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1.1 Capitalisation of internal development costs

Reference to standard: IAS 38 para 57
Reference to standing text: 21.32
Background
A pharmaceutical entity is developing a vaccine for HIV that has successfully completed Phases I and II of clinical testing. The drug is now in Phase III of clinical testing. Management still has significant concerns about securing regulatory approval and it has not started manufacturing or marketing the vaccine.
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally,
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
Should management start capitalising development costs at this point?
Solution
No, management should not capitalise the subsequent development costs, because the project has not met all of the capitalisation criteria. There is no definitive starting point for the capitalisation of internal development costs. Management must use its judgement, based on the facts and circumstances of each project. However, a strong indication that an entity has met all of the above criteria arises when it obtains regulatory approval. It is the clearest point that the technical feasibility of completing the asset is proven [IAS 38 para 57(a)] and this is the most difficult criterion to demonstrate. Filing for obtaining regulatory approval is also sometimes considered the point that all relevant criteria, including technical feasibility, are considered to be met. The technical feasibility of the project is not yet proven in the above scenario.

1.2 Capitalisation of internal development costs when regulatory approval has been obtained in a similar market – scenario 1

Reference to standard: IAS 38 para 57
Reference to standing text: 21.32
Background
A pharmaceutical entity has obtained regulatory approval for a new respiratory drug in country A. It is now progressing through the additional development procedures and clinical trials necessary to gain approval in another country B.
Management believes that achieving regulatory approval in this secondary market is a formality. Mutual recognition treaties and past experience show that country B’s authorities rarely refuse approval for a new drug that has been approved in country A.
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally.
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
Can the development costs be capitalised?
Solution
The company can capitalise any additional development costs if it judges that the development criteria have been met. The company has judged that registration is highly probable and there are likely to be low barriers to obtaining regulatory approval, so it is likely to be technically feasible.

1.3 Capitalisation of internal development costs when regulatory approval has been obtained in a similar market – scenario 2

Reference to standard: IAS 38 para 57
Reference to standing text: 21.32
Background
A pharmaceutical entity has obtained regulatory approval for a new AIDS drug in country A and is progressing through the additional development procedures necessary to gain approval in country B.
Experience shows that significant additional clinical trials will be necessary to meet country B’s regulatory approval requirements. Some drugs accepted in country A have not been accepted for sale in country B, even after additional clinical trials.
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally.
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
Can the development costs be capitalised?
Solution
The company should not capitalise additional development expenditure. It cannot demonstrate that it has met the criterion of technical feasibility, because registration in another market requires significant further clinical trials. Approval in one market does not necessarily predict approval in the other.

1.4 Examples of development costs that can be capitalised

Reference to standard: IAS 38 para 57, IAS 38 para 8
Reference to standing text: 21.32, 21.25
Background
A laboratory is developing a drug to cure SARS. Management has determined that it meets the criteria in paragraph 57 of IAS 38, and that certain development costs must therefore be capitalised, because regulatory approval has been obtained. Management is unsure about what costs to include.
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally.
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. [IAS 38 para 8].
What kinds of expenditure can be considered development costs in the pharmaceutical industry?
Solution
Management should consider the following development costs, assuming that the criteria for capitalising development costs have been met [IAS 38 para 57]:
  • employee benefits for personnel involved in the investigation and trials, including employee benefits for dedicated internal employees;
  • directly attributable costs, such as fees to transfer a legal right and the amortisation of patents and licences that are used to generate the asset;
  • overheads that are directly attributable to developing the asset and that can be allocated on a reasonable and consistent basis;
  • allocation of depreciation of property, plant and equipment (ppe) or rent;
  • legal costs incurred in presentations to authorities;
  • design, construction and testing of pre-production prototypes and models; and
  • design, construction and operation of a pilot plant that is not of an economically feasible scale for commercial production, including directly attributable wages and salaries.

1.5 Capitalisation of development costs for generics

Reference to standard: IAS 38 para 57
Reference to standing text: 21.32
Background
A pharmaceutical entity is developing a generic version of a painkiller that has been sold in the market by another company for many years. The technical feasibility of the asset has already been established, because it is a generic version of a product that has already been approved, and its chemical equivalence has been demonstrated. The lawyers advising the entity do not anticipate that any significant difficulties will delay the process of obtaining commercial regulatory approval. (The scenario assumes that the other conditions in paragraph 57 of IAS 38 can be satisfied).
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally.
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
Can management capitalise the development costs at this point?
Solution
There is no definitive starting point for capitalisation. Management should use its judgement, based on the facts and circumstances of each development project. Regulatory approval is deemed probable in this scenario, so management can start capitalising internal development costs. [IAS 38 para 57]. It might still be appropriate to expense the costs if there are uncertainties about whether the product will be commercially successful.

1.6 Capitalisation of development costs for biosimilars

Reference to standard: IAS 38 para 57
Reference to standing text: 21.32
Background
A pharmaceutical manufacturer is developing a biosimilar product and has submitted its application to the FDA. The application included robust analytical studies and data comparing the proposed product to the existing FDA-approved reference product to demonstrate biosimilarity. The FDA has reviewed the product’s structural and functional characterisations and requested the manufacturer to move forward with comparative Phase I clinical studies. Management does not anticipate any significant difficulties with clinical trials.
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally.
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
Should management start capitalising development costs at this point?
Solution
No, management should not capitalise additional development expenditure, because the product has not met all of the capitalisation criteria. It cannot demonstrate that it has met the criterion of technical feasibility. The abbreviated pathway for biological products does not mean that a lower approval standard is applied to biosimilar or interchangeable products. The manufacturer must still demonstrate that the product is biosimilar to the reference product and complete the requested Phase I, and later Phase III, clinical trials to support approval.
There is no definitive starting point for the capitalisation of internal development costs. Management must use its judgement, based on the facts and circumstances of each product. However, a strong indication that an entity has met all of the above criteria arises when it obtains regulatory approval of the biosimilar product. It is the clearest point that the technical feasibility of completing the asset is proven  [IAS 38 para 57(a)]. This is the most difficult criterion to demonstrate.

1.7 Accounting for marketing expenditure once development criteria are met

Reference to standard: IAS 38 para 66, IAS 38 para 67
Reference to standing text: 21.61, 21.64
Background
Pharmaceutical entity MagicCure has obtained regulatory approval for a new respiratory drug. MagicCure determined that the development criteria were met when it received regulatory approval. MagicCure is now incurring expenditure to educate its sales force and perform market research.
Relevant guidance
Development costs are capitalised as an intangible asset if the criteria specified in IAS 38 are met.
Capitalisable costs are all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by management. [IAS 38 para 66].
Selling, administration, general overheads, inefficiencies and training cannot be capitalised as part of an intangible asset. [IAS 38 para 67].
Should the management of MagicCure capitalise these costs?
Solution
MagicCure should expense sales and marketing expenditure, such as training a sales force or performing market research. This type of expenditure does not create, produce or prepare the asset for its intended use. Expenditure on training staff, selling and administration should not be capitalised. [IAS 38 para 67].

1.8 Accounting for development expenditure once capitalisation criteria are met

Reference to standard: IAS 38 para 57, IAS 38 para 66
Reference to standing text: 21.32, 21.61
Background
Pharmaceutical entity Delta has determined that it has met the six criteria for capitalisation for a vaccine delivery device. It is continuing expenditure on the device to add new functionality. The development of this device will require new regulatory approval.
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally.
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
Capitalised costs are all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by management. [IAS 38 para 66].
Should the management of Delta capitalise these costs?
Solution
Delta should not capitalise the expenditure that it incurs to add new functionality, because new functionality will require filing for new regulatory approval. This requirement implies that technical feasibility of the modified device has not been achieved.

1.9 Development of alternative indications

Reference to standard: IAS 38 para 57
Reference to standing text: 21.32
Background
Pharmaceutical entity Arts Pharma markets a drug approved for use as a painkiller. Recent information shows that the drug might also be effective in the treatment of cancer. Arts has commenced additional development procedures necessary to gain approval for this indication.
Relevant guidance
Development costs are capitalised as an intangible asset if all of the following criteria are met [IAS 38 para 57]:
  1. The technical feasibility of completing the asset so that it will be available for use or sale.
  2. The intention to complete the asset and use or sell it.
  3. The ability to use or sell the asset.
  4. The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally.
  5. The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  6. The ability to measure reliably the expenditure attributable to the intangible asset.
When should management start capitalising the development costs relating to alternative indications?
Solution
Arts should begin capitalisation of development costs as soon as the criteria in paragraph 57 of IAS 38 are met. Entities involved in developing new drugs or vaccines usually expense development expenditure before regulatory approval. There is no definitive starting point for capitalising development costs of alternative indications. Management must use its judgement, based on the facts and circumstances of each project.
Arts must determine whether the existing approval indicates that technical feasibility has been achieved, to assess if capitalisation is required earlier than achieving regulatory approval for the alternative indication.
Management should consider, amongst other factors:
  • the risks associated with demonstrating effectiveness of the new indication;
  • whether a significantly different dosage might be needed for the other indication (potentially requiring new side effect studies); and
  • whether the new indication will target a different group of patients (for example, children versus adults).
If these considerations indicate that the uncertainties are comparable to a new drug, and that commercialisation is substantially dependent on regulatory approval, the entity should not begin to capitalise development costs prior to achieving regulatory approval.

1.10 Costs incurred for performance comparisons

Reference to standard: IAS 38 para 8, IAS 38 para 69
Reference to standing text: 21.25, 21.35
Background
Pharmaceutical entity Van Gogh Ltd has obtained regulatory approval for its new antidepressant drug and has started commercialisation. Van Gogh is now undertaking studies to verify the advantages of its drug over competing drugs already on the market. These studies will support Van Gogh’s sales efforts. These studies are not required as a condition for regulatory approval.
Relevant guidance
Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. [IAS 38 para 8].
The cost of an internally generated intangible asset comprises all directly attributable costs incurred to create, produce and prepare the asset for its intended use. [IAS 38 para 66]. Expenditure might be incurred to provide future economic benefits to an entity, but no intangible asset or other asset is created that can be recognised. This includes, for example, expenditure on advertising and promotional activities. [IAS 38 para 69].
Should costs incurred to compare various drugs, with the intention of determining relative performance for certain indications, be capitalised as development costs?
Solution
The expenditure incurred for studies to identify performance features, after the start of commercial production or use, should not be capitalised as part of the development cost. This is because it does not qualify for capitalisation under IAS 38. Development costs after an asset has been brought into use are not directly attributable costs necessary to create, produce and prepare the asset to be capable of operating in the manner intended by management. The studies are directed at providing marketing support and the nature of the amounts spent is that of marketing and sales expense. This expense should be included in the appropriate income statement classification.

1.11 Development costs for a drug which will treat a small patient group

Reference to standard: IAS 38 para 57, IAS 38 para 21, IAS 36 para 9, IAS 36 para 10
Reference to standing text: 21.32, 21.16, 24.9, 24.10
Background
Pharmaceutical entity Da Vinci Pharma is currently developing a drug that will be used in the treatment of a very specific ailment affecting a small group of patients. Management has decided to pursue this drug for reputational reasons. Da Vinci has introduced an innovative pricing mechanism for this drug, whereby a patient will only pay if the drug is proven to be effective. Da Vinci has received regulatory approval and believes that all other capitalisation criteria in paragraph 57 of IAS 38 have been met, except for concerns about its market potential.
Relevant guidance
To qualify for capitalisation as development cost the asset should generate probable future economic benefits; demonstrated by the existence of a market for the asset’s output and the usefulness of the asset if it is to be used internally. [IAS 38 para 57(d)].
An intangible asset should only be recognised if it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity and the cost of the asset can be measured reliably. [IAS 38 para 21].
Should the development costs for a limited market be capitalised?
Solution
All development criteria must be met to start capitalising development costs. A strong indication that an entity has met all of the above criteria is when it obtains regulatory authority for final approval. Da Vinci should capitalise development costs for this drug when the criteria in IAS 38 are met, this is likely to be on regulatory approval.
Da Vinci will need to assess the capitalised costs for any indication of impairment at each reporting date [IAS 36 para 9], and to test for impairment annually before it is available for use. [IAS 36 para 10]. The concern over the potential market might be a trigger for impairment.

1.12 Patent protection costs

Reference to standard: IAS 38 para 20
Reference to standing text: 21.72
Background
Pharmaceutical entity Velazquez Pharma has a registered patent on a currently marketed drug. Pharmaceutical entity Uccello Medicines Ltd copies the drug’s active ingredient and sells the drug during the patent protection period. Velazquez goes to trial and is likely to win the case, but it has to pay costs for its attorneys and other legal charges.
Relevant guidance
Subsequent expenditure on an intangible can only be capitalised if it enhances the expected future economic benefits of the intangible.
[IAS 38 para 20].
Should legal costs relating to the defence of pharmaceutical patents be capitalised?
Solution
Velazquez should not capitalise patent defence costs, because they maintain rather than increase the expected future economic benefits from an intangible asset. Such costs should not be recognised in the carrying amount of an asset under paragraph 20 of IAS 38. Patent defence costs should be expensed as incurred.

1.13 Priority review vouchers

Reference to standard: IAS 38 para 21, IAS 38 para 25
Reference to standing text: 21.16, 21.50
Background
Pharmaceutical entity Egram developed a vaccine for a rare paediatric disease. It was awarded a paediatric priority review voucher (PRV) by the FDA when it received marking approval. The PRV entitles the holder to request priority review by the FDA of any future drug application that would otherwise get a standard review. The holder can use the PRV on one of its own applications, or it can sell it to another company. The PRV does not guarantee that the FDA will approve the drug application. Egram sold the PRV to pharmaceutical entity Fiorel for C65 million.
Relevant guidance
An intangible asset should be recognised if [IAS 38 para 21]:
  1. it is probable that the future economic benefits from the asset will flow to the entity; and
  2. the cost of the asset can be measured reliably.
The price that an entity pays to acquire a separate intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. The effect of probability is reflected in the cost of the asset and the probability recognition criterion in paragraph 21(a) of IAS 38 is always considered to be satisfied for separately acquired intangible assets.
[IAS 38 para 25].
How should Fiorel account for the acquired PRV?
Solution
The PRV is identifiable, because it can be sold or transferred to another company and it arises from a legal right. The PRV will allow Fiorel to fast track a review with the FDA, saving costs and potentially accelerating the time to market. Fiorel therefore has the power to obtain future economic benefits.
The recognition criteria in paragraph 25 of IAS 38 are met when an intangible is separately acquired. The C65 million reflects the expectation of future economic benefits and the cost can be reliably measured. Fiorel should therefore recognise the PRV on its balance sheet at cost.
Fiorel will subsequently need to assess whether the useful life of the PRV is finite or indefinite under paragraph 88 of IAS 38. The PRV has a finite life that ends when the priority review has been committed and used with the FDA, or when the PRV is sold to another company. The asset is consumed on a unit of production basis (when used) and, therefore, this would be the most appropriate amortisation method. As such, the PRV will be amortised in full when Fiorel uses the voucher for a priority review.

1.14 Exchange of intangible assets

Reference to standard: IAS 38 para 45, IAS 38 para 46, IAS 38 para 47
Reference to standing text: 21.54, 21.55, 21.58
Background
Pharmaceutical entity Egram is developing a hepatitis vaccine. Pharmaceutical entity Fiorel is developing a measles vaccine. Egram and Fiorel enter into an agreement to swap the two products. Egram and Fiorel will not have any continuing involvement in the products that they have disposed of. The fair value of Egram’s compound has been assessed as C3 million and the carrying value of the compound is C0.5 million.
Relevant guidance
An intangible asset might be acquired in exchange for a non-monetary asset or assets, or a combination of monetary and non-monetary assets. The cost of the acquired intangible asset is measured at fair value, unless (a) the exchange transaction has no commercial substance, or (b) the fair value of neither the asset received nor the asset given up is reliably measurable. [IAS 38 para 45].
Whether an exchange transaction has commercial substance is determined by considering the degree to which future cash flows are expected to change. An exchange transaction has commercial substance if [IAS 38 para 46]:
  1. the risk, timing and amount of the cash flows of the asset received differ from the risk, timing and amount of the cash flows of the asset transferred; or
  2. the entity-specific value of the portion of the entity’s operations affected by the transaction changes as a result of the exchange; and
  3. the difference in (a) or (b) is significant, relative to the fair value of the assets exchanged.
The fair value of the asset given up is used to measure cost, unless the fair value of the asset received is more clearly evident. [IAS 38 para 47].
How should Egram’s management account for the swap of vaccine products?
Solution
The exchange of vaccine products for different diseases has commercial substance. Egram is switching from a hepatitis vaccine product to a measles vaccine product. The timing and value of cash flows expected to arise from the development and commercialisation of the products differ. Egram’s management should recognise the compound received at the fair value of the compound given up, that is C3 million. Management should also recognise a gain on the exchange of C2.5 million (C3 million – C0.5 million), because there is no continuing involvement.

1.15 Partial disposal of an intangible asset

Reference to standard: IAS 38 para 45, IAS 38 para 46, IAS 38 para 47
Reference to standing text: 21.54, 21.55, 21.58
Background
Pharmaceutical entity Giant is developing a hepatitis vaccine. Pharmaceutical entity Hercules is developing a measles vaccine. Giant and Hercules enter into an agreement to swap these two products. Under the terms of the agreement, Giant will retain the marketing rights to its drug for all Asian countries. The fair value of Giant’s compound has been assessed as C3 million, including C0.2 million relating to the Asian marketing rights and the carrying value of the compound is C0.5 million.
Relevant guidance
An intangible asset might be acquired in exchange for a non-monetary asset or assets, or a combination of monetary and non-monetary assets. The cost of the acquired intangible asset is measured at fair value, unless (a) the exchange transaction has no commercial substance, or (b) the fair value of neither the asset received nor the asset given up is reliably measurable. [IAS 38 para 45].
Whether an exchange transaction has commercial substance is determined by considering the degree to which future cash flows are expected to change. An exchange transaction has commercial substance if [IAS 38 para 46]:
  1. the risk, timing and amount of the cash flows of the asset received differ from the risk, timing and amount of the cash flows of the asset transferred; or
  2. the entity-specific value of the portion of the entity’s operations affected by the transaction changes as a result of the exchange; and
  3. the difference in (a) or (b) is significant, relative to the fair value of the assets exchanged.
The fair value of the asset given up is used to measure cost, unless the fair value of the asset received is more clearly evident. [IAS 38 para 47].
How should Giant’s management account for the swap of vaccine products, assuming that the transaction has commercial substance?
Solution
Giant’s management should recognise the compound received at the fair value of the compound given up, that is C2.8 million (C3.0 million – C0.2 million). The fair value of C0.2 million relating to the Asian marketing rights is excluded from the calculation. This is because the rights have not been sold. Management should also recognise a gain on the exchange of C2.3 million [C2.8 – (0.5 – ((0.2/3) × 0.5))].

1.16 Intangible asset derecognition on out-licence of rights

Reference to standard: IAS 38 para 112, IAS 38 para 113, IAS 38 para 116, IFRS 15 para B63
Reference to standing text:21.134, 21.135, 21.136, 11.94
Background
Pharma Co A enters into a contract with Pharma Co B with the following terms:
  • Pharma Co A grants Pharma Co B an exclusive perpetual licence to sell and market an arthritis drug in the US.
  • Pharma Co A retains the rights to sell and market the drug in the rest of the world.
  • Pharma Co A will continue to manufacture the arthritis drug.
  • Pharma Co B will purchase the drug from Pharma Co A at cost plus a fair value mark-up.
The consideration payable by Pharma Co B under this agreement comprises:
  • An up-front payment of C10 million.
  • A milestone payment of C5 million payable when sales exceed C 30 million.
  • Royalties of 5% payable on sales.
Pharma Co A has a capitalised intangible asset of C15 million in relation to the intellectual property for the arthritis drug. The relative value of the US market to the rest of the world is 40%.
Relevant guidance
An intangible asset should be derecognised [IAS 38 para 112]:
  1. on disposal; or
  2. when no future economic benefits are expected from its use or disposal.
The gain or loss arising from the derecognition of an intangible asset should be determined as the difference between the net proceeds, if any, and the carrying amount of the asset. Gains should not be classified as revenue. [IAS 38 para 113].
The amount of gain or loss arising from the derecognition of an intangible asset is determined in accordance with the requirements for determining the transaction price in paragraphs 47–72 of IFRS 15. [IAS 38 para 116].
An entity should recognise revenue for a sales-based royalty in exchange for a licence of intellectual property only when (or as) the later of the following events occurs [IFRS 15 para B63]:
  1. the subsequent sale or usage occurs; and
  2. the performance obligation to which some or all of the sales-based royalty has been allocated has been satisfied (or partially satisfied). [IFRS 15 para B63].
How should Pharma Co  A account for the disposal of the US rights to the arthritis drug?
Solution
Pharma Co A has granted Pharma B a right-of-use licence for the US rights to the arthritis drug. The gain or loss arising from the disposal is the difference between the proceeds and the carrying amount of the asset.
Judgement is required to determine the portion of the carrying amount of the intangible asset to derecognise, relative to the amount retained.
Pharma Co A has determined that 40% of the carrying amount of the intangible asset should be derecognised, since this is the relative value of the US rights out-licenced compared to the rights retained in the rest of the world.
The proceeds to include in the gain or loss arising from the derecognition of the intangible asset are determined in accordance with IFRS 15. The consideration for the contract comprises a fixed element (the up-front payment) and two variable elements (the milestone payment and the royalties). Initially, only the fixed consideration is recognised as proceeds. The sales milestone and royalties are recognised when the subsequent sale occurs, using the royalty exception applicable to licences. Therefore, the variable consideration is excluded from the calculation of the gain or loss arising on the derecognition of the intangible asset. The variable consideration is recognised in the income statement when the underlying sales are made.
A gain is recognised on disposal of the US rights of C4 million (that is, up-front payment of C10 million minus carrying amount of intangible asset disposed of amounting to C6 million (calculated as C15 million × 40%)).
Note: Cash flows from future milestones and royalties in relation to the derecognised rights should not be used, in ongoing impairment calculations, to support the carrying value of the remaining intangible that has not been derecognised.

1.17 Patent acquired in exchange for own shares

Reference to standard: IFRS 2 para 10
Reference to standing text:13.16
Background
Pharmaceutical entity Buonarroti entered into a competitive bidding arrangement to acquire a patent. Buonarroti won the bidding and agrees to settle in exchange for 5% of its publicly listed shares.
Relevant guidance
For equity-settled, share-based payment transactions, the entity measures the goods received at the fair value of the goods received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods received, it measures their value by reference to the fair value of the equity instruments granted.
[IFRS 2 para 10].
How should an asset acquired in exchange for listed shares be recognised?
Solution
The acquisition of the patent in exchange for shares is a share-based payment. Buonarroti should recognise the patent at its fair value. If the fair value cannot be measured, the patent would be measured at the fair value of the publicly traded price of the shares on the acquisition date.
The accounting for the seller of the patent under IFRS 9 and IFRS 15 is explained in Solution 5.14.

1.18 In-licence of technology

Reference to standard: IAS 38 para 21, IAS 38 para 25
Reference to standing text: 21.16, 21.50
Background
Pharmaceutical entities Regal and Simba enter into an agreement in which Regal will in-licence Simba’s know-how and technology (which has a fair value of C3 million) to manufacture a compound for AIDS. It cannot use the know-how and technology for any other project. Regal will use Simba’s technology in its facilities for a period of ten years. The agreement stipulates that Regal will make a non-refundable payment of C3 million to Simba for access to the technology. Regal’s management has not yet concluded that economic benefits are likely to flow from this compound or that relevant regulatory approval will be achieved.
Relevant guidance
An intangible asset should be recognised if [IAS 38 para 21]:
  1. it is probable that the future economic benefits from the asset will flow to the entity; and
  2. the cost of the asset can be measured reliably.
The price that an entity pays to acquire a separate intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. The effect of probability is reflected in the cost of the asset and the probability recognition criterion in paragraph 21(a) of IAS 38 is always considered to be satisfied for separately acquired intangible assets. [IAS 38 para 25].
How should Regal account for the three-year licence?
Solution
The three-year licence is a separately acquired intangible capitalised under paragraph 25 of IAS 38. The probability of economic benefit is assumed to be factored into the price that the buyer is prepared to pay.
The right should be measured at its cost of C3 million. The intangible asset should be amortised from the date when it is available for use (see Solution 1.28). The technology, in this example, is available for use when the manufacturing of the compound begins. The amortisation should be presented as cost of sales in the income statement (if expenses are presented by function) or as amortisation (if expenses are presented by nature), because it is an expense directly related to the production of the compound.
Regal continues to expense its own internal development expenditure until the criteria for capitalisation are met and economic benefits are expected to flow to the entity from the capitalised asset. See Solution 5.15 for Simba’s accounting under IFRS 15.

1.19 In-licence of marketing rights for a drug in development

Reference to standard: IAS 38 para 21, IAS 38 para 25, IAS 38 para 26
Reference to standing text: 21.16, 21.50, 21.43
Background
Pharmaceutical entities Sargent and Chagall enter into a collaboration deal in which Sargent in-licences a new antibiotic from Chagall. Chagall will continue to develop the drug. Sargent will have exclusive marketing rights to the antibiotic if it is approved. The contract terms require the following payments:
  • up-front payment of C20 million on signing of the contract;
  • milestone payment of C50 million on Phase III clinical trial approval; and
  • milestone payment of C80 million on securing final regulatory approval.
Development services are paid at cost plus a reasonable mark-up.
Relevant guidance
The price that an entity pays to acquire a separate intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. The effect of probability is reflected in the cost of the asset and the probability recognition criterion in paragraph 21(a) of IAS 38 is always considered to be satisfied for separately acquired intangible assets. [IAS 38 para 25].
The cost of a separately acquired intangible asset can usually be measured reliably. This is particularly so where the purchase consideration is in the form of cash or other monetary assets. [IAS 38 para 26].
How should Sargent account for the in-licence?
Solution
Sargent has assessed that the C20 million up-front payment is for the acquisition of an asset rather than prepaid R&D. A separately acquired intangible is capitalised under paragraph 25 of IAS 38. The probability of economic benefit is assumed to be factored into the price that the seller is prepared to accept.The intangible is recognised at cost of C20 million.
The future milestones must be assessed to determine if they meet the capitalisation criteria. A milestone payment can be outsourced development work or an acquisition of an identifiable asset.
The substance of the payment will determine its classification; the label given to a payment is not relevant. This is a judgemental area under the accounting standards and Sargent should develop an accounting policy that is clearly articulated and understood by the organisation.
A robust method of making this judgement is to assess whether the payment is due only on a verifiable outcome, or whether it is due for the execution of activities. A verifiable outcome would be the successful completion of Phase III trials. The payment for a verifiable outcome is more likely to indicate the additional value of the intangible asset. The execution of activities might be enrolling 3,000 patients for a clinical trial. The payment for enrolling patients is for normal activities undertaken during the development stage.
The milestones paid by Sargent are for the successful outcome of trials and regulatory approval. They are likely to meet the capitalisation criteria and would be accumulated into the cost of the intangible. Development services are being paid separately at fair value and, therefore, it is less likely that any milestone is for prepaid development services.
There is a policy choice on how to treat variable payments for intangible assets: either a cost accumulation approach or a financial liability approach.
Industry practice is generally to follow a cost accumulation approach to variable payments for the acquisition of intangible assets. Contingent consideration is not considered on initial recognition of the asset, but it is added to the cost of the asset initially recorded, when incurred.

1.20 In-licence of development-phase compound where the licensee continues to do the development work

Reference to standard: IAS 38 para 21, IAS 38 para 25, IAS 38 para 26
Reference to standing text: 21.16, 21.50, 21.43
Background
Biotech Co has successfully developed a drug for Syndrome Q through Phase II trials. Biotech and a large pharmaceutical entity, Pharma Co, have agreed the following terms:
  • Biotech grants a licence to Pharma to manufacture, sell and market the product in the US for the treatment of Syndrome Q. Biotech retains the patents and underlying intellectual property associated with the product.
  • Pharma is to fund and perform all Phase III clinical development work on the drug developed by Biotech.
  • There is a development committee that oversees the development of the product. The development committee makes all strategic decisions regarding the product. Biotech is not required to attend the committee, but it has the right to and expects to, attend.
  • Biotech gives Pharma a guarantee to defend the patent from unauthorised use.
  • Biotech retains the right to sell the product in the rest of the world.
The consideration payable by Pharma includes:
  • up-front payment of C10 million on signing the contract;
  • milestone payment of C20 million on regulatory approval;
  • royalties of 15% payable on sales; and
  • sales milestone of C20 million in the first year that annual sales exceed C500 million.
The up-front payments and milestones are non-refundable in the event that the contract is cancelled after the payments have been made.
Relevant guidance
The price that an entity pays to acquire a separate intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. The effect of probability is reflected in the cost of the asset and the probability recognition criterion in paragraph 21(a) of IAS 38 is always considered to be satisfied for separately acquired intangible assets. [IAS 38 para 25].
The cost of a separately acquired intangible asset can usually be measured reliably. This is particularly so where the purchase consideration is in the form of cash or other monetary assets. [IAS 38 para 26].
Subsequent expenditure on an intangible can only be capitalised if it enhances the expected future economic benefits of the intangible. [IAS 38 para 20].
How should Pharma account for the in-licence?
Solution
The up-front purchase of the compound is a separately acquired intangible, which is capitalised under paragraph 25 of IAS 38. Biotech has no further performance obligations for development services. The intangible is recognised at cost of C10 million.
The variable payments  must be assessed to determine whether they meet the capitalisation criteria.
The substance of the payment will determine its classification; the label given to a payment is not relevant. This is a judgemental area under the accounting standards and Pharma should develop an accounting policy that is clearly articulated and understood by the organisation.
The milestones paid by Pharma are for regulatory approval and a sales target. They are likely to meet the capitalisation criteria and would be accumulated into the cost of the intangible.
There is a policy choice on how to treat variable payments for intangible assets: either a cost accumulation approach or a financial liability approach.
Industry practice is generally to follow a cost accumulation approach to variable payments for the acquisition of intangible assets. Contingent consideration is not considered on initial recognition of the asset, but it is added to the cost of the asset initially recorded, when incurred.
Royalties should be accrued for in line with the underlying sales and recognised as a cost of sales.
See Solution 5.18 for IFRS 15 guidance.

1.21 In-licence of development-phase compound where the licensor continues to do the development work

Reference to standard: IAS 38 para 21, IAS 38 para 25, IAS 38 para 26, IAS 38 para 20
Reference to standing text: 21.16, 21.50, 21.43, 21.72
Background
Biotech Co is a well-established company that has the expertise to perform clinical trials. Biotech enters into a contract with Pharma Co with the terms:
  • Biotech grants Pharma a licence to manufacture, sell and market product.
  • Biotech is responsible for performing clinical trials and obtaining regulatory approval.
  • Biotech gives Pharma a guarantee to defend the patent from unauthorised use.
The consideration payable by Pharma under this agreement comprises:
  • up-front payment of C10 million;
  • milestone of C20 million payable for enrolling 1,000 patients for Phase III trials;
  • milestone of C10 million on regulatory approval; and
  • royalties of 25% payable on sales.
Relevant guidance
The price that an entity pays to acquire a separate intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. The effect of probability is reflected in the cost of the asset, and the probability recognition criterion in paragraph 21(a) of IAS 38 is always considered to be satisfied for separately acquired intangible assets. [IAS 38 para 25].
The cost of a separately acquired intangible asset can usually be measured reliably. This is particularly so where the purchase consideration is in the form of cash or other monetary assets. [IAS 38 para 26].
Subsequent expenditure on an intangible can only be capitalised if it enhances the expected future economic benefits of the intangible. [IAS 38 para 20].
How should Pharma account for the in-licence?
Solution
Pharma needs to assess whether the up-front payment is for the acquisition of an intangible or for prepaid R&D. There is no separate payment for R&D services and so it is likely that the up-front payment is, at least in part, a prepayment for R&D. Any prepayment recognised is released to the income statement over the development period.
The future milestones must be assessed to determine whether they meet the capitalisation criteria. A milestone payment can be outsourced development work or an acquisition of an identifiable asset.
The substance of the payment will determine its classification; the label given to a payment is not relevant. This is a judgemental area under the accounting standards and Pharma should develop an accounting policy that is clearly articulated and understood by the organisation.
A robust method of making this judgement is to assess whether the payment is due only on a verifiable outcome, or whether it is due for the execution of activities. A verifiable outcome would be regulatory approval. The payment for a verifiable outcome is more likely to indicate the additional value of the intangible asset that is controlled by the entity. The C10 million milestone on regulatory approval is likely to meet the capitalised criteria and can be accumulated into the cost of the intangible. The execution of activities is a normal R&D activity and should be expensed.
See Solution 5.19 for IFRS 15 guidance.

1.22 Up-front payments to conduct research

Reference to standard: IAS 38 para 54
Reference to standing text: 21.27
Background
Pharmaceutical entity Astro engages a contract research organisation (CRO) to perform research activities for a period of two years in order to obtain know-how and try to discover a cure for AIDS. The CRO is well known in the industry for having modern facilities and good practitioners dedicated to investigation. The CRO receives a nonrefundable, up-front payment of C3 million in order to carry out the research under the agreement. It will have to present a quarterly report to Astro with the results of its research. Astro has full rights of access to all of the research performed, including control of the research undertaken on the potential cure for AIDS. The CRO has no rights to use the results of the research for its own purposes.
Relevant guidance
Expenditure on research should be expensed when incurred. [IAS 38 para 54].
How should Astro account for up-front payments made to third parties to conduct research?
Solution
The payment is made for research activity to an external CRO, it does not meet the definition of an intangible asset and it cannot be capitalised. The up-front payment is recognised as a prepayment in the income statement over the period of the research activity.

1.23 Accounting for research which results in a development candidate

Reference to standard: IAS 38 para 54, IAS 38 para 57, IAS 38 para 71
Reference to standing text: 21.27, 21.32, 21.33
Background
Pharmaceutical entity Sisley Pharma contracts with pharmaceutical entity Wright Pharma to research possible candidates for further development in its antihypertension programme. Sisley pays Wright on a cost-plus basis for the research, plus C100,000 per development candidate that Sisley elects to pursue further.. Sisley will own the rights to any such development candidates. After two years, Wright succeeds in confirming ten candidates that will be used by Sisley.
Relevant guidance
No intangible asset arising from research (or from the research phase of an internal project) should be recognised. Expenditure on research (or on the research phase of an internal project) is recognised as an expense when it is incurred. [IAS 38 para 54].
An intangible asset arising from development (or from the development phase of an internal project) shall  be recognised if, and only if, an entity can demonstrate meeting all relevant criteria. [IAS 38 para 57].
Expenditure on an intangible item that was initially recognised as an expense shall not be recognised as part of the cost of an intangible asset at a later date. [IAS 38 para 71].
How should Sisley account for the payments to Wright?
Solution
Costs incurred for research should not be capitalised. Sisley’s payments relating to the cost-plus portion of the contract should be expensed. No separate intangible has been acquired and the technological feasibility criterion is not met. At the point of regulatory approval, the research costs previously expensed cannot be reversed and capitalised.

1.24 Third-party development of own intellectual property

Reference to standard: IAS 38 para 21, IAS 38 para 25, IAS 38 para 57
Reference to standing text: 21.16, 21.50, 21.32
Background
Pharmaceutical entity Tiepolo Pharma has appointed Tintoretto Laboratories, a third party, to develop an existing compound owned by Tiepolo on its behalf. Tintoretto will act purely as a service provider, without taking any risks during the development phase, and it will have no further involvement after regulatory approval. Tiepolo will retain full ownership of the compound. Tintoretto will not participate in any marketing and production arrangements. A milestone plan is included in the contract. Tiepolo agrees to make the following non refundable payments to Tintoretto:
  • C2 million on signing the agreement; and
  • C3 million on successful completion of Phase II.
Relevant guidance
The price that an entity pays to acquire a separate intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. The effect of probability is reflected in the cost of the asset and the probability recognition criterion in paragraph 21(a) of IAS 38 is always considered to be satisfied for separately acquired intangible assets. [IAS 38 para 25].
Internally generated intangible assets should only be recognised if, amongst other criteria, the technical feasibility of a development project can be demonstrated. [IAS 38 para 57].
How should Tiepolo account for up-front payments and subsequent milestone payments in a research and development (R&D) arrangement in which a third party develops its intellectual property?
Solution
Tiepolo owns the compound. Tintoretto performs development on Tiepolo’s behalf. No risks and rewards of ownership are to be transferred between the parties. By making the initial up-front payment and the subsequent milestone payment to Tintoretto, Tiepolo does not acquire a separate intangible asset that could be capitalised. The payments represent outsourced R&D services to be expensed over the development period, provided that the recognition criteria in paragraph 57 of IAS 38 for internally generated intangible assets are not met.

1.25 Joint development of own intellectual property

Reference to standard: IAS 38 para 21, IAS 38 para 25, IAS 38 para 27, IAS 38 para 57
Reference to standing text: 21.16, 21.50, 21.44, 21.32
Background
Pharmaceutical entity Tiepolo Pharma has appointed Tintoretto Laboratories, a third party, to develop an existing compound owned by Tiepolo on its behalf. The agreement out-licences Tiepolo’s compound to Tintoretto. Tiepolo and Tintoretto will set up a development steering committee to jointly perform the development and they will participate in the funding of the development costs according to specific terms. Tiepolo agrees to make the following payments to Tintoretto:
  • C5 million on signing the agreement as an advance payment. Tintoretto is required to refund the entire payment if it fails to successfully complete Phase III
  • 50% of total development costs on successful completion of Phase II (after deducting the advance payment).
Tiepolo will commercialise the drug. In the case of successful completion of development and commercialisation, Tintoretto will receive milestone payments and royalty streams.
Relevant guidance
The price that an entity pays to acquire a separate intangible asset reflects expectations about the probability that the expected future economic benefits embodied in the asset will flow to the entity. The effect of probability is reflected in the cost of the asset and the probability recognition criterion in paragraph 21(a) of IAS 38 is always considered to be satisfied for separately acquired intangible assets. [IAS 38 para 25].
The cost of a separately acquired intangible asset comprises [IAS 38 para 27]:
  1. its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and
  2. any directly attributable cost of preparing the asset for its intended use.
Internally generated intangible assets shall only be recognised if, amongst other criteria, the technical feasibility of a development project can be demonstrated. [IAS 38 para 57].
How should Tiepolo account for the advance payment in an R&D arrangement in which a third party develops its intellectual property?
Solution
Tintoretto becomes party to substantial risks in the development of Tiepolo’s compound and  Tiepolo effectively reduces its exposure to ongoing development costs. However, Tiepolo does not acquire a separate intangible asset that could be capitalised. The payments represent funding for development of its own intellectual property by a third party.. Tiepolo should record the C5 million as prepaid expense initially and it should recognise the prepaid amount to R&D expense over the term of the agreement on successful completion of Phase II.

1.26 Cost-plus contract research arrangements

Reference to standard: IAS 38 para 54, IAS 38 para 56, IAS 38 para 59
Reference to standing text: 21.27, 21.26, 21.30
Background
Pharmaceutical entity Whistler Corp enters into a contract research arrangement with pharmaceutical entity Ruskin Inc to perform research on the geometry of a library of molecules. Ruskin will catalogue the research results in a database.
Whistler will refund all of Ruskin’s direct costs incurred under the contract and it will pay a 25% premium on a quarterly basis as the work is completed.
Relevant guidance
Research expenses are recognised as incurred. [IAS 38 para 54]. Examples of research activities include the search for alternatives for materials, devices, products, processes, systems or services. [IAS 38 para 56(c)].
Examples of development activities include the design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services. [IAS 38 para 59(d)].
How should Whistler account for contracted research arrangements?
Solution
Whistler should expense costs for the contract research as incurred by Ruskin. The activity is within the definition of research. It will not result in the design or testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services that could be capitalised as a development intangible asset. If the payment from Whistler was fixed rather than cost-plus, the accounting treatment would be the same but the research costs would be accrued and expensed over the service period.

1.27 Useful economic lives of intangibles

Reference to standard: IAS 38 para 57, IAS 38 para 97, IAS 38 para 8, IAS 38 para 88, IAS 38 para 104
Reference to standing text: 21.32, 21.123, 21.25, 21.102, 21.126
Background
A laboratory has capitalised certain costs incurred in the development of a new drug. These costs have met the capitalisation criteria in paragraph 57 of IAS 38, because regulatory approval has been obtained.
Relevant guidance
The depreciable amount of an intangible asset should be amortised on a systematic basis over the best estimate of its useful life. [IAS 38 para 97].
Useful life is defined as the period of time over which an asset is expected to be used by the entity. [IAS 38 para 8].
Management should assess the useful life of an intangible asset, both initially and on an annual basis. [IAS 38 paras 88, 104].
What factors should management consider in its assessment of the useful life of capitalised development costs (including ongoing reassessment of useful lives)?
Solution
Management must consider a number of factors that are relevant to all industries when determining the useful life of an intangible asset. It should also consider industry-specific factors, such as the following:
  • duration of the patent right or licence of the product;
  • anticipated duration of sales of product after patent expiration; and
  • competitors in the marketplace.

1.28 Commencement of amortisation

Reference to standard: IAS 38 para 97, IAS 36 para 10
Reference to standing text: 21.97, 24.10
Background
A pharmaceutical entity acquired a compound in Phase III for C5 million on 1 January 20X3. The entity receives regulatory and marketing approval on 1 March 20X4 and it starts using the compound in its production process on 1 June 20X4. The entity amortises its intangible assets on a straight-line basis over the estimated useful life of the asset.
Relevant guidance
Amortisation of an asset starts when it becomes available for use. The asset should be in the location and condition that is required for it to be operating in the manner intended by management. [IAS 38 para 97].
When should the entity begin amortising its intangible assets?
Solution
Amortisation should begin from 1 March 20X4, because this is the date that the asset is available for use. The intangible asset should be tested for impairment at least annually, prior to 1 March 20X4, irrespective of whether any indication of impairment exists. [IAS 36 para 10(a)].

1.29 Amortisation method of development – intangible assets

Reference to standard: IAS 38 para 97, IAS 38 para 98, IAS 38 para 94
Reference to standing text: 21.123, 21.122, 21.107
Background
Pharmaceutical entity Raphael & Co has begun commercial production and marketing of an approved product. Development costs for this product were capitalised in accordance with the criteria specified in IAS 38. The patent underlying the new product will expire in ten years and management does not forecast any significant sales once the patent expires.
Relevant guidance
The depreciable amount of an intangible asset with a finite useful life should be allocated on a systematic basis over its useful life. The amortisation method used should reflect the pattern in which the asset’s future economic benefits are expected to be consumed. [IAS 38 para 97].
Acceptable methods include the straight-line method, the diminishing balance method and the unit of production method. The method used is selected on the basis of the expected pattern of consumption, and it is applied consistently from period to period, unless there is a change in the expected pattern of consumption of benefits. There is rarely, if ever, persuasive evidence to support an amortisation method for intangible assets that results in a lower amount of accumulated amortisation than under the straight-line method. [IAS 38 para 98].
The useful life of an intangible asset that arises from legal rights should not exceed the period of the legal rights, but it might be shorter, depending on the period over which the entity expects to use the asset. [IAS 38 para 94].
What is the appropriate method of amortising the capitalised development costs, once a drug is being used as intended?
Solution
The patent provides exclusivity and premium cash flows over a ten-year period. The economic benefits are consumed rateably over time. The limiting factor of the patent is time. Whether the drug is a blockbuster and exceeds expectations, or it just breaks even, the patent’s economic benefit will still be consumed equally over time. Straight line amortisation appropriately reflects the consumption of economic benefits.
Raphael should therefore amortise the capitalised development costs on a straight-line basis over the patent’s ten-year life, unless the business plan indicates use of the patent over a shorter period. A systematic and rational amortisation method should be utilised over this shortened remaining useful life. In addition, Raphael should perform impairment testing whenever it identifies an impairment indicator.

1.30 Amortisation life of intangibles

Reference to standard: IAS 38 para 97, IAS 38 para 98, IAS 38 para 94
Reference to standing text: 21.123, 21.122, 21.107
Background
Pharmaceutical entity Raphael & Co has begun commercial production and marketing of an approved product. The production is done using a licensed technology that will be used in the production of other products for 20 years. The patent underlying the new product will expire in ten years. An up-front payment for the 20-year licence of the technology and development costs for the new product were capitalised in accordance with the criteria specified in IAS 38.
Relevant guidance
The depreciable amount of an intangible asset with a finite useful life should be allocated on a systematic basis over its useful life. The amortisation method used should reflect the pattern in which the asset’s future economic benefits are expected to be consumed. [IAS 38 para 97].
Acceptable methods include the straight-line method, the diminishing balance method and the unit of production method. The method used is selected on the basis of the expected pattern of consumption and it is applied consistently from period to period, unless there is a change in the expected pattern of consumption of benefits. There is rarely, if ever, persuasive evidence to support an amortisation method for intangible assets that results in a lower amount of accumulated amortisation than under the straight-line method. [IAS 38 para 98].
The useful life of an intangible asset that arises from legal rights should not exceed the period of the legal rights, but it might be shorter, depending on the period over which the entity expects to use the asset. [IAS 38 para 94].
What is the useful life of the intangibles?
Solution
Each of these intangibles should be amortised on a straight-line basis. The intangible asset attributable to the patent should be amortised over its ten-year expected useful life. The intangible asset attributable to the technology should be amortised over the full 20-year life. Use of the straight-line method reflects consumption of benefits available from the patent  based on the passage of time. If the time that the technology or patent will generate economic benefits decreases, Raphael should perform impairment testing, and a systematic and rational amortisation method should be utilised over this shortened remaining useful life.

1.31 Indefinite-lived intangible assets

Reference to standard: IAS 38 para 88, IAS 36 para 10
Reference to standing text: 21.102, 24.10
Background
Management of a pharmaceutical entity has acquired a branded generic drug as part of a business combination. The brand is a well-established leader in the market and has a strong customer loyalty. Management believes that the brand has an indefinite useful life and it has decided not to amortise it.
Relevant guidance
An intangible asset can be regarded as having an indefinite useful life when there is no foreseeable limit to the period over which the asset  is expected to generate positive cash flows for the entity. [IAS 38 para 88].
Can management regard the brand as having an indefinite life and how should management account for it?
Solution
Yes, management can regard the brand as having an indefinite life in accordance with IAS 38. Management would need to test the indefinite-lived asset annually for impairment, comparing its recoverable amount with its carrying value. [IAS 36 para 10(a)].
Technological and medical advances will reduce the number of situations where an indefinite life would apply. Only in exceptional cases would the active ingredient of pharmaceutical products have unrestricted economic lives as a result of limited patent lives.

1.32 Indicators of impairment intangible assets

Reference to standard: IAS 36 para 9, IAS 36 para 12
Reference to standing text: 24.11, 24.12
Background
A pharmaceutical entity has capitalised a number of products as intangible assets that it is amortising.
Relevant guidance
An entity should assess whether there is any indication that an asset is impaired at each reporting date. [IAS 36 para 9].
Indicators can be external or internal. Examples are included in the standard. [IAS 36 para 12].
What indicators of impairment should management consider?
Solution
Specific indicators relevant to the pharmaceutical entity include:
  • development of a competing drug;
  • changes in the legal framework covering patents, rights or licences;
  • failure of the drug’s efficacy after a mutation in the disease that it is supposed to treat;
  • advances in medicine and/or technology that affect the medical treatments;
  • lower than predicted sales;
  • impact of adverse publicity over brand names;
  • changes in the economic lives of similar assets;
  • litigation;
  • relationship with other intangible or tangible assets; and
  • changes or anticipated changes in participation rates or reimbursement policies of insurance companies, Medicare and governments for drugs and other medical products.

1.33 Indicators of impairment – property, plant and equipment

Reference to standard: IAS 36 para 9, IAS 36 para 12, IAS 36 para 59
Reference to standing text: 24.11, 24.12, 24.139
Background
Pharmaceutical entity GloPharma Ltd announced a withdrawal of a marketed product from the market, due to unfavourable study results. Management informed healthcare authorities that patients should no longer be treated with that product. The property, plant and equipment (PPE) is either dedicated specifically to the production of the terminated product, or it has no foreseeable future alternative use.
Relevant guidance
An entity should assess, at the end of each reporting period, whether an asset might be impaired. [IAS 36 para 9].
An entity should consider internal and external sources of information that indicate that there might be an adverse effect on an asset. [IAS 36 para 12].
The carrying amount of an asset shall  be reduced to its recoverable amount if, and only if, the recoverable amount is less than its carrying amount. That reduction is an impairment loss. [IAS 36 para 59].
Should an impairment test be carried out for GloPharma?
Solution
Management should carry out an impairment test, because there is a trigger for impairment. The withdrawal of the product from the market will adversely affect how the property, plant and equipment are used, since there is no alternative use. Management should consider whether this event is an impairment trigger for any other assets held. Any intangible recognised in connection with the marketed product is also likely to be impaired.

1.34 Acquired compound where development is terminated

Reference to standard: IAS 38 para 97, IAS 36 para 59, IAS 36 para 18
Reference to standing text: 21.123, 24.139, 24.53
Background
Pharmaceutical entity Seurat Pharmaceutical has acquired a new drug compound that is currently in Phase I clinical development. Seurat has capitalised the costs for acquiring the drug as an intangible asset. Soon after acquisition of the drug, the results of the Phase I clinical trials show that the drug is not likely to be effective for the intended therapy. Management terminates development of the drug for the intended therapy.
Relevant guidance
An intangible asset with a finite useful life should be amortised on a systematic basis over its useful life. Amortisation begins when the asset is available for use in the manner intended by management. [IAS 38 para 97].
The carrying amount of an asset shall  be reduced to its recoverable amount if, and only if, the recoverable amount is less than its carrying amount. That reduction is an impairment loss. [IAS 36 para 59].
The recoverable amount of an asset is the higher of its fair value less costs of disposal and its value in use. [IAS 36 para 18].
How should Seurat account for the drug compound?
Solution
Seurat should not start to amortise the intangible asset when it is acquired, because it is not ready for use. The poor results of the clinical trials indicate that the intangible asset might be impaired. Management must perform an impairment test on the asset or relevant cash-generating unit and it might have to write it down to the higher of the fair value less costs of disposal and the value in use.

1.35 Acquired compound used in combination therapy

Reference to standard: IAS 38 para 97
Reference to standing text: 21.123
Background
Pharmaceutical entity Picasso Pharma has acquired a new drug compound that is currently in Phase I clinical development. Picasso has capitalised the costs of acquiring the new drug compound as an intangible asset. Subsequently, Picasso’s scientists detect that the new drug substance is much more effective when used in a combination therapy with another drug. Management stops the current development activities for the new drug.
New Phase I clinical trials are started for the combination therapy.
Relevant guidance
An intangible asset with a finite useful life should be amortised on a systematic basis over its useful life. Amortisation begins when the asset is available for use in the manner intended by management. [IAS 38 para 97].
How should Picasso account for the new drug compound?
Solution
Picasso should not amortise the intangible asset subsequent to its acquisition, because it is not yet available for use. Picasso should start amortising the intangible asset when the combination therapy obtains regulatory approval and is available for use.
The intangible asset is not impaired by cessation of development of the initial drug compound as a stand-alone product. The intangible asset continues to be developed by Picasso, who expect to create more value with it by using the new drug compound as part of a combination.

1.36 Impairment of IPR&D prior to approval

Reference to standard: IAS 1 para 99
Reference to standing text: 4.108
Background
Pharmaceutical entity Dali Pharmaceuticals has capitalised separately acquired IPR&D as an intangible asset. Dali identified side-effects associated with the compound during development that indicate that its value is severely diminished and an impairment charge must be recognised.
Relevant guidance
Impairment is shown as a separate line item in an income statement for expenses that are classified by nature. Impairment is included in the function(s) that it relates to if expenses are classified by function. [IAS 1 para 99].
Where should Dali classify impairment charges on development intangible assets before such assets are available for use?
Solution
Dali should classify the impairment charge relating to the unapproved drug as a component of R&D expense if presenting the income statement by function. Dali should classify the charge as an impairment charge if presenting the income statement by nature of expense.

1.37 Impairment of development costs after regulatory approval

Reference to standard: IAS 1 para 99
Reference to standing text: 4.108
Background
Pharmaceutical entity Dali Pharmaceuticals has capitalised development costs as an intangible asset relating to a drug that has been approved and is being marketed. Competitive pricing pressure from the early introduction of generic drugs causes Dali to recognise an impairment of the intangible asset.
Relevant guidance
Impairment is shown as a separate line item in an income statement for expenses that are classified by nature. Impairment is included in the function(s) that it relates to if expenses are classified by function. [IAS 1 para 99].
Where should Dali classify impairment charges on development intangible assets that are currently marketed?
Solution
Dali should classify the impairment consistently with the amortisation expense, usually in cost of goods sold, if presenting the income statement by function. Dali should classify the charge as an impairment charge if presenting the income statement by nature of expense.

1.38 Single market impairment accounting

Reference to standard: IAS 36 para 9, IAS 36 para 12
Reference to standing text: 24.11, 24.12
Background
Pharmaceutical entity Veronese SpA acquired the rights to market a topical fungicide cream in Europe. The acquired rights apply broadly to the entire territory. Patients in Greece prove far more likely to develop blisters from use of the cream, causing Veronese to withdraw the product from that country. Fungicide sales in Greece were not expected to be significant.
Relevant guidance
An entity should assess, at each reporting date, whether there is any indication that an asset might be impaired. If any such indication exists, the entity should estimate the recoverable amount of the asset. [IAS 36 para 9].
In assessing whether there is any indication that an asset might be impaired, an entity should consider significant changes with an adverse effect on the entity that have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used. [IAS 36 para 12(f)].
How should Veronese account for the withdrawal of a drug’s marketing approval in a specific territory?
Solution
The cash-generating unit for the marketing right, in this example, is viewed as sales from Europe. There is an impairment trigger if there is a significant change with an adverse effect on the entity. Veronese should decide whether the withdrawal from Greece is considered significant. Veronese’s management should carefully consider whether the blistering in one jurisdiction is indicative of potential problems in other territories. An impairment test should be performed if the issue cannot be isolated.
Any development costs that Veronese has capitalised specifically for achieving regulatory approval in Greece must be written off, following the withdrawal of the product from the territory.

1.39 Reversals of impairment losses (cost model)

Reference to standard: IAS 36 para 114, IAS 36 para 115
Reference to standing text: 24.153
Background
Pharmaceutical entity Rubens Corp markets a weight-loss drug, for which development costs have been capitalised. A competing drug was launched on the market with much lower pricing. Rubens recognised an impairment of the capitalised development intangible asset, due to a reduction in the amounts that it estimated that it could recover as a result of this rival drug. The competing drug was subsequently removed from the market because of safety concerns. The market share and forecast cash flows generated by Rubens’ drug significantly increased.
Relevant guidance
An impairment loss recognised in prior periods for an asset accounted for under the cost model is reversed if there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognised. The carrying amount of the asset is increased to its recoverable amount, but it should not exceed its carrying amount adjusted for amortisation or depreciation if no impairment loss had been recognised for the asset in prior years. That increase is a reversal of an impairment loss. [IAS 36 para 114].
A reversal of an impairment loss reflects an increase in the estimated service potential of an asset, either from use or from sale, since the date when an entity last recognised an impairment loss for that asset. An entity must identify the change in estimate that causes the increase in estimated service potential. [IAS 36 para 115].
How should Rubens account for reversals of impairment losses for intangible assets accounted for under the cost model?
Solution
The competing drug withdrawal is a reverse indicator. An impairment test should be performed, comparing the carrying amount to the recoverable amount. The revised carrying value of the intangible asset cannot exceed the amount, net of amortisation, that would have been recognised if no impairment charge had been recognised.

1.40 Impairment testing and useful life

Reference to standard: IAS 36 para 9, IAS 36 para 18, IAS 36 para 19, IAS 36 para 17
Reference to standing text: 24.11, 24.53, 24.55, 24.16
Background
Pharmaceutical entity Fra Angelico Inc has a major production line that produces its blockbuster antidepressant. The production line has no alternative use. A competitor launches a new antidepressant with better efficacy. Angelico expects sales of its drug to drop quickly and significantly. Management identifies this as an indicator of impairment, although positive margins are forecast to continue. Management might exit the market for this drug earlier than previously contemplated.
Relevant guidance
An entity should assess, at each reporting date, whether there is any indication that an asset might be impaired. If so, the entity estimates the recoverable amount of the asset. [IAS 36 para 9].
The recoverable amount is defined as the higher of an asset’s fair value less costs to sell and its value in use [IAS 36 para 18]. If either of these amounts exceeds the asset’s carrying amount, no impairment is indicated and the other amount does not have to be calculated. [IAS 36 para 19].
If there is an indication that an asset might be impaired, this could indicate that the remaining useful life or residual value needs to be reviewed and potentially adjusted, even if no impairment loss is recognised for the asset. [IAS 36 para 17].
How should Angelico assess the impairment and useful lives of long-lived assets where impairment indicators have been identified?
Solution
Angelico must evaluate the carrying value of the antidepressant’s cash-generating unit (including the production line) for impairment relative to its recoverable amount. The recoverable amount is likely to exceed the asset’s carrying value, given the margin achieved on the remaining sales. Angelico could determine that no impairment is required. Angelico should also reduce the remaining useful life to the revised period that sales are expected over.

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