AUDIT OF

PREPAYMENT AND
INTANGIBLE ASSET

PROBLEM 6-1
The INTANGIBLES COMPANY engaged in the following transactions at the beginning of
2018:

1. Purchased a patent for P700,000 that had originally been filed in January 2012. The
acquisition was made to protect another patent that the company had filed for in January 2014
and subsequently received.

2. Purchased the rights to a novel by a best-selling novelist in exchange for 100,000 ordinary
shares (P10 par) selling for P60 per share. The book sells 1 million copies in 2018 and is
expected to sell a total of 500,000 copies in future years.

3. purchased the franchise to operate a ferry service from the government for P100,000. A bridge
has been planned to replace the ferry, and it is expected that it will be completed in five years.
The company hopes that the ferry will continue as a tourist attraction, but profits are expected to
be only 20% of those earned before the bridge is opened.

4. paid P280,000 to attorneys for the services to successfully defend the patent acquired in
transaction 1.

5. Paid a taxi operator P500,000 to have the company name prominently displayed on his taxis
for two years.
Based on the preceding information, determine the carrying value of the following at the end of
2018:

1. Patent
A. P630,000 C. P910,000
B. P656,250 D. P650,000

2. Copyright
A. P2,000,000 C. P3,000,000
B. P0 D. P4,000,000

3. Franchise
A. P100,000 C. P80,000
B. P84,000 D. P76,000

SOLUTION 6-1

1. Cost of patent P700,000

Amortization for 2018 (p700,000/14 years) (50,000)
Carrying value, December 31, 2018 P650,000
Answer: D

The competing patent purchased to protect another patent with a life of 16 years has a remaining
legal life of 14 years and should be amortized over that period

2. cost of copyright P6,000,000

Amortization for 2018
(6,000,000 x 1 milllion/1.5 million) (4,000,000)
Carrying value, December 31, 2018 P2,000,000
Answer: A

3. Cost of franchise P100,000

Amortization for 2018 (P100,000/5) (20,000)
Carrying value, December 31, 2018 P80,000
Answer: C

PROBLEM 6-2

The following independent situations relate to the audit of intangible assets. Answer the
question/s at the end of each situation.

Situation 1
 YOLING INDUSTRIES reports the following patents on its December 31, 2017, statement of
financial position.

Initial cost Date of acquisition Useful life

(at the date of acquisition)
Patent A P1,224,000 March 1, 2014 17 years
Patent B 450,000 July 1, 2015 10 years
Patent C 432,000 Sept. 1, 2016 4 years

The following events occurred during the year ended December 31, 2018.

1. Research and development costs of P737,100 were incurred during the year. These costs were
incurred prior to projects achieving economic viability.
2. Patent D was purchased on july 1 for P855,000. It has a remaining life of 91/2 years.
3. A possible impairment of Patent B’s value may have occurred at December 31, 2018. This is due
to a significant reduction in the demands for certain products protected by Patent B. The
company’s controller estimates the following future cash flows from Patent B.
December 31, 2019 P60,000
December 31, 2020 P60,000
December 31, 2021 P60,000

The appropriate discount rate to be used for these cash flows is 8%.

1. What is the total carrying value of Yoling’s Patents on December 31, 2017?
A. P2,383,500 C. P2,106,000
B. P1,390,620 D. P1,573,500

2. What amount of impairment loss should be reported by Yolling for the year ended December 31,
2018?
A. P137,880 C. P337,500
B. P292,500 D. P154,620

3. What is the total carrying value of Yolling’s patents on December 31,2018?

A. P1,969,080 C. P2,158,500
B. P2,020,620 D. P2,203,500

SITUATION 2
In your audit of the books of DIEHARD CORP. for the year ended December 31, 2018, you
found the following items in connection with the company’s patents account.

a) Diehard had spent P360,000 during the year ended December 31, 2017, for research and
development costs. This amount was debited to its patents account. The company’s cost records
disclose that it had spent a total of P424,500 for the research and development of its patents, of
which P64,500 spent in 2017 had been debited to Research And Development Expense.

b) The patents were issued on July 1, 2017. In connection with the issuance of the patents, the
company incurred legal expenses of P42,840, which debited to Legal And Professional Fess
Expense.

c) On January 5, 2018, Diehard paid a retainer of P45,000 for legal services in connection with a
patent infringement suit brought against it. Deferred costs was charged for the amount.

d) In reply to your inquiry about the company’s liabilities as of December 31, 2018, you
received a letter from the company’s legal counsel dated January 20, 2019, which indicated that a
settlement of the patent infringement suit had been arranged. The plaintiff will drop the suit and
release the company from all future liabilities in exchange for P60,000. Additional lawyer’s fees
were incurred amounting to P3780.

4. The correcting journal entries (excluding amortization) on December 31, 2018, wpould
include net debit (credit) to

Patents Legal and professional fess expense

A P(317,160) P108,780
B (208,380) 0
C (272,160) 63,780
D (253,380) 45,000

SITUATION 3

As the recently appointed auditor for SUPERPOWER COMPANY, you have been asked to
examine selected accounts. Your audit client, organized in 2017, has setup a single account for all
intangible assets. The following summary shows the debit entries that have been recorded during
2018.
jan. 2 Purchased patent (8-year life) P 870,000
April 5 Goodwill 720,000
June 30 Payment of 12 months’ rent on property leased by 182,000
superpower
July 1 Purchased franchise with 10-year life; expiration date, 900,000
july 1, 2028
Aug. 3 Payment for copyright (5-yearlife0 312,000
Sept. 1 Research and development costs related to patent 320,000
(incurred prior to achieving economic viability)
P 3,304,000

5. What is the total carrying value of superpower’s intangible assets as of December 31, 2018?
A. P2,928,917 C. P2,927,705
B. P2,622,250 D. P2,713,250

SOLUTION 6-2
1. patent A
Initial cost P1,224,000
Amortization:
2014 (P1,224,000/17 x 10/12) P60,000
2015-2017 (p1,224,000 x 3/17) 216,000 (276,000) P948,000

patent B
Initial cost P450,000
Amortization:
2014 (P1,224,000/17 x 10/12) P22,500
2015-2017 (p1,224,000 x 3/17) 90,000 (112,500) P337,500

patent C
Initial cost P432,000
Amortization:
2014 (P1,224,000/17 x 10/12) P36,000
2015-2017 (p1,224,000 x 3/17) 108,000 (144,000) P288,000
Total carrying value of patents, Dec. 31, 2017 P1,573,500

ANSWER: D

2. Patent B
Carrying value, December 31, 2017 P337,500
Less: 2018 amortization (P450,000 x 1/10) 45,000
Carrying value, December 31, 2018 292,500
Present value of future cash flows (P60,000 X 2,5770) 154,620
Impairment loss P137,880
ANSWER: A
3. patent A
Carrying value, December 31, 2017 P948,000
Less: 2018 amortization (P1,224,000x1/17) 72,000 P876,000
Patent B 154,620
Patent C
Carrying value, \december 31, 2017 P288,000
Less: 2018 amortization (P432,000 x ¼) 108,000 180,000
Patent D
Initial cost P855,000
Less: 2018 amortization (P855,000/9.5 x 6/12) 45,000 810,000
Total carrying value of patents, December 31, 2018 P2,020,620
ANSWER: B

SITUATION 2

4. Adjusting Journal Entries

December 31, 2018

a) Retained earnings 360,000

patents 360,000

b) Patents 42,840
retained earnings 42,840

c) Legal and professional fees expense 45,000

deferred costs 45,000

d) Legal and professional fees expense 63,780

liability for settlement of patent
infringement suit 60,000
accrued attorney’s fees 3,780
ANSWER: A

SITUATION 3

5. patent P870,000
Less: Amortization (P870,00/8) 108,750 P 761,250
Goodwill 720,000
 Franchise P900,000
Less: Amortization(P900,000/10 X 6/12) 45,000 855,000
Copyright P312,000
Less: Amortization(P312,000/5 x 5/12) 26,000 286,000
Total carrying value, December 31, 2018 P2,622,250
ANSWER: B

PROBLEM 6-3

The following situations are found in the records of the KILIMANJARO, INC. in your audit of
the company’s financial statements for the year ended December 31, 2018.

1. December 1, 2018:

Advertising expense 72,000

Cash 72,000
Payment of 2018 advertising contract.

2. Balance of Office supplies expense, Dec. 31, 2018 P45,000

Balance of unused office supplies, Dec. 31, 2018 15,000
Inventory of office supplies, Dec. 31, 2018 22,500

3. June 2, 2018

Prepaid insurance 54,000

Cash 54,000
Payment of one-year insurance premium for inventory.

4. Balance of factory supplies expense account, Dec. 31, 2018 P69,000

Physical inventory of factory supplies, Dec. 31, 2018 58,500

5. On May 1, 2018, a two-year subscription to the industry journal in the amount of P14,400 was
paid. Subscription expense was charged for the entire amount.

Prepare the adjusting journal entries on December 31, 2018, based on the situations described.

SOLUTION 6-3

ADJUSTING JOURNAL ENTRIES

December 31, 2018
1. Prepaid advertising 72,000
Advertising expense 72,000

2. Unused office supplies 7,500

Office supplies expense 7,500
(P22,500 – P15,000)

3. Insurance expense 31,500

Prepaid insurance 31,500
(P54,000 X 7/12)

4. Factory supplies inventory 58,500

Factory supplies expense 58,500

5. Prepaid subscriptions 9,600

Subscription expense 9,600
(P14,400 X 16/24)

PROBLEM 6-4

KENYA ENTERPRISE developed a new machine that reduces the time required to mix the
chemicals used in one of its leading products. Because the process is considered very valuable to
the company, Kenya patented the machine.

Kenya incurred the following expenses in developing and patenting the machine:

Research and development laboratory expenses P750,000

Materials used in the construction of the machine 240,000
Blueprints used in the construction of the machine 96,000
Legal expenses to obtain patent 360,000
Wages paid for the employees’ work on the research,
development, and building of the machine (60% of
the time was spent in actually building the machine) 900,000
Expense of drawing required by the patent office to be
submitted with the patent application 51,000
Fees paid to Patent Office to process application 75,000

One year later, Kenya Enterprises paid P525,000 in legal fees to successfully defend a patent
against an infringement suit by Gaya-gaya Company.

1. What is the total cost of the patent?

A. P993,000 C. P564,000
 B. P486,000 D. P126,000

2. What is the total cost of the new machine?

A. P1,362,000 C. P780,000
B. P0 D. P876,000

3. What is the entry to record the legal fees paid for the successful defense of the patent against
the infringement suit?
A. Patents 525,000
Cash 525,000
B. Legal fees expense 525,000
Cash 525,000
C. Machinery 525,000
Cash 525,000
B. Amortization expense - patents 525,000
Cash 525,000

SOLUTION 6-4

1. Legal expenses to obtain patent P360,000

Expense of drawing required by patent office
to be submitted with patent application 51,000
Fees to be paid to process patent application 75,000
Total cost of patent P486,000
ANSWER: B

2. Materials used in the construction of the machine P240,000

Blueprints used to design the machine 96,000
Wages of the employees’ work on the
construction of the machine (P900,000 x 60%) 540,000
Total cost of machine P486,000
ANSWER: B

3. The legal fees paid for the successful defense of the patent should be expensed, not
capitalized. This expenditure does not meet the definition of and the recognition criteria for an
intangible asset. The entry to record the legal fees paid is:

Legal fees expense 525,000

Cash 525,000
ANSWER: B

PROBLEM 6-5 Identifying Intangible Assets

The following amounts are included in the general ledger of MARGHERITA PEAK
CORPORATION at December 31, 2018:
 Organization costs P 72,000

Trademarks 45,000

Patents 225,000

Discount on bonds payable 105,000

Deposits with advertising agency for ads to

promote goodwill of company 30,000

Cost of equipment acquired for various research

and development projects 320,000

Costs of developing a secret formula for a product

that is expected to be marketed for at least 20 years 240,000

On the basis of the information above, what is the total amount of intangible assets to be reported
by Margherita Peak in its statement of financial position at December 31, 2018?

A. P342,000 C. P510,000
B. P270,000 D. P830,000

SOLUTION 6-5
Trademarks P 45,000
Patents 225,000
Total intangible assets 270,000
Answer: B

 Organization cost should be recognized as expense in the period it is incurred.

 Discount on bonds payable should be reported as a contra account to bonds payable.
 Cost of equipment acquired for various research and development projects should be included in
the property, plant, and equipment section.
 Deposits with advertising agency for ads to promote goodwill of the company should be reported
as prepaid advertising in the current assets section. PAS 38 does not preclude recognizing a
prepayment as an asset when payment for the delivery of goods or rendering of the services.

PROBLEM 6-6 Patent

As a member of the audit team for the audit of RAS DASHEN COMPANY’s financial
statements for the year ended December 31, 2018, you have been asked to examine selected
accounts. The controller for Ras Dashen mentions that there is only one account (shown below)
kept for intangible assets.

INTANGIBLE ASSETS

Debit Credit Balance

Feb. 1 Organization costs P72,000 P72,000

Mar. 15 Research and development 1,880,000 1,952,000

April 3 Legal costs to obtain patent 150,000 2,102,000

May 1 Payment on 12 months’ rent

on property leased by Ras

Dashen 240,000 2,342,000

June 15 Promotional expenses related

to start-up of business 414,000 2,756,000

Dec. 31 Unamortized bond discount

on bonds due Dec. 31, 2038 168,000 2,924,000

Dec. 31 Operating losses for first year 482,000 3,406,000

1. The amount of organization expenses to be reports in Ras Dashen’s income statement for the
year ended December 31, 2018 is
A. P2,348,000 C. P582,000
B. P486,000 D. P240,000
2. What is the carrying value of the patent at December 31, 2018 assuming that its useful life is 10
years?
A. P150,000 C. P135,000
B. P138,750 D. P0
3. The prepaid rent to be shown on Ras Dashen’s statement of financial position at December 31,
2018, is
A. P160,000 C. P80,000
B. P240,000 D. P0

SOLUTION 6-6
1. Organizational costs P 72,000
Promotional expenses related to start-up of business 414,000
Total organization expenses P486,000

Answer: B

2. Legal cost to obtain patent P150,000

Less: Amortization, April 3 – Dec. 31
(150,000/10 x 9/12) 11,250
Balance, Dec. 31, 2018 P138,750

Answer: B

3. Prepaid rent, Dec. 31, 2018 (P240,000 x 4*/12) P 80,000

*Jan. 1, 2019 – May 1, 2019

Answer: C

PROBLEM 6-7 Lease Bonus and Leasehold Improvements

MERU, INC. leases an old building which it intends to improve and use for administrative
purposes. The company pays a bonus of P100,000 to obtain the lease. Annual rental for the 10-
 year lease period is P160,000. No option to renew the lease or right to purchase the property is
given by the lessor.

After obtaining the lease, improvements on the leased building are made costing P400,000. The
building has an estimated remaining useful life of 19 years.

1. What is the annual cot (excluding depreciation) of this lease to Meru, Inc.?
A. P210,000 C. P160,000
B. P200,000 D. P170,000

2. What is the amount of annual depreciation (straight-line), if any, should Meru, Inc. record?
A. P40,000 C. P50,000
B. P30,000 D. P0

3. What is the entry to record the lease bonus paid at the inception of the lease?
A. Rent expense 100,000
Cash 100,000

B. Prepaid rent 100,000

Cash 100,000

C. Prepaid rent 90,000

Rent expense 10,000
Cash 100,000

D. Rent expense 90,000

Prepaid expense 10,000
Cash 100,000

SOLUTION 6-7
1. Annual Rental P160,000
Amortization of lease bonus 10,000
 Annual cost of lease P170,000

Answer: D

2. Annual depreciation on leasehold improvements

(400,000/10 years) P40,000

Answer: A

3. Prepaid Rent 100,000

Cash 100,000

Answer: B

PROBLEM 6-8 Organizational Costs

ELGON COMPANY was organized in 2017 and began operations at the beginning of 2018. The
company provides landscaping services. The following costs were incurred prior to the start of
operations:

Legal fees in connection with organization of the company P171,000

Improvements to leased office space prior to the occupancy 225,000
Costs of meetings of incorporators to discuss
organizational activities 63,000
Filing fee to incorporate 9,000
P468,000
What is the total amount of organization costs that should be reported in Elgon’s income
statement?
A. P243,000 C. P180,000
B. P468,000 D. P207,000

SOLUTION 6-8

Legal fees in connection with organization of the company P171,000

 Costs of meetings of incorporators to discuss
organizational activities 63,000
Filing fee to incorporate 9,000
P243,000
Answer: A

Improvements to leased office space prior to occupancy of P225,000 should be classified as

leasehold improvements.

PROBLEM 6-9 Accounting for Patent, Franchise, R&D Costs

CAMEROON CORP. has provided information on intangible assets as follows:

 A patent was purchased from Patintero Company for P6,000,000 on January 1, 2017. On the
acquisition date, the patent was estimated to have a useful life of 10 years. The patent had a net
book value of P6,000,000 when Patitero sold it to Cameroon.
 On February 1, 2018, a franchise was purchased from the Franchisor Company for P1,440,000.
The contract which runs for 20 years provides that 5% of revenue from the franchise must be
paid to Franchisor. Revenue from the franchise for 2018 was P7,500,000.
 The following research and development costs were incurred by Cameroon in 2018:
Materials and equipment P 426,000
Personnel 567,000
Indirect costs 306,000
Total P1,299,000
Because of recent events, Cameroon, on January 1, 2018, estimates that the remaining useful life
of the patent purchased on January 1, 2017, is only 5 years from January 1, 2018.

1. On December 31, 2018, the carrying value of the patent should be

A. P4,320,000 C. P1,680,000
B. P6,000,000 D. P0
2. The unamortized cost of the franchise at December 31, 2018, should be
A. P999,999 C. P1,440,000
B. P1,356,250 D. P1,725,000
3. How much should be charged against Cameroon’s income for the year ended December 31,
2018?
A. P2,280,000 C. P2,820,000
B. P2,826,000 D. P1,725,000
4. An auditor will most likely obtain evidence regarding the continuing validity and existence of the
patent by obtaining a written representation from
A. The Securities and Exchange Commission (SEC)
B. A patent attorney
C. The patent investigator
D. The patent owner

SOLUTION 6-9
1. Acquisition cost of patent purchased Jan. 1, 2017 P6,000,000
Less: Amortization:
2017 (P6,000,000/10 years) P 600,000
2018 (P6,000,000 – P600,000 = P
5,400,000/5 years) 1,080,000 1,680,000

Carrying value of patent, December 31, 2018 P4,320,000

Answer: A

2. Acquisition cost of franchise purchased Feb. 1, 2018 P1,440,000

Less: Amortization (P1,440,000/20 years x 11/12) 66,000
Carrying value of franchise, Dec. 31, 2018 P1,374,000

Answer: D

PAS 38 provides that the depreciable amount of an intangible asset that has a finite life should be
allocated (amortized) on a systematic basis over its useful life. Amortization begins when the
asset is available for use, i.e., when it is in the location and condition necessary for it to be
capable of operating in the manner intended by management. On the other hand, an intangible
asset with an indefinite useful life should be amortized but should be tested for impairment by
comparing its recoverable amount with its carrying amount at least annually, and whenever there
is an indication that the intangible asset may be impaired.
3. Chargers against 2018 income:
Amortization of patent (see no. 1) P1,080,000
Amortization of franchise (see no. 2) 66,000
Payment to franchisor (P7,500,000 x 5%) 375,000
Research and development costs 1,299,000
Total P2,820,000

Answer: C

4. A patent attorney
Answer: B

PROBLEM 6-10
Research and Development Costs

EMI KOUSSI CORP. has its own research department. However, the company purchases patents
from time to time. The following is a summary of transactions involving patents now owned by
the company.

 During 2012 and 2013, Emi Koussi spent a total of P459,000 in developing a new process that
was patented (Patent A) on April 1, 2014; additional legal and other costs of P50,000 with
incurred.
 A patent (Patent B) developed by Nonoy Inventor, an inventor, was purchased for P187,500 on
December 1, 2015, on which date it had an estimated useful life of 12 ½ years.
 During 2014, 2015, and 2016, research and development activities cost P510,000. No additional
patents resulted from these activities.
 A patent infringement suit brought by the company against a competitor because of the
manufacture of article infringing on Patent B was successfully prosecuted at a cost of P42,000. A
decision in the case was rendered in June 2016.
 On July 1, 2017, Patent C was purchased for P172,000. The patent had 16 years yet to run.
 During 2018, Emi Koussi expended P180,000 on patent development. However, the company is
still undecided as to how the patent, if approved by the Bureau of Patents, will generate probable
future economic benefits.
Assume that the legal life of each patent is also its useful life.

1. What is Patent A’s carrying value on December 31, 2018?

a. P120,888
b. P497,125
c. P38,125
d. P388,113

2. What is Patent B’s carrying value on December 31, 2018?

a. P141,250
b. P28,906
c. P32,092
d. P173,342

3. What is Patent C’s carrying value on December 31, 2018?

a. P162,000
b. P327,600
c. P159,840
d. P156,600

4. What is the total patent amortization expense to be reported in Emi Koussi’s income statement
for the year ended December 31, 2018?
a. P37,300
b. P28,741
c. P74,325
d. P28,300

SOLUTIONS 6-10
Date Patent Cost Useful Life Annual
Amortization
April 1, 2014 A P 50,000 20* years P 2,500
Dec. 1, 2015 B 187,500 12.5 years 15,000
 July 1, 2017 C 172,800 16 years 10,800
P 410,300 P 28,300

*According to RA 8293, the Intellectual Property Code of the Philippines, the term (legal life) of
patent is 20 years from the date of filing the application.

1. Cost of Patent A P 50,000

Less: Amortization, April 1, 2014- Dec. 31, 2018
(P2,500 x 4 9/12) 11,875
Carrying Value, Dec. 31, 2018 P 38,125
Answer: C

2. Cost of Patent B P 187,500

Less: Amortization, Dec. 1, 2015- Dec. 31, 2018
(P15,000 x 3 1/12) 46,250
Carrying Value, Dec. 31, 2018 P 141,250
Answer: A

3. Cost of Patent C P 172,800

Less: Amortization, July 1, 2017- Dec. 31, 2018
(P10,800 x 1 6/12) 16,200
Carrying Value, Dec. 31, 2018 P 156,600
Answer: D

4. Amortization of patents for the year ended Dec. 31, 2018

(see schedule) P 28,300
Answer: D

Legal costs incurred in prosecuting or defending a patent are subsequent costs of maintaining,
rather than enhancing the original future economic benefits that are expected to flow from the
patent. These subsequent legal costs should be expensed, not capitalized.

PROBLEM 6-11
Patent Amortization
 ANDES CORPORATION expended P510,000 in research and development costs. These
activities resulted to a new product called the Oido Organ. It was patented at additional legal and
other costs of P54,000. The patent application was filed on October 1, 2014, and the patent was
estimated to have a useful life of 10 years.

On June 1, 2016, Andes spent P28,440 to successfully prosecute a patent infringement. In

addition, the patent’s estimated useful life was extended to 12 years from June 1, 2016. At the
beginning of 2018, Andes determined that a competitor’s product would make the Oido Organ
obsolete and the patent worthless by December 31, 2019.

Based on the preceding information, calculate the patent amortization expense for each of the
following years:

1. 2014
a. P14,100
b. P12,750
c. P5,400
d. P1,350

2. 2015
a. P51,000
b. P56,400
c. P2,700
d. P5,400

3. 2016
a. P4,438
b. P2,188
c. P3,750
d. P5,820

4. 2017
a. P4,438
b. P6,120
c. P3,750
d. P2,188

5. 2018
a. P31,875
b. P19,531
c. P39,062
d. P3,750

SOLUTION 6-11

1. PATENT AMORTIZATION FOR 2014:

Oct. 1- Dec. 31 (P54,000/10 x 3/12) P 1,350
Answer: D

2. PATENT AMORTIZATION FOR 2015:

Jan. 1- Dec. 31 (P54,000/10) P 5,400
Answer: D

3. PATENT AMORTIZATION FOR 2016:

Cost of Patent P 54,000
Less: Amortization, Oct. 1, 2014- June 1, 2016:
(P54,000/10 x 1 8/12) 9,000
Unamortized Cost, June 1, 2016 P 45,000
Revised remaining life /12 years
Revised annual amortization P 3,750
 Amortization for 2016:
Jan. 1- June 1 (P54,000/10 x 5/12) P 2,250
June 1- Dec. 31 (P3,750 x 7/12) 2,188
Total P 4,438
Answer: A

4. PATENT AMORTIZATION FOR 2017:

(P45,000/12 years) P 3,750
Answer: C

5. PATENT AMORTIZATION FOR 2018:

Cost of Patent P 54,000
Less: Amortization:
2014 P 1,350
2015 5,400
2016 4,438
2017 3,750 14,938
Unamortized Cost, Jan, 1, 2018 P 39,062
Revised remaining life /12 years
Revised annual amortization P 19,531
Answer: B

PROBLEM 6-12
Research and Development Costs

The following cost were incurred by EVEREST COMPANY during 2018:

Searching for applications of new research findings. P 57,000

Trouble-shooting in connection with breakdowns during commercial
production. 87,000
Adaptation of an existing capability to a particular requirement or
customer’s need as a part of continuing commercial activity. 39,000
Engineering follow-through in an early phase of commercial
production. 45,000
Radical modification of the formulation of a glassware product. 78,000
Laboratory research aimed at discovery of new knowledge. 204,000
Testing for evaluation of new products. 72,000
Quality control during commercial production, including routine
testing of products. 174,000
Materials consumed in research and development projects. 177,000
 Consulting fees paid to outsiders for research and development
projects. 300,000
Personnel costs of persons involved in research and development
projects 384,000
Indirect costs reasonably allocable to research and development
projects. 150,000
Materials purchased for future research and development projects. 102,000
Research and development costs reimbursable under a contract to
perform research and development for Client Corporation. 1050,000
Design, construction, and testing of preproduction prototypes and
models. 870,000
Routine on-going efforts to refine, enrich, or otherwise improve upon
the qualities of an existing product. 750,000
Total P 4,539,000

What is the total amount to be classified and expensed as research and development for 2018?

a. P3,342,000
b. P2,292,000
c. P2,394,000
d. P2,220,000

Solution 6-12

Searching for applications of new research findings. P 57,000

Radical modification of the formulation of a glassware product. 78,000
Laboratory research aimed at discovery of new knowledge. 204,000
Testing for evaluation of new products. 72,000
Materials consumed in research and development projects. 177,000
Consulting fees paid to outsiders for research and development
projects. 300,000
Personnel costs of persons involved in research and development
projects 384,000
Indirect costs reasonably allocable to research and development
projects. 150,000
Design, construction, and testing of preproduction prototypes and
models. 870,000
Total P 2,292,000
Answer: B
 PAS 38 classifies the generation of an intangible asset into:

a. A research phase; and

b. A development phase
An intangible asset that relates to research activities should not be recognized because the entity
cannot demonstrate that an intangible asset exist that will generate probable future economic
benefits. Therefore, such expenditure is expensed when it is incurred.

Examples of research activities are:

1. Activities aimed at obtaining new knowledge;

2. The search for, evaluating, and final selection of application of research findings or other
knowledge;
3. The search for alternatives for materials, devices, products, processes, system or services; and
4. The formulation, design, evaluation, and final selection of possible alternatives for new or
improved materials, devices, products, process, system or services.
An intangible asset that arises from the development phase shall be recognize if, and only if, an
entity can demonstrate all of the following:

a. The technical feasibility of completing the intangible asset so that it will be available for use or
sale;
b. Its intention to complete the intangible asset and use or sell it;
c. Its ability to use or sell the intangible asset;
d. How the intangible asset will generate probable future economic benefits (for example, the entity
must be able to demonstrate the existence of a market for the intangible asset or its output or, if it
is to be used internally, the usefulness of the intangible asset);
e. The availability of adequate technical, financial, and other resources to complete the
development and to use or sell the intangible asset; and
f. Its ability to measure reliably the expenditure attributable to the intangible asset during its
development.
Examples of development activities are:

1. The design, construction, and testing of pre-production or pre-use prototypes and models
2. The designs of tools, jigs, moulds, and dies involving new technology;
3. The design, construction, and operation of a pilot plant that is not of a scale economically
feasible for commercial production; and
4. The design, construction, and testing a chosen alternative for new or improved materials,
devices, products, processes, systems or services.

PROBLEM 6-13
Cost of Internally Generated Intangible Asset

MOSES COMPANY’s own research department has an on-going project to develop a new
production process. At the end of 2017, Moses had already spent a total of P300,000, of which
P270,000 was incurred before November 1, 2017. On November 1, 2017, the company’s newly
developed production process met the criteria for recognition as an intangible asset.

During 2018, Moses incurred additional expenditure of P600,000. At the end of 2018, the
recoverable amount of the intangible asset was estimated to be P570,000, including future cash
outflows to complete the process before it is available for its intended use.

1. At December 31, 2017, the production process should be recognized at a cost of

a. P300,000
b. P0
c. P30,000
d. P270,000

2. What is the total cost of the production process at December 31, 2018?
a. P630,000
b. P600,000
c. P870,000
d. P900,000
3. How much impairment loss should be recognized by Moses in 2018, in connection with the new
production process?
a. P300,000
b. P0
c. P30,000
d. P60,000

SOLUTION 6-13
1. Cost of the production process at Dec. 31, 2017
(P300,000 – P270,000) P 30,000
Answer: C

PAS 38 provides that the cost of an internally generated intangible asset is the sum of
expenditure incurred from the date when the intangible asset first meets the recognition criteria.
The standard prohibits recognition as a part of the cost of an intangible asset at a later date, the
expenditure that was initially recognized as an expense when it was incurred.

2. Expenditure incurred:
From November 1, 2015- December 31, 2017
(P300,000 – P270,000) P 30,000
During 2018 600,000
Total as of December 31, 2018 P 630,000
Answer: A

3. Carrying amount as of December 31, 2018 (see no. 2) P 630,000

Recoverable Value 570,000
Impairment Loss P 60,000
Answer: D

Problem 6-14
 KIKIKTAT CORPORATION was organized in 2017. Its accounting records include only one
account for all intangible assets. The following is a summary of the debit entries that have been
recorded and posted during 2017 and 2018.

INTANGIBLE ASSETS
July 1, 2013 8-year franchise; expires June 30, 2024 P 162,000
Oct. 1, 2013 Advance payment on leasehold (term of
Lease is 2 years) 84,000
Dec. 31, 2013 Net loss for 2017 including incorporation fee,
P3,000, and related legal fees of organizing
P15,000 (all fees incurred in 2017) 48,000
Jan. 2, 2014 Acquired patent (10-year life) 222,000
Mar.1, 2014 Cost of developing a secret formula 225,000
April 1, 2014 Goodwill purchased 835,200
July 1, 2014 Legal fee for successful defence of patent
Patent purchased above 37,950
Oct. 1, 2014 Research and development costs 480,000

Ignore Income tax effect.

1. The unamortized patent cost at December 31, 2014 should be

A. P199,800 C. P222,000
B. P235,440 D. P197,490

2. The unamortized franchise cost at December 31, 2014, should be

A. P110,250 C. P102,375
B. P94,500 D. P118,125

3. The amount of prepaid rent to be reported in KIKIKTAT’s December 31, 2014 statement of
Financial Position is
A. P73,500 C. P84,000
B. P31,500 D. P63,000

4. The adjusting entries on December 31, 2014 should include net debit to the retained earnings
accunt of:
A. P889,275 C. P60,375
B. P42,000 D. P66,375

5. As a result of the adjustments at December 31,2014, the total charges against Kikiktat’s 2014
income should be
A. P840,900 C. P597,900
B. P882,900 D. P841,275
 SOLUTION 6-14
1. Cost of Patent, Jan. 2, 2014 P222,000
Less: Amortization for 2014 (P222,000/10 years) 22,200
Unamortized patent cost, Dec. 31, 2014 P199,800

2. Cost of franchise, July 1,2013 P126,000

Less: Amortization, July 1, 2013-Dec,31 2014
(P126,000/8x1 6/12) 23,625
Unamortized franchise cost, Dec. 31,2014 P102,375

3. Prepaid rent, Dec. 31, 2018 (P84,000 x 9/24) P31,500

4. ADJUSTING ENTRIES
December 31, 2014

a. Franchises 126,000
Prepaid rent 84,000
Retained earnings 48,000
Patents 222,000
Research and development expense
(P225,000 + P480,000) 705,000
Goodwill 835,000
Legal fees expense 37,950
Intangible Assets 2,058,150

b. Franchise amortization expense (P126,000/8) 15,750

Retained earnings (P126,000/8 x 6/12) 7,875
Franchises 23,625

c. Rent expense (P84,000/2 years) 42,000

Retained earnings (P84,200 x 3/24) 10,500
Prepaid rent 52,500

d. Patent amortization expense 22,200

Patent (P222,000/10years) 22,200

Net debit to retained earnings

(P48,000 + P7,875 + P10,500) P66,375

5. Charges against 2014 income:

Research and development expense P705,000
Legal fees expense 37,950
 Franchise Amortization expense 15,750
Rent expense 42,000
Patent amortization expense 22,200
Total P822,900

Problem 6-15
KIJIK LABORATORIES holds a valuable patent (No.362436) as a device that burns body fats.
Kijik does not manufacture or sell the products and processes it develops; it conducts research
and develops products and processes which it patents, and then assigns the patents to
manufacturers on a royalty basis. The history of patent No. 362436 is as follows:

DATE ACTIVITY COST

2008-2009 Research conducted to develop device P7,680,000
2010
Jan.5 Design and construction of a prototype 1,752,000
Mar.15 Testing of models 840,000
2011
Jan.2 Legal and other fees to process patent application 1,241,000
2012
Dec.10 Legal fees paid to successfully defend
device patent 714,000
2013
April 3 Research aimed at modifying the design of
the patented device 860,000
2017
July 28 Legal fees paid in a successful patent infringement
Suit against a competitor 680,000

A 17-year useful life was assumed by Kijik when it received the initial device patent.

On January 1,2016, it revised its useful life estimated downward to 5 remaining years.

The company’s reporting date is December 31,2018

Based on the preceding information, compute the carrying value of Patent No. 362436 on each of
the following dates:

1. December 31,2011
A. P1,168,000 C. P1,241,000
B. P3,607,529 D. P1,178950

2. December 31,2015
A. P1,488,000 C. P350,000
B. P876,000 D. P817,600

3. December 31,2018
A. P657,000 C. P525,600
B. P876,000 D. P350,400

SOLUTION 6-15

1. Cost to obtain patent, Jan 2,2011 P1,241,000

Less: 2009 amortization (P1241,000/17years) 73,000
Carrying value, Dec 31,2011 P1,168,000

2. Carrying value, Dec. 31,2011 P1,168,000

Less: Amortization, 2012-2015:
(P73,000 x 4years) 292,000
Carrying value, Dec. 31,2015 P876,000

3. Carrying value, Dec 31,2015 P876,000

Less:Amortization, 2016-2018 (P876,000 x 3/5) 525,600
Carrying value, Dec. 31,2018 P350,400

PROBLEM 6-16

ACADIA CORP. was incorporated on January 2,2017. The corporation’s financial statements for
its first year’s operations were not examined by a CPA. You have been engaged to audit the
financial statements for the year ended December 31, 2018, and your audit is substantially
completed. The corporation’s trial balance appears below.

Acadia Corp.
TRIAL BALANCE
December 31, 2018

Debit Credit
Cash P300,000
Accounts Receivable 1.460,000
Allowance for doubtful accounts P29,200
Inventories 1,004,000
Machinery and equipment 2,380,000
Accumulated depreciation 524,000
Patents 2,564,000
Leasehold improvements 600,000
Prepaid expenses 900,000
Goodwill 600,000
Licensing agreement No.1 1,200,000
 Licensing agreement No.2 1,120,000
Accounts payable 1,460,000
Unearned revenue 345,600
Share capital 6,000,000
Retained earnings, January 1,2018 3,181,200
Sales 14,400,000
Cost of goods sold 9,500,000
Selling and administrative expenses 3,722,000
Interest expense 190,000
Loss on extinguishment of debt 400,000
Totals P25,940,000 P25,940,000

The following information relates to accounts that may yet require adjustment.

1. Patents for Acadia’s manufacturing process were acquired January 2, 2018, at a cost of
P1,870,000. An additional P694,000 was spent on December 29,2018, to improve machinery
covered by the patents and charged to the Patents account. Depreciation on property, plant and
equipment has been properly recorded for 2018. Acadia uses the straight-line method for all
depreciation and amortization and the legal life on its patents.

2. On January 3, 2017, Acadia purchased Licensing Agreement No. 1, which was believed to have
an indefinite useful life. The balance in the Licensing Agreement no.1 account includes it’s
purchased price of P1,140,000 and expenses of P60,000 related to the acquisition. On January 1,
2018, Acadia purchases Licensing Agreement no.2, which has a life expectancy of 10 years. The
balance in the Licensing Agreement No.2 account included its P1,080,000 purchase price and
P120,000 in acquisition expenses, but it has been reduced by a credit of P80,000 for the advance
collection of 2019 revenue from the agreement.
In late December 2017, an explosion caused a permanent reduction in the expected revenue-
producing value of Licensing Agreement No.1 and in January 2019, a flood caused additional
damage that rendered the agreement worthless. The recoverable amount of Licensing Agreement
No.1 was determined to be P480,000 at December 31,2017.

3. The balance in the Goodwill account represents amount paid on December 30,2017, for a four
year advertising program, estimated to assist in increasing Acadia’s sales.

4. The Leasehold Improvements account includes (a) the P300,000 cost of improvements with a
total estimated useful life of 12 years, which Acadia as tenant made to leased premises in January
2017, and movable assembly line equipment costing P300,000that was installed in the leased
premises in December 2018, Acadia paid its rent in full during 2018. A 10-year non-renewable
lease was signed January 3, 2017, for the leased building that Acadia used in Manufacturing
operations.

Prepare the adjusting journal entries that should be made on December 31,2018. Use a separate
account for the accumulation of each type of amortization.
 SOLUTION 6-16

Acadia Corp
ADJUSTING JOURNAL ENTRIES
December 31, 2018
1. Machinery 694,000
Patents 694,000
To reclassify the cost of improving machinery to the Machinery account

2. Cost of goods sold (Patent amortization) 93,500

Accumulated amortization –Patents 93,500
To record 2018 amortization of Patent. (P1,870,000/20years)

3. Licensing agreement No.2 80,000

Unearned revenue 80,000
To recognized unearned revenue for the advance collection 2019 revenue from the
government

4. Retained earnings 720,000

Licensing agreement No.1 720,000
To record the impairment in value of Licensing Agreement No.1

Cost of Licensing Agreement No. 1 P1,200,000

Recoverable value 480,000
Impairment loss in 2017 P720,000

5. Cost of goods sold

(Licensing agreement amortization) 120,000
Accumulated amortization-
Licensing Agreement No.2 120,000
To record 2018 amortization of Licensing Agreement No.2
(P1,080,000+P120,000=P1,200,000/10=P120,000)

6. Prepaid expenses (P600,000 x ¾) 450,000

Selling and administrative expenses
(P600,000 x 1/4 ) 150,000
Goodwill 600,000
To reclassify prepaid advertising expense improperly charged to goodwill.

7. Machinery and equipment 300,000

Leasehold improvements 300,000
To reclassify cost of equipment charged to leasehold improvements.
8. Retained earnings (P300,000/10) 30,000
Cost of goods sold (P300,000/10) 30,000
Accumulated Depreciation-
Leasehold improvements 60,000
To record 2017 and 2018 depreciation on leasehold improvements.

Problem 6-17

During 2016, APEX COMPANY purchased a building site for its proposed research and
development laboratory at a cost of P1,200,000. Construction of the building was started in 2016.
The building was completed on December 31,2017, at a cost of P5,600,000 and was placed in
service on January 2, 2018. The estimated useful life of the building for depreciation purposes
was 20 years; the straight-line method of depreciation was to be employed and there was no
estimated salvage value.

Management estimates that about 50% of the projects of the research and development group
will result in long-term benefits (i.e,, at least 10 years) to the corporation. However, Apex fails to
demonstrate how such projects will generate probable future economic benefits. The remaining
projects either benefit the current period or are abandoned before completion. A summary of the
number of projects and the direct costs incurred in conjunction with the research and
development activities for 2018 appears below.

Upon recommendation of the research and development group, Apex Company acquired a patent
for manufacturing rights at a cost of P1,600,000. The patent was acquired on April 1, 2017, and
has as economic life of 10 years.

Number Salaries and Other Expenses

of projects employee Benefits (excluding building
Depreciation charges)
Completed projects with
Long-term benefits 30 P1,800,000 P1,000,000
Abandoned projects or
projects that benefit the
current period 20 P1,300,000 P300,000
Projects in process-
results indeterminate 10 P800,000 P240,000
Total 60 P3,900,000 P1,540,000
1. The total research and development expensed for 2018 should be
A. P2,920,000 C. P5,440,000
B. P5,880,000 D. P5,720,000

2. What is the amount of patent amortization for 2018?

A. P80,000 C. P120,000
B. P160,000 D. P0

3. What is the book value of the building on December 31, 2018?

A. P5,320,000 C. P5,040,000
B. P5,600,000 D. P6,460,000

4. What is the carrying value of the patent at December 31,2018?

A. P1,280,000 C. P1,600,000
B. P1,320,000 D. P0

SOLUTION 6-17
1. Salaries and employees benefits P3,900,000
Depreciation-building (P5,600,000/20years) 280,000
Other expenses 1,540,000
Total research and development expenses P5,720,000

2. Patent amortization for 2018 (P1,600,000/10years) P160,000

3. Cost of building P5,600,000

Less: Accumulated depreciation, Dec.31,2018
(P5,600,000/20 years) 280,000
Book Value, Dec.31,2018 P5,320,000

4. Cost of patent purchased April 1, 2017 P1,600,000

Less Amortization
April 1- Dec.31,2017
(1,600,000/10x9/12) P120,000
Jan.1-Dec.31,2018
(1,600,000/10) 160,000
Carrying Value, Dec. 31,2018 P1,320,000

Problem 6-18

The following information pertains to BAKER COMPANY’S Intangible assets:

1. On January 1, 2018, Baker signed an agreement to operate as a franchisee of Max & Jess Food
Chain, Inc. for an initial franchise fee of P1,500,000. Of this amount, P300,000 was paid when
the agreement was signed and the balance is payable in 4 annual payments of P300,000 each,
beginning January 1,2019. The agreement provides that the down payment is not refundable and
no future services are required of the franchisor. The present value at January 1,2018, of the 4
annual payments discounted at 14% (the implicit rate for a loan of this type) is P874,000. The
agreement also provides that 5% of the revenue from the franchise must be paid to the franchisor
annually. Baker’s revenue from the franchise for 2018 was P19,000,000.
Baker estimates the useful life of the franchise to be 10 years.

2. Baker incurred P1,300,000 of experimental and development costs in its laboratory to develop a
patent which was granted on January 2, 2018. Legal fees and other costs associated with
registration of the patent totalled P272,000. Baker estimates that the useful life of the patent will
be 8 years.

3. A trademark was purchased from Banawe Company for P640,000 on July 1, 2015. Expenditures
for successful litigation in defence of the trademark totalling P163,200 were paid on July 1,2017.
Baker estimates that the useful life of the trademark will be 20 years from the date of
acquisition.

1. What is the carrying value of the franchise at December 31, 2018?

A. P1,350,000 C. P1,056,600
B. P1.500.000 D. P1,174,000

2. What is the carrying value of the patent at December 31,2018?

A. P238,000 C. P1,375,500
B. P272,000 D. P258,400

3. What is the carrying value of the trademark on December 31, 2018?

A. P686,400 C. P544,000
B. P528,000 D, P707,200

4. The total expenses resulting from the transactions that would appear on Baker’s income
statement for the year ended December 31,2018, should be
A. P1,255,760 C. P1,133,400
B. P1,260,560 D. P183,400

SOLUTION 6-18

1. Down payment P300,000

 Present value of 4 annual payments 874,000
Total cost of franchise 1,174,000
Less: Amortization for 2018 (P1,174,000/10) 117,400
Carrying value of franchise, Dec. 31,2018 P 1,056,600

2. Cost of securing patent on Jan.2, 2018 P272,000

Less: Amortization for 2018 (P722,000/8) 34,000
Carrying value of patent, Dec. 31,2018 P238,000

3. Cost of trademark P640,000

Less: Amortization, July 1,2015-Dec31,2018
(P640,000/20 x 3 6/12) 112,000
Carrying value of trademark, Dec. 31,2018 P528,000

4. Interest Expense (P874,000 x 14%) P122,360

Amortization of franchise (P1,174,000/10) 117,400
Amortization of patent (P272,000/8) 34,000
Amortization of trademark (P640,000/20) 32,000
Franchise fee (P19,000,000 x 5% ) 950,000
Total expense P1,255,760

PROBLEM 6-19 Purchase of a Business

In line with CANDLER COMPANY’S expansion program, it has become interested in acquiring
a plant in Mindanao to handle many of production functions in that area. One prospective seller
is Sayo Na Co. whose owners have decided to sell their business if a proper settlement can be
obtained. Sayo Na Co.’s statement of financial position appears as follows:

Current assets P 4,500,000 Current liabilities P 2,400,000

Investments 1,500,000 Noncurrent liabilities 3,000,000
Property, Plant, and Ordinary shares 1,500,000
equipment (net) 12,000,000 Share premium 5,100,000
__________ Retained earnings 16,000,000
Total assets P 18,000,000 Total equities P 18,000,000

Candler has hired Kilatis Appraisal Company to determine the proper price to pay for Sayo Na
Co. The appraisal company finds that the investments have a fair value of P4,500,000 and the
inventory is understated by P2,400,000. All other assets and equities are properly stated.

An examination of the company's income for the last 4 years indicates that the net income has
steadily increased. In 2018, the company had a net operating income of P3,000,000, which is
expected to increase 20% each year over the next 4 years. Candler believes that a normal return
in this type of business is 18% on net assets. The asset investment in the Mindanao plant is
expected to stay the same for the next 4 years.
 According to Kilatis Appraisal Company, the fair value of Sayo Na Co. can be estimated in many
different ways. Calculate an estimate of the value of Sayo Na Co., assuming that any goodwill
will be computed as:

1. The capitalization of the average excess earnings of Sayo Na Co. at 18%.

A. P44,840,000 C. P18,286,416
B. P36,000,000 D. P26,840,000

2. The purchase of average excess earnings years over the next four years.
A. P24,364,800 C. P30,960,000
B. P19,591,200 D. P22,831,200

3. The capitalization of average excess earnings of Sayo Na Co. at 24%.

A. P31,500,000 C. P18,381,888
B. P24,630,000 D. P98,520,000

4. The present value of the average excess earnings over the next four years discounted at 15%.
(The present value of an ordinary annuity of 1 at 15% for 4 periods is 2.85498.)
A. P31,792,979 C. P22,542,844
B. P55,932,484 D. P27,250,135

5. If Candler were to pay P23,100,000 to purchase the assets and assume the liabilities of Sayo Na
Co., how much would be charged to goodwill?
A. P8,840,000 C. P 0
B. P6,364,800 D. P5,100,000

SOLUTION 6-19

Current assets (P4,500,00 + P2,400,00) P 6,900,000

Investments 4,500,000
Property, plant, and equipment (net) 12,000,000
Current liabilities (2,400,000)
Noncurrent liabilities (3,000,000)
Net assets at fair value P18,000,000

Normal earnings (P18,000,000 x 18%) P3,240,000

Projected net income:

2019 P
3,600,000
2020 4,320,000
2021 5,184,000
2022 6,220,800
P
19,324,800
Average earnings over the next 4 years
 (P19,324,800/4) P
4,831,200

Average excess earnings (P4,831,200 – P3,240,000) P

1,591,200

1. Goodwill (P1,591,200/18%) P 8,840,000

Fair value of net assets 18,000,000
Total P 26,840,000
Answer: D

2. Goodwill (P1,591,200 x 4) P 6,364,800

Fair value of net assets 18,000,000
Total P 24,364,800
Answer: A

3. Goodwill (P1,591,200/24%) P 6,630,000

Fair value of net assets 18,000,000
Total P 24,630,000
Answer: B

4. Goodwill (P1,591,200 x 2.85498) P 4,542,844

Fair value of net assets 18,000,000
Total P 22,542,844
Answer: C
5. Purchase price P 23,100,000
Fair value of net assets 18,000,000
Goodwill P 5,100,000
Answer: D

PROBLEM 6-20 Goodwill

You have been instructed by CANNON COMPANY, a high-flying conglomerate, to conduct a

purchase audit of XYZ Co.’s books to determine a possible purchase price for XYZ Co.'s net
assets. You find the following information:

Total identifiable assets of XYZ Co. at fair market value P

5,000,000
Liabilities 1,200,000
Average rate of return on net assets for XYZ Co.'s industry 15%
Forecasted earnings per year based on past earnings figures 700,000

Determine the purchase price on the basis of the assumptions:

1. Goodwill is equal to 3 years' excess earnings.

 A. P5,510,000 C. P3,930,000
B. P5,900,000 D. P4,190,000

2. Goodwill is equal to the present value of excess earnings discounted at 15% for 3 years. (The
present value factor of an ordinary annuity of 1 at 15% for 3 periods is 2.28323.)
A. P5,398,261 C. P4,690,460
B. P4,096,820 D. P5,101,441

3. Goodwill is equal to the capitalization of excess earnings of 15%.

A. P7,600,000 C. P4,666,667
B. P8,466,667 D. P6,400,000

SOLUTION 6-20

Total identifiable assets P

5,000,000
Less: Liabilities 1,200,000
Net assets P
3,800,000
Average rate of return on net assets x
15%
Average earnings P
570,000

Forecasted earnings P
700,000
Average earnings 570,000
Excess earnings P
130,000

1. Goodwill – 3 years' excess earnings (P130,000 x 3) P 390,000

Net assets 3,800,000
Purchase Price P 4,190,000
Answer: D

2. Goodwill (P130,000 x 2.28323) P 296,820

Net assets 3,800,000
Purchase Price P 4,096,820
Answer: B

3. Goodwill (P130,000 ÷ 15%) P 866,667

Net assets 3,800,000
Purchase Price P 4,666,667
Answer: C

PROBLEM 6-21 Goodwill

DANSKIN, INC. is considering purchasing A & B Enterprises, which has the following assets
and liabilities.

Cost Fair Market Value

Accounts receivable P 4,800,000 P 4,400,000

Inventory 4,800,000 5,000,000
Prepaid Insurance 200,000 200,000
Buildings and equipment 1,400,000 4,000,000
(net)
Accounts payable (3,200,000) (3,200,000)
Net assets P 8,000,000 P 10,400,000

If the purchase price is P12,600,000, the amount of goodwill to be charged in recording the
acquisition is

A. P4,600,000 C. P2,200,000
B. P2,400,000 D. P 0

SOLUTION 6-21

Purchase Price P
12,600,000
Fair market value of net assets 10,400,000
Goodwill P
2,200,000
Answer: C

PROBLEM 6-22 Accounting for Computer Software Cost

DAURIAN COMPANY develops software for small businesses and home computer markets.
Most of the company's computer programmers are involved in developmental work designed to
produce software that will perform fairly specific tasks in a user-friendly manner. Extensive
testing of the working model is performed before it is released to production for preparation of
masters and further testing. This careful preparation has resulted to the production of several
computer software packages that have been very successful in the marketplace.

Daurian incurred the following costs during 2016:

Salaries and wages of programmers doing research P705,000

Expenses related to projects prior to establishment of 235,200
technological feasibility
Expenses related to projects after technological feasibility
has been established but before software is available
for commercial production 148,500
Amortization of capitalized software development costs
from current and prior years 80,250
Costs to produce and prepare software for sale 168,900

Additional data for 2018:

Sales of products for the year P 1,545,000

Beginning inventory 426,000
Portion of goods available for sale sold during year 60%
Income tax rate is 30%

What is Daurian's net income for 2018?

A. P139,797 C. P215,072
B. P195,681 D. P243,746

SOLUTION 6-22

Sales P 1,545,000
Cost of goods sold:
Beginning inventory P 426,000
Software production costs (including amortization of
capitalized software costs) (P168,900 + P 80,250) 249,150
Goods available for sale 675,150
Ending inventory (P675,150 x 40%) 270,060 405,090

Gross Income 1,139,910

Expenses:
Salaries and wages of programmers P 705,000
Research-related expenses 235,200 940,200
Income before income tax 199,710
Income tax (30%) 59,913
Net Income P 139,797
Answer: A