Explore IFRS vs. US GAAP recognition and measurement approaches to intangible assets, focusing on both internally developed and acquired intangibles, key analytical implications, and potential earnings management practices.
Studying intangible assets can sometimes feel, well, intangible. You know, you can’t exactly walk through the halls of a company and stub your toe on a trademark. Yet these assets—such as patents, brands, and software—can drive enormous value for a business. In this section, we’ll dissect how internally developed intangibles differ from those that are acquired, compare IFRS and US GAAP rules, and examine the analysis implications for financial statement users.
Perhaps you’ve come across a tech startup with “big ideas,” but minimal physical assets. Most of its value might lie in intangible assets like code, brand, or proprietary algorithms. Analysts must understand how these intangible investments show up (or sometimes don’t) on the balance sheet and how that affects valuation and performance measurement.
Under International Financial Reporting Standards (IFRS), the accounting for intangible assets is guided primarily by IAS 38 – Intangible Assets. You might recall from earlier sections (such as the discussion on expense recognition in Chapter 2) that IFRS distinguishes between research costs and development costs:
• Research Phase: Costs in this earliest phase are expensed as incurred. The idea is that there’s no “probable future economic benefit” yet because the entity is still exploring feasibility.
• Development Phase: Once an entity surmounts the initial research stage and can demonstrate technical feasibility, intention to complete the asset, and evidence of future economic benefits, development costs can be capitalized.
This big IFRS split between research and development can be a game-changer. Let’s say you’re analyzing a pharmaceutical company that invests billions in R&D. Under IFRS, those projects that move from “possible” to “technically feasible” might allow capitalizing development costs. This can boost reported assets and reduce current period expenses.
These criteria ensure only intangible assets with probable (and measurable) future benefits are recognized on the balance sheet.
With US GAAP, the story is simpler in some respects for most R&D: it’s usually expensed as incurred. One exception is for certain software development costs:
• Software to Be Sold, Leased, or Marketed (ASC 985-20): After an entity establishes “technological feasibility,” subsequent development costs can be capitalized.
• Internal-Use Software (ASC 350-40): Similar idea. Certain development-stage costs for in-house software may be capitalized if certain conditions are met, like direct costs incurred after a software project has progressed beyond the preliminary stage.
Most other internally developed intangible assets—like brand creation or early-stage research—are expensed. So you often see a relatively conservative stance under US GAAP, meaning less intangible asset capitalization compared to IFRS, with the exception of software.
When an intangible is purchased from another party—think about buying a patent from an inventor—both IFRS and US GAAP generally require you to record it at its fair value on the acquisition date. Because there’s an actual transaction with a presumably reliable purchase price, it’s more straightforward to determine the intangible’s value.
These purchased intangibles might include:
• Patents
• Copyrights
• Trademarks
• Licenses
• Franchise agreements
If the intangible has a finite life (like a patent valid for 15 years), it is amortized over its useful life. Companies must assess impairment if there are indicators that its recoverable amount might be lower than its carrying amount on the books.
When intangible assets are obtained through a business merger or acquisition, IFRS (IFRS 3) and US GAAP (ASC 805) both require the acquirer to measure and recognize the identifiable intangible assets at fair value on the acquisition date. That means you might see intangible assets recognized on the balance sheet that the acquired company never had recorded, simply because it developed them internally and treated them as expenses.
Indefinite-lived intangibles—like certain trademarks—are not amortized but tested for impairment at least annually. Goodwill is also recognized in business combinations, although it’s not an identifiable intangible asset and is discussed separately (see Chapter 3.2 on Intangible Assets and Goodwill and Chapter 10 on Business Combinations).
Current IFRS and US GAAP guidelines classify intangibles into two categories:
• Finite-Lived Intangibles: Amortized over their useful life and tested for impairment.
• Indefinite-Lived Intangibles: Not amortized but tested for impairment at least annually (or when indicators arise).
For example, a patent often has a finite life corresponding to its legal protection term, while some brand names are deemed indefinite if they can exist perpetually and continue generating economic benefits.
Ah, the classic question: “Are they capitalizing intangible costs to inflate short-term earnings?” Potentially, yes. Companies that capitalize intangible-related expenditures (especially under IFRS) can show higher earnings in the current period by reducing R&D expense. But in future periods, they’ll take ongoing amortization charges—possibly leading to lower earnings.
From a portfolio manager’s or analyst’s standpoint, if you’re comparing two biotech companies—the first capitalizes development costs while the other expenses them—be aware that near-term profitability metrics might look skewed. Over multiple periods, the differences may even out, but short-term illusions are possible, which is exactly where your diligence as a CFA professional comes in.
We all love a good apples-to-apples comparison, but intangible asset recognition can throw a wrench into our ratio analyses. Some companies expense nearly all intangible-related costs under US GAAP. Others, under IFRS, might be capitalizing development costs.
• Profitability Ratios: Return on Assets (ROA), Return on Equity (ROE), and profit margins could all be affected by intangible capitalization practices.
• Leverage Ratios: Total assets might look higher for a capitalizing firm, while intangible-heavy companies might appear more leveraged if intangible assets are large but intangible intangible is intangible (pun intended!).
• Price-to-Book Ratios: If intangible assets are capitalized, book value is higher, possibly reducing the P/B ratio.
Capitalizing intangible assets offers short-term benefits but also sets the stage for possible impairment. If the intangible’s expected future benefits drop—due to technology obsolescence, for example—the company might be forced to recognize an impairment loss. This can create earnings volatility.
Picture a retail giant developing an in-house inventory management system. During the preliminary project stage, it expenses the brainstorming and planning. Once it’s decided the project is feasible and useful, direct coding and testing costs can be capitalized. Down the line, though, if the system becomes obsolete, they might need to write it down. Analysts have to watch that risk over time, especially if new technologies or competitor solutions overshadow the company’s proprietary system.
Let’s say we have PharmaX, a mid-sized pharmaceutical firm. They spend $50 million exploring a potential new treatment. During early-stage research, IFRS requires them to expense, say, $10 million in research costs. But then they identify a workable formula, prove it can be commercialized, and plan to finish development and eventually license the treatment. At that point, the remaining $40 million of development costs are capitalized, recognized as an intangible asset once IFRS criteria are met.
Initially, net income is lower because they expensed $10 million. But now they’re capitalizing $40 million, which will appear on the balance sheet. Over the drug’s useful life, maybe 10 years, the intangible asset is amortized. Analysts must keep an eye on these transitions because they alter the financial statement profile significantly.
Meanwhile, TechStartup Inc., operating under US GAAP, invests heavily in software for external sale. They pass the threshold of “technological feasibility,” so further coding and testing costs are capitalized. That intangible asset eventually shows up on the balance sheet at, hypothetically, $5 million. The intangible is amortized over, let’s say, three years as they sell the software. If the tech becomes outdated, they might record an impairment. Or if it thrives, the intangible might remain on the balance sheet until fully amortized.
Below is a simple Mermaid diagram illustrating how intangible assets (particularly internally developed) move through phases: from research/preliminary stage (often expensed) to development/capitalizable stage, then to ongoing amortization or impairment testing.
flowchart LR
A["Research <br/>Phase (Expensed)"] --> B["Development <br/>Phase (Capitalized)"]
B --> C["Completed Intangible <br/>Asset on Balance Sheet"]
C --> D["Amortization <br/>(Finite-Lived)"]
C --> E["Annual <br/>Impairment Testing"]
D --> F["Reduced Asset <br/>Value Over Time"]
E --> F
In practice, intangible accounting can feel more complex, but this diagram captures the high-level flow.
• Stay alert to management’s judgment: The line between research and development can be blurry at times.
• Compare intangible recognition policies across firms in the same industry: This helps you refine comparability.
• Adjust for intangible intensity: Some analysts add back expensed R&D to get a better read on enterprise value or economic returns.
• Evaluate relative intangible investment over time: A company with consistent intangible investment may reveal stable or growing innovative capacity.
• Rapid Technological Change: Sudden obsolescence can trigger large impairments.
• Unclear Useful Lives: Guessing a finite intangible’s useful life is tricky, especially for emerging technology or creative industries.
• Management Incentives: Short-term earnings pressure can lead to more (or fewer) capitalizations.
• Regulatory Divergence: The IFRS vs. US GAAP difference can hamper cross-border comparisons.
While intangible accounting becomes more intricate at advanced levels, a strong understanding now sets the foundation for future analysis. For instance, you’ll integrate intangible assets into pro forma statements (see Chapter 16) or factor intangible capital into advanced ratio analysis (Chapter 13). Stay on the lookout for intangible-heavy industries, as they often present questions on how intangible policy choices can influence balance sheets, earnings, and valuation metrics.
• IAS 38 – Intangible Assets: https://www.ifrs.org/issued-standards/list-of-standards/ias-38-intangible-assets/
• ASC 985-20 (Software—Costs of Software to Be Sold, Leased, or Marketed) and ASC 350-40 (Internal-Use Software): https://fasb.org/
• “Accounting for Intangibles” (CFA Institute) for deeper case examples and IFRS/US GAAP comparisons.
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