognizant of locally

set precedents to ensure consistent

application of policies at the consolidated

group level. To reduce the number of

consolidation entries, early in the transi-

tion process the group-level IFRS project

team may want to inventory the IFRS

policies adopted locally by subsidiaries

and consider driving more consistent

policies for subsidiaries that have not yet

adopted IFRS for statutory purposes.

KPMG’s Insights into IFRS10 publication

contains detailed practical guidance on

first-time IFRS adoption issues.

First time adoption issues related to R&D

and other intangibles include:

• IPR&D: Where an entity under U.S. GAAP recognized an IPR&D asset and immediately expensed it for business combinations prior to the effective date of FAS 141R11 and for asset acquisi-tions, the entity would reverse this write-off and recognize an intangible asset unless the intangible asset will have been fully amortized or aban-doned under IFRS at the date of the opening IFRS balance sheet. Any adjustments are recognized to retained earnings at the date of transition.

• Intangible assets acquired separately: Retrospective application of IAS 38 is required for intangible assets acquired separately outside of a business combi-nation, for example patents or licenses. In particular, companies will need to consider whether the same conclusion would be reached about whether the asset is finite- or indefinite-lived and if finite-lived, the useful life and amortiza-tion method.

10 Insights into IFRS emphasizes the application of IFRS in practice and explains conclusions we’ve reached on interpretative issues. The guide includes illustrative examples to elaborate on or clarify the practical application of the standards. Insights into IFRS is available online to subscribers to KPMG’s Accounting Research Online (www.aro.kpmg.com).11 This applies in a business combination consummated prior to the adoption of FAS 141R and where the entity has elected not to restate the business combination in its first-time adoption of IFRS.



• Internally-generated intangible assets: A first time adopter is required to recog-nize in its opening IFRS balance sheet all internally generated intangible assets that qualify for recognition under IFRS. However, IFRS 1 prohibits the use of hindsight when determining whether to recognize an asset and, if recognized, its measurement upon first-time adop-tion of IFRS. In our view, the constraint on the use of hindsight coupled with the requirements for first-time adoption should be interpreted as requiring either of the following:

– Contemporaneous evidence that all recognition requirements of IAS 38 were considered at the time the expenditure was incurred. Expenditures should be capitalized only from the date that it can be demonstrated that this information was available. Supporting historical information could include timely docu-mentation and approvals surrounding product development milestone attainment.

– The existence of a process or control system to ensure that no expenditure of this nature is incurred without all recognition requirements having been considered (such as where the entity had a well-managed product devel-opment program that considered all recognition criteria) and there is no reason to believe that the normal process or control systems were not followed. Technology companies that have extensive product development management programs often have control procedures and systems in place that periodically assess the probability of future economic ben-efits. In our view, if an entity has such a monitoring system and costs incurred were captured contempo-raneously, then this data likely will satisfy the requirements for contem-poraneous assessment of the prob-ability of future economic benefits.

Closing Comments

The business environment continues to

change at unprecedented speed, and

all companies face greater risks in this

volatile period. In challenging economic

times, there is a business imperative for

robust R&D portfolio management to

enable enhanced R&D resource alloca-

tion decisions and ensure that return on

investment in R&D is maximized. Gaining

an early understanding of IFRS–U.S.

GAAP similarities and differences can be

an important step in a successful transi-

tion to IFRS from U.S. GAAP.

We have highlighted some topics of par-

ticular relevance to the technology sector

in this publication. Contemplated changes

in R&D systems/processes and internal

controls should factor in requirements

under IFRS, such as ensuring that prog-

ress toward attainment of capitalization

criteria is monitored and costs can be

captured. In many cases, the impact will

vary by entity.

Future Developments

The IASB has on its agenda a research proj-

ect to address accounting issues related

to the initial and subsequent accounting

for identifiable intangible assets other

than those acquired in a business combi-

nation. The development of this project

is intended to be a joint project with the

FASB. The expected timing and initial type

of document to be published are yet to

be determined by the IASB, and we do not

expect any such decisions in the near term.



KPMG Can Help

As a global network of member firms

with experience in more than 1,500 IFRS

convergence projects around the world,

we can help ensure the issues are identi-

fied early and leading practices to better

avoid pitfalls are shared. KPMG has

extensive experience in the technology

industry and the capabilities needed to

support you throughout the IFRS assess-

ment and conversion process. Our global

network of technology industry experts can

help manage the IFRS conversion process,

including training company personnel and

transitioning financial reporting processes.

Our approach comprises four key work-

streams:

• Accounting and reporting

• Business impact

• Systems, processes, and controls

• People.

This approach helps ensure that manage-

ment is in control of the conversion pro-

cess and has the necessary information

to make appropriate decisions throughout

the conversion process.

Global Delivery

KPMG has a dedicated group of profes-

sionals drawn from KPMG member

firms around the world. Our approach is

applied uniformly to deliver consistent,

high-quality services for our clients across

geographies.

Contact Us

For more information about this whitepaper and how IFRS may affect your company,

please contact one of these KPMG professionals:

Gary MatuszakGlobal Chair, Information, Communications & Entertainment 650-404-4858 [email protected]

Jana BarstenAudit Sector Leader, Electronics, Software & Services 650-404-4849 [email protected]

Scott DeckerNational IFRS Leader, Audit 817-339-1221 [email protected]

Tom LamoureuxGlobal Advisory Sector Leader, Electronics, Software & Services 650-404-5052 [email protected]

mailto:[email protected]






!

Appendix A: Summary of Accounting for Intangible Assets

IDENTIFIABLE INTANGIBLES

ACQUIRED INTERNALLY GENERATED

RE

CO

GN

ITIO

N

Criteria Satisfy 4 elements:

• identifiable 1

• controlled

• future economic benefits probable

• measured reliably

Satisfy 4 elements:

• identifiable 1 2

• controlled

• future economic benefits probable

• measured reliably

Additional recognition criteria

• Research phase costs are expensed

• Development phase costs are capitalized if certain criteria are met

ME

AS

UR

EM

EN

T

Initial measurement At cost

Intangibles acquired in a business combination are measured at fair value at acquisition date 3

At cost (i.e., sum of expenditure incurred from the date when the intangible asset first meets the recognition criteria)

Subsequent measurement Cost less accumulated amortization and accumulated impairment losses 4

Can revalue to fair value only where active market for the asset exists 5

Cost less accumulated amortization and accumulated impairment losses 4

Can revalue to fair value only where active market for the asset exists 5

AM

OR

TIZ

AT

ION

Finite life 5 Amortize on a systematic basis over useful life—reflecting pattern of economic benefit

Review amortization period and method at least at end of each reporting period

Consider residual value 7

Amortize on a systematic basis over useful life—reflecting pattern of economic benefit

Review amortization period and method at least at end of each reporting period

Consider residual value 7

Indefinite life 6 No amortization

Useful life reviewed at each reporting period

No amortization

Useful life reviewed at each reporting period

Not yet available for use N/A No amortization

IMPA

IRM

EN

T

Finite life Test for impairment whenever there is an indicator of impairment

Test for impairment whenever there is an indicator of impairment

Indefinite life Test for impairment annually and whenever there is an indicator of impairment present

Test for impairment annually and whenever there is an indicator of impairment present

Not yet available for use N/A Annual impairment testing

Internally generated brands, mastheads, publishing titles, customer lists, and similar items CANNOT be recognized as intangible assets.

!

Source: IAS 38 Intangible Assets, IFRS 3 Business Combinations, IAS 36 Impairment of Assets.



The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. Additional information may be obtained from our offices, 2009.

Source: IAS 38 Intangible Assets, IFRS 3 Business Combinations, IAS 36 Impairment of Assets.

FURTHER GUIDANCE ON INTERNALLY GENERATED INTANGIBLES

Research and development defined

Research • Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding

Development • Application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services before the start of commercial production or use

Refer to IAS 38 par. 56 and IAS 38 par. 59 for examples of research and development activities respectively.

Development phase

Intangible asset arising from development shall only be recognized if and only if the entity can demonstrate ALL of the following:

• Technical feasibility of completing the intangible asset so that it will be available for use or sale

• Intention to complete the intangible asset and use or sell it

• Ability to use or sell the intangible asset

• How the intangible asset will generate probable future economic benefits

• The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset

• Its ability to measure reliably the expenditure attributable to the intangible asset during its development

NB: If research phase cannot be distinguished from the development phase, entity must treat the expenditure on that project as if it were incurred in research phase only and expense.

Capitalize versus Expense

CAPITALIZE

• Directly attributable costs

– Costs of materials and services used or consumed

– Costs of employee benefits

– Other directly related costs

• Overheads that are necessary to generate the asset

• Borrowing costs in certain cases (refer to IAS 23 for guidance)

NB: An entity cannot reinstate costs previously expensed.

EXPENSE

• Selling, administrative, and other general overhead costs

• Inefficiencies and initial operating losses

• Expenditure on training staff to operate the asset

• Start-up costs (establishment, pre-opening, pre-operating)

• Advertising and promotional activities

• Costs of relocating, reorganizing, and redeploying assets

FOOTNOTES

1 Intangible asset

• An identifiable non-monetary asset without physical substance

• Must be identifiable to distinguish it from goodwill (if acquired in a business combination)

2 Identifiability criterion

• Is separable—capable of being separated or divid-ed from the entity and sold, transferred, licensed, rented, or exchanged either individually or together with a related contract, asset, or liability, OR

• Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations

3 Intangibles acquired in a business combination

• Refer to IAS 3 Illustrative Examples for examples of identifiable intangibles that can be brought to account on acquisition.

• Acquirer recognizes an intangible asset at acquisition providing it meets recognition criteria irrespective of whether the asset was previously recognized by the acquiree.

4 Subsequent expenditure

The nature of intangible asset is such that, in many cases, there are no additions or replacements of a part. Therefore, only rarely will subsequent expenditure—i.e., expenditure incurred after the initial recognition of an intangible asset—be recog-nized in the carrying amount of an asset.

NB: Subsequent expenditure on internally generated brands, mastheads, etc. must always be expensed.

5 Active market A market in which all of the following conditions exist:

• The items traded in the market are homogeneous

• Willing buyers and sellers can normally be found at any time

• Prices are available to the public

6 Finite vs indefinite useful life

When determining whether useful life is finite or indefinite consider such factors as:

• Typical product life cycles

• Period of control (renewable rights)

• Technical, technological, and commercial obsolescence

• Changes in market demand

Refer to IAS 38 par. 88 - 90 and Illustrative Examples for further guidance.

7 Residual value • The depreciable amount of an intangible asset with a finite useful life is determined after deducting its residual value.

• The residual value of a finite intangible asset will be assumed to be zero except if certain criteria are met (refer to IAS 38 par. 100).



Appendix B: Summary of IFRS Compared to U.S. GAAP – Expenditures for R&D and Related Intangibles

The table below compares IFRS and U.S. GAAP for selected areas of accounting for

expenditures for research and development activities and related intangible assets.12

IFRS U.S. GAAPAn intangible asset is an identifiable non-monetary asset with-out physical substance. To meet the definition of an intangible asset, an item must lack physical substance and must be:

• Identifiable;• Non-monetary; and• Controlled by the entity and expected to provide future eco-

nomic benefits to the entity (i.e., it must meet the definition of an asset).

Under U.S. GAAP an intangible asset is an asset (not including a financial asset) that lacks physical substance. Although this definition differs from IFRSs, generally we would not expect differences in practice.

An intangible asset is recognized when:

1. It is probable that future economic benefits that are attribut-able to the asset will flow to the entity; and

2. The cost of the asset can be measured reliably.

Under U.S. GAAP an acquired identifiable intangible asset is recognized when:

1. It is probable that future economic benefits that are attribut-able to the asset will flow to the entity, like IFRSs; however, unlike IFRSs, this is part of the definition of asset rather than a recognition criterion; and

2. Fair value can be measured with sufficient reliability.

An intangible asset is recognized initially at cost. The cost of an intangible asset acquired in a separate transaction is the cash paid or the fair value of any other consideration given. The cost of an intangible asset acquired in a business combination is its fair value. The cost of an internally generated intangible asset includes the directly attributable expenditure of preparing the asset for intended use. The principles discussed in respect of property, plant, and equipment apply equally to the recognition of intangible assets.

Generally an identifiable intangible is recognized initially at fair value; however, generally we would not expect a difference from IFRSs in practice. As an exception, internally developed intangible assets (i.e., direct-response advertising, software developed for internal use, and software developed for sale to third parties only) are recognized initially by accumulating costs incurred after the capitalization criteria (discussed below) are met; however, the capitalization criteria differ for each category and they differ from IFRSs (see below).

The cost of an intangible asset acquired in a separate transac-tion is the fair value of any consideration given.

Unlike IFRSs, an identifiable intangible asset is measured initially based on fair value. However, for an identifiable intangible asset acquired in a separate transaction, fair value generally is measured based on the fair value of any consideration given, like IFRSs.

Research is original and planned investigation undertaken with the prospect of gaining new knowledge and understanding. Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, products, processes etc. Development does not include the maintenance or enhance-ment of ongoing operations.

Research is planned search or critical investigation aimed at the discovery of new knowledge with the hope that such knowl-edge will be useful in developing a new product or service or a new process or technique or in bringing about a significant improvement to an existing product, service, process, or tech-nique. Development is the translation of research findings or other knowledge into a plan or design for a new product, ser-vice, process, or technique whether intended for sale or use. Because the precise language under U.S. GAAP differs from IFRSs, it is possible that differences may arise in practice.

12 For more comparative information for intangible assets, refer to KPMG’s publication IFRS Compared to U.S. GAAP, KPMG LLP (U.S.) and KPMG IFRG Limited, a U.K. company, limited by guarantee, 2009.



IFRS U.S. GAAPResearch costs generally are expensed as incurred. Like IFRSs, research costs generally are expensed as incurred.

If an internally generated intangible asset arises from the devel-opment phase of a project, then directly attributable expenditure is capitalized from the date that the entity is able to demonstrate:

• The technical feasibility of completing the intangible asset so that it will be available for use or sale;

• Its intention to complete the intangible asset and use or sell it; • Its ability to use or sell the intangible asset; • How the intangible asset will generate probable future eco-

nomic benefits; the entity must demonstrate the existence of a market for the output of the intangible asset or the intangi-ble asset itself or, if it is to be used internally, the usefulness of the intangible asset;

• The availability of adequate technical, financial and other resources to complete the development of, and to use or sell, the intangible asset; and

• Its ability to measure reliably the expenditure attributable to the intangible asset during its development.

Unlike IFRSs, with the exception of certain internally developed computer software and direct-response advertising (see below), all other internal development costs are expensed as incurred.

In-process research and development acquired in a business combination is recognized initially at fair value. Subsequent to initial recognition, the intangible asset is accounted for following the general principles outlined in this Appendix.

Like IFRSs, in-process research and development acquired in a business combination is recognized initially at fair value. Unlike IFRSs, subsequent to initial recognition, the intangible asset is classified as indefinite-lived (regardless of whether it has an alternative future use) until the completion or abandonment of the associated research and development efforts, and is subject to annual impairment testing during the period these assets are considered indefinite-lived. The costs incurred to complete the project are expensed as incurred.

Subsequent expenditure to add to, replace part of, or service an intangible asset is recognized as part of the cost of an intangible asset if an entity can demonstrate that the item meets:

• The definition of an intangible asset (see above); and• The general recognition criteria for intangible assets (see above).

The general recognition criteria for internally generated intangi-ble assets are applied to subsequent expenditure on in-process research and development projects acquired separately or in a business combination. Therefore capitalization after initial recog-nition is limited to development costs that meet the recognition criteria (see above).

Under U.S. GAAP expenditure incurred subsequent to the completion or acquisition of an intangible asset is not capitalized unless it can be demonstrated that the expenditure increases the utility of the asset. While this wording differs from IFRSs, generally we would not expect differences in practice.

Unlike IFRSs, subsequent expenditure on internal-use software (see below) that results in additional functionality is considered to be a separate project and costs incurred during the applica-tion development stage are capitalized. Unlike IFRSs, there are more limits under U.S. GAAP regarding the types of costs that are capitalized.

(Continued)



IFRS U.S. GAAPSoftware developed for sale

There are no special requirements for software developed for sale. Costs of software developed for sale are accounted for following the general principles for internally generated intangible assets.

Software developed for sale

Unlike IFRSs, there are special requirements for software devel-oped to be sold. Costs incurred internally in creating a computer software product to be sold, leased, or otherwise marketed as a separate product or as part of a product or process are research and development costs that are expensed as incurred until technological feasibility has been established for the product. Technological feasibility is established upon completion of a detailed program and product design, or in the absence of the former, completion of a working model whose consistency with the product design has been confirmed through testing. Thereafter all software development costs incurred up to the point of general release of the product to customers are capital-ized and reported subsequently at the lower of amortized cost and net realizable value. Although the technological feasibility capitalization threshold is similar to the general recognition prin-ciples for internally generated intangible assets under IFRSs, because the precise language under U.S. GAAP differs from IFRSs, it is possible that differences may arise in practice.

Internal-use software

There are no special requirements for the development of internal-use software. The costs of internal-use software are accounted for under the general principles for internally gener-ated intangible assets or, in the case of purchased software, following the general requirements for intangible assets.

Internal-use software

Unlike IFRSs, there are special requirements for the development of internal-use software. Costs incurred for internal-use software that is acquired, internally developed, or modified solely to meet the entity’s internal needs are capitalized depending on the stage of development. The stages of software development are the preliminary project stage, application development stage and post-implementation/operation stage. Costs incurred during the preliminary project stage and the post-implementation/operation stage are expensed as incurred.

Costs incurred in the application development stage that are capitalized include only:

• External direct costs of materials and services consumed in developing or obtaining internal-use software;

• Payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal-use software project; and

• Interest incurred during development.

General administrative and overhead costs are expensed as incurred.

The application development stage, which is necessary to com-mence capitalizing costs under U.S. GAAP, often will occur sooner than the date that the criteria for capitalizing develop-ment costs under IFRSs are met. Therefore both the timing of commencing capitalization and the amounts capitalized are likely to be different from IFRSs.

Website development costs

Costs associated with websites developed for advertising or pro-motional purposes are expensed as incurred. For other websites, expenditure incurred during the application and infrastructure development stage, the graphical design stage and the content development stage are capitalized if the criteria for capitalizing development costs are met. The costs of developing content for advertising or promotional purposes are expensed as incurred.

Website development costs

Unlike IFRSs, website development costs are subject to the same general capitalization criteria as internal-use software. Therefore costs incurred during the application development stage are capitalized. U.S. GAAP provides detailed guidance on the activities deemed to be within the application development stage for website development. Unlike IFRSs, U.S. GAAP does not provide guidance on the account-ing for the costs of developing content for websites, and therefore differences from IFRSs may arise in practice.



Appendix C: IFRS Accounting Disclosures for R&D and Related Intangible Assets

The extracts below illustrate examples of public company disclosures for R&D and related intangible assets.

In-process research and development acquired in business combinations:

Alcatel-Lucent2008 Annual Report [extract]

…With regard to business combinations, a portion of the purchase price is allocated to in-process research and development projects that may be significant. As part of the process of analyzing these business combinations, Alcatel-Lucent may make the decision to buy technology that has not yet been commercial-ized rather than develop the technology inter-nally. Decisions of this nature consider existing opportunities for Alcatel-Lucent to stay at the forefront of rapid technological advances in the telecommunications-data networking industry.

The fair value of in-process research and devel-opment acquired in business combinations is usually based on present value calculations of income, an analysis of the project’s accom-plishments and an evaluation of the overall con-tribution of the project, and the project’s risks.

The revenue projection used to value in-process research and development is based onestimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product in-troductions by Alcatel-Lucent and its competi-tors. Future net cash flows from such projects are based on management’s estimates of such projects’ cost of sales, operating expenses andincome taxes.

The value assigned to purchased in-process research and development is also adjusted to reflect the stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.

Such value is determined by discounting the net cash flows to their present value. The selection of the discount rate is based on Alcatel-Lucent’s weighted average cost of capi-tal, adjusted upward to reflect additional risks inherent in the development lifecycle.

Capitalized development costs considered as assets (either generated internally and capital-ized or reflected in the purchase price of a business combination) are generally amortized over 3 to 10 years.

Capitalization of internal or acquired development costs:

Koninklijke Philips Electronics NV 2008 Annual Report [extract]

…The Company expenses all research costs as incurred. Expenditure on development activities, whereby research findings are applied to a plan or design for the production of new or substantially improved products and processes, is capitalized as an intangible asset if the product or process is technically and commercially feasible and the Company has sufficient resources and the intention to complete development.

The development expenditure capitalized includes the cost of materials, direct labour and an appropriate proportion of overheads. Other development expenditures and expen-ditures on research activities are recognized in the income statement as an expense as incurred. Capitalized development and ex-penditure is stated at cost less accumulated amortization and impairment losses. Amortiza-tion of capitalized development expenditure is charged to the income statement on a straight-line basis over the estimated useful lives of the intangible assets. The useful lives for the intangible development assets are from three to five years.

Costs relating to the development and purchase of software for both internal use and software intended to be sold are capitalized and subse-quently amortized over the estimated useful life of three years.

Impairment assessments for capitalized development costs:

Nokia Corp2008 Annual Report [extract]

…During the development stage, manage-ment must estimate the commercial and technical feasibility of these projects as well as their expected useful lives. Should a prod-uct fail to substantiate its estimated feasibility or life cycle, we may be required to write off excess development costs in future periods.

Whenever there is an indicator that develop-ment costs capitalized for a specific project may be impaired, the recoverable amount of the asset is estimated. An asset is impaired when the carrying amount of the asset ex-ceeds its recoverable amount. The recoverable amount is defined as the higher of an asset’s net selling price and value in use. Value in use is the present value of discounted estimated future cash flows expected to arise from the continuing use of an asset and from its dis-posal at the end of its useful life. For projects still in development, these estimates include the future cash outflows that are expected to occur before the asset is ready for use…

Impairment reviews are based upon our projections of anticipated discounted future cash flows. The most significant variables in determining cash flows are discount rates, terminal values, the number of years on which to base the cash flow projections, as well as the assumptions and estimates used to determine the cash inflows and outflows. Management determines discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons.

Terminal values are based on the expected life of products and forecasted life cycle and fore-casted cash flows over that period. While we believe that our assumptions are appropriate, such amounts estimated could differ materi-ally from what will actually occur in the future.



Appendix D: Technical References

U.S. GAAP References

• Financial Accounting Standards Board (FASB): FAS 2, Accounting for Research and Development Costs

• Financial Accounting Standards Board (FASB): FAS 34, Capitalization of Interest Cost

• Financial Accounting Standards Board (FASB): FAS 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed

• Financial Accounting Standards Board (FASB): FAS 141R, Business Combinations

• Financial Accounting Standards Board (FASB): FAS 142, Goodwill and Other Intangible Assets

• Financial Accounting Standards Board (FASB): FAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets

• Financial Accounting Standards Board (FASB): FAS Implementation Guide–Q&A 86, Computer Software Guidance on Applying Statement 86

• Financial Accounting Standards Board Staff Position: FSP FAS 142-3, Determination of the Useful Life of Intangible Assets

• AICPA Statement of Position (SOP) 97-2, Software Revenue Recognition

• AICPA Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use

• Emerging Issues Task Force (EITF) 00-2, Accounting for Web Site Development Costs

• Emerging Issues Task Force (EITF) 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities

• Emerging Issues Task Force (EITF) 09-2, Research and Development Assets Acquired in an Asset Acquisition

IFRS References

• International Accounting Standards Board (IASB): IAS 16 Property, Plant and Equipment

• International Accounting Standards Board (IASB): IAS 17 Leases

• International Accounting Standards Board (IASB): IAS 18 Revenue

• International Accounting Standards Board (IASB): IAS 23 Borrowing Costs

• International Accounting Standards Board (IASB): IAS 36 Impairment of Assets

• International Accounting Standards Board (IASB): IAS 38 Intangible Assets

• International Accounting Standards Board (IASB): IFRS 1 First-time Adoption of International Accounting Standards

• International Accounting Standards Board (IASB): IFRS 3 (2008) Business Combinations

• International Accounting Standards Board (IASB): IFRS 5 Non-current Assets Held For Sale and Discontinued Operations

• Standing Interpretations Committee: SIC 32 Intangible Assets–Web Site Costs


About the Authors

Gary Matuszak is KPMG’s Global Chair – Information, Communications & Entertainment

with additional responsibility for the Global Electronics, Software & Services practice. Gary

has devoted virtually his entire career to serving the needs of fast-growth multinational

technology companies. He is experienced with both structuring and executing due dili-

gence on mergers and acquisitions for global organizations. Gary has been instrumental in

developing industry positions on emerging issues that affect the software industry, and he

served as the Chairman of the AICPA Software Revenue Recognition Task Force. Gary is

also a frequent speaker on topics impacting the technology industry.

Jana Barsten is KPMG’s Audit Sector Leader for the Electronics, Software & Services

practice. She has worked with global technology companies for more than twenty years,

with a primary focus on the software industry. Jana’s clients have included many of the

largest global software companies, and she has taught numerous courses on software

revenue recognition in the United States and internationally.

Dan Wilson is a partner in KPMG Canada’s Electronics, Software & Services Audit

practice. He has focused on the technology industry for more than ten years, advising

leading global technology SEC registrants on complex accounting matters under U.S.

and Canadian GAAP, and more recently IFRS. Dan is particularly experienced in advis-

ing both audit and non-audit clients on revenue recognition, and he provides training

internationally on this subject.

Margaret Gonzales is a U.S. partner currently on secondment in KPMG’s Mannheim,

Germany office. Her clients have included many of the world’s leading technology

companies. Prior to her secondment, she was a member of KPMG’s Department

of Professional Practice (DPP) assisting engagement teams and clients on complex

IFRS and U.S. GAAP accounting matters. Margaret co-authored KPMG publications

“Share-Based Payment, An Analysis of Statement No. 123R” and “Software Revenue

Recognition.” In addition, she instructs IFRS technical trainings for internal and external

audiences and has contributed to KPMG IFRS publications such as “IFRS Compared

to U.S. GAAP.”

Contributors

We acknowledge the significant contribution of the following individuals, who assisted

in developing this publication:

Tom Adkins

Brian Allen

Steve Douglas

Phil Dowad

Michael Hayes

Charles Lynch

Paul Munter

Patricia Rios


38


KPMG LLP, the audit, tax, and advisory firm (www.us.kpmg.com), is the U.S. member firm of KPMG International. KPMG International’s member firms have 137,000 professionals, including more than 7,600 partners, in 144 countries.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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