1. Chapter 6
Intangible Assets

2. Learning Objectives Describe the characteristics of intangible assets.
Identify the costs to include in the initial valuation of intangible assets.
Explain the procedure for amortizing intangible assets.
Describe the types of intangible assets.
Explain the conceptual issues related to goodwill.
Describe the accounting procedures for recording goodwill.
Explain the accounting issues related to intangible-asset impairments.
Identify the conceptual issues related to research and development costs.
Describe the accounting for research and development and similar costs.
Indicate the presentation of intangible assets and related items.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

3. Copyrights Patents Franchises
Intangible Assets
Intangible assets are those noncurrent economic resources that are used in the operations of the business but have no physical existence.
Copyrights
Patents
Franchises

4. Computer software costs ® a registered trademark
Intangible Assets
Intangible assets are those noncurrent economic resources that are used in the operations of the business but have no physical existence.
Computer software costs
Goodwill
Trademarks
® a registered trademark

5. Intangible Assets Intangible Assets Lack physical substance.
Useful life is often difficult to determine.
Intangible Assets
Economic benefits last beyond the current period.
Usually acquired for operational use.

6. Intangible Assets Classification Attributes
Manner of acquisition
Identifiability
Exchangeability
Period of expected benefit
Patent
Pending

7. Intangible Assets Accounting
At acquisition:
record at cost.
During use:
use the matching principle to allocate cost to expense.
At disposition:
use the revenue recognition principle to record any gain or loss that might result.

8. Intangible Assets Determination of Cost
Record at current cash equivalent cost, including purchase price, transfer, and legal fees.
If the asset is acquired through a nonmonetary exchange, cost is
- cash paid, plus
- the current market value of the noncash consideration given.

9. Intangible Assets Determination of Cost
If the asset is created internally, the cost may include
- only the costs directly associated with the creation of the intangible asset.
Costs classified as R&D must be expensed in the period incurred.
- SFAS No. 2

10. Intangible Assets Amortization of Cost
Intangibles are written off over their useful lives, where the assets have determinable useful lives.
Where the intangibles have indefinite useful lives, they are not amortized.
Acquired intangibles should not be written off at acquisition.

11. Intangible Assets Amortization of Cost
Factors to consider when estimating the useful life of an intangible asset:
Legal, regulatory, or contractual provisions that place a limit on the maximum economic life.
Provisions for renewal or extension of rights or privileges covered by specific intangible assets.
Effects of obsolescence, customer demand, competition, rate of technological change, and other economic factors.
Continued

12. Intangible Assets Amortization of Cost
Factors to consider when estimating the useful life of an intangible asset:
Possibility that the economic lives of intangibles may be related to life expectancies of certain groups of employees.
Expected actions of competitors, regulatory bodies, and others.

13. Intangible Assets With a Finite Life Are Amortized.
Intangible Assets Amortization of Cost
Intangible Assets With a Finite Life Are Amortized.
The calculation of the amortization of intangible assets follows the same principles as the depreciation of tangible assets.

14. Intangible Assets Amortization of Cost
Amortization systematically and rationally allocates the acquisition cost of intangible assets to expense.
Cost
Acquisition Cost
Expense
Allocation

15. Intangible Assets Amortization of Cost
Select a method based on the pattern of benefits, if not determinable, use the straight line method.
Intangible assets do not have a residual value.

16. Intangible Assets Amortization of Cost
The entry to record amortization of an intangible asset includes:
- a debit to Amortization Expense.
- a credit directly to the intangible asset account.

17. Intangible Assets Amortization of Cost
A company purchases a patent for $85,000.
Patent 85,000
Cash 85,000
At year-end the patent is amortized over 10 years (no expected residual value).
Amortization Expense (or
Factory Overhead) 8,500
Patent (or Accumulated
Amortization: Patent) 8,500

18. Patents
An exclusive right recognized by law and registered with the US Patent Office.
The holder is allowed to use, manufacture, sell, and control the item, process, or activity without interference or infringement by others.

19. Patents Costs of purchasing patents are capitalized.
Costs to research and develop patents are expensed as incurred.
Patents are amortized over the shorter of the legal life (20 years) or their useful lives.
Legal fees incurred to successfully defend patents are capitalized.

20. Patents Question
Batter-Up, Inc. has developed a new device. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in federal registration fees. What is Batter-Up’s amortizable cost?

21. Batter-Up’s cost for the new patent is $3,000.
Patents Question
Batter-Up, Inc. has developed a new device. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in federal registration fees. What is Batter-Up’s amortizable cost?
Batter-Up’s cost for the new patent is $3,000.

22. Patents Question
Batter-Up has estimated that the device has a useful life of 5 years. The legal life is 20 years. At the end of year 1, what is Batter-Up’s amortization expense?

23. Patents Question
Batter-Up has estimated that the device has a useful life of 5 years. The legal life is 20 years. At the end of year 1, what is Batter-Up’s amortization expense?
Use the shorter of useful life or legal life; 5 years.
Amortization = Cost ÷ Est. Useful Life
= $3,000 ÷ 5 years
= $600

24. Patents Question
Prepare the adjusting entry to record Batter- Up’s amortization expense for the period.

25. Patents Question
Prepare the adjusting entry to record Batter- Up’s amortization expense for the period.

26. Copyrights
A form of protection given by law to authors of literary, musical, artistic, and similar works.
Copyright owners have exclusive rights to print, reprint, copy, sell or distribute, perform and record the work.

27. Copyrights
Copyrights are granted for life of the creator plus 70 years.
Copyrights can be sold or assigned, but cannot be renewed.
Copyrights are amortized over their useful life.
Costs of acquiring copyrights are capitalized.
Research and development costs involved are expensed as incurred.

28. Trademarks and Trade Names
A symbol, design, or logo associated with a business.
Trademarks and trade names are renewable indefinitely by the original user in periods of 10 years each.

29. Trademarks and Trade Names
Costs of acquired trademarks or trade names are capitalized.
If trademarks or trade names are developed by the a business, all direct costs (except R&D costs) are capitalized.

30. Franchises and Licenses
A franchise is a contractual agreement under which:
The franchisor grants the franchisee:
the right to sell certain products or services,
the right to use certain trademarks or trade names, or
the right to perform certain functions, within a certain geographical area.

31. Franchises and Licenses
A franchise may be for a limited time, for an indefinite time period, or perpetual.
The cost of a franchise (for a limited time) is amortized over the franchise term.
A franchise (for an unlimited time) is carried at cost and not amortized.
Annual payments for a franchise are expensed.

32. Intangible Assets Goodwill
Represents the value associated with favorable characteristics of a firm that result in earnings in excess of those expected from identifiable assets of the firm.
For many large firms, goodwill is a major reported asset.

33. Intangible Assets Goodwill
Goodwill is always present, but is only recorded when one company combines with another company.
Goodwill is the excess of the actual purchase price of an acquired firm over the fair market value (FMV) of the identifiable net assets acquired.

34. Intangible Assets Goodwill Example
Eddy Company paid $1,000,000 to purchase all of James Company’s assets and assumed James Company liabilities of $200,000. James Company’s assets were appraised at a fair value of $900,000.

35. Goodwill Question
What amount of goodwill should be
recorded on Eddy Company books?
a. $100,000
b. $200,000
c. $300,000
d. $400,000

36. Goodwill Question
What amount of goodwill should be
recorded on Eddy Company books?
a. $100,000
b. $200,000
c. $300,000
d. $400,000

37. Goodwill Example
Sara Company purchases all the assets of Trevor Company for $790,000 cash and Trevor Company is dissolved. Trevor Company’s identifiable assets had a fair value of $920,000 and its liabilities totaled $200,000.
Assets 920,000
Goodwill 70,000
Liabilities 200,000
Cash 790,000
Individual assets and liabilities actually would be debited or credited.

38. Negative Goodwill
Fair value of net assets acquired is higher than purchase price of assets.
Resulting credit is negative goodwill (badwill).
FASB requires that any remaining excess be recognized as an extraordinary gain.

39. Goodwill Write-Off
Acquired goodwill has an indefinite life and should not be amortized but is subject to impairment.
Impairment test should be performed at least annually.
If applicable, loss recorded.

40. Impairments of Intangibles
An impairment occurs when:
-- the carrying amount of an asset is not recoverable, and
-- a write-off of the impaired amount is needed
To determine the amount of impairment, a recoverability test is used.

41. Impairment Tests Impairment Tests
Type of Asset
Property, Plant & Equipment
Limited Live Intangible
Indefinite-life intangible, other than goodwill
Goodwill
Impairment Tests
Recoverability test,then fair value test
Recoverability test, then fair value test
Fair value test
Fair value test on reporting unit, then fair value test on implied goodwill

42. Impairments: The Recoverability Test
Sum of expected
future net cash flows
from use and disposal
of asset is less than
the carrying amount
Sum of expected
future net cash flows
from use and disposal
of asset is
equal to or more than
the carrying amount
Impairment has
occurred
No impairment

43. Impairments: Measuring Loss
Impairment has occurred
Loss =
Carrying amount
less
Fair value of asset
Yes
Determine
impairment loss
Does an active market
exist for the asset?
Loss =
Carrying amount
less
present value of
expected net cash
flows
Use company’s market
rate of interest No

44. Impairment: Accounting
Loss = Carrying value less Fair value
Amortize new cost basis
Restoration of impairment loss is NOT permitted

45. Impairment Test: Fair Value Test
Compares fair value of intangible asset with
assets' carrying amount.
If fair value less than carrying amount,
impairment recognized.

46. Impairment of Goodwill
The fair value of the reporting unit should be
compared to its carrying amount including
goodwill.
The fair value of the goodwill must be determined
and compared to its carrying amount.

47. Impairment of Goodwill
The Kent Company acquired the Devon Company as a subsidiary several years ago. The Devon Company has a book value of $3.6 million, including goodwill of $400,000. Kent now Company estimates that its fair value is $3 million. If Kent Company allocates $2.7 million of the fair market value to Devon Company’s identifiable assets and liabilities, this means that $300,000 is implied for goodwill. Thus, there has been an impairment loss of $100,000.

48. Impairment of Goodwill
Book Value Fair Value
Net Assets $3,200,000 $2,700,000 Goodwill 400, ,000
Total $3,600,000 $3,000,000
Impairment Loss on Goodwill ,000
Goodwill 100,000

49. Research and Development Costs
-- Planned search or critical investigation aimed
at discovery of new knowledge
Development
-- The 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

50. Research and Development Costs
R&D costs are expensed as incurred.
Material R&D costs must be disclosed.
Equipment, facilities, and purchased intangibles related to the research should be capitalized . . .
. . . if those items have alternative future uses.

51. Research and Development Question
Batter-Up, Inc. has developed a new device. Research and development costs totaled $30,000. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in federal registration fees. What is Batter-Up’s amortizable cost?

52. Research and Development Question
Batter-Up, Inc. has developed a new device. Research and development costs totaled $30,000. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in federal registration fees. What is Batter-Up’s amortizable cost?
Batter-Up’s cost for the new patent is $3,000. The $30,000 R & D cost is expensed as incurred.

53. Computer Software Cost SFAS No. 86
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed
All costs incurred to establish the technological feasibility of a computer software product are to be treated as R&D and expensed as incurred.
Subsequent costs to obtain product masters are to be capitalized as an intangible asset.

54. Computer Software Cost Amortization
Amortization of capitalized computer software costs starts when the product begins to be marketed.
Two methods are allowed:
-- Revenue method
-- Straight-line method

55. Computer Software Cost Disclosures
Balance Sheet
-- Unamortized computer software product master cost is an asset.
Income Statement
-- Amortization expense associated with computer software cost.
-- R&D expense associated with computer software development cost.

56. C 6
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