intangible assets

Intangible assets

Prepared by: Group 4

Two Main Characteristics:

Characteristics

(1) Lack of physical existence.

(2) They are not financial instruments.

Normally classified as long-term asset.

Common types of intangibles:

Patents

Copyrights

Franchises or licenses

Trademarks or trade names

Goodwill

Intangible Assets Issues

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.

Valuation


Internally Created Intangibles:

Expense as incurred

Only capitalize direct costs incurred in developing the intangible, such as legal costs.

Determine 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


Amortization of IntangiblesLimited-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.

Accounting Treatment for Intangibles


Six Major Categories:

1) Marketing-related.

2) Customer-related.

3) Artistic-related.

4) Contract-related.

5) Technology-related.

6) Goodwill.

Types of Intangibles

Marketing-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.


Customer-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.


Artistic-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)


Contract-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.


Technology-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.


Goodwill

• 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.


Recording: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.

Goodwill

CashAccounts ReceivablesInventoryProperty, plant & Equipment (net)PatentsLiabilitiesFair value of net identifiable assetsPurchase priceValue assigned to goodwill

$ 35,000 22,000 145,000 230,000 40,000 (52,000) 420,000 500,000$ 80,000

Goodwill

Journal entry recorded by ABC Ltd.

CashAccounts ReceivablesInventoryProperty, plant & Equipment (net)Patentsgoodwill Liabilities Cash

$ 35,000 22,000 145,000 230,000 40,000 80,000

52,000 500,000

Goodwill

Goodwill 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.

Goodwill

Impairment 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.

Goodwill

Example: ABC Ltd. Purchased X division. Its management is now reviewing for recognizing an impairment.

ABC Ltd. determines the fair value is $2,800,000.

No Impairment of Goodwill

Assets (cash, PPE, Inventory)GoodwillLiabilities Net assets

$ 2,000,000 800,000 300,000$ 2,500,000

Goodwill

If the fair value of X division is $2,200,000 then

So the journal of impairment of goodwill will be:

Fair value of X divisionLess: net asset (excluding goodwill)Implied value of goodwillCarrying amount of goodwillLoss on impairment

$ 2,200,000 1,700,000 500,000 800,000 $ (300,000)

Loss on impairmentGoodwill

300,000300,000

Goodwill

Impairment of Limited-Life Intangibles

Same 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 $50000

The 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.


Recoverability test: If the sum of the expected future net cash flows is less than the carrying amount of the asset, an impairment has occurred.

Expected Future Cash Flow $ 50000

Carrying Amount $ 80000

Difference $ (30000)

Asset is Impaired


(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2007.

Fair Value Test

Carrying Amount $80000

Fair value $65000

Loss $ (15000)

Loss on impairment 15000Copyrights 15000


(b) Prepare the journal entry to record amortization expense for 2008 related to the copyrights.

New Cost Basis $65000

Remaining Useful Life 10 Years

Yearly Amortization $ 6500

Amortization expense 6500Copyrights 6500


Impairment of Indefinite-Life Intangibles Other than 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.


Why 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.


Summary of Impairment Tests


Frequently results in something that a company patents or copyrights such as:

new product,

process,

idea,

formula,

composition, or

literary work.

Because of difficulties related to identifying costs with particular activities and determining the future benefits, all R & D costs are expensed when incurred.

Research & Development Costs

Identifying R & D ActivitiesResearch Activities

Planned search or critical investigation aimed at discovery of new knowledge.

ExamplesLaboratory research aimed at discovery of new knowledge; searching for applications of new research findings.

Development Activities

Translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use.

Examples

Conceptual formulation and design of possible product or process alternatives; construction of prototypes and operation of pilot plants.


Accounting for R & D ActivitiesCosts 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.


• 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.


• 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.


Other 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.


Balance 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)

Presentation of Intangibles

Intangible Assets Goodwill

$ 8,500 3,200

Income Statement (partial)as part of continuing operationsAmortization ExpenseImpairment Losses

$ 420 52

Cost of equipment acquired that will have alternative uses in future R&D projects over the next 5 years.

Materials consumed in R&D projects

Consulting fees paid to outsiders for R&D projects

Personnel costs of persons involved in R&D projects

Indirect costs reasonably allocable to R&D projects

Materials purchased for future R&D projects

$280,000

59,000

100,000

128,000

50,000

34,000

$56,000

59,000

100,000

128,000

50,000

0

R&D Expens

e

$393,000

$280,000 / 5 = $56,000

Compute the amount to be reported as research and development expense.

Presentation of R&D

intangible assets

Documents