Intermediate

Financial Accounting I

Intangible Assets

Chapter Outline

Definition and common types of

intangible assets
Valuation and costs of intangibles
Accounting for finite-life intangibles and
intangibles with indefinite lives.
Accounting for patents, copyrights,
franchise and licenses, trade names and
trademarks, and start-up costs.
Accounting for R&D and computer
software costs.
Accounting for goodwill
Intangible Assets

Definition Of Intangible Assets

Assets -a. with future economic benefits,
b. no physical substance,
c. with high degree of uncertainty
concerning the future benefit.
Intangible Assets

Common Types of Intangibles

Patents, copyrights, franchises,

start-up costs, trade names,
trademarks, goodwill etc..

Intangible Assets

Valuation of Intangibles

Intangibles are recorded at cost and

are also reported at cost at the end of
an accounting period.
Intangibles with limited life are subject
to amortization and possible
impairment test.
Intangibles with indefinite life are only
subject to impairment test at least
annually.
Intangible Assets

Costs of Intangibles

Costs of Intangibles include acquisition

costs plus any other expenditures
necessary to make the intangibles ready
for the intended uses (i.e., purchase price,
legal fees, filing fees etc.; not including
internal R&D).
Essentially, the accounting treatment of
valuation for intangibles closely parallels
that followed by tangible assets.
Intangible Assets

Examples
1. Issuance of stock to acquire intangibles.
2. Lump-sum purchase of intangibles.

Costs will be allocated in accordance

with the fair market value of each
individual intangible.

Intangible Assets

Intangibles Assets with Finite lives

Patents (20 years), copyrights (the life

of the creator plus 70 years), franchise
and license (the contractual life).
The costs are subjected to amortization
(a process of cost allocation) over the
shorter of the legal or useful life, not to
exceed 40 years.
Intangible Assets

Amortization of Intangibles

The impairment test needed only when

events indicate that the book value may
not be recoverable.
Amortization Method: Straight-line
method.
Other method can be applied if it is more
appropriate than the S-L method.
Residual value: Usually zero.
Intangible Assets

Amortization of Intangibles (contd.)

Journal Entry:
Amortization Expense

xxx

Intangible Asset

xxx

(or Accumulated Amortization)

Intangible Assets

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Intangibles Assets with Indefinite

Lives

Trade names, trademarks, goodwill, inprocess R&D.

The costs are not subject to
amortization.
Impairment test is required at least
annually.

Intangible Assets

11

1. Patents

Granted by the U.S. Patent and

Trademark Office for a period of 20
years.
A patent gives the holder the exclusive
right to produce, use and sell a product
or process without interference or
infringement from others.
Intangible Assets

12

Patents (contd.)

Cost of patent: If purchased from an

inventor, the cost will include the
purchase price plus any legal fees (to
successfully protect the patent).
In addition, any legal fees occur after the
acquisition of a patent which
successfully defend the right of the
patent should also be capitalized.
Intangible Assets

13

Patents (contd.)

The cost of a patent should be

amortized over the legal life or the useful
life, whichever is shorter.

Intangible Assets

14

Patents (contd.)
Journal Entry
Amortization Expense
Patents
(or Accu. Patent Amortization)

xxx
xxx

Using straight-line method (partial year should be

applied)
Intangible Assets

15

Patents (contd.)

If events indicate the book value of a patent

may not be recoverable, an impairment test
is required (see Chapter 11 for details)
If a patent becomes worthless, the net value
of the patent should be written off as loss.
If a patent is internally developed, no cost
can be capitalized.
Most of the research and development
(R&D) costs are expensed.
Intangible Assets

16

2. Copyrights

A federally granted right to authors,

sculptors, painters, and other artists for
their creations.
A copyright is granted for the life of the
creator plus 70 years.
It gives the creator and heirs an
exclusive right to reproduce and sell
the artistic work or published work.
Intangible Assets

17

Copyrights (contd.)

If purchased, the cost includes the

purchase price plus any legal fees.
If developed by the owner (the creator),
no cost can be capitalized.
Amortization: Straight-line method or a
unit-of-production method.
Impairment test needed only if events
indicate that book value may not be
recoverable.
Intangible Assets

18

3. Franchise & License

A franchise is a contractual agreement

under which the franchiser grants the
franchisee the right to sell certain products
or service or to use certain trade names or
trademarks.
A license is a contractual agreement
between a governmental body (i.e., city,
state, etc.) and a private enterprise to use
public property to provide services.
Intangible Assets

19

Franchise & License (contd.)

Costs: Franchise fees plus any legal

fees should be capitalized.
Amortization: over the shorter of the
contractual life or the useful life, not to
exceed 40 years.
Impairment test is needed only if events
indicate that the book value may not be
recoverable.
Intangible Assets

20

4. Trademarks & Trade Names

A word, a phrase, or a symbol that

distinguishes a product or an enterprise
from another (i.e., company names,
XEROX,)
Cost: Similar to that of copyrights.

Intangible Assets

21

Trademarks & Trade Names

Life: register at the US Patent Office for

10 years life. The registration can be
renewed every 10 years for unlimited
times.
Amortization: no amortization necessary.
Impairment test is required at least
annually.
Intangible Assets

22

5. Start-Up Costs (including Organization

Costs)
Start-up costs: Any costs incurred for the

preparation of introducing a new product or

new service or start business in a new
territory.
Org. Costs: Costs associated with the
formation of a corporation including fees to
underwriters (for stock issuance), legal fees,
promotional expenditures, etc.

These costs should be expensed as

incurred.
Intangible Assets

23

6. Research and Development (R&D)

Prior to SFAS 2 (effective in 1974), the

practice was to either expense or
capitalize R&D related expenditures.
SFAS 2 requires to expense and
disclose all R&D costs if the results of
R&D are for internal use.

Intangible Assets

24

6. Research and Development

(R&D)
R&D costs include salaries of personnel

involved in R&D, costs of materials used,

equipments, facilities and intangibles used
in R&D activities.

If equipment has an alternative usage,

the equip. should be capitalized and only
the depreciation expense will be included
in the R&D expense.
Intangible Assets

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R&D: An Example
Cash expenditures related to the R&D are as
follows:
R&D salaries and wages
$100,000
R&D material &supplies used
50,000
R&D equip. purchased*
120,000
Payments to others for service
performed related to R&D
30,000
Patent filing and legal fees
for completed project
25,000

Intangible Assets

26

R&D: An Example (contd.)

*The equipment purchased will be used in

other projects and the depreciation on the
equipment in 2008 was $ 10,000.
R&D expenses include the followings:
R&D salary: $100,000; R&D material:
$50,000; depre. Expense: $10,000;
payments to others: $30,000 .
The following expenditures are capitalized:
Equipment: $120,000 ; Patent: $25,000.
Intangible Assets

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R & D Contracts

Costs of R&D performed under

contracts for others are capitalized as
inventory or receivable.
Income from these contracts can be
recognized based on percentage-of
completion or complete contract
method as discussed for the long-term
construction contracts.
Intangible Assets

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Purchased R&D

When acquiring another company, the

purchase price is allocated to tangible
assets, intangibles (developed
technology) and in-process R&D.
The remaining will be the goodwill.
The in-process R&D is expensed prior
to 2009.
Intangible Assets

29

Purchased R&D (Contd.)

The fair value of in-process R&D is

capitalized as indefinite-life intangible
asset for business acquisition made in
fiscal years beginning on or after
12/15/2008 (SFAS 141 (revised)).
The capitalized in-process R&D should
not be amortized but is subject to
impairment test.
Intangible Assets

30

International Financial Reporting

Standards R&D (IAS 38)

Research expenditures are expenses

as incurred.
Development expenditures meet
certain criteria (i.e., development costs
can be measured , the product is
technically and commercially feasible
and the economic benefits are
probable) are capitalized as an
intangible asset.
Intangible Assets

31

7. Computer Software Costs

Computer software costs including planning,

designing, coding, testing, documentation
and preparation of training materials.
Expense most of the costs if the software is
to be sold.
SFAS 86 requires these costs be expensed
as R & D expenses prior to the
establishment of technological feasibility of
the software.
Intangible Assets

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Costs Associated With a Software

Costs occurred after the establishment

of technological feasibility but before
the software is ready for general release
are capitalized as an intangible asset.
Costs occurred after the software is
ready for general release and
production are recognized as produce
costs (will be expensed as CGS later).
Intangible Assets

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8. Goodwill

Cannot be separated from the business.

Can only be recognized if the whole
business was purchased and the
purchase price is greater than the
market value of the net assets (i.e.,
market value of assets market value
of liabilities).
Intangible Assets

34

Factors Contribute to Goodwill

Superior management team.

Outstanding sales organization.

Favorable tax condition.

Effective advertising.

Good labor relations.

Outstanding credit rating.

Intangible Assets

35

Methods of Measuring Goodwill

Theoretically, estimate the value of each

factor which contributes to the goodwill (not
practical).
There are two alternatives used in
measuring goodwill:
a. Master valuation approach.
b. Capitalization of excess earnings power.
Intangible Assets

36

a. Master Valuation Approach

Goodwill1 = Purchase price of a business market value of net assets of the business.
Market value of net assets
= M.V. of assets - M.V. of liabilities.
1. Goodwill is measured as the excess of cost over
the fair value of the identifiable net assets acquired.

Intangible Assets

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b. Capitalization of Excess Earnings

Power

Excess earnings power = the difference

between what a firm earns and what is
normally earned for a similar firm in the
same industry.

Goodwill = Discounting the excess

earnings over the estimated life of the
excess earnings.
Intangible Assets

38

b. Capitalization of Excess Earnings

Power (contd.)

Example
Excess earning = $10,000
Discount Rate = 10%
Estimated life = 10 years

Goodwill = $10,000 x 6.145 = $61,450

annuity, 10 -period, 10%
Intangible Assets

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b. Capitalization of Excess Earnings

Power (contd.)

Excess Earnings = annual average

earnings of a firm (excluding
extraordinary items) normal annual
earnings of a similar firm in the industry.
Normal earnings = industry rate of return
on assets the market value of the
acquired firms net assets.
Intangible Assets

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Goodwill (contd.)

Recording of Acquisition:
Assets (at market value)
xxx
Goodwill
xxx
Liability (at market value)
xxx
Cash
xxx

Intangible Assets

41

Goodwill (contd.)

Amortization of goodwill is abolished by

SFAS No. 142, effective July 2002.
Goodwill is subject to impairment tests
at least annually.
See the notes in chapter 11 for Assets
Impairment for the goodwill impairment
procedures.

Intangible Assets

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Negative Goodwill

Negative Goodwill: Cannot be recognized.

(in the case when price paid is less than
the market value of the net assets)

The negative goodwill is used to reduce the

costs assigned to the noncurrent assets
acquired. The reduction is proportionately
to the relative market value of the
noncurrent assets.
Intangible Assets

43

Impairment of Intangible Assets

(see Impairment Notes in Ch. 11 for Details)

All principles (SFAS 144) apply to

impairments of long-lived assets also apply
to intangible assets.
Thus, when changes in circumstances
indicate that the book value of the
intangibles may not be reconcilable (i.e., fair
value of intangible < carrying amount), a
write-down should be performed to
recognize the loss.
Intangible Assets

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Impairment of Intangible Assets

(contd.)

Example:
Carrying amount of a copyright
Fair value
Loss on Impairment

$1,200,000
500,000
$700,000

The journal entry to record the loss:

Loss on Impairment
Copyright

700,000
700,000
Intangible Assets

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Summary of the Chapter

Intangible

Legal Life

Amortization

Patent

20

The shorter of useful or

legal life

Copyrights

Life of creator + 70
years

The shorter of useful or

legal life not to exceed
40 years

Franchises or
Licenses

Contractual
agreements

The shorter of
contractual Life or
useful life

Trade Names &

Trademarks

Unlimited (renewed
every 10 years)

Impairment test only

(at least annually)

In-Process R&D

Unlimited

Impairment test only

Goodwill

Unlimited

Impairment test only

Intangible Assets

46