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There are some characteristics that legal intangibles are required to have, in order to be called legal intangibles. Both the U.S GAAP, and the IFRS, identify intangible assets in the same manner. Firstly, intangible assets are recognized when there is a future economic benefit involved from the asset, and when costs can reliably be measured. Legal intangibles are technically considered property, opposed to competitive intangibles, and can be defended in court. Legal intangibles include trade secrets like copyrights, patents, trade names, franchise licenses, and trademarks, but also goodwill. Legal intangibles are assets that are identifiable, but do not have a physical substance and are non-monetary.
2.1.1 Identification and separability
A legal intangible asset must be both identifiable and separable. This means that, it can be distinguished from goodwill, and it is created through legal or contractual rights. It also has to be separable, which means it can be separated from the entity that owns it, and can be sold, transferred, or licensed individually, or with a related contract, asset, or liability.
2.1.2. Limited or indefinite useful life
Intangible assets are accounted according to their expected useful life. Often, items like patents and copyrights have an identifiable life time, and these are amortized on a straight line basis according to their useful life time, until the value of the asset reaches zero. The length of the life time for these items is usually based on, either their legal, or economic life, whichever is shorter.
If however, the future cash flow benefits from the intangible asset cannot be foreseeable, the life time of the intangible asset is indefinite. As in the case of goodwill, it has to be assessed at least annually for impairment. If impairment is realized, the carrying cost of the asset is more than its fair value, and this difference is accounted for as a loss in the income statement.
Goodwill is created when, for example, a company is acquired, and the price is more than the fair value of net assets. On a side note, goodwill is never amortized.
2.2 U.S. GAAP
GAAP stands for generally accepted accounting principles, and is used by accountants as a framework of guidelines to help them prepare financial statements, records transactions, and summarize annual reports. Every country has their own set of generally accepted accounting principles. But, in this report we will be comparing the U.S.GAAP, which is, as the name states, used in the United States to provide their accountants with set of accounting principles. Because of the economical growth experienced by the U.S. in the last century, many U.S based companies have expanded their activities overseas, so the influence of the U.S GAAP has spread to many other countries than just the U.S.
2.2.1 SFAS No.142
In the U.S GAAP, set by the financial accounting standards board (FASB), statement number 142 includes the guidelines that concern goodwill, and other intangible assets. It was a replacement for the former Accounting Policies Board (APB) Opinion no. 17 Intangible Assets, and changed many accounting policies concerning intangible assets, especially goodwill.
The international financial reporting standards (IFRS) are a set of accounting principles set by the international accounting standards board (IASB). The IFRS were develop in order to have a globally accepted accounting standard, which could be used commonly as an accounting language across the globe. Already 117 countries permit the use of IFRS by their domestic companies, and many economically significant countries, like Canada and India, are on their way in adopting IFRS in the next couple of years.
2.3.1 IAS 38
In the international financial reporting standards, sections 38 of the international accounting standards (IAS 38) define how intangible assets are to be accounted for when using the IFRS.
IAS 38 contain all the information for intangible assets that are not found in other standards. It contains criteria on how to identify intangible assets, and how to identify internally generated assets from normal intangible assets. It also describes how to measure the useful life of the asset, and if to account for infinite(impairment) or definite(amortizing) useful life times of assets. Also, IAS 36 Impairment of Assets, is used when assets are not amortized but assessed for impairment.
3. Differences with GAAP & IFRS
The IFRS and U.S GAAP have some major differences in their accounting principles, but both International Accounting Standards Board and Financial Accounting Standards Board are seeking ways of converging the two different accounting standards.
The U.S. GAAP will probably have to make way for the IFRS in the near future, as in essence, the international financial reporting standards are designed to be much broader, and allow for a lot more interpretation, and in some ways are designed, in structure, against the U.S. GAAP.
A lot of effort has already been made in order to steer the whole of the world towards a common accounting standard, which could be shared and understood by all. Many of the developing countries are eager to welcome these new accounting policies, as it makes it easier for foreign investors to get financial data, which they can consider reliable, in order to invest in developing countries. Some countries face political resistance, China as an example, but it is also in they're best interest to adapt to the new standards, so they can even further fuel their economical growth.
3.1 Rules vs. principles
The fundamental difference between the U.S. GAAP and the IFRS is that, the IFRS has a principles-based approach, when the U.S GAAP has a rules-based approach. A more flexible set of principles can make it easier for more countries to adapt, but it also brings a lot of difficulties, when companies have more space to modify their data. The U.S GAAP is not just a guideline on how to report data, but specific rules on how to apply specific data. The IFRS is also more able to handle with the constant changes which happen in the business world, as it is more interpretable.
On the other hand, as the U.S. GAAP has a clear set of rules, it requires less explanation from the reporters to the auditors. In comparison, the auditors of the a report which has been prepared using IFRS, the auditor might be required to have special expertise in that area of industry, to which the report relates to.
3.2 Revaluation of intangible assets
A practical example of a difference between the U.S based GAAP, and IFRS, is the manner in which intangible assets can be reevaluated. According to IAS 38 the revaluation of intangible assets is permitted if the asset is traded in an active market. And active market need to fulfill three conditions, summarized by IASC Foundation staff, in a Summary of IAS 38:
" (a) the items traded in the market are homogeneous;
(b) willing buyers and sellers can normally be found at any time; and
(c) prices are available to the public "
Where as according to the U.S GAAP, revaluation of intangible assets is totally prohibited.
3.3 Research and development costs
When comparing internally generated intangible assets, the U.S GAAP and IFRS have some significant differences. IFRS separates the development phase and the research phase from each other. The research costs are expensed as they are incurred, and intangible assets that arise from research, are not recognized.
Development costs on the other had are capitalized, and intangible assets arising from development activities are recognized if they meet all of the conditions listed in IAS 38, which have been summarized by the IASC Foundation staff, in their Summary of the IAS 38 as follows:
"(a) the technical feasibility of completing the intangible asset so that it will be available for use or sale.
(b) its intention to complete the intangible asset and use or sell it.
(c) its ability to use or sell the intangible asset.
(d) 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.
(e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
(f) its ability to measure reliably the expenditure attributable to the intangible asset during its development. "
According to the U.S. GAAP, development and research costs are both expensed as they are incurred, unless there are specific rules that say otherwise. And as the U.S. GAAP is more a set of rules, compared to the "guidelines" provided by the IFRS, it has more specific rules on how to account for certain items. For example, computer software is this kind of exemption, and different rules apply according if the software is developed for internal use, or for outsiders. In the IAS 38, just the general criteria is used in the case of software.
Goodwill is in essence accounted for according to same rules, but some differences occur, for example with impairment of goodwill.
In the case of impairment, the U.S GAAP uses a two-step method of determine impairment. First, at a reporting unit level, goodwill is tested to see if the carrying value exceeds the fair value of the asset, and if this difference is recognized, impairment testing is initiated.
In IFRS, goodwill is always tested for impairment on a cash unit level, where carrying value is tested against recoverable amount.