Chapter 12: Intangible Assets 1

2 Intangible Assets Intangible Assets Intangible assets characterized by – (1) lack of physical evidence, and – (2) high uncertainty about future benefits (unlike financial instruments which also lack physical substance). Valuation – Purchased Intangibles: recorded at cost to acquire and prepare the asset for its intended use. Costs include purchase price, legal fees, other transaction costs. – Internally Developed Intangibles: patented ideas, for example, incur research and development costs to create. If incurred internally, these costs are usually expensed (more later in the chapter).

3 Intangible Assets Intangible Assets Cost for limited life intangibles is amortized over useful life (or legal life, if less). Cost of unlimited life intangibles (goodwill) tested for impairment, and written down (or off) when indicated. Intangibles include the following: (1) Patents (2) Copyrights (3) Trademarks and Trade Names (4) Leaseholds and Leasehold Improvements (5) Franchises and Licences (6) Goodwill

4 Intangible Assets (1) Patents – 20 year legal life A company may capitalize the following – the cost of acquiring an externally developed patent. – filing fees for internally or externally developed patents. – the legal fees for acquiring and successfully defending a patent (internal or external). A company cannot capitalize the following. – legal fees for unsuccessfully defending a patent. – Research and development costs for an internally developed patent.

5 Intangible Assets (1) Patents – 20 year legal life A company may capitalize the following – the cost of acquiring an externally developed patent. – filing fees for internally or externally developed patents. – the legal fees for acquiring and successfully defending a patent (internal or external). A company cannot capitalize the following. – legal fees for unsuccessfully defending a patent. – Research and development costs for an internally developed patent.

6 Intangible Assets (2) Copyrights – granted for the life of the creator plus 70 years. – capitalization rules similar to patents: costs of internally developed copyright material cannot be capitalized. (3) Trademarks and Trade Names – granted for 10 year periods, but indefinite renewals. – some of design costs may be capitalized. (4) Leaseholds and Leasehold Improvements – Capitalize advance payments to lessor, until used. – Capitalize improvements and amortize over the live of the lease, or the life of the improvements, whichever is shorter.

7 Intangible Assets (5) Franchises and Licenses – Rights to deliver a product or service under specified conditions. – Franchise or license fee should be capitalized and amortized over the life of the agreement.

8 Goodwill (6) Goodwill – The “unidentifiable” intangible; not amortized, as life is assumed to be indefinite. – If loss in value, may write down or write off. – Causes include reputation, good customer relations, superior product development, etc. – Recognized when one company purchases another company. – To calculate: Purchase price paid for the company versus the fair market value of the net assets acquired = Goodwill (the excess amount paid) Ex: Purchase price $1,000,000 FMV of net assets 900,000 Excess = Goodwill$ 100,000

9 Goodwill The journal entry to record goodwill occurs in a business combination (specifically a merger), where all of the assets and liabilities of a company are being purchased, and goodwill is recognized as one of the assets purchased. In the previous example, assume that identifiable assets are $1,400,00 and identifiable liabilities are $500,000. To record the merger, the acquiring company would prepare the following entry (but the individual accounts would be recorded): Goodwill 100,000 Other Assets1,400,000 Liabilities 500,000 Cash1,000,000

10 Goodwill If the company is acquired at a discount, where the fair value of the identifiable net assets acquired is greater than the amount paid, the amount of the discount is recorded as a gain on the acquiring company’s books. If a gain is recognized, the company must also disclose the details of the transaction, so that financial statement users can determine the quality of the reported earnings.

11 Goodwill Impairment Goodwill is not amortized, and may last indefinitely. However, goodwill is tested for impairment. The test is a two step process. – First, the company compares the fair value of the reporting unit to the carrying amount, including the goodwill. If fair value is greater than carrying value, goodwill is not impaired. – If FV is less than CV then the company performs a second step, and calculates the fair value of the goodwill component, then compares it to the original recorded value. If fair value is less, then an impairment loss is recognized for the difference.

12 Impairment of Other Intangibles For other indefinite life intangibles, like renewable leases, a fair value test is calculated, then impairment is recognized if fair value is less than carrying value. For limited life intangibles, the test is the same as for property, plant and equipment. First, use undiscounted cash flows to test for impairment. Then use discounted cash flows to calculate the amount of impairment.

13 Research and Development Costs Research activities – planned search or critical investigation, aimed at the discovery of new knowledge. 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. R&D activities do not include routine alternations to existing products or processes.

14 Research and Development Costs General Rule – expense in the period incurred. For specific activities: – Materials, equipment and facilities: expense entire cost unless the items have future use. – Personnel: expense salaries and other related personnel costs as incurred. – Purchased intangibles: account for as limited or unlimited life intangibles. – Contract services for R&D: expense as incurred. – Indirect costs – include a reasonable allocation in R&D, except for general and administrative, which must be clearly related to include with R&D.

15 Other Similar Costs Start-up costs: one time activities for a new operation – expense as incurred. Initial operating losses: recognize as incurred (no capitalization. Advertising costs: expense as incurred or at the first time that the advertising takes place. Computer software costs (developed for sale): expense R&D until technological feasibility is established, then capitalize. Software costs incurred for internal use: expense during preliminary product stage, capitalize costs once it reaches the application development stage.