New Accounting Practices Impact Intangible Assets
Generally Accepted Accounting Practice in South Africa is being amended in the way in which it deals with intangible assets and intellectual property. The amendments are aimed at bringing Generally Accepted Accounting Practice in line with International Financial Reporting Standards (IFRS).
One of the areas where there has been a substantial change to the way in which intangible assets and intellectual property are dealt with is in relation to transactions involving the sale of a business. Legal requirements dictate that the sale of business agreement must define clearly the purchase price that is being paid for the business and the group of assets that are being sold. These assets can be diverse, such as plant and equipment, buildings, fixtures and fittings, systems and software, contracts, stock-in-trade, accounts receivable and intangible assets. It is important to apportion the purchase price amongst the various classes of assets, as the way in which the allocation is made will have tax consequences for the purchaser of the business.
Difficulties arise when the allocation is to be made to goodwill and intangible assets. Terms such as "intangible assets", "goodwill", "intellectual property" and "intellectual capital" have often been used interchangeably. This is problematic though as intangible assets, intellectual capital and intellectual property each have distinct meanings. To use these terms without a clear understanding of their meaning can result in unexpected tax consequences. The South African Revenue Service is certainly alive to the difference in meaning between these terms and we have had to advise a number of clients where SARS has questioned the misallocation of value as a result of these terms being used in a loose and inappropriate way.
Intangible assets include a wide and diverse range of assets, a portion of which is referred to as Intellectual Capital.
Intellectual Capital is the knowledge embodied in human, organisational and customer/supplier capital.
Within the group of assets referred to as Intellectual Capital there is a sub-set that is referred to as Intellectual Assets.
Intellectual Assets are the codified and recorded knowledge derived from intellectual capital with value potential.
Narrowing the focus further, Intellectual Property is a sub-set of Intellectual Assets.
Intellectual Property is often defined as legally protected Intellectual Assets.
In other words, Intellectual Property is a specific class of assets that falls within the broader definition of Intellectual Assets, which is in turn a sub-category of Intellectual Capital.
Historically intangible assets, intellectual capital, intellectual assets and intellectual property have been bundled together and referred to as goodwill. However, with many businesses being established almost entirely on intangible assets (as opposed to fixed assets) it has become necessary to allocate value within the various categories of intangible assets as a majority of the value of the business is not reported adequately under existing accounting standards.
In some instances it has become necessary to break these broad categories of intangible assets down further. For example, there are many technology companies where it would be superficial to allocate value to intellectual property as a single asset class. In some technology companies it may be important to differentiate between various types of intellectual property, such as patents, trade marks, registered designs, copyright, plant breeders rights, domain name registrations etc. Under the Financial Standards Reporting in the United States it is sometimes even necessary to break this allocation down even further into intellectual property assets that are owned and those that are licensed. The detailed analysis of intellectual property rights is necessary in certain circumstances where different types of intellectual property have different lives. This has consequences in the way in which these assets are treated. For example, patents have a maximum life of twenty years while trade marks can effectively be registered in perpetuity, subject to renewal fees being paid.
Returning to the amendments that have been made to Generally Accepted Accounting Practice, where intangible assets are purchased as part of a transaction involving the sale of a business, the intangible assets must now be recognized separately from goodwill. This only applies where the intangible assets are:
controlled by the business;
will derive future economic benefits for the business; and
the fair market value of these assets can be measured reliably.
In order to satisfy these requirements it then becomes necessary to understand the nature of the different types of intangible assets, human capital, intellectual assets and intellectual property. As has already been mentioned, in some instances it may be necessary to focus this analysis in on different types of intellectual property, such as patents, trade marks, copyrights, registered designs etc.
The amendments that have been made to Generally Accepted Accounting Practice have also impacted on the accounting treatment of goodwill and intangible assets. In the past goodwill was amortised over the useful life of the goodwill. The changes that have been made mean that goodwill is now treated at cost and is then assessed for impairment on an annual basis. Where there has been an impairment or decrease in the value of the goodwill and intangible assets, this will be charged against the value of the goodwill. By contrast, where there may have been an increase, or negative impairment, of the goodwill and intangible assets, this is now recognised as a gain in the income statement for the period.
In conclusion, it is now necessary to analyse the intangible assets of the business and where the value lies within the various types of intangible assets. To treat this in a superficial way will result in unforeseen and perhaps detrimental tax consequences.