Key Points
- Costs incurred during the research phase are always expensed; only development-phase expenditure qualifies for capitalisation.
- All six criteria in IAS 38.57 must be met simultaneously before capitalisation begins.
- Internally generated brands, mastheads, publishing titles, customer lists, and items similar in substance are specifically prohibited from recognition under IAS 38.63.
- Misclassifying the boundary between research and development shifts thousands (or millions) of euros between the income statement and balance sheet in a single period.
What is Internally Generated Intangible Asset?
IAS 38.51 splits every internal project into a research phase and a development phase. If the entity cannot distinguish between the two, IAS 38.53 requires it to treat all expenditure as research and expense it as incurred. That alone eliminates the capitalisation question for many early-stage projects.
Once a project enters the development phase, the entity must demonstrate that it satisfies all six conditions in IAS 38.57 before it capitalises any spending: technical feasibility of completing the asset, intention to complete it, ability to use or sell it, the way it will generate probable future economic benefits, availability of adequate resources to complete the work, and the ability to measure the expenditure reliably. Four of these are judgment calls, not numerical thresholds, which is why audit teams spend disproportionate time on this standard relative to the amounts involved.
After initial recognition, the entity measures the asset at cost less accumulated amortisation and any accumulated impairment losses (IAS 38.74). The revaluation model under IAS 38.75 is available only when an active market exists for the asset, a condition that rarely holds for internally generated software or proprietary technology. ISA 540.13(a) requires the auditor to evaluate whether management's method for determining the point of capitalisation is appropriate, which in practice means testing whether the six criteria were genuinely met at the date management started capitalising.
Worked example: O'Sullivan Tech Ltd
Client: Irish SaaS company, FY2025, revenue EUR 8M, IFRS reporter. O'Sullivan is building a new customer analytics platform intended for licensing to mid-market retailers. The project started in March 2024 with feasibility studies and market research. In September 2024, the board approved a formal development plan with a EUR 1.6M budget and a target launch date of June 2025.
Step 1 — Identify the research and development phases
From March 2024 to August 2024, the team conducted market analysis, evaluated competing platforms, and built throwaway prototypes. These activities fall within the research phase under IAS 38.56(a)-(b). Expenditure in this period totals EUR 220,000. From September 2024 onward, the team began building production code against a locked specification.
Step 2 — Test the six capitalisation criteria at 1 September 2024
(a) Technical feasibility: the CTO's assessment confirms the architecture is proven, based on the prototype results. (b) Intention to complete: board minutes record the approval. (c) Ability to use or sell: O'Sullivan has signed letters of intent with two pilot customers. (d) Probable future economic benefits: management's revenue forecast for the platform shows a positive NPV of EUR 2.1M over five years. (e) Adequate resources: the approved budget of EUR 1.6M is funded from existing cash reserves and an undrawn credit facility. (f) Reliable measurement: the project uses time-tracking software that allocates developer hours to the platform at a blended cost per hour.
Step 3 — Measure the capitalised amount at 31 December 2025
Development expenditure from 1 September 2024 to 31 December 2025 totals EUR 1,340,000, comprising developer salaries (EUR 980,000), cloud infrastructure for the development environment (EUR 210,000), and directly attributable testing costs (EUR 150,000). The platform launched on 15 June 2025. Research-phase expenditure of EUR 220,000 remains expensed.
Step 4 — Determine amortisation post-launch
O'Sullivan estimates a useful life of five years based on the expected product cycle in the retail analytics market. Amortisation begins on 15 June 2025 (the date the asset is available for use per IAS 38.97). The FY2025 charge covers 6.5 months: EUR 1,340,000 divided by 5 years, multiplied by 6.5/12, giving EUR 145,167.
Conclusion: the capitalised development cost of EUR 1,340,000 is defensible because each of the six IAS 38.57 criteria is individually documented at the transition date, cost components are traceable to time records, and research-phase spending has been fully excluded.
Why it matters in practice
The most common error is capitalising expenditure before all six IAS 38.57 criteria are met. Teams often treat board approval of the project as the capitalisation trigger without separately evidencing technical feasibility or probable future economic benefits. ISA 540.13(b) requires the auditor to evaluate whether the data supporting each criterion is appropriate. Accepting a single board minute as proof of all six conditions leaves the file exposed if any individual criterion was not met at that date.
Entities routinely capitalise general administrative overhead, training costs for staff working on the project, or inefficiency costs (wasted materials, rework) that IAS 38.66-67 explicitly exclude. Auditors who test only the total capitalised balance without vouching individual cost lines to the eligibility criteria miss these inclusions.
Internally generated vs. acquired intangible asset
| Dimension | Internally generated (IAS 38.51-67) | Acquired separately or in a business combination (IAS 38.25-47 / IFRS 3) |
|---|---|---|
| Recognition test | Must meet all six IAS 38.57 criteria; research-phase costs always expensed | Separability or contractual-legal criterion per IAS 38.12; recognition is generally straightforward because the acquisition price provides evidence of future economic benefits |
| Cost measurement | Accumulated from the date all criteria are first met; excludes prior expenditure | Purchase price plus directly attributable costs; in a business combination, fair value at acquisition date under IFRS 3 |
| Subsequent measurement | Cost model is standard; revaluation model rarely available (requires active market) | Cost or revaluation model; fair value at acquisition may establish a revaluation baseline if an active market exists |
| Prohibited categories | Brands, mastheads, publishing titles, customer lists cannot be recognised even if criteria are met (IAS 38.63) | These same items can be recognised when acquired, because the transaction price provides reliable measurement |
| Audit focus | Verifying the capitalisation trigger date, testing individual cost components against eligibility criteria, and confirming the research/development boundary | Verifying the purchase price allocation, testing the fair value methodology, and confirming the useful life estimate |
The distinction matters because a customer list that is worthless on the balance sheet when built internally becomes a recognised intangible the moment it is acquired in a business combination. Auditors working on post-acquisition engagements need to confirm that the acquirer did not retrospectively capitalise development costs that were correctly expensed before the acquisition by bundling them into the purchased intangible's fair value.
Related terms
Frequently asked questions
Can I capitalise costs for an internally generated brand or customer list?
No. IAS 38.63-64 specifically prohibits recognition of internally generated brands, mastheads, publishing titles, customer lists, and items similar in substance. The standard treats expenditure on these items as indistinguishable from the cost of developing the business as a whole. This prohibition applies even if the entity can demonstrate that the six IAS 38.57 criteria are met.
When does amortisation start on an internally generated intangible asset?
Amortisation begins when the asset is available for use, not when it first generates revenue. IAS 38.97 defines "available for use" as the date the asset is in the location and condition necessary for it to operate in the manner intended by management. For software, this is typically the go-live date or the date the platform passes user acceptance testing.
How do I audit the boundary between research and development?
Obtain the project timeline, identify the date management asserts the development phase began, and test whether each of the six IAS 38.57 criteria was demonstrably met at that date. ISA 500.6 requires the auditor to obtain sufficient appropriate evidence. In practice, this means reviewing board minutes, technical feasibility assessments, market analyses, funding approvals, and cost-tracking systems independently rather than relying on a single summary document from management.