Chapter 21 INTANGIBLE ASSETS

Related standard: PAS 38 Intangible Assets

Learning Competencies
 Define Intangible asset.
 State the initial measurement of intangible assets
that are (a) externally acquired and (b) internally
developed.
 State the subsequent measurement of intangible
assets that (a) have finite useful life and (b)
indefinite useful life.
 Account for subsequent expenditures on
intangible assets.
 Give examples of intangible assets within the
scope of PAS 38 and explain their accounting
INTERMEDIATE ACCTG 1B (by: MILLAN)

requirements.
Intangible assets
 An intangible asset is an identifiable non-monetary
asset without physical substance.

 Goodwill acquired in a business combination is outside

the scope of PAS 38 because it is unidentifiable.
Goodwill is accounted for under PFRS 3 Business
Combinations and PAS 36 Impairment of Assets.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Essential criteria in the definition of intangible
assets

1. Identifiability – separable or arises from

contractual rights
2. Control – power to obtain (or restrict
others from obtaining) the economic
benefits from an asset.
3. Future economic benefits – may include
revenue from the sale of products or
services, cost savings, or other benefits
resulting from the use of the asset by the
entity.
INTERMEDIATE ACCTG 1B (by: MILLAN)
Recognition

An intangible asset shall be recognized if

management can demonstrate that:
1. The item meets the definition of
intangible asset;
2. It is probable that the expected future
economic benefits will flow to the entity;
and
3. The cost of the asset can be measured
reliably.
INTERMEDIATE ACCTG 1B (by: MILLAN)
 Initial measurement
An intangible asset shall be measured initially at cost.
Measurement of cost depends on how the intangible asset
is acquired. Intangible assets may be acquired through:
1. Separate acquisition
2. Acquisition as part of a business combination
3. Acquisition by way of a government grant
4. Exchanges of assets
5. Internal generation

INTERMEDIATE ACCTG 1B (by: MILLAN)

Separate acquisition

The cost of a separately acquired intangible asset

comprises:
1. Its purchase price, including import duties and non-
refundable purchase taxes, after deducting trade
discounts and rebates; and
2. Any directly attributable cost of preparing the asset
for its intended use.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Acquisition as part of a business
combination
 The cost of intangible asset acquired in a business
combination is its fair value at the acquisition date.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Acquisition by way of a government
grant

Intangible assets acquired by way of

government grant may be recorded at
either:
1. fair value
2. alternatively, at nominal amount or
zero, plus direct costs incurred in
preparing the asset for its intended use

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Exchanges of assets
 If the exchange has commercial substance, the intangible asset is initially
recognized using the following order of priority:
a. Fair value of the asset Given up (Plus cash Paid or minus cash received)
b. Fair value of the asset Received
c. Carrying amount of the asset Given up (Plus cash Paid or minus cash received)

 If the exchange has lacks commercial substance, the intangible asset is

initially recognized using (c) above.

 An exchange transaction has a commercial substance if the expected future

cash flows from the asset received significantly differ from those of the
asset given up.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Internally generated intangible assets

The costs of self-creating an intangible asset are classified into:

a. Research costs – include costs of searching new knowledge and
identifying and selecting possible alternatives.
b. Development costs – include costs of designing from selected
alternative and using knowledge gained from research.

 If an entity cannot identify in which phase a cost is incurred, the cost is

regarded as incurred in research phase.

INTERMEDIATE ACCTG 1B (by: MILLAN)

R&D Costs
1. Costs incurred in research phase are expensed immediately.
2. Costs incurred in development phase are expensed immediately, unless
they meet all of the following conditions for capitalization:
(1) Technical feasibility,
(2) Intention to complete,
(3) Ability to use or sell,
(4) Probable economic benefits,
(5) Availability of adequate resources, and
(6) Measured reliably.

INTERMEDIATE ACCTG 1B (by: MILLAN)

R&D Costs (continuation)
The following are not R&D expenses but rather regular expenses.
a. Costs incurred during commercial production:
i. Trouble-shooting during commercial production
ii. Periodic or routine design changes to existing products
iii. Modification of design for a specific customer
iv. Design, construction and operation of plant that is feasible for
commercial production
v. Engineering follow through in an early phase of commercial
production
vi. Quality control during commercial production
b. Advertising and other marketing expenses
c. Training costs

(HINT: R&D expense relates to something that is still in the process of being invented.
It does notACCTG
INTERMEDIATE relate
1B (by:to periodic changes to an existing product . The following terms
MILLAN)
generally indicate that a cost is not an R&D expense: ‘commercial,’ ‘customer,’
‘advertising’ and ‘market’.)
Items of PPE used in R&D activities

 If the item of PPE can be used in various R&D activities

or other purposes, the cost of the PPE is capitalized and
depreciated. The amount of depreciation is included as
R&D expense.
 If the item of PPE is can only be used on one specific
R&D project, the cost of the PPE is expensed
immediately in its entirety as R&D expense.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Items not recognized as intangible assets
 The cost of internally generated brands, mastheads,
publishing titles, customer lists, goodwill and items
similar in substance are expensed when incurred.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Subsequent expenditure

 Subsequent expenditures on an intangible

asset are generally recognized as
expense.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Reinstatement of costs in
subsequent period

 Expenditure on an intangible item that

was initially recognized as an expense
shall not be recognized as part of the cost
of an intangible asset at a later date.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Measurement after recognition

 After initial recognition, an entity shall

choose as its accounting policy either the
a. Cost model, or
b. Revaluation model – applicable only if
the intangible
asset has an active market.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Amortization

 Intangible assets with finite useful life

are amortized over the shorter of the
asset’s useful life and legal life.
 Intangible assets with indefinite useful
life are not amortized but tested for
impairment at least annually.
 The default method of amortization is the
straight line method.

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Type of
intangible Initial cost Amortization
asset
Patent  Purchase cost + direct cost,  Over shorter of
if purchased. useful life and
 Legal and registration costs legal life of 20
only, if self-created. years.
Copyright  Purchase cost + direct cost  Over shorter of
if purchased. useful life and
 All necessary costs that legal life equal to
meet all of the conditions the creator’s life
for capitalization, if plus 50 years.
internally generated.  May be expensed
outright, if
internally
generated.
INTERMEDIATE ACCTG 1B (by: MILLAN)
 Type of
intangible Initial cost Amortization
asset
Franchise  Purchase cost + direct cost  Over finite useful
if purchased. life.
 Not amortized if
with indefinite
useful life.
Trademark  Purchase cost + direct cost  Not amortized;
if purchased. legal life is 10
 All necessary costs that years renewable
meet all of the conditions for indefinitely.
capitalization, if internally
generated.

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Type of
intangible Initial cost Amortization
asset
Computer  Purchase cost + direct cost  Over useful life.
software if purchased.
 Only costs after
technological feasibility is
established, normally
include:
i. Costs of coding and testing
after technological
feasibility,
ii. Cost of producing product
master, and
iii. Cost of installation for
internal use software
INTERMEDIATE ACCTG 1B (by: MILLAN)
 Type of
intangible Initial cost Amortization
asset
Web site cost  Purchase cost + direct cost  Over useful life
if purchased. which should be
 Only costs incurred in short.
i. Application and
Infrastructure Development
ii. Graphical Design stage, and

iii. Content Development

stages are capitalized as
intangible asset, if self-
created.

 Costs of web sites used

solely for advertisement
and promotion are
INTERMEDIATE ACCTG 1B (by: MILLAN)
expensed.
 Type of
intangible Initial cost Amortization
asset
Brands,  Recognized only if  Over useful life.
mastheads, externally generated.
customers’
list, order or  Internally generated are
production expensed immediately.
backlog and
similar items

INTERMEDIATE ACCTG 1B (by: MILLAN)

Assertions Audit Objectives Audit Procedures

I. Existence or Occurrence A. To determine that intangibles exist and are 1. Obtain an analysis of ledger accounts for
represented by contractual rights, privileges or intangibles.
earning power owned by the company. 2. Examine documentation supporting
intangibles.

II. Completeness B. To determine that all transactions related to 3. Vouch additions to or acquisitions during the
intangibles have been properly recorded. year.
4. Evaluate dispositions and write offs during
the year.

III. Rights and Obligations C. To determine that the intangibles are owned 5. In addition to audit procedure no. 2,
by the company. perform analytical procedures.

IV. Valuation or Allocation D. To determine that intangibles are stated at 6. In addition to audit procedure nos. 3 & 4,
cost less amortization. evaluate amortization policy and verify
computation of amortization.

V. Presentation E. To determine whether presentation and 7. Evaluate financial statement presentation

disclosures concerning intangibles are and disclosure for intangibles.
adequate and in accordance with PAS/PFRS.

INTERMEDIATE ACCTG 1B (by: MILLAN)

INTERMEDIATE ACCTG 1B (by: MILLAN)
INTERMEDIATE ACCTG 1B (by: MILLAN)
INTERMEDIATE ACCTG 1B (by: MILLAN)
INTERMEDIATE ACCTG 1B (by: MILLAN)
 Exercise 1

Requirement (a)
The annual depreciation for years 11 to 25 is P1,667. By the
end of the 25th year, the building would be fully depreciated.
[(50,000 – 25,000) / 15 years)

Requirement (b)
If the original lease had contained a renewal clause for an
additional 20 years, the depreciation rate would still be 5%,
which is based on the original term of the lease. The
renewal of the lease contract is not certain and therefore will
not be considered in the determination of the amortization
period.

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Exercise 2: Cartwright Corporation

Note to Instructor: For ease of discussion, the adjusting entries in the solution are
dated to correspond with the original erroneous journal entries. In actual practice, they
would be dated as of the year-end.

Jan. 1 Organization Expenses 17,500

Intangibles 17,500
To classify incorporation fees.
10 Organization Expenses 7,500
Intangibles 7,500
To classify legal fees for the
organization of the company.
5 Advertising Expense 15,000
Intangibles 15,000
To expense advertising costs.
Apr. 1 Land 15,000
Building 20,000
Intangibles 35,000
To reclassify land and buildings for R
& D activities.
May 15 Research and Development Expenses 15,000*
Intangibles 15,000
To expense materials purchased.

INTERMEDIATE ACCTG 1B (by: MILLAN)

 * Alternatively, unused materials and supplies,
if material, may be set up as prepaid
expenses.
June 30 Patent 10,000
Intangibles 10,000
To reclassify the patent.

July 1 Income Summary / Retained Earnings 12,000

Intangibles 12,000
To record operating loss.

Dec. 10 Research and Development Expenses 12,000

Intangibles 12,000
To record acquisition of equipment.

31 Research and Development Expenses 30,000

Intangibles 30,000
To expense R & D costs.

31 Research and Development Expenses 750

Accumulated Depreciation: Building 750
To record ¾ year depreciation on R &
D building (20-year life) from April 1
entry.

31 Amortization Expense 250

Patent 250
To record ½ year amortization (20-
year life) on June 30 patent.

PAS 38 prohibits capitalization of start-up expenses such as organization costs.

No amortization should therefore be recorded.

INTERMEDIATE ACCTG 1B (by: MILLAN)

Exercise 3: Bayer, Inc.

Bayer, Inc. Lead, Inc.

Net tangible assets per records, Nov. 1, 20X7 P328,500 P298,500
Add: Agreed increase in value of equipment 40,000
Net adjusted tangible assets P368,500 P298,500
Add: Value of Goodwill (Schedules 1 & 2) 74,900 12,900
Total amount to be paid for net tangible assets
and goodwill P443,400 P311,400

Supporting Computations:

Schedule 1: Goodwill of Bayer, Inc.

Average pre-tax earnings 11.1.X2 to 11.1.X7 P82,000

Less: Additional annual depreciation equipment taken over
at P40,000 in excess of book value (P40,000 / 5) 8,000
Adjusted pre-tax earnings P74,000
Less: Required earnings on net tangible assets
(15% x P368,500) 55,275
Excess annual pre-tax earnings P18,725
Goodwill (excess earnings capitalized at 25%) P74,900

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Schedule 2: Goodwill of Lead, Inc.

Average pre-tax earnings 11.1.X2 to 11.1.X7 P44,000

Less: Adjustment for effect of organization cost written off in
20X2 (P20,000 / 5) 4,000
Adjusted pre-tax earnings P48,000
Less: Required earnings on net tangible assets
(15% x P298,500) 44,775
Excess annual pre-tax earnings P 3,225
Goodwill (excess earnings capitalized at 25%) P12,900

INTERMEDIATE ACCTG 1B (by: MILLAN)

INTERMEDIATE ACCTG 1B (by: MILLAN)
 Exercise 4: Phoenix Supply Company

Requirement (a)

Allocation of the P1,375,000 cost to the individual assets in the group of assets
acquired is based on the relative fair value of the individual assets.

Appraisal Portion of Total Allocated

Asset Value Total Value Cost Cost
Patent A P 300,000 30/151.7 x P1,375,000 = P 271,920
Patent B 400,000 40/151.7 x 1,375,000 = 362,560
Equipment 197,000 19.7/151.7 x 1,375,000 = 178,560
Land 620,000 62/151.7 x 1,375,000 = 561,960
P1,517,000 P1,375,000
INTERMEDIATE ACCTG 1B (by: MILLAN)
 Journal entries for 20X5, 20X6 and 20X7, relative to intangible assets, are as
follows:

20X5
Apr. 27 Patent A 271,920
Patent B 362,560
Equipment 178,560
Land 561,960
Cash 1,375,000
To record the acquisition of assets.

Oct. 31 Amortization of Patents 42,300

Patent A (27,192 / 5 x 6/12) 27,190
Patent B (36,256 / 12 x 6/12) 15,110
To record amortization of patents
for 20X5.

20X6
Mar. 7 Legal Expenses 176,000
Cash 176,000
To record legal fees related to defense
of patents.

Mar. 7 Amortization of Patents 18,130

Patent A 18,130
To record amortization on Patent A
to date of write-off (Nov. 20X5 to
Feb. 20X6).

Mar. 7 Loss on Patent A 226,600

Patent A 226,600
To record write-off of Patent A after
unsuccessful defense.

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Oct. 31 Amortization of Patents 30,210
Patent B 30,210
To record amortization of Patent B for 20X6.

20X7

Oct. 31 Amortization of Patents 30,210

Patent B 30,210
To record amortization on Patent B for 20X7.

Computations
Amortization for 20X7:
Patent A: (P271,920 / 5 years) (6 / 12) P 27,190
Patent B: (P362,560 / 12 years) (6 / 12) 15.110
P 42,300

Amortization on Patent A, 10/31/20X5 – 3/7/20X6:

(P271,920 / 5 years) (4/12) P 18,130
Book value of Patent A to 3/7/20X6:
Cost P271,920
Amortization recognized P27,190
18,130 45,320
P226,600

Amortization for 20X6 and 20X7:

Patent B: (P362,560/12 years) P 30,210

The cost basis of patent B is P362,560 - P15,110 + P88,000 - P35,460). 20X6, a full
year’s amortization is taken by dividing the unamortized cost by the remaining
useful
INTERMEDIATE life.
ACCTG InMILLAN)
1B (by: 20X7 this is P399,990/10 ½ years or P38,090.
 Requirement (b)

The legal costs of a court defense should be charged to expense whether the suit
is won or lost because it does not meet the recognition criteria. Also, the
unsuccessful defense implies that Patent A is of no further value to the company
and leads to the write-off of the remaining unamortized cost of that patent.

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Exercise 5: Broadway Corporation

Requirement (1)

Broadway Corporation
Intangibles Section of Statement of Financial Position
December 31, 20X7

Franchise from IE Copy Service, Inc., net of

accumulated amortization of P6,870 (Schedule 1) P 61,830
Patent, net of accumulated amortization of P2,050
(Schedule 2) 14,350
Trademark, net of accumulated amortization of
P7,294 (Schedule 3) 42,706
Total intangibles P118,886

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Schedule 1:

Computation of Franchise from

IE Copy Service, Inc.

Cost of franchise at January 1, 20X7

Down payment P25,000
Present value of installments 43,700
Initial amount capitalized
P68,700
Amortization of franchise for 20X7 (P68,700  10 (6,870)
years)
Franchise balance, December 31, 20X7 P61,830

Schedule 2:
Computation of Patent

Capitalized cost of patent at January 2, 20X7 – legal

fees and other costs associated with registration P16,400
Amortization of patent for 20X7 (P16,400  8 years) (2,050)
Patent balance, December 31, 20X7 P14,350

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Schedule 3:

Computation of Trademark

Accumulated
Cost Amortization
Cost of trademark at July 1, 20X4 P40,000
Amortization through December 31, 20X7
(P40,000  20 years = P2,000 x 3 ½ years) P7,000
Balance, December 31, 20X7 P40,000 P7,000
Deduct accumulated amortization (7,000)
Trademark balance, December 31, 20X7 P33,000

Cost of successful litigation in defense of trademark should be charged to expense.

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Requirement (2)
Broadway Corporation
Expenses Resulting from Intangibles Transactions
For the Year Ended December 31, 20X7

Franchise from IE Copy Service, Inc.

Amortization of franchise (Schedule 1) P 6,870
Franchise fee on revenues from operations
(P900,000 x 5%) 45,000
Imputed interest expense on unpaid balance of
initial franchise fee (P43,700 x 14%) 6,118
P57,988
Amortization of patent (Schedule 2) 2,050
Litigation expense – Trademark 10,000
Amortization of trademark 2,000
Total expenses P72,038

INTERMEDIATE ACCTG 1B (by: MILLAN)

 Exercise 6: Español Co.

Franchises ............................................................................ 42,000

Prepaid Rent ......................................................................... 28,000
Retained Earnings (Organization Costs of P6,000 in 6,000
20X7) ..............................................................................
Retained Earnings (P16,000 – P6,000) ................................ 10,000
Patents 74,000
........................................................................................
........................................................................................
Legal fees ............................................................................. 12,650
Research and Development Expense ..................................
(P75,000 + P160,000) ........................................................ 235,000
Goodwill 278,400
Intangible Assets ................................................... 686,050

Franchise Amortization Expense (P42,000  8) ................... 5,250

Retained Earnings (P42,000  8 X 6/12) .............................. 2,625
Franchises ............................................................. 7,875

Rent Expense (P28,000  2) ................................................ 14,000

Retained Earnings (P28,000  2 X 3/12) .............................. 3,500
Prepaid Rent ......................................................... 17,500

Patent Amortization Expense ................................................ 7,400

Patents .................................................................. 7,400
(P74,000  10)

Note—No amortization of goodwill; goodwill should be tested for impairment

on at least an annual basis in future periods.

INTERMEDIATE ACCTG 1B (by: MILLAN)