A European example of an issue relating to the useful life of intangible assets
Here’s another of the issues arising from extracts of enforcement decisions issued in the past by the European Securities and Markets Authority (ESMA) (for more background see here); this is from their 13th edition:
- “The issuer is a listed company specialising in the distribution of photographic products and services. The issuer’s statement of financial position included an intangible asset described as an “externally acquired customer relationship”, which represented 7 % of total assets.
- The issuer changed its assessment of the useful life of this intangible asset from ‘finite’ to ‘indefinite’. The issuer argued that IAS 38 paragraph 88 requires an intangible asset to be considered as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. The issuer understood the lack of a foreseeable limit to mean the lack of a ‘predictable limit’. According to this view, the fact that there is no precisely determinable limit would suffice for the assessment of an intangible asset as having indefinite useful life.
- The issuer considered that an intangible asset has an indefinite useful life when it is impossible to foresee the period of its useful life and it argued that due to a number of factors (e.g., technological evolution, changing consumer behaviour), it had become impossible to foresee the useful life of the relationship with a consumer. In support of its argument, the issuer referred to IAS 38 paragraph 91 that states that the term ‘indefinite’ does not mean ‘infinite.'”
The enforcer (as ESMA likes to term it) disagreed with all this, taking the view that the change in the assessment of the useful life of the externally acquired customer relationship from ‘finite’ to ‘indefinite’ didn’t comply with the requirements of IAS 38. It points out: “Under IAS 38, an intangible asset has an indefinite useful life only if there is no ‘foreseeable’ limit (i.e. expected limit) to its useful life as e.g. in case of a brand name or a customer relationship with a corporate entity.” In this case, the summary soberly notes, “the customer relationship was with individuals and therefore there is by definition a time limit (namely the death of the customer).” It observes that IAS 28.BC65(a) says difficulties in accurately determining an intangible asset’s useful life don’t provide a basis for regarding that useful life as indefinite.
Grappling with the concepts
As much as anything, this example seems to illustrate the difficulty of grappling rationally with concepts of intangible assets, and therefore the risk of over- (or under-, depending how you look at it) thinking oneself into a hole. It should be basically obvious that an asset representing a customer relationship doesn’t carry indefinite value, and that its cash flow generating potential will fall away over time in one way or another. But because the asset is so difficult to articulate in the first place in common sense terms, it can sometimes be hard to conclude that anything about the area is at all obvious.
To the extent possible, the model set out in IAS 38 is actually largely a replica of the model set out in IAS 16 for property, plant and equipment, even using the same language in many spots. It’s hard to imagine anyone convincing themselves that (say) a piece of machinery, if in active use, doesn’t need to be depreciated (leaving aside the narrow situation indicated in IAS 16.52, where it can be demonstrated that an asset’s residual value exceeds its carrying amount). In that area of IFRS, because we’re generally more comfortable relating to such malleable notions, the application of depreciation is obvious, and the difficulty of measuring it is something to be taken in stride. But in a parallel situation with an intangible asset, such intuition can go out of the window.
It follows that most practitioners have probably experienced situations where (for instance) a preparer suggested recognizing an intangible asset that didn’t meet the recognition criteria of IAS 38, on the basis of a strategic (or intuitive) assessment of what certain expenditures represented, rather than a technical one. And while it’s often easy to say that a particular intangible asset is completely impaired, because whatever it represented is simply a dead line of activity, it can be much harder to derive reasonable cash flow projections for an intangible asset for which the carrying value is challenged, but not yet clearly extinguished. It’s not hard to see why some commentators still question the utility of recognizing intangible assets separately from goodwill, especially when the value that a particular entity carries on its balance sheet as intangible assets may in no way represent all the value represented by (say) the brands and intellectual property it’s developed internally over the years. As much as with any aspect of the financial statements, whatever fair presentation we achieve here is strictly defined with reference to the rules of the game. All the more reason then, not to flagrantly screw those up.
The opinions expressed are solely those of the author