DE LA SALLE LIPA

College of Business, Economics, Accountancy and Management

Accountancy Department
2nd Semester A.Y. 2012-2013
Auditing Problem
AUDIT OF INTANGIBLES

I. Research and Development Costs

Problem 1. GE Inc. developed a time machine which will be commercialized in 2012. As a new audit staff of SGV & Co.,
you are assigned to audit the research and development costs of GE in 2011. The following expenditures in 2011 were
recorded by GE Inc. in the research and development account:

Periodic design changes to existing products P1,000,000

Quality control during commercial production including routine testing 200,000
Design of tools, jigs, molds and dies involving the new time machine 100,000
Testing in search for time machine 300,000
Conceptual formulation and design of time machine 400,000
Routine design of tools, jigs, molds and dies of time machine 500,000
Engineering follow through in an early phase of commercial production 600,000
Trouble shooting breakdown during production 300,000
Laboratory research aimed at obtaining or discovering new product 200,000
Design, construction and testing of preproduction prototype and model 300,000
Searching for application of research finding and other knowledge 300,000
Design, construction and testing of the improved product 200,000
Routine on-going effort to refine or improve the quality of an existing product 100,000
Design, construction and operation of a pilot plant 200,000

Required: Based on the result of your audit, determine the following for the year ended December 31,2011:

____________1. Total Research Costs

____________2. Total Development Costs
____________3. Total Research and Development Costs
____________4. Expenses which are not Research and Development Costs

II. Internally Developed Computer Software

Problem 2. On January 1,2011, Microsoft Inc. decided to develop a new Operating System known as “Windows Infinite”.
In 2011, the software developed incurred the following costs in the process of designing, developing and producing the
new Operating System:

Salaries and wages of programmers doing research P500,000

Designing and planning the Operating System 200,000
Code Development 300,000
Testing the Operating System 400,000

On January 1,2012, the technological feasibility of the Operating System has been established. On the same
date, the company incurred P10,000,000 as the total cost of production of product master. The production of the software
started on February 1,2012 and the product was marketed on the same date. The total costs of produced and prepared
software for sale is P5,000,000. The total sales of Windows Infinite during 2012 is P8,000,000. The normal gross profit
rate of Microsoft Inc. is 40%. Microsoft estimated that the total sales revenues over the 5-year life of the product will be
P40,000,000.

Required: Based on the result of your audit, determine the following:

____________1. Total Research and Development Costs to be expensed in 2011
____________2. Amount to be capitalized as software development cost subject to amortization in 2012
____________3. Amortization of software development cost in 2012
____________4. Carrying value of software development cost on December 31, 2012
____________5. Amount of Ending Inventory on December 31,2012

DLSL CPA Board Operation – Auditing Problem

Page 1 of 3
III. Assets Classified as Intagible Assets

Problem 3. The following items are included in the Intangible Asset Account of Goodwill Inc.:

Investment in an Associate Company P1,000,000

Agricultural Land 2,000,000
Research and development costs 200,000
Initial Operating Losses 300,000
Organization costs in forming corporation 100,000
Internally generated goodwill 200,000
Cost of purchasing a trademark 300,000
Operating software of a personal computer 200,000
Long-term receivables 100,000
Cost of developing a trademark 500,000
Computer software for a computer-controlled machine that cannot operate without the software 100,000
Legal costs incurred in securing a patent 200,000
Purchase of a franchise 300,000
Lease prepayments 300,000
Engineering follow through during production 200,000
Cost of equipment obtained under a finance lease 300,000
Internally generated mastheads 200,000
Cost of purchased customer lists 400,000
Internally generated brand 300,000
Cost of purchased publishing titles 200,000
Training costs incurred in start-up operation 100,000
Goodwill from business combination 300,000
Cost of testing in search for product alternatives 500,000
Cost of developing a software before technical feasibility 100,000
Cost of purchasing a patent from an investor 200,000
Legal costs in successful defense of a patent 150,000
Legal costs in unsuccessful defense of a patent 100,000
Cost of conceptual formulation of possible product alternatives 200,000
Cost of purchasing a copyright 300,000
Infrastructure asset when the concession operator has received a right, not a license, to charge users
for the public service and the revenue receivable is not agreed upon in advance 1,000,000
Infrastructure asset when the concession operator has a guaranteed contractual right to receive
a specific amount of cash over the life of the arrangement 2,000,000

Required: What is the total amount to be recognized as intangible assets?

IV. Internally Generated Patent

Problem 4. As a newly hired assurance associate of PWC – Philippines, you are assigned to audit the Patent Account of
Sony Inc. for year ended December 31,2011. On January 1, 2010, Sony Inc. developed a new machine that reduces the
time required to mix the chemicals in one of its leading products. Because the process is considered very valuable to the
company, Sony patented the machine. The following expenses were incurred by Sony Inc. in 2010 in developing and
patenting the machine:

Research and development laboratory expenses P2,000,000

Salary of Research Engineer who work on the research, development and building of
the machine (20% of the time was spent in actually building the machine 200,000
Materials used in the construction of the machine 300,000
Blueprints used to design the machine 100,000
Legal expenses to register and obtain the patent 400,000
Expense of drawing required by Bureau of Patents to be submitted in patent application 50,000
Fees paid to Bureau of Patents to process application 60,000
Useful life of the Patent 25 years

On January 1,2011, Sony paid P500,000 in legal fees to successfully defend the paten against an infringement suit by
Toshiba Inc. In is the company’s policy to take full year depreciation in the year of acquisition.

Required: Based on the result of your audit, determine the following:

____________1. Cost of Patent
____________2. Cost of Machine
____________3. Amount that should be charged as expense in 2010
____________4. Amount that should be charged as expense in 2011 aside from amortization
____________5. Amortization on 2010
____________6. Amortization on 2011

DLSL CPA Board Operation – Auditing Problem

Page 2 of 3
____________7. Carrying value of patent on December 31,2011

V. Acquisition, Amortization and Impairment of Intangible Assets

Problem 5. Acer Inc. engaged KMPG – Philippines as its external auditor for the year ended December 31,2011. As a
newly promoted Senior Associate of the said auditing firm, the engagement partner assigned you to the year-end audit of
Acer Inc. Based on the result of risk assessment procedure, your audit team determined that the internal control of the
client is weak. As such, you have to perform an extensive substantive test of the company’s Intangible Asset transactions
during 2011. The following data are provided by the accounting department of Acer:

 On January 1,2011, Acer paid legal fees of P500,000 and stock certificate costs of P250,000 to complete the
organization of the corporation.
 On January 2,2011, Acer hired a clown to stand up in front of the corporate office for 2 weeks and hand to hand
out pamphlets and candy to create goodwill for the new enterprise. Clown cost – P20,000; Pamphlets and candy
– P30,000.
 On April 1,2011, Acer patented a newly developed process with costs as follows:
o Legal expenses to obtain a patent P200,000
o Expenses of drawing required by the Bureau of Patent 100,000
o Patent application and licensing fees 300,000
(The useful life of the patent is 30 years)
 On July 1,2011, Acer acquired a customer list from Asus Inc. by issuing 10,000 Ordinary Shares with par value of
P5. The Ordinary Share of Acer is quoted at P10 at this date.
 On October 1,2011, Acer signed an agreement to operate as franchisee of Apple Inc. for an initial franchise of
P1,000,000. Of this amount, P200,000 was paid when the agreement was signed and the balance was payable in
four annual payments of P200,000 each starting September 1,2012. The agreement provides that the down
payment is not refundable and no future services are required of the franchisor. The implicit rate for loan of this
type is 10%. The agreement also provides that 5% of the revenue from the franchise must be paid to the
franchisor annually. Acer’s revenue from the franchise for 2011 was P200,000. Acer estimated that the useful life
of the franchise to be 5 years.
 On November 1,2011, Acer acquired trademark from Toshiba Inc. for P150,000. The legal life of the trademark in
the Philippines is 10 year which are renewable for periods of ten years each.
 On December 1,2011, Acer constructed a shed for P4,000,000 to house prototypes of experimental models to be
developed in future research products.
 On December 2,2011, Acer incurred salaries for an engineer and computer programmer involved in product
development totaling P300,000.
 On December 10,2011, Acer incurred P50,000 legal fees to successfully defend its patent against a competitor.
 On December 15,2011, Acer incurred P100,000 for internally generated brand and mastheads.
 On December 20,2011, Acer purchased a subsidiary. As a result of business combination, P500,000 goodwill was
recorded by Acer.
 On December 31,2011, the following data are also provided by Acer Inc.:
Intangible Asset Fair Value less Cost to Sell Value in Use
Patent P 500,000 P 700,000
Customer List 120,000 50,000
Franchise 700,000 1,180,000
Trademark 130,000 50,000
Required: Based on the result of your audit, determine the following:
____________1. Initial Cost of Patent
____________2. Initial Cost of Customer List
____________3. Initial Cost Franchise
____________4. Trademark
____________5. Amount that shall be expensed as incurred (exclusive of amortization and contingent franchise fee)
____________6. Total Amortization in 2011
____________7. Total Impairment Loss in 2011
____________8. Carrying value of Intangible Assets in December 31,2011

DLSL CPA Board Operation – Auditing Problem

Page 3 of 3