Intangible Assets A.

Classification--intangible assets are assets that derive their value from the rights and privileges granted to their owner, are long-term in nature, and lack physical substance Valuation 1. Cost--cost is the cash or cash equivalent price of obtaining the intangible asset and making it ready for its intended use a. Purchased Intangibles--the cost of a purchased intangible asset is determined in essentially the same way as the cost of property, plant, and equipment b. Internally-created Intangibles--the cost of an internally-created intangible asset includes only the direct costs incurred in obtaining the intangible asset, such as legal fees, registration fees, etc. 1) Research and Development Costs--all research and development costs are expensed when incurred 2. Special Considerations a. Marketing-related Intangible Assets--marketing-related intangible assets are those intangible assets that are used in the marketing or promotion of products or services (such as trademarks or trade names, newspaper mastheads, internet domain names, and noncompetition agreements) 1) Purchased Intangibles--the capitalizable cost of a purchased marketing-related intangible asset is its purchase price plus any costs incurred in a successful legal defense of it a) Illustration--a corporation purchased a trademark at a cost of $400,000; the corporation incurred costs of $50,000 to successfully defend the trademark Trademark = 400,000 + 50,000 = 450,000 2) Internally-created Intangibles--the capitalizable cost of an internally-created marketing-related intangible asset includes legal fees, registration fees, design costs, consulting fees, successful legal defense costs, and other expenditures directly related to securing it a) Illustration--a corporation developed a trademark; the trademark had a fair market value of $400,000; the corporation incurred costs of $10,000 to registrar the trademark, costs of $20,000 to design the trademark, and costs of $50,000 to successfully defend the trademark Trademark = 10,000 + 20,000 + 50,000 = 80,000

B.

b.

Customer-related Intangible Assets--customer-related intangible assets are those intangible assets that occur as a result of interactions with outside parties (such as customer lists, order or

production backlogs, and both contractual and noncontractual customer relationships) 1) Purchased Intangibles--the capitalizable cost of a purchased customer-related intangible asset is its purchase price a) Illustration--a corporation purchased a customer list at a cost of $400,000 Customer List = 400,000 2) Internally-created Intangibles--the capitalizable cost of an internally-created customer-related intangible asset is zero Illustration--a corporation developed a customer list; the customer list had a fair market value of $400,000 Customer List = 0

c.

Artistic-related Intangible Assets--artistic-related intangible assets are those intangible assets that are granted by the federal government to the owner for the exclusive right to reproduce and sell an artistic or published work (such as plays, literary works, musical works, pictures, photographs, and video and audiovisual material) 1) Purchased Intangibles--the capitalizable cost of a purchased artistic-related intangible asset is its purchase price plus any costs incurred in a successful legal defense of it a) Illustration--a corporation purchased a copyright at a cost of $400,000; the corporation incurred costs of $50,000 to successfully defend the copyright Copyright = 400,000 + 50,000 = 450,000 2) Internally-created Intangibles--the capitalizable cost of an internally-created artistic-related intangible asset includes legal fees, registration fees, successful legal defense costs, and other expenditures directly related to securing it Illustration--a corporation developed a copyright; the copyright had a fair market value of $400,000; the incurred costs of $10,000 to register the copyright, costs of $20,000 for research and development, and costs of $50,000 to successfully defend the copyright Copyright = 10,000 + 50,000 = 60,000

d.

Contract-related Intangible Assets--contract-related intangible assets are those intangible assets that represent the value of rights that arise from contractual arrangements (such as franchise and licensing agreements, construction permits, broadcast rights, and service or supply contracts) 1) Purchased Intangibles--the capitalizable cost of a purchased contract-related intangible asset is its purchase price a) Illustration--a corporation purchased a broadcast license

at a cost of $400,000 Broadcast License = 400,000 2) Internally-created Intangibles--the capitalizable cost of an internally-created intangible asset includes legal fees, registration fees, a lump-sum payment in advance, and other expenditures directly related to securing it a) Illustration--a corporation incurred costs of $10,000 to obtain a broadcast license Broadcast License = 10,000

e.

Technology-related Intangible Assets--technology-related intangible assets are those intangible assets that are granted by the federal government to the owner for the exclusive right to use, manufacture, and sell a product or process without interference or infringement by others 1) Purchased Intangibles--the capitalizable cost of a purchased technology-related intangible asset is its purchase price plus any costs incurred in a successful legal defense of it a) Illustration--a corporation purchased a patent at a cost of $400,000; the corporation incurred costs of $50,000 to successfully defend the patent Patent = 400,000 + 50,000 = 450,000 2) Internally-created Intangibles--the capitalizable cost of an internally-created technology-related intangible asset includes legal fees, registration fees, successful legal defense costs, and other expenditures directly related to securing it a) Illustration--a corporation developed a patent; the patent had a fair market value of $400,000; the corporation incurred costs of $10,000 to register the patent, costs of $20,000 for research and development, and costs of $50,000 to successfully defend the patent Patent = 10,000 + 50,000 = 60,000

f.

Goodwill--goodwill is that intangible asset that represents the the value of a business that is associated with its good reputation, managerial expertise, excess earnings power, etc. 1) Purchased Intangibles--the capitalizable cost of purchase goodwill is the excess of the purchase price of an acquired business over the fair market value of the identifiable net assets of the acquired business a) Illustration--a corporation purchased a business at a cost of $1,000,000; the book value of the identifiable net assets of the business were $700,000; the fair market value of the identifiable net assets of the business were $900,000

Goodwill = 1,000,000 900,000 = 100,000 2) Internally-created Intangibles--the capitalizable cost of internally-created goodwill is zero a) Illustration--a corporation had a fair market value of $1,000,000; the book value of the identifiable net assets of the corporation were $700,000; the fair market value of the identifiable net assets of the corporation were $900,000 Goodwill = 0

C.

Amortization--amortization is the allocation of the cost of intangible assets in a systematic and rational manner to those periods expected to benefit from the use of the intangible assets 1. Limited-life Intangibles--intangible assets with a limited useful life (such as patents, copyrights, franchises with a limited life, etc.) should be amortized over the shorter of their useful life or their legal life a. Methods 1) Units of Activity Method--if the intangible asset is consumed or used up in a pattern of production, the units of activity method should be used to amortize the intangible asset 2) Straight-line Method--if the intangible asset is not consumed or used up in a pattern of production, the straight-line method should be used to amortize the intangible asset b. Legal Life 1) Copyrights--a copyright is granted for a period of 70 years beyond the death of the creator 2) Patent--a patent is granted for a period of 20 years 3) Trademark--a trademark is granted for an indefinite number of renewals for periods of 10 years each and is considered to have an indefinite life c. Illustrations 1) A corporation purchased a patent at a cost of $400,000; the patent had a useful life of 10 years Amortization = 400,000 / 10 = 40,000 2) A corporation purchased a franchise at a cost of $400,000; the franchise had a 40 year life; the franchise agreement required additional annual payments of 2% of sales; sales were $1,000,000 Amortization = 400,000 / 40 = 10,000 Operating Expense = 2% x 1,000,000 = 20,000 2. Indefinite-life Intangibles--intangible assets with an unlimited useful life (such as goodwill, trademarks, franchises with an indefinite life,

perpetual franchises, etc.) should not be amortized a. Illustration--a corporation purchased a trademark at a cost of $400,000 Amortization = 0 D. Impairment--impairment occurs when the carrying amount of an asset is not recoverable due to events or changes in circumstances (such as a projection of continuing losses associated with an asset, an accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset, a significant adverse change in legal factors or in the business climate that affects the value of an asset, a significant decrease in the fair market value of an asset, and a significant change in the extent or manner in which an asset is used) 1. Limited-life Intangibles a. Recoverability Test--an impairment has occurred if the undiscounted future net cash flows expected from the use of the intangible asset and its eventual disposition is less than the carrying amount of the intangible asset b. Amount of Loss--the impairment loss is the excess of the carrying amount of the intangible asset over its fair market value, if an active market for it exists, or the present value of the future net cash flows expected from the use of the intangible asset and its eventual disposition, if an active market for it does not exist 1) Carrying Value--the reduced carrying value of the intangible asset becomes its new cost 2) Illustrations a) A corporation had a patent with a carrying amount of $500,000, undiscounted expected future net cash flows of $520,000, and a fair market value of $420,000 525,000 > 500,000 No Entry b) A corporation had a patent with a carrying amount of $500,000, undiscounted expected future net cash flows of $470,000, and a fair market value of $420,000 470,000 < 500,000 Loss on Impairment (500,000 420,000) Patent 2. 80,000 80,000

Indefinite-life Intangibles a. Other Than Goodwill 1) Fair Value Test--an impairment has occurred when the fair market value of the intangible asset is less than the carrying amount of the intangible asset

2)

Amount of Loss--the impairment loss is the excess of the carrying amount of the intangible asset over its fair market value a) Carrying Value--the reduced carrying value of the intangible asset becomes its new cost b) Illustrations I) A corporation had a trademark with a carrying amount of $500,000 and a fair market value of $520,000 520,000 > 500,000 No Entry II) A corporation had a patent with a carrying amount of $500,000 and a fair market value of $420,000 420,000 < 500,000 Loss on Impairment (500,000 420,000) Trademark 80,000 80,000

b.

Goodwill 1) Fair Value Test--a potential impairment has occurred if the fair market value of the business is less than the carrying amount of the business, including goodwill 2) Amount of Loss--the impairment loss is the excess of the fair market value of the business less the fair market value of the identifiable net assets of the business over the carrying amount of the goodwill a) Carrying Value--the reduced carrying value of the goodwill becomes its new cost b) Illustrations I) A corporation had a fair market value of $1,200,000; the fair market value of the identifiable net assets of the corporation were $1,075,000; the corporation had goodwill with a carrying amount of $100,000 (1,200,000 1,075,000) > 100,000 No Entry II) A corporation had a fair market value of $1,200,000; the fair market value of the identifiable net assets of the corporation were $1,125,000; the corporation had goodwill with a carrying amount of $100,000 (1,200,000 1,125,000) < 100,000

Loss on Impairment (100,000 75,000) Goodwill E.

25,000 25,000

Disclosure 1. Intangible Assets--all intangible assets should be reported as separate items in the balance sheet 2. Amortization--amortization expense and impairment losses for the current year and amortization expense for each of the succeeding 5 years should be disclosed 3. Goodwill--changes in the carrying amount of goodwill during the period should be disclosed 4. Research and Development Costs--the total research and development costs expenses should be disclosed for each period for which an income statement is presented