Recording Intangible Assets

Intangible assets that are acquired either individually or with a group of other assets (but not those acquired in a business combination) should be initially recognized and recorded at their fair value. Fair value would be measured based on the fair value of the resources given up by the not-for-profit organization, which is straightforward if it pays for the intangibles in cash. If not cash, cost would be measured based on the fair value of the consideration given or the fair value of the net assets acquired, whichever is more reliable.

Internally Developed Intangible Assets

GAAP provides specific guidance about capitalizing costs of internally developed intangible assets. Costs of internally developing, maintaining, or restoring intangible assets that are not specifically identifiable, that have indeterminate lives, or that are inherent in a continuing business and related to the organization as a whole should be recognized as an expense in the period incurred. (More on this topic is provided later in this chapter.)

Determining the Useful Life of an Intangible Asset

This determination is extremely important as to the accounting for intangible assets. Intangible assets that have finite useful lives are amortized while intangible assets that have infinite useful lives are not amortized.

The useful life of an intangible asset is the period over which the asset is expected to contribute directly or indirectly to the cash flows of the organization. FASB ASC 350 specifies the following pertinent factors that would contribute to an estimate of the useful life of an intangible asset:

• The expected use of the asset by the organization;
• The expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate;
• Any legal, regulatory, or contractual provisions that may limit the useful life;
• Any legal, regulatory, or contractual provisions that enable renewal or extension of the asset's legal or contractual life without substantial cost (provided there is evidence to support renewal or extension and renewal or extension can be accomplished without material modifications of the existing terms and conditions);
• The effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels);
• The level of maintenance expenditures required to obtain the expected future cash flows from the asset (such as when a material level of required maintenance in relation to the carrying amount of the asset may suggest a very limited useful life).

If no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an intangible asset to the reporting entity, the useful life of the asset is considered under GAAP to be indefinite. FASB ASC 350-30-55 provides a number of examples that might be helpful to the accountant with an unclear situation as to the estimated life of an intangible asset.

Amortization of Intangible Assets

Intangible assets with finite useful lives should be amortized over the useful life to the reporting organization. If the precise length of the useful life is not known, the best estimate of the useful life should be used. Intangible assets with indefinite lives are not amortized.

The method of amortization used should reflect the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. If that pattern cannot be reasonably determined, a straight-line method of amortization should be used.

The amount of the intangible asset to be amortized should be reduced by any residual value of the intangible asset. However, GAAP limits the circumstances in which the residual value can be set at an amount other than zero. The circumstances are when the intangible asset is expected to continue to have a useful life to another entity and (1) the reporting entity has a commitment from a third party to purchase the asset at the end of its useful life, or (2) the residual value can be determined by reference to an exchange transaction in an existing market for that asset and that market is expected to exist at the end of the asset's useful life.

Internally Developed Intangibles

Intangible assets could be developed internally rather than purchased from another entity. For example, an organization may patent a unique product that it develops. Expenses incurred to develop an identifiable intangible asset (such as a patent, copyright, or trademark) should be capitalized. Research and development costs should not be capitalized; instead, those costs should be expensed when incurred.

Generally, the only costs of an internally developed intangible asset that will be capitalized are the costs associated with registering the asset (such as legal fees, filing fees, costs of models or drawings, etc.). However, registration of certain intangibles (such as patents, copyrights, or trademarks) does not guarantee ownership. Ownership of such assets is not conclusively proved until it is successfully defended in court. Therefore, the authors believe that the costs of successful court defenses also should be capitalized as part of the cost of an intangible.

The financial statement preparers will also need to follow the guidance of FASB ASC 350-40, which requires that entities capitalize certain internal-use software when certain conditions are met.

The FASB issued ASU 2015-5, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement. Previous GAAP did not provide specific guidance as to accounting for fees paid in a cloud computing arrangement. The accounting for these fees depends on whether the cloud computing arrangement includes a software license. If it does, then the accounting should be consistent with the acquisition of other software licenses, which would essentially result in capitalization and amortization. If a software license is not acquired, the arrangement would be accounted for as a service contract, essentially expensed as costs are incurred.

ASU 2015-5 also discussed factors to be considered in determining whether a software license is acquired. Capitalization would only be appropriate for internal-use software that a customer obtains access to in a hosting arrangement if both of the following criteria are met:

1. The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
2. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

For purposes of applying these criteria, the term without significant penalty is said to contain two concepts:

1. The ability to take delivery of the software without incurring significant cost;
2. The ability to use the software separately without a significant diminution in utility or value.

In most cases, no value should be assigned to an unidentifiable internally developed intangible asset, such as goodwill. Such assets should only be recorded if they are purchased from another entity. Thus, the costs of developing, maintaining, or restoring such intangibles should be charged to expense when incurred. For example, the costs that a not-for-profit organization incurs internally for the development of a database of potential donors should not be recorded as an asset. These costs would be expensed as incurred.

Sometimes, circumstances result in increases or decreases in an intangible asset's useful life. If so, an organization should change the asset's useful life and record the change prospectively. This means that the asset's unamortized cost should be amortized over the remaining number of periods in the asset's revised useful life.

An organization should continually evaluate and assess whether an intangible asset is impaired and should be written off or adjusted. This occurs when the carrying value of a long-lived intangible asset exceeds what an organization will actually recover from the asset. FASB ASC 360-10 provides the accounting for impairment of identifiable intangible assets. It generally requires organizations to take the following steps to determine whether such assets have been impaired:

1. Determine whether events or conditions indicate that the asset may be impaired.
2. Estimate the cash flows expected from continuing to use the asset.
3. Compare the estimated cash flows to the asset's carrying amount. An impairment loss would be necessary if the carrying value of the asset exceeds the estimated cash flows. If an impairment loss is indicated, goodwill should be reduced to zero before adjusting the carrying amount of the impaired assets.

If an intangible asset has an indefinite life and is not being amortized, it should be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of the intangible asset with its carrying amount. If the carrying amount exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.

In August 2018 the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. ASU 2018-15 was issued to assist entities to evaluate the accounting for fees paid by a customer in a cloud computing environment (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by ASU 2018-15.

ASU 2018-15 requires an entity (customer) in a hosting arrangement that is a service contract to follow the existing guidance to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. Costs to develop or obtain internal-use software that cannot be capitalized under existing guidance, such as training costs and certain data conversion costs, also cannot be capitalized for a hosting arrangement that is a service contract. Therefore, an entity (customer) in a hosting arrangement that is a service contract determines which project stage (that is, preliminary project stage, application development stage, or postimplementation stage) an implementation activity relates to. Costs for implementation activities in the application development stage are capitalized depending on the nature of the costs while costs incurred during the preliminary project and postimplementation stages are expensed as the activities are performed.

ASU 2018-15 also requires the entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The term of the hosting arrangement includes the noncancelable period of the arrangement plus periods covered by (1) an option to extend the arrangement if the customer is reasonably certain to exercise that option, (2) an option to terminate the arrangement if the customer is reasonably certain not to exercise the termination option, and (3) an option to extend (or not to terminate) the arrangement in which exercise of the option is in the control of the vendor. The entity also is required to apply the existing impairment guidance to the capitalized implementation costs as if the costs were long-lived assets.

For not-for-profit organizations, ASU 2018-15 is effective for annual reporting periods beginning after December 15, 2020.

For intangible assets other than goodwill with indefinite lives, the FASB has issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. ASU 2012-02 essentially makes provisions similar to those of ASU 2011-8 (described below) that are applicable to goodwill available for impairment considerations for other intangible assets with indefinite lives.

ASU 2012-02 permits an entity to first assess qualitative factors to determine whether the existence of events and circumstances makes it more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the indefinite-lived intangible asset is impaired, then the not-for profit organization is not required to take further action. If the not-for-profit organization concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. The more-likely-than-not threshold is defined as having a likelihood of more than 50%.

Impairment of long-lived assets is covered more fully in Chapter 21.

Goodwill

Upon implementation of FASB ASC 954-850 relating to an acquisition of a not-for-profit organization, goodwill may be recorded in certain instances and become subject to the accounting requirements for goodwill contained in FASB ASC 350. Goodwill should not be amortized. Rather, goodwill should be tested for impairment and adjusted for any impairment loss using the methodologies described below. Under GAAP, impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. There is a two-step impairment test that is used to identify potential goodwill impairment and then measure the amount of a goodwill impairment loss to be recognized (if any).

NOTE: In May 2019 the FASB issued ASU 2019-06, Intangibles—Goodwill and Other (Topic 350), Business Combinations (Topic 805), and Not-for-Profit Entities (Topic 958), which extends the private company option to amortize goodwill to not-for-profit organizations. The accounting alternative described in Topic 805 applies when a not-for-profit entity is required to recognize or otherwise consider the fair value of intangible assets as a result of any one of the following transactions:

1. Applying the acquisition method in a business combination.
2. Assessing the nature of the difference between the carrying amount of an investment and the amount of underlying equity in net assets of an investee when applying the equity method.
3. Adopting fresh-start reporting as part of a reorganization.

Under the accounting alternative, a not-for-profit entity should amortize goodwill on a straight-line basis over 10 years, or less than 10 years if the not-for-profit entity demonstrates that a shorter useful life is more appropriate. A not-for-profit entity that elects this accounting alternative is required to make an accounting policy election to test goodwill for impairment at either the entity level or the reporting unit level. A not-for-profit entity is required to test goodwill for impairment when a triggering event occurs that indicates that the fair value of the entity (or a reporting unit) may be below its carrying amount. Under the amendments to the accounting alternative in Topic 805 for transactions occurring after adoption of the alternative, a not-for-profit entity should subsume into goodwill and amortize customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of a business and all noncompetition agreements acquired.

This amendment became effective upon issuance.

Recognition and Measurement of an Impairment Loss

The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, thus the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test should be performed to measure the amount of impairment loss, if any. A reporting unit is an operating segment (as at FASB ASC 280-10) or, in certain circumstances, one level below an operating segment. Given the nature of most not-for-profit organizations, the reporting unit would likely be the operations of the acquired organization if they are maintained separately. In other cases, there may be no distinguishable operating segments and the reporting unit would be the organization as a whole.

The fair value of a reporting unit refers to the price that would be received to sell the unit as a whole in an orderly transaction between market participants at the measurement date. Quoted market prices in active markets are the best evidence of fair value and should be used as the basis for the measurement, if available. This scenario is probably very unlikely in the not-for-profit environment. Accordingly, an estimate of the fair value of a reporting unit of a not-for-profit organization would need to be made using various valuation techniques. Although a typical “multiple of earnings” approach may be difficult to implement, certainly the results of the reporting unit's activities can be viewed with various other value indicators to determine whether fair value remains higher than the carrying amount.

The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess. The loss recognized cannot exceed the carrying amount of goodwill. After goodwill impairment loss is recognized, the adjusted carrying amount of goodwill shall be its new accounting basis. Subsequent reversal of a previously recognized goodwill impairment loss is prohibited by GAAP once the measurement of that loss is completed.

Zero or Negative Goodwill of Reporting Units

The FASB issued ASU 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts, to address questions about entities with reporting units with zero or negative carrying amounts because some entities concluded that Step 1 of the test is passed in those circumstances because the fair value of their reporting unit will generally be greater than zero. The impact of ASU 2010-28 is expected to be that goodwill impairments will be reported sooner, as reporting units with zero or negative goodwill will be required to perform the Step 2 test, which makes it more likely that impairment would be recorded sooner. Of course, if the reporting unit is the organization acquired as a whole (as discussed on the previous page), there would not be negative goodwill recorded in total, and if goodwill were zero as a whole, it would also not be recorded and there would be no need to evaluate impairment in these circumstances.

The requirements of ASU 2010-28 modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

Upon adoption of the amendments, an entity with reporting units that have carrying amounts that are zero or negative was required to assess whether it is more likely than not that the reporting units' goodwill is impaired. If the entity determines that it is more likely than not that the goodwill of one or more of its reporting units is impaired, the entity should perform Step 2 of the goodwill impairment test for those reporting unit(s). Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. Any goodwill impairments occurring after the initial adoption of the amendments should be included in earnings.

The FASB further amended the requirements for impairment testing through ASU 2011-8 to simplify how entities, both public and nonpublic, test goodwill for impairment. The provisions of ASU 2011-8 permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350 and as described above. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit.

The more-likely-than-not threshold is defined as having a likelihood of more than 50%. Previous guidance under Topic 350 required an entity to test goodwill for impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount, including goodwill (Step 1). If the fair value of a reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the amount of the impairment loss, if any.