IAS 38 Internally Generated Intangibles — Core Rule
Under IAS 38 Internally Generated Intangibles, development costs may be capitalised only when six specific criteria are simultaneously met, while research costs and internally generated goodwill, brands, and mastheads must always be expensed.
How IAS 38 Internally Generated Intangibles Works
IAS 38 draws a hard line between two phases of internal projects:
- Research phase — always expense (IAS 38.54): Any expenditure incurred during the research phase must be recognised as an expense when incurred. The entity cannot demonstrate that a probable future economic benefit will flow from an asset at this stage. If you cannot distinguish research from development, treat all spend as research (IAS 38.53).
- Development phase — capitalise only if all six criteria are met (IAS 38.57): An intangible asset arising from development shall be recognised if, and only if, the entity can demonstrate all of: (i) Technical feasibility of completing the intangible asset; (ii) Intention to complete and use or sell it; (iii) Ability to use or sell; (iv) Probable future economic benefits — existence of a market or internal usefulness; (v) Adequate technical, financial, and other resources to complete the project; and (vi) Reliable measurement of the expenditure attributable to the asset.
- Prohibited assets (IAS 38.63–38.64): Internally generated goodwill, brands, mastheads, publishing titles, customer lists, and items of similar substance shall never be recognised as intangible assets. The rationale is that expenditure on these cannot be distinguished from the cost of developing the business as a whole.
- Initial measurement (IAS 38.65–38.66): Once capitalisation commences, the cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset for its intended use — including materials, employee costs, fees to register rights, and amortisation of patents or licences used. Borrowing costs are included if IAS 23 criteria are met.
- Subsequent measurement (IAS 38.72–38.73): After initial recognition, the entity applies either the cost model (cost less accumulated amortisation and impairment) or the revaluation model, though the revaluation model is only available where an active market exists — which is rare for most internally generated intangibles.
- Disclosure (IAS 38.118–38.128): Entities must disclose, by class of intangible asset, the useful lives or amortisation rates, the gross carrying amount, accumulated amortisation and impairment losses, and the line items in profit or loss where amortisation is included. For internally generated assets, the carrying amount must be disclosed separately from acquired assets (IAS 38.118(c)).
IAS 38 Internally Generated Intangibles — Practical Example
A software company begins developing a new SaaS platform. Costs in the first quarter (€120,000) relate to feasibility studies — pure research phase, expensed immediately. In Q2, management formally documents that all six IAS 38.57 criteria are met and begins the coding phase. Q2 attributable costs: developer salaries €200,000, cloud testing infrastructure €30,000, directly attributable overheads €20,000. Total capitalised development costs: €250,000.
Q1 — Research phase (expense)
| Account | Dr (€) | Cr (€) |
|---|
| Research & Development Expense (P&L) | 120,000 | |
| Accrued Liabilities / Cash | | 120,000 |
Q2 — Development phase (capitalise)
| Account | Dr (€) | Cr (€) |
|---|
| Intangible Asset — Development Costs | 250,000 | |
| Salaries Payable / Cash | | 200,000 |
| Infrastructure Costs Payable | | 30,000 |
| Overhead Allocation | | 20,000 |
Once the platform launches, amortisation begins over its estimated useful life (say, 5 years, straight-line): €250,000 ÷ 5 = €50,000/year.
| Account | Dr (€) | Cr (€) |
|---|
| Amortisation Expense | 50,000 | |
| Accumulated Amortisation — Intangible Asset | | 50,000 |
IAS 38 Internally Generated Intangibles — Common Pitfalls
- Capitalising too early: Starting capitalisation before all six IAS 38.57 criteria are formally evidenced — particularly "adequate resources" and "technical feasibility" — is a frequent audit finding. Management needs contemporaneous documentation at the date criteria are met, not retrospectively.
- Including general overheads and selling costs (IAS 38.67): Selling, administrative, and general overhead costs that cannot be directly attributed to preparing the asset for use must be excluded from the cost. Entities often misallocate HR overhead or executive time without tracing it directly to the project.
- Forgetting to reassess when facts change: If a project no longer meets one of the six criteria (e.g., funding falls through), previously capitalised costs are not reversed under IAS 38 — but impairment testing under IAS 36 is triggered immediately, and future spend reverts to expense.
IAS 38 Internally Generated Intangibles — Key Paragraphs
- IAS 38.54 — Mandatory expensing of all research phase expenditure.
- IAS 38.57 — The six-criteria test for development phase capitalisation.
- IAS 38.63–38.64 — Prohibition on recognising internally generated goodwill, brands, and customer lists.
- IAS 38.65–38.67 — Cost components that are (and are not) included in the cost of an internally generated intangible.
- IAS 38.118 — Disclosure requirements by class, including the split between internally generated and acquired assets.
