Reference no: EM132518409

Accounting for intangible assets

Mags Ltd is an Australian mail-order company. Although the sector in Australia is growing slowly, Mags Ltd has reported significant increases in sales and net income in recent years. While sales increased from $50 million in 2009 to $120 million in 2015, profit increased from $3 million to $12 million over the same period. The stock market and analysts believe that the company's future is very promising. In early 2016, the company was valued at $350 million, which was three times 2015 sales and 26 times estimated 2016 profit.

Company management and many investors attribute the company's success to its marketing flair and expertise. Instead of competing on price, Mags Ltd prefers to focus on service and innovation, including:

1. free delivery
2. a free gift with orders over $200.

• As a result of such innovations, customers accept prices that are 60% above those of competitors, and Mags maintains a gross profit margin of around 40%.
• Nevertheless, some investors have doubts about the company as they are uneasy about certain accounting policies the company has adopted. For example, Mags Ltd capitalises the costs of its direct mailings to prospective customers ($4.2 million at 30 June 2015) and amortises them on a straight-line basis over 3 years. This practice is considered to be questionable as there is no guarantee that customers will be obtained and retained from direct mailings.
• In addition to the mailing lists developed by in-house marketing staff, Mags Ltd purchased a customer list from a competitor for $800 000 on 4 July 2016. This list is also recognised as a non-current asset. Mags Ltd estimates that this list will generate sales for at least another 2 years, more likely another 3 years. The company also plans to add names, obtained from a phone survey conducted in August 2016, to the list. These extra names are expected to extend the list's useful life by another year.
• Mags Ltd's 2015 statement of financial position also reported $7.5 million of marketing costs as non-current assets. If the company had expensed marketing costs as incurred, 2015 net income would have been $10 million instead of the reported $12 million. The concerned investors are uneasy about this capitalisation of marketing costs, as they believe that Mags Ltd's marketing practices are relatively easy to replicate. However, Mags Ltd argues that its accounting is appropriate. Marketing costs are amortised at an accelerated rate (55% in year 1, 29% in year 2, and 16% in year 3), based on 25 years' knowledge and experience of customer purchasing behaviour.

Required

Question 1: Explain how Mags Ltd's costs should be accounted for under AASB 138/IAS 38 Intangible Assets, giving reasons for your answer