Intangible Assets IssuesCharacteristics Two Main Characteristics: (1) Lack of physical existence. (2) They are not financial instruments. Normally classified as long-term asset. Common types of intangibles: Patents Trademarks or trade names Copyrights Goodwill Franchises or licenses
Intangible Assets IssuesValuation Purchased Intangibles: Recorded at cost. If purchased in exchange of stock, the fair value of the consideration given or received which is evident, should be recognized. Includes all costs necessary to make the intangible asset ready for its intended use.Internally Created Intangibles: Expense as incurred Only capitalize direct costs incurred in developing the intangible, such as legal costs.
Intangible Assets IssuesDetermine The Useful Life• Expected Use• Useful Life of relative assets• Legal Regulatory Conceptual Framework• Limiting useful life• Law supporting renewal or extension• Effect of obsolesce, demand, competition. Level of Maintenance cost
Intangible Assets Issues Amortization of Intangibles Limited-Life Intangibles: • Amortize to (Cost Less Residual Value) • Assume zero Residual value unless it has value to another company after its useful life • Reflect the pattern in which the company consumes the asset (if Determined) • Credit asset account or accumulated amortization.Indefinite-Life Intangibles:• No foreseeable limit on time the asset is expected to provide cash flows.• No amortization.
Intangible Assets IssuesAccounting Treatment for Intangibles
Types of IntangiblesSix Major Categories: 1) Marketing-related. 2) Customer-related. 3) Artistic-related. 4) Contract-related. 5) Technology-related. 6) Goodwill.
Types of IntangiblesMarketing-Related Intangible Assets • Examples are: Trademarks or trade names, newspaper mastheads, Internet domain names, and noncompetition agreements. • Trademark or trade name has legal protection for indefinite number of 10 year renewal periods. • Capitalize acquisition costs. • No amortization.
Types of IntangiblesCustomer-Related Intangible Assets • Examples are: customer lists, order or production backlogs, and both contractual and noncontractual customer relationships. • Capitalize acquisition costs. • Amortized to expense over useful life.
Types of IntangiblesArtistic-Related Intangible Assets • Examples are: plays, literary works, musical works, pictures, photographs, and video and audiovisual material. • Copyright is granted for the life of the creator plus 70 years. • Capitalize costs of acquiring and defending a copyright. • Amortized to expense over useful life or legal life(Whichever is shorter)
Types of IntangiblesContract-Related Intangible Assets • Examples are: franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts. • Franchise (or license) with a limited life should be amortized to expense over the life of the franchise. • Franchise with an indefinite life should be carried at cost and not amortized.
Types of IntangiblesTechnology-Related Intangible Assets • Examples are: patented technology and trade secrets granted by the U.S. Patent and Trademark Office. • Patent gives the holder exclusive use for a period of 20 years. • Capitalize costs of purchasing a patent. • Expense any R&D costs in developing a patent. • Legal fees incurred successfully defending a patent are capitalized to Patent account.
Types of IntangiblesGoodwill• Created by good relationships by building up a reputation.• A going concern valuation.• Measured at the time of business to be sold.• The excess or residual amount of the cost over the fair value of the identifiable net assets purchased.• The most intangible of the intangible assets.• Can not be amortized; can only be impaired.• Internally created goodwill should not be capitalized.
GoodwillRecording:Purchased goodwill: Goodwill is recorded only when an entire business is purchased. The difference between fair value of identifiable net assets and purchased price is considered as goodwill.For example: ABC Ltd. purchased the net assets of XYZ company for $500,000 on 31 December 2012.
GoodwillCash $ 35,000Accounts Receivables 22,000Inventory 145,000Property, plant & Equipment (net) 230,000Patents 40,000Liabilities (52,000)Fair value of net identifiable assets 420,000Purchase price 500,000Value assigned to goodwill $ 80,000
GoodwillGoodwill Write-off• Goodwill is considered to have an indefinite life• Should not be amortized• Only adjust carrying amount when goodwill is impaired.Bargain Purchase- Negative goodwill• Purchase price less than the fair value of the identifiable net assets acquired.• Also referred as Negative goodwill.• Results from a market imperfection.• The excess amount is recorded as a gain by the purchaser.
GoodwillImpairment of goodwill• Comparison between fair value and carrying amounts.• If the fair value is more than the carrying amount, goodwill is not impaired. Impairment of goodwill is a two step process: Step 1: the fair value is less than the carrying amount of net assets (including goodwill), goodwill is impaired. Step 2: Determine the fair value of goodwill (implied value of goodwill) and compare to carrying amount.
GoodwillExample: ABC Ltd. Purchased X division. Its management is now reviewing for recognizing an impairment. Assets (cash, PPE, Inventory) $ 2,000,000 Goodwill 800,000 Liabilities 300,000 Net assets $ 2,500,000ABC Ltd. determines the fair value is $2,800,000. No Impairment of Goodwill
GoodwillIf the fair value of X division is $2,200,000 then Fair value of X division $ 2,200,000 Less: net asset (excluding goodwill) 1,700,000 Implied value of goodwill 500,000 Carrying amount of goodwill 800,000 Loss on impairment $ (300,000)So the journal of impairment of goodwill will be: Loss on impairment 300,000 Goodwill 300,000
Impairment of intangible assetsImpairment of Limited-Life IntangiblesSame as impairment for long-lived assets in Chapter 11.1. If the sum of the expected future net cash inflows is less than the carrying amount of the asset, an impairment has occurred (recoverability test).2. The impairment loss is the amount by which the carrying amount of the asset exceeds the fair value of the asset (fair value test). The loss is reported as part of income from continuing operations, “Other expenses and losses” section.
Impairment of intangible assets (Copyright Impairment) Presented below is information related to copyrights owned by Walter de la Mare Company at December 31, 2007. Cost $100000 Carrying Amount $80000 Fair Value $65000 Expected Future Cash flow $50000The copyright has a remaining useful life of 10 years.(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2007.(b) Prepare the journal entry to record amortization expense for 2008 related to the copyrights.
Impairment of intangible assetsRecoverability test: If the sum of the expected futurenet cash flows is less than the carrying amount of theasset, an impairment has occurred.Expected Future Cash Flow $ 50000Carrying Amount $ 80000Difference $ (30000) Asset is Impaired
Impairment of intangible assets(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2007.Fair Value TestCarrying Amount $80000Fair value $65000Loss $ (15000) Loss on impairment 15000 Copyrights 15000
Impairment of intangible assets(b) Prepare the journal entry to record amortization expense for 2008 related to the copyrights.New Cost Basis $65000Remaining Useful Life 10 YearsYearly Amortization $ 6500 Amortization expense 6500 Copyrights 6500
Impairment of intangible assetsImpairment of Indefinite-Life Intangibles Otherthan Goodwill• Should be tested for impairment at least annually.• Impairment test is a fair value test. • If the fair value of asset is less than the carrying amount, an impairment loss is recognized for the difference. • Recoverability test is not used.
Impairment of intangible assetsWhy No Recoverability Test?• For intangible assets with indefinite life, the recoverability test is not used as a measure of impairment.• As they have an unlimited life, they will easily pass the test.
Impairment of intangible assetsSummary of Impairment Tests
Research & Development CostsFrequently results in something that a companypatents or copyrights such as: new product, formula, process, composition, or idea, literary work.Because of difficulties related to identifying costs withparticular activities and determining the futurebenefits, all R & D costs are expensed whenincurred.
Research & Development CostsIdentifying R & D Activities Research Activities ExamplesPlanned search or critical Laboratory research aimed at discoveryinvestigation aimed at of new knowledge; searching for applications of new research findings.discovery of new knowledge. Development Activities ExamplesTranslation of research findings Conceptual formulation and design ofor other knowledge into a plan possible product or process alternatives;or design for a new product or construction of prototypes and operationprocess or for a significant of pilot plants.improvement to an existingproduct or process whetherintended for sale or use.
Research & Development CostsAccounting for R & D Activities Costs Associated with R&D Activities: • Materials, Equipment, and Facilities: a)Unless the items have alternative future value, entire cost is recorded as expense Example: i)Acquisition of R & D equipment for use on current project only b) If it has alternative future uses, then carry the item as inventory and allocate as consumed or capitalize and depreciate as used. Example: i) construction of long range research facility for use in current and future projects. ii) Purchase of materials for use on current and future R&D products.
Research & Development Costs• Personnel: cost of personnel engaged R&D is recorded as expense.Example: i) salaries for research stuff designing new product.• Purchased intangibles: recognize and measure at fair value then account for in accordance with their nature.Example : i) Cost of successfully defending patent. ii) Legal fees to obtain patent.
Research & Development Costs• Contract services: Expense the cost of services performed by others. Example: i) Research cost incurred under contract with another company.• Indirect costs: a reasonable all ocation of indirect cost in R&D cost, except for general and administrative cost. Example: i) material, labor and overhead costs of product development. ii) Commissions of sales stuff marketing new products.
Research & Development CostsOther Costs Similar to R & D Costs • Start-up costs for a new operation: Incurred for one time activities to start a new operation. • Initial operating losses: Some contend that the initial operating losses which incurred in the start up should be capitalized as they are not avoidable. •Advertising costs: Company must expense advertising cost as incurred but company can record it as an asset if any tangible asset used. •Computer software cost: The acquisition, development or improvement of a product for use in their selling and administrative activities should be excluded from R&D activities.
Presentation of IntangiblesBalance sheet• Intangible assets shown as a separate item.• Contra accounts normally not shown.Income statement• Report amortization expense and impairment losses in continuing operations.• Total R&D costs charged to expense must be disclosed.
Presentation of Intangibles Balance Sheet (Partial)Intangible Assets $ 8,500Goodwill 3,200 Income Statement (partial)as part of continuing operationsAmortization Expense $ 420Impairment Losses 52
Presentation of R&DCompute the amount to be reported as research and developmentexpense. $280,000 / 5 = $56,000 R&D ExpenseCost of equipment acquired that will have alternativeuses in future R&D projects over the next 5 years. $280,000 $56,000Materials consumed in R&D projects 59,000 59,000Consulting fees paid to outsiders for R&D projects 100,000 100,000Personnel costs of persons involved in R&D projects 128,000 128,000Indirect costs reasonably allocable to R&D projects 50,000 50,000Materials purchased for future R&D projects 34,000 0 $393,000