Magna Ltd is an Australian online retail company. Although the sector in Australia is growing slowly, Magna Ltd has reported significant increases in sales and net income in recent years. Sales increased from $50 million in 2015 to $120 million in 2021, profit increased from $3 million to $12 million over the same period. The stock market and analysts believe that the companys future is very promising. In early 2022, the company was valued at $350 million, which was three times 2021 sales and 26 times estimated 2022 earnings before interest and tax (EBIT). Company management and many investors attribute the companys success to its marketing flair and expertise. Instead of competing on price, Magna Ltd prefers to focus on service and innovation, including:

free delivery

a free gift with orders over $200.

As a result of such innovations, customers accept prices that are 60% above those of competitors, and Magna maintains a gross profit margin of around 40%. Magna Ltd capitalises the costs of its direct mailings to prospective customers ($4.2 million on 30 June 2021) and amortises them on a straight-line basis over 3 years. This practice is questionable, and the accountant suggest that it may not be compatible with the recommendations of AASD138. In addition to the mailing lists developed by in-house marketing staff, Magna Ltd purchased a customer list from a competitor for $800,000 on 4 July 2022. This list is also recognised as a non-current asset. Magna Ltd estimates that this list will generate sales for at least another 2-3 years. The company also plans to add names, obtained from a phone survey conducted in August 2022, to the list. These extra names are expected to extend the lists useful life by another year. Magna Ltds 2021 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, 2021 net income would have been $10 million instead of the reported $12 million. The company accountant is uneasy about this capitalisation of marketing costs, as he believes that this practice is not consistent with the recommendations of AASB 138. However, Magna Ltd argues that its accounting is appropriate. These marketing costs have created internal goodwill and is capitalised and amortised at an accelerated rate (55% in year 1, 29% in year 2, and 16% in year 3). This goodwill is based on 25 years knowledge and experience of customer purchasing behaviour. The companys external auditor for June 2023 annual report issued a qualified report heavily criticising the practice of recognising internally generated goodwill and drastically revalued the company down. The management of Magna was not impressed with such requirements and did not want to lose the internally created market value of the company. They registered a new company in the name of Jupiter Ltd to buy the business of Magna Ltd at a price of $500 million. The fair value of all tangible assets of Magna Ltd came to $240 million. As a result, Jupiter Ltd was allowed to record $260 million ($500 million - $240 million) as goodwill.

Required

a. Explain how Magna Ltds costs should be accounted for under AASB 138/IAS 38 Intangible Assets, giving reasons for your answer.

b. The case has exposed an apparent paradox and fallacy impose by AASB138 in the prohibition of recognising internally generated value, but the same value is recognised when taken over by another company. Critically analyse the arguments used in the standard to prohibit capitalisation of internally generated goodwill and prepare a statement of strong rebuttal against the arguments used in the standard.