Internally-generated intangible assets – magical thinking

Another European example of issues relating to internally-generated 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 12th edition:

  • “The issuer is a provider of specialist recruitment services. In its 2009 financial statements, the statement of financial position included ‘Candidate database’, an internally generated intangible asset related to identifying and recruiting the candidates.
  • The note on disclosure of critical accounting estimates explained that the asset represents the cost of the database of candidates looking for international permanent placements based on the judgement that the asset satisfies the criteria set out in IAS 38 for the recognition of an internally generated intangible asset.
  • The accounting policy disclosure specified that costs directly associated with the production of the candidate database are recognised as intangible assets and that direct costs include employee costs and external costs incurred in identifying and recruiting the candidates.
  • The issuer confirmed to the enforcer that the database contained information for international candidates and that most of the recognized costs related to collection of information about individual candidates. Increments to the cost of the asset were represented by the costs of collecting and processing batches of candidate information. System development costs represented a small proportion of the costs of the intangible asset. The enforcer also found that travel costs were capitalized.
  • Paragraph 63 of IAS 38 prohibits internally generated brands, mastheads, publishing titles, customer lists and items similar in substance from being recognised as intangible assets as expenditure on such items cannot be distinguished from the cost of developing the business as a whole.
  • The issuer put forward several arguments in support of the accounting treatment adopted:
  1. As the candidate database contained detailed information in respect of individuals that the company wished to place in employment, rather than information about the organizations (the customers) into which the candidates would be placed, the prohibition in paragraph 63 of IAS 38 in respect of customer lists would not apply.
  2. The costs of developing the database were very specific in nature and, therefore, distinguishable from the costs of developing the business as a whole, unlike the types of expenditure listed in paragraph 63 of IAS 38. The issuer also explained that the process of procuring an ‘international candidate’ might take up to 4 years to complete.”

The enforcer (as ESMA likes to term it) disagreed with treating the database as an asset, regarding it as being similar in substance to a customer list, consisting of information accumulated for the purpose of securing customer contracts. In addition: “The size and extent of reliance on the database in the issuer’s operations, and the fact that most of the database costs related to collecting and processing information for individual candidates on a continuing basis, indicated that the candidate database costs were not distinguishable from the costs of developing the business as a whole.”

This seems to have been an example of somewhat magical thinking on the issuer’s part, reflecting the same point I made here about the risk of regarding IAS 38 as a matter of technicalities rather than of substance. That is, it sounds from the description provided (which of course is highly summarized) as if the issuer spent more time thinking about how to differentiate itself from the explicit prohibition attaching to customer lists than on considering the specific characteristics of its candidate database, relative to the standard’s basic principles. One can see the broad point, that the database represented a sort of focal point for the company’s overall skills and knowledge; consequently, all kinds of expenditures could be regarded as attaching to that asset. But IAS 38.62 says that the kinds of costs that might be attributed to internally-generated intangible assets are “salary and other expenditure incurred in securing copyrights or licences or developing computer software” – by no means an exhaustive list, but clearly seeking to focus on the incremental costs of the asset itself rather than those of the knowledge or value processed within or circulating around it. In this regard, an intangible asset is sometimes a smaller and more limited thing than some might hope.

In addition, the costs of an internally-generated asset are those of creating, producing and preparing the asset to be capable of operating in the manner intended by management, not those of making it really good, so to speak. Anyway, the broader point of all this is that the costs of internally generated intangible assets treated as assets are likely to be unusually visible to readers, and to regulators in particular, and probably carry a disproportionate likelihood of attracting a comment letter. Perhaps the same should be true when issuers are potentially over-conservative, and expense the costs of developing an intangible item that could and should be recognized an asset – it’s not meant to be a matter of choice after all. But it’s hard to imagine regulators expending much effort on (for example) arguing that a particular expensed cost should have been assessed as generating probable future economic benefits, if the issuer insists otherwise…

The opinions expressed are solely those of the author

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