Question

Intangible assets are resources of a company which have potential value beyond the period of expenditure, yet such resources lack physical substance. Discuss the manner in which such expenditures are accounted for in accordance with U.S. GAAP. One areas where international convergence of accounting standards has not occurred is in the area of accounting for internally generated intangibles. Discuss both FASB's and IASB's points of view on the matter.

A company's income tax expense calculated in accordance with U.S. GAAP often differs from a company's income tax liability payable to governmental agencies. Discuss this incongruity, particularly permanent and temporary differences in GAAP financial income and taxable income.

Answer 1

Intangible Assets

Intangible asset is an asset that is not physical in nature. Goodwill, brand recognition and intellectual property, such as patents, trademarks, and copyrights, are all intangible assets. Intangible assets exist in opposition to tangible assets, which include land, vehicles, equipment, and inventorybecause of its nonphysical nature. An intangible asset is an asset that lacks physical substance; in contrast to physical assets, such as machinery and buildings, and financial assets such as government securities. An intangible asset is usually very hard to evaluate. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names.Intangible assets which have been acquired by a third party are recorded on the balance sheet at their purchase price.In order to have value, intangible assets should generate some measurable amount of economic benefit to the owner, such as incremental revenues or earnings (pricing, volume, and better delivery, among others), cost savings (process economies and marketing cost savings), and increased market share or visibility.

Both FASB and the IASB also have a standard that deals with intangible assets: FASB’s is SFAS 142 Goodwill and Other Intangible Assets , IASB’s is IAS 38 Intangible Assets. These each state that only certain internally generated intangible assets should be recognized as such. They then specifically exclude brands, mastheads, publishing titles, customer lists and items similar in substance. The contradiction is that the business combination standards (SFAS 141; IFRS 3) not only permit, but encourage recognition of assets such as brands (trademarks) while the intangible asset standards (SFAS 142; IAS 38) expressly forbid recognition of the same class of assets because it has not been bought.

An examination of the requirements that cause this difference exposes a level of sophistication in the business combinations standards that had not been reached when the intangible assets standards were drafted. The business combination standards recognize acquired intangible assets, including brands, as cash-generating units that can be identified by a fair value measurement whereas, in the older standards, internally generated intangible assets, specifically brands, must be measured according to their historical cost and this cannot be separated from the costs of developing the business over all.

FASB's Point of view

Financial Accounting Standards Board.Established in 1973, the Financial Accounting Standards Board (FASB) is the independent, private-sector, not-for-profit organization based in Norwalk, Connecticut, that establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow Generally Accepted Accounting Principles (GAAP).The FASB derives its authority to set accounting standards from the U.S. Securities and Exchange Commission (SEC).The FASB's mission is achieved through an open and independent process that encourages broad participation from all stakeholders and objectively considers and analyzes all their views.

From the definition of intangible assets by FASB, it is worth pointing out these assets’ long life character, their immaterial nature and, the main difference with IASB’ statements: their non-financial character. The term non-financial is wider than the term non- monetary and it should be used to avoid inclusions within these resources that, because of the lack of physical substance, are not considered immaterial assets.Identifiability is established as our first criterion, hence distinguishing twocategories of intangible assets: identifiable, which are those whose future economic benefits can be clearly distinguished (separable or with legal right upon them) and unidentifiable which constitute the goodwill.The second criterion regards the origin of the assets, that is, the way they were incorporated to the company’s estate. Within each of these categories, we distinguish between intangible assets acquired in business combinations (or external) and intangible assets created by the company itself (internal).

The different intangible elements will be grouped according to the nature and content of the corresponding investments. Within identifiable intangible assets (whether acquired or developed internally) we find: research and development expenditures, industrial property (patents, trademarks, utility models, business names and signs), copyright intellectual property, transfer rights, computer applications, franchises, etc. Unidentifiable intangible assets from the acquisition of another company are called acquired goodwill or external goodwill or simply goodwill. These assets can be recognized in the balance sheet of the entity and consist on elements such as customers, business name, business location, market share, commercial competition level, organization structure, prestige, creativity, human resources, good management team, efficient staff and commercial channels. In contrast, the internally generated goodwill (self-generated goodwill or internal goodwill) would not meet the recognition requirements and would not be considered an asset in the entity’s balance.Moreover, intangible assets can be grouped into visible and hidden, depending on whether they are accountably recognised. We call visible intangible assets those that comply with the recognition requirements (such as the possibility of reliable measurement), therefore they are recognised as assets in the entities’ balance. These are regulated by the different accounting regulations, although as previously mentioned, there is no single, unanimously accepted, treatment. On the contrary, hidden intangible assets are those that cannot be recognised as assets according to current accounting regulations and therefore, at present they do not appear in balance sheets. Within hidden intangible assets we find internally generated unidentifiable intangible assets. Finally, note that although most of existing literature on models of intellectual capital measurement equal intellectual capital with intellectual assets,

IASB's point of view

The International Accounting Standards Board (IASB) is an independent, private-sector body that develops and approves International Financial Reporting Standards (IFRSs). The IASB operates under the oversight of the IFRS Foundation.The IASB has overall responsibility for all technical matters, which include preparing and issuing IFRSs; preparation, and issuance, of exposure drafts; setting up procedures for reviewing comments received on documents that have been published for comment; and issuing bases for conclusions.Though both the IASB and the FASB have the goal of establishing accounting and financial reporting standards, the FASB focuses on accounting standards in the United States, while the IASB focuses on global standards.

IAS 38 Intangible Assets develops its case in the following words:

• It is probable that the expected future economic benefits that are attributable to the asset will flow to the entity’,

• The cost of the asset can be measured reliably’.

What distinguishes this method of measurement from the one that is to be found in the later standards is the word ‘cost’.

• ‘An intangible asset shall be measured initially at cost’.

• Internally generated brands … shall not be recognized as intangible assets’.

The reason for this is:

• ‘Expenditure on internally generated brands … cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are not recognized as intangible assets’.

Differences in GAAP financial income and taxable income.

The taxable income is the amount of income a company must pay taxes on, while pre-tax financial income is the amount a company makes before taxes are factored in.Taxable income is that bottom-line number you report on the appropriate tax return.Financial income on the income statement. All earned and recognizable revenue minus all allowable expenses per GAAP gives you income before taxes. Income before taxes gives users of the financial statements a clear picture on how well the company performs during the financial period. After all, taxes are a somewhat involuntary disbursement of income instead of an accounting event that causes income.But thetaxable income to include and which expenses are allowable to reduce the total income. Taxable income is that bottom-line number you report on the appropriate tax return.Most companies report different financial and taxable income, for this reason: Accounting management prepares the financial books using a full accrual method but, for the tax return, uses a modified cash method, which uses some elements of GAAP and some elements of the cash method. For example, the company may accelerate asset depreciation.The gap between book and tax income generally results from three categories of differences: temporary, permanent, and loss carryforwards/carrybacks.