1. INTERMEDIATE ACCOUNTING Chapter 12 Intangibles © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

2. Where’s the Value?  Even though intangible assets do not have a physical or financial nature, they can create an enormous value for companies.  The World Bank estimates that intangible assets are not only the single most important component of wealth, but the fastest growing one as well.  Intangible assets are assets that do not have a physical or financial nature but do have value based on the rights and privileges they convey to the company that owns and uses them.  Intangible assets generally have a higher degree of uncertainty regarding their future economic benefits due, in large part, to their intangible nature that makes them harder to separate and sell relative to tangible assets.

3. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Nature and Accounting for Intangible Assets (Slide 1 of 3)  Intangible assets that are externally acquired are purchased from others, either in a separate transaction or as a part of a business acquisition.  Purchased intangible assets are capitalized at the cost to obtain the asset and prepare it for use.  Intangible assets that are internally developed are generally expensed because the future economic benefits associated with them are difficult to measure.  The costs incurred to develop internally developed intangible assets are often difficult to measure separately from the normal, ongoing operating costs of the business.

4. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Identifiable intangible assets are intangible assets that can be separated from the company and sold, transferred, licensed, rented, or exchanged. Examples of identifiable intangible assets include:  Trademarks and trade names  Patents  Copyrights  Franchise rights  Customer lists and relationships  Unidentifiable intangible assets are intangible assets that cannot be separated from the entity and sold, transferred, licensed, rented, or exchanged.  The primary unidentifiable intangible asset is goodwill. Nature and Accounting for Intangible Assets (Slide 2 of 3)

5. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Purchased intangible assets  Those that are purchased from others, either in a separate transaction or as a part of a business acquisition.  Purchased intangibles are capitalized at the cost to obtain the asset and prepare for use. Nature and Accounting for Intangible Assets (Slide 3 of 3)  Internally developed intangible assets  Internally developed intangible assets are generally expensed because the future economic benefits associated with them are difficult to measure.  The costs incurred to develop internally developed intangible assets are often difficult to measure separately from the normal, ongoing operating costs of the business.

6. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Classification and Accounting for Intangible Assets

7. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Amortization and Impairment of Intangible Assets  The allocation of the cost of intangible assets in a systematic and rational manner over the asset’s useful life is called amortization.  An impairment of an intangible asset occurs when the fair value of the asset is less than its carrying value.  Intangible assets are separated into two categories to determine whether they are amortized and how they are reviewed for impairment. The two categories are:  intangible assets with a finite, or limited life  intangible assets with an indefinite life

8. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Intangible Assets with a Finite Life (Slide 1 of 2)  An identifiable intangible asset that has a finite life is amortized over its useful life.  Factors that a company should consider in estimating the useful future life of an intangible asset are:  Expected use of the intangible asset  Expected useful life of another asset that is related to the life of the intangible asset  Any legal, regulatory, or contractual provisions that enable renewal or extension of the intangible asset’s legal or contractual life without substantial economic cost  Effects of obsolescence, demand, competition, and other economic factors  Level of maintenance costs required to obtain the expected future cash flows from the asset

9. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  GAAP requires that a company review its intangible assets for impairment.  Testing of impairment of intangible assets with a finite life consists of two steps:  Recoverability Test. If the total undiscounted cash flows expected to result from the use of the intangible asset are less than the asset’s book value, the book value is not recoverable, and the company must recognize an impairment loss.  Measurement of the Loss. The impairment loss is measured as the difference between the asset’s book value and its fair value. Intangible Assets with a Finite Life (Slide 2 of 2)

10. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Intangible Assets with an Indefinite Life  An intangible asset with an indefinite life is not amortized but is reviewed for impairment.  An intangible asset with an indefinite life is impaired when its fair value is less than its book value.

11. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Research is a the planned search or critical investigation aimed at discovering new knowledge that hopefully will be useful in developing or improving a new product or process or in significantly improving an existing product or process.  Development is the translation of research findings into a plan or design for a new product or process or for significantly improving an existing product or process. Research and Development Costs (Slide 1 of 3)

12. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Example of Activities Included in R&D

13. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Example of Activities Excluded From R&D

14. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. In-Process R&D  In-process R&D is the intangible asset created in an acquisition when the acquiring company allocates a portion of the purchase price to the R&D activities that are purchased.  In-process R&D is initially capitalized at fair value and treated as an intangible asset with an indefinite life until the R&D activities are completed or abandoned.  In-process R&D is expensed immediately if the project is abandoned.

15. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Start-Up Costs  Start-up costs are the costs incurred for one-time activities related to:  Opening a new facility or commencing a new operation  Introducing a new product or service  Conducting business in a new territory or with an entirely new class of customer  Initiating a new process in an existing facility  Start-up costs include organization costs such as legal fees, stock certificate costs, underwriting fees, and accounting fees associated with forming a company.  GAAP requires that the costs of start-up activities be expensed as incurred.

16. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. How Are Intangible Assets Disclosed? (Slide 1 of 2)  At the end of each period when a company presents a balance sheet, it should disclose the following:  For intangible assets that are amortized—the total cost, accumulated amortization, and estimated amortization expense for the next five years  For intangible assets that are not amortized—the cost of each major class of intangible asset  The total of all identifiable intangible assets as a separate line item (asset) on the balance sheet  For any intangible asset impairment other than goodwill The facts leading to the impairment The amount of the impairment loss The method of determining the fair value of the intangible asset Any impairment losses should be included in income from continuing operations

17. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  At the end of each period when a company presents a balance sheet, it should disclose the following:  For goodwill—the amount of goodwill acquired and the amount of any impairment losses recognized; any impairment loss should be reported as a separate line item in income from continuing operations, unless the impairment is related to a discontinued operation  If intangible assets are acquired during the period, GAAP requires a company to disclose:  Cost of any intangible assets acquired  Residual value and the weighted-average amortization period for intangible assets that are amortized  Cost of any research and development acquired and written off, and where it is included on the income statement How Are Intangible Assets Disclosed? (Slide 2 of 2)

18. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Identifiable Intangible Assets  Identifiable intangible assets can be classified into five basic categories related to:  Marketing  Customers  Artistic works  Contracts  Technology

19. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Marketing-Related Intangible Assets  Marketing-related intangible assets are resources used to market or promote a company’s products or services.  A trademark (or trade name) is a word, name, phrase, or symbol that identifies the source of a product and distinguishes it from the products or other companies.  Registration of a trademark or trade name with the U.S. Patent and Trademark Office establishes a right to exclusive use of the trademark or trade name for ten years. The right is renewable indefinitely as long as the trademark or trade name is used continuously.  Internet domain names are the names used to identify a particular Internet address.

20. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Customer-Related Intangible Assets  Customer-related intangible assets arise from the relationship between a company and its customers.  If these assets are developed internally, the cost of developing them is expensed.  Customer-related intangible assets are generally considered to have a finite life and are amortized on a straight-line basis.

21. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Artistic-Related Intangible Assets  Artistic-related intangible assets represent the right to reproduce, copy, or perform artistic works.  A copyright is a grant by the federal government that gives the owner the exclusive right to publish, sell, or otherwise control literary or artistic products for the life of the author plus 70 years.  Under U.S. GAAP, increases in the market value of intangible assets are not recognized in the financial statements.

22. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Contract-Based Intangible Assets  Contract-based intangible assets represent the value of rights arising from contractual agreements.  Included in this category are:  Franchise agreements  Licensing and royalty agreements  Construction permits  Broadcast rights  Use rights  Franchises are contractual agreements in which, for a fee, the franchisor gives the franchisee the right to perform certain functions or sell certain products or services.

23. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Technology-Based Intangible Assets (Slide 1 of 2)  Technology-based intangible assets are assets that represent technological advancement and provide economic benefits to companies through either legal or contractual protection.  A patent:  Is an exclusive right granted by the federal government.  Gives the owner control of the manufacture, sale, or other use of the invention.  Is granted for 20 years from the date of the filing.  Is an intangible asset that cannot be renewed because it has a finite life.

24. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Software development costs for software that is to be sold, licensed, or leased to third parties include:  The costs of designing the software.  The costs of coding the software.  The cost of testing the software.  GAAP requires that these costs be treated as R&D expense until the technological feasibility of the product is established.  Technological feasibility is established the date the company completes a detailed program design or, in its absence, when it completes a working model of a product. Technology-Based Intangible Assets (Slide 2 of 2)

25. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  The costs that are incurred in the preliminary stage of developing internal-use computer software are expensed as incurred.  Once the preliminary stage is completed and management agrees to fund the development of the software, the company capitalizes the software costs. Accounting for Software Development Costs

26. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Internally Developed Goodwill  Internally developed goodwill is distinguished from other identifiable intangible assets by two characteristics:  It is not separable from the other assets of a company.  Measuring the value of internally developed goodwill would be difficult and less representationally faithful than measuring the value of identifiable intangible assets.  The costs associated with internally developed assets are expensed as incurred.  Goodwill is an unidentifiable intangible asset with an indefinite life that is only recognized when one company purchases another company.  Goodwill is the excess of the purchase price over the fair value of the acquired company’s identifiable net assets.

27. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Purchased Goodwill  Purchased goodwill is the difference between the purchase price of the acquired company and the fair value of the identifiable net assets.  Four factors can account for the difference between the value of the company as a whole and the book value of the net assets:  Many assets are listed on the balance sheet at amounts different from their fair market value.  Identifiable intangible assets may be unrecorded or undervalued.  Unidentifiable intangible assets may exist but not be recognized on the target company’s balance sheet.  The acquirer may simply pay too much.

28. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Impairment of Goodwill (Slide 1 of 3)  Goodwill is considered to have an indefinite life.  Examples of circumstances that would indicate an impairment exists include:  Macroeconomic situations such as a deterioration in general economic conditions  Industry and market considerations such as a deterioration in the business environment or increased competition  Cost factors such as increases in raw materials, labor, or other costs  A decline in financial performance of the company  Changes in management, key personnel, strategy, or customers  An expectation that a reporting unit may be sold

29. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Impairment of Goodwill (Slide 2 of 3)  Because goodwill is an unidentifiable intangible asset that cannot be separated from the company itself, the goodwill must be assigned to a reporting unit within the company.  A reporting unit is an operating segment or component of a company for which discrete financial information is available that is regularly reviewed by management.  Goodwill is tested for impairment within the context of its reporting unit.

30. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  If a qualitative assessment indicates that it is more likely than not that the fair value of the reporting unit is less than its carrying value, a company must perform a two-step quantitative impairment test. Step 1. Determine if an impairment has occurred by comparing the fair value of the reporting unit with its book value, including goodwill. Step 2. Measure and recognize an impairment loss for the amount by which the implied fair value of the goodwill is less than its carrying value. If the fair value of the reporting unit is less than its book value, the second step of the impairment test must be performed to measure the amount of the impairment loss, if any. Impairment of Goodwill (Slide 3 of 3)

31. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Bargain Purchase  It is possible that the cash paid for the company is less than the fair value of the identifiable net assets acquired.  While such a situation is not common, it may occur if there is a forced liquidation or distressed sale.  If such a bargain purchase occurs, negative goodwill is not recorded.  The acquiring company recognizes a gain on the bargain purchase: Gain on Bargain Purchase Fair Value of Identifiable Net Assets Purchase Price = ‒