Issues in Accounting

PART II: Corporate Accounting Concepts and Issues
Lecture 14
Intangible Assets
Instructor
Adnan Shoaib
1
Learning
Learning Objectives
Objectives
1.
Describe the characteristics of intangible assets.
2.
Identify the costs to include in the initial valuation of intangible assets.
3.
Explain the procedure for amortizing intangible assets.
4.
Describe the types of intangible assets.
5.
Explain the conceptual issues related to goodwill.
6.
Describe the accounting procedures for recording goodwill.
7.
Explain the accounting issues related to intangible asset impairments.
8.
Identify the conceptual issues related to research and development

costs.
9.
Describe the accounting for research and development and similar costs.
10.
Indicate the presentation of intangible assets and related items.
Intangible
Intangible Assets
Assets
Intangible
Asset Issues
Types of
Intangibles
Impairment of
Intangibles
Research and
Development
Costs
Characteristics
Marketingrelated
Limited-life
intangibles
Identifying
R&D
Intangible
assets
Customerrelated
Indefinite-life
intangibles
other than
goodwill
Accounting
for R&D
R&D costs
Valuation
Amortization
Artisticrelated
Contractrelated
Technologyrelated
Goodwill
3
Goodwill
Summary
Similar costs
Conceptual
questions
Presentation of
Intangibles and
Related Items
Intangible
Intangible Asset
Asset Issues
Issues
Characteristics
(1) Lack physical existence.
(2) Not financial instruments.
Normally classified as long-term asset.
Common types of intangibles:
Patents
Trademarks or trade names
Copyrights
Goodwill
Franchises or licenses
LO 1 Describe the characteristics of intangible assets.
Intangible
Intangible Asset
Asset Issues
Issues
Valuation
Purchased Intangibles:
Recorded at cost.
Includes all costs necessary to make the intangible asset

ready for its intended use.
Typical costs include:
Purchase price.
Legal fees.
Other incidental expenses.
LO 2 Identify the costs to include in the initial valuation of intangible assets.
Intangible
Intangible Asset
Asset Issues
Issues
Valuation
Internally Created Intangibles:
Generally expensed.
Only capitalize direct costs incurred in developing the

intangible, such as legal costs.
LO 2 Identify the costs to include in the initial valuation of intangible assets.
Intangible
Intangible Asset
Asset Issues
Issues
Amortization of Intangibles
Limited-Life Intangibles:
Amortize by systematic charge to expense over useful life.
Credit asset account or accumulated amortization.
Useful life should reflect the periods over which the asset
will contribute to cash flows.
Amortization should be cost less residual value.
LO 3 Explain the procedure for amortizing intangible assets.
Intangible
Intangible Asset
Asset Issues
Issues
Indefinite-Life Intangibles:
No foreseeable limit on time the asset is expected to

provide cash flows.
No amortization.
Must test indefinite-life intangibles for impairment at least

annually.
Intangible
Intangible Asset
Asset Issues
Issues
Illustration 12-1
Accounting Treatment
for Intangibles
Types
Types of
of Intangibles
Intangibles
Six Major Categories:
10
(1) Marketing-related.
(4) Contract-related.
(2) Customer-related.
(5) Technology-related.
(3) Artistic-related.
(6) Goodwill.
LO 4 Describe the types of intangible assets.
Types
Types of
of Intangibles
Intangibles
Marketing-Related Intangible Assets
Examples:
11
Trademarks or trade names, newspaper

mastheads, Internet domain names, and noncompetition agreements.
In the United States trademark or trade name has

legal protection for indefinite number of 10 year renewal
periods.
Capitalize acquisition costs.
No amortization.
Types
Types of
of Intangibles
Intangibles
Customer-Related Intangible Assets
Examples:
12
Customer lists, order or production backlogs, and both

contractual and non-contractual customer
relationships.
Capitalize acquisition costs.
Amortized to expense over useful life.
Types
Types of
of Intangibles
Intangibles
Illustration: Green Market Inc. acquires the customer list of a
large newspaper for $6,000,000 on January 1, 2012. Green
Market expects to benefit from the information evenly over a
three-year period. Record the purchase of the customer list and
the amortization of the customer list at the end of each year.
Jan. 1
Customer List
6,000,000
Cash
Dec. 31
2010
2011
2012
13
Amortization expense
Customer list
6,000,000
2,000,000
2,000,000
Types
Types of
of Intangibles
Intangibles
Artistic-Related Intangible Assets
Examples:
Plays, literary works, musical works, pictures,

photographs, and video and audiovisual material.
Copyright granted for the life of the creator plus 70 years.
Capitalize costs of acquiring and defending.
Amortized to expense over useful life.
and
14
Mickey
Mouse
LO 4
Types
Types of
of Intangibles
Intangibles
Contract-Related Intangible Assets
Examples:
15
Franchise and licensing agreements, construction

permits, broadcast rights, and service or supply
contracts.
Franchise (or license) with a limited life should be amortized

to expense over the life of the franchise.
Franchise with an indefinite life should be carried at cost

and not amortized.
LO 4
Types
Types of
of Intangibles
Intangibles
Technology-Related Intangible Assets
Examples:
16
Patented technology and trade secrets granted by the

U.S. Patent and Trademark Office.
Patent gives holder exclusive use for a period of 20 years.
Capitalize costs of purchasing a patent.
Expense any R&D costs in developing a patent.
Amortize over legal life or useful life, whichever is shorter.
Types
Types of
of Intangibles
Intangibles
Illustration: Harcott Co. incurs $180,000 in legal costs on
January 1, 2012, to successfully defend a patent. The patents
useful life is 20 years, amortized on a straight-line basis. Harcott
records the legal fees and the amortization at the end of 2012 as
follows.
Jan. 1
Patents
180,000
Cash
Dec. 31
Patents
17
180,000
9,000
9,000
Types
Types of
of Intangibles
Intangibles
Goodwill
Conceptually, represents the future economic benefits arising
from the other assets acquired in a business combination that
are not individually identified and separately recognized.
Only recorded when an entire business is purchased.
Goodwill is measured as the excess of ...
cost of the purchase over the FMV of the identifiable net
assets purchased.
Internally created goodwill should not be capitalized.
18
LO 5 Explain the conceptual issues related to goodwill.
Recording
Recording Goodwill
Goodwill
Illustration: Multi-Diversified, Inc. decides that it needs a parts
division to supplement its existing tractor distributorship. The
president of Multi-Diversified is interested in buying Tractorling
Company. The illustration presents the statement of financial
position of Tractorling Company.
Illustration 12-3
19
LO 6 Describe the accounting procedures for recording goodwill.
Recording
Recording Goodwill
Goodwill
Illustration: Multi-Diversified investigates Tractorlings underlying
assets to determine their fair values.
Illustration 12-4
Tractorling Company decides to accept Multi-Diversifieds offer of

$400,000. What is the value of the goodwill, if any?
20
Recording
Recording Goodwill
Goodwill
Illustration: Determination of Goodwill.
Illustration 12-5
21
Recording
Recording Goodwill
Goodwill
Illustration: Multi-Diversified records this transaction as follows.
Property, Plant, and Equipment
Patents
18,000
Inventories
122,000
Receivables
35,000
Cash
25,000
Goodwill
50,000
Liabilities
Cash
22
205,000
55,000
400,000
Recording
Recording Goodwill
Goodwill
Example: Global Corporation purchased the net assets of Local
Company for $300,000 on December 31, 2012. The balance sheet of
Local Company just prior to acquisition is:
FMV of Net
Assets =
$200,000
23
Recording
Recording Goodwill
Goodwill
Company for $300,000 on December 31, 2012. The value assigned to
goodwill is determined as follows:
Book Value = $130,000

Revaluation
$70,000
Fair Value = $200,000

Goodwill
$100,000
Purchase Price = $300,000

24
Recording
Recording Goodwill
Goodwill
Company for $300,000 on December 31, 2012. The value assigned to
goodwill is determined as follows:
25
Recording
Recording Goodwill
Goodwill
Company for $300,000 on December 31, 2012. Prepare the journal entry
to record the purchase of the net assets of Local.
Journal entry recorded by Global:

Cash
15,000
Receivables
10,000
Inventory
70,000
Equipment
130,000
Goodwill
100,000
Accounts payable
Cash
26
25,000
300,000
Goodwill
Goodwill
Goodwill Write-off
Goodwill considered to have an indefinite life.
Should not be amortized.
Only adjust carrying value when goodwill is impaired.
Bargain Purchase
27
Purchase price less than the fair value of net assets

acquired.
Amount is recorded as a gain by the purchaser.

Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Impairment of Limited-Life Intangibles
Same as impairment for long-lived assets.
1. If the sum of the expected future net cash flows is less
than the carrying amount of the asset, an impairment has
occurred (recoverability test).
2. The impairment loss is the amount by which the carrying
amount of the asset exceeds the fair value of the asset
(fair value test).
The loss is reported as part of income from continuing
operations, Other expenses and losses section.
28
LO 7 Explain the accounting issues related to intangible-asset impairments.
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Presented below is information related to copyrights owned by
Botticelli Company at December 31, 2012.
The copyright has a remaining useful life of 10 years.

(a) Prepare the journal entry (if any) to record the impairment of the
asset at December 31, 2012.
(b) Prepare the journal entry to record amortization expense for 2013
related to the copyrights.
29
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Recoverability test: If the sum of the expected future net cash
flows is less than the carrying amount of the asset, an
impairment has occurred.
Asset is Impaired
30
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
(a) Prepare the journal entry (if any) to record the impairment of
the asset at December 31, 2012.
Loss on impairment
Copyrights
31
1,100,000
1,100,000
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
(b) Prepare the journal entry to record amortization expense for
2013 related to the copyrights.
320,000
Copyrights
320,000
32
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Impairment of Indefinite-Life Intangibles Other
than Goodwill
33
Should be tested for impairment at least annually.
Impairment test is a fair value test.
If the fair value of asset is less than the carrying

amount, an impairment loss is recognized for the
difference.
Recoverability test is not used.
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Illustration: Arcon Radio purchased a broadcast license for
$2,000,000. Arcon Radio has renewed the license with the FCC
twice, at a minimal cost. Because it expects cash flows to last
indefinitely, Arcon reports the license as an indefinite-life intangible
asset. Recently the FCC decided to auction these licenses to the
highest bidder instead of renewing them. Arcon Radio expects cash
flows for the remaining two years of its existing license. It performs an
impairment test and determines that the fair value of the intangible
asset is $1,500,000.
Illustration 12-7
34
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Impairment of Goodwill
Two Step Process:
Step 1: If fair value is less than the carrying amount of the
net assets (including goodwill), then perform a
second step to determine possible impairment.
Step 2: Determine the fair value of the goodwill (implied
value of goodwill) and compare to carrying amount.
35
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Presented below is net asset information related to the Mischa Division of
Santana, Inc. as of December 31, 2012 (in millions):
Management estimated its future net cash flows from the division to be
$400 million. Management has also received an offer to purchase the
division for $335 million. All identifiable assets and liabilities book and fair
value amounts are the same.
36
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Instructions
(a) Prepare the journal entry (if any) to record the impairment at December
31, 2012.
Step 1: The fair value
of the reporting unit is
below its carrying
value. Therefore, an
impairment has
occurred.
Step 2:
Loss on impairment
Goodwill
37
335
160
175
200
(25)
25,000,000
25,000,000
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Instructions
(b) At December 31, 2011, it is estimated that the divisions fair value
increased to $345 million. Prepare the journal entry (if any) to record
this increase in fair value.
38
No entry necessary.
Adjusted carrying amount of the goodwill is its new accounting

basis.
Subsequent reversal of recognized impairment losses is not

permitted under SFAS No. 142.
Impairment
Impairment of
of Intangible
Intangible Assets
Assets
Summary of Impairment Tests
Illustration 12-11
39
Research
Research and
and Development
Development Costs
Costs
Research and development (R&D) costs are not in
themselves intangible assets.
Frequently results in something that a company patents or
copyrights such as:
40
new product,
formula,
process,
composition, or
idea,
literary work.
LO 8 Identify the conceptual issues related to research and development costs.
Research
Research and
and Development
Development Costs
Costs
Companies spend considerable sums on research and
development.
Illustration 12-12
41
Research
Research and
and Development
Development Costs
Costs
Identifying R & D Activities
Illustration 12-13
Research
Research Activities
Activities
Planned
Planned search
search or
or critical
critical investigation
investigation
aimed
at
discovery
of
new
aimed at discovery of new knowledge.
knowledge.
Development
Development Activities
Activities
Translation
Translation of
of research
research findings
findings or
or other
other
knowledge
into
a
plan
or
design
for
knowledge into a plan or design for a
a
new
new product
product or
or process
process or
or for
for a
a
significant
significant improvement
improvement to
to an
an existing
existing
product
product or
or process
process whether
whether intended
intended for
for
sale
sale or
or use.
use.
42
Examples
Examples
Laboratory
Laboratory research
research aimed
aimed at
at discovery
discovery of
of
new
knowledge;
searching
for
applications
new knowledge; searching for applications of
of
new
new research
research findings.
findings.
Examples
Examples
Conceptual
Conceptual formulation
formulation and
and design
design of
of
possible
product
or
process
alternatives;
possible product or process alternatives;
construction
construction of
of prototypes
prototypes and
and
operation
operation of
of pilot
pilot plants.
plants.
Research
Research and
and Development
Development Costs
Costs
Accounting for R & D Activities
Costs Associated with R&D Activities:
43
Materials, Equipment, and Facilities.
Personnel.
Purchased Intangibles.
Contract Services.
Indirect Costs.
LO 9 Describe the accounting for research and development and similar costs.
Research
Research and
and Development
Development Costs
Costs
Costs Similar to R & D Costs
44
Start-up costs for a new operation.
Initial operating losses.
Advertising costs.
Computer software costs.
Research
Research and
and Development
Development Costs
Costs
Compute the amount to be reported as research and development
expense.
$330,000 / 5 = $66,000
Cost of equipment acquired that will have alternative
uses in future R&D projects over the next 5 years.
R&D
Expense
$330,000
$66,000
59,000
59,000
Consulting fees paid to outsiders for R&D projects
100,000
100,000
Personnel costs of persons involved in R&D projects
128,000
128,000
Indirect costs reasonably allocable to R&D projects
50,000
50,000
Materials purchased for future R&D projects
34,000
Materials consumed in R&D projects
$403,000
45
Presentations
Presentations of
of Intangibles
Intangibles and
and Related
Related Items
Items
Presentation of Intangible Assets
Balance Sheet
46
Intangible assets shown as a separate item.
Reporting is similar to the reporting of property, plant, and

equipment.
Contra accounts may not be shown for intangibles.
Companies should report as a separate item all intangible

assets other than goodwill.
LO 10 Indicate the presentation of intangible assets and related items.
Presentations
Presentations of
of Intangibles
Intangibles and
and Related
Related Items
Items
Presentation of Intangible Assets
Income Statement
47
Report amortization expense and impairment losses in

continuing operations.
Total R&D costs charged to expense must be disclosed.
Presentations
Presentations of
of Intangibles
Intangibles
Illustration 12-15
48
Presentations
Presentations of
of R&D
R&D Costs
Costs
Illustration 12-16
49
ACCOUNTING FOR COMPUTER SOFTWARE COSTS
Diversity in Practice
Companies can either
purchase computer software or
create it.
How should companies account for the costs of developing

software?
Should they expense such costs immediately, or capitalize
and amortize them in the future?
50
LO 11 Understand the accounting treatment for computer software costs.
The Professions Position

FASB ASC 985-20-05 - Major recommendations of this
pronouncement are:
1. Until a company has established technological
feasibility for a software product, it should charge to
R&D expense the costs incurred in creating the product.
2. Technological feasibility is established when the
company has completed a detailed program design or a
working model.
51
Accounting for Capitalized Software Costs

If companies are to capitalize software costs, then they must
establish a proper amortization pattern.
As a basis for amortization, one of two amounts is used:
1. the ratio of current revenues to current and anticipated
revenues (the percent-of-revenue approach), or
2. the straight-line method over the remaining useful life of the
asset (straight-line approach).
Must use whichever of those amounts is greater.

52
Illustration: AT&T has capitalized software costs of $10 million,

and current (first-year) revenues from sales of this product of $4
million. AT&T anticipates earning $16 million in additional future
revenues from this product; it estimates that the product has an
economic life of four years. Under the two approaches, the
calculations are as follows for the first years amortization:
Percent-of-revenue approach
53
Straight-line approach
Reporting Software Costs

Companies should report the following information relating to
software.
1. Unamortized software costs.
2. The total amount charged to expense and the amounts, if any,
written down to net realizable value.
54
RELEVANT FACTS
55
Like GAAP, under IFRS intangible assets (1) lack physical substance
and (2) are not financial instruments. In addition, under IFRS an
intangible asset is identifiable. To be identifiable, an intangible asset
must either be separable from the company (can be sold or
transferred) or it arises from a contractual or legal right from which
economic benefits will flow to the company. Fair value is used as the
measurement basis for intangible assets under IFRS,
As in GAAP, under IFRS the costs associated with research and

development are segregated into the two components.
Costs in the research phase are always expensed under both

IFRS and GAAP.
Under IFRS costs in the development phase are capitalized

once technological feasibility is achieved.
RELEVANT FACTS
56
IFRS permits revaluation on limited-life intangible assets.

Revaluations are not permitted for goodwill and other indefinite-life
intangible assets.
IFRS requires an impairment test at each reporting date for longlived assets and intangibles and records an impairment if the assets
carrying amount exceeds its recoverable amount. The recoverable
amount is the higher of the assets fair value less costs to sell and its
value-in-use. Value-in-use is the future cash flows to be derived from
the particular assets, discounted to present value.
End
End of
of Lecture
Lecture 14
14
57

Issues in Accounting

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Issues in Accounting

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PART II: Corporate Accounting Concepts and Issues

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

Indicate the presentation of intangible assets and related items.

Trademarks or trade names

LO 1 Describe the characteristics of intangible assets.

Includes all costs necessary to make the intangible asset

Typical costs include:

Other incidental expenses.

LO 2 Identify the costs to include in the initial valuation of intangible assets.

Only capitalize direct costs incurred in developing the

LO 2 Identify the costs to include in the initial valuation of intangible assets.

Amortize by systematic charge to expense over useful life.

Credit asset account or accumulated amortization.

Amortization should be cost less residual value.

LO 3 Explain the procedure for amortizing intangible assets.

No foreseeable limit on time the asset is expected to

Must test indefinite-life intangibles for impairment at least

LO 3 Explain the procedure for amortizing intangible assets.

LO 3 Explain the procedure for amortizing intangible assets.

LO 4 Describe the types of intangible assets.

Trademarks or trade names, newspaper

In the United States trademark or trade name has

Capitalize acquisition costs.

Customer lists, order or production backlogs, and both

Capitalize acquisition costs.

Amortized to expense over useful life.

LO 4 Describe the types of intangible assets.

LO 4 Describe the types of intangible assets.

Plays, literary works, musical works, pictures,

Copyright granted for the life of the creator plus 70 years.

Capitalize costs of acquiring and defending.

Amortized to expense over useful life.

Franchise and licensing agreements, construction

Franchise (or license) with a limited life should be amortized

Franchise with an indefinite life should be carried at cost

Patented technology and trade secrets granted by the

Patent gives holder exclusive use for a period of 20 years.

Capitalize costs of purchasing a patent.

Expense any R&D costs in developing a patent.

Amortize over legal life or useful life, whichever is shorter.

LO 4 Describe the types of intangible assets.

LO 5 Explain the conceptual issues related to goodwill.

LO 6 Describe the accounting procedures for recording goodwill.

Tractorling Company decides to accept Multi-Diversifieds offer of

LO 6 Describe the accounting procedures for recording goodwill.

LO 6 Describe the accounting procedures for recording goodwill.

LO 6 Describe the accounting procedures for recording goodwill.

LO 6 Describe the accounting procedures for recording goodwill.

Book Value = $130,000

Fair Value = $200,000

Purchase Price = $300,000

LO 6 Describe the accounting procedures for recording goodwill.

LO 6 Describe the accounting procedures for recording goodwill.

Journal entry recorded by Global:

LO 6 Describe the accounting procedures for recording goodwill.

Goodwill considered to have an indefinite life.

Should not be amortized.