Intangible Assets (Ch. 12) - ACC 332

characteristics of intangible assets

(1). *lack physical existence* - intangible assets derive their value from the rights and privileges granted to the company using them (2). *not financial instruments* - financial instruments derive their value from the right (claim) to receive cash or cash equivalents in the future and aren't intangibles - does not include: stocks, investments, accounts receivable, bank deposits - in most cases, intangible assets provide benefits over a period of years. therefore, companies *normally classify them as long-term assets*

goodwill

- *goodwill* is the excess of cost of the purchase over the fair value of the identifiable net assets (assets less liabilities) purchased - 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 - internally created goodwill should not be capitalized - in many business combinations, the purchasing company records goodwill - sometimes referred to as a *plug*, a *gap filler*, or a *master valuation* because measured as a residual rather than measured directly - "most intangible of the intangible assets" because it's identified inly with the business as a whole - only way to sell goodwill is to sell the business - only can get when we buy another company - some assets are at LCNRV (inv), HC, fair value -> come up with price of business based on this information - bought business, so record all assets and all their liabilities (net assets) -> record assets and liabilities at fair value - intangibles were recorded at direct cost but not at FMV - cash you exchange is higher than net fair value - companies don't record soft assets (goodwill shows amount over and above)

presentation of intangible assets

- FASB requires disclosure for goodwill and intangibles - the notes to the financial statements should include info about acquired intangible assets, including the aggregate amortization expense for each of the succeeding 5 years - if separate accumulated amortization accounts aren't used, accumulated amortization should be disclosed in the notes - the notes should include info about changes in the carrying amount of goodwill during the period

computer software costs

- FASB's intent was that companies exclude from the definition of R&D activities of the acquisition, development, or improvement or a product or process *for use in their selling or admin activities*

initial operating losses

- GAAP requires that operating losses during the early years *should not be capitalized* - the accounting and reporting standards should be no different for an enterprise trying to establish a new business than they are for other enterprises

identifying R&D activities

- R&D activities do not include routine or periodic alterations to existing products, production lines, manufacturing processes, and other ongoing operations, even though these alterations may represent improvements

development activities

- translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use EX: conceptual formulation and design of possible product or process alternatives; construction of prototypes and operation of pilot plants

marketing-related intangible assets

- used in the marketing or promotion of products or services - EX: *trademarks* or *trade names*, newspaper mastheads, internet domain names, and non-competition agreements -> Kleenex, Pepsi-Cola, Buick, Wheaties - in the US trademarks or trade names have legal protection for *indefinite* number of *10-year* renewal periods - capitalize acquisition costs - no amortization

common types of intangibles

-patents -copyrights -franchises or licenses -trademarks -trade names -goodwill The Coca-Cola Company's success comes from its secret formula for making Coca-Cola, not its plant facilities

types of intangible assets

1. marketing related 2. customer related 3. artistic related 4. contract related 5. technology related 6. goodwill

costs similar to R&D costs

1. start-up costs 2. initial operating losses 3. advertising costs 4. computer software costs

factors in determining useful life

1. the expected use of the asset by the company 2. the expected useful life of another asset or a group of assets to which the useful life of the intangible asset may relate 3. any legal, regulatory, or contractual provisions that may limit the useful life 4. any provisions (legal, regulatory, or contractual) that enable renewal or extension of the asset's legal or contractual life without substantial costs 5. the efforts of obsolescence, demand, competition, and other economic factors 6. the level of maintenance expenditure required to obtain the expected future CFs from the asset

accounting for R&D activities

Costs associated with R&D activities (expensed): (1) Materials, equipment, facilities -> expense the entire costs, *unless the items have alternative future uses* (2) Personnel -> expense as incurred salaries, wages, etc. (3) Purchased intangibles -> recognize and measure at FV (4) Contract services -> expense the costs of services performed by others in connection with the R&D as incurred (5) Indirect costs -> include a reasonable allocation of indirect costs in R&D costs, except for G&A cost, which must be clearly related in order to be included in R&D

impairment of limited-life intangibles

same as impairment for long-lived assets in ch. 11 (1). if the sum of the expected future net cash flows (undiscounted) 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 f 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 - a company should review for impairment at certain points - whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable - in performing the *recoverability test*, the company estimates the future CFs expected from use of the asset and its eventual disposal - *impairment test* measures the impairment loss by comparing the asset's fair value with its carrying amount - may not recognize restoration of the previously recognized impairment loss

valuation: internally created intangibles

- recorded at cost - generally expensed - only capitalize direct costs incurred in developing the intangible, such as legal costs, and expense the rest - why? costs incurred bear no relationship to their real value, difficult to associate costs, underlying subjectively - purchase price and direct -> capitalized ->amortized with straight-line - cannot internally create goodwill -> only way is through buying another business

trademark or trade name

- a word, phrase, or symbol that distinguishes or identifies a particular company or product - the right to use a trademark or trade name, whether registered or not, rests exclusively with the original user as long as the original user continues to use it - if a company buys a trademark or trade name, it capitalizes the purchase price as the cost of the asset - if a company develops a trademark or trade name, it capitalizes costs related to securing it, such as attorney fees, registration fees, design costs, consulting fees, and successful legal defenses costs. However, it excludes R&D costs - when the total cost of a trademark or trade name is insignificant, a company simply expenses it - the value of a marketing-related intangible can be substantial (i.e., internet domain)

amortization of intangibles: limited-life intangibles

- amortize to expense over useful life - credit asset account or accumulated depreciation - useful life should reflect the periods over which the asset will contribute to cash flows - amortization should be cost less residual value - companies should evaluate the limited-life intangibles for impairment (only when certain circumstances and think will have impairment) - the useful life should reflect the periods over which these assets will contribute to CFs - the amount of amortization expense for a limited-life intangible asset should reflect the pattern in which the company consumes or uses up the asset if the company can reliably determine that pattern - the residual value is assumed to be zero unless at the end of its useful life the intangible asset has value to another company - limited life = *amortize over lesser of useful life or legal life* - may be able to sell it (some) -> residual value - can include additional costs (include if successful)

presentation of research and development costs

- companies should disclose in the the financial statements the total R&D costs charged to expense each period for which they present an income statement

advertising costs

- for the most part, expense advertising costs as incurred or the first time advertising takes place

goodwill write-off

- goodwill considered to have an *indefinite life* (straight to the fair value test) - should *not* be amortized - only adjust carrying value when goodwill is impaired -> impacts I/S -> because investors want to know amount invested in goodwill - nonamortization of goodwill combined with an adequate impairment test should provide the most useful financial information to the investment community

recording goodwill: purchased goodwill

- goodwill is recorded only when a entire business is purchased - goodwill is the residual - the excess of cost over fair value of the identifiable net assets acquired - to record goodwill, a company compares the fair value of the net tangible and identifiable intangible assets with the purchase price of the acquired business - in many cases, the values of long-term assets such as PPE and intangibles may have increased substantially over the years. This difference could be due to inaccurate estimates of useful lives, continual expensing of small expenditures, inaccurate estimates of residual values, and the discovery of some unrecorded assets - would pay more as a premium on the future earning power of these attributes as well as on the basis asset structure of the company today - the procedure for valuation is called a *master valuation approach*. it assumes goodwill covers all the values that cannot be specifically identified with any identifiable tangible or intangible asset - *goodwill = excess cost - FV of net assets acquired*

impairment of intangible assets

- in some cases, the carrying amount of a long-lived (PPE or intangible) is not recovered. Therefore, a company needs to record a write-off (impairment)

start-up costs

- incurred for one-time activities required to start a new operation - EX: opening a new plant, introducing a new product/service, new territory - include *organizational costs*, such as legal state fees incurred to organize a new business entity - expense start-up costs as incurred

artistic-related intangible asset

- involve ownership rights to plays, literary works, musical works, pictures, photographs, and video/audiovisual materials - copyrights protect these ownership rights - a *copyright* is a federally granted right that all authors, painters, musicians, sculptors, and other artists have in their creations and expressions - it gives the owner or heirs the exclusive right to reproduce and sell an artistic or published work - *copyright* granted for the life of the creator plus 70 years (limited; not renewable) - capitalizes costs of acquiring and defending a copyright - amortized to expense over the useful life of the copyright if less than is legal life (creator + 70) - copyrights are not renewable and can be valuable - companies must expense the R&D costs that lead to a copyright as those costs are incurred - exception = Disney and Mickey Mouse

impairment of goodwill

- must be tests for impairment at least annually - two step process: (1). if fair value is less than the carrying amount of the reporting unit (including goodwill), then perform a second step to determine possible impairment -> a company compares the fiar value of the reporting unit to its carrying amount, including goodwill -> if FV > CV -> no impairment (2). determine the fair value of the goodwill (implied value of goodwill) and compare to carrying amount

amortization of intangibles: indefinite-life intangibles

- no foreseeable limit (indefinite) on time the asset is expected to provide cash flows - must test indefinite-life intangibles for impairment at least annually (GAAP) - no amortization (expect CFs into foreseeable future) - if no factors (legal, regulatory, contractual, competitive, or other) limit the useful life - the *impairment test* for indefinite-life intangibles differs from the one for limited-life intangibles. only the fair value test is performed for indefinite intangibles; there is no recoverability test. - Why? indefinite-list intangible assets might never fail the undiscounted CFs recoverability test because CFs could extend indefinitely into the future go straight to step 2 because sum of CF will be very big when compared to CV ex: goodwill *Global View*: - IFRS requires capitalization of some development costs

recording goodwill: internally created goodwill

- not capitalized because measuring the components of goodwill is simply too complex, and associating any costs with future benefits is too difficult - because no objective transaction with outside parties takes place, a great deal of subjectivity (even misrepresentation) may occur)

research and development costs

- not in themselves intangible assets - frequently results in something that a company *patents or copyrights* such as: - new product - process - idea - formula - composition literary work - companies *must expense* all R&D costs when incurred - two difficulties arise in accounting for R&D: (1) identifying the costs associated with particular activities, projects, or achievements; and (2) determining the magnitude of the future benefits and length of time over which such benefits may be realized

research activities

- planned search or critical investigation aimed at discover of new knowledge - EX: lab research aimed at discovery of new knowledge; searching for applications of new research findings

valuation: purchased intangibles

- recorded at cost (acquisition cost) - includes all costs necessary to make the intangible asset ready for its intended use (acquisition + expenditures) - typical costs include: -> purchase price -> legal fees -> other incidental expenses - sometimes companies acquire intangibles in exchange for stock or other assets. in such cases, *the cost of the intangible is the fair value of the consideration given or the fair value of the intangible received, whichever is more clearly evident* - if a company buys several intangibles ("basket purchase") -> allocate the cost on the basis of fair values - because they're hard to value/reliable, FASB says you can't include all R&D costs -> must be expensed - costs included: direct expenses (not R&D)

technology-related intangible assets

- relate toe innovations or technological advances - EX: patented technology and trade secrets granted by the U.S. Patent and Trademark Office - *patent* gives holder exclusive right to use, manufacture, and sell a product or process for *20 years* without interference or infringement by others - 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 - the two principal kinds of patents are *product patents*, which cover actual physical products, and *process patents*, which govern the process of making products - changing demand, new inventions superseding old ones, inadequacy, and other factors often limit the useful life of patent to less than its legal life - a company charges all unrecovered legal fees and other costs incurred in successfully defending a patent suit to patents, an asset account (amortized) - amortization expense should reflect the pattern, if reliably determined, in which a company uses up the patent - if modifications -> the effect may be to extend the life of the old patent. if the new patent provides essentially the same benefits, the company can apply the unamortized costs of the old patent to the new patent - if a patent becomes impaired because demand drops for the product, the asset should be written down or written off immediately to expense

presentation of intangible assets: income statement

- report amortization expense and impairment losses other than goodwill in continuing operations - goodwill impairment losses should be presented as a separate line item in the continuing operations section, unless goodwill impairment is associated with a discontinued operation

presentation of intangible assets: balance sheet

- reporting is similar to reporting of PPE - contra accounts are not normally shown for intangibles - companies should report as a separate item all intangible assets other than goodwill -> goodwill recorded separately

contract-related intangible assets

- represent the value of rights that arise from contractual agreements - a *franchise* is a contractual arrangement under which the franchiser grants the right to sell certain products or services, to use certain trademarks or trade names, or to perform certain functions, usually with a designated geographical area - EX: 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 of the life of the franchise - franchise with an indefinite life should be carried at *cost* and not amortized - the franchisor, having developed a unique concept or product, protects its concept or product through a patent, copyright, or trademark or trade name. the franchisee acquires the right to exploit the franchisor's idea or product by signing a franchise agreement - franchises and licenses may be for a definite period of time, indefinite period, or perpetual - franchise gives right to work to franchisor

customer-related intangible assets

- result from interactions with outside parties - EX: customer lists, order or production backlogs, and both contractual and non-contractual customer relationships - capitalize acquisition costs - amortized to expense over *useful life* - companies should assume a zero residual value unless the asset's useful life is less than the economic life and reliable evidence is available concerning the residual value

bargain purchase

- results from market imperfection; the seller would have been better off to sell the assets individually than in total EX: forced liquidation or distressed sale due to death of company founder - purchase price *less than* the fair value of net assets acquired - amount is recorded as a *gain* by the purchaser - FASB requires companies to disclose the nature of this gain transaction

impairment of indefinite-life intangibles other than goodwill

- should be tested for impairment at least annually - impairment test is a *fair value test* -> if fair value of asset is less than carrying amount, an impairment loss is recognized for the difference -> recoverability test is not used - *fair value test* compares the fair value of the intangible asset with the asset's carrying amount - companies use this one-step test because many indefinite-life assets easily meet the recoverability test

amortization

- the allocation of the cost of intangible assets in a systematic way - limited are amortized and indefinite are not amortized (like land)

which intangibles have an indefinite life?

- trademarks - trade name - goodwill - internet domain names