What Are Intangible Assets Accounting Essay

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it is becoming very clear that intangible assets have a major role in defining the growth of a company since the search for adding value always leads to calculating and identifying these assets, increased business competition and the adaptation on new information technologies increase the importance of intangibles as the major driving force of corporate value ( Leo, 2011).

Hall (2001) also explains the discrepancies between the stock market value of the firm and the value recorded by the firm itself. This being due to not recognizing the cash flows, which are generated by the intangible assets, thus affect firm's future earning power. In this report first explains what intangibles are as per the major accounting standards, this report reflects the handling of the intangible assets of the companies which are present in the annual financial report. This report reviews the annual financial reports of Downer EDI Limited and Boart Longyear Limited from 2010 to 2012. These two companies are part of Top 100 companies in the Australian Stock Exchange. Downer provides engineering and infrastructure management services to the public and private transport, energy, infrastructure, communications and resource sectors while Boart Longyear is a global mineral exploration company. The company's annual reports show us the policies and standards followed by these companies in recognizing and measuring intangible assets.

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First we have listed the intangible assets which are present in company's annual report. We have shown the example of major accounting treatments of the intangible assets by the two companies. The acquiring of intangible assets by the two companies in the year 2010, then the amortization of intangible assets in the year 2011, at the end impairment of goodwill by the two companies in the year 2012.

We have compared and commented on the differences of book value at the reporting dates with the market value at the same date. We have explained the differences between the book value and the market values and how they can be related to the measurement and recognition of their intangible assets. In the end we explained that how these differences could have an effect on the usefulness of general purpose financial reports.

What are intangible Assets:

According to the AASB 138 standards defined that "intangible asset is an identifiable non-monetary item without physical substance". Company can recognize intangible assets only if the item satisfies the recognition criteria in relation with AASB 138 and the expenditure on intangible asset meets the capitalization threshold that is material to the entity. The elements of identifiability control over a resource and existence of future economic benefits must be met by the entity to recognize the intangible assets. After the recognition of intangible asset at cost, the entity must choose for each class of intangible asset whether to measure the assets using the cost model or revaluation model. Revaluation model can only be selected if fair value can be determined in an active market .But as IAS 38 notes that it is uncommon for an active market to exist for intangible assets.

The following table shows the intangible assets recorded in the books of downer Edi Ltd and the Boart longyear Ltd for the years 2010, 2011 and 2012.

Downer EDI Ltd

Boart Longyear Ltd

Goodwill

Goodwill

Intellectual property

Trademarks and trade names

Software

Contractual customer relationships

Patents

Research and development assets

Software

List of Intangible Assets

The information given below shows the example of major accounting treatments of the intangible assets by the two companies. The acquiring of intangible assets by the two companies in the year 2010, then the amortization of intangible assets in the year 2011, at the end impairment of goodwill by the two companies in the year 2012.

Acquisition:

Companies can recognize intangibles internally or externally as per IAS38 standards. Both Downer and Boart follow these strict standards in acquiring their intangible assets. Downer's intangible assets are recognized externally. In the year 2010 Downer added 25.4 million to its intangible assets in the form of goodwill, this was through business acquisitions in which it paid this amount in addition to the fair value of the acquired businesses. Downer also added another 3.9 million by purchasing intellectual property and software to its intangibles assets because they clearly meet the definition of intangible assets as per the AASB 138 standards.

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While Boart Longyear Limited clearly states the accounting policies it follows on how to recognise and treat different intangibles assets, its accounting notes do not give much detail on how it recognised or acquired its intangible assets. For example, it states that the goodwill moved up by 20.4 million USD but no details on how this movement occurred. It also added 25.5 million USD to its other intangible assets such as patents, trademarks, software and development asset. Development asset is the only internally generated intangible asset among Boart's intangibles. A development asset can only be reported in the accounting books only if it meets the six conditions set by the IFRS.

Amortization:

Amortization is systematic allocation of the depreciable amount of intangible assets over its useful life. AASB 138 states that amortization shall begin when asset is available for use that is, when it is location and condition necessary of it to be capable of operating in the manner intended by the management. Amortization shall cease at the earlier of the date that the asset is classified as held for sale in accordance with the AASB 5 and the date when the asset is derecognized. In the year 2011 downer amortize its intellectual property and software by 2.4 million Aud.

While boart long year Ltd amortized all of its intangibles namely trademarks, patents, customer relationships, research and development assets and software by 9.128 million US$. In these three years goodwill was never amortize by the two companies which is in accordance to the accounting principles.

Impairment:

Under IFRS, the standards of IAS 36 provide a series of accounting treatments about impairment of goodwill. For Downer's company, goodwill has been allocated to individual cash-generating units (CGUs) for impairment assessing. Moreover, the carrying value of goodwill is tested annually at reporting date or whenever there is an existence of impairment indicator. The company determines to use a comparison of the CGUs' carrying amount, including goodwill, to its recoverable amount based on value in use of the assets. The Downer Asia has impaired by $9.3 million due to increased competition in other Asia operators and has not sufficient work to support the value of goodwill in the entity, whereas CPG Australia has inferior performance on operational work by impairment goodwill by $8.7 million in the 2012. However, Boart Longyear Limited has similar process on impairment testing. With regard to geographic area, the carrying value of goodwill is calculated in CGUs and impaired in an annual basis at 31 October or when there is an indication, then written down to recoverable amount. Value in use is used to calculate recoverable amount by using projected cash flows based on the three years strategic plan of the company. In 2012, the Boart has incurred a total of $6.839 million impairment loss due to underperformed of a subsidiary and restructure of infrastructure business and deprivation of non-mining environment.

The Gap between Market value and the Book Value:

The following table shows the market value and the book value at the same dates, and it also shows the market to book value ratio of the two companies:

Downer EDI Ltd

Year

Total Equity

Total shares

Book value

Market value

Market to Book ratio

2010

1242851000

336582351

3.69

3.51

0.95

2011

1442385000

429100296

3.36

3.76

1.11

2012

1617700000

429100296

3.76

3.06

0.81

Reference: Downer EDI Ltd Annual report year 2010, 2011, 2012.

Boart Longyear Ltd

Year

Total Equity

Total shares

Book value

Market value

Market to Book ratio

2010

1059969000

457129000

2.31

2.80

1.21

2011

1134440000

455755000

2.48

4.06

1.64

2012

1135417000

454710000

2.49

2.72

1.10

Reference: Boart longyear Ltd Annual report year 2010, 2011, 2012.

Before explaining the differences between the book and market value we need to know how intangible assets impact the prices of a company in a stock market. Since both tangible assets and intangible assets generate an expected stream of cash flows, a rational stock market should recognize the value of intangible assets just as it values firms' property, plant and equipment. Indeed, there are various studies providing theoretical and empirical evidence that firms' intangible assets are positively valued in the stock market. Among others, McCarthy and Schneider (1995) presents a significant positive relationship between goodwill and the market value of a firm; Choi, Kwon and Lobo (2000) concludes that the level of intangible assets reported on the balance sheet is positively related to market valuation of firms' equity; Berk, Green and Naik (1999) stresses the importance of growth options (intangible assets) versus assets-in-place in affecting stock market value.

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For Downer EDI Ltd, their book value is higher than market value which results in their market-to-book ratio less than one in 2010 & 2012. The possible reason is because they obtained more increasing share in many intangible assets. According to Beattie and Thomson (2005), they concluded that a low M/B ratio can be contributed by the company focused on reporting too much of unimportant assets. Also, they stated that the importance of intellectual capital is overstated as it isn't in great significance in the value creation process (Beattie & Thomson 2005).

For Boart longyear Ltd, their market value is greater than the book value which results in their market to book ratio being higher than one in 2010, 2011 & 2012. The reason for higher market value could be the high impairment cost on intangible assets. The other possible reason could be not recognizing software in their book value which Downer Edi Ltd has recognized.

The high market value added is usually affiliated with the growing importance of intangible assets (LEV 201, which can be further divided into generative and commercially exploitable intangibles ( Ahonen 2000) the generative intangible which include human capital internal and external structures are also called intellectual capital ( bontis 2001,2002) the goal of business is the long term productivity of the invested capital. Financial market expectations of the company economic performance are reflected the market value of the company, however financial market base their estimates on limited information, because they use mainly information on leadership management intangible assets, even in the best case quit scarce information on intangible assets ( Lev, 2001; hussi, 2001; Lee, 2001)

General Purpose financial Statement:

On reviewing the annual reports of downer and Boart Ltd we can assure that the difference between the book value and the market value is very minimal, in comparison to the most of the companies which have got substantial differences, one main reason being not recognizing intangibles (Gu and Lev, 2005). The principal reason that published financial statements do not report intangible asset values is because, measuring the value of these assets is subjective and is prone to measurement errors (Lous and Sougiannias, 1996; Gaum et al., 2000; Taylor, 2001; Upton, 2001; Lev, 2001). Intangible assets do not fit the definition of an "accounting asset" and reporting their monetary worth is likely to provide unreliable information to investors. But, regardless of whether such values are reported in published financial statements or not, investors do seem to consider the strength of these assets when making investment decisions. For example, a few years ago, when Dell Corp. implemented a well-working supply chain system, the markets recognized the intangible value of the supply chain to Dell by making adjustments to the market value of Dell's stocks (Schwartz, 2000).

Analysts and others caution that market capitalization of a firm's stock is not a true reflection of a firm's intangible asset values and investors must use prudence while using such subjective values (Gu and Lev, 2005).

Conclusion:

To conclude the above information we understand that the quality of financial information has been improved by adopting the various guide line given by the governing bodies such as IFRS, AASB etc. But these guide lines have not resolved the problems of how to measure and report intangible assets (Scholz, 2001). The fundamental idea behind measuring intangibles is a wish to explore the results and effectiveness of the different development projects undertaken. The measurement of intangibles is highly company-specific. Successful companies not only posses all kind of intangibles but always have a relative emphasis on type on intangibles which get supports from other intangibles and tangibles assets. By comparing the book and market value of the two companies we have found that intangibles are one of the major drives in accessing these values. Therefore there is a realization there that the governing bodies should come up be a clear reporting frame work for intangible which is both relevant and reliable to companies and the user of the general purpose annual reports, which could help both in better judgment and decision making.