IAS 38 Intangible Assets states that the three attributes to intangible assets are identifiability, control and future economic benefits. In addition, the cost of the intangible asset should be capable of reliable measurement. Development costs are capitalised only after the technical and commercial feasibility of the asset have been established.
The entity must intend and be able to complete the intangible asset and either use it or sell it and be able to demonstrate how the asset will generate future economic benefits. In principle, the above criteria may appear to be satisfied in the case of the costs of adapting the medical equipment imported by Medsupply.
However, only the costs incurred in developing the initial know-how of $3 million may be capitalised as these are the costs of establishing the technical and commercial feasibility of the equipment. The costs of adapting each piece of equipment of $50,000 are simply production costs to be included in costs of sales and, if the equipment is not sold, they should be included in the inventory valuation of the equipment.
IAS 37 Provisions, Contingent liabilities and Contingent Assets requires that a provision be recognised if the following conditions are met:
(i) present obligation (legal or constructive) as a result of a past event;
(ii) probable outflow of economic resources to settle the obligation; and
(iii) the amount of the obligation can be estimated reliably.
An outflow of economic resources is deemed probable when the outflow of resources is more likely than not to occur. In order for an estimate of the amount of the obligation to be reliable, it is sufficient if a range of probable outcomes can be determined.
The amount recognised as provision should be the best estimate of the expenditure which an entity would rationally pay to settle. Medsupply’s lawyers feel that the court could conclude that the patent claim is not valid. However, Medsupply has offered $7 million to settle both claims without going to court and therefore this implies that Medsupply believes that it is more likely than not that a present obligation exists and this is the result of a past event.
The amount of the provision may not correspond to the amount which has been offered to Cosine as there is no certainty that Cosine will accept the offer. Therefore,as it is difficult to determine the amount of the provision within a range of probable outcomes, IAS 37 states that where a continuous range of possible outcomes exists, and each point in that ranges is as likely as any other, the mid-point of the range should be used. Thus, Medsupply should recognise a provision of $10 million in its financial statements at 31 May 2018 and disclose the uncertainties relating to the amount or timing of these cash outflows.
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