Impairment of Intangible Assets according to Standard C-15 | Financial Reporting Standard - NIF C-15
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What is an intangible asset?
An intangible asset is a non-physical resource that has an economic value and can generate benefits for the company that owns it. Although it cannot be seen or touched, an intangible asset can be crucial to the success and competitiveness of an organization. Intangible assets are essential in the creation of long-term value, especially in technological, creative and service sectors.
Some common examples of intangible assets include:
- Intellectual property: Includes patents, trademarks, copyrights and trade secrets. These assets protect a company's inventions, brands and creations, giving it competitive advantages.
- Goodwill: It reflects the value of a company's reputation, its relationships with customers, its position in the market and other intangible factors that impact its commercial success.
- Concessions and Licenses: Rights to use third party properties or technologies. For example, software licenses are an intangible asset that allows the use of technologies developed by others.
- Software and Technology Development: Includes both acquired software and internally developed programs. These assets improve efficiency and can generate revenue through improved operational processes.
- Lease and Use Rights: These may include lease rights over properties or assets, which acquire value because of their location or access to specific resources.
- Clients and Client ListsCustomer databases can also be considered valuable intangible assets, as they represent a continuous source of income.
- Research and Development: Costs related to research and development of new products or technologies that provide long-term value to the company.
Accounting for and valuing intangible assets is often more complex than that of tangible assets due to the non-physical nature of these items. However, they play a crucial role in creating business value and long-term competitiveness.
What is impairment of intangible assets?
Impairment of an intangible asset occurs when its carrying amount exceeds its recoverable value. That is, when the value of an intangible asset on the company's books (its book value) is greater than the value the company expects to obtain by using or selling it. Impairment reflects a loss in value due to factors such as changes in the market, technological advances, or the obsolescence of the asset.
The process of assessing intangible assets for impairment involves performing an impairment test, which involves comparing the asset's carrying amount to its recoverable value. If the recoverable amount is lower than the carrying amount, the company must recognize an impairment loss on its financial statements. This reduces the value of the intangible asset on the balance sheet and can negatively affect the company's net income.
Assessing impairment is essential to ensure that the financial statements accurately reflect the company's financial situation. It also provides relevant information to investors and other interested parties about the real value of intangible assets.
NIF C-15 and its relationship with intangible assets
NIF C-15, which regulates the impairment of long-term assets, is the standard that must be followed in Mexico to evaluate and record the impairment of assets, including intangible assets. This standard establishes the specific procedures that companies must follow to determine whether long-term assets have suffered a deterioration in their value.
Although NIF C-15 covers both tangible and intangible assets, its relevance to intangible assets is due to the fact that they are considered long-term assets, subject to variations in value. Intangible assets subject to impairment include patents, trademarks, software, goodwill, and licenses, among others.
Key Guidelines of NIF C-15 for Intangible Assets:
- Determination of Impairment: IFRS C-15 establishes that entities must perform impairment tests when there are indications that the value of an intangible asset has decreased. This includes factors such as changes in the market, technological advances, or the disappearance of demand for the products or services associated with the asset.
- Recoverable ValueThe recoverable value of an intangible asset is defined as the higher of its value in use and its net selling price. The impairment assessment should compare the asset's carrying amount with this recoverable value. If the carrying amount is higher, an impairment loss should be recorded.
- Impairment TestIn practice, impairment testing involves calculating the value in use, which is determined from the future cash flows expected to be generated by the asset. This value is then discounted at a rate that reflects the time value of money and the risk associated with the asset.
- Reversal of Deterioration:NIF C-15 also mentions that if in the future the recoverable value of the asset increases, the previously recorded impairment loss can be reversed by adjusting the book value of the asset.
- Disclosure in Financial StatementsThe standard requires companies to disclose in their financial statements both the amount of the impairment loss and the reasons behind the loss. It must also indicate how the recoverable value was determined and what assumptions were used in the impairment test.
Common causes of impairment of intangible assets
Impairment of intangible assets can be caused by several factors that affect their value. Some of the most common causes include:
- Regulatory changes: Changes in laws or regulations affecting intangible assets may reduce their value. For example, changes in intellectual property laws, such as the length of patent protection, or new regulations on the use of certain technologies may decrease the value of assets such as patents, trademarks or copyrights.
- Technological advances: In industries such as technology, a major breakthrough can quickly render a patent or software obsolete. Increased competition or the improvement of alternative technologies can negatively impact the value of these assets.
- Changes in market demand: Intangible assets are often tied to demand for specific products or services. If an asset is tied to a technology or product for which demand is falling (for example, software for which the market is shrinking), its value will also decline.
- Loss of key customers or business relationships: The value of assets such as customer lists or goodwill can be affected if the company loses important business relationships or if its reputation is damaged due to poor business decisions or crises.
Examples of impairment of intangible assets
- Software: Suppose a company purchases a software license to run its operations. Over time, the company discovers that the software is not compatible with new operating systems or that it no longer receives security updates. This reduces its ability to generate value and therefore there may be a deterioration in its book value.
- Goodwill: A typical example of goodwill impairment could be a company purchasing another company that has a strong reputation and an established customer base. However, over time, the acquired company faces financial or reputational difficulties, such as a scandal or a decline in service quality. This could decrease the goodwill associated with the purchase, as reputation and business relationships lose value.
- Patents: Let's imagine a company that owns a patent for a specific technology. If, in the future, a more advanced and cheaper technology is developed that replaces the product of the original patent, the value of the patent would decrease, since the future income expected to be obtained from this patent would be lower.
Methods for estimating recoverable value
To assess whether an intangible asset has suffered impairment, NIF C-15 establishes that its value must be determined. recoverable value, which is defined as the largest of the use value and the net sales price.
- Use value: This value is calculated by projecting the future cash flows that the asset is expected to generate. These future cash flows must be discounted at an appropriate discount rate, which reflects both the inherent risk of the asset and the time value of money. That is, the future income generated by the asset must be estimated and then adjusted for uncertainty (risk) and the time value of money.
- Net sales price: This is the price that would be expected to be obtained by selling the asset in an open market, less the associated costs of sale. If the value in use of the asset is greater than the net selling price, then the recoverable value will be the value in use. However, if the net selling price is greater than the value in use, the latter will be used for the valuation.
Impact of impairment of intangible assets on financial statements
The impairment of an intangible asset has significant effects on a company's financial statements, mainly in the following aspects:
- Effect on net income: Impairment of intangible assets is recorded as a loss on a company's financial statements. This reduces net income as the asset's carrying value decreases on the balance sheet and the loss is reflected in the income statement. For example, if the value of a software product is found to have decreased, the company must record an impairment loss, which will reduce its profitability.
- Impact on financial ratios: Impairment of an intangible asset also affects several financial ratios that are used to assess a company's financial health. For example:
- Return on assets (ROA): A decrease in the value of an asset will reduce the total assets on the balance sheet, which may cause ROA (net income/total assets) to decrease.
- Liquidity: Impairment of an intangible asset does not directly affect a company's liquidity, but it could alter investors' perception of the company's ability to generate future cash flows, which could affect the share price.
- Solvency: Impairment losses can affect a company's equity, affecting solvency ratios such as the debt/equity ratio.
Deterioration reversal process
Although IFRS C-15 states that impairment losses can be reversed, this reversal is only possible if the recoverable value of the asset increases in the future. The reversal cannot exceed the carrying amount that the asset would have had it not been previously impaired. Some important aspects of the reversal include:
- Conditions for reversal: For a reversal to be possible, conditions must exist that point to an improvement in the situation that caused the impairment. This may include an improvement in the economic outlook, a restoration of demand for related products or services, or advancement in the technology associated with the asset. For example, if software that had become obsolete over time receives an update that makes it compatible with new platforms, its value could increase, allowing a partial or complete reversal of the impairment.
- How the book value is adjusted: When an impairment is reversed, the asset's carrying amount must be adjusted to the new recoverable amount. However, it is important that this adjustment does not exceed the original carrying amount that the asset would have had if the impairment had not been recorded. This means that the reversal cannot increase the carrying amount beyond what was originally recorded on the books, thus avoiding an artificially inflated value.
Considerations in the audit of impairment of intangible assets
Auditing intangible assets and their impairment requires a detailed approach, due to the subjective nature of the calculations involved. Some key aspects of the audit include:
- Audit tests: Auditors review the impairment tests performed by the company, evaluating the assumptions and estimates used in determining the recoverable value. This includes reviewing the projected cash flows, the discount rate used and assessing the risks associated with the assets.
- Transparency and documentation: It is critical that the company clearly and transparently documents the process used to determine impairment, including the key methods and assumptions used. This not only helps ensure the accuracy of the financial statements, but is also important to avoid legal or tax risks if regulatory authorities or investors question the company's accounting decisions.
Comparison between NIF C-15 and International Accounting Standards on Impairment of Intangible Assets
In the international context, the accounting treatment of impairment of intangible assets varies according to the standards applied in each jurisdiction. International Accounting Standard (IAS) 36, issued by the IASB, governs the impairment of assets, including intangible assets, and is similar to IFRS C-15 in many respects. Some key differences include:
- Impairment Test: IAS 36 also states that companies should perform impairment tests when there are indications that the value of assets may have decreased. However, in some cases, international standards may require more frequent or more detailed testing depending on the type of asset or industry.
- Reversal of impairment: Unlike IFRS C-15, which allows impairment reversal only if the recoverable value increases, international standards also allow impairment reversal in certain specific cases, even if the global economic situation has changed.
When comparing IFRS C-15 with IAS 36, companies operating in multiple jurisdictions should consider the differences in accounting approaches and ensure compliance with applicable regulations in each country.
